Wednesday, May 11, 2011

In trading no one should ever be absolutely sure

...and the one who is will get punished sooner or later. This has happened countless times, to traders of all skill levels. Once you think you've got a trade on your hands that can't possibly go wrong, you're brewing a recipe for disaster. Everybody knows this, me included, however I just barely escaped such a situation by plain luck.

A couple of days ago I ran my spread scanner and the good old GLD-GDX spread caught my eye. It was so streched up, that I decided to trade it. In fact it was at an extreme that has not happened for a very verly long time. This spread is a 'classic' for spread traders and it has been mean reverting for years now. I'm was sure that it would mean  revert again, and quickly got on board. The only thing that prevented me from betting big was the shortage of free cash and I did not want to close any other positions. So I ended up with a usual size of a spread bet, that I don't allow to produce more than 2% of portfolio volatility.
What happened next is a short story. The spread moved further against me, knocking 2% off my portfolio. A pity, but not a disaster.
The good part is that I can still handle this situation with calmness and make reasonable decisions about keeping this spread or taking a loss. Things could be different if my position was larger and I lost months worth of work on a single trade.
This reminded me again that trading should not be convinced with gambling or one will end up the as >90% of amateur day traders- with a blown account, but more on this later...

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