Until just a few weeks ago, the Nasdaq had been running wild and free, up 30% since last June. That parabolic pace generated some heady portfolio gains, but I suspect it also lulled many traders into complacency.

Over the last two weeks, I’ve sensed an uncharacteristic hush in the air. I doubt it represents the stoic confidence of the bulls. Rather, I suspect it is the Silence of the Shocked.

Although the Nasdaq has tilted only about 6%, with the wind chill it feels more like 10-15%. In a down-market, “wind chill” is the blowback from using margin, which recently reached record high levels.

With full margin, a 6% decline would certainly feel like 12. And some high fliers such as Amazon (AMZN) have already plunged double-digits from their peak a few weeks ago. Multiply that by 2 and one could catch a serious cold. 

Stock traders don’t often get in trouble unless they are day traders or use full margin for their swing trades. Futures traders, on the other hand, are almost always margined to the hilt and many might not realize it.

An S&P e-mini futures contract has an initial margin around $5,000, but this contract leverages $86,000 of index value, or about 17X one’s minimum investment. Unfortunately, leverage cuts both ways.

One aspiring (novice) futures trader I know lost 50% of his account since the big flush began on January 24th. That morning he was holding a number of Nasdaq futures contracts (long) overnight and hesitated to sell into the weakness. I don’t blame him.

Considering the Nasdaq’s recent behavior, he had good reason to be optimistic.

Paul was also holding a larger size than normal, so this perfect storm of circumstances proved to be his downfall.

He foundered in a state of shock, lost perspective and began a 5-stage process similar to the one people go through when informed that they have a fatal disease. Denial/rationalization, fear/anger, bargaining, depression and a final acceptance.

THE BOTTOM LINE

To survive as a trader you need to avoid this process by taking the snowball-size loss that feels “too big to take” before it becomes an avalanche.

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WINTER TRADERPLANET JOURNAL

Stay tuned for Dr. Reid’s Trading Psychology column in the upcoming issue of the quarterly TraderPlanet Journal —released next week. Reid will address the 7 Stages of Trader Development.

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