Today’s guest post is by Tom Morton.  Tom started his career at the Chicago Mercantile Exchange in 1996, working in the Eurodollar futures pit, then moving to the Nasdaq 100 pit in 1998. In 1999, Tom left the floor and began building a successful career trading individual equities.  He is the co-founder of The Equities Room.

Trading on Tilt is something that just about every successful trader goes through from time to time.  It’s basically a disruption of the normal discipline and trading style that had helped a trader find success, causing him to make irrational decisions.

For me, I think it is important to understand how and why tilt happens so that I can help prevent and/or limit the damage it can cause the next time it rears its ugly head, which is part of the process of becoming a better trader.

With that in mind, let me illustrate one of my first experiences in trading on tilt, which I lovingly call….

“The After Hours Fade Trade Gone Bad”

For a bit of background, I had been trading for a number of years, made it through the dot-com crash and had started putting up some pretty consistent numbers month over month and year over year. I was confident in my own style and ability as a day trader, and I had been coming off an especially good run of late.

I had no qualms about trading after hours earnings reports, as I usually kept my share size small and was able to capitalize on the wide spreads and overreactions in stocks that had released earnings reports.

One day, I happened to see that $CREE had come out with an earnings report that read, (I’m sort of paraphrasing here, but this is how I remember it), ” in-line EPS and Revs for the current quarter and guiding lower for the next quarter by a few cents.”  I thought nothing of it, as it didn’t seem like a big enough beat or miss to get me involved in an after hours trade.

A few minutes later, my friend who was sitting next to me pointed out that it was trading a couple bucks lower…now down almost 15% or so.   It seemed like an overreaction to a somewhat modest miss so I decided to bid some, a relatively small amount, due to the fact that it was a knife catch play and that we were in the thinly traded after hours session.

Immediately the trade was a loser, and the stock dropped another buck or so…and it did so with one single offer that kept refreshing and dropping his price.  This is where my thought process on the trade first changed.  My original little bottom picking scalp trade was now turning into a battle against this single seller.

“Once this offer leaves,” I thought,  ”this should get a relief bounce…especially since its now down over 20%.  Time to buy more.”  I did, and wouldn’t you know, the annoying offer left and I thought I was in the clear.  The stock immediately jumped back up a bit, and had I been offering out, I may have been able to come close to breaking even.

Honestly, I can’t remember if I didn’t exit the trade there because I was being greedy, or if it was because it happened quickly and I couldn’t get my offers out fast enough.  Either way, the window of opportunity closed quickly and I didn’t get out, and that awful seller was back taking everything on the offer and dropping the price again to new lows.

Now, with a pretty big position on, and my P/L getting uncomfortable (nothing disastrous yet..but about equal to what a pretty bad day would be), I had a decision to make.

As you might have guessed, I made the wrong decision, and kept adding to the trade.   Pretty soon, I was numb.  I was trading a position size that I never would be in during the regular trading day, let alone the after hours session.

I began to justify what I was doing in all sorts of ways.   First, my goal was to break even, then it was to get back ½ of my losses…by the end, I just wanted to see ONE STUPID UPTICK!  The stock was now down 35+%, without hardly any sort of relief bounce!!!   Unfortunately for me, it never bounced that afternoon and by about 6:00 that night, I finally dumped the position.

It was a killer loss for me.  In one after hours session I had lost more than I ever had on a single trade or in a single day and had wiped out a month’s worth of gains.  What started out as an innocent fade trade for a quick scalp had turned into my worst trade ever.

What I know now about my own trading psychology is that this scenario had all of the characteristics that are common in my trips into the “Tilt Zone.”

• First, I had been coming off a good run and was likely trading a little bit too confidently.
• Second, I scrapped my original trade plan and I tried to “out-think” the trade.
• Third, I ignored the chance to cut the trade when there was still a chance to limit the damage.
• Finally, the shock of the losses on my screen teased me into trading angrily and out of my comfort zone, trying to make up losses by adding bigger position size.   It was a snowball effect of poor decision-making.

If I have learned anything in my years in this business, it’s that you need to be honest with and about yourself in order to have success.   Though this was the first time I went on Tilt, it wasn’t the last time, but I do my best never to forget it, treating it like a scar, in order to remind me of some of my potential failings as a trader.  By acknowledging and improving on those failings I have become that much better of a trader.

Follow Tom and The Equities Room On StockTwits.

Subscribe to bclund.com Via E-mail or Via RSS

(Note: If you are new to my blog, I post about all sorts of things.  Sometimes it involves something extremely personal, like creating a 30K baby or my Monster Trades.  Other times it deals with hot ex-porn stars who trade stocks.  And sometimes it’s about how to avoid “suicide”.  But a good place to start is The Best of bclund.  If you like what you read, please tell a friend.  If you don’t, please tell two friends.)

There is really no such thing as an “easy” market to make money in, however some types of markets are more conducive to success than others, and right now we are in the middle of one those types of markets.

If you are not making money in the market right now, you need to seriously re-evaluate your trading (and conversely, if you are making money hand over fist right now, you need to make sure it is because of your trading, not because everything is just going up).

So if your trading P/L is currently bleeding red, here are ten tips that might help put it back in the black.

1.  Cut your position size – Everybody goes through losing streaks, and if you are in one right now you should be progressively cutting your position size down until you return to your winning ways.  This ensures that you are trading the smallest size during your worst periods. Think of it like an out of control night in Vegas; as it gets later in the evening you should be drinking less, not reaching for the beer-bong.

2.  Stop trying to short stocks –  No matter what type of market we are in, short selling is probably the hardest thing for a trader to do profitably on a consistent basis. Those that can are part of a very small and specialized group of traders.  It may seem “cool” to try to make your money selling short, but what is really cool is just making money. Besides every time you short a stock, somewhere a kitten dies.

3.  Trade less (make more) – Take it easy Racer X, you don’t have to be going full bore all the time, (besides you’ll never catch the Mach 5 anyway).  There is no law that says you have to trade every day of the week.  If you are consistently losing money right now, trading more often will just increase your rate of loss.  Dial it back a bit and take that extra time to review your charts and find optimal set ups.  Then maybe Trixie will finally pay attention to you.

4.  Stay out of low-priced stocks – Trading cheap stocks may seem tempting, especially if you have a smaller sized account, but these types of stocks are often illiquid with wide spreads relative to their price.  Not unlike short selling this is a very specialized trading niche, and right now there is no lack of well capitalized and liquid stocks making nice moves in this market.

5.  Pay attention to what the market is telling you - If out of the blue your wife starts going to the gym, getting “elective” procedures, and wearing high heel boots to “work,” you better pay attention or know a good divorce lawyer.  Each time the market takes a nosedive I see the streams come alive with traders closing out their longs, or going short. But that is not what the market has been telling you.  It has been telling you that this is a “buy on the dip” market, where you add to your longs on support and you certainly don’t short there.  At some point this will change, but until then don’t try to go against the grain.

6.  Trade in the best sectors – The overall market tone is the most important factor in moving individual stocks, and right behind that is sector performance.  If you are not trading stocks in the sectors that are moving with the market, you are putting yourself at a great disadvantage.  Just look at the coal stocks during this recent rally; they have been nothing but dogs.  Make sure that you are trading stocks in the sectors that are moving up with the broader market.

7.  Check your methodology – Or more importantly, make sure you have a methodology.

8.  Review your risk/reward ratios – Are you averaging larger losses on your losing trades that profits on your winning ones?  If so you need to adjust your risk/reward parameters when entering a trade.  The minimum you should strive for is a 1:3 ratio, which means you can “win” on a smaller number of trades and still be profitable.  For more info take a look at my “Deconstructing A Trade” videos where I cover that subject so often you will want to puke….but in a good way.

9.  Eliminate external distractions – One day in 2005 I was battling a bad market, a bad Wi-Fi connection, and was forcing bad trades.  Even worse than that, my wife kept bugging me every three minutes or so. “Honey, can you come over here?”  ”Yeah, yeah, just give me a minute,” I would say. Finally she said, “honey, I think the baby is coming!”  Out of deference to her, and the doctor, and the nurse, and the intern staring at me, I closed my laptop and stopped trading for the day.  (Oh man, I wish I was kidding about this story). Point is, if there are distractions in your personal or professional life, they can often cause you to lose focus in your trading.  If you can’t eliminate them, it might be best to hold off on trading until you can get a handle on them.

10.  Subscribe to a trading service – As I have written about in the past, I am a big fan of quality subscription services.  If you are a beginning trader it is like having an experienced mentor, and if you are a seasoned trader, it is like having an extra pair of eyes on the market. The money you make in trading spends the same way no matter if you found the trade yourself, or somebody else gave you a heads up on it, so put your ego aside and make good use of this “tool.”

And of course most importantly, finding an interesting and informative free blog that talks about the relationships between the markets and life, in a humorous and relatable way, will take your mind off your trading losses and let you relax.  Just make sure you can subscribe via E-mail or RSS.

Why not subscribe to bclund.com for free  Via E-mail or Via RSS and follow me on StockTwits and Twitter?

What bclund is, is the intersection of markets, trading, and life (with some punk rock, pop culture, and off-beat humor mixed in).  Check out “The Best Of bclund” to get started.