How to avoid getting stopped out too soon

Yesterday Tim sent out a Tim alert that he went short on RWC:

Private: Shorted 10,000 More RWC at 3.82ish...now short 15,000 shares total at 3.89ish (Wed 9th Dec, 2009)
Private: shorted 5000 RWC at 4.01

Unfortunately today he didn't like the action in the stock and got squeezed for $3000:

Private: covered 15000 RWC at 4.10ish, squeezed but safe

Posted by timothysykes on Thu 10th of Dec, 2009 09:53:37 AM

I anticipated a little squeeze and as I write this, this morning spike is failing, the stock back down to 3.90, but with the overall market so strong, this probly will not crack big today, so even though I got out 10-15 cents/share too high, losing approximately $3,000, I protected myself against a big potential spike....not a great or even a good trade on my part, but I did play it safe, as I will always strive to do, next!

This generated a lot of comments, including the following:

Kerry: the stock dipped to my SL (which wasnt too tight IMO) then recovered to where I would've made a profit if I had held.... I dont understand how to avoid it,

Tim: Kerry, this is why i never use SLs, market makers love taking them out...gotta watch your trades manually

Me: It took -$1173 loss today on RWC. I bought in at same price as Tim, and got stopped out at pretty much the same place as his exit, with a hard stop. That is too much loss for me, but I have only myself to blaim, I pressed the buttons. My current position is $64 in the green so far on a much smaller position after shorting closer to the top at $4.05.

Kerry responded: For those of us who are trying to learn your system while working full time, it's just not realistic to watch the market all day... But even if I had watched them instead of using a SL how would that have changed anything?

With all due respect, Tim might be right about the market makers, I've heard his response elsewhere. But Tim also has at least a decade experience in trading to really press the button to take the loss and keep it small.

For the rest of us, Kerry hit the most important issues on the head: Psychology, experience, and time. Tim isn't so tempted to let $3K loss turn into $4K then $5K then $6K, hoping for a turn around. The rest of us probably dont have the same discipline when we are starting out. The rest of us have to trade as if we are more castrated than "chior boy" Tim. In fact, most of the rest of us haven't even had the chance to grow the balls in the first place. Our accounts represent a bigger part of our net worth then Tim's does of his. But even if not, we still shouldn't trade stupid while we are just learning.

The much better answer is this: Part 1: Kerry, you probably set your SL based on the maximum loss amount you wanted to risk. If you trade a smaller share size, you could set your SL farther away to take the same amount of risk. Of course, with the SL farther away, your profit target may not look as appetizing, it might go from 1-to-5 to just 1-to-3. You need to make a decision, based on your trading rules, if that is still enough to interest you. And it should only interest you if you recognize a pattern with better than 50% chance of succeeding. If not, pass, or maybe trade an even smaller share size, looking only to build up your experience and win ratio. The money will come later.

Tim's advice to use only mental stop loss is reckless for most of us. Look at a daily chart for AMCE, a recent Tim Watchlist stock. On 3/23/09 (probably before it became a Tim watchlist on Dec 4, 2009) AMCE spiked from 1.42 to $5, crashed to $2, spiked back to $4, and then crashed back to $1.50 the same day. That is on 15 minute candles. If you overtraded on that, and then lost your internet connection at the wrong time, you could get wiped.

And just because you set a hard SL, there is still nothing to stop you from doing it Tim's way with a mental SL. Here's how: If you set the hard SL at a greater distance, and trade a smaller size, (let's say in this case you traded half the shares,) and set a SL 40 cents away, instead of the 20 cents that got you stopped out, you could do it Tim's way.... You could decide like he did that the action getting to 20 cents wasn't good, and cover your position ahead of the stop. Or you could just sit back and rely on your risk management that let you decide 40 cents was reasonable. You watch it go to 30 cents against you, then it turns around and heads back into profit... Alls kinds of psychological benefits: You win, while staying in your comfort level..... You get greater confidence this way in your original risk-stop-loss/profit calculation, you maintain control, and you have an emergency break at that hard stop loss to avoid wiping out your account in case you lose your internet connection, or any of a million other snafus take you away from the market at just the wrong moment.

Part 2: Tenative suggestion: Spend the time to take a look at one minute charts for previous Tim alerts, and focus on the price and volume action at the time of his alert. How long does it take you to act on a Tim alert? Often the market moves by the time you can act. Where could you have gotten in the trade? Has the stock dropped a lot by the time you could have, and is that drop often followed by some pullback before the real drop? You might consider a strategy of getting into positions only where you can get a price at least as good as Tim's original price, by shorting on a pullback. You might miss some trades, but maybe you'll miss more losses. You have to study and decide if you want to make this part of your trading rules.

Part 3: Education: You have to read some quality books by someone other than Tim. Tim recommends this himself. Focus on the books about trader psychology, they are probably the most important. Avoid other trading strategy books, or the latest indicators, they don't apply to Tim's approach. Some of the best are by Alexander Elder, Steenbarger "The daily trading coach", or maybe Martin Pring for technical analysis. Elder and Steenbarger are psychologists, they'll help you understand the psychological element to this game. Elder is great because he really gives solid risk management advice.

Part 4: Do some classic running your trading as a business stuff: Write a business plan. Write a trading plan. Study Tim's stuff and make a set of written rules that you commit to following. Augment with advice from Elder & Steenbarger, and maybe some patterns from Pring. Keep a journal of every trade: What you were thinking before you got into the trade, how the trade worked out, then grade yourself afterwards. Then follow your rules. Only change your rules until after a real clear pattern is manifest in your journal, and you see how to fix it. Dont change your rules in the middle of trading, and give them a chance to work. Be very careful with your trading after changing your rules.

Part 5: Finally, trade just 100 shares on every trade for 6 months until you see a real track record for yourself. Forget all about Tim's "I'm shorting 9 billion shares of XYZ" You're not Tim. You are not even allowed to sing in the chior yet, you still need to complete your catechism. Spend your time studying Tim, studying the other books, improving your game.

Yeah, I know we all want to be the guy that is the next I made $250K tim-testimonial. But we can't get there if we don't avoid wiping out our account by trading scared until we can prove we are trading smart.