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Trading Tools and Tactics: Reading the Mind of the Market by Greg Capra

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Chapter 13

Making Failure Work for You

Recognizing When Patterns Fail

You might wonder, “What is the purpose of having a chapter that discusses failure?” Obviously, if you are this far into the book you realize that not all patterns work, no matter how accurate the method. It is always a matter of probability and trying to get the odds in our favor as much as possible on every trade. Therefore, some good patterns will fail, and that is precisely why we put a protective stop loss in place. If we can always maximize the potential gains from our winning trades, and limit all of our losing trades to the intended amount as designated by the original stop loss, we will be good traders as long as we can pick reasonable plays. So, since the stop loss is our failsafe, why even have a discussion about failure? There are several reasons, which we will discuss in this chapter.

First, from a psychological point of view, it is good to determine, before we even place a trade, at what point we will have considered the pattern a failure. Determining this helps us accept our stop loss and to exit the trade when there is no hope of recovering. Traders who always hang on to the hope for recovery always turn into losing traders. Defining the points at which decisions should be made before getting into the trade is always the proper thing to do. See Figure 13.1.

Figure 13.1 A Pattern Fails and Moves Quickly in the “Wrong” Direction

Chart courtesy of Mastertrader.com.

Second, under a similar theory, ...

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