Trade Management

Risk management is a concept that is crucial to your success in the markets. Some of the best traders in the world have destroyed their funds for not respecting risk. If you haven't heard about 32 year old Brian Hunter and his stint at Amaranth Advisors, this is a story that you must look into some day soon. The 32 year old hot shot trader in natural gas failed to understand and respect risk. In the postmortem analysis, it seems not only did Hunter not understand and respect risk, but the firms risk management oversight failed badly. In the end, Hunter took a $9 billion dollar fund and reduced its assets to $4.5 billion dollars in one week!

Another aspect of the story was trade management and not understanding when to take profits off the table, or in this case perhaps more appropriately, when to reduce risk.

Finding a good trade is a precious moment for a trader; not falling in love with it and understanding that the markets are dynamic and will abruptly change from your best friend to your worst enemy in minutes is another essential ingredient to your long term success. While we all have to learn lessons the hard way sometimes, a little research into Amaranth may help you set up trade management strategies that serve you well. It's always better to learn from someone else's mistakes then your own.

Below is our trade management in silver and oil today. It's not a spectacular story, but I think revisiting today's actions may be beneficial, if for no other reason then to get you thinking about the subject.

 I created this trend channel years ago when reading about the Turtle Traders. Although initially I had a totally different reason for creating it, I've found that it has served me well in ways I didn't initially intend.  Briefly for those of you using my Trend Channel, it's important to understand what it is, it's not like envelope channels or many others available in commercial charting packages. Those channels are usually static, you set up a period and the channel stays within that period. My channel is different in that it looks at a stock's recent 10 bar volatility. What this does is establishes a baseline for how that particular stock behaves. The channel is then widened by 2 standard deviations, so in a long position, when a break of the highest point of the lower channel occurs, you know that something out of the ordinary has happened and changes in character are important to keep track of. We started the morning with a 10 minute channel in SLV like what you see above, it locked in gains and was appropriate for where SLV was. However, it wasn't wide enough to accommodate a pullback, which wasn't an issue earlier today, but was going to be an issue later.

 At 2 pm today, I posted an update and widened the channel to deal with a potential pullback. Gains were still locked in, but now we could deal with an intraday pullback. The original earlier channel would have been stopped out.  This was just my personal opinion on the stop. Shorter term traders who feel that the move wouldn't last may have stuck with the tighter channel in which case they would have been stopped out today close to the top of today's range.

 USO as you can see was showing a negative divergence indicating on this 1 min chart that a pullback was likely. Toward the close 3C turned more positive, so hopefully we'll see more upside tomorrow.

 The original early 15 min channel was appropriate this morning, we wanted to lock in gains and watch how the trade progressed. With the negative divergence it became clear that a pullback would occur and at 2 pm I widened this channel as well.

 I suggested either the above 30 min version which continued to lock in gains as USO moved higher and also allowed for a pullback, but preferred the longer 60 min channel below.

Here you can see gains were locked in, but the pullback didn't threaten the position.

The goal is to get to a daily channel, we need another day or so of upward trending price to get there.

PCLN is another example, last night because of market conditions, I tightened the stop from a daily channel to a 1 hour channel to preserve profits in the short position, which can be reestablished at higher levels.

The trade was taken out around $508 today, preserving about 10 points of profit in the trade.

Usually we don't have to do some much work in trade management, but the recent choppy environment requires that we adjust to market conditions.

 In white trending markets are much easier to manage. The volatility associated with tops makes it a bit more challenging.

 Recent chop has made it difficult for bulls and bears alike to hold trades for more then a few days.

The good news is we should see stage 4 (decline) soon which is similar to the tending characteristics of  stage 2 mark up in the white boxes.

Remember, it's easier to keep money then to make it back.