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TME 005: The Whipsaw

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What is the Whipsaw? Can we ever beat the whipsaw in trading? How can we minimize whipsaw? This week we will discuss the answers to these questions. In trading the whipsaw is a necessary evil that we can beat with a good system.

First let’s go back to the old days. There was a time when they actually used a whipsaw. What was a whipsaw?

The definition says that a whipsaw or a pit saw was originally a type of saw used in a saw pit. It consisted of a narrow blade held by a frame and called a frame or sash saw. This evolved into a two to three-meter stiff blade without a frame and a handle at each end. It was used close to the felling site to reduce large logs into beams and planks.

Sawyers either dug a pit or constructed a sturdy platform. This allowed a two-man crew to saw. On man was positioned below the log and the other was on top of the log. One was called the pit man and the other was called the top man. The cut was only on the downward stroke. This made it easier for the top man to raise the saw. This reduced fatigue and back ache.

The two worked together to raise and lower the saw. The pit man had to deal with saw dust in his mouth and eyes. He also had the risk of being crushed by a falling log to think about.  That doesn’t sound to appealing for the pit man.

How do we keep from getting whipsawed to death by falling logs? or falling trades?

Whipsaw in Trading: What is it?

If you look at the definition of the whipsaw in trading it says a condition where a price moves in one direction then is followed quickly by movement in the opposite direction. The origin of the term is derived from the push and pull action used by lumberjacks to cut wood with a type of saw. The saw shares the same name.

There are two types of whip saw patterns. The first involves an upward movement in share price which is then followed by a drastic downward move. This causes the share price to fall relative to its original position. The second type of whipsaw is one where the prices drops for a little while then surges towards the positive direction.

Whipsaw in Trading: Example

You get into a trade. Your system gives a buy signal. At lunch the market goes in the opposite direction of your trade. It goes down far enough to hit your sell signal. You just got whipsawed out of a trade. You might ask how can I prevent getting whip sawed? There is only one way to prevent getting whipsawed and that is don’t trade.  If you have a trading system then you will experience the whipsaw in trading. The whipsaw is a necessary evil in trading.

 

So, let’s simplify the whipsaw example. Some people may not understand fully what the whipsaw is.  Imagine a man that is a fisherman.  This man makes his living by the fish that he catches. This man makes $1 for every fish that he catches. He uses worms to bait his hook and he pays 1 penny for every worm. So, every time he loses a worm it cost him one penny.

This man is a very organized fisherman. He has built a fishing system and he calculates that it will take him 10 worms to catch one fish. Each fish as I said is worth 1 dollar. So, he gives up 10 cents and gains a dollar.

Imagine that the losing of a worm is a whipsaw or a lost trade. Would you give up 10 cents for a dollar? That is the way to beat the whipsaw. You have to catch those big trends that pay for all the small whipsaws. Now let’s imagine that the fisherman decided to put two worms on the hook.

Suppose the man decided to put three worms on the hook. His risk begins to increase he will become more negatively impacted by the whipsaw.  That whipsaw log may fall on his head.  The best way to beat the whipsaw is to make the losses small. Follow the trading system.  You are fishing for the big trend. The big trend will pay for all those small losses.  This will also give you money to buy more worms or trades. This will allow you to catch more fish or trends.

Whipsaw in Trading: Don’t Quit?

Trading is not that complicated. Sometimes people try to make it complicated. Sometimes the way people talk about trading is complicated but it is not that complicated.  So many times, we quit before the big trend or we quit before it is time.  We may have a string of losses in a perfectly good system.  We get discouraged and quit before it is time to quit.

Whipsaw in Trading: How to Beat it?

On our site, we have a membership that was called the SilverX Membership. It is now called the margin trader membership.  It can be a very discouraging system.  It is very volatile.  One year the back tested result shows that it had a 92% gain. That sounds great, right? Sign me up. What is the catch? The catch is you have to have a gut of steak to trade it. You may gain 8% this month and lose 15% the next. You may lose another 8% the next month and another 7% the next month.  Next thing you know your account is down 30%. If you have a 1million dollar account it is now worth 700k.

Can you trade that system? The next month you gain 20%. By the end of the year you are up 90%. It sounds good on paper but it took you around the world to get there.  By that time your nerves are shot and maybe you have to take a pill to keep you from losing your mind.

The worst thing you could do and some do is to get to that 30% draw down and quit.  When you quit you just got beat by the whipsaw. That margin trader is a little extreme and not many people can’t handle it.  There are other plans that we have that are much less volatile with much less drawdowns.

For new traders, it is good to start with a system that is not so volatile because the effects of the whipsaw are not so bad.  Your gains will not be as good. At the end of the year you will not have as much gains as you would have had in a more volatile system.

We can’t eliminate the whipsaw. It is the cost of trading. One way to contain it is to contain its effects on us. We trade a system that we are comfortable with.

Whipsaw in Trading: Stick to the Plan

The whipsaw can be our friend when it leads us to big gains. We don’t know when we are going to catch that big gain. If we quit on the system because we are losing then we will not be able to catch that big trend that will pay for all the small losses.

The whipsaw can be a very discouraging thing. When you are in the middle of a whipsaw. When the market is sideways and you are trading your plan. You go months and months and months getting whipsawed and you keep losing that 2% it can be discouraging.

That is the time when having a good system is key. That is the time when sticking to a plan is key.

When a pilot gets in an aircraft they go by GPS. I have heard that a pilot can get disoriented and think up is down and down is up. When that happens, it becomes very dangerous and it becomes very important to look at your instruments. The whipsaw market can make us want to abandon our systems. When we abandon our systems, it is very dangerous territory. It can be the end for our trading.

 

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