Week 2 in Review

Last week proved really hard to trade in due to the direction less moves taking place. The S&P traded in a range of about 30 points all week, one day up and then the next down with reversals throughout the day. This made it a hard playground for anyone going long or short. Without a clear defined trend, this puts the odds against me considerably and I think I would have had a good chance of stomaching some losses. Knowing my limitations, I stayed out of the market and paper traded. I've posted a screenshot below to show that my balance hasn't changed since May 8.

In the meantime I've found a new broker to trade with. They charge 0.01 per share with a minimum of $0.99 per trade, so in other words one dollar per 100 shares in and a dollar to exit the position. That's two cents lost immediately on entry plus the spread (difference between the bid and ask at any one time) which I don't pay more than 2 or 3 cents for. So in total, I lose about $3 round trip if I exit as soon as I enter.

So why is this a worthwhile venture? Well for one, I can risk less capital at any one time with 100 shares worth of capital. With my current broker, it costs $14 round trip plus a 2 cent spread requires a 16 cent profit just to break even. It's unlikely anyone can win like this in the long run unless they are already extremely experienced (which I am not yet) and even if they were, their opportunity cost in time wasted would ensure they would search for something else to do. 

Now, one might ask "okay sure, you risk less, but don't you also win less?". That's a very valid point and I agree with it completely, but I'm going to offer a different perspective. When one enters a trade, most times it does not reverse against them as soon as they enter. It rarely happens unless you manage to buy right at a peak or sell short when the stock has bottomed. If you manage to buy at the peak or short at the bottom more than 60% of the time, you'll be a millionaire soon since you can just do the opposite and make money. Since there aren't many successful traders that make millions like this we can assume this is not the case. What is the case however, is that most trades at one point or another do end up being profitable but are none the less closed in a loss. 

Say you buy 700 shares during an up trend (average commission of 0.01 per share) and find yourself up 5 or 7 cents ($35 or $49) in the next minute. Price falls a bit and you're down 9 cents ($63). In the next few minutes it's back up to 8 cents profit ($56). Now, you won't exit because:

1. You still think the market will go in the direction you want (which is a bad mindset but that's another story) and you believe that since price was down earlier but has come back up, it must keep going up. 
2. You've already paid $14 in commission, so you might as well stick with it and see how the trade goes since if you sell at break even you lose that money

Now what will happen is that price will fall below your entry by 24 cents. You still believe in the trade, so you continue holding it. It goes up again and your only down 4 cents, but if you exit now with a 4 cent loss you lose that 14 cent commission also. So instead, you wait. It's been 15 to 25 minutes now and your trade has gone nowhere. You've had at least 3 chances to get out for a scratch trade (break even) or for a small gain,  but this time around the price manages to fall and it falls hard,  maybe down 50 cents ($350) in a minute. Eventually, you cannot psychological endure the loss any more and quit on a reactionary emotion. What happened? Well that initial trade that went in your favour initially was turned into an unnecessary loss almost triple the highest return you had at any one point due to trader error and the desire not to waste that $14 on the trade. 

Wherein lies the problem is that the longer you hold a position where the price stays range bounded or doesn't immediately go in your direction after entry, the more your risk of loss increases. This is because you can only win when price goes up but can lose in two ways (break even losing commission or selling at a loss). Since price isn't going the direction you believed it to and now 15 minutes have passed, then you are most likely wrong. This is because not enough traders believe the same thing as you do in order to create a an imbalance on the demand or supply side and get price moving. You are a sitting duck, the trade is no longer under your control and you are now gambling on an outcome. A recipe for disaster and heartache.

Let's re-identify the problems. Firstly, the trade was too large to begin with and the trader was not psychologically primed to deal with that huge of a swing. Secondly, since the position was so big and the commission is hefty, the trader subconsciously has a connection to his trade where he feels he has to stick with it since he's already put so much at stake. Plus, he also thinks that if he's right and waits just a little while longer, he can score big and make several hundred in profit - this is pure greed and acts like beer goggles.

With only 100 shares at stake, the trader would have lost $50 at most if they sold on the drop. Instead, if they hadn't exited earlier (the most correct decision) they can still wait for a retracement in the next few minutes and sell maybe at only a $24 dollar loss. The previous trader that went in big with 700 shares won't be able to do that since he panicked when he saw a $350 loss, where as the 100 share trader can stomach a $50 loss (since $50 represents a smaller emotional value to him) and wait for a price reversion to the mean. He'll still lose, but maybe not as much. Of course, the best decision was to have exited before hand and captured that small $9 profit earlier when price was fluctuating. Now, he still loses but not as much, but also incurs opportunity cost.

While it's true that trading just 100 shares at a time won't bring in the big money, it still has the potential to bring in a decent amount of money, maybe a hundred or so. For me, since I still consider myself a beginner, this is fine for me. I'm not looking to strike it out of the park, but what I am looking for is to learn and if possible subsidize the cost of my entire education with the market's money. In other words, if I can learn (emotional control, analysing bad trades, recognizing set-ups until it becomes second nature, reading volume flows etc.) while still making some money on the side or at least breaking even, it's still worth it to me.

The end goal, I believe, of anyone looking to succeed shouldn't be to make money, but instead to do the right thing when it is required. If one can make the right trades and react when faced with new information, the rest will come on its own. My goal is to become proficient enough with 100 shares at a time, then when I've shown that I can handle and return profit with an positive expected value, then I'll double it to 200 shares at a time as necessary. Over time, the change should be seamless enough that it won't feel like a huge plunge. That's what I think anyway, and it makes sense to me.  

I paper traded on Friday using 100 and 200 shares on average, holding no more than that at any one time. Data was delayed by 20 minutes, but I did not cheat (that's going to have to be taken on trust). Fills are also pretty accurate. I had sell orders on the ask that were not filled unless there was volume coming through. I made a total of 68 trades for the day, about 5230 shares traded, and with a profit at the end of the day of $420. Total commission cost was (5230*2)*0.01 = $104. With the current commission scheme, that would have cost 7 times 68 or $476. See image below.

For the next week until my new account is opened up, I'm going to be paper trading daily and posting my results. My hope is to get 3 days out of 5 in profit.