Title : The New Trading for a Living: Psychology, Discipline, Trading Tools and Systems, Risk Control, Trade Management
Author : Alexander Elder
Tags : Business & Economics, Finance, General, Accounting
Ids : isbn:9781118443927, amazon:1118443926, google:ydY5BAAAQBAJ
Published : Sep 2014
Publisher : WileyPART 1 Individual Psychology
5. Reality versus Fantasy
Trade with Your Eyes Open
The public wants gurus, and new gurus will come. As an intelligent trader, you must realize that in the long run, no guru is going to make you rich. You have to work on that yourself.
A successful trader cannot afford wishful thinking—he must be a realist. There are no cheat sheets in the markets—you can see the truth in your trade diaries and equity curves.
To win in the markets, we need to master three essential components of trading: sound psychology, a logical trading system, and an effective risk management plan. These are like three legs of a stool—remove one and the stool will fall. It is a typical beginner mistake to focus exclusively on indicators and trading systems.
You have to analyze your feelings as you trade to make sure that your decisions are sound. Your trades must be based on clearly defined rules. You have to structure your money management so that no string of losses can kick you out of the game.
6. Self-Destructiveness
Controlling Self-Destructiveness
You need to be aware of your tendency to sabotage yourself. Stop blaming your losses on bad luck or on others, and take responsibility for your results. Start keeping a diary—a record of all your trades, with reasons for entering and exiting them. Look for repetitive patterns of success and failure. Those who don’t learn from the past are condemned to repeat it.
A trader needs a psychological safety net the way a mountain climber needs his survival gear. I found the principles of Alcoholics Anonymous, outlined below, to be of great help at an early stage of trader development. Strict money management rules also provide a safety net, while the diary helps you learn from your mistakes as well as successes.
The Demolition Derby
Almost all professions provide safety nets for their members. Your bosses, colleagues, and clients will warn you when you behave badly or self-destructively. There is no such safety net in trading, which makes it more dangerous than most human endeavors. The markets offer endless opportunities to self-destruct.
Buying at the high point of the day is like swinging your car door open into the traffic. When your order to buy reaches the floor, traders rush to sell to you—to tear off your door along with your arm. Other traders want you to fail because when you lose they get your money.
Markets operate without normal human helpfulness. Every trader gets hit by others. Every trader tries to hit others. The trading highway is littered with wrecks. Trading is the most dangerous human endeavor, short of war.
Self-Sabotage
When traders get in trouble, they tend to blame others, bad luck, or anything else. It hurts to look within yourself for the cause of your failure.
We cling to our self-defeating patterns. They can be treated—failure is a curable disease.
The mental baggage from childhood can prevent you from succeeding in the markets. You have to identify your weaknesses and work to change. Keep a trading diary—write down your reasons for entering and exiting every trade. Look for repetitive patterns of success and failure.
Gambling
Gamblers feel happy when trades go in their favor. They feel terribly low when they lose. They differ from successful professionals who focus on long-term plans and don’t get particularly upset or excited over any single trade.
The key sign of gambling is the inability to resist the urge to bet. If you feel that you are trading too much and the results are poor, stop trading for a month. This will give you a chance to re-evaluate your trading. If the urge to trade is so strong that you cannot stay away from the action for a month, then it is time to visit your local chapter of Gamblers Anonymous or start using the principles of Alcoholics Anonymous, outlined later in this chapter.
Unfortunately, trading often appeals to impulsive people, gamblers, and those who feel that the world owes them a living. If you trade for the excitement, you’ll inevitably take trades with bad odds and accept needless risks. The markets are unforgiving, and emotional trading always results in losses.
7. Trading Psychology
Bending the Rules
You need to make trading as objective as possible. Be sure to follow money management rules. Keep a spreadsheet listing all your trades, including commissions and slippage. Keep a diary of all your trades with “before and after” charts. At the early stages of your trading career, you may have to devote as much energy to analyzing yourself as analyzing the markets.
The Insight
Your success or failure as a trader depends on your emotions. You may have a brilliant trading system, but if you feel arrogant, frightened, or upset, your account is sure to suffer. If you become aware of fear, greed, or a gambler’s high, close your trades.
In trading, you compete against the sharpest minds in the world. Commissions and slippage slant the field against you. Now, on top of that, if you allow your emotions to interfere with your trading, the battle is lost. My friend and partner in SpikeTrade.com Kerry Lovvorn is fond of repeating: “It is hard enough to know what the market is going to do; if you don’t know what you are going to do, the game is lost.”
Having a good trading system is not enough. Many traders with good systems wash out because psychologically they are not prepared to win.
8. Trading Lessons from AA
Rock Bottom
A drunk can begin his journey to recovery only after he admits that he is an alcoholic. He must see that alcohol controls his life and not the other way around. Most drunks cannot accept this painful truth. They can face it only after they hit rock bottom.
The pain of hitting rock bottom makes an alcoholic see how deep he has sunk. He sees a simple stark choice—either turn his life around or die. Only then is an alcoholic ready to begin his journey to recovery.
Profits give traders an emotional high and a feeling of power. They try to get high again, put on reckless trades, and give back their profits. Most traders cannot stand the pain of severe losses. They die as traders after hitting rock bottom and wash out of the markets. The few survivors realize that the main trouble is not with their methods—it is with their thinking. They can change and become successful traders.
Denial
There is a stark parallel between an alcoholic and a trader whose account is being demolished by losses. As he keeps changing his trading tactics, he acts like an alcoholic who tries to solve his problem by switching from hard liquor to beer. A loser denies that he’s lost control over his trading life.
9. Losers Anonymous
Trader’s First Step
The absolute maximum a trader may risk on any trade is two percent of his account equity.
If your account is small, limit yourself to trading fewer shares, less expensive futures, or mini-contracts. If you see an attractive trade, but a logical stop would have to be placed where more than 2 percent of equity would be at risk—pass on that trade. You may risk less, but you may never risk more. You must avoid risking more than 2 percent on a trade the way a recovering alcoholic avoids bars.
If you lose even a dollar more than your businessman’s risk, including commissions and slippage, you are a loser.
Poor record-keeping is a sure sign of a gambler. Good businessmen keep good records. Your trading records must show the date and price of every entry and exit, slippage, commissions, stops, all adjustments of stops, reasons for entering, objectives for exiting, maximum paper profit, maximum paper loss after a stop was hit, and any other data necessary to review and fully understand your trade later in the future.
Trader’s Rock Bottom
Hitting rock bottom feels horrible. It is painful and humiliating. You hit it when you lose money you cannot afford to lose. You hit it when you gamble away your savings. You hit it after you tell your friends how smart you are and later have to ask them for a loan. You hit rock bottom when the market comes roaring at you and yells: “You fool!”
Many traders who hit rock bottom slink away from the market and never look back. Many who trade today will be gone in a year, if not sooner. They’ll hit rock bottom, crumble, and leave. They’ll try to forget trading like a bad dream.
Some will lick their wounds and wait until the pain fades away and then return, having learned little. They’ll be fearful, and their fear will further impair their trading.
Fortunately, some traders will recoil from rock bottom to begin the process of change and growth. For these individuals, the pain of hitting rock bottom will break the vicious cycle of getting high from winning and then losing everything and crashing. When you admit that your personal problem causes you to lose, you can begin building a new trading life. You can start developing the discipline of a winner.
10. Winners and Losers
In Charge of Your Life
You have to analyze your behavior instead of acting out your feelings.
All of us have our own demons to exorcise on the journey to becoming successful traders.
- Decide that you are in the market for the long haul—that is, you want to be a trader even 20 years from now.
- Learn as much as you can. Read and listen to experts, but keep a degree of healthy skepticism about everything. Ask questions, and do not accept experts at their word.
- Do not get greedy and rush to trade—take your time to learn. The markets will be there, offering more good opportunities in the months and years ahead.
- Develop a method for analyzing the market—that is, “If A happens, then B is likely to happen.” Markets have many dimensions—use several analytic methods to confirm trades. Test everything on historical data and then in the markets, using real money. Markets keep changing—you need different tools for trading bull and bear markets and transitional periods as well as a method for telling the difference (see the sections on technical analysis).
- Develop a money management plan. Your first goal must be long-term survival; your second goal, a steady growth of capital; and your third goal, making high profits. Most traders put the third goal first and are unaware that goals 1 and 2 exist (see Section 9, “Risk Management”).
- Be aware that a trader is the weakest link in any trading system. Go to a meeting of Alcoholics Anonymous to learn how to avoid losses or develop your own method for cutting out impulsive trades.
- Winners think, feel, and act differently than losers. You must look within yourself, strip away your illusions, and change your old ways of being, thinking, and acting. Change is hard, but if you want to be a professional trader, you have to work on changing and developing your personality.
In order to succeed, you need drive, knowledge, and discipline. Money is important, but less so than any of those qualities.
Emotional Trading
Most people crave excitement and entertainment. Singers, actors, and professional athletes command much higher incomes than such mundane workmen as physicians, pilots, or college professors. People love to have their nerves tickled—they buy lottery tickets, fly to Las Vegas, and slow down to gawk at road accidents.
Like an Ocean
The market is like an ocean—it moves up and down regardless of what you wish.
A sailor cannot control the ocean, but he can control himself. He can study currents and weather patterns, learn good sailing techniques, and gain experience. He can learn when to sail and when to stay in the harbor. A successful sailor uses his intelligence.
A sailor whose boat is being battered by ocean winds battens his sails—reduces sail area. The first remedy for a trader battered by the market is to reduce the size of his trades. Trade small while you’re learning or when feeling stressed. A professional trader uses his head and stays calm. Only amateurs become excited or depressed. Emotional trading is a luxury that nobody can afford.
Most of all, your success or failure depends on your ability to use intellect rather than act emotionally. A trader who feels overjoyed when he wins and depressed when he loses is at the mercy of market moves and cannot accumulate equity.