I came across an interesting post in a blog written by someone who just started trading.

On the sidebar, he mentions that he has recently read Trade Your Way to Financial Freedom and How I Made $2,000,000 in the Stock Market. Currently, he is reading Japanese Candlestick Charting Techniques and Tools and Tactics for the Master Day Trader.

So, two days into my new career as a master day trader (joke!) and I have chalked up 5 straight trading losses. The good news is that I am being disciplined and ensuring I have stops in place to limit my risk, or at least I thought I had.

I felt compelled to read the entire post because it was, well, like staring at a trainwreck. I could have left a comment on this fellow's blog, but I thought it might be more useful to dissect the trades - with only the knowledge that he should have known based on the books he's read to date.

I scanned the rest of the blog, noted that he is a contract consultant in the IT business. With his profile, he is probably quite proficient at the computer, and can probably crunch a few spreadsheets. With this background, he ought to have a leg up on most novice traders.

One of my posts elicited a question about ‘R’ and what it is. So, I thought I would explain. ‘R’ stands for risk. When trading, day-trading or otherwise, you need to know both your entry and your exits, unless you are into gambling. The difference between your entry and your stop-loss exit is your risk or ‘R’.

However, there really is a little more to this. I want to limit my risk per-trade to a percentage of my equity (0.3% in my case) and that is the size of the trade. For example, let’s say I am willing to risk losing $100 per trade. If I find a stock X that has a difference between the potential entry and stop-loss of 25c, I could buy 400 shares of X, have my initial stop-loss triggered and lose only $100. If I had bought 1000 shares, I would lose $250; too risky !

So position size is a key element of the risk. I have a spreadsheet that tells me what my position size is, given my per-trade risk and the potential entry and stop-loss. I then setup my order and wait for it to be filled.

While it sounds scientific and all, the key question is this - without going into liquidity issues, what if his stop-loss placement strategy is simply wrong?

Let's look at the three examples that were posted to the blog. The first trade was SNDK - “(10:41:37) Long 400 shares at 58.36 with a 57.98 stop. (11:04:43) Closed out at 57.944 for a -1.13R loss” (his chart).

SNDK had been dumping for a few days prior to Thursday morning, so I can see why someone would want to play it for an intraday bounce. No problem with the logic.

For days it had been making lower lows, testing the low from the day before and then bounced. We can see that there are a number of ways to skin this cat, but given what he knows from the books, let's start with the first possiblity.

After three big down candlesticks, a doji forms on the 15-minute chart. There is a moment of indecision, of balance between the buyers and the sellers. Note that this doji was also an inside bar - a bar with a lower high and a higher low than the previous bar. A doji that is also an inside bar represents a sudden contraction of movement, as if the market was taking a breather.

One way to play this is to frame this candlestick with stops, that is, enter a buy stop one tick above the high and enter a sell stop below the low. Whichever way the market goes, we go with it, and use the other stop as the stop loss. In this case, the buy stop would have been triggered on the next bar, and eventually, SNDK traded back up above the prior day's low and a small rush of short-covering took it up a couple of bucks.

Next IGT - “(12:41:44) Long 500 shares at 27.57 with a 27.27 stop. (13:35:06) Stopped out at 27.25 for a -1.11R loss.” (his chart).

Now, any one of you who have ever taken my trading course can see what setup this is - a retracement in an uptrend, but let's backtrack. IGT had whipsawed traders to death for a week, gapping and spiking, but on the Thursday, it had not only spiked down and reversed, it has also upfilled a gap. This would no doubt be interpreted as bullish price action.

I can't remember off the top of my head, but I recall that there is some candlestick warning not to get in after it's gone 10 bars in one direction.

For whatever reason, (maybe it was one of those “It's going without me and I can't take it anymore” trades) our trader opened a long position on the 11th up candle. I know entries are not that big of a deal compared to position sizing and exits, but we have to at least try to avoid the obvious low-percentage setups. In any event, with ADX rising, price above the 20-EMA, the 10EMA above the 20EMA, a quick Fast Flag retracement setups gives you a spot to buy the dip and take the money. That's it.

The last trade was TOMO - “(13:45:31) Long 900 shares at 20.03 with a 19.86 stop. (14:49:32) Stopped out at an average of 19.8182 for a -1.32R loss.” (his chart).

This stock gapped up and moved more than $2 from the close of the day before, more than a 10% move in one day. How much more can get expect? Not a lot, and because of that, traders will be unwilling to commit until there has been a pause to digest the price action. Best to stand aside on these, because as the trading range contracts, all we have is a triangle, and being on the wrong side of it is very annoying. That is precisely what happened to our novice trader.