Lessons from a reader: trade review of CREE

I received a good question from a long-time reader on a trade he executed in CREE. Here’s Jim’s (edited) question:

I’ve been trying to swing trade for a few years now… Regrettably, the broad market indices usually leave me in the dust each month. An incident this morning dealt another blow to my rather fragile trading morale. On March 9 [2016] I had taken a small position in CREE hopefully to ride “one clean swing.” Perhaps I should have exited before today, since CREE mostly went sideways thereafter, but that’s hindsight. Before the market opened today, April 6, a news article reported that the company had made a quarterly earnings preannouncement:  “The lighting maker said its sales will fall far short of expectations because of new product delays and software problems.” The result? An opening gap down of over 14% through my stop and a loss of about five times what I thought I was risking on the trade.  How do you deal with trading events like this? I avoid taking a position in a company that is close to announcing earnings. However, the preannouncement blind-sided me, since it came “out of the blue.” I’ve never been the victim of one before this. Longer term investing, day trading, passive investing, or strictly using ETFs for swing trading are looking more attractive all the time.

In general, I think trade review of specific trades is probably overemphasized, since most of what we see is random. However, there are times that a trade and its management has good lessons, and this is one of those cases. I’ll take the tone through this answer of a stern teacher, and just call out the mistakes as I see them. First, let’s deal with the trade itself. Here’s a chart of the trade, with the reader’s long entry marked as (A). Before reading further, look at the chart, and think about how you feel about the long entry at A. Is this a good trade or not? Why?
CREE trade

Why are you here?

It’s important to remember why we are in any trade or position. Is it intended to be a long-term investment, held for quarters and years? Is it a one swing with trend trade? Is it a countertrend trade? These questions are critical because each of these trades takes a different approach to trade management and risk. From a simple perspective, we might have a much larger position (relative to our total trading capital) for a swing trade compared to an investment. The swing trade will likely have a closer stop than the investment, which might legitimately have no stop. (Gasp.) If we get “confused” and manage a swing trade like an investment, we’re violating our rules and common sense, but also are taking a big risk on an even larger position.

So, Jim tells me he took a position at (A) with the intent of holding it for “one clean swing.” He then tells me that he should have exited because the market went sideways, but “that’s hindsight”. I would argue, that no, it is not hindsight. Rather, it is a clear violation of your intent for the trade. You thought you were buying for one clean swing, and then the market went sideways. Fine–what you thought would happen did not happen, and there’s a word for that: you were wrong. When you’re wrong, you get out of the trade because your reason for being in the trade no longer exists. That’s a critical point.

Jim’s idea was that CREE would snap back quickly. A trade is basically an experiment; he thought one thing would happen, but something else happened. So you unemotionally get out of the trade. To be perfectly honest, there is absolutely no justification for being in the trade when this surprise gap down happened, based on the information in the question. Error #1: not exiting when the reason for the trade was violated.

Are you reading the market correctly?

Another question I would ask Jim is “you did realize you were doing an aggressive countertrend trade, right?” Was your thesis that this was a stock in a strong uptrend that had a minor collapse, or did you realize that a short-term uptrend was violated with extreme volatility? Here’s the chart of CREE again, with a few more points marked for discussion:

CREE analysis

First, you need to look at the big picture. Go look at a weekly chart (not shown here), and you will see that CREE had been in a pretty significant downtrend (from 75.00 to 25.00) since about 2013. This is the context: this is a stock in a longer-term downtrend. Now, maybe we think we identified a trend change in late 2015/early 2016, or perhaps we simply wish to trade a long position in a dowtrending name. This is fine, but let’s at least understand that this is not a strong and intact bull market in this stock.

Now, here’s why we use volatility-adjusted measures: the decline at (A) was a -4.2 sigma decline, the largest volatility-adjusted decline since June 2015. In addition, this selloff put the market through the lower Keltner channel–certainly an extraordinary single-day move. If nothing else, we can look at the chart and see that this is a really big down bar (that’s very technical language there!) If we need further confirmation, we see that the MACD made a new low (relative to its own recent history) at B, indicating that momentum has shifted to the downside–this is a significant change of character to the downside. I would ask Jim if he saw that at the time. We should have been thinking short, not long.

Actually, this trade setup is one of my favorite trades–this is pretty close to a textbook Anti pattern, which is a strong setup for a short trade. Now, maybe Jim just missed this in real time, and that’s ok–we make mistakes. However, if he looks at this now, and has been through my blog, trading course, and book, I would gently suggest that he needs to review basic trading patterns. Familiarity with the Anti would have prevented this trade entry, or at least emphasized the danger in the trade.

Trade management

Now, none of this is hindsight. The lower channel was touched. MACD made a new low. We had a very large sigma single day decline. These are objective, readable price structures, and they must shift our focus to the bear case. Jim may still have a trade here–you want to buy this because you think it’s oversold? That’s a legitimate trade, but then you must consider the expectations of that trade. You are now in an aggressive countertrend trade. Your job is to take profits quickly (probably within a week), to move the stop to breakeven quickly, and generally, to reduce risk. I don’t want to create a fearful environment, but you just pulled a pin on a hand grenade and let go of the spoon. The clock, in other words, is ticking.

Jim thought he was in for “one clean swing”, but the doji at (C) led to a decline that took the market through his entry price at least twice. You were back to breakeven on the trade twice. Does that seem like one clean swing? In addition, without knowing where his stop was it’s hard to know, but the trade probably stood at +1.0R before going back to breakeven. We had some sharp down days (D), that were also inconsistent with your long idea. Was the trade working, or were you hoping?

Unpredictable events

Shit happens in trading. There’s no other way to put it–sometimes bad things happen to good traders, and bad things happen to good trades. However, it is also remarkable how often events align with clear technical structures. I’m not sure anyone knew why the stock declined at (A), and that makes me very suspicious. I’m sure Jim has spent a lot of time wondering how he could have predicted this loss. It does happen. (I remember losing 5R or so in a YHOO trade back in the day.) But it doesn’t happen that often. The issue is not predicting the unpredictable–in this case, it’s being long in a stock that is clearly showing weakness, and that’s a lesson that can be learned.

Everything else

Now, I can also see the pain and suffering in Jim’s message. He talks about his fragile trading morale, and his frustrations with learning to trade. As we know, there’s a whole industry offering succor to struggling traders in the form of trading psychology. So often, I think the answer to trading psychology is doing the right thing. In this case, Jim was doing the wrong thing: he was in a stock with a clear bearish setup, did not leave the trade when his long thesis was violated, maybe was unaware of the danger in the long position, but did not manage the trade appropriately. The psychological distress is a natural consequence of being out of phase with the market.

I hope this has been interesting. What’s Jim’s best course of action here? To review the chart and the pattern, and make sure he understands it. Perhaps to review other charts and look for similar patterns. Perhaps to consider a trading rule like “if I see a large shock against the trend, I will treat any mean reversion trade as aggressively countertrend. I expect countertrend trades to snap against me. I will reduce my risk as appropriate.” And, perhaps, to reconsider his trade management plan and to be sure he has a clear plan for with-trend and countertrend trades.

One last little “trick”: Something that has served me well over the years is that I now expect any trade I get into to be a losing trade. I know I’m about a 50% trader who makes more, on average winning trades, than he loses on losing trades. I literally assume that I am wrong when I get into any position, and then my mindset shifts to making the trade prove itself to me. Why am I going to stay in a trade that’s not working? I’m probably wrong anyway, so I’ll just get out and move on. This might seem like a strange way to think about positions, but it is a good way to manage your psychology, expectations, and to lessen the influence of confirmation bias.


Adam Grimes has over two decades of experience in the industry as a trader, analyst and system developer. The author of a best-selling trading book, he has traded for his own account, for a top prop firm, and spent several years at the New York Mercantile Exchange. He focuses on the intersection of quantitative analysis and discretionary trading, and has a talent for teaching and helping traders find their own way in the market.

This Post Has 12 Comments

  1. Ernie

    Adam, I enjoy reading your blog and thoughts, thanks for doing them. In your blog a couple of weeks ago you wrote that “For intraday traders, highs and lows of the day do deserve respect”. Would you mind expanding on what you meant by this? Respect because highs and lows of the day are tough to break or respect because things move fast directionally once they are broken? I’m sure you have stats for this just like you had for Fibonnacci. FYI I would have responded in the comments for that post but I’m guessing you don’t read them after a few weeks. Thanks for any help

  2. cesarcf1977

    Hi Adam. I may have read so many authors at this stage, but just eyeballing the chart (hindsight, of course) I was thinking it’s a nice recent resistance (tested 3 times) now becoming support (L. Beggs), with a huge sigma move at/below channel (you), candidate for a quick pullback to value (the EMA, A. Elder)…we certainly won’t learn to trade just reading, but I don’t understand how some people actively discourage reading as “books won’t teach you how to trade!”. We may agree to disagree.
    By the way, how the h*** do you learn to enter into a trade convinced that you are wrong? I mean, psychologically, at this stage I can’t see myself pulling the trigger if I wasn’t at least remotely confident in the chances of my trade working. I got the point of honouring my stops 100% of the time (huge improvement), but that next step seems tough…I may not even understand it properly. I mean, you have data that supports your setups, you know “you are right” in the long run, how do you convince yourself otherwise? I mean, I could talk myself into it, but I probably would not believe me, I’d believe the data…Regards.

    1. daniel.mobidia

      I think it’s right to say “books won’t teach you how to trade!”. I learned trading by trading. I was really angry after a few hundred trades because my account was down over 30%. I then reviewed each of my trades and found the problem and turned around. I now simply buy when the market goes up and sell when the market goes down. I don’t use indicator. But I do look at the direction of the market.

      1. daniel.mobidia

        I don’t even wait for a pullback. I hate to miss out a strong market without a pullback. I get out immediately if I’m wrong without hesitating a second. If the market resumes its strength right after I sell, I’ll buy them back immediately. I would try 3 times to make a good trade or move on if it doesn’t work.

  3. Blue Octopus

    “So often, I think the answer to trading psychology is doing the right thing.” Thanks. Exactly. I’m putting that on a poster beside my computer.

  4. Edward Jenner

    It seems like a reasonable trade to me, with a stop just below the low at A. However, in my mind it did pull back to the ‘moving average’ – whatever is used in the charts or about 1/2 or the 3 day drop, so it seems to me the target was hit and anything past that is ‘extra’.

    The initial stop is relatively tight (1/4 the Band width or less). So either you are not expecting to be in the trade long or the stops you use may in general be a little too tight and result in getting stopped out a lot – hence the frustration?

    I guess it is just my style or thought process, but the way I see trading is that the longer I’m in a trade, the more chance of something bad happening (shoot, sometimes you get trading halted on a stock and it opens 50% lower during the day). So personally I always take partial profit, at least at 1R and make sure I’m never holding a ‘large’ position overnight. Just looking at the character of the stock, with the stop in question, I couldn’t imaging holding that position size for more than 1-2 days and even 1/2 the position for more than 5days – if it really just keeps on going up I might hold 1/3 to 1/4 the initial position for as long as possible.

    Just some thoughts trying to help anyone else reading this.

    1. daniel.mobidia

      The uptrend was broken by the ugly long bar and it got into a busy zone(other people call it consolidation or balancing). Based on my experience, what comes out of a busy zone is like tossing a coin. As you said a quick scalp or two should be fine. I normally don’t trade these kind these days because the direction of the market is not clear.

  5. Ashton Maggs

    Adam – great post! You mention the trade probably reached 1xR (1 x risk), but you might like to remind Jim what you do at 1xR – which is to sell 50% of your position – period. This helps smooth returns and reduce risk on a trade. One may even go so far as to say on these very short-term swings (mean reversion ‘snap’ over 3-5 days Vs momentum entry after a days/weeks consolidation), you should exit your entire position at 1xR, as this is a very good return for a 3-5 day trade (i.e. don’t get greedy).

    Does Jim use any bands (e.g. Keltner Channel – which adjust for volatility Vs Bollinger)? Bands are not a black and white thing – they simply provide context as to whether prices are closer to extremes or not. And although this was a dramatic -4.2 Sigma day at A, I know a lot of swing traders would not be picking a ‘snapback 3-5 day’ trade where price is still within the bands. You’d simply get too may signals. Yes, equity markets have a tendency to mean revert after a big move, but potentially Jim was picking a sub-optimal trade set-up (i.e. although a big downward move triggered his entry, it would not even come up on my radar, as there had been no closes below the band. (Jim – FYI Adam’s research gives you a daily list of stocks which are ‘over-extended’ (outside the bands) and is a good universe to start from for ‘snap-back’ mean-reverting 3-5 day trades).

  6. A_Joe

    Many Lessons from this One Trade; Thank You Mr Adam,
    Friend (Jim) – Let this trade bring you – one step closer, to the next Winning trade..

  7. Chris M

    Great post Adam! I learn a lot from real world examples, such as this one.

    My 2 cents for Jim and others, analyze each trade from both the bullish and the bearish perspective before entering. Sometimes our minds see what they want to see, until we consider the alternate scenario.

  8. Randy Kelsey

    This is one of the most educational pieces from Adam since I started following his material. This is a real case study that has many applications. Speaking only for myself, Jim is not alone in his current situation. It is going through the hard work that will make us all better traders.
    To Adam’s point about thinking all trades will be losers. I have cut my original positions by 50%, and then adding to them as the market confirms my original trading idea. If the market does not confirm my idea, I am out with a very small loss and move on. This helps me with the trading psychology as it is a small position and I feel no pain if I am wrong. This also helps me see more clearly what the market is actually telling me, as I have very little skin in the game, and I can remain highly objective. From a money management perspective, I helps me have more chips on the table when I have winners and very few chips when I have a loss. This is a little like card counting in Blackjack. Increase your bets when you know you have an advantage.
    Enjoy the path to being a better trader.

  9. Adrian

    This doesn’t look like a farewell post…
    Adam, I hope you are doing just fine and we wait for new interesting, subtle and no-nonsense ideas that you familiarized us with.

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