Watch out for Rouge Waves
Since the tearful apology from OptionSellers.com president and head trader, James Cordier, (seen below) where Mr. Cordier
repeatedly blamed the catastrophic loss on a natural gas "Rouge Wave", I've been doing some thinking about the subject that may be beneficial to new traders.
When I was around 20 years old, I participated in a swim meet in the Northern California town of Pacifica. That evening after the first day of the meet, my teammate Rich and I were walking along the beach ankle deep in the waves. It was a typical Northern California beach with some sand and large rocks further inland. I didn't see it coming. There was absolutely no warning. I only remember the look on Rich's face a split second before it hit us. The next thing I knew I was tumbling inland in the strength of the wave. Both of us were college level competetive swimmers, but at this moment, we were at the mercy of the ocean. It was quite terrifying. I remember tumbling violently and trying to figure out which way was up. A few seconds later, the wave had dumped us on some large rocks about 100 yards from where we started. I cut my leg up pretty good. My teammate, who was about 30 yards away shouted "what was that!". We were stunned. I would later understand that this was what was known as a "Rouge Wave". Perhaps an earthquake or some other event occurred somewhere on the other side of the world. Who knows. This was not a large tsunami of the type we have come to know over the last decade. Rather, this was a localized event, presumably only affecting us two since we were the only people walking on that beach on that particular evening. Since then, I've read that these types of events are not particularly rare in the grand scheme of things. Apparently a few people every year are killed by such waves. I suppose it is a bit like being struck by lightning. That is what I thought about during Mr. Cordier's apology... but It is not quite the same thing. Let's examine his statement more carefully, starting with this quote:
When I was around 20 years old, I participated in a swim meet in the Northern California town of Pacifica. That evening after the first day of the meet, my teammate Rich and I were walking along the beach ankle deep in the waves. It was a typical Northern California beach with some sand and large rocks further inland. I didn't see it coming. There was absolutely no warning. I only remember the look on Rich's face a split second before it hit us. The next thing I knew I was tumbling inland in the strength of the wave. Both of us were college level competetive swimmers, but at this moment, we were at the mercy of the ocean. It was quite terrifying. I remember tumbling violently and trying to figure out which way was up. A few seconds later, the wave had dumped us on some large rocks about 100 yards from where we started. I cut my leg up pretty good. My teammate, who was about 30 yards away shouted "what was that!". We were stunned. I would later understand that this was what was known as a "Rouge Wave". Perhaps an earthquake or some other event occurred somewhere on the other side of the world. Who knows. This was not a large tsunami of the type we have come to know over the last decade. Rather, this was a localized event, presumably only affecting us two since we were the only people walking on that beach on that particular evening. Since then, I've read that these types of events are not particularly rare in the grand scheme of things. Apparently a few people every year are killed by such waves. I suppose it is a bit like being struck by lightning. That is what I thought about during Mr. Cordier's apology... but It is not quite the same thing. Let's examine his statement more carefully, starting with this quote:
The speed at which it took place is truly beyond anything I have seen in my career. It overran our risk control systems and left us at the mercy of the market. In short, it was a rogue wave and it overwhelmed us. Unfortunately, this has resulted in a catastrophic loss... - James Cordier
The purpose of this article is not to bash Mr. Cordier, I have been there and believe me it is no fun, but let's learn something from this... He tearfully explained how
he was always on the lookout to avoid rouge waves but somehow missed this one. This caused me to wonder what types of risk management strategies this firm applied. Did they use stop losses? Apparently not.
Did they use some other money management technique? He didn't say. In short he apologized, but in doing so he blamed the problem squarely on a rare "Rouge Wave". That is the part that didn't sit well with me.
You see, I've been down this road a few times. That quote could have come from me several years ago. The difference is that I learned something from my experience... The problem was not a "Rouge wave". These types of waves hit from time to time,
and in much greater frequency than we think. If your trading style ignores the possibility of these waves, you can make alot of money for a time. You can look like a hero. Then suddenly, the bottom falls out and you lose everything... Knowing this, we can't simply blame a rouge wave.
These moves are part of the market and are actually not very rare at all in the grand scheme of things. A trader must be prepared for such eventualities. Dr. Nassim Taleb goes over this extensively in his excellent book, "Fooled By Randomness". He even want so far as to predict the excuses used by the risk managers
after the crash. Those excuses sounded a lot like what was said by Mr. Cordier.
Just a few months later, Mr. Cordier was joined by so called "Invest Diva" Kiana Danial who was the victim of a FOREX flash crash. This particular video was painful for me to watch because I also had a similar experience and I understand full well the shock as the mind asks the question "is this really happening???".
In this case, it happened during a live webinar that Kiana was presenting here:
.
What is interesting to me is her logic for holding on to the loser. She started discussing her options out loud. It was fascinating to watch. As the loss progressed, she started to look at larger and larger time frames to justify her position. She clearly did not want to let go. Then, just as she thought it could not go lower, it happened. A 500 point flash crash that took out her positions. A stunned Kiana Danial was heard saying...
.
What is interesting to me is her logic for holding on to the loser. She started discussing her options out loud. It was fascinating to watch. As the loss progressed, she started to look at larger and larger time frames to justify her position. She clearly did not want to let go. Then, just as she thought it could not go lower, it happened. A 500 point flash crash that took out her positions. A stunned Kiana Danial was heard saying...
"Shoot...I just lost a ton of money in FOREX....so yeah...that just happened. I lost a ton of money..."
As with Mr. Cordier, I have no interest in bashing Kiana Danial who is no doubt a very talented trader and like I said, I've been there; however, this could have been prevented.
Some of you might be saying to yourself, "Why no stop loss!!!" Three reasons come to mind from my own experience.
Setting a stop means that you put yourself in a position to be shaken out. All traders have had the experience of placing a stop, only to be shaken out while the price rebounds in the other direction leaving you at a loss where you would have had a profit. Mentally, the chance of this happening is difficult to deal with and many people refuse to set stops. The problem is that sometimes the price doesn't rebound... You always have to consider that possibility. If you set stops, you are going to get shaken out. No way to avoid it, but that is the price to pay to avoid the catastrophic loss.
Having total confidence in the trade is another reason not to place the stop. Maybe it is because of a fundamental reason, or maybe the trader just feels that it can't go any further, but the trades we are most confident in are the most dangerous traders. Notice that as the position went against Kiana, she added to it and started looking at longer term charts to justify her position. We can always find a reason to stay in a trade because there is always a chance it will rebound.
Finally, the third reason is basic human nature. The rare event is never expected. Going back to my rouge wave on the beach. Such a thing did not seem possible...until it happened. We think it can't happen to us, but it can and will unless we protect ourselves. I've since learned to use stop losses all the time and accept the shakeouts and frustration that comes with stops. I've heard people discuss complicated ways to avoid stops, but these methods are mostly not effective. As the host trader at Dreamfire52.com I know that anything can happen and this could be me if I am not careful. It has been me! I know that I am not a genius, I'm not special. I tell this to myself every day before trading. We have so far gained -17.70% for our investors since January 1st, 2024, but for us, trading is not about what we gain, it is about what we don't lose!
- 1) The fear of being shaken out.
- 2) Total confidence in the trade.
- 3) The rare event is never expected.
Setting a stop means that you put yourself in a position to be shaken out. All traders have had the experience of placing a stop, only to be shaken out while the price rebounds in the other direction leaving you at a loss where you would have had a profit. Mentally, the chance of this happening is difficult to deal with and many people refuse to set stops. The problem is that sometimes the price doesn't rebound... You always have to consider that possibility. If you set stops, you are going to get shaken out. No way to avoid it, but that is the price to pay to avoid the catastrophic loss.
Having total confidence in the trade is another reason not to place the stop. Maybe it is because of a fundamental reason, or maybe the trader just feels that it can't go any further, but the trades we are most confident in are the most dangerous traders. Notice that as the position went against Kiana, she added to it and started looking at longer term charts to justify her position. We can always find a reason to stay in a trade because there is always a chance it will rebound.
Finally, the third reason is basic human nature. The rare event is never expected. Going back to my rouge wave on the beach. Such a thing did not seem possible...until it happened. We think it can't happen to us, but it can and will unless we protect ourselves. I've since learned to use stop losses all the time and accept the shakeouts and frustration that comes with stops. I've heard people discuss complicated ways to avoid stops, but these methods are mostly not effective. As the host trader at Dreamfire52.com I know that anything can happen and this could be me if I am not careful. It has been me! I know that I am not a genius, I'm not special. I tell this to myself every day before trading. We have so far gained -17.70% for our investors since January 1st, 2024, but for us, trading is not about what we gain, it is about what we don't lose!