While we would love for everything in our life to go our way, it simply isn't possible. I sat with my good friend Patrick Lilley this weekend, and while that won't mean much to most, it means something to me.
Patrick was stuck in the -30 degree temperatures of the Great White North and the mountains of snow were piling up at the bottom of the driveway. It is safe to say, things weren't going his way. In a moment of haste or desperation or simple choice, he hopped a plane with his beautiful wife and made his way to Austin, Texas, less than 24 hours later to arrive with 65 degree temperatures awaiting them.
And then just like that, he awoke to 35 degrees and rain. I started to apologize for the weather. How crazy is that? I have no control over the weather and yet I sat apologizing for the fact that he didn't make a very good trade. But he was delighted to point out it was going to be over 40 by midday and the rain was to leave us.
So, what does this have to do with trading? Absolutely nothing? Well, maybe or maybe not. The thing is, we are going to have parts of a trade beyond our control. There are forces outside our control when it comes to trading, just like the weather. In the end, we have to be comfortable, for better or worse, with the decision we make. Who wouldn't trade Canada for Austin, Texas in the dead of winter? What I viewed as a losing trade, Patrick viewed as a measured risk and, even though the temperature did not stay above 60 degrees, it was still a more-than-60-degree improvement over the weather left behind.
We have to work with the information we have and hope for the best. No, hope isn't a strategy. But some results are a bit beyond our control and we simply must manage the risk as best as we can.
Last week, I mentioned the idea of trading 5-minute charts on gap downs. It looks easy, but sometimes we trade cold weather for 65 degrees and get 35 degrees instead. And sometimes we get gap down reversal trades that don't quite reverse. They remain quite cold, like zulily (ZU).
ZU was not greeted with a warm reception on the morning of Feb. 12. Earnings left something to be desired and the stock gapped down big. It looked perfect for a gap-down reversal trade. After the first 30 minutes, there was a nice clear bottom in place on the 5-minute, along with a bullish crossover on the stochastics. The aggressive investor could buy here and this would be the best-case buy. A more conservative investor may wait for a confirmation crossover. Those folks might also stand outside and wait for the snow to melt in Canada, eh.
Even the best entry here did not return much though. A 2% pop was about the best-case scenario. But there is a positive here and that's what being wrong offers. It still offers 35 degrees rather than -30 degrees, even if you want 65 degrees. Your clear stop on this trade was $14.45.
No one likes a loss. I hate them. My Canadian friend hates them. But they happen and here it was clear that ZU was not going to turn higher. The horizontal lines on the chart show us where we are wrong here. We're wearing shorts and it is still 35 degrees. You know what? Take the loss. Head back inside. Put on some trousers and call it a day.
There is no perfect system, but if you can look back at a loser and use it to clearly define your loss, then you have a system that is potentially a winner system. The winners using this approach from last week were significantly better than the losers, or my Canadian friend in shorts. That's exactly what we want to see in a trading approach.