Trading Tip #5 – Never Add to a Losing Position. Except…
Those of you who just read Trading Tip #4 – Being Able to Admit When You’re Wrong, there is a section that speaks about never adding to a losing position. While this is true almost all the time, there is one instance when I find adding to a losing position can be part of the trading strategy.
This is when there is either a blowoff top from a massive spike or a blowoff bottom from a massive sell off such as what happened tonight with the up move in Netflix and the down move in Apple.
In after-hours trading, Apple dropped $50 -9.83% due to revenues. On a move such as this, I would test the market by buying one quarter of whatever my position in Apple was going into the close. I would look at this as a new position – not a dollar cost average of the original position. By initiating a new position at this level, it will be easier to take the emotion out of the trade that your original longs are creating in your mind at this moment. The new long position can easily be followed, and if it starts going against you – the entire position, both the original long and the new ones, can be sold into the market so you can get flat and think clearly. Personally, (and this is NOT a recommendation) I believe Apple’s fundamentals are still sound and there is tremendous market growth. The company has an enormous amount of cash and I would personally be a small buyer of Apple and put it away for a long term trade.
Many traders feel the pressure that they must recapture the loss of the original trade. It is times like this that define the trader on who they are. It gives people the ability to see who is good trader simply by watching which traders loses their cool and starts trading like a maniac, trying to make up losses that seem out of reach. There are times if a traders head is just to screwed up to think clearly, getting flat and taking a few days off can be the best medicine. As someone who only trades his own money, when I have these kind of butt kicking days, I would take the advice that I would give to the traders I used to manage. Walk away, clear your head, and do not trade out of emotion. While trading is about pain and pleasure, if the pain is just too much, there are times the risk of getting back into the ring wasn’t an option. Discipline is the key to being a great trader. Without discipline, downsize risk is exponential and infinite.
If I was long Netflix or short Apple, I would use the trading technique given in Trading Tip #2 – Test and Test Often. There are very few times, after an overnight move such as this, that the market or stock continues to go in just one direction. However, one thing to keep in mind for tomorrow (writing this at 8:45pm) and I can tell you from experience, is that this is one of those nights where risk managers are being dragged into the CEO offices to find out what the clients and firms exposure on the positions for Apple and Netflix are. There may be a few more large swings while liquidation and, yes, profit-taking occur.
Moves like this have the ability to blow up professionals and average traders. The risk management profiles, even if treated within the normal parameters, cannot hold up.
Trading throughout tomorrow morning will be interesting across the board. There will be margin issues, as well as bottom pickers in Apple, and people trying to find a top in NFLX. Add that to if the market gaps open lower (at this moment it looks like it will). The weak longs who have established their positions in the past few days will bailout, and the market should slide and have a correction that many have been waiting for. While the shorts, who have been feeling excruciating pain the past few weeks, will do their best to slam this market as far as they possibly can.
The only thing I know for sure is that tomorrow could be a very interesting day.
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