Lessons From a Losing Trade - TheStreet

I purchased three stocks last Tuesday:

Commerce One

(CMRC)

,

Ciena

(CIEN) - Get Report

and

Rambus

(RMBS) - Get Report

. The good news is I bought them at the close and slept that night like a baby. The bad news is, these trades did not turn out very well for me.

Before you shout, "The king has no clothes!", realize that you can learn just as much from a losing trade as you can from a winning trade. Hey, if I only made winning trades I would be in Hawaii drinking those florescent umbrella drinks with Don Ho.

I purchased these stocks because they all ended up in the upper one-third of the pattern for the day, they had positive momentum, traders showed huge interest and the market was looking positive overall at the close. In addition, more government inflation numbers were to be released on Wednesday, and from all indications, they were very positive. I had intended to hold these stocks until they closed below the midline of the trading pattern (for more on this midline trading strategy, see my May 1

column), or the market waved one of its subtle warning flags, indicating that it was again changing.

Well, the government numbers were positive. And although there wasn't the very strong buying for the first 30 to 45 minutes that I have seen recently, I decided to hold, expecting buyers to come into the market in force after a quick 50-point drop in the

Nasdaq

. As I mentioned, this particular play calls for a sell if the stock

closes

the day below the midline of the pattern. However, I didn't wait for the close to exit because another very subtle warning flag was raised.

As you can see from the chart below, the consistent buying spree I had been seeing over the last several weeks at approximately 1 p.m. EDT did not happen. This was a warning flag that the market was changing again, and you know how I feel about staying in trades when the market changes!

I exited these three trades as they started to drop near the close with an overall loss of $1,200. As you can see from the charts, all three stocks dropped drastically in the last hour of trading on Wednesday afternoon, validating my concern with the lack of buying at 1 p.m.

Spotting this hidden warning flag limited my losses. Although I lost money on these three trades, the methods worked like a charm. Not every trade can be a winner, nor should you expect them to be. Losses are a normal part of trading; your goal is to limit the losses and maximize gains as much as you possibly can. In the end, the percentages will be in your favor.

Well, bad is usually followed by good, and on Thursday the King got his clothes back. I used

Qualcomm

(QCOM) - Get Report

as my indicator stock. This is the stock that I expect all my leader stocks to follow.

I picked Qualcomm again because it remains a very popular stock and still has tremendous daytrader interest. I normally watch my indicator stock for a bottom, then wait for it to bounce and climb two full points to ensure that the buying momentum will carry through, then buy the leader stocks that are following it. However, in this skittish market, any buying rallies are immediately met with selling without a lot of follow-through. So you have to grab the momentum where you find it. If I waited until Qualcomm climbed $2, the game would have been over already and I would have missed it.

As you can see from the charts below, Qualcomm put in a clear bottom at 9:35 a.m. at 61 1/2 for an easy buy along with Rambus at 55. I picked Rambus because it is also a very popular stock and had been following the general trend of the market recently. When the momentum on Qualcomm slowed at 9:43 at 63 1/4, it was a clear exit sign for an easy 1 3/4-point gain on Qualcomm and for a 2-point gain on Rambus at 57.

Qualcomm was following the overall market. Since it was topping, I started looking for a short, as most other leading stocks were following it and topping out at the time. So as Qualcomm topped out at 9:43, I pulled up the

Nasdaq 100

(QQQ) - Get Report

tracking stock.

I caught it a bit over 92 for a short and rode it down until Qualcomm bottomed at around 9:54 and covered the short at 91 for a 1-point gain. As you can see from the chart, the QQQ followed Qualcomm down from its high and bottomed shortly after Qualcomm bottomed. I played several other shorts at the same time as Qualcomm, all producing acceptable gains.

In this type of market a good trader adapts his methods to the current market conditions. This week sent me back to the basics, looking for short-term momentum swings, both long and short. I will continue to look for these shorter-term momentum swings until the market decides who will win, the buyers or the sellers.

Ken Wolff is founder and chief executive officer of Paradise, Calif.-based MTrader.com, a daytrading and swingtrading Web site. This column provides general information about momentum trading. TheStreet.com has no affiliation with MTrader.com, and no endorsement of MTrader.com or momentum trading is intended. While Wolff cannot provide investment advice or recommendations here, he invites your feedback at

ken@mtrader.com.