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My Trading Blunders: A Lesson in Overconfidence and Risk Management from 2008

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My Trading Blunders: A Lesson in Overconfidence and Risk Management from 2008

Introduction

This article was posted on Tuesday, 06:51, UTC.

The Background

This story happened in January 2008 in what proved to be the early days of the biggest financial crisis of our generation (so far). It was also the time of your humble writer’s baby steps in the financial market. Fun fact: my first trading account was opened in September 2007, 10 days before the exact top of the bull market. Great timing. To be honest, this was more of a lucky coincidence for me than the average beginner trader, as I wrote my thesis a few months before that on credit markets, CDSs and whatnot, so I had a pretty good idea about the sorry state of the US subprime market, which was already in shambles in the autumn of 2007. I even made a bet on with a great friend that Lehman will trade in single digits in a year… color me prophetic. An important side note is my poetically young age of 24 at the time.

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Some experienced traders might stop reading at this point because the ingredients are all there for a sad, but all too common, trading disaster. A young, beginner trader with an eagerness to outsmart the market, a degree that makes him think that he already has trading figured out, and the worst blessing of all: he is right about something. The dangerous thing about being right at the right time without experience is that ALL your trades are working and you quickly forget about risk management, money management, position sizing, and the other neat things that are there to protect your capital from the biggest enemy, your ego.

It took me 5 months to reach a +25% return on my portfolio, by trading with a bearish bias in a market that was clearly rolling over. Some would say that ok nice, but nothing extraordinary. For me, it was the best of times. I was euphoric, since I was trading with a 2% stop-loss limit and a 3% initial target on my capital, and 90% of my trades were positive. Being a math guy, I naturally started compounding those returns and quickly concluded that I will be the next Paul Tudor Jones.

The Trade Of The Century

In February, 2008 it took me exactly 0 trading days to go from +25% to -10%, and at the end of 2008 I was up by 5%, in a market that was doing exactly what I thought it would. How on earth did that happen? Well, overconfidence and weekend gaps were among the main reasons, but the root of the issue is the common error of looking for the “Trade of The Century”.

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Disaster struck on a Friday afternoon on a typical Friday-Trend-Day. Day-traders might be familiar with the pattern of an initial surge (or slump) and a gradual but unstoppable drift in the direction of the trend, with sometimes a buying (selling) “panic” near the end of the session. It was a bearish trend-day, with all the major indices down by multiple percents, the VIX near the 40s, Armageddon-like headlines… one could almost hear the cries of fear and despair through the trading platform.

My portfolio was up by 5% on that day, my trades hit their targets one after the other (I was trading S&P futures, FXI (the main Chinese ETF), Morgan Stanley, and VIX futures). Near the end of the session I was watching my market window with sheer excitement (error #1), and with deep regret that I am out of my positions and not profiting off the massacre (error #2). Although all of the indicators were screaming Oversold!! I started thinking about new positions (error #3). And in a moment of pure genius, I decided to double, oh wait, triple (!!!) my original position sizes (error #4 and #5). I thought it will be a “Black Monday” like open after the weekend, with the indices limit down and me walking away with 2 years of returns in one day. Sure enough, I put up the shorts on the indices and Morgan Stanley and the long on the VIX before the market close with a devilish smile on my face (error #6), while violating ALL of my risk management rules (error #7) and forgetting about gap risk (error #8).

The Fallout

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The VIX at the time of the trade

The rest is history. It was the first in a series of bail-out weekends when central bankers and other leaders would sit down and come up with a plan to restore confidence and save the market during the crisis. By the US open, all of my positions were stopped out, and my stock shorts simply gapped over my stops, inflicting even more damage than I thought would be possible. I still remember the feeling when I saw FXI opening up by 10% (a stock index mind you); it was not pleasant. I lost a whopping 30% on my portfolio, and got sent back to square one, or more like square -2. I quit trading for a few weeks, which probably saved me from more losses, but after that, I needed a few more months to gather enough confidence to trade normally again.

The hardest part to accept was the fact that I was fully aware of the errors in real-time, I just shrugged them off with “I feel the rhythm of the market and it’s going lower” argument. That argument was fed by the feeling of being right, and almost invincible. On a positive note, these trades made me remember that I am no prophet, no analysis is perfect, and the weirdest things can happen in financial markets.

The Takeaway

This wasn’t my only mistake as a trader (I wish it would be), but for sure the most painful. Good thing is that you can learn a lot from it without committing the same errors that led to it. Simply put, don’t let your greed or fear overwrite your trading plan and your risk management rules. Don’t get me wrong, concentrated trades are great for experienced traders who are aware of the risks that they take on, but forgetting the negative part of the deal is unforgivable. In this case, I not only broke my own rules, but also ignored the fact that the assets I traded were highly correlated, so in reality, I had one huge position not 5 separate ones.

Stock correlations rise in times of crises (source: Business Insider)

Let’s sum up the most important lessons:

  • Follow your trading rules, no matter what
  • Being right is not the same as being profitable
  • Expect the unexpected in financial markets
  • Don’t look for the Big Trade
  • Be aware that market conditions can change quickly
  • Correlation sometimes negates diversification

A Timely Note on Cryptocurrencies

With the recent boom in cryptocurrencies, a lot of traders might feel like I did back in 2008; the blockchain technology is revolutionary, Bitcoin is the new gold, the market is headed for $1 trillion in market cap and you will make a fortune by investing in this technology. Remember, even if that is true it doesn’t mean that throwing caution in the wind is allowed when investing or trading the coins. Stress-test your positions with corrections up to percentage losses that might seem insane (50%, 60%, even 70%). Booms and trends in general, don’t move in straight lines, there are several emotional waves and bumps on the road.

When trading cryptocurrencies, don’t rationalize holding on to a losing trade with the “it will come back” argument. It might, but will your capital survive that, or will you panic out at the bottom? Also, in a broad correction holding several different coins might not mean that you are diversified. When the tide turns the currencies might go down together. Look at the big picture, especially when trading cryptocurrencies, and accept what the market is telling you.

As an investor, if you are in for the long run, don’t try to micromanage your holdings or catch exact turning points. Wait for deep corrections to load up, and strong rallies to ease out of full exposure if you want to trade in to the trend. This way you won’t get caught in the daily fluctuations and won’t mistake trading with investing.

What’s Your Story?

I hope that this story will help you in your path to financial freedom, and you will remember the lessons of it when the time comes. Please feel free to share your experience, trading errors, or questions regarding this post so we can all learn from it. I am positive that all traders have some similar (hopefully less painful) stories to tell.

Important: Never invest money you can't afford to lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here.



Feedback or Requests?

Mate Cser

Mate Cser

Trader and financial analyst, with 10 years of experience in the field. An expert in technical analysis and risk management, but also an avid practitioner of value investment and passive strategies, with a passion towards anything that is connected to the market.

Comments
  • user

    AUTHOR jedadoo

    Posted on 7:00 am May 16, 2017.

    This is wonderful. Thank you so much for sharing and keeping us grounded. I’ll take this to hear!

  • user

    AUTHOR Lukem

    Posted on 10:42 am May 16, 2017.

    Thanks for story, I do enjoy your blog and the whole website. I really am interested in trading but I’m struggling at the moment. Would you be interested in mentoring me?

    • user

      AUTHOR Mate Cser

      Posted on 3:35 pm May 16, 2017.

      Hi Lucas,

      I am glad that you enjoy the site! We have a personalized mentoring solution in the works, we will keep you posted on that. Until then feel free to ask anything in the comments, it might help other members as well. Believe me, all traders face bad times, with similar psychological hurdles. We are here to help overcome them!

  • user

    AUTHOR pgobbato

    Posted on 8:23 pm May 16, 2017.

    This all rings so familiar, thank you for sharing. I got into the crypto trading world a couple months ago. I caught the boom, and placed my investments well, and doubled my initial investment and then some. On a big rush from winning, I opened a huge margin long position… You can imagine what happens next. Poloniex down, couldn’t close position, by the time I could take action again my account was about to hit maintenance margin. Thinking it couldn’t go down any more, I kept my position open. That night it rock bottomed, my account was liquidated, lost about 3/5ths of my portfolio.

    Tough lesson to learn, could have been worse, I suppose. Thanks you again for sharing!

    • user

      AUTHOR Mate Cser

      Posted on 12:56 am May 17, 2017.

      Thanks for sharing this tough experience, it’s not easy to resist the euphoria and the greed. Don’t let this stop you from harvesting strong trends, just have a risk management plan, and stick to it. Holding a core position, and trading with a smaller amount usually helps with dealing with the “Fear of Missing Out”. Good luck out there!

    • user

      AUTHOR majykman

      Posted on 2:21 am May 17, 2017.

      wow I just realised our comments basically have the same story haha. Good to learn this kind of lesson early though.

  • user

    AUTHOR majykman

    Posted on 12:25 am May 17, 2017.

    Great article. Very relatable. Polo has been hitting people hard recently with the ddos attacks at crucial times. I’m new to trading really and I got confident because I’ve joined the game at a good time and just seem to make all the right calls until Polo crashed seconds before I tried to close a margin. That’s when I realised I don’t know half of what I need to know about trading haha. I left stop loss of one time and bam that one time. But the choices I made is why I lost 80% of all I’d made that month and now it will take more then a site crashing for a while to make me take such a loss. Lot’s of lessons learned.

    • user

      AUTHOR Mate Cser

      Posted on 1:21 am May 17, 2017.

      Thanks! I am glad you realize that it’s not just the exchange’s fault, that’s the good mindset. Thing is, when the market moves quickly, crazy things happen – glitches, flash crashes…- so again we have to expect the unexpected… Thanks again for sharing!

  • user

    AUTHOR Mac

    Posted on 10:55 am May 23, 2017.

    Thank you for sharing such valuable lesson. I just recently learned my lesson when I dumped all my Bitcoins into Ripple after it had already nearly peaked. I then panicked and changed my entire position back to Bitcoin and woke up that morning only to discover Ripple still climbing. However, it was truly now at its peak and I still changed back to Ripple. It began falling and I kept changing my positions to other coins that didn’t move. By the time I slapped myself to wake up my portfolio was down by 25%. Fortunately I was able to partially recover and I’m now down by 12%, but it’s a lesson I’ll never forget.

  • user

    AUTHOR Elyad

    Posted on 4:49 am June 10, 2017.

    a week ago I made a mistake and bought peer coin in hype at 0.00105 and now its 0.00077.
    what should I do in this situations? should I buy and accept the loss or sell and invest in other oppotunities like byte coin ?

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