7/19/14 Anatomy of a Loss/ Miners

I took two consecutive (simultaneous, actually) losses on Friday: (i) a position in VXX went against me almost immediately, and (ii) a short on Emerging Markets (the bet was a continuation of global selloffs overnight) which landed me on the wrong side of an extraordinary squeeze.

Losses are part of trading.  One might even say it's the most important part of trading.  Yet it's a topic that's not often discussed.  Let's discuss it.

(a) The difference between a good trader and a great trader lies in the ability to handle losses.  (There are no bad traders, as the term is an oxymoron- no one who trades badly survives long enough to become a trader.)

(b) I'll start by being lazy and include two more quotes, this time from Barry Ritholtz:

Loss cutting:  Trading has this amazing historical footnote: If you study the great traders throughout history, they all share the same statement as their number one rule: CUT YOUR LOSSES! Capital preservation “keeps you in the game.” It is especially important once you understand the math: a 25% drawdown requires a 33% gain to get to break even; Down 33% means you need to rally 50% to get back to square one; As we saw in 2008-08, a -50% loss requires a +100% gain to get back to even. In sports “Defense Wins Championships.” The same goes for stock trading. Most traders need to focus more on defense.

Even Warren Buffett understand the traders credo: “The first rule of investing is don’t lose money. The second rule is don’t forget Rule No. 1.

(c) VXX.  I set a stop that made sense from the perspective of my psyche.  I stopped out at the point at which a loss would offset a gain on the same position the previous day.

(d) RYWYX.  From the same perspective, this loss was fundamentally more difficult to handle.  Being on the wrong side of a squeeze is painful enough.  Having the position 'locked up' until one of two trading windows is worse.  But I knew this going in.  Thus, my backstop (not just financial, but also emotional) was position size.  A 'very small' position enabled me to bypass the 1030 am window and give the position more time to play out.  It played out even further against me, extending a -3.19% loss at 1030 est into a -3.84% loss at 4 pm.  No worries- I had sized the position correctly.

(e) So how do I define 'handling a loss?'  I use a proactive definition.  I open a position not with a target gain, but a target stop.  Defining my loss parameters then allows me to appropriately assess and size the trade.

Miners.

Gold and miners caught bids at important support levels at Tuesday's close, then rallied hard Thursday on high volume (GDXJ or juniors in particular).  On Friday, they had every reason to give it all back, yet both majors and minors managed to retain most of Thursday's gains.  IMO, that bodes well for prices going forward.  No guarantees, of course.  Which is why I opened positions with target stops.  That said, I place odds on another leg up in miners next week.