Email Of the Week

Traditionally email of the week is a catalogue of the idiocy of people attempting to make some headway in trading and this week was no exception with two excellent contenders. Early in the week we had some one who was trying to convince us that she was a conservative long term investor and she sought to manifest this strategy by selling puts under the S&P500. Let me know how that works out for you. Our second contender was a peanut who said and I am paraphrasing here that he was a losing trader, could not follow a trading plan and he had losses that were much larger than his wins but he did have fund managers lining up to give him vast sums of money because they liked his method. I am calling bullshit on this one.

However, our winner is actually a sensible piece whose email touches on a number of problems that traders have particularly when winning positions move against them.

I had forgotten all about this stock  before seeing this email – it falls well outside my tradable universe price range so I had to look it up and check out what was happening.

On the chart above I have dropped 52 weeks highs and volume just to get a sense of the stock. My observation is of a stock that has trended very strongly for the past year with numerous breakouts followed by dropping out of bed in the past week. In responding to the email I thought it better to break it down into pasts and respond to each of those.

I wanted to ask you have you ever had a stock get slammed and stop you out only for it to then retreat and make back all the loses of the session? This happened to me today with SRX and its left me a little stunned. 

The quick answer is yes – it is unfortunately part of the game and it is normal to be somewhat dazed by this if you have not experienced it before .Price action is to my way of thinking unpredictable and small changes in sentiment or narrative can cause interesting responses that can become self fulfilling. However when viewed over the long term you can see that the stock has doubled in a time when the local market has gone nowhere so its performance has been stellar. It should be expected that at sometime the stock will simply falter. one of the issues that we face is that when we have a stock perform so well we become conditioned to this as being normal and we anchor ourselves both to the new higher prices but more importantly to its relative performance. We expect this to become the new normal and if the stock has doubled then shy should it not double again. We have to take a step back and ponder whether this is a logical perception to have of a stock or do we fall back on basic probability and understand that this is an outlier and that outliers can snap back very quickly.

Ordinarily I wouldn’t worry about it and just take the next trade but this position was in my investment portfolio for a longer term growth play and given they are about to go into phase 3 trials in Jan 2015 for their SIRFLOX technology for treating liver cancer im tempted to buy back in if it bounces. 

The first response here is the correct response – dont worry about it whether a stock is in your long term portfolio or not the same rules apply. The definition of your portfolio does not change the perception of basic rules – if it has broken your rules then it goes. There is an interesting question here – why is there selling in a stock from weeks before going into phase three trial. (For those not familiar with the terminology of trials Phase three refers to a clinical study done with a large study population. It compares the intervention to a control group and pays particular attention to adverse outcomes from the intervention)

From my perspective this is an example of an emotional narrative taking over – the stock has been good to me so far but why has it let me down now. We become attached to people, we do not become attached to stocks since they are the ultimate disposable item. We owe them no loyalty no matter how good you think they might be. the worry here is also that confirmation bias is creeping into the decision making. The price action reasons for deserting the stock were obviously  compelling looking for reasons as to why you should act/feel differently is sign of a blind spot.

I was long and strong and got stopped out at 23.78 only for it to then bounce back from its low of 23.41 making up all its losses to close only 2.7% lower after being 11% lower during the day. Have you ever had this happen to you? What does it mean when the stock does this? Is it just some a case of some late comers helping the price recover or something else?

To be honest I dont think there is anything to read into what has happened. Markets will always behave in the way they behave. trying to find a justification or explanation may make us feel better but it doesnt detract from the reality that we are simply building a story to make ourselves feel better. The important thing is the structure and function of your rules in these situations.

The chart action looks terrible – big fat candles to the downside with increasing volume and lower lows and lower highs so my head tells me to wait but i know when this stock turns it runs hard  real quick so the temptation to buy back in is very real especially given the trials are around the corner.

You are the weakest link in the system – all of us are the weakest links in our trading systems thats why we should not be listened to. The market doesn’t care what you feel or what your perceptions are and you have no way of convincing the market of the veracity of your story/feelings. Rules matter – thoughts and feeling dont.