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Thursday, February 24, 2011

Bad setups sometimes work

"Hi X. Let me start off by saying I don't know how you do it, but I have been reading your posts for five years and more than anything else they are responsible for helping me to stop losing money and start making consistent profits. So, a sincere thank you.

Having said that, I still consider myself a novice even all these years later, and I still question myself and my methods even though I have turned the corner to profitability. A good case is a trade I took in ROYL today. I made over 18% on this one trade, but I also broke one of my rules in taking it. Namely, I entered when price was below the 5EMA. But, if you look at the chart (5-minute) without any indicators and plot your Fibonacci lines over the first swing high (so, actually, the low and the high for the Fibonacci lines cover the range of the first two bars), price pulled back from the high and found support at the retracement zone, and then stepped up and found support on the top of the retracement zone, making a "higher high" and a "higher low" which is very bullish. The 14th bar was a hammer, though it had a red body (which is another rule I broke). I entered on a break of the 14th bar's high, and rode it all the way up to $6.

So, I guess I am asking how do you know when to bend your rules so you don't miss a big mover like this? Looking at it with the 5EMA, I would pass. Looking at it strictly from the setup in relation to the Fibonacci lines, it seemed pristine.

Fast Eddie"

Fast Eddie, first and foremost - cool name!

Now to the question - there are a few instances in my trading career that I consider "aha moments". One was when I learned to accept this fact:

Bad setups sometimes work.

I am not calling your setup bad, by the way. I am simply saying rules exist for a reason. For me, I have been studying charts for longer than I care to remember. As a result, I have a good understanding of the setups that work 40-50% of the time, the setups that work 60% of the time, and the setups that work 80-90% of the time.

If you have been reading my blog for years, you know that I strive to be in the latter category - a high win rate, and a lower number of setups/trades. Thus I have rules. A setup has to adhere to those rules, or I pass. But the trap that we as traders fall into is that, when we pass on those setups, they sometimes work beautifully. And that usually frustrates us so much that the next time we will "bend the rules" and take a setup that isn't quite right...and inevitably, it won't work this time.

It can be a vicious cycle and, if you don't get control, it will chip away at your discipline and ultimately your self-confidence. So always remember:

Bad setups sometimes work.

I have posted both charts below (with and without the 5EMA) with the trigger bar and exit marked. I hope everyone has a great end to the week!

Note - I am still playing with the colors on my charts, searching for the combination that makes them easier for you guys to read. Also, "loanme5" posted a great comment that I will address over the weekend.



Times of Your Life said...

ah i didn't trade much this week

this is a great post...

Anonymous said...

Aha moment? I have those all the time here. Thanks.

Eric O. said...

Nice post and I think you hit the nail on the head. It is like the old adage "a broke clock is right twice a day". If I can stop chasing mediocre setups and pick one timeframe and setup type, I think 2011 would be a stellar year for me. Discipline!

bl said...

X are you still of the opinion that the 10 min time frame is best in terms of set ups and risk? I like slight pullbacks, inside bar type of set ups like TRLG INT SIMO on Friday. I'll sometimes put a 5 min chart next to it.

john said...

re Todd's trade ...there is a cleaner entry on the take out of the 9th bar high on the 10 minute chart. What is your opinion about shopping time frames when the initially considered one fails to meet your rules?

Thanks ..and good to see you back.