Yesterday was a bit of a bloodbath. I gave back around 4 risk units of unrealised profit and closed AUD/USD and gold as the markets dropped. In the short term, I sold out pretty much at the bottom, but at the time the markets were still falling sharply and there was no justification for staying in.

I said as this trade was starting to run that one gets less practice of how to deal with large winners than with ordinary trades, because large winners are rarer. On the other hand, I have been trading for almost a year now, so I should have built up some experience. So the expectation should be that when I get into a good trend, I will not play it brilliantly, but nor will I make a complete hash of it. This is what has happened here.

First the good bits. I sold out of my long equity position because I was concerned about the growing foreclosure mess in the US — it looked like the market was starting to focus on it. It looks like I sold near a short-term top, which is good. I had two currency positions that added up to long EUR/USD: long EUR/GBP and long GBP/USD. When the latter was looking shaky, I closed it out for a small profit; yesterday, I closed out EUR/GBP because it was also part of the QE trade, albeit that it had not fallen like the other trades, and also because of the uncertainty around the UK government’s spending review today. I am happy with how I played this trade.

Now the bad bits. I was stopped out of USD/SGD having got in as the market seemed to be running. With hindsight perhaps the MAS was just catching up with reality — certainly I have been too cautious about avoiding trades where a central bank seems likely to intervene — often they don’t, or their intervention is not effective. But to some extent this trade was just unlucky — I took an entry point into a trend and it was one of the ones that didn’t work. That will happen sometimes.

In AUD/USD and gold, I was already worried that they did not behave as expected when Ben Bernanke gave a speech on Friday. BB was as positive as one could have expected about the prospects for further QE, but both markets fell. This was a major warning sign, and I should have got out. Yesterday, the Chinese unexpected raised interest rates by 25bps. With the markets already fragile after a strong run up in expectation of QE, and no longer running because of that expectation, they were very vulnerable to surprise news and fell precipitously. I nevertheless took around 3 risk units of profit out of these two trades.

The lessons that I draw from this episode are:

  • I need to be clearer about what counts as a reason for getting out of a trade.
  • I need to improve my management of trades that I allow to run for more than 2 ATR in order to avoid giving back large paper profits.
Reasons for getting out of a trade:
  1. I have made 2 risk units of profit. Only hold beyond this point if the market is running strongly.
  2. Lost conviction in the trend.
  3. Trend looks at risk/market not responding as expected to newsflow.
  4. Trade is getting crowded.
  5. Made enough profit.
In terms of trade management, it seems to me that stops should get tighter the further beyond 2 risk units of profit the trade has made. My research suggests that narrowing the stop before you have made 2 risk units damages profit potential. Stops are a blunt instrument and the extent of their interference with trading should be kept to a minimum. On the other hand, as I allow a trade to run beyond 2 risk units, the chances of a pullback increase and it makes sense to tighten the stop. I think I will tighten the stop to lock in 1 unit if I allow the position to run beyond 2 units; thereafter, I will narrow the stop every time another risk unit of profit is made on a position. This means that, in a situation like yesterday’s, I will be automatically out of the market as a big pullback begins, and will not have the unpleasant experience of losing most of my profits and selling out at the bottom.