Hi everyone,
I have another entry from Daytrader's Diary...
I've posted the article below, but if I can do a bit of shameless self-promotion, please read it via the link instead (there are some graphics which you can't get here). Also, it would be wonderful if you registered with iSpec while you're at it. End of ad...
intelligentspeculator.com
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November 6th, 1999 - What went wrong the first time?
"...gotta get it right the first time / That's the main thing / I can't afford to let it pass / You get it right the next time / that's not the same thing / Gonna have to make the first time last."
- Billy Joel
As I mentioned in my previous article I lost money in my original foray as a private trader. This was from November 15th, 1996 through to the end of April, 1997. I have the records somewhere (or maybe I burnt them, haha) but I still remember - roughly - my account's progress. I've had several years to mull over the experience, so I wanted to put down some of my thoughts on paper, before the next round starts.
Below is a graphic showing the daily history of the Nasdaq composite with my approximate profits and losses over the months. Starting account value was $100,000; net result after commission was about a $13,000 loss.
nasdaq1.gif
P/L:
Nov 15 - Dec 30,1996: -$10,000
January, 1997: +$9,000
February, 1997: +$2,000
March, 1997: -$14,000
Net: -$13,000
Most of the SOES/daytrading houses will tell you that you should expect to lose money for the first 3-6 months. I thought that I might be able to shorten this learning curve because of my previous trading & technical analysis experience. There is still, however, the factor of learning the execution software. While I made a few keyboard mistakes in the beginning, I was able to cover the positions quickly, so I can't attribute more than a few hundred dollars of losses to that.
Tangent: That reminds me of a notable "keyboard mistake" made by a trader in the same office as me. I was on "The Watcher" software, and to buy 1000 shares of a stock on SOES or from the Island you hit Shift-B, or Shift-H (the "Monster Key" - which you hit to get price priority - the good old days). Let's call this trader, "J". I guess J wanted to buy some INTC, so he pressed Shift-H. But he didn't do what he usually did, or what most people do, which would be to hold down the Shift key with one hand, and then quickly tap and release the H key with the other. No. Instead (as we later found out) J held down Shift with one hand, and then pressed and held the H key with the other! I take it that he was being "decisive." J was filled for about 8000 shares of INTC before he released the keys. INTC was trading around $100 at the time. That's a pretty big position when you have $150,000 in your account. He got whacked with a quarter million dollar margin call. INTC had rallied a bit by the time he exited everything about two minutes later, so that afternoon the clearing firm gave him a choice: cough up the quarter mill and keep the profits, or don't keep the profits but don't worry about the margin. J choose the latter. What would have happened had INTC declined instead? Scary. I hope that Broadway now has some safeguards in place to prevent someone's cat from walking over their keyboard and picking up 10,000 PHCM or something!
Back to the main topic? I've broken down my previous bad habits into a few categories, even though they overlap a lot. Addressing these problems is critical when I start to trade again:
1) Overtrading
This is a "broad" type of mistake that manifests itself in different ways. When you have a positive trade expectation, it is not so terrible, since the more you trade, the more money you make (even if it is inefficient to do so). Things are much worse if you overtrade with a negative expectation, however. Sitting in front of a direct access terminal has been likened to playing a video slot machine; the flashing lights and numbers on the screen are hypnotic and addictive. You need to keep feeding the slot machine all day. Commissions become a big issue when you overtrade. Net I lost $13,000, but over that time I paid over $30,000 in commissions (3 cents per share at the time). So perhaps my "market sense" was not so bad, but I did not exploit it in the best manner. I will be paying smaller commission charges this time. Additionally, Broadway charges by the share, so if you trade in 100 share lots, the commission is 1/10th of doing 1000 share lots. Therefore I am going to force myself to trade only 100 share lots for the first two months, during which time I will be able to work on potential overtrading problems without the experiment costing too much. Limiting myself is going to be very hard when we have such a seemingly fertile market right now (with routine 10-20 point moves in the mo-mo stocks), but I'm not trying to get rich quick - I want to learn the skills to prosper in the coming years. I will let myself buy an additional 100 shares to average up, but none of this snap buying or selling 1000 shares at a time. Incidentally, the very successful trader "D" to whom I alluded in my previous diary entry (and whom I hope to interview next week for an article) turned his initial three month losing streak around into consistent monthly profitability by trading 100 share lots in a very disciplined and aggressive manner.
2) Paying the spread too much
If you always buy the offer and sell the bid, you can give up a lot of profits in daytrading. Obviously, when you have to exit a trade in order to control risk, the best strategy is to bite the bullet and pay the spread. But when I was trading, there were many times that I would jump into 1000 shares of a big-cap Nasdaq issue, get worried for no good reason, and punch it out a minute or two later, losing 1/8 point plus commish. Dumb, dumb, dumb? Trading 100 rather than 1000 shares will take care of the skittishness problem initially. Also, the Watcher software is set up with a default market buy/sell of 1000 shares, and you can't lower that. So to do 100 shares you have to preference Selectnet to buy in or sell out, or bid/offer on Island. I think this fact will force me to be less impulsive since more than one keystroke is required to get in. So there will definitely be a "playing market maker" aspect to my trading. Since I would be ecstatic if I could get an average positive expectation of 5 cents per share, attempting to capture the spread may help me to reach this goal. I realize that just "capturing the spread" is harder than it looks, however.
3) Dependence on a few "home run" trades
I distinctively remember a few multiple point profitable trades. While in a sense I am glad to have profited, and, on the flip side, I was disciplined enough never to have a multiple point loss, I would rather go for consistency than home runs. There were many times that I entered a stock properly; it ran up a bit, and I could have sold on the offer several levels up for ó or a point profit. But the greed of looking for a big run would set in and I would hold on. The stock would settle back down and I would panic and sell out by hitting the bid. If it was trading with ¬ spread, then I would reduce my profit to 1/8 or ¬. I haven't done the math, but my instinct is that reducing the profits on a "typical" winner hurt me more, over time, than the occasional big winner helped me. Therefore, I am going to try to follow the maxim of "get out when you can, not when you have to."
4) Focussing too much on going long with momentum
Definitely from January onward, my account progress was quite correlated to the market. My biggest up days were those days that the Nasdaq was rallying. I had a real reluctance to go short (and I still do) which cost me heavily in March (anyone remember when COMS and its ilk rolled over?) In March my whole risk/reward matrix got skewed by the way I was playing. I was trying to scalp long with momentum - catch the "bottoms" on the market when I thought the declines had ended. But there were lots of fake rallies and bull traps. The state of the market in March was such that the size of my winners was reduced, while the losses were larger. Plus a bit of desperation caused some overtrading. Analyzing my mental state, I would have to say that at the end of January I was on top of the world. I would not have minded making 10 grand a month consistently. But one month does not a trader make. February I eked out a small profit. So I entered March way too confident and inflexible, whereas if I had been willing to go short I would have had a much better month. The money I had seen made on the long side had blinded me. Presently, I am still trying to work out, through paper trading, rules for shorting; I will soon be able to test those rules in the market. As many readers know, it is difficult to short into momentum. You have to catch the countertrend rallies instead. I love trading the long side, and I wish the market would go up forever. But I've been around long enough to know that some day the "irrational exuberance" will end, and I would rather exploit the situation than be a victim.
Regrets? I don't like "woulda, coulda, shoulda" whiners, but I'll be one myself for an instant. Notice what the Nasdaq did after I quit trading. It should be irrelevant to a good trader whether the market goes up or down, but still? A general principle applies: when you are trading, your account state (and mental state) is always the worst just before things turn around. But you have to keep the losses small during the dark periods so that you're still around to take advantage of the bright times. I quit trading and decided to go back to school to finish my degree, a decision that I don't regret. But part of me wishes that I had kept trading. So the next time I feel like quitting, I'll have to remember how I felt in April 1997.
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