Investopedia explains ‘Whipsaw’
A condition where a security’s price heads in one direction, but then is followed quickly by a movement in the opposite direction. The origins of term is derived from the push and pull action used by lumberjacks to cut wood with a type of saw with the same name.
The last few weeks the markets have rewarded all the wrong things: longs must take profits quickly or they will lose them, shorts can sit on losses and it will be okay with time. Buy and holders even got to sit smugly on the sidelines and mock active traders in this recent market environment with lots of moves that have taken us no where. But just when we think that the market is trapped in a range it will break and run on us. I think this is a great time to review the advice and wisdom that appears in the classic Whipsaw Song of market wizard Ed Seykota. It is important to remind ourselves that if we are patient in time volatility will decrease and a trend will emerge to reward faithful trend traders. We are currently range bound and will stay this way until we get a sustained break out in one direction of the other. We are currently a hostage of Europe not really knowing what that end game looks like and for how long the shell game over there can continue before they are rejected by both the buyers of bonds of the Southern European countries and the Euro bulls that will eventually lose faith in that currency. The problem is that the EU could fall apart tomorrow or could go on for many more years with games and monetary mirror. Greece having to leave could be a catalyst of systemic chaos or Germany leaving could be the end game, the finale is unknowable all we can do is be positioned to take advantage of the trend that emerges out of the smoke when the fire really starts. Where do we go from here? Where ever we go, follow these rules:
1. Do not be overly concerned about whipsaws a good trend pays for them all.
A whipsaw is when you enter a position but get stopped out quickly when the market reverses opposite to your position. If you are a trend trader this may happen many times in a row in a range bound market. This can be very frustrating to a trader and it may cause them to completely change their method. The fact is that one really good trend will pay for all of these whipsaws as long as you keep your losses small, and if you change your system you lose the benefit of that big trend.
To avoid whipsaw losses, stop trading. -Ed Seykota
2. When you catch a Trend, ride it to the end.
Your system must be able to jump on a trending market, but then also be able to ride that trend to the end. Most new traders will jump out of trades before they are finished trending because they are scared the market has gone too far and will take back their paper profits. Let a trailing stop take you out of a trade when the trend is over, and only exit once you are stopped out.
The trend is your friend except at the end where it bends. -Ed Seykota
3. When you show a loss, give the loss a toss.
Every single successful trader ever interviewed as far as I have read has said something along the lines of “Cut your losses short”,”Let your winners run.” “Pull the weeds, water the flowers”.
The elements of good trading are cutting losses, cutting losses, and cutting losses. -Ed Seykota
4: We know if our risk is right when we make a lot of money, but can still sleep at night.
Risk is the amount of risk per trade: the dollars risked between your entry and your stop loss based on your position size and what percent this is of the total capital in your trading account. Also how much your total risk is in regards to how many positions you have open at one time as a capital at risk for your entire account.
Here’s the essence of risk management: Risk no more than you can afford to lose, and also risk enough so that a win is meaningful. If there is no such amount, don’t play. -Ed Seykota
5. When price breaks through, or there is a shock news announcement – DO NOTHING. Your stops are already set.
Stick with your stop losses. Do not let anything stop you from exiting a trade based on your predetermined stop.
It can be very expensive to try to convince the markets you are right. -Ed Seykota
6. When you get a drawdown (or series of losses), stick to your plan and pull the trigger on your entry signals.
A draw down in equity happens to all traders not just new traders. This is where the trader has a long string of losses or an overall losing period. If you are averaging 50% wins in your trading, you will still have a series of 1o losses at some point in your account.
Don’t change your methods in a draw down. If you have tested your system and it works, stick to it and keep taking your entry signals or you will miss that one big trend that pays for all or most of the previous losses. There is one thing here to remember – sometimes your method has to be adjusted for market volatility or if it is range bound.
It’s all about sticking to your plan and experiencing feelings as they arise. If you are unwilling to feel your feelings, the temptation is to avoid them by jumping off your system. -Ed Seykota