Please Note: Blog posts are not selected, edited or screened by Seeking Alpha editors.

Commitment and Just Letting Go

Yesterday I was in a trade that I took a loss in.

The trade may serve as a good example of when its time to walk away and how we process information.

A common (probably the most common mistake) that new traders make is commitment to a trade. A trader will give different levels of thought to entering a trade. Usually I find that the reasons to enter are way to small in relation to the risk at hand but that’s another topic. Whats important is that the trader has A REASON to be in the trade and commits capital and/or risks capital to be in a trade. That’s all fine and dandy but here is the problem that often comes up. The price action and/or the reason for being in the trade change but the trader puts on mental blinders and ignores the negatives to being in the trade and focuses on the positive reasons. Worse yet often a new trader will have ALL the reasons for being in a trade go away and then go into ‘HOPE’ mode. Even worse still is when we start changing our trading plan and ‘double up’ or as brokers like to say to the unknowing public ‘dollar cost average’. Yes this technique works and works often but that doesn’t mean you have gained an edge. In fact if your edge on average for those trades is a net negative all you have done by adding to the position is create a larger loss in the long run.

It is part of our natural makeup to want to avoid losses. This is what ‘feels right’ and this is why most traders lose. The market punishes most of the people most of the time for doing what feels right in the long run. Its actually easy to understand why so few can make so much and so many lose. The ones that are making the money understand that they need to become removed from the emotional attachment or ‘commitment’ and let the market tell them what to do. This is also one of the best parts about a market for those that understand AND can follow the rules. They get to make huge amounts of money while others struggle trying to figure out why the market appears out to ‘get them’. The market is obviously not out to get anyone and its a mental game we play with ourselves. Since most new traders don’t know the mental games and why our emotions can trick us into making the wrong decisions while in a trade they tend to lose on a very consistent basis. Learning about how our brain processes information to make decisions as well as dealing with emotion is much more important than learning the ‘ultimate setup’. No setup or trading rule in the world will allow us to make money if our emotions get in the way and we change our trading plan in the middle of a trade.

Going back to yesterday I traded a stock called HLTH. A big mistake was made with this stock (well maybe two). My first mistake was entering into the short at the point I did. HLTH had not fully qualified as a setup. As it was a very cheap stock I ‘gave it a couple of pennies’ and went ahead and shorted it. This was arguably the most important and deadly mistake. Had I used strict rules of entry I would not had shorted it. These rules where just recently modified and I knew under my old rules of a week ago I could be short at the price I actually entered into the short. (Of course whats the point of having updated rules to avoid losers if your not going to follow them ). The other mistake was once I entered in I added size very quickly. Much more quickly than usual due to it being a low price stock. This I consider a minor mistake as I do believe in raising size as profits grow and my account at the time of entry was at an all time high so that did cause my loss to be bigger I accept that as part of the price of my other trading gains being bigger as well. While the price did move against me, I was thinking that abiding by entry rules seemed to be rather easy in my other trades and why not this one?? In fact I had two other trades that day and in both cases I risked losing the trade as I would not budge in my required entry price.

So I am in this HLTH short trade and while I am not feeling that great about it I am also not worried and in fact was thinking that all the size I had on it would be a nice payday when the price did break and retraced back down. I was also not sized up to the point where I was needing to worry about how much leverage I was using.

What did happen was in the chat room I was told that there was news out on HLTH. This normally means nothing to me. I fade large moves up in stocks as the main component to my trading much like a market maker will do. So not only am I used to news being a driving force in the price of a stock but I expect that there is news. no big deal normally. This time ‘it was different’. HLTH was being bought out by a division of HLTH called WBMD for a price of .4444 of WBMD of stock. With the price of WBMD at its current price it put HLTH price at about 20-30 cents higher in value than it currently was trading for and could be expected to close the gap as time moves on. (a stock will not trade at full buyout price due to risk of deal evaporation as well as the time premium to the buyout date). I put up a spreadsheet on a monitor and entered in some WBMD prices in the cells and had it calculate the correct HLTH price and I quickly found out that I should no longer be short HLTH but rather I may want to consider being long. Even better might be to be long HLTH and short WBMD as a par trade arbitrage. Shorting WBMD was not an option on itself as it had too small of volume and in the next days I could see the volume of both stocks drying up pretty quickly.

This leads us back to the commitment and seeing a different landscape. Once I could see that the reasons for the price appreciation was not unjustified greed by an anxious crowd and actually a rational price increase I knew the reason for being in the trade was gone. While I can not say that I liked it I knew all I needed to do in this trade was to get out and get out as fast as possible while limiting my losses in the process. To do ANYTHING other would be the same as throwing darts at a board and buying/shorting whatever the dart landed on. You can NEVER grow committed to a stock and you must treat them with a total lack of emotion.

When you exit a trade with a stop loss (in this case maybe we could call it a stop reason) you may be thinking that at that moment now more than ever before the trade makes sense and that price should now go your way. But not actually getting out may feel right as it will allow you to avoid the current loss but will in the end destroy your trading capital. Its what happens in the end that matters. Our income is based on ALL the choices we make in the year as a WHOLE and if you let ANY ONE trade take you out of the game you will not get a chance to gain from the rest of the good trades that you would have otherwise been able to make.

So yesterday I took my first loss in over a month and while it was not enjoyable it was good to know that I made the right choice in getting out of the trade even if I didn’t fully make the right choice getting into the trade. The next time your looking at entering into a trade be sure that you know under what reasons you will exit at a loss, like with a stop loss or or stop reason. Having it all planned out in advance will keep you in the game and will keep your emotions in check and most importantly will keep your capital intact.

Disc:  no posistions