Surviving A Crash

Downtown’s Rules for Surviving a Crash

• Joshua M Brown
• August 19th, 2011

Pay attention because my entire career has been spent against the backdrop of one big slow-motion crash amid the secular bear market that began in the spring of 2000 and probably won't end until later this decade.  I've had my ass kicked a million times by crashes but have gotten better at avoiding these things with each successive postmortem I've conducted.
You want to survive this crash and the next one?  Then follow Downtown Josh Brown's Rules for Surviving a Crash:

1.  Acknowledge that its a crash.  Once we're past down 10% in the Dow Jones Industrial Average from wherever the peak was (yes, the Dow is a way better crash gauge than the S&P 500), you can stop saying correction and start saying crash.  Better to be wrong in hindsight on the nomenclature.

2.  Pencils Down!  Whatever trendlines or individual stock research you were working on needs to be shelved for the moment.  Your drawings and calculations will not work here.  If you happen to buy a stock and it rips higher, it will not be because of your research, it will be because the market went up.  Correlations always get jiggy in crashes, stocks become commoditized like bushels of wheat that must be liquidated regardless of the underlying businesses.

3.  Don't listen to "stockpickers" or sell-side equity analysts.  They are only looking out from within their own little bubble and they cannot comprehend the other little bubbles around them let alone the whole bathtub.  Anyone covering specific stocks needs to know when the macro gyrations trump whatever earnings they've estimated or the conference calls they've listened to.  There'll be a time to "know your stocks" but this ain't it.

4.  Ignore the asset-gatherers and the brokerage firm strategists, their job is to calm markets and soothe investors.  Let's say Morgan Stanley runs $1 trillion in stock market wealth for investors.  And then let's say they felt there was serious trouble ahead.  Do you really think they would ever make the sell call?  Can Morgan Stanley really say "Sell 20% of your equities"?  No.  Because that would be $200 billion in supply hitting the stock market at once - they would crash it all by themselves!  Too Big To Keep It Real has always been the problem with the wirehouse advice model.

5.  Make sacrifices by reducing stock exposure by beta and volatility.  This is my iron-clad rule.  The moment you recognize the crash, kick the small caps, biotechs, emerging markets etc.  You must separate your feelings for a particular asset class, sector or individual stock and recognize that the higher the volatility, the worse they're gonna act in the short-term.  I have a prenuptial agreement with every position I put on and we get divorced cleanly in a crash situation if need be.

5a.  Also, margin balances must get cleaned up immediately, take the losses, I don't care.  Because broker-dealers and clearing firms can and will raise equity requirements right at the moment of maximum pain and force you to sell out later - and lower.  I could tell you war stories you would not believe, kids.

6.  Make two lists.  The first list everyone knows about and talks about - the "if they get cheap enough I'll buy it at that price" shopping list.  Fine, but don't forget the "things I will sell on the next bounce list".  Even the worst markets have short-term bounces in the midst of the chaos, use these bounces to get rid of the things that make you ill on the red days, even if you're taking a loss.  The stocks you bought on a flyer one day or the companies that have been disappointing or where the story has changed - sell 'em on the rips.

7.  Watch sentiment more closely than technicals or fundamentals.  Pay attention to the squishier things in a crash moreso than you would normally.  Are people screaming in pain?  Or are they still looking for a bottom?  Or have they given up entirely?  There is no math to this, a lot of it is "feel".

8.  Abandon any hope or intention of catching the bottom.  You won't and it is unnecessary.  No one will carry you out on their shoulders if you manage to do it but you will definitely get carried out on a stretcher if you get it really wrong with your own capital.  Keep in mind that time becomes more important than price...not where will it end but when?

9.  Suspend disbelief.  "Bank of America could NEVER be a $5 stock!"  "How could Bear Stearns possibly go out of business, its a hundred-year-old firm!"  "No way this stock should trade at 5 times earnings, it's a Dow component!"  "How could the market go down 5% four days in a row?"  Guys, anything can happen in a crash, there are machines making the trades and they have no respect for the prestige or standing of a particular company.  This is both gut-wrenching to behold and great for the level-headed who eventually got to buy Wells Fargo in the teens or Apple in the $100s once the bottom was in.

10.  Stop being a know-it-all and shut up.  If you are telling people a price or a support line where the selling will end, you are only kidding yourself.  Have a guess based on your discipline and research, but don't act like you're talking facts.  Fair Value is fine, but call it a guideline.  Support is also fine, but call it a historical estimate of where buyers have come in before.  The deal with crashes is that extremes are the norm, not the exception.  Things tend to overshoot through reversion to the mean trendlines or fair value estimates on their way back to stasis.

Anyway, I've been through a lot of these, and I promise you I'll find myself standing tall on the other side of this one.  Following these rules will give you a shot at doing the same.

TRADING PLAN

Objective:  

To become a consistent, confident trader by following my rules and trading plan

RULES:

PLAN THE TRADE, TRADE THE PLAN

Choose only the best setups.  $300 Loss Limit on any given trade.  Position size accordingly.  Know my risk, manage my risk, and accept my risk.  Predetermine profit taking levels based on support/resistance, Bollinger Bands, MAs, and other key levels.  There is no hesitation executing my trade wheN my entry materializes.  NEVER deviate from the plan.

STOPS

Stops are placed to protect me from my emotions.  Accept that the trade is not working, accept the risk, and exit the trade.  Stops will never be moved lower.  Stops can only be moved up.  Once my stop is breached, exit the trade, without exception.  I can always reenter the trade once the setup appears.

POSITION SIZE

Position size is based on risk.  If the trade requires a risk of $1, than my maximum position size is 300 shares (Loss limit $300/$1 risk = 300 shares).  Position sizes can never exceed my risk.

DON'T LOOK BACK

If I miss a trade, don't chase it.  The market will present another trade shortly. If my profit target is hit, be happy with my gains.  It's OK if my stop is hit, and the stock reverses in my original direction.  Move on to the next opportunity.

REVIEW MY TRADES

Review and post each trade.  Examine the setups, execution, levels.  What can I do better next time?  Did I execute my plan?  Did I deviate from my plan?  Did I control my emotions?

EQUITY CURVE

Keep track of my daily and monthly equity curves.  My equity curve should be consistently rising, with the occasional small drawdown.

2011 GOAL

TRADING GOAL:

1.  Trade with discipline

2.  Trade according to my plan.  Become consistent

3.  Focus on trading, not the $$$$

ACCOUNT GOAL:

I want to end up B/E for the year.  At this time, I need to overcome a $5000 drawdown.

POSITION SIZE:

Again, the focus is on sizing positions based on risk.

Full postions size is between $5000 and $10000 / trade

LOSS LIMIT:

$300 / Trade

3 Consecutive losses = Stop trading, re-evaluate

If I suffer a major loss (ie:  overnight downgrade, private offering, ect...) I will not trade that day

POSITIONS:

Maximum of 3 open day trade positions.  Maximum of 4 swing positions.

STYLE:

My predominant style of trading will be day and scalp trading.  I will swing trade ideal setups

In order to be successful as a trader, I must be consistent.  In order to become consistent as a trader, I must:  (Trading In the Zone)

1.  I objectively identify my setups

2.  I predefine the risk of every trade

3.  I completely accept the risk or I am willing to let go of the trade

4.  I act on my setups without hesitation when my entries materialize

5.  I predefine my profit points based on MAs / previous support/resistance and scale out to ensure profit

6.  I continually monitor my susceptibility for making errors

7.  I understand the necessity of these principles of consistent success and will NEVER violate them

Accepting the principle of probability:  (Trading In the Zone)

1.  Anything can happen in the market

2.  I don't need to know what's going to happen next  in order to make money

3.  There is a random distribution of wins and losses for any given edge

4.  An edge is nothing more than an indication of a higher probability for one outcome over another

5.  Every moment in the market is unique

From Trader Stewie and the Art of Trading

YOU NEED TO BE CONSTANTLY WATCHING YOURSELF, your body language, your tone of voice, your attitude and you need to quickly adjust any behavior that's hurting you (over-trading, anger, revenge trading, trading with huge size, etc...)  you need to be your own therapist, mental coach, and motivator.  You need to be hungry to win every day, even if winning means not trading.  You need to be ALWAYS seeking to improve yourself, learning, adjusting your attitude, minimizing your ego, and maximizing your drive to be better than the day before.  Don't worry about the money, when you are trading well the money will find you, trust me.  Take most care of your account when you are losing because the winning trades are waiting just around the corner, but they are waiting for you to adjust yourself first.

Trading Psychology:  The 16 Truths about Great Trading  by:  Dr. Doug Hirschhorn

1.  45-55% (Average winning % of any given trader)

2.  Traders do not mind losing money, they mind losing money doing stupid things

3.  You can lose money on a great trade

4.  Focus on the trade, Not the money$$

5.  Trading is a game of probabilities, not perfection

6.  Trade to make money, not to be right

7.  Nicht Speielen Zum Passz (if it doesn't make sense, don't do it)

8.  The market does not know how much you are up or down, so don't trade that way (think if I had not trade right now, what would I do?)

9.  Learn to endure the pain of your gains

10.  There is no ideal trader personality type

11.  Fear and Fear drive the markets, not fear and greed

12.  Keep it simple:  Up-Down-Sideways

13.  Make sure the size of your bet matches the level of conviction you have in it

14.  Making money is easy, keeping it is hard

15.  H+W+P=E (Hoping + Wishing + Praying = Exit the trade)

16.  Trading is not like sports

SOME LATE NIGHT TRADING WISDOM (YOUNG GUNS Trader)

• A person with good self-discipline but a poor trading method will outperform a person with poor self-discipline and the best trading method
• Make sure your trading goals are 1. Realistic 2. Attainable 3. Measurable.  If they don't meet these criteria, then the goal is nothing
• Losing trades don't diminish you as a person.  You're also not your winning trades.  They are just by-products of the business you're in
• Just because the market gave you X amount has nothing to do with whether it'll continue in your direction.  Time hath no bearing on money
• Being an active loser is the only way to win.  Actively cutting losers prevents damaging, large, and unmanageable losses
• Holding onto losers is like keeping cancer.  Remain flexible and admit wrongness to protect your existing capital
• The self-image controls everything we do in life.  It is what we believe to be true about ourselves.  Do you deserve to make money?
• You don't have to trade everyday
• After 3 consecutive losses, it's about time to stop trading.  Don't fall into the trading death spiral
• Act in your best interest - placing a trade because you're afraid of missing out on a big move is NOT acting in your best interest
• Flawless execution comes from forming a habit.  A habit is formed when it is repeated over and over
• Don't let personal/external factors affect the trading.  Let the market show you what to do.
• In trading, protecting yourself and acting in your best interest is much more important than taking a chance.  Can't stress that enough
• 7 characteristics of objectivity:  1.  No pressure  2.  No fear  3.  No sense of rejection  4. No right or wrong  5.  Let the market show you  6.  Observe from the perspective of not having a position  7.  Not focused on money
• Let go of the fear of being wrong.  I'm wrong all the time and I accept it.  To improve yourself, you must be honest with yourself
• One of the biggest mistakes is doing something wrong, but making money, and continuing to do the wrong thing because "it worked" 
• The way I look at it is you can keep hoping for something to happen OR free up your capital for the next big opportunity.  Your call$$

DAY TRADE SETUPS

EARNING GAPS

• These trades are based on earnings announcements or significant news
• Look for stocks that are gapping up or down in pre-market with > 10000 shares traded (the more volume, the better chance of continuation)
• Prioritize stock gaps by where they are on the daily chart (gapping above important support/resistance levels, MAs, new highs)
• Let the trade develop (usually a pullback after initial up move)
• Enter on break of High of Day, Stop at break of Low of Day

BREAKOUTS

• Look for pre-market movers gapping above their previous day's high, with high volume (the more volume the better)
• Look for gaps above major resistance levels, MAs, new highs
• PRIORITY goes to KICKERS (gap up after a red candle day, gap down after a green candle day - gap must be completely outside previous day's range)
• At the open, give the trade time to form a pattern.   Enter on break of HOD on increasing volume.  Stop at break of LOD
• Based on high probability chart patterns found on the daily chart (high and tight, flag, symmetrical triangles, break of descending trendline)

SECONDARY BREAKOUTS

• Usually occur in the afternoon after a morning breakout and pull back.  Enter on break of HOD, or on break out of pattern (triangle, tightening consolidation, trendline)

BREAKDOWN

• Enter on break of LOD
• Probability of continuation increases if the general market is down, break of important support/resistance levels, break of whole numbers
• Stop just above previous LOW

BULLISH KICKER

TRIANGLE / WEDGE

• Pattern Breakout
• Look for tightening consolidation with increasing volume to push price through trend line
• Entry on break of trend line, Stop just below trend line 

SWING TRADE SETUPS

BREAKOUTS

• Long trades based on high probability chart patterns found on daily charts.  Highest probability setups are:  High and Tight flag, flag, symmetrical triangle, ascending triangle, descending triangle, descending wedge
• Looking for a strong and clear level of resistance.  Even better if the level of resistance has been hit many times (double, triple tops) and not breached
• Looking for decreasing volume in consolidation zone
• Narrowing Bollinger Bands, Doji strings signify tightening consolidation and IMMINENT move
• Identify stop price (flag low, MA, trend line, ect...) and place stop below (never use round numbers $10.00).  Range should not be greater than 1%-3%.
• Identify profit targets to scale out at previous resistance levels, MAs, BBs, previous highs
• Aggressive Entry is in the Flag (1/2 position, full position on confirmation of breakout). Conservative entry on break out of flag

HIGH & TIGHT FLAG

 

BREAK OF FLAG ENTRY / BREAK OF DESCENDING TRIANGLE

DESCENDING WEDGE ENTRY / BREAK OF HIGH ENTRY

BREAKDOWNS

• Market ideally in a strong downtrend (ie: 20 day below 50 day, below 100 day, below 200 day)
• Look for high probability chart patterns:  descending triangle, ascending wedge, symmetrical triangle, lower highs
• The key is a strong level of support.  Probability increases if level has not been breached
• Identify a stop above a significant level of resistance, or under a moving average
• Identify profit targets to scale out above previous resistance levels, MAs, BBs
• Buy on break of support level.  DO NOT BUY IN ANTICIPATION

****charts and diagram from John Lee, Charts Gone Wild

Breakout Setups

I played to setups this morning, and both failed.  In both cases, I did not wait for the pattern to develop and top picked.  I looked at the setups that sustained their breakouts this morning and noticed similarities between all of them.

Failed SUNH and FTWL

And the sustained breakouts

Every successfull breakout pattern developed.  Either the stock retraced and broke the opening high, or printed a few up candles, flaged/consolidated, and kept running.  My 2 trades were forced and although followed my plan, were flawed.  Let the trade develop.

Not waiting for Break of HOD

I want to start taking trades earlier in order to capitalize on the run to the HOD.  This way, I am not getting stuck top picking the break of HOD.  Tried this strategy with SUNH today.  Waited for a break of the morning resistance which was $3.17 and bought a 1/2 position.  Sold 1/2 on the first spike (+$0.10), and held the rest with the plan on adding a full position on the break of HOD.  Filled at $3.40 (entry @ $3.37) and sold 1/2 of new position @ $3.45 and 1/2 @ $3.47.  Stopped out of remaining 1/2 (original position) on break of $3.40.

I felt more patient with the earlier entry.  I had secured a profit, and was ok having the break of HOD retrace the way it did.

Jesse Livermore Quotes

Averaging Buys/Sells: “When I’m bearish and I sell a stock, each sale must be at a lower level than the previous sale. When I am buying, the reverse is true. I must buy on a rising scale. I don’t buy long stocks on a scale down, I buy on a scale up.”
Discipline: “The market does not beat them. They beat themselves, because though they have brains they cannot sit tight.”
Price Action: “The price pattern reminds you that every movement of importance is but a repetition of similar price movements, that just as soon as you can familiarize yourself with the actions of the past, you will be able to anticipate and act correctly and profitably upon forthcoming movements.”
Stock Picks/Following People: “The average man doesn’t wish to be told that it is a bull or a bear market. What he desires is to be told specifically which particular stock to buy or sell. He wants to get something for nothing. He does not wish to work. He doesn’t even wish to have to think.”
Cutting Losses: “A loss never bothers me after I take it. I forget it overnight. But being wrong – not taking the loss – that is what does damage to the pocketbook and to the soul.”
Timing: “It isn’t as important to buy as cheap as possible as it is to buy at the right time.”
Being Right: “There is only one side of the market and it is not the bull side or the bear side, but the right side.”
Stocks Not Acting Right: “If a stock doesn’t act right don’t touch it; because, being unable to tell precisely what is wrong, you cannot tell which way it is going. No diagnosis, no prognosis. No prognosis, no profit.”
Stock Tips: “I know from experience that nobody can give me a tip or series of tips that will make money for me than my own judgement.”
Not Taking It Personally: “Getting sore at the market doesn’t get you anywhere.”
Learning Curve: “It took me five years to learn to play the game intelligently enough to make big money when I was right.”
Self-Confidence: “A man must believe in himself and his judgement if he expects to make a living at this game.”
Hard Money: “People who look for easy money invariable pay for the privilege of proving conclusively that it cannot be found on this earth.”
Importance of a Plan: “My plan of trading was sound enough and won oftener that it lost. If I had stuck to it I’d have been right perhaps as often as seven out of ten times.”
Lesson Learned: “It takes a man a long time to learn all the lessons of all his mistakes.”
Waiting for Opportunities: “After spending many years in Wall Street and after making and losing millions of dollars I want to tell you this: It never was my thinking that made the big money for me. It always was my sitting.”
Intuition: “I knew something was wrong somewhere, but I couldn’t spot it exactly. But if something was coming and I didn’t know where from, I couldn’t be on my guard against it. That being the case I’d better be out of the market.”
More on Sitting: “The desire for constant action irrespective of underlying conditions is responsible for many losses in Wall Street even among the professionals, who feel that they must take home some money every day, as though they were working for regular wages.”
Daily Personal Struggle: “A stock operator has to fight a lot of expensive enemies within himself.”
Pain is Good: “If I hadn’t made money some of the time I might have acquired market wisdom quicker.”
Blowing Up: “There is nothing like losing all you have in the world for teaching you what not to do. And when you know what not to do in order not to lose money, you begin to learn what to do in order to win. Did you get that? You begin to learn!”
Physically and Mentally Fit: “I couldn’t afford anything that kept me from feeling physically and mentally fit. Even now I am usually in bed by ten. As a young man I never kept late hours, because I could not do business properly on insufficient sleep.”
Accept Responsibility: “The customers, who were all eager to be shoved and forced into doing things so as to lay the blame for failure on others…”
Greed: “One of the most helpful things that anybody can learn is to give up trying to catch the last eighth – or the first. These two are the most expensive eighths in the world. They have cost stock traders, in the aggregate, enough millions of dollars to build a concrete highway across the continent.”
Taking Breaks: “I can always give up trading to play, unless of course it is an exceptionally active market in which my commitments are rather heavy.”

Trading Psychology

How To Kill Your Trading Career In 4 Easy Steps

From http://www.attitrade.com/

Trading is like any other skills based activity in that it takes time and practice to become proficient. There are no short-cuts, at least none that lead to longevity in the markets. Ask anyone who trades for a living and they’ll tell you about long hours spent poring over data, charts, earnings reports, etc. Those charging you thousands for their “market secrets” would tell you otherwise.
The rewards of making a living from the markets are numerous and well worth the effort. If you treat trading like a career rather than a job or an ATM then your natural desire would be to work at it at least 40 hours a week.  I’ve had many 12 hour days in my trading career, even a few that lasted 16 hours because I was hedging a position with futures. I wouldn’t trade those long hours for anything as that sweat equity has paid big dividends over the years.
However, if hard work, self-discipline, and learning isn’t your idea of fun then I’d suggest following these four steps below to help you exit the trading world as fast as possible.
1. Trade mismatch

Probably the most common way to blow up an account and end your trading career is to participate in the wrong market and/or employ the wrong strategy. Many walk away each year from the markets jaded and penniless because they tried to trade a strategy/system that works for someone else without giving a thought to whether or not they had the psychological makeup to produce a profit over a sustainable period. I’m referring to matching a trading style with your personality.

You wouldn’t go into a store and grab the first pair of pants you see because they look good on someone else would you? No! You’d shop around, try a few pairs on and make an informed decision about which pants work best for you. Trading should be no different. Don’t make it more difficult that it has to be.

2. Limit resources

With today’s technology and the vast availability of free information out there it’s impossible not to take advantage of it like a $4.95 all-you-can-eat buffet. Seriously though, trading takes time and money so proceed knowing that you will not make a fortune in your first few weeks, despite what others may have told you. In fact, it may take a year or more to master a setup or strategy and turn a profit.

Spending most of your capital on “education,” leaving a small amount to trade with, will no doubt crush your dreams of being a successful market participant. You need to be well funded in order to survive the learning curve that is the market. There is no way around this.

3. Go it alone

Bottom line is that without a good mentor, or even more than one, you will die a lonely and poor trader. There are great resources out there, many of which are free, that can provide education and an opportunity to meet others and perhaps create a lasting relationship that could lead to many mentoring opportunities. StockTwits is a great example of free resources out there with people ready to lend their knowledge about trading. Other examples include local universities, trading organizations, and virtual education centers.

The point is that you wouldn’t start any job, let alone one you wanted to make a career, by jumping in head first. Sniff around a bit, visit your local library and check out some books (Google books works as well) and do some legwork. Find the email addresses, phone numbers, twitter handles, etc. of people that seem to know what they are doing and hit them up for advice. You’d be surprised how willing most people are to share their knowledge.

4. Be overly self-critical

It’s real easy to pick out and focus on the negative aspects in life. Trading is no different. I’m not suggesting you trade with rose colored lenses but rather focus on the positive things you do. The negative mindset is a cancer and will overcome the positive aspects of your trading if you let it. I have yet to meet a trader that hasn’t made numerous mistakes. It’s those traders that learn from their mistakes while focusing on positive outcomes that find longevity in the markets.

It’s easy to lose in the markets and walk away with a negative attitude about how it’s a rigged game. After all, you’re just one of the little guys that can’t be expected to compete with the Goldman Sachs of the world. Don’t be a statistic, man up and be a legend.

1st Day Back

Back from my leave of absence.  Needed to re-evaluate my trading plan, strategies, and my psychology.  I started the year off very well, gave it all back, and started digging a hole.  My position sizing was a major issue leading to big losses. I was getting frustrated because I was focusing too much on $$$ and not enough on trading.  Proper position size allows me to keep my risk in check and allows the trade to work.  If I manage my risk, play the right setups, profits will come.  

HNSN