The China Blow-Off Top Trade

Using mental game planning to anticipate and not react

An overlooked trading hack is how you prepare your mind.

So much of the trading conversation is spent on finding the right stocks to trade, the “best” patterns, or optimal entry and exit points. These all have their time and place. However, the mind you bring is the key to consistent success in this performance domain.

Yet we spend so little time giving it our full attention.

After the China blow-off top on Tuesday, the overwhelming feedback from the traders in my office was one of disappointment at failing to anticipate this trade. I felt the same. This failure to adapt in real time was entirely due to a lack of mental game planning and framing. I was entirely focused on one side of the ledger and when a different scenario played out, I froze.

Our worst trading practices are triggered by fight-or-flight reactions to stressful situations.

Physiological arousal stimulates → cognitive and emotional arousal which precipitates → reactive (and suboptimal) action.

This was exactly how I found myself as China stocks traded from limit up to collapse all within the space of a few hours.

How many times do you react physically and emotionally to a movement in a stock, only to enter at entirely the wrong spot or hit the eject button in panic at the very worst time? Fight or flight reactions have taken over and we become part of the herd rather than trading from a position of strength.

The solution is to initiate mental best practices. These facilitate open-mindedness and enable you to execute better in the moment.

In this post, I will expand on these points and offer an example in my China trade write-up from this week.

Prepping the mind

Some of the biggest trades can be pre-planned and mentally rehearsed.

When I look at my biggest winners over the years, they inevitably fall into 2 categories:

1. Big catalyst: needs price AND time for the market to position.

2. Breaking news: needs time for the information to be widely disseminated.

These trades have different variables and require different skill sets. “Breaking news” events require thinking on feet and fast execution. They are extremely powerful but are very rare. Fortunately, the “Big catalyst” trades are more common and they are the basis of the stocks-in-play business model. They can also be deeply planned. These are the situations I expand upon in this newsletter.

The ultimate goal in mental rehearsal is to get into a framework where you:

“know what you want to see, where you want to see it, and when you want to see it¹”

Several techniques can help facilitate this mental state. These include:

• Building IF-THEN statements

• Game planning trade scenarios

• Visualising patterns

• Training to stay calm

If-then logic is when a predefined set of conditions triggers a specific action. For instance, if a stock reaches a certain price, then you buy. This clarity cuts through the noise and enables swift decision-making in the moment. It guardrails against emotional trading and instead enhances discipline. Not only does it aid entry decision-making, but it also improves risk management so that if a trade goes against you by a certain amount, you exit.

Define the conditions and set your actions.

The beauty of this simple logic is that you can prepare for various market scenarios in advance and thereby impose structure.

Game planning trade scenarios and visualising patterns work similarly. This involves mapping possible trajectories ahead of time and creating specific actions under each story. The playbook defines the rules to execute. The mental prep is to visualise how the idealised pattern may play out. What do you want to see for your strategy to be confirmed? What would suggest the idea is wrong?

As an example, take a morning drive strategy that looks to buy a stock early on positive news. The possible scenarios could include:

• Gap and go: the stock gaps, holds the open, and instantly moves higher. There is meaningful volume into the offers. The book is well supported by fresh bids. The stock never looks back. I will look to add quickly into this momentum.

• Gap, pull in, and go: the stock gaps, retests the open, whips around, and then moves higher. The early gap creates volatility. If I see this messy tape, I will wait for a predefined range and then only add in time once the stocks moves higher from this range.

• Gap and fail: the stock gaps and instantly breaks the open on volume. The book is very weak. It is a screaming trap. The protection on the bid gets hit. I will cut quickly and wait.

• Gap down: the stock gaps down which is totally unexpected. Do nothing. My take on the catalyst is wrong for now.

Framing patterns ahead of time makes it easier to execute in the moment. It facilitates the flow state when underlying price action emerges.

I try to illustrate these scenarios in my write-ups under “execution options”. See the DRO gap-up playbook as an example here:

Spend 5 minutes to mentally prep

As an exercise, try introducing one of these mental models into your morning preparation. Spend 5 minutes adding an extra layer to think about if-then statements and what you want to see in the moment to have conviction. If you don’t see this, the trade is most likely not ready. After all, the best trades go from the start.

Over the weekend China announced a 2.3 Trillion yuan bond package. This may be softer than market expectations but let the price action be the guide. What potential trade scenarios can you form and is this a trade for your system?

In the write-up below, I go deeper into ways to use these techniques.

China trade write-up