Dear Reader,
On Tuesday, I gave you everything you need to start building your trading plan.
Once you have yours in hand, it’s time to put it to the test.
But I want to offer you a word of caution before you dive in.
Because there’s a certain myth that’s being fed to traders – especially newer traders.
I’m even willing to bet that you heard it when you started trading, too.
And you might have centered your entire trading methodology on it.
But here’s the thing…
Even if it seems like what you heard is paying off, it will eventually hurt you – and your pockets.
Today, I want to make sure you’re ready to spot the difference between a good trade and a bad trade – and it’s not as easy as you might think.
Let’s get started…
A “Good” Trade Does NOT Have to be a Winning Trade
As a trader, you will constantly evaluate your success – that’s part of the job. To be honest with you, this is probably something you’ll try to do after every trade, especially early on.
Each time you close a position, you will almost always feel inclined to judge whether it was a “good” trade or not.
And while this may not sound like it’s a bad thing, here’s the problem…
There’s a long-standing myth out there that a winning trade is a “good” trade, and a losing trade is a “bad” trade.
This destructive thinking has led nine out of every ten traders deep into the red within their first 12 months of trading.
What’s even worse is that it’s become the barometer that traders use to base their trading strategies on.
And I just don’t want to see you join this statistic.
So what is a “good” trade?
Let me run a couple of scenarios by you to offer some perspective…
Scenario 1: The stock moves down and you “stop out” with a 50% loss
In this case, you buy a call option for $4.00 ($400 for one contract). You anticipate that the stock will move higher and plan to close your position out for a double (a 100% return on investment).
And if this move doesn’t happen…. well, you covered yourself by entering the order as good-til-cancelled – and with a stop in place at 50% of the option’s value. So no matter what happens, you’ve got a plan in place to preserve at least half of your initial capital.
The stock moves down, dropping the total value of the option from $4.00 to $2.00. Your position gets closed at $2.00 – giving you a 50% loss ($200).
Out of curiosity, you decide to check on that stock a few days later to see what happened after your position was closed. Fortunately, you got out when you did because it ended up falling all the way to zero. This means that if you had held on to that position, your contract would have become worthless – and cost you the entire $400.
Scenario 2: The stock goes up and you hit a double
In this case, you buy a call option for $4.00 ($400 for one contract). You anticipate that the stock will move higher and plan to close your position out for a double.
The stock moves in your favor, and you reach the double. So you decide to close out your position and pocket the profits.
Out of curiosity, you decide to check on that stock a few days later to see what happened after your position was closed. But the stock actually continued to move higher to the point that – had you stayed in the trade- you could’ve closed out your position for four times the profit.
At the time you closed your position, you felt GREAT… but after seeing the profits that you missed out on, you now feel pretty upset.
So which of these scenarios is the “good” trade?
This is actually a trick question…
The answer is both.
Now according to this myth we talked about above, the “good” trade should be the winning trade – scenario two.
But here’s why we’re debunking this today…
Both scenarios are actually “good” trades because of one key element: discipline.
In both cases, you came up with a game plan, executed it, and stuck to it.
And although you lost money in the first scenario, the discipline you applied to your trade saved you from losing 100% of the money you spent on it.
In the second scenario, the discipline you applied to your trade doubled your money. Sure, you may have missed out on four times the profit…. but had you not exercised discipline, the stock could’ve moved the opposite way – handing you a 100% loss.
Just because a trade winds up being a win doesn’t mean it was a good trade.
In fact, many newer traders who jump into the markets without a reliable strategy are often fooled by their own early luck picking random winners.
You can throw a dart at a board and profit by accident, but that doesn’t make it a good trade.
So the next time you’re judging your trades, forget this nonsense that a “good” trade is a winning trade… because at the end of the day, it’s about being a good trader.
And that means sticking to your trading plan.
Now, every trader I know has a story about a bad trade that turned out to be a winner. If you’ve got one of your own, click here to tell me all about it.
And if you have any questions about the difference between a good trade and a bad trade, you can ask them right here.
Good Trading,
Tom Gentile
America’s Pattern Trader