I received an email from one of my remote trader trainees that I thought might raise some interesting points for discussion, so I asked him if I could answer him in this blog format. Here are his questions, and I’ll wrap up a bit at the end…
Hi Adam,
I encountered this situation today and would like to ask for your thoughts … CPX was in the SMB Radar and I was thinking that this was the setup:
- CPX is on a multi-day uptrend since the 14th.
- It broke out of the resistance.
-
And it’s now pulling back.
I was thinking, “Great, this is a good breakout play.” As I was waiting for the confirmation, I saw this …
So if the current candle breaks 33.10 and I get in, my stop would be a little below 32.90 which is roughly 0.25. I was hesitant to enter this trade because risking 0.25 seems big for me. Another reason why I was hesitant is because my P&L at that time is +16. I was thinking if the trade didn’t work out, I’d end the day being negative. So I was confused and hesitant to enter the trade. I opted to stay away but this left me wondering what’s the right thinking for this case.
Just to put things in perspective, this guy is a newer trader who has been trading live for less than 30 trading days. At this point, we encourage traders to keep their risk small and to focus on less volatile stocks, so this stock would have been a bit out of character for the other stocks this guy usually trades. In addition, his average losing trade is less than 0.09, so the risk on this trade, while not large, is also a bit more than he is used to. Let’s open this for discussion in the comments here, and I’ll do another blog post in a few days where I’ll try to summarize the discussion and share my thoughts. There is more than one right answer to the questions he is asking here, but I see the main issues as follows:
- How is the quality of the setup? (Ignore what happened after, evaluate on its own.) Is this a reproducible pattern you can trade again and again?
- Is his assessment of the risk in the trade correct?
- Was he correct in skipping the trade?
9 Comments on “Traders Ask: How to Manage the Risk”
As a breakout play, it’s horrible.
As a pullback play, looks pretty good.
That’s all I have to add.
I don’t see what his daily P+L has to do with whether or not to make the trade, and that seems inconsistent with Bella’s “One Good Trade” philosophy. In his book, he even suggested covering up the P+L with a piece of tape (if you’re old school) or removing from the screen, so as to not let that color his decision on a future trade. So I would say, no his decision to skip the trade is not correct as he let his P+L be the animating factor, and not the process.
I think the set-up is worth trading, but why didn’t he get long what was the reason for not getting long when it first broke through the 32.75 level? Are new traders taught to wait for the pull back? If so, then I think he’s in fine shape.
re: risk management, I think buying around 33.10 with a 0.25 stop offers a fine-risk reward if you believe the upside is the previous high of 33.64+ and the downside is 33/32.90.
I would have skipped.
looking at the daily: resistance broke going back to 12/10 at 32.72, so support is likely at this area
MMMhhh..one could argue that resistance is 34, but that is a tall wick, and one could conservatively argue that is a Wile E. Coyote moment ( U know, where he runs off the cliff without realizing, and then knows he’s toast-could be a fat fingered market order) so a more conservative resistance would be 33.65. His entry above .10 with a .25 stop gives him just greater than a 1:2 Risk/Reward ratio…not your standard SMB play. So, skipping the breakout would seem to be a good idea. To, the top of the wick, would be almost 1:5 which would be your standard, so that would make it acceptable, which gets to the question of how risk averse one is as a trader.
It would seem, if I read your style of play correctly, a more conservative play would be to try and get this closer to the support level indicated by the horizontal line, using, the break of support as the stop, and try to play the spread to reduce risk. (Then again, T&S reading may indicate held bids or offers that would provide entries not indicated by the chart)
Having said that, the most recent green candle, and the preceding red candle, form a bullish piercing pattern, so, without knowledge of the order flow, a break above .10 could be valid (or even somewhere on the red candle-again, don’t know the T&S), given that the red candle after the green, is within the green, the stop could even be the bottom of the green candle, with a reentry at support if T&S indicates. However, the volume on those three most recent candles doesn’t tell me much
It’s also possible, on the break of support, it could be a short down to 31.75ish(conservatively) with 31.10 a possibility. Having said that, I know nothing about this stock in regards to it’s reactions to movement in SPY IWM QQQ or DIA, which may give me another sense of where this puppy would go
I am interested learning other thought processes for this, b/c I’m also a noob. I encounter similar setups in other stocks. IMHO, I think it’s a great setup. CPX is consolidating near the highs and wedging near a daily technical area 32.75. So that’s a check for conviction. I think this is reproducible. I saw this in JNJ on 4/29 where it consolidated near the previous days high 64.20 and broke out. It then consolidated near the next daily level at 64.54. I got long on the 64.54 breakout when the seller lifted. JNJ topped out at 64.70, pulledback near 64.20, then trended higher without looking back till the close of 65.60. I made the mistake of selling too early, not keeping JNJ on my radar, and not buying again on the pullback. I should have recognized that a breakout of two technical levels is a sign of strength and plus the sector has been in play lately = Trade2hold.
For risk assessment I would have given it up to .89, and hit out if it printed lower than .89, b/c the low of the green candle on my charts is .89. Not sure if it makes a difference, but I’ve have observed stocks that print above the previous inside bar, then pullback .01 cent above the low of the candle used to define risk before trading higher.
I think he did the correct thing of skipping the trade since it was out of the risk parameters. For CPX charts, I would have been hoping for another inside candle closer to 32.89. If it didn’t materialize then I would have had to move on and try to find other NYSE stocks w/ a tighter range range on the 5min. And lately, that hasn’t been easy.
thx for pointing this out. I forgot the part mentioning that P&L was part of the trade decision. I have been taught to cover my P&L. I use my alerts window to cover it up b/c tape is kind of ghetto, ha. As Adam has said, “to see the trade without any preconceived notions.”
As said below, I do not see this as a breakout trade. More like a trend following trade (i.e. buy on the pullback).
Now for the risk assessment, I’m just not sure where the entry was so I cannot quantify it correctly but… if you assume there is some risk, you should also assume there is a reward. Where was the potential reward ? Was it 0.1 ? 0.5 ? 1 ? This has a huge impact on the decision (and, in this case, the biggest impact). It seems to me that a retest of 33.75 was probable, which makes for about 0.60 reward. That’s less than 3:1 so maybe it’s not a great trade for a beginner (unless the probability is 90% or something).
Now as for the decision itself, there are 2 things :
* “the 0.25 risk was too big for me”. Size down. “Sell to the sleeping point” as Jesse Livermore would say ;p Now as said above, you should not be looking at the risk only, take the reward into account as well.
* “P&L was XXX”. It has been said in other comments : focus on the process, not the outcome. If your trade is valid (i.e. all the signals are green) and the risk/reward is acceptable, go for it. Re-read One Good Trade ;p
Good luck with your learning curve !
I have no ideia what this stock is or where it ended up going, but my first instict would be to try to short on a re-test of 33.50ish…
I think most are missing the issue. The point was not the setup. If it was part of his trading plan then the setup is valid regardless of if you agree with it or not. The question is should he take the risk.
If the setup is part of his plan then the answer would be clear. Lower your size to handle the risk and take it. Ignore completely your PNL on the day as the market does not care about your PNL be the casino and take every trade in your tested setup.
If you are unable to lower your size to accommodate your allowed risk per trade according to your plan then skip the trade and move on to the next.