Anatomy of a Trading Blowout (by Biffermas)

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I'll never forget 2002, the year I began trading.  Initially I
followed very simple chart patterns based on William O’ Neill and Investor’s
Business Daily (hey, a cup and handle!). 
For several months I did pretty well, averaging a 2-5% gain per month
taking short-term position trades on individual stocks.  It didn’t seem too difficult
consistently making small gains.  At the
time I was reading every book on trading I could locate and rapidly adding an
array of indicators and methods to my plan. 
One book I read covered the business cycle, and it seemed that steel
stocks and the economy were ripe for a rebound after the crushing bear market.  Another book I read covered options, but I
didn’t read beyond chapter 1: calls and puts. 

Blowup

I watched
American Steel carve out a double bottom with a bullish divergence in
MACD.  It’s long, declining trend line
was breached, and like a good trader I waited several days before buying to
avoid a potential false break.  My account
at the time was $45,000, and I used it all to buy front month call options that
were out of the money by $2.00.  I
initiated this trade near the top click of the range, and within 5 minutes I
was down $2000.  I’d never lost more
than $150 on a trade until then, and I became oddly paralyzed, unable to sell
and accept such a hit.  A week later my
account was below $20,000, I eventually sold the options when it hit $3000.

Blowup 2

The worst
part wasn’t losing the money, it was losing hope that I could actually trade
successfully, something that I absolutely loved doing.  I didn’t trade again for two years.  As you see, American Steel took off nine
months later, quadrupling in short order, but I was not aboard.

With
every market defeat lessons are learned. 
Roughly half of my current trading plan is geared towards avoiding a
repeat of that awful trade.  Here are
some of the lessons I learned:

  1. When
    faced with severe losses, it’s nearly impossible to objectively evaluate your
    position.
  2. Leverage can be a killer.
  3. A trading
    plan should be simple, not based on the collective opinions of 15 financial
    authors.
  4. Never buy
    front month out of the money options, they are strictly for crazy
    speculators.  If you're going to use
    these, sell them to crazy speculators against your longer-term positions.
  5. Bullish
    and Bearish divergences fail frequently.
  6. If you
    want to arrive early to the party, be prepared to wait a long time for the
    action to arrive.
  7. Those funny
    Greek names, Delta and Theta, actually mean something!
  8. It’s not
    acceptable to have multiple blowups like this. 
    Many great traders have suffered a crushing capital blow early in their
    careers, only to return stronger and wiser. 
    Others, like Jesse Livermore, ended his career (and life) after one too
    many detonations.

 Thanks
for reading, and trade safe!