Hey everybody, it’s Michael Martin. So yesterday I kind of touched on the emotional side of knowing pullbacks versus corrections. Today typically we will talk about more of the specifics. Again, I don’t want to start looking at charts because that’s a bit of a snooze. Again, your position size is typically based on the volatility that you can take within the account, and your protective stop is typically adjusted for your position size and your position size is adjusted by the volatility. So it depends how you kind of back your way into the trade. Typically, people start with there, I think the popular expression is their risk unit. How much of their capital are they willing to risk on any one particular trade? It’s a really good idea to keep that number consistent. Don’t adjust it and change it because you have strong feelings for Nvidia, because some jackass tells you how AI is going to change the world.
The price will tell you what everyone else is thinking. That’s the truth, literally and figuratively. You can’t trade on other people’s recommendations. At the end of the day, a pullback is typically something that’s within, you know how I say if there’s an uptrend, things are moving up and down but in an upward fashion. So those down moves are kind of what people would consider pullbacks within an upward moving trend. A pullback is not necessarily a reason to get out of a trade because at that point you’re kind of like the whole thing about the trees in the forest. So I would not let that psych me out. A correction is perhaps, and you can operationally define this, how you see fit, because there is no universal definition where you could be like AV top, a sharp move against you. Piece of news comes out. It corrects if your stop is placed correctly.
That type of activity will knock you out of a trade. Is it frustrating? Not for me because I know what’s going to happen. If you are watching your p and l and you watch an eight R trade go to two R and you get knocked out, that’s the way it goes. Those things are going to happen. You can’t insure against that by taking small three R gains your whole life, you need to sit in for the bigger winners and sometimes the things will also take off and it’ll be announced that someone’s acquiring the company. Someone’s acquired a big position, there’ll be a 13 F announcement. There’ll be something that motivates the crowd to do something that you did a couple of weeks ago and now they have to rush in and buy the stock and you make a bunch of money. That’s the admission ticket that I speak about because you’re already inside sitting comfortably. So get used to that. So I would look at a pullback as just a small intraday countertrend move still within the parameters of staying inside the trend line or above the trend line in an uptrend. And remember, we’re not drawing channels, so there’s no reason to connect the tops, no reason to do that.
You draw trend lines below the chart and downtrend lines. You connect the tops, but there’s no reason to connect channels to think that that’s the only way the instrument can move is inside that channel. That to me is small-minded thinking. So I’m looking at my notes here. So a correction could be, well, maybe you have a two standard deviation move or a two or three ATR move against you. It really depends instruments to instrument. It also depends on how are you using leverage because in that moment of time, because the leverage cuts both ways, your job as a speculator is to play superior defense. Obviously, like we said this week, you have to demand gigantic gains from the marketplace. But if you’re trading with leverage, when you smell smoke, you have to assume it’s a five alarm fire. That’s why you have to honor your stops.
I wouldn’t necessarily call the correction of black swan, but moves can happen for various reasons. New fundamental data comes out. It could be legislative risk is new and hasn’t been digested by the market, but oftentimes when I’ve seen corrective or what you would consider corrective activity, people sleep on it and they’re like, it’s not so bad. I’m going to come by and buy some more tomorrow. So I can’t say that universally a corrective activity is reason to get out. What I do think you should do though, regardless of how you define pullback or correction, is honor your stops
And put them in. Leave them in. You could always think with the clear head overnight come back. Worst case scenario, you buy in at higher prices. It’s not the end of the world if the trend is going to go. You can’t think that the near term high is the only high, the absolute high or the move is done. A lot of people get the mistake of looking at a chart and they see it started here and it’s over here. It’s like, oh man, it’s in the top right corner. I moved as if this is the place where you exit the pros. Look at that as a good place to enter, in fact. So you need to know your timeframes. Don’t worry about buying zones. That’s all. Again, short term, kind of small-minded thinking and back out the chart, look at the weeklies or the monthlies and see what the overall market is telling you because that data is less random despite what everyone else is thinking because it’s a voting mechanism.
If everyone’s so damn bullish on ai, why isn’t NVIDIA seven 50? Serious question. So that’s kind of how you start to calibrate the hype and keep yourself out of bad situations. But pullbacks are nothing to be afraid of because that’s what your protective stop is for. Now, pullback is a word you would use for something that’s up trending. If you’re short and the market rallies, I suppose that would be perhaps the precursor to corrective activity. Admittedly, there’s a chart called V tops and then there’s V bottoms. Those are kind of difficult to trade in terms of calculating a buy signal. You’d have to see maybe if you were looking at bigger selloffs where things where the selling became kind of cataclysmic and it became concave down, Y equals negative X square kind of a deal, inverted parabola. You can look and see sometimes those markets do get washed out and if you’re looking at some kind of channeling indicator, there might be room for something that’s a snapback.
But again, that’s a countertrend kind of like I’m going to get cute and scalp with the market. Whereas maybe you could make some money that way. Buying an oversold market long or using a call option, let the market rally back up to your strikes or to your stops. But those are all unique spots to be in. I don’t know that you could build a business on it, especially if you’re starting out because in my experience, when there is that big kind of cataclysmic selling, that’s usually the first spot. Even though there might be a wave of short-term buying, whether it’s the shorts covering or value players trying to come in and accumulate stock on a lower valuation basis. You remember valuations come from earnings, not PE ratios, and the earnings part is very difficult to predict going forward. So you can only really trade on the past pe.
So what happens when the PE goes from 30 to 20 or 30 to 18 and you’re like, man, there’s value here, but then the earnings get cut again and all of a sudden the stock is down 50%, but now the multiple is 40 and you’re like, oh my God. Now the thing is way overvalued at a lower price. What happens, and I’m not the only guy to say this, but it kind of comes from school of hot knocks. The cheaper prices don’t mean value. So what I would do for yourself though is kind of define what your risk is. If you’re risking one half or 1% and you’re using any number or multiple of standard deviation or ATR, you can use a half an ATR. You can use a full ATR, you could use two ATR with whatever that risk unit is. And then you could think, okay, well I define a pullback then as twice what my volatility measurement is.
I think of a correction maybe three or four times that you can come up with your own measurement based on what you observe because it’s all based on your personality and your temperament for risk. There’s no universal understanding. Obviously, if you have a stock that gets cut in half in one day, it’s probably safe to say that was a correction, right? The day after Kramer made that big rant about Bear Stearns or close to it, the thing went from 30 to 15 in a day. It might’ve been the same day, I don’t remember. It was a long time ago. But the thing is based on your trading strategy and how much room you normally give the thing, that’s why you have to operationally define, because if you’re in the business of giving the thing two ATR move, if there’s a two ATR move against you, well that’s what you were planning for based on what your own algorithm is for position sizing. So for you, a correction might be a five standard deviation move, right? Not in one day, but I guess that’s really what that is though. It is in shorter timeframe, but say a five ATR pullback in the move, you could be pricing for very volatile moves, especially if you’re trading for futures. That’s really up to you to figure out how you want to do it.
So that’s how we can begin the conversation. I don’t know if there’s more to say on it, but you really have to define that for yourself. A pullback to me is just part of a natural reaction that happens in a move. Move doesn’t have to be overextended. I know I’ll be doing more of that in our groups to kind of look at it and to study it, but that just requires an enormous amount more of preparation on my part, and I don’t have the time to do that for these types of videos. Maybe there’ll be a premium aspect to the channel here where we can kind of borrow some of that recorded stuff and make it available. I don’t know yet. I like doing these for free, but ultimately this is the time that I can afford to give away and help you all, which I’m willing and it’s my pleasure.
I think it’s my responsibility to do it. That’s my intention. But when it starts to becoming more time intensive, then I have to look at other, there has to be an exchange of value. This is what I’m willing to do under the charitable give back to the community way more time commitment makes it more professional, and that means compensation on some level. But we’ll have to see. I don’t have that worked out yet, but at any rate, it’s been a good week. I appreciate your comments and keep watching the show. Go back and watch the earlier episodes because there’s really chapters. I’m going to try to create two, I don’t know how I’m going to do it just yet, but I have the people to help me and start to think in terms of playlists and then organizing the themes and call the playlist by the theme so that for those of you who are in various stages of your trading, can come into the show, especially if you’re new here and look at a particular playlist and get a whole host of episodes that speak to that theme because we do have the transcripts and we can kind of search for kind of keywords and kind of bracket these things out so that you can go on a bit of a diet of a particular subject matter that we cover in the overall scope of the show, which is kind of related in that it’s all traitor psychology and emotional intelligence, but within that, there’s some specialty stuff that speaks to managing risk on entries and exits and position sizing and different things that might resonate with you at different times during your own kind of trading upbringing, if you will.
Anyway, it’s been a great week. I always appreciate you being here, and I thank you for taking the time to write. It means a lot to me. As always, if you have things that you’d like me to consider or send them over, I’ll definitely, I look at everything. I only try to comment on things that I know I can speak from experience because no one needs bullshit theory, and yes, I can give you my hunch. I appreciate you thinking that that might be valuable, but I really always try to speak from experience because I know that I’ve had to live through it, and that makes it much more real and I think also much more believable for those of you who are watching. So thanks very much for being here. I hope you have a great weekend and I’ll see you Monday. I.