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I received several emails about managing risk with respect to my What Do You Make of Wheat post last week.
When the market goes parabolic and you watch your equity burgeon, you can actually become as frozen as if Jennifer Aniston herself asked you if you’d like to see the “way back” of her Range Rover. Stuttering and stammering isn’t sexy. You need to have an answer in the moment. For the record, I would be interested. In fact, there are some very interesting things that you may not know about the “way back” of a Range Rover that IMO one should definitely know about, but I digress…
A parabola – a mathematical expression for exponential growth or decay – doesn’t last forever and they consume themselves (or the host). You must act fast, whether you have galloping pneumonia or a highly levered portfolio in CBOT Wheat. A simple parabola is the equation y=x^2.
For the less experienced trader, I would suggest entering a Stop order to offset your position. I say “offset” b/c you can be long or short. In this case, you were long.
Entering the order serves two purposes:
1) the markets move too fast to try and day-trade out of a sizable position. Mishandle it and you will have substantial skid – skid that can be avoided if you order is “on the floor” or whatever is left of it. Almost all trading is done on the screen these days.
Second, it instills discipline in your trading. You’ve picked a spot where you’ll be financially and emotionally stable to offset your position. If you’re stopped out, that’s a good things: you don’t have any knowledge where the, ahem, bottom will be found.
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You’ll notice via the 5-minute bars, that the damage was done in the first 20 minutes of trading of the outcry session. Funny too, considering that 95% of all volume is done on the screen. There was plenty of time to offset the position before the “opening bell.”
However, if you waited for the market to open you were overrun with a wave of selling: you got caught in a $1.20 “long ruler” range day that might have left you paralyzed. Just as bad as watching the tail lights of the Range Rover drive away.