Integrating time into your risk management

It seems most educational trading articles feature cherry-picked trade scenarios that show the discussed theme in action. Sure, it's useful to see real-world evidence of the opportunity one is reading about, but only to a point.  Because when you try to copy the trade when the market provides a similar scenario, it usually goes bust. And you're left with a loss, wondering what happened.  Now, there are limitations to these scenarios, and no article can cover all the bases.  Ultimately you have to develop your own feel, your own personal edge.  And managing risk is a huge part of that edge.

I've heard that many successful traders have many scratches or small winners, followed by some losers, and just a handful of grand slams.  While we would all like to have huge winners on a reliable basis, reality has unfortunately different things in mind.  So, for this post I'm going to walk you through one of my scratch trades, which I define as an exit that is roughly equal to my entry, give a tick or two.  I'll elaborate on what is going on in my head as I observe the market, analyze intraday price levels, and manage the trade once filled - and what prompted me to take the action I did.

Market Profile view of the two completed auctions

Let's start in the morning, at the open.  How the market opens relative to the previous pit session is very important.  Opening in the same value area means not much has changed, opening out of value and/or range could mean perception of value has changed, and a directional push could be in the cards (or, a rejection of that breakout attempt and a move back into last known value).

On Monday, 11/3 the market opened just barely above range, a 3-tick gap.  That it wasn't even one point demonstrates the buyers aren't very excited (but who is, so close the life high?), yet are still exerting influence over price.  The tiny little gap is immediately filled, buyers just aren't going to euphorically lift the market to the moon on a one-way move off the open, and since the gap was so small the usual rotations at the open took it out with ease.  Again, given the high prices, perfectly understandable.  So, my attention shifts to what the next move is - will we continue to move down and develop value in yesterday's very well-defined value area, marked with a very prominent PoC, or possibly touch 'n go off that visual reference?  I see the market come very close to touching the PoC, but just couldn't do it - suddenly buyers were to be found!  Now they're excited to buy it, rescuing the market before it can even reach that obvious target.  Can they maintain control from here?

Tick Chart of 11/3 - Captures activity and intraday price levels of interest 

A retest of the low area is made, and rather decisively rejected, based on the swift up-push shown at 9:53.  From there, value begins to get fleshed out for the day as the market goes sideways while sloping upwards.  Around noon the globex high is taken out on a second swift up-push, this one even faster than the initial one off the low area as it rallies 3 pts in two minutes.  Put it all together: the market has been moving up since about 9:30, with developing value (at the time) above prior value w/o overlap, and we just witnessed a strong momentum up-push above the previous life high.  Jim Dalton's gap rule appears to be unfolding before my eyes, so I need to find a spot to get on board with the directional push upwards.

The old axiom "Support becomes Resistance, Resistance becomes Support" is said for a reason: when well-defined levels are taken out, they are often excellent areas to enter on a test from the other direction.  Looking at the tick chart, the level that sticks out to me is the swing high at 2015.75 that was made just before the momentum up-push took place. Putting in my limit bid just beneath it, I patiently wait until I'm finally filled.  Now, my attention shifts to what other traders are doing at this price level - remember, they have to agree with me, and agree relatively quickly if this price level is indeed a good entry (the window of opportunity in good trade locations doesn't last very long, after all).  Watching the DOM, I slowly see market sell orders abate, and a slow-but-steady influx of market buy orders, lifting the offer over time.  Within 6 minutes, the market has traveled 5 ticks my way, and looks to be continuing as 700 market buys lift the offer at 16.75... but then the most interesting and frustrating thing occurs: buyers just give up.

As you can observe on the tick chart, 2 downbars negated 8 upbars of effort.  The market didn't take very long to move down and it faced very little opposition in doing so, which is a red flag.  Traders are supposed to be very interested in buying here!  Then, the market trades down to the low it just established when it filled me, not a good sign either (we're looking for it to continually slope up, trapping sellers along the way) - red flag 2.  And the final red flag? I've been in the position over 15 minutes and I'm still at scratch.  This is the single most important takeaway of the whole episode: I do not give my trades unlimited time to work. If they just won't perform, cut them and wait for a better one in the future.

Now, every once and again the market will fool me.  I'll cut a trade that isn't working how I'd like, only to watch it zip deep into profit right afterwards.  But I'll take the pain of missing a winner over that of booking a loser any day.  I find it's better to put a few bucks in my pocket, keep my "mental capital" up, and know that I probably did the right thing as I await the next opportunity all the while feeling fine because I haven't taken an avoidable loss.

This particular time I was right - the bad feeling I was getting about the position was demonstrated in the unforgiving 4pt dump that occurred shortly after I scratched out of the position, with the market eventually printing a new low on the day.  The satisfaction of now knowing I did the right thing & avoided a loss is second only to knowing that I did the right thing and secured a profit.

Sometimes in trading, time isn't money.