In this recent post, I referred to Ocwen Financial Corp, a US stock that had been on my watchlist, and which broke out to new highs just ahead of earnings, triggering a possible entry.
Now, as I have mentioned numerous times, I do not initiate positions just ahead of such releases - the potential for price gapping against me is a risk I choose to pass on. My own belief is that is gambling, not speculating.
In this particular instance, price did gap down, which, had I taken the trade on the breakout, would have caused a loss greater than my initial risk.
But what if you did take the trade?
Some traders would have been caught like the proverbial rabbit in the headlights - they would probably have reasoned that the gap would be closed, that the reaction was overdone. Others couldn't countenance taking the loss as it was too big - which suggests that their risk control was too aggressive in the first place, or that they did not have a plan for dealing with such price moves.
Now, in some cases price gaps like this do get closed. But what if they don't?
As we can see, in this particular instance, price has only moved in one direction since the earnings release. What was a containable loss on the next day's open has only gotten bigger.
As a trader, you also need to ensure that you do not compound your mistakes.
This is the classic type of situation where a trader could look to average down by opening an additional new long position, trying to recoup those losses.
Marty Schwartz talked about this when he talked about his sunspot theory, where all rationality goes out of your trading decisions. Emotion takes over. You start 'hoping' instead of acting in an objective manner.
It is this type of situation that can seriously damage a trader - both financially and psychologically. And, if their risk per trade was too aggressive, then it could lead to a significant drawdown or even a blow up.
Instead, resolve to do what those traders who have been successful over the long period of time do - at the first sign of trouble, get out. What's done is done. Learn from it. And move on.
"Losers average losers." - Paul Tudor Jones
"Being wrong is acceptable. Staying wrong is unacceptable." - Mark Minvervini
