How To Profit When Nothing Is Certain

As I get older, I increasingly derive a great deal of satisfaction from sharing with others the lessons learned over nearly twenty years in dealing rooms around the world. There are some lessons that are worth remembering in general life as well as at a trading desk. As a trader I knew once proved beyond a doubt, for example, using scissors to cut through the power supply cable in order to punish and kill a computer that has dared to show the market moving against you is a bad idea. (Yes, Henrik, wherever you are, I am talking about you.) Some lessons, however, are specific to the market and, if understood early enough, can ensure a long and successful career. One of the most fundamental of those is that trading offers no certainties.

That may seem like a statement of the obvious, but if you start using a system that produces a run of winning trades it is easy to believe otherwise, and that is the most dangerous belief a trader can have. Certainty that your trades are certainties leads to only one certain thingconclusion…a spectacular bust at some point. The belief that you cannot be wrong makes cutting losers and managing losses almost impossible, and it is that, rather than picking winners, that separates the career traders from 90 percent or so of trainees who fail.

Once you accept that any price can move in any direction, some less obvious trades often look smart. Take oil, for example. I have been saying for some time now that the more times WTI approaches the $62 level and then backs off, the more significant that level becomes. We saw exactly that again this week, marking the 5th time since the beginning of May that futures have powered through $60, only to back off again.

On the surface, increasing the significance of a resistance level like this makes it more likely that at some point soon the downside will be tested, but that isn't the only significance of a solid chart point. It also means that a break in either direction is likely to be exaggerated. Shorting futures or, for those who trade only in stocks, the US Oil ETF (OIL), is a fairly obvious play from here but it is one that, because it is so obvious, it is becoming a little crowded as a trade. If WTI does break above $62, all of those shorts being squeezed will provide significant momentum to the upside.

Short oil looks like a certain winner, but as we know there is no such thing. It is important to have a plan for if things go wrong and the strength of the resistance level suggests one; placing a stop above the level, but for twice the size of your short position. If we do break above $62, stop loss fills are likely to be pretty ugly for most of us, but the upward momentum should be sustained, meaning that transitioning to a long position will give the opportunity to at least get back some of your losses, or maybe even turn a loser into a winner.

The most likely thing for oil from these levels, given this week's price action, looks like a move down, but a break to the upside, resulting in a sharp run up that is still a possibility. Setting a trade in advance to quickly flip to a long position if that happens is a logical thing to do.

Of course, now that we have accepted that there are no certainties in trading we know that none of this is certain either. We could fake above $62 and then track lower, meaning that you would be left with a double loser, but hey, I never said it was easy! On balance, though, so long as you are aware of that risk and prepared to cut quickly if that scenario does present itself, employing this strategy provides profit from the probable with protection from the possible; the kind of trade I was trained to look for.