Trade expectations are the number one cause of stress in trading.
Sure, we all want every trade to be a big winner, but it’s not reality. Accepting this fact improves your trading performance immediately.
The best analogy I can think of is driving on the highway. 55 mph yesterday doesn’t mean 55 mph today. In trading terms, every bull-flag is different. Too many new traders believe a chart is a chart.
Your trade expectations must be adjusted to reflect the current probability, as well as, profit potential. The chart below is a terrific lesson in technical analysis. The trade is solid but it does not warrant holding much longer (April 7, 2015).
This chart of $BA Boeing, is a great example of adjusting, and setting trade expectations. By using more than one chart, we make better decisions. Multiple time frame analysis is a key to successful trading. Using one chart is simply bad trading.
Trade Expectations Defined for the New Trader
On the surface it sounds like probability and profit potential are the same.
Probability is defined as follows: The odds of your profit target being reached versus your stop-loss. Profit potential is defined on the amount you could earn on the trade.
Great trading combines the two. The best example of this is when deciding to add to an existing position. I have a friend who recently became a proprietary trader. One of the traders in her office is very experienced and swings a big line. She watched him trade and started to model his style.
Nothing wrong with this, he is one of the best day traders around. The problem for her was the trade expectation associated with the stocks she was trading versus his watch list. He was trading stocks with a huge average true range, she was new and trading stocks with lower volatility. (BTW smart move while you are learning)
Her problem was adjusting for follow-through. She was adding to every winning position because that is what he did. Her stocks didn’t warrant the new shares.
Because there was little expectation for a bigger move, she was adding at the far end of the average daily range. This turned great trades into a flat (no profit).
Probability was solid, profit potential was solid, her adjustments for trade expectation were incorrect.
A Lesson on Trade Adjustments from an Options Trading Mentor
Options traders are different from equity traders. They are smart.
They really think things through from start to finish.
About a year ago I had a conversation with a well-respected options trader and mentor, Seth Freudberg. The discussion centered on him teaching me the strategic decisions around managing an options trade.
Seth was explaining how a good options trade, begins with the end in mind.
The objective, is to assess and adjust, as the trade unfolds. The adjustments develop over a finite period of time. (The expiration period) The part of the strategy that fascinated me was that, adjustments were taught as a part of the process.
Options traders expect to adjust.
Very few equity trading books teach what to do after the entry. I am not talking about setting stop-loss and profit targets. I am talking about managing the trade.
The way Seth explained it to me, it was like trading blinders were removed. BTW, a sign of a good mentor, is when they can make something complicated easy to understand.
Any equity trader can learn from this. We tend to think in terms of P&L. The concept of planning for adjustment was brilliant. He planned the middle, as much as the start and finish.
Options trading has expectations, but not in the same context as a directional equity trade. We day trade or swing trade to the target, or the stop-loss, in an undefined window (Other than price). He trades in a defined window (expiration) and makes trade adjustments to achieve his goal within the window.
The lesson here for equity traders, lies in your game plan. Although we don’t have a defined time to be in an equity trade (unless your strategy is time based-such as hold the first 90 minutes) we should plan as many if/then scenarios as possible.
Set your targets, assess your trade expectations AND plan your adjustments. This will eliminate a lot of the stress and indecision from your trades.
Seth is a great guy and hard-working mentor. I would highly recommend you check out his work at optionstribe.com.