The Misunderstanding of the Conviction Trade

“I am going to stay in this until I am proven wrong.  This is a Conviction Trade.”

Things heard on a prop trading desk, from a retail trader, at a macro hedge fund, on the Financial Media Entertainment Complex.  If only most of the above had conviction when they should.

I was in my office chatting with a new trader about the distinction between a Conviction Trade for an experienced intraday trader and the misunderstanding of a Conviction Trade by a new trader.  This newb felt he had conviction in a trade while it was sitting in a trading pattern that made sense to him.  The trade had not moved, it was sitting.  There was no confirmation from the price action and volume that his idea was correct.  As an experienced intraday trader, I do not make conviction plays without confirmation from the market.  I have confidence in a trade that is then confirmed by the trade working for me based on price and volume.   After confirmation by price and volume my confidence in the trade increases and I gain conviction.  This distinction is enormously important for all traders, save those who trade at a macro hedge fund or have a real news edge.

Few traders trade at a macro hedge fund so to steal a phrase: do not try this at home.  Macro hedge funds enter conviction trades based on massive research efforts and quantitative risk models.  Their entry points and draw downs are not as important as most other traders because they are making much longer term trades.  Most other traders, particularly swing and intraday traders, trade patterns that tend to work for them quickly.  This makes sense since their winning holding time is shorter.  Thus the time the trade might trade against them at first should be brief as well.  To most traders: hey you are not a macro hedge fund trader mate.

We are all pattern traders whether fundamental, technical or tape readers.  We have seen patterns repeat so over time we gain an edge trading specific setups.  I say in The PlayBook, that all traders must develop a methodology to build from their strengths.  Said specifically to build a PlayBook.  Inside of your Playbook you will mark your A+ trades, the best of the best, for which you will have more confidence trading.  But even these setups will fail often and you must control your risk when you are wrong.  Sitting there and saying you have conviction when the trade is working against you is a mistake for most traders. We should not gain the ultimate confidence in our position unless it is an A+ setup AND the stock is working for us.  Anything else is misunderstanding what a Conviction Trade is for the type of trading you do.

Mike Bellafiore

The PlayBook

One Good Trade

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