Monday, April 30, 2007

Lessons from a Stock Trading Loss

Those of you who have observed my trading over some period of time have probably seen that I have had a fairly high ratio of winning trades to losing trades, but I wonder how many of you notice that I try to emphasize that I DO HAVE LOSING TRADES. That's part of the business of being a trader. In my estimation, a great deal of knowledge can be gained from a losing trade. Last week, I'm sorry to report, I had my second worse dollar per share loss on a trade I have had since I began trading for my living. Before I bought the stock, I noted my exit plan in the event the stock turned against me. Unfortunately, the stock did turn down, but I did not exit right away. Instead, I decided to stay in the stock because I knew an earnings announcement was coming and I expected good earnings news. The stock had remained above both horizontal price support, the 200 day moving average, and another uptrend support. I intended to exit on a break below the horizontal price support and or the 200 day moving average. Earnings were announced and the net income was up 63% over the same period the prior year, earnings and revenue also were up. Great news. Guess what? The stock plummeted. It gapped down $3.79 on the open the next morning and it has continued to fall even as I write this piece. All this followed a pretty good earnings report. I did get out that day and thankfully so since it just continued to drop for the next couple of days.

What can I learn from this lousy experience? Well, I already knew I was human and, therefore, fallible, but this trade certainly reminded me that all trading involves risk. In this situation, I had bought no protective puts since the stock has no options. I did not place a stop loss order, instead, I placed an alert.. The fact is a stop loss order would have done little good. When a stock gaps down as mine did, a stop loss doesn't do much good since a stop sends the order to the market as a market order once the price is hit or passed. Obviously, the gap would take it through any stop I would have placed.

I learned that my more common practice of getting out of a position before earnings are announced generally is a good practice. Here, the earnings announced were good or even great yet my stock tanked. In the future, it will be the rare case where I hold onto a stock through the earnings announcement. Notice how often stocks drop right after an announcement? If bullish, I think I'm better off not being there at the time of the announcement. Naturally, I will miss a few big jumps, but better isn't that better than taking a large loss.

I learned that I'm glad I stick to my money management plan because my risk is always limited and even when I take a big dollar per share loss I am still ok overall. That's why I have a money management plan. I have also reinforced my knowledge that I want to stick with my first exit. The adage is the first loss is the best loss. I am a confirmed believer.

I've learned that a lot of subscribers quit when I have a bad trade. I guess they think all my trades are supposed to be great winners. Quite frankly, that is a very unrealistic expectation. The object of the service is to show you what I am doing so you can make your own analysis, talk to your financial advisor or broker about it and get their thoughts, assess the risk I am undertaking and build your base of knowledge. No trader, no matter how successful, is going to have winners every time. In one of my articles, I showed how a trader could make a profit through proper money management even if he lost 60% of his trades. I hate losses and most of all, I hate big losses, but I know what I am doing is risky, sometimes very risky. Successful trading requires many things: patience, money management skill, knowledge of strategies, risk awareness to name a few. It comes only with work and persistence and even then it may not come to everyone.

Those of you who subscribe have the chance to see the risks I take, how I take them, and some of the things I do when a play turns against me. It is my money that I risk in a trade that I make and undoubtedly my risk tolerance, trade size, financial status, knowledge and trading experience will be different from each of yours. When you risk your money in a trade, you need to assess each of those categories as it applies to you and your personal business plan. Again, I urge you to continue your education, paper trade before risking real dollars and establish a relationship with your broker and/or financial advisor so that you can discuss real money trades before you ever enter one.

Bill Kraft, Editor
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