Note
I'll be traveling and on vacation this week, so my blog articles will focus on very brief topics regarding current market themes or my own trading strategies. I'll return to my "normal" blog postings regarding market action, outlook, historical tendencies, etc. when I return on Monday, August 20th.
Friday, August 17th
At ChartCon 2018 last week, Dr. Alexander Elder pointed out the obvious - that large losses kill returns. A 20% loss on a stock requires a 25% gain on the proceeds to break even. For those needing to see the math, here it is:
$10,000 invested at a 20% loss nets to $8,000 in proceeds ($2,000 loss on $10,000 investment equals 20%)
$8,000 invested must then earn $2,000 to return to your original $10,000 position
$2,000 divided by the $8,000 investment equals 25% return.
This also doesn't consider the emotional capital that big losses take, nor the opportunity costs while holding onto a losing position.
Stop the madness. Sell losers quickly and immediately begin to enjoy better returns.
Let me give you an example of a recent trade I made in Alexion Pharmaceuticals (ALXN). It wasn't a good one. ALXN was on my Strong Earnings ChartList as it had recently reported excellent quarterly results that topped Wall Street consensus estimates as to both revenues and EPS. But you can't enter a trade feeling invincible. Always remain skeptical. Yes, you might get stopped out just before a stock makes a meteoric rise. But acting on that belief system will unfortunately result in the large losses that you simply cannot afford. Here was the chart of ALXN the day I entered the trade:
I really liked this trade. I saw a potential reversing candle that was quite similar to prior reversing candles (blue circles). I connect the recent highs during this uptrend and drew that same sloped line connecting the late-April low and it hit the August 6th low almost to the penny! I saw a couple levels of price support between 121-123 with an intraday tail below those levels that signaled to me that perhaps market makers had gone long and a major reversal was underway. Also, I didn't annotate it on the chart, but ALXN had printed a negative divergence with a lower PPO on the last price high in late-July. Recent action down to at least the 50 day SMA was to be expected. Finally, note that the RSI had fallen back into the mid-30s, where we've seen previous key reversals on ALXN. So I entered at 122.90 late in the day and set a physical intraday stop beneath 120.00. I was risking 2.90, or roughly 2.5%. Given the strong earnings report, I was looking for a rebound to test overhead price resistance at 138.00. So my profit potential was 15.10. Given my risk of 2.90 per share, ALXN provided me better than a 5 to 1 reward to risk entry. I'll take those every single time. But I won't make excuses if it doesn't work. Move below 120 and you'll be cut from my trading lineup. It's that simple. Sure enough, this trade failed as you can see below:
Now we could debate back and forth whether I should have entered ALXN on August 6th, but I was committed to it at that level. It turned out to be a bad call and my stop was triggered and I lost roughly 2.5%. But my point here is that loss is manageable. If I can set up my trades to manage my downside, then correct calls where profits of 6%, 8%, 10%, possibly more occur will more than offset those losses.
The bottom line is don't accept big losses if at all possible. They'll ruin your trading results. Once a stop triggers, forget about it. Losses happen and some of my best trades ever have been taking small losses and living to trade another day with nearly all of my capital intact.
Happy trading!
Tom
