Trading Rules I Learned from a Losing Trade

Learning trading rules and lessons from bad trades is never fun. But sometimes learning the hard way, along with some pain, makes those important rules stick better.

Writing about this particular trade is pretty painful for me and something I’d rather not do. It was a difficult decision to make but I’ve decided that it’s worth feeling embarrassed in order to teach some important lessons that will hopefully prevent others from making the same mistakes I did. Most of all, writing this will hopefully burn these lessons into my own mind, so that I never make them again.

Here’s what the trade was and the trading rules I’ve carved into my consciousness.

The Trade

The ticker was TEAM, which is an Australian software company called Atlassian Corporation. The actual company doesn’t really matter, since the trade was completely based on technicals, although the sector the company is in — high growth software — does play a part in this story.

The market moved higher on Wed. morning Jan. 18, 2023. The high growth software names, including TEAM, were popping, giving off the (false) impression that the green light had turned on for this sector and it was time to get on board.

At around 10am, over $2 million worth of call option sweepers printed on the BlackBoxStocks platform that I use. They were deep in the money with an expiration date of 6/23. It seemed like some smart money players were placing their bets on TEAM moving higher.

The stock was pushing higher with volume as these calls came in, which could have been a result of the market maker buying stock to hedge the $2 million of calls it just sold.

Watching the stock surge higher, I decided to jump in for a short term day trade. With the sector moving higher and the huge call buying, I assumed that the odds of the stock continuing higher were squarely in my favor.

Below is a 1 minute chart of TEAM. You can see the surge higher on relatively heavy volume. I placed a market order and got filled at the high — 157.63. Ouch.

Fast forward to the end of the trade, I got stopped out at around 20 cents above the day’s low (see the white arrow).

Now that I’ve ripped the bandaid off and showed off my raw wound, let’s go through the trade and tried to learn something from it.

Trade Plan

You must have a trade plan before you enter a trade.

Your trade plan should explain your reason for entering the trade. In this case it was a combination of call flow, price rising on heavy volume and overall sector strength. As far as a I know, there was no news item that served as the catalyst for the price surge.
Your plan should also clearly delineate in what circumstances you will exit the trade, either at a profit or loss. In this trade, my stop loss could have been set below one of the moving averages. A break below the 21 (yellow), 34 (blue) or 89 (white) would have been sensible places to cut my losses. A drop below the 200 ema, which is the gray line stretching horizontally across the chart, should have removed all doubt that my thesis for taking the trade was wrong.
Whether or not your trade plan should include a profit target is a point of debate. Some traders like setting a specific target. Others, including myself, prefer to see how the chart unfolds and take profits when the chart tells you to.
You must establish the timeframe for your trade. Your timeframe will dictate what charts you should be using. I’ll expand on this in the following section.

Timeframe

If you’re trading based on technical analysis, you need to make sure that the charts you’re using correspond to the timeframe in your trade plan. If you’re scalping or trading very short term, you’ll want to use the 1min, 5min and 15min, while still being aware of longer term trends and support resistance levels based on longer term charts. For longer term trading, you need to focus on the longer term charts and not get shaken out by short term price moves.

I got into the TEAM trade based on call flow going out to June, 2023, which means that I should have been focusing on a daily and weekly chart. Instead, used the 1 minute chart. Now that would be ok, if I changed my trading plan from the outset, from swing to a scalp, in which case I should have stopped on the cross below the 89 or 200 on the 1 min. Instead, I held on to my swing plan, but then got shaken out when I saw the price dropping, until I finally got taken out at the worst possible price.

Had I stayed will my original long term thesis that I had based on the longer term flow, I should have held the position. Whether that would have been the right move to make is an unknown, because no one knows what the future will bring. But the goal here is to follow a plan, and I failed to do that.

FOMO – Don’t Chase

The “fear of missing out” is one of the worst enemies of a trader. It makes you get into positions that have already made a significant move (in either direction), because you don’t want to miss out on getting in on the momentum. That’s not to say that just because something has run it can’t continue even more in the same direction.

But in most cases, stocks don’t just go up in a straight line. At some point, demand will cool down or dry up completely and sellers and profit takers will take control, causing the price to pull back. If you believe that the stock will continue to go higher, then you’ll want to wait for that pullback to buy.

Volume is a good way to judge the strength and sustainability of a move. In my TEAM trade, you can see that the volume at the top dropped off, although it still was relatively greater than average. The drop in volume and the fact that the stock had already run over 4 points should have made me pause and wait to see if a pullback was coming. Instead, FOMO got the best of me and I entered into the chase, only to be left holding onto the the hot potato when everyone else was dropping theirs.

Uncertainty – Risk Management

The truth is that you can never know what the market will do in the next second. All you can do is take educated guesses based on probabilities, which you determine using whatever type of analysis or information you’ve chosen to use.

Even with the probabilities stacked in your favor, the market can still go in the opposite direction. The way to mitigate that unfortunate occurrence is by employing risk management.

Risk management in trading can include position sizing, hedging, stop losses and profit targets. In my TEAM trade, I failed to stop out of my losing position at several points that would have been logical exit opportunities. But I did take a relatively small position size, which made my total loss on the trade tolerable.

Losing money is never fun, but it is an integral part of trading. The greatest traders in the world don’t win 100% of the time. Everyone loses. The trick is to manage your risk so that no loss takes you out of the game or makes it impossible to recover from.

Even though my TEAM trade was a bad one and the I felt the pain of losing money, because my position size was small, I could take the loss and move on without suffering any permanent damage to my account.

Position sizing is your arguably your most powerful risk management tool in that it is totally in your control. Only you can decide how many shares or contracts you’ll trade. If you are unsure about the trade, you can minimize your risk my simply sizing down from your normal risk amount. You can also size up if you believe the stars have all lined up in your favor.

In the TEAM trade, I knew I was getting into a risky position so I sized down — although in hindsight, I probably should have sized down even more based on the riskiness of the setup.

Bottom Line – Lessons Learned

Here’s what I learned from my losing TEAM trade:

Make a trade plan and follow it.
Determine a timeframe and base your exits on the charts appropriate to that timeframe.
Don’t let FOMO get the best of you — DON’T CHASE. The market will give you plenty of other opportunities.
Don’t be afraid to stop out and take a small loss before it turns into a big one.
Size your position accordingly, to manage your risk.

UPDATE – 2/16/23

As of this morning, TEAM was trading at just over 187. That’s over 30 points than what I bought it at on my bad trade day. Had I followed the right timeframe, that flow that I initially followed to enter the trade would have paid off nicely, as I’m sure it did to the buyer of those call positions.

Here’s today’s daily chart: