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You Can't Become Rich In Your Pocket Until You Become Rich In Your Mind | ||||
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Many traders know that Reminiscences of a Stock Operator by Edwin Lefevre is a book about Jesse Livermore, the famed trader who made approximately $100 millionSpeaking of Jesse Livermore Many traders know that Reminiscences of a Stock Operator by Edwin Lefevre is a book about Jesse Livermore, the famed trader who made approximately $100 million in 1929 dollars in the stock market crash (about a billion in today's dollars). What many people do not know is that on March 5, 1934, he filed for bankruptcy, and on November 28,1940, he blew his brains out in the bathroom stall of a hotel. Although this may not sound like a strong endorsement for the book, it is a must read for any serious trader. While this book talks about the trading strategies that made him his fortune, the book Jesse Uvermore, World's Greatest Stock Trader by Richard Smitten also goes into detail about the years and days leading up to his suicide. I majored in history and was trained to take pieces of historical data and form an opinion, based on facts, about what really happened in the past. From what I've read of Jesse Livermore's life and eventual demise, my opinion is that he suffered a bout of euphoria after the 1929 crash. This euphoria caused him to trade recklessly and with huge size, and this caused him to lose his fortune in less than five years. Although he had gone broke and made a fortune three times before, the size of this loss did permanent psychological damage, and the pressing weight of trying to make it all back is what eventually did him in. Let's take a look at what euphoria can do to a trader. Euphoria: Redefining Stupid Euphoria is the worst emotion for a trader to succumb to, even worse than greed. What happens with euphoria is that traders have such a great day in the markets thai they proclaim themselves king of the trading world. Normally let's say they trade 10 contacts. Well now, since they are king, they are going to start off with 50 contracts, and go up from there if they feel like it. After all, they are now the world's greatest trader and can do no wrong. This happens to traders frequently, and the resulting act of insanity is just like doubling each bet on a roulette wheel. People can sit on red and keep doubling up on each bet until they win. This works great right up until the time that they have maxed out their capital on red, and the color comes up black. Doubling and tripling up on positions just because a trader is feeling confident is yet another sucker's game. What's worse is that this strategy always leads to traders giving back all the fantastic gains that made them euphoric in the first place. This places added pressure on tradersnow they have to trade in order to get back to where they were. This, of course, causes a multitude of bad habits. Increasing trading size just because you are feeling awesome about your trading is like being in a marriage that is going fantastically well. The conversations are sparkling, the mutual adulation adoring, and life under the covers is grand. Happiness abounds in spades. How can you make this better? Double up! Have an affair. A good idea in theory, but this is only going to turn out one wayvery, very badly. PAPER TRADINGWHY IT'S MORE WORTHLESS THAN AN IRAQI DINAR There are a few good reasons for people to paper trade. Paper trading will help a trader learn a new execution platform. This way they can figure out how to use the software through a demo account and save themselves costly errors that arise when they try to place orders on an unfamiliar system. Also, paper trading is good for forward testing a system or strategy to see how it works before committing real money. However, paper trading does have one distinct disadvantageit can be worthless in a way because it does not take into account how a trader will act when there is real money on the line. That is what makes or breaks a trader. It's ok to trade a smaller size, but without real money on the line, a trader won't understand how they hold up under pressure. This is also a good way for a trader to test how far apart they are mentally from paper trading vs. real trading. A trader should feel the same trading paper as they do real money. To the extent that they feel extreme emotions when really trading vs. paper trading, it will give them a clue where they are on the psychological trading scale- In other words, how screwed up they are psychologically when they are actually trading real money. When a trader freaks out on a real trade, it is a red flag that they are trading too big for their account size. In this case, a trader should keep trading smaller size until they feel the same emotionally as when they are in a paper trade. The most dramatic instance Tve seen with this is in working with traders in Asiat specifically in Taipei. Hong Kong, Tokyo, and Shanghai. Asians are fantastic gamblers, willing to risk huge sums. This can be a problem with trading and it only takes one bad trade to ruin an account. One guy I worked with was trading 100 lots at a time in a $100,000 account. Each I point move in the S&Ps represented $5,000. The first day he made 5 points ($25,000), and the next day he lost 7 points ($35,000). These were normal fluctuations for him, and it showed. He'd get so excited and animated that I thought he was going to implode. 1 had him cut his size down to 10 lots. At first he was bored, but then a strange thing happened. He wasn't excited, so he traded objectively ... and he made money. We got him to trade in the same fashion as if he were paper trading, and it made all of the difference. Being able to work with traders overseas is a great win/win forme as I get to learn how other people view the U.S. markets, as well as see how U.S. news is filtered through their local news channels. Being able to put yourself in another person's shoes brings more understanding of how the world really works. That may not help you decide whether or not to take the next trading setup that comes your way, but it does help form a macro view of the worldand it does make life more interesting. Good Ideas to Keep in Mind A trader's relationship with the market is really like a dance, and it's best to let the market lead. It's important not to come into the market with an overly bullish or overly bearish out-look. The stronger a trader believes in an idea, the easier it will be to get suckered into taking the wrong side of a trade. In an upcoming chapter I talk about how to read market internals, and this is a great way to get a read on what's happenihg in the markets. Instead of coming into the day a raging bull or a roaring bear, I just come in as an interested observer. The radar screen that I watch keeps me in the loop and gives me odds on the path of least resistance. As long as we're dancing together, I'd like to know when my partner is going to try to dip me. And there's a little saying that I always like to remember, it's called discipline before vision, which is something 1 first heard from Peter Borish, the former head of research for Paul Tudor Jones. I might think the market is going to crash today, but Vm still going to have a stop in place in case I'm wrong. The vision of being short during a crash is a pleasant one, and the thought of a big move gets traders to do stupid things, like doubling up and adding to losing positions. Disciplined traders live to fight another day. Through most of 2004 and 2005, I've heard many traders who are staying positioned for the next, inevitable terrorist attack. After the events of September 11, they saw how that impacted on the market* and they want to get positioned for the next attack. (Yes, this is a terrible way to look at a disaster, but this is how traders think. If there is a hurricane in Florida, then it's time to go long lumber because they will have to rebuild a lot of houses). The funny thing is, this vision of being positioned for a crash totally clouds their judgment. The only thing the market hates is uncertainty. The events of September 11 were unexpected, and the market got crushed. However, terrorist activity is now a certainty. It is no longer an unexpected event, and therefore the market has already priced in future terrorist attacks. Sound insane? On July 7, 2005, America woke up to the news of the London bombings. The Dow at one point was down over 200 points pre-market open. All of these people got heavily short. The markets rallied and closed positive on the day, and these waiting for the next disaster traders'* got crushed. Discipline before vision. It is also important to remember that there is no need to spend wasted years looking for complicated setups or the next Holy Grail. There are very simple setups out there to use. Some of the best traders I know have been trading the same setup, on the same time frame, on the same market for 20 years. They don't care about anything else, and they don't want to learn about anything else. This works for them, and they are the masters of this setup. They have nothing else coming in to interfere with their focus. If a setup doesn't happen that day, then they don't take a trade. Other successful traders I know have learned to celebrate their losses. When they get into a trade and get stopped out, they jump up and clap their hands. When they get into a trade and it hits their target, they do nothing. They're doing the exact opposite of everyone else, and they're making money. When Jesse Lrvermore was in the process of making his fortune, one of his favorite quotes was, If I bought a stock and it went against me, I would sell it immediately. You can't stop and try to figure out why a stock is going in the wrong direction. The fact is that it is going in the wrong direction, and that is enough evidence for an experienced speculator to close the trade Small losses make all the difference, and traders must learn to reward themselves for doing their job in this regard. [t is important to remember that a trader is not trading stocks, or futures, or options. Traders are trading other traders. There is another person or system out there taking the opposite side of the trade. One side is going to be right, and the other side is going to be wrong. Whoever has the better setup on this trade is going to win. Is the trader on the other side of the trade an amateur or a professional? That trader should be wondering the same thing about you. The next time you succumb to greed and chase a trade, remember that there is a professional somewhere else in the world who has been waiting patiently for this setup and is doing just the opposite. I have found that the most important step to becoming a successful trader is just learning how to accept a loss without any anger or frustration or shame. It's just part of trading. It's not a big deal. I take losses every day, and I do it live in front of people all of the time. It's just part of the process. Okay, this trade just hit its stop. Next. It's like Tom Hanks's character in the movie A League of Their Own. who screams at his female player and makes her cry. Are you crying? he asks, shocked. 'There's no crying in baseball! And there's no crying in trading and no throwing your coffee cup against the wall or screaming at your monitor. Losses and missed trades are just part of the deal. On some days things are just not going to come together. If fin using a setup and I'm stopped out two times in a row, then I just stop using that setup for the rest of the day. For whatever reasons, it is out of sync with the markets on that particular day. No big deal. There is no need to reformat the MACD. It's just part of trading. The key is to have two specific sets of rules. First there needs to be a trading methodology. For this setup, do the traders go all in or scale in? Do they scale out or get all out at a specific target? Do they trail a stop or leave it? Where is the stop placement in relation to the target? These are all things that have to be set in stone before the trade is placed. Once the trade is placed, there is no room for rational thought. The setup has (o be followed the same way each and every time, or the traders will never be able to gauge if the setup is going to help them or hun them in their trading. Otherwise they are just making impulse trades, and those are the sucker trades. Second, there has to be a money management rule. How many shares or contracts does a trader allocate towaid this setup? How much equity is a trader willing to risk on this setup over the course of a day* a week, a month, or a year? After traders do this for a while, what happens is that they develop the habit of following their rules and they eventually learn to trust themselves. Once traders learn to trust themselves, they can then free their mind to focus on market opportunities that present themselves, instead of being wrapped up tight in a ball of fear, frustration, and doubt. This is where traders make the transition out of the first three phases and begin to really have an opportunity to do this for a living. The transition involves focusing on developing their own trading skills instead of focusing on the money. And the skills are easykeep the emotions in check and have the discipline to follow the setups. Don't focus on making $ 1,000, That is what the amateurs do. Focus on developing your skills and executing the setups the same way each and every time. It sounds simple enough, but I've worked with enough traders to know that most of them can't do it over the long haul. They get impatient and don't want to miss out on the action, so they jump in and chase without a clear setup. Once they do this, they go back into the barrel with all the amateurs. Most of trading involves waiting. First, it involves waiting for a setup. Once the setup occurs, then the professional trader takes it without hesitation. The skill comes in waiting for it to set up and not succumbing to an impulse trade. Then, once in a setup, a trader has to have the discipline to wait for the exit parameters to be hit and not cave and bail out too early. Waiting is the hardest thing for many traders to do, but it's the waiting that separates the winners from the losers. Even for a day trade, it can be hours before a setup happens or a parameter is hit. And that's the whole key. Just being patient and waiting. The person who chases four rabbits catches none. Also, it is so important to realize that professional traders are not in every move. It is okay to have the market leave the station without you. Catching every move is iinpossibJe. but chasing every move is the mark of an amateur. This is why it is imperative for traders to have a set of rules to follow for both entries and exits, as opposed to relying on their own gut feelings to manage a position. Develop a set of rules and have the discipline to follow them; they exist for your protection. For me, the biggest difference in my trading occurred when I learned to ignore my brain and just focus on a handful of good setups. Once I learned the setups, the next challenge was to have the discipline to follow them the same way each and every time. No thinking, no hemming, no hawing, I did this by recording my trading activity and grading myself on how well I executed each setup, instead of how much money I was making or losing. Whereas focusing on the P&L automatically encourages the bad habits that plague many traders, a setup-based approach encourages habits that can push a trader into the realm of consistent profitability. In the end, professional traders focus on limiting risk and protecting capital. Amateur traders focus on how much money they can make on each trade. Professional traders always take money away from amateurs. Amateur traders start to turn into professional traders once they stop looking for the next great technical indicator, and they start controlling their risk on each trade. You cannot be disciplined in great things and undisciplined in small things. Brave undisciplined men have no chance against the discipline and valor of other men. Have you ever seen a few policemen handle a crowd? |
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