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In Real Time: How The “Fed Reversal” Trade Played OutBy Jeff ClarkThursday, August 10, 2006 I almost did something silly yesterday…
In Tuesday’s edition, I told you my trading plan for after the FOMC decision. I was going to buy into any weakness or sell into any strength, as whatever the market does on the day of the announcement is typically reversed the following day.
So… as we approached the close of trading on Tuesday afternoon, and the Dow was down over 40 points, I started betting on a rally the next day. I started buying call options.
Specifically, I bought a bunch of calls on the widely popular Nasdaq 100 ETF (QQQQ) for $0.95 each.
My plan for Wednesday morning was to sell the calls if the market reversed Tuesday’s losses – which is typical action following a Fed decision. Since the QQQQs were down $0.26 on Tuesday, I was looking for a $0.26 gain on Wednesday to exit the trade for a nice profit.
True to form, the market opened higher on Wednesday. The QQQQs did more than reverse Tuesday’s losses by opening $0.50 higher. My calls were trading at $1.20… about 25% higher from where I bought them.
My plan was to exit the position as scripted – but I hesitated. I started thinking it could be the breakaway rally that would shoot the S&P 500 up to my long held target of 1,300. I started thinking I could hang onto the calls a while longer and ride the rally for even bigger gains.
But then I remembered one of the most important rules of trading… Never make a decision in the heat of the moment, and stick to the plan.
So I stuck to my plan and sold the calls for a 25% overnight profit.
Two hours later, I regretted the decision as the market gained strength and pushed the calls to $1.40. I was kicking myself… thinking maybe this one time I should have ignored my plan and followed my gut instincts.
Then, as if the market Gods were looking to reinforce a lesson, the market started to fall. The Dow was down nearly 100 points yesterday and my options gave back all their gains.
Had I stayed with my gut instincts, I’d be stuck with a 15% loss on my calls. Instead, I walked away with a nice profit. It also renewed my appreciation for planning the trade and trading the plan.
So if you ever find yourself in a similar situation, remember…
Never make a decision in the heat of the moment. Smart traders plan their trades before the market opens. They know what stocks they’re looking at. They know what price they’re willing to buy them at, and they know what they want to sell them for.
The next time your gut is telling you to do something, drown it out with a strong dose of logic.
Best Regards & Good Trading,
Jeff Clark
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