Yesterday was one of those days when the markets behave just how you expect them to.
The Dow was as close to a perfect example of my trading methods as I was likely to find. So I broke out the video camera and used it for the basis of a new video tutorial for Trading for Profit Academy members.
Naturally, I was not 100% confident that the trade would work out (in fact, it didn’t! More on that later).
But the key message was that my methods show you the right place to place a trade, and the right place to set your protective stop loss (to minimise your risk in case you are wrong).
The secret of trading
You’re going to have losing trades. That’s a fact of life. The important thing is to manage your losses when they happen.
In fact, minimising losses on your losing trades is one of the most disregarded rules of trading. I know that’s true, because I’ve read about it in my email inbox over the past few weeks.
I’ve received countless emails from traders who have been caught out by the huge volatile swings in the Dow (and other stock indexes). Many did not use a sensible stop-loss policy, and suffered the consequences.
So what is the secret of good trading? Simply this: with discipline – lose as little as possible on your losers and let your winners make your profits.
It’s so simple as to be obvious. But it’s a subtle idea, one which takes a long time to master.
For example: always place your stops so that you know in advance what your maximum loss will be. Remember, no trader on earth wins every bet, so do not expect that of yourself.
Also, never fall in love with any trade. I find generally that the stronger I believe in it, the less likely it is to work out. Isn’t that strange?
In fact, some of my best trades have been those where I had little faith and appeared unlikely to work out.
My textbook example
This was the setup in the Dow when I recorded my textbook example video yesterday, on a long-term or weekly view:
I had a superb tramline pair working with great touch points and a prior pivot point from late December (shown on the chart as a PPP). OK, that gave me a solid pair of long-term tramlines.
Next, I zoomed into the most recent rally since the beginning of February, using the hourly chart. This view revealed that an Elliott-wave pattern was developing:
Clearly, I have a valid Elliott wave count complete with a long and strong wave 3 and a momentum divergence at wave 5 (I’ve shown this as a red bar).
So, we have
• a hit on the upper long-term tramline,
• a complete Eliott wave pattern, and
• a break on the short-term tramline.
All of those combined to suggest a high-probability bet that the Dow was about to fall.
Let’s zoom in for a closer look:
How I bet on this
Putting all of this evidence together, the correct trade was to bet short (ie, that the Dow was about to fall) as close as possible to the C wave high.
I knew where to place my trade. But no matter how confident I am, I always place my stop-loss in advance to protect me in the event that I am wrong.
That is a whole subject in itself. But for our purposes, we can simply apply my 3% rule: your stop-loss should be placed in such a way that your maximum losses from this trade would be 3% of your total account.
In this case, I bet the market would fall from the 17,660 level on Thursday morning with my protective stop-loss at 17,700.
How did the trade work out?
Well, I was blown away! The market just kept on climbing past all of my Fibonacci levels and crashed through my upper tramline. It was the equivalent of a 100-to-one nag winning the Derby!
That trade was a loss. But it was allowed for beforehand. I didn’t shed any tears. I took a 3% loss, and moved on to the next trade.
And that’s all there is to it. Do your homework and find low-risk trades. When you’re right, enjoy your wins. When you’re wrong, have a plan in place so that you don’t lose much money.
It all sounds so easy, right?!