Playing the Percentages: Exceptions Happen

As a Momentum Trader, I play the percentages. That means I track patterns so I can assign a fairly accurate win-loss percentage to each type in various market conditions.

When certain patterns appear and move as expected, I decide whether to trade on that pattern based on these percentages. Over time, this works and, in the end, I win more than I lose.

But does it always work? Does every pattern that I assign a high win percentage do what I expect? Certainly not! Sometimes they turn into what I call exceptions -- doing the exact opposite of what I expect.

Consider VeriSign's (VRSN Quote) performance two weeks ago. On Sept. 7, I watched VeriSign in the premarket because it was gapping up and news of an upgrade had hit the streets.

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As the chart above demonstrates, VeriSign closed on Sept. 6 at $34.16 and opened the next day at $34.41, gapping up $0.25.

But as the above chart shows, the Nasdaq itself was gapping down 10 points. The upgrade news was good, but not that good in my early estimates. From the buying percentages in the premarket, I expected both VeriSign and the Nasdaq to have a small buying spree, then drop, making the first top on VeriSign a good short.

This third chart shows that the Nasdaq did exactly that: It climbed immediately after the open, then, at 09:34 EDT, dropped like a rock. In fact, most of the stocks on my screen dropped, too. Then I looked at VeriSign, expecting it to top out.

At 09:35 EDT, the buying decreased, pausing before selling started. At that point, I entered a short position, which I estimated to have a 70% chance of success. I nailed the top, and it started to drop, but less than half a point, then bounced, which I didn't expect. Such a spike was contrary to the overall movement of the market. So I exited the trade with a quarter-point loss as the stock continued to climb.

Take another look at the above Nasdaq chart. At 10:08 EDT, all the stocks on my screen started to plunge. I was ready to try another short sell on VeriSign. At this point, the stock was up almost two points from the open. I estimated an 85% chance of success at this top, and VeriSign did, indeed, top out one minute later. The Nasdaq continued to drop like a rock the entire day, but VeriSign didn't follow as I expected. After a small dip, it continued to climb, closing at $38.55, more than 4 points higher than it opened. I was late exiting and lost another half point on this trade before I covered.

Contrary to what you might think, this was a good trade. I did lose three-quarters of a point, but I did exactly what I normally do, and exactly what I should have done on this trade. My tracking showed that this type of pattern, in this type of market, should have made a great short. Even though it turned out contrary to what I normally see and track, I kept my stops and moved on to the next trade, not letting this "exception" manipulate my trading program.

Trades like this will happen, and so will those that follow what I expect from my pattern tracking. I play the percentages, and, over time, if I stick to what I know works, I will win more than I lose. Don't let a few exceptions ruin a disciplined trading program. Keep those stops!