Be Aware of the Path of Least Resistance
I will never forget the day a few years ago when I was watching the risk in our proprietary trading firm. It was a quiet, nondescript day. Like all days, I was watching our firm-wide P&L like a hawk.
All morning our P&L was up $3,000 to $5,000.
We had 25 traders trading mostly Eurex Bund, Dow Jones EuroStoxx 50 and DAX. No single trader was ahead more than a couple of thousand and none were behind more than a few hundred.
Just another normal, quiet day…
or so I thought.
Then I looked at my P&L screen and saw that we were no longer up $5,000, but we were down $10,000 then a second later we were down $50,000, then $110,000.
I raced out of my office and asked the traders what was happening in words not suitable for polite company.
The traders replied similarly that they did not have a clue, but the DAX and the Dow Jones EuroStoxx 50 were in free fall.
Seconds later when I looked at my P&L screen, it showed us down $215,000 for the day.
Almost all of the loss was from one senior trader, Jeremy, who had a modest-sized Dow Jones Euro Stoxx position of 20-30 contracts that had gone horribly wrong.
By the time I talked to Jeremy, minutes later, the market had started to rebound and recover some of the loss. Jeremy and I agreed that he would let the market rebound, and when the rebound stalled, he would exit the trade.
The market continued its rebound for a few minutes until, unbelievably, Jeremy exited the Dow Jones EuroStoxx 50 trade with a comparably modest loss of $5,000.
Jeremy did exactly what we had agreed. The rebound stalled and he got out.
He took a $5,000 loss when we could have lost over $200,000. Most traders would have waited the few more ticks to get out even, but Jeremy got out when the rebound stalled, as we agreed.
The market never recovered to where it started the plunge and, after Jeremy got out, the market took another dramatic plunge lower.
Had he waited to get out without a loss, he would have faced a loss of not a few thousand dollars, but tens of thousands.
Shortly after Jeremy exited his trade, we heard that a German bank trader had oversold a position in the DAX by thousands of contracts causing the precipitous drop in prices.
What began as a mistake ended up starting a drop in the market that lasted for days. What the error in the DAX revealed was the weakness in the market and the ease with which it could fall.
This reminds me of Thursday’s 998 point drop in the DOW.
Everyone is asking, how could this happen?
This may eventually reveal a lot about the systematic weakness in electronic markets, but, to me, the most important thing it reveals today is how easily the market falls. The market has tipped its hand and shown us the path of least resistance.
Just like Jeremy and my experience with the DAX error, what starts as a random event may reveal a great deal about the future direction of the market.
It is more important to learn from the price action than it is to figure out why it happened.
We just need to be aware of the path of least resistance.
To find the path of least resistance to success in your trading, you should look into my Electronic Trader Mentoring Program.
Wishing you success in your trading, this is Jeff Quinto
Copyright © 2010 by Jeff Quinto, All rights reserved