Hello and welcome to my thread, i hope everyone can get something out of it.
Purpose of this Thread.
I have spent many years in the markets now and over those years i have spoken with and worked with hundreds if not thousands
of traders. The one thing all traders have in common it a correct mental state or good psychology. This is what separates
pro traders from everybody else. Now you might be thinking, great another psychology post, bla, bla. But I have managed to
consistently trade to a reasonable profit due to one reason and its not a "holy grail" or a magic indicator, its because i
managed to train my brain into certain thought processes and of of others. I would now like to explain my system and how i
can make it work.
Simple Rules.
Now you only need to look around the systems section of FF to see how many ways there are to trade. I would like to suggest
that none of these are systems at all, they are simply "rules" for placing trades, if it was a system everyone would be able
to use it. For over 20 years i have based everything on price action alone, the most simple set of rules there is. But if i
teach a thousand people my method and what i look for, how many would be able to make a living from it?
What i am trying to suggest is that the system is 10% of trading. Its all in your head!
Those of you that trade to a good consistant profit will probably have to agree with this, and will find very little in this
post that they don't do already, be it conscious or unconscious. Those of you who struggle to make any profit without giving it
back, probably have a good set of rules, but either break them or have a lack of psychological knowledge. Our heads are the
reason we fail, and the reason the "drop out rate" for traders is so high.
Right now down to the specifics. What i am trying to do is put the core essentials in this post from a book i have written over the years. Of course i cant post 100 pages of my system so i will try to give you the bones. If you would like a copy let me know and i will email it to whoever would like one.
First, I want to point out that self-discipline, emotional control, and
learning to change one's mind after making a commitment are all
psychological issues that have nothing to do with news services, advisory
services, new exchanges, or technical or fundamental trading systems
computerized or not.
Second, from my trading experiences, observations, and research, I have
discovered that all traders - both winners and losers - seem to share some very common experiences. Either in the beginning or at some point early in their trading career, all traders experience confusion, frustration, anxiety, and the pain of failure. The few-traders who pass through this phase to accumulate wealth are those who eventually confront and work through some very difficult psychological issues about what it means to be a trader, and this process of realization and change normally takes several years, even for the best of them.
If self-discipline and emotional control are the keys to success, they are
also not necessarily traits any of us are born with. On the contrary, they are characteristics we acquire by learning certain mental skills. Acquiring these mental skills is often the result of a trial-and-error learning process that can be very costly financially and usually filled with emotional pain and suffering. The biggest problem with a trial and error approach in trading is that most people lose all their money before they get through the process.
And other traders who have enough money to keep on trading never fully
recover from the effects of the psychological trauma they have inflicted on themselves to ever learn how to trade successfully on a consistent basis.
This leaves only a relatively small number of people who make it.
All the great traders, both past and present, have found it very difficult
to explain what it is they do, how they do it, and more important, the
progression of steps they took to get where they got. Many would gladly
share with others what they know about the market and its behaviour but not necessarily about their behaviour as individuals. They would, however,
often caution those who sought their wisdom to understand that all the
market knowledge in the world won't do them any good until they learned
what can be called self-discipline and emotional control, without necessarily being able to explain what they were.
CULTURALLY LEARNED BEHAVIOUR THAT RESULTS IN AN UNSUCCESSFUL
TRADING EXPERIENCE
In an emotionally charged situation that requires split-second decision
making (which could lead to failure of some kind), there's little time to
compare the present event with previous market experiences. You
probably wouldn't even notice if you had behaved similarly in the past and
suffered the same disastrous consequences. Because the present situation is so immediate, you may have no concept of how typical and even thoughtless your behaviour may be.
In fact, it may be news to you that there are only a limited number of
such typical reactions leading to failure. Being able to recognize them can
prevent you from repeating past mistakes without losing any of that time
so necessary for split-second decisions.
The following typical trading errors have a specific cause rooted in a
thinking methodology that can be changed.
1. Refusing to define a loss.
2. Not liquidating a losing trade, even after you have acknowledged the
trade's potential is greatly diminished.
3. Getting locked into a specific opinion or belief about market
direction. From a psychological perspective this is equivalent to
trying to control the market with your expectation of what it will
do: "I'm right, the market is wrong."
4. Focusing on price and the monetary value of a trade, instead of the
potential for the market to move based on its behaviour and structure.
5. Revenge-trading as if you were trying get back at the market for what
it took away from you.
6. Not reversing your position even when you clearly sense a change
in market direction.
7. Not following the rules of the trading system.
8. Planning for a move or feeling one building, but then finding
yourself immobilized to hit the bid or offer, and therefore denying
yourself the opportunity to profit.
9. Not acting on your instincts or intuition.
10. Establishing a consistent pattern of trading success over a period of
time, and then giving your winnings back to the market in one or
two trades and starting the cycle over again.
HOW IS THIS DIFFERENT FROM A TRADING SYSTEM?
Trading systems give us a way to define, quantify, and categorize market
behaviour. Since the markets offer traders a seemingly infinite combination of behaviours, all with their corresponding opportunities and risks, it is easy to understand how our minds can become overwhelmed. Trading systems limit the scope of market behaviour, and therefore make this activity a little easier for our minds to manage. They also give us direction and suggestions about what to do in a given market situation. Without them traders could easily feel as if they are floating aimlessly in an endless sea of possibilities and opportunities with no land in sight.
Since trading systems define opportunity and offer suggestions,
following these suggestions can lead to the development of skills, even
though as suggestions they merely point the way for your awareness to be directed. A true skill not only points the way, but almost automatically
begins to direct awareness as well. And a thinking methodology controls the selection of which skills should be used and when.
The Market Is Always Right
If all trading stopped at any particular price, what would this last posted
price represent? At the most fundamental level, this last price (or any
current price) would represent the consensus belief about value, relative to the future, of all the traders who are in the market in that moment. The current price is a direct reflection of the beliefs of all the traders who choose to act as a force on prices by putting on a trade. So, when there are two traders, one wanting to buy and one wanting to sell at a price and do so, they have made a trade, and they have also made a market.
All that is needed to make the market right are two traders willing to trade
at a price. Regardless of the criteria they used to determine value, how
rational, irrational, meaningful, or meaningless by your or anyone else's
belief system, if two traders are willing to express their belief in future
value by making a trade, they have made a market. Unless the trade can be undone, it has to be right by virtue of the fact that it was made.
What you wanted, thought, believed, or expected is of no consequence
in the overall scheme of things unless you can trade with enough volume
to control the market and move prices in the direction you deem to be
correct. To do this, you would personally have to represent a buying or
selling force strong enough to absorb all the counteracting buying or
selling represented by the traders who didn't happen to agree with you, at
any given moment, with enough financial power left over to bid or offer the price where you want it to be.
For an observer of market behaviour, each trade that is made and the type of movement it creates in prices can tell you something about the
consistency of the market and potential for movement in a direction—if you can discern the meaning and put that meaning within some framework
defining opportunity. Price movement creates opportunities to buy low and
sell high, or vice versa, if you can perceive what is likely to be high and low relative to some point in the future. Movement in any given direction is equivalent to the amount of force that is being applied to create that
movement.
For example, if prices penetrated all-time lows, the fact that you may
have believed that they would not do it is meaningless, unless you can
personally trade with enough volume to move the price back above the old
low. You have to consider that for prices to have penetrated all-time lows, there must have been more traders who believed that the current price was above what they considered to be of value, at least enough to where they believed the all-time low was a selling opportunity or they would not have sold. For prices to follow through and continue to go lower would indicate that there are more traders willing to act on their belief that prices are high and as a result sell than there are traders who are willing to buy at those prices (all-time lows).
What you believed about value and your reasons for believing it may be
of highest quality, but if the market doesn't share your belief, it doesn't really matter how "right" you are based on your superior reasoning process or what you believe to be the quality of your information, because prices are going to go in the direction of the greatest force.
The point here is that right and wrong as you may traditionally think of
them don't exist in the market environment. Academic credentials,
degrees, reputations, even a high I.Q. don't make you right in this
environment as they would in society. Traders, acting on their belief in the
future by putting on a trade, are the only force that can act on prices to make them move. Movement creates opportunity to make money, and making money is what trading is all about. This is also true for the hedger trading to protect the value of his assets.
Each individual trader will define what market condition represents enough
of an opportunity to put on a trade for whatever reason suits him. Regardless of how wrong you think he may be, if the net result of the collective actions of all the traders participating is moving prices against your position, then they're right and you're the one who is losing money.
The market is never wrong in what it does; it just is. Therefore, you as an
individual trader interacting with the market—first as an observer to perceive opportunity, then as a participant executing a trade, contributing to the overall market behaviour—have to confront an environment where only you can be wrong, and it's never the other way around. As a trader, you have to decide what is more important—being right or making money—because the two are not always compatible or consistent with one another.
The Three Stages to Becoming a Successful Trader
Before we cover the three stages to becoming a successful trader, it would be a good idea to review some of the material already covered. In the market environment you have to make the rules to the game and then have the discipline to abide by these rules, even though the market moves in ways that will constantly tempt you into believing you don't need to follow your rules this time. This movement allows you to indulge in any illusion or distortion that suits you in any given moment. Certainly you wouldn't choose to feel pain (confronting your illusions about the market) if there is any reasonable information that would support the possibility of your expectation being fulfilled.
In an unlimited environment, if you can't confront the reality of a loss,
then the possibility exists for you to lose everything, in each and every trade.
If you believe trading is like gambling, it isn't. In any gambling game you
have to actively participate to lose and do nothing to stop losing. In the
market environment, you have to actively participate to get into a trade and actively participate to end your losses. If you do nothing, the potential exists to lose everything you own.
When you participate in gambling games, you know exactly what your
risk is and the event always ends. With the markets you don't ultimately
know what your risk is, even if you are disciplined enough to use stops,
because the market could gap through your stops. Also because the event never ends and is in constant motion, there is always the possibility of getting back what you are losing in any trade. You won't need to actively participate to get back what you are losing; you just have to stay in your trade and let the market give it to you. As a result, there is the constant temptation not to cut your losses which is very difficult to resist.
Why choose pain over the possibility of being made whole, when all you need do is ignore the risk.
ACCUMULATING PROFITS
Your ability to accumulate profits either in a single trade or cumulatively
with several trades over a period of time is a function of your degree of self valuation.
This sense of self-valuation is, in fact, the most important
psychological component of success and will override all others in
determining your results.
Your degree of self-valuation will regulate how much money you will
give yourself (the market doesn't give you the money, you give it to yourself based on your ability to perceive opportunity and execute a trade) out of the maximum potential available or perceivable at any given moment or time frame perspective. Regardless of the depth of understanding you have of market behaviour or what you consciously intend, you will only "give" yourself the amount of money that corresponds to your level of self valuation.
This concept can be explained with a simple illustration. If you perceive
an opportunity, based on your definition or what market conditions
constitute an opportunity, and do not follow through by executing a trade, what stopped you? In my mind, there can be only two possible reasons. You were either immobilized by the fear of failure or you are struggling with a belief (value) system that says you don't deserve the money. Otherwise, you would have acted on your perception.
THE UNDERLYING PHILOSOPHY
When we enter the trading arena we enter an environment unlike anywhere else. The rules we have lived by in the normal outside world no longer apply and, indeed, will cause us loss. Our very motivation can be our own worst enemy as we seek to extract money from
the markets.
To succeed in the markets we need to put in place an entire structure, as we have put in place an entire structure (personality) in the outside world. Let me give you two examples of why our normal behaviour and motivations are not going to help us in the markets. Many people enter the markets because they have had a successful career or business life
elsewhere. At this point they may feel a little bored with life and seek a new challenge. This is very normal, and the kind of stimulus all of us have felt at one time or another. But think about this for a minute. Such an individual, starting to trade, will probably, like many other traders,
trade in a fairly haphazard manner to start with. I term such trading “emotional,” because whatever method traders may think they are using, the ultimate decision is more usually an emotional one. So the overall rationale can be described as “the person is bored and wants to trade.” So what happens the next time boredom sets in? Once able to trade, it is very likely that a person will make the emotional decision to do just that when bored.
This timing is unlikely to correspond with a low risk trading opportunity; I will also be talking a lot about those later in this book. So the first question traders must ask themselves is “Why do I trade?” The answer to that simple question may save you a fortune.
The rules we live by in everyday life do not work in the market environment. We need to construct a separate trading “personality” to succeed in the markets. This personality must learn much greater control over the emotions. Each of us will seek a different trading personality, making the most of our strengths and minimizing our weaknesses.
_ The Trading Pyramid has the following levels:
– YOU
– Commitment
– Discipline
– Money management
– Risk control
– The three simple rules
– System parameters
– Your system/methodology
– Operation
– Profits/losses
_ The structure is organic and each level interrelates with each other level
_ Trade what you see, not what you think. (Joe Ross)
This part describes some other ways of looking at the path traders take to success.
For some years I have set out a simple process which all traders seem to encounter on the road to success. This is detailed below and thereafter I expand this in a way which I feel will be useful for those who want to tread this path.
STARTS OFF “Greed orientated.”
Loses because:
1 Market problems
a Not a zero sum game, a “very negative” sum game
b Market psychology – doing the wrong thing at the wrong time
c The majority is always wrong
d Market exists on chaos and confusion.
2 Own problems
a Overtrading
b No knowledge
c No discipline
c No protection against market psychology
d Random action through uncertainty, broker’s advice for example
e Market views.
RESULT: the “greed orientated” trader gets a good kicking and
becomes “fear orientated.”
Loses because:
1 Market problems as above
2 Scared money never wins
3 Own problems
a Still overtrading – derivatives
b Fear brings on what it fears
c Tries to cut losses too tight creating more losses
d Still no real understanding of what it takes.
RESULT: Traders who persevere “travel through the tunnel” and
becomes “risk orientated.” This is when they start to make money
because they:
1 Develop a methodology which give them an edge
2 Use an effective Money Management system
3 Develop the discipline to follow their methodology
4 Erase “harmful” personality traits.
Trading Chaos
The layout of Trading Chaos is designed to get you there. The book offers five stages, each including different goals, and different tools to help you attain those goals. The five stages are: novice, advanced beginner, competent, proficient and expert. The goals are respectively; to
minimize losses, to make money consistently on a one-contract basis, to maximize your profits, to trade your own belief systems, and to trade your states of mind. Each stage offers better tools to achieve these objectives.
In this context tools refers to analysis techniques plus your own inherent abilities. The book doesn’t tell you how to tap the vast potential of your neck top computer but then this has been the goal of all mystics and spiritual gurus through the ages and is perhaps too much to expect. But if you want to see the Holy Grail, look in a mirror!
I have written this chapter because I believe the more we understand about ourselves the easier it will be to find success in the markets. The chapter may seem incomplete but it will be many decades, or even centuries, before we, as human beings, have a full understanding of -ourselves, if indeed we ever do. So do not expect precise an
swers; and they are probably not even desirable.
What you need are subtle signposts to steer you in the right direction (possibly such signposts should be aimed at parts of the brain other than the left hemisphere), I hope this one helps.
Using Money Management
So how do you use MM practically? For this I will use an illustration concerning one of my trading services. This sets out the MM rules behind this. This is universally applicable to any trading approach not merely to this system. The essential factor behind any winning approach is that it
gives you an “edge.” Without an edge it is impossible to win – if anybody doubts this please e-mail me to discuss it. I consider that my methodology gives me an edge of around 60–70 per cent. This has to be related to a random process which could be gauged at 50 per cent. The figure of 50
per cent is not totally accurate as it ignores the costs of trading, but we will over discount for this factor by assuming that my approach will yield a success rate of 55 per cent.
It now comes to apply an MM system to this. Let us assume that a trader has $10 000 he is prepared to lose. As a general rule a 20 per cent loss is considered the time to get out – so we are assuming that the trader has capital of $50 000 of which he is prepared to lose $10 000. With $10 000 our MM rule is that we are not prepared to lose more than 10 per cent per trade (i.e. $1000) and this equates to 20 points on a single S&P e-mini contract, or 10 points on two contracts.
If we adopt this approach it means we would have to suffer 10 trades in a row to be wiped out of the market – i.e. we would lose our $10 000 (20 per cent of our total trading capital of $50 000). So we then take our expected success rate of 55 per cent and see what the odds are of making 10 successive losing trades. The odds on this are 45 per cent (the failure rate being 100 per cent less 55 per cent) to the power of 10. This comes down to 0.035 per cent – i.e. 3.5 times out of 10 000 trades. The 45 per cent failure rate also shows us that we have a 1 in 10 chance of making three losses in a row, a four out of 100 chance of four losses in a row, and a 2 out of 100 chance of five losses in a row. These odds make sense and we can see how this approach can be monitored to
ensure that the original assumptions are correct. If so, it is also easy to go further and to develop confidence in the approach. Now to some of you a 20 point stop may seem a little high, but there are ways to mitigate this exposure and at less risk. You will also note how applying 10 per cent to one fifth of the capital equates to 2 per cent of all of the capital. It is my view that any one trade should not incur risk of more than 2 per cent.
Position size
The above sets out one way of approaching Money Management. I believe that this is an eminently practical way of approaching this extremely important area of trading. Now I want to say a few words about position size. Let us assume that you have just devised a new system and that your testing of this system has led you to believe that it is excellent. Let us also say that you have $100 000 of trading capital and that you can hardly wait for those megabucks of profit you are going to make – so off you go, at least 10 contracts right from the start. Right? No, wrong! Paper trading is useful, testing is useful, but when you start to play for real the game changes, if only because you start to hit emotional/ psychological problems you never even dreamt existed. These problems can be overcome but when you enter a new arena (i.e. actually trading your new system/approach) then you must minimize your risk – indeed good traders minimize risk at all times. So you don’t trade 10 contracts, you trade just one. And you keep trading just one until your actual results confirm that you should increase position size.
At that point the area of risk (new territory) has become more quantified and you can move ahead without that being such a worry. It would make sense to increase position size in appropriate steps. What you stand to gain from this approach is obvious. If your system had some flaws then you do not lose all your capital and you also develop some discipline along the way. What do you stand to lose? Just a little time. If all goes according to plan you may well be trading at the size you originally wanted to just a few months later – and in real terms that is nothing. What I find frustrating is that I can explain this to consultancy clients until I am blue in the face but then they often ignore the advice, go off over-trading, survive for a while, maybe even make some money,
then that trade with their number comes along and its “adios amigo!”
Monitoring position
Another area where we can reduce risk is in careful monitoring of a position in the early stages. Sometimes when looking at a bar chart it is obvious where the market diverged from the expected path. Such divergence is a warning sign and often a very strong one. Indeed one factor I have noticed is that once a market diverges from a pattern that often a very strong move comes in the other way. The logic of this is fairly clear in that there will be plenty of traders, following the original
signal, who will be caught out by just such a move. To an extent the need for careful monitoring will depend on your entry methodology and the logic/philosophy behind it. If you are looking for entries which ought to catch “unacceptable” prices then you would want such prices to
be swiftly rejected by the market. The lack of such rejection might be a reason to exit a position. After all you are looking for the best opportunities and one which does not show such rejection may
well not make that grade. Such things have to be related to each individual’s trading style and time frame. But this is where a real time price service can pay for itself.
Stops can be a central feature of an MM system. There are various ways in which stops can be utilized and these will be covered later. That concludes our brief resume of some of the more important points of MM, a subject of many books. But it should serve to prompt a few thoughts about how you might be able to improve your approach to the market.
The traders who win are those who minimize risk. This is another key part and its importance is such that readers should read it carefully and ensure they understand its contents.
Those who do not minimize risk inevitably pay the price and get wiped out. It is for this reason that you often see strong moves after a news item is out of the way, often a news item suggesting a strong move in the opposite direction. The big traders, who got that way by minimizing risk in the first place, wait until the risk is at its lowest, when the news is out of the way.
Risk Control includes the following:
1 Not trading in too big a size, thus reducing the risk of a wipe out. Actually you should eliminate
the risk of a wipe out .
2 Not holding overnight unless you have a profit buffer in place. How- ever this does not apply to particular methodologies seeking to take advantage of certain factors which may apply to holding overnight.
3 Not holding over the weekend, subject to the same caveats as “2” above.
4 Taking appropriate action prior to major new items. This means not normally opening positions, maybe reducing position size if already positioned – although it does depend on your trading objectives. But in markets there are two types of risk and we need to look at both.
First there is the risk of loss inherent in the market itself. Second there is the risk of loss inherent in the vehicle we are trading. I deal with this in more detail later on, but simply put, the risk of making a losing trade when buying an option is far higher than when writing an option. But you can lose a lot more writing options, than you can buying them. This neatly demonstrates the two types of risk and, as traders, we need to understand how this works.
The trading secrets
Secret 1: Cut your losses
The first function that the new trader must accomplish is to learn the
business (instruct the core). Whilst doing so the key is to minimize your
tuition fees, so cut those losses, because they are your tuition fees. The
money spent on software, newsletters, books, seminars etc. is often
trivial in comparison.
As we learn the business we find that we tend to churn away without
getting very far. We learn to cut losses, but find that we make plenty of
good trades but not only are we cutting losses, we are also cutting our
profits. No surprise there. The ego, desperate for anything positive, takes
any profit it sees. But this is also no good because if you are going to
make money you have got to take those big profits. To do so you need:
Secret 2: Run your profits
OK, now you are starting to make progress. You should be making consistent profits on a one contract basis. But you have not cracked it yet. But you have your core on your side and your right hemisphere is starting to get involved. Now you can start to implement the final secret:
Secret 3: Trade selectivity
You have got to learn how to pick only the best opportunities. This takes
time. You have got to find the right trading approach for yourself. You
have got to narrow your focus on the market. There is far too much
information out there to absorb, even for your right hemisphere. So
decide on your methodology, concentrate on what you need, and
become an expert in its application. When you do this you will know
which are the best opportunities and which are not. At the same time
you will need to develop the mental discipline and patience to wait for
just those opportunities. Actually I will give you an added bonus:
Secret 4: Trade with the trend
That way you will have many more winners.
Following the rules
Now let’s look at the practical problems in following these three “simple”
rules. You would think that cutting losses would be simple enough.
It is hardly a difficult concept after all. But it does bring a lot of additional
baggage with it. It certainly makes the whole trading approach a
lot more complex. But the alternative is to be wiped out – at least for the
majority.
The above are just a few of the things that every profitable trader will know, and practice. Please find attached my very simple system, it is important to remember that i can only trade because i spent many years training my brain to be different.
You will need to do the same whichever system you decide to use.
I hope this has been helpful to some of you, feel free to contact me with feedback or to request a full copy.
Happy Trading!
Purpose of this Thread.
I have spent many years in the markets now and over those years i have spoken with and worked with hundreds if not thousands
of traders. The one thing all traders have in common it a correct mental state or good psychology. This is what separates
pro traders from everybody else. Now you might be thinking, great another psychology post, bla, bla. But I have managed to
consistently trade to a reasonable profit due to one reason and its not a "holy grail" or a magic indicator, its because i
managed to train my brain into certain thought processes and of of others. I would now like to explain my system and how i
can make it work.
Simple Rules.
Now you only need to look around the systems section of FF to see how many ways there are to trade. I would like to suggest
that none of these are systems at all, they are simply "rules" for placing trades, if it was a system everyone would be able
to use it. For over 20 years i have based everything on price action alone, the most simple set of rules there is. But if i
teach a thousand people my method and what i look for, how many would be able to make a living from it?
What i am trying to suggest is that the system is 10% of trading. Its all in your head!
Those of you that trade to a good consistant profit will probably have to agree with this, and will find very little in this
post that they don't do already, be it conscious or unconscious. Those of you who struggle to make any profit without giving it
back, probably have a good set of rules, but either break them or have a lack of psychological knowledge. Our heads are the
reason we fail, and the reason the "drop out rate" for traders is so high.
Right now down to the specifics. What i am trying to do is put the core essentials in this post from a book i have written over the years. Of course i cant post 100 pages of my system so i will try to give you the bones. If you would like a copy let me know and i will email it to whoever would like one.
First, I want to point out that self-discipline, emotional control, and
learning to change one's mind after making a commitment are all
psychological issues that have nothing to do with news services, advisory
services, new exchanges, or technical or fundamental trading systems
computerized or not.
Second, from my trading experiences, observations, and research, I have
discovered that all traders - both winners and losers - seem to share some very common experiences. Either in the beginning or at some point early in their trading career, all traders experience confusion, frustration, anxiety, and the pain of failure. The few-traders who pass through this phase to accumulate wealth are those who eventually confront and work through some very difficult psychological issues about what it means to be a trader, and this process of realization and change normally takes several years, even for the best of them.
If self-discipline and emotional control are the keys to success, they are
also not necessarily traits any of us are born with. On the contrary, they are characteristics we acquire by learning certain mental skills. Acquiring these mental skills is often the result of a trial-and-error learning process that can be very costly financially and usually filled with emotional pain and suffering. The biggest problem with a trial and error approach in trading is that most people lose all their money before they get through the process.
And other traders who have enough money to keep on trading never fully
recover from the effects of the psychological trauma they have inflicted on themselves to ever learn how to trade successfully on a consistent basis.
This leaves only a relatively small number of people who make it.
All the great traders, both past and present, have found it very difficult
to explain what it is they do, how they do it, and more important, the
progression of steps they took to get where they got. Many would gladly
share with others what they know about the market and its behaviour but not necessarily about their behaviour as individuals. They would, however,
often caution those who sought their wisdom to understand that all the
market knowledge in the world won't do them any good until they learned
what can be called self-discipline and emotional control, without necessarily being able to explain what they were.
CULTURALLY LEARNED BEHAVIOUR THAT RESULTS IN AN UNSUCCESSFUL
TRADING EXPERIENCE
In an emotionally charged situation that requires split-second decision
making (which could lead to failure of some kind), there's little time to
compare the present event with previous market experiences. You
probably wouldn't even notice if you had behaved similarly in the past and
suffered the same disastrous consequences. Because the present situation is so immediate, you may have no concept of how typical and even thoughtless your behaviour may be.
In fact, it may be news to you that there are only a limited number of
such typical reactions leading to failure. Being able to recognize them can
prevent you from repeating past mistakes without losing any of that time
so necessary for split-second decisions.
The following typical trading errors have a specific cause rooted in a
thinking methodology that can be changed.
1. Refusing to define a loss.
2. Not liquidating a losing trade, even after you have acknowledged the
trade's potential is greatly diminished.
3. Getting locked into a specific opinion or belief about market
direction. From a psychological perspective this is equivalent to
trying to control the market with your expectation of what it will
do: "I'm right, the market is wrong."
4. Focusing on price and the monetary value of a trade, instead of the
potential for the market to move based on its behaviour and structure.
5. Revenge-trading as if you were trying get back at the market for what
it took away from you.
6. Not reversing your position even when you clearly sense a change
in market direction.
7. Not following the rules of the trading system.
8. Planning for a move or feeling one building, but then finding
yourself immobilized to hit the bid or offer, and therefore denying
yourself the opportunity to profit.
9. Not acting on your instincts or intuition.
10. Establishing a consistent pattern of trading success over a period of
time, and then giving your winnings back to the market in one or
two trades and starting the cycle over again.
HOW IS THIS DIFFERENT FROM A TRADING SYSTEM?
Trading systems give us a way to define, quantify, and categorize market
behaviour. Since the markets offer traders a seemingly infinite combination of behaviours, all with their corresponding opportunities and risks, it is easy to understand how our minds can become overwhelmed. Trading systems limit the scope of market behaviour, and therefore make this activity a little easier for our minds to manage. They also give us direction and suggestions about what to do in a given market situation. Without them traders could easily feel as if they are floating aimlessly in an endless sea of possibilities and opportunities with no land in sight.
Since trading systems define opportunity and offer suggestions,
following these suggestions can lead to the development of skills, even
though as suggestions they merely point the way for your awareness to be directed. A true skill not only points the way, but almost automatically
begins to direct awareness as well. And a thinking methodology controls the selection of which skills should be used and when.
The Market Is Always Right
If all trading stopped at any particular price, what would this last posted
price represent? At the most fundamental level, this last price (or any
current price) would represent the consensus belief about value, relative to the future, of all the traders who are in the market in that moment. The current price is a direct reflection of the beliefs of all the traders who choose to act as a force on prices by putting on a trade. So, when there are two traders, one wanting to buy and one wanting to sell at a price and do so, they have made a trade, and they have also made a market.
All that is needed to make the market right are two traders willing to trade
at a price. Regardless of the criteria they used to determine value, how
rational, irrational, meaningful, or meaningless by your or anyone else's
belief system, if two traders are willing to express their belief in future
value by making a trade, they have made a market. Unless the trade can be undone, it has to be right by virtue of the fact that it was made.
What you wanted, thought, believed, or expected is of no consequence
in the overall scheme of things unless you can trade with enough volume
to control the market and move prices in the direction you deem to be
correct. To do this, you would personally have to represent a buying or
selling force strong enough to absorb all the counteracting buying or
selling represented by the traders who didn't happen to agree with you, at
any given moment, with enough financial power left over to bid or offer the price where you want it to be.
For an observer of market behaviour, each trade that is made and the type of movement it creates in prices can tell you something about the
consistency of the market and potential for movement in a direction—if you can discern the meaning and put that meaning within some framework
defining opportunity. Price movement creates opportunities to buy low and
sell high, or vice versa, if you can perceive what is likely to be high and low relative to some point in the future. Movement in any given direction is equivalent to the amount of force that is being applied to create that
movement.
For example, if prices penetrated all-time lows, the fact that you may
have believed that they would not do it is meaningless, unless you can
personally trade with enough volume to move the price back above the old
low. You have to consider that for prices to have penetrated all-time lows, there must have been more traders who believed that the current price was above what they considered to be of value, at least enough to where they believed the all-time low was a selling opportunity or they would not have sold. For prices to follow through and continue to go lower would indicate that there are more traders willing to act on their belief that prices are high and as a result sell than there are traders who are willing to buy at those prices (all-time lows).
What you believed about value and your reasons for believing it may be
of highest quality, but if the market doesn't share your belief, it doesn't really matter how "right" you are based on your superior reasoning process or what you believe to be the quality of your information, because prices are going to go in the direction of the greatest force.
The point here is that right and wrong as you may traditionally think of
them don't exist in the market environment. Academic credentials,
degrees, reputations, even a high I.Q. don't make you right in this
environment as they would in society. Traders, acting on their belief in the
future by putting on a trade, are the only force that can act on prices to make them move. Movement creates opportunity to make money, and making money is what trading is all about. This is also true for the hedger trading to protect the value of his assets.
Each individual trader will define what market condition represents enough
of an opportunity to put on a trade for whatever reason suits him. Regardless of how wrong you think he may be, if the net result of the collective actions of all the traders participating is moving prices against your position, then they're right and you're the one who is losing money.
The market is never wrong in what it does; it just is. Therefore, you as an
individual trader interacting with the market—first as an observer to perceive opportunity, then as a participant executing a trade, contributing to the overall market behaviour—have to confront an environment where only you can be wrong, and it's never the other way around. As a trader, you have to decide what is more important—being right or making money—because the two are not always compatible or consistent with one another.
The Three Stages to Becoming a Successful Trader
Before we cover the three stages to becoming a successful trader, it would be a good idea to review some of the material already covered. In the market environment you have to make the rules to the game and then have the discipline to abide by these rules, even though the market moves in ways that will constantly tempt you into believing you don't need to follow your rules this time. This movement allows you to indulge in any illusion or distortion that suits you in any given moment. Certainly you wouldn't choose to feel pain (confronting your illusions about the market) if there is any reasonable information that would support the possibility of your expectation being fulfilled.
In an unlimited environment, if you can't confront the reality of a loss,
then the possibility exists for you to lose everything, in each and every trade.
If you believe trading is like gambling, it isn't. In any gambling game you
have to actively participate to lose and do nothing to stop losing. In the
market environment, you have to actively participate to get into a trade and actively participate to end your losses. If you do nothing, the potential exists to lose everything you own.
When you participate in gambling games, you know exactly what your
risk is and the event always ends. With the markets you don't ultimately
know what your risk is, even if you are disciplined enough to use stops,
because the market could gap through your stops. Also because the event never ends and is in constant motion, there is always the possibility of getting back what you are losing in any trade. You won't need to actively participate to get back what you are losing; you just have to stay in your trade and let the market give it to you. As a result, there is the constant temptation not to cut your losses which is very difficult to resist.
Why choose pain over the possibility of being made whole, when all you need do is ignore the risk.
ACCUMULATING PROFITS
Your ability to accumulate profits either in a single trade or cumulatively
with several trades over a period of time is a function of your degree of self valuation.
This sense of self-valuation is, in fact, the most important
psychological component of success and will override all others in
determining your results.
Your degree of self-valuation will regulate how much money you will
give yourself (the market doesn't give you the money, you give it to yourself based on your ability to perceive opportunity and execute a trade) out of the maximum potential available or perceivable at any given moment or time frame perspective. Regardless of the depth of understanding you have of market behaviour or what you consciously intend, you will only "give" yourself the amount of money that corresponds to your level of self valuation.
This concept can be explained with a simple illustration. If you perceive
an opportunity, based on your definition or what market conditions
constitute an opportunity, and do not follow through by executing a trade, what stopped you? In my mind, there can be only two possible reasons. You were either immobilized by the fear of failure or you are struggling with a belief (value) system that says you don't deserve the money. Otherwise, you would have acted on your perception.
THE UNDERLYING PHILOSOPHY
When we enter the trading arena we enter an environment unlike anywhere else. The rules we have lived by in the normal outside world no longer apply and, indeed, will cause us loss. Our very motivation can be our own worst enemy as we seek to extract money from
the markets.
To succeed in the markets we need to put in place an entire structure, as we have put in place an entire structure (personality) in the outside world. Let me give you two examples of why our normal behaviour and motivations are not going to help us in the markets. Many people enter the markets because they have had a successful career or business life
elsewhere. At this point they may feel a little bored with life and seek a new challenge. This is very normal, and the kind of stimulus all of us have felt at one time or another. But think about this for a minute. Such an individual, starting to trade, will probably, like many other traders,
trade in a fairly haphazard manner to start with. I term such trading “emotional,” because whatever method traders may think they are using, the ultimate decision is more usually an emotional one. So the overall rationale can be described as “the person is bored and wants to trade.” So what happens the next time boredom sets in? Once able to trade, it is very likely that a person will make the emotional decision to do just that when bored.
This timing is unlikely to correspond with a low risk trading opportunity; I will also be talking a lot about those later in this book. So the first question traders must ask themselves is “Why do I trade?” The answer to that simple question may save you a fortune.
The rules we live by in everyday life do not work in the market environment. We need to construct a separate trading “personality” to succeed in the markets. This personality must learn much greater control over the emotions. Each of us will seek a different trading personality, making the most of our strengths and minimizing our weaknesses.
_ The Trading Pyramid has the following levels:
– YOU
– Commitment
– Discipline
– Money management
– Risk control
– The three simple rules
– System parameters
– Your system/methodology
– Operation
– Profits/losses
_ The structure is organic and each level interrelates with each other level
_ Trade what you see, not what you think. (Joe Ross)
This part describes some other ways of looking at the path traders take to success.
For some years I have set out a simple process which all traders seem to encounter on the road to success. This is detailed below and thereafter I expand this in a way which I feel will be useful for those who want to tread this path.
STARTS OFF “Greed orientated.”
Loses because:
1 Market problems
a Not a zero sum game, a “very negative” sum game
b Market psychology – doing the wrong thing at the wrong time
c The majority is always wrong
d Market exists on chaos and confusion.
2 Own problems
a Overtrading
b No knowledge
c No discipline
c No protection against market psychology
d Random action through uncertainty, broker’s advice for example
e Market views.
RESULT: the “greed orientated” trader gets a good kicking and
becomes “fear orientated.”
Loses because:
1 Market problems as above
2 Scared money never wins
3 Own problems
a Still overtrading – derivatives
b Fear brings on what it fears
c Tries to cut losses too tight creating more losses
d Still no real understanding of what it takes.
RESULT: Traders who persevere “travel through the tunnel” and
becomes “risk orientated.” This is when they start to make money
because they:
1 Develop a methodology which give them an edge
2 Use an effective Money Management system
3 Develop the discipline to follow their methodology
4 Erase “harmful” personality traits.
Trading Chaos
The layout of Trading Chaos is designed to get you there. The book offers five stages, each including different goals, and different tools to help you attain those goals. The five stages are: novice, advanced beginner, competent, proficient and expert. The goals are respectively; to
minimize losses, to make money consistently on a one-contract basis, to maximize your profits, to trade your own belief systems, and to trade your states of mind. Each stage offers better tools to achieve these objectives.
In this context tools refers to analysis techniques plus your own inherent abilities. The book doesn’t tell you how to tap the vast potential of your neck top computer but then this has been the goal of all mystics and spiritual gurus through the ages and is perhaps too much to expect. But if you want to see the Holy Grail, look in a mirror!
I have written this chapter because I believe the more we understand about ourselves the easier it will be to find success in the markets. The chapter may seem incomplete but it will be many decades, or even centuries, before we, as human beings, have a full understanding of -ourselves, if indeed we ever do. So do not expect precise an
swers; and they are probably not even desirable.
What you need are subtle signposts to steer you in the right direction (possibly such signposts should be aimed at parts of the brain other than the left hemisphere), I hope this one helps.
Using Money Management
So how do you use MM practically? For this I will use an illustration concerning one of my trading services. This sets out the MM rules behind this. This is universally applicable to any trading approach not merely to this system. The essential factor behind any winning approach is that it
gives you an “edge.” Without an edge it is impossible to win – if anybody doubts this please e-mail me to discuss it. I consider that my methodology gives me an edge of around 60–70 per cent. This has to be related to a random process which could be gauged at 50 per cent. The figure of 50
per cent is not totally accurate as it ignores the costs of trading, but we will over discount for this factor by assuming that my approach will yield a success rate of 55 per cent.
It now comes to apply an MM system to this. Let us assume that a trader has $10 000 he is prepared to lose. As a general rule a 20 per cent loss is considered the time to get out – so we are assuming that the trader has capital of $50 000 of which he is prepared to lose $10 000. With $10 000 our MM rule is that we are not prepared to lose more than 10 per cent per trade (i.e. $1000) and this equates to 20 points on a single S&P e-mini contract, or 10 points on two contracts.
If we adopt this approach it means we would have to suffer 10 trades in a row to be wiped out of the market – i.e. we would lose our $10 000 (20 per cent of our total trading capital of $50 000). So we then take our expected success rate of 55 per cent and see what the odds are of making 10 successive losing trades. The odds on this are 45 per cent (the failure rate being 100 per cent less 55 per cent) to the power of 10. This comes down to 0.035 per cent – i.e. 3.5 times out of 10 000 trades. The 45 per cent failure rate also shows us that we have a 1 in 10 chance of making three losses in a row, a four out of 100 chance of four losses in a row, and a 2 out of 100 chance of five losses in a row. These odds make sense and we can see how this approach can be monitored to
ensure that the original assumptions are correct. If so, it is also easy to go further and to develop confidence in the approach. Now to some of you a 20 point stop may seem a little high, but there are ways to mitigate this exposure and at less risk. You will also note how applying 10 per cent to one fifth of the capital equates to 2 per cent of all of the capital. It is my view that any one trade should not incur risk of more than 2 per cent.
Position size
The above sets out one way of approaching Money Management. I believe that this is an eminently practical way of approaching this extremely important area of trading. Now I want to say a few words about position size. Let us assume that you have just devised a new system and that your testing of this system has led you to believe that it is excellent. Let us also say that you have $100 000 of trading capital and that you can hardly wait for those megabucks of profit you are going to make – so off you go, at least 10 contracts right from the start. Right? No, wrong! Paper trading is useful, testing is useful, but when you start to play for real the game changes, if only because you start to hit emotional/ psychological problems you never even dreamt existed. These problems can be overcome but when you enter a new arena (i.e. actually trading your new system/approach) then you must minimize your risk – indeed good traders minimize risk at all times. So you don’t trade 10 contracts, you trade just one. And you keep trading just one until your actual results confirm that you should increase position size.
At that point the area of risk (new territory) has become more quantified and you can move ahead without that being such a worry. It would make sense to increase position size in appropriate steps. What you stand to gain from this approach is obvious. If your system had some flaws then you do not lose all your capital and you also develop some discipline along the way. What do you stand to lose? Just a little time. If all goes according to plan you may well be trading at the size you originally wanted to just a few months later – and in real terms that is nothing. What I find frustrating is that I can explain this to consultancy clients until I am blue in the face but then they often ignore the advice, go off over-trading, survive for a while, maybe even make some money,
then that trade with their number comes along and its “adios amigo!”
Monitoring position
Another area where we can reduce risk is in careful monitoring of a position in the early stages. Sometimes when looking at a bar chart it is obvious where the market diverged from the expected path. Such divergence is a warning sign and often a very strong one. Indeed one factor I have noticed is that once a market diverges from a pattern that often a very strong move comes in the other way. The logic of this is fairly clear in that there will be plenty of traders, following the original
signal, who will be caught out by just such a move. To an extent the need for careful monitoring will depend on your entry methodology and the logic/philosophy behind it. If you are looking for entries which ought to catch “unacceptable” prices then you would want such prices to
be swiftly rejected by the market. The lack of such rejection might be a reason to exit a position. After all you are looking for the best opportunities and one which does not show such rejection may
well not make that grade. Such things have to be related to each individual’s trading style and time frame. But this is where a real time price service can pay for itself.
Stops can be a central feature of an MM system. There are various ways in which stops can be utilized and these will be covered later. That concludes our brief resume of some of the more important points of MM, a subject of many books. But it should serve to prompt a few thoughts about how you might be able to improve your approach to the market.
The traders who win are those who minimize risk. This is another key part and its importance is such that readers should read it carefully and ensure they understand its contents.
Those who do not minimize risk inevitably pay the price and get wiped out. It is for this reason that you often see strong moves after a news item is out of the way, often a news item suggesting a strong move in the opposite direction. The big traders, who got that way by minimizing risk in the first place, wait until the risk is at its lowest, when the news is out of the way.
Risk Control includes the following:
1 Not trading in too big a size, thus reducing the risk of a wipe out. Actually you should eliminate
the risk of a wipe out .
2 Not holding overnight unless you have a profit buffer in place. How- ever this does not apply to particular methodologies seeking to take advantage of certain factors which may apply to holding overnight.
3 Not holding over the weekend, subject to the same caveats as “2” above.
4 Taking appropriate action prior to major new items. This means not normally opening positions, maybe reducing position size if already positioned – although it does depend on your trading objectives. But in markets there are two types of risk and we need to look at both.
First there is the risk of loss inherent in the market itself. Second there is the risk of loss inherent in the vehicle we are trading. I deal with this in more detail later on, but simply put, the risk of making a losing trade when buying an option is far higher than when writing an option. But you can lose a lot more writing options, than you can buying them. This neatly demonstrates the two types of risk and, as traders, we need to understand how this works.
The trading secrets
Secret 1: Cut your losses
The first function that the new trader must accomplish is to learn the
business (instruct the core). Whilst doing so the key is to minimize your
tuition fees, so cut those losses, because they are your tuition fees. The
money spent on software, newsletters, books, seminars etc. is often
trivial in comparison.
As we learn the business we find that we tend to churn away without
getting very far. We learn to cut losses, but find that we make plenty of
good trades but not only are we cutting losses, we are also cutting our
profits. No surprise there. The ego, desperate for anything positive, takes
any profit it sees. But this is also no good because if you are going to
make money you have got to take those big profits. To do so you need:
Secret 2: Run your profits
OK, now you are starting to make progress. You should be making consistent profits on a one contract basis. But you have not cracked it yet. But you have your core on your side and your right hemisphere is starting to get involved. Now you can start to implement the final secret:
Secret 3: Trade selectivity
You have got to learn how to pick only the best opportunities. This takes
time. You have got to find the right trading approach for yourself. You
have got to narrow your focus on the market. There is far too much
information out there to absorb, even for your right hemisphere. So
decide on your methodology, concentrate on what you need, and
become an expert in its application. When you do this you will know
which are the best opportunities and which are not. At the same time
you will need to develop the mental discipline and patience to wait for
just those opportunities. Actually I will give you an added bonus:
Secret 4: Trade with the trend
That way you will have many more winners.
Following the rules
Now let’s look at the practical problems in following these three “simple”
rules. You would think that cutting losses would be simple enough.
It is hardly a difficult concept after all. But it does bring a lot of additional
baggage with it. It certainly makes the whole trading approach a
lot more complex. But the alternative is to be wiped out – at least for the
majority.
The above are just a few of the things that every profitable trader will know, and practice. Please find attached my very simple system, it is important to remember that i can only trade because i spent many years training my brain to be different.
You will need to do the same whichever system you decide to use.
I hope this has been helpful to some of you, feel free to contact me with feedback or to request a full copy.
Happy Trading!
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