You may be thinking: Is this guy nuts? He has taken a loss and he’s happy?
The reality of trading in the real world is that everyone takes losses. There is no such thing as a risk-free trade. That applies to buying gold, shares, houses, art, and even unmade beds (à la Emin). Losses are inevitable in life.
We must take a view on market direction when we trade – and sometimes we get it wrong. There is no shame in this.
But what separates the amateurs from the pros is that the latter can emerge from a losing trade with a minor loss, while the amateur may not be so disciplined.
The smart trading policy is to make sure your losses are as small as possible – and that is what I achieved with my Dow trade, as I will explain today.
Proof that I can trust my Fibonacci levels
I had two alternate scenarios mapped out. Either the market would decline immediately or it would push through the Fibonacci resistance and move onto at least the next 78% level.
This was my scenario number one on the hourly:
And this was my alternate scenario:
I had established a short position near the A wave high based upon my Elliott wave labels. I had a nice five waves down (new down trend) off the 14 May high and the 62% retrace of that wave down was a very common termination point for relief rallies. A short trade was a high probability one.
Because the market made a direct hit on the Fibonacci 62% level and bounced down, this was obviously an important level for the market and allowed me to enter a very close protective stop just above this level. In fact, my stop was placed only 20 pips away.
Normally, such a close stop would be guaranteed to be picked off simply by market noise alone, and would be a suicidal policy. But because I can trust my Fibonacci levels to within a few pips, this stop made a lot of sense.
In fact, the market did decline by almost 100 pips off this level to the B wave low, confirming the 62% level as a level of some resistance. But that was it for the downside and the market rallied once more to approach the 62% level again, which is where I left it on Friday.
And yesterday, the market blasted right through the 62% level – and my stop was hit.
MoneyWeek Trader is our FREE spread betting & trading email offering you the very best tips, secrets and guidance from our trading expert, John Burford, who has years of first-hand experience.
To start receiving John's emails three times a week (plus occasional promotions), enter your email address below:
Why I’m happy to take a loss
This is the picture this morning:
My protective stop at 16,585 was hit and I took my loss.
Consider what would happen if I traded without a stop. The market is trading close to the 16,700 level as I write. My entry was at 16,565 and this means a potential loss of 135 pips.
If I was trading at the minimum £1 per pip, that is a potential loss of $1,350 (roughly £800). Even if this represents 3% of my account and following my 3% rule, then my account needs to be at least £27,000 for that loss to be within the 3% rule.
So, I hope you see why I am happy taking a 20-pip loss. It allows me to retain almost all of my trading capital and I can fight another day virtually unscathed. My next trade may be a winner. Also, I do not have to be in the market all the time – a fact that many traders do not realise.
You can’t avoid losses – but you can keep them small
With the market still in rally mode, what does the bigger picture look like?
This is the daily chart:
I have drawn the upper line off the 2007 high that has been a major line of resistance for these seven years. It should be respected. Remember, the longer a line of support or resistance has been in place, the more reliable it will continue to be. And seven years is a very long time. Respect it!
There is a lovely wedge taking shape and momentum is showing a large-scale divergence with price. The buying pressure is weakening – and that means a reversal very likely lies up ahead. But where will it appear?
My final target is around my upper line and that lies in the 16,800 region. We are only 100 pips away, so the high can arrive at any time. My view is that when the final high is in place, the move down will be historic.
Because an overshoot of a resistance line indicates a buying exhaustion, it would be fitting if one appeared in the next few days. And because I suffered only a small loss on my last trade, I have plenty of ammunition left to fire at my next trade.
What is a winning attitude? Expect losses and keep them tiny. The winners will take care of themselves.
If you’re a new reader, or need a reminder about some of the methods I refer to in my trades, then do have a look at my introductory videos:• The essentials of tramline trading
• Advanced tramline trading
• An introduction to Elliott wave theory
• Advanced trading with Elliott waves
• Trading with Fibonacci levels
• Trading with 'momentum'
• Putting it all together