Today I am going to do a quick review of a crude oil short trade that I entered on 1/25/16 and exited for a loss on 1/26/16. While I was in the trade only for a day, I have a couple of important takeaways that I would like to share. First let me explain the details of the trade.
Crude put in a vicious 15% rally in two days to finish last week’s trading. Many were, once again, calling for the bottom in crude. The following trading day, crude quickly reversed, dropped 10% and put in a nasty engulfing candle. After touching the middle band and reversing, I received a short signal. I entered short oil via SCO (proshares ultrashort bloomberg). Below is the daily chart of USOIL on the entry day.
The following trading day, we gapped up on news of a potential OPEC deal. I decided to exit the trade because of the strong adverse momentum to my position. I took a small .5R loss.
From this trade I can draw two very important lessons:
1) Position sizing is crucial to trading success. In this trade, oil was overextended to the downside and this last potential bear flag was the 3rd pullback in the new downtrend leg that started in November of last year. When trades are overextended, there is a high probability of a snap back rally, which has to be accounted for when positioning. Additionally, the last pullbacks in trends have a higher rate of failure, the pullbacks in the beginning of trends have a higher rate of success. That is why when I entered short on the breakdown of the first pullback (1) , that I have highlighted below, I had confidence to use a relatively tight stop which allowed me to use an increased position size. In this last pullback (3) , my initial stop was extremely loose, which caused me to have a light position size.
2) Most entries are based at major inflection points. What does this exactly mean? In many cases, this is the reason why you can be stopped out of a trade in only a couple of days after the entry. Markets fluctuate between a state of momentum and mean reversion. When I entered this bear flag, I was assuming the rally that caused the flag was a continuation pattern to the downside (momentum). Instead the market showed that this rally may be a some sort of failed breakdown, signaling a bounce (mean reversion). Think about your entries, when you enter a breakout, that is major inflection point. If the probabilities are in your favor, the market will break to the upside and exert range expansion (momentum). Consequently, the market can quickly close back below the breakout zone and return back to equilibrium (mean reversion).
Hopefully these couple lessons served as a valuable learning experience. If you have any questions do not hesitate to reach out to me. Thanks for reading.