Why We Have Rules: A Fictional Account of Last Week’s Trade Idea, SHW

investing risks, roulette, risk reward, gamblingBy Alex Salomon
This is a quick and purely hypothetical entry about a trading idea I mentioned last week; Sherwin-Williams (SHW). Although what follows can be categorized as a “what if” account, I wanted to reflect on the trading idea and unfolding “what if” scenario to provide candid feedback about the rigors of trading, and ultimately, why traders and investors have rules.

Last week, I mentioned SHW in my trading column as a trading idea, writing:

“It [The Sherwin-Williams] is currently resting near support and the Stochtastics are turning, which could mean that the recent “relative” weakness was a sign of accumulation and correction over time (not price). And thus portending to a move higher… On a longer term risk profile, I would use June 1 “remember the gloom and doom” of $124 as my risk and thus book profits at $136, $142 and trail the rest as long as possible — using a longer trail (for instance, if the stock hit $142, I would use a $130 trail).”

Well, on Thursday July 19 ,SHW announced their earnings and the stock sank in pre-hour trading, to $122-$123.

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Honestly, that would have been a nightmare to trade. Unfortunately, I have been there before, which is why I am sharing this hypothetical account (even though I had no position in SHW). And as much as I’d like to say experience makes it easier, that’s not always the case. If I had owned the stock that morning, rest assured that one of 2 things would have happened:

1. If I had NOT been in front on my PC for SHW earnings, I would have taken a loss (stopped out) and would now be “mad” that SHW “panned out”… but I would still respect my rules.

2. If I had been in front of my PC, I would have broken my own rules and taken off the $124 stop and been watching every tick lower, knowingly violating my rules. Here is what a possible play-by-play of in my mind would look like: “$123.86… it’s so close to $124, let’s see, let’s hope … I’ll cut at $123.50… I can take another $0.50 loss [forgetting that I already have a -3.2% loss] … let’s see [justification to violation], the earnings were good, it is going to bounce… $123.50 now [chewing my fingernails], people don’t get it, the earnings were good, this should bounce, I’ll keep it… $122.79, the unbeknowst low of the day [that’s my pain, I need to cut].” And I would have found a way out, only adding to my loss.

OK, SHW did bounce, hard, big time, and actually all the way back up to $132. But what if it had not? What if a gap down to $121 or lower would have printed? I probably would have scrambled to sell, maybe even made the the sell decision worse by adding to the position prior to selling (during the emotional justification process), further increasing the loss%.

So this is my investing lesson of the day: I have been actively trading for 14 years and I am very proud of my returns. And yet, I would have been tempted to violate my rules.

But as I write this, I am also very proud of my returns because I have rules and understand that they are not meant to be broken.

Pros tell you to have rules and stick to them, but many pros don’t stick to their own rules (yielding trading losses, and sometimes scandal). It is human nature to allow emotions to take over and begin the process of “hoping.” And hope + emotion is a bad recipe for investors looking for steady returns!

So, if you invest actively, don’t hope. Don’t glue yourself to the ticker action. And do not justify.

Instead, have a plan, choose levels for entry/exit, use stops and targets, and when the temptation of emotion + hope lurks, then shut the investment down! Know how to take losses: it will help you learn how to make large gains.


Twitter:  @alex__salomon   @seeitmarket     Facebook:  See It Market

Any opinions expressed herein are solely those of the author and do not in any way represent the views or opinions of his employer or any other person or entity.

No position in any of the securities mentioned at the time of publication.