thus increasing my average profit per trade.3. Exit and reverse if you get an opposite signal. If you are short and get a buy signal, don't wait for thestop orbailout exit, go with the most curent signal.That is all I have to tell you about exits. Don't get greedy, let the rules, not your emotions, take care of yourtrades.
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Chapter 12
Thoughts on the Business of Speculation
Speculation is not bad, but bad speculation is a disaster.
It is one thing to correctly call the twists and turns of the markers. but that is not how long-termwealth is created, nor is that talent sufficient. in and of itself, for a career in this business.Career success does not mean you have ferreted out a winning trade or two. Anyone can do that at anygiven time That is not a career that is either getting lucky or getting good. The business end of speculationamounts to consistently. doing the right thing-not getting off track. down in the dumps over the currentlosing trade or floating in the sky because you have had two winners in a row. I am much more interested inthe career aspect of this art than I am in the last trade or two. Anyone can drive a nail or two into a board, butthat is not what builds a house. To build a house you need not only the skills, but also a plan, the intentionsto follow and complete the plan and the ability to show up every day, rain or shine.
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What Speculation Is All AboutThe art of speculation is about figuring out the most probable direction the future will take. The future isseldom predictable to any precise level or event, yet all such investment predictions will entail threeelements: selection, timing, and management of the prediction. Mastering one of these aspects is notadequate, you must understand and be proficient in all three of them, so let's take a look at each element.There are two aspects of selection: one is selecting a market ready to move; the other is selecting so youcan focus. just because a market trades, don't expect your favorite commodity to suddenly have a rip-roaringmove that will enrich your bank account. A study of any charted history of any stock or commodity willdivulge an amazing secret that separates the wouldbe speculators from folks like you and me; price usuallymoves sideways in meandering back-and-forth pattern, perhaps with a slight trend direction. There are onlythree or four optimum times a year to take advantage of immediate and substantial changes in price. Goahead, check some charts, see and learn for yourself that big price changes do not occur every day. In fact,they are less likely, rather than more likely, to take place ... they are the exception, not the rule.That is why trade selection is so important. You don't want to get stuck in the mud of a choppy,trendless market; it will wear you out or shake you out. In either event, you lose. If not money, time. It isimperative, then, that you learn to know when a market has been set up and is ready to roar.I have given you numerous setup considerations in this book that include TDM, TDW, holidays, andintermarket correlations. There are others, such as the net long or short positions of the largest (and thereforesmartest) traders, the invariably wrong positions of the public, even major news events that alter marketactivity. A successful speculator plays a waiting game. Most people can not wait, they would rather wager.The sooner the better. Speculator kings and queens have the patience to put off taking action until thetumblers have clicked into place, knowing profits are then more likely to prevail.There is another reason selection can be paramount to profits. I have always done the best when I havetraded just one or two markets. By eliminating all the others, the distractions, I have been able to thoroughly,learn how my selected markets operate, what moves them, and perhaps of even greater importance, whatdoes not move them. No great accomplishment has ever come about without focusing talent, intentions, andaction. This business is no different. The more focused you are on what you are doing, the more successfulyou will become.This thought fits well with the way business works. Heart specialists make more money than generalpractitioners. In this day, and age of complexity, specialization has a large payoff. Years ago, I heard about awise trader who made millions in the stock market. He lived high in the Sierra Mountains and would call his
161broker about three times a year always to buy or sell the same stock. His broker told me the man hadindeed amassed a fortune, all from this one stock, by using financial focus.
It's about TimeIf you are now focused on a specific commodity that your new tools, techniques, and dreams sayshould soon have a tradable move, it is still not time to rush in. Selection is about what should move;timing, the next element of speculation, is about precisely when that should happen. Timing is aboutnarrowing down when price change should begin. Tools you can use here are simple trendlines, volatilitybreakouts, patterns, and the like. The essence of timing is to let the market prove to you that it is ready toexplode in Your selected direction.Just what does that mean? In case of wanting to go long, I can tell you this; a decline in price sure asheck does not mean the upside explosion has begun. Au contraire! A price decline suggests further pricedecline: it is that simple Newtonian idea that an object once set in motion continues to stay in motion.Traders have a great conflict going at all times, we want to buy, thus conventional logic says to buy at thecheapest possible price. Yet trend analysis says don't buy what is going down! My advice is to forgetbuying cheap. Buy when the explosion has begun. Yes, you will miss catching the low, but that is far betterthan having new lows in price catch you!
Trade ManagementThe third aspect of speculation has to deal with how you manage the trade itself as well as themoney you are committing to the trade. Traditional wisdom is that you should not trade with money youcannot afford to lose. Maybe.But consider this, if your mind-set is that this is play money, I assure you that you will play with it.And probably lose. If it is real money-money you cannot afford to lose-the chances that you will pay closeattention are much greater, and so are your chances of winning. Necessity is not only the mother ofinvention but also the control of speculation.Trade management goes beyond money management as it relates to how long you will stay in thetrade and how much profit to take. It directly concerns itself with your emotions: this means not gettingcarried away; it means not overtrading, not undertrading., it means doing the right thing and managing youremotional state during the trade.
162Knowing how to trade is not the same as knowing how to win at trading. The art of trading combinesselection and entry techniques with money management. That is the essence of what needs to be done, butthe superior trader understands that it is the management-the control or the use of these techniques-thatmaximizes market profits.
Essential Points about SpeculationRich People Don't Make Big BetsRich people, who are generally smart, have learned that you don't bet the farm on one spin of the wheel,investment deal, or trade. Wannabe speculators are consumed with the notion that they will amass tons ofmoney very quickly by making a killing. They become the hapless victims, as in the process they havebecome plungers. Yes, you can plunge once or twice in your life, but if you consistently plunge, you willlose on one of these wagers, and since you are betting it all, you will lose it all. That is why rich people don'tmake big bets.They are far too shrewd to risk all they have on an investment, as they know investment decisions canbe random. In their wisdom, they know the future is somewhat unpredictable; hence they play the game thatway. Years ago, I was on the board of directors of a small bank in Montana and in that position reviewedmany loan requests. The business applications always included a pro forma, a projection of how the businesswould do, and how the loan could be repaid.I don't think I ever saw any pro forma of what should happen become a reality! They were always offtarget, and as you might imagine, the reality of the business was not as prosperous as the pro forma wouldhave led one to believe. An old-time banker had a great saying, "Nothing good ever comes in certified mailand pro formas are never right."Rich people make more money by finding a good investment or two, and investing an optimal amountin those investments. There is no need to take the risk of being wiped out in exchange for the thrill ofplunging; it simply is not worth it.
To Make a Thousand, You've Cot to Bet a ThousandThis is a favorite expression of pit bosses in Las Vegas and is a subset to the idea that rich people don'tbet big.
163That's the favourite expression of Las Vegas pit bosses, and it's dead wrong.Here's the right way to "make a thousand. "There is not that much difference between gambling and speculation. The big compelling contrast isthat gamblers can never get a leg up on the game, the odds are against them all the time (unless they countcards and play blackjack). It has always amazed me that in a game where the odds are against us, we flockto the table to play.Las Vegas stays open 24 hours a day for a simple reason; players won't quit and in any endeavourwhere you have an advantage, especially a slight one, the longer you play the more certain you are ofwinning. So they never stop. To casinos, the public is the bank account they tap every minute of every dayWeaknesses of the Pit Boss Adage. Pit bosses are supposed gurus of gambling knowledge; after all,they have seen it all. But the advice that to make a thousand you need to bet a thousand is "house talk" thatwill get you into serious trouble.Last year, my daughter traded $10,000 to $110,000, while I took an account from $50,000 to over$1,000,000. At no time did we make "a big bet." It was quite the contrary, our bet size was small, neverrisking more than 20 percent of our stake and that was larger than it should have been or needed to be.If you have an advantage in the game, as a speculator must before he decides to play, then play by thereal rule that has kept Las 'Vegas building all those extravagant Meccas of money; risk little and playaround the clock.The problem with betting a thousand to make a thousand is you can lose that thousand just as quickly.So why not seek out a strategy that makes a thousand by the natural growth of the game, not by the luck orlack of it on the next trade. There is plenty of money to be made trading and the game is not going to getshut down anytime soon, so learn to harvest your winnings over time, not on one roll of the dice.In my 36 years of following the markets, I have seen more people lose fortunes than make them. Thelosers-all of them---did the opposite of the winners, they bet big thinking they could make a killing on oneor two trades. The winners made their fortunes by consistently doing the right thing. When you step out tomake a killing, you are more likely to be killed than to survive.Rich People Don't Make Big Bets. Really rich-and smart-people don't make big bets. First they are notout to "prove" anything, they are out to make more money, and second, they know that risk control is asimportant as the other two legs of speculation, selection and timing. That is all this business Of commoditytrading gets down to, selection, timing, and risk control.
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Speculation Is for People Who Love Roller CoastersTrust me on this. If you don't like the thrill and up-and-down gyrations of a roller coaster, put thisbook down, ask for your money back and go on with your humdrum life. The life of a speculator is literallyone roller coaster ride after another; it is a series of ups and downs, highs and lows where hopefully thelows are progressively higher, but the reality is often the lows are lower. Worse yet, so are the highs!Although many are attracted to the life of speculation because of the thrill, they don't envision the upsand downs, they think it will be a steady stream of Rolls Royce limousines and lollipops. It is not; it's asteady stream of unknown, free-form verse that at times seemingly leads nowhere. In this business, thrillkills.You must, at heart, be a thrill seeker. But you cannot let that take over your trading style; indeed, if youdo not learn to corral or harness your thrill seeking nature, you will never make it as a speculator. That isprobably what makes this business so difficult; while it takes a thrill seeker to speculate, it takes arisk-aversive person to make a career out of speculation. What you must have to succeed in this business,you also must learn to regulate, to control. Clamp down on the roller coaster or it will jump the track. Myadvice to be a long-term winner in the game of speculation is this; kill thrill.
If You Don't Have the Patience to Wait, There Will Be Nothing to Wait ForThis is one of the elements of thrill you must learn to control. Thrill seekers, like you and me (Iinclude you because you didn't put this book down and are still reading), enjoy the rush we get from theexperience so much that we want it all the time; hence the neophyte speculator will trade, wager, at the dropof a hat. Set up a proposition and he or she will plunk down her money, simply because win or lose, there's asure payoff-the rush.The core problem new commodity traders have is what we call "overtrading." This comes about whentraders look more for an adrenaline high than for market profits. They find this by either (a) trading moreoften than they should, or (b) trading more contracts than they should.It is really a question of intensity: the more contracts you have on, the more thrill you will experience.The more often you trade, the more often you will get an injection of endorphins pumping through yourbrain. These, then, are your mortal enemies: too many trades or too many contracts. Rich people don't betbig and they don't bet every day.
165Patience dictates that you trade for a reason beyond the rush, beyond the swashbuckling images wecarry in our minds of what a speculator does and thinks. Frequency and intensity, in my world ofspeculation, are not bigger and better. I want to be selective, to wait for the ideal time to take my very bestshot. This is certainly not a business of scattergun shooting; we are like hunters waiting in the bushes untilour game is in full view and about three feet away. Then and only then should we fire away!Impatient traders literally use up all their ammunition, money, and emotions, so when it is time toshoot, their guns are empty.
If You Can't Follow It, What Good Is a System or Strategy?Technicians and the like are forever developing trading systems to beat the pants off the market.They spend thousands of hours and dollars in pursuit of profits. That is good; I do the same thing almostevery day of my life in an attempt to seek greater understanding of the markets.The difference is once they have arrived at their "master system" they take a trade or two and thenbegin either tinkering with the system or overruling what it is telling them to do. Years ago, my long-timefriend Lin Eldridge put it best, "Why keep a system and do all that work if you're not going to follow it?"Be honest with yourself. If you are not going to abide by the rules you create, why create the rules?You should be spending your time doing something else. When it comes to speculation, rules are not madeto be broken unless you want to end up broke. The rules of speculation exist to tell the ideal time to get inand out, but more importantly the rules exist to protect us from ourselves.Maybe you think this is not your problem, that following a system is an easy thing to do. It isn't.Last year in America almost 52,000 people were killed-about 1,000 a week-in car accidents becausethey failed to obey one of two very simple rules, don't speed and/or don't drive if you have been drinking.Those are easy rules, not complex, not chock-full of emotions like the rules of speculation. Yet familieswent through major turmoil and grief due to those unexpected wrecks caused by not following a verysimple system. Should you choose to speculate in a swashbuckling fashion, trust me, the financial resultswill be the same. There most assuredly will be carnage and ruin on your speculative highways.The law of gravity always prevails and the law of gravity in our business must be obeyed.
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Christmas Doesn't Come in DecemberHere is the real rub with this business of being a commodity trader or speculator; we never, ever,know when we will make our money for the year.Jewelry storeowners know they will make most of their money around the holidays or at Christmas.That is true of most retail stores, they know when the money is going to roll in and can plan for that event.We cannot. That's one reason why I have written books and published a newsletter, I wanted a senseof some steady income in my life, plus it is profitable! I may make money hand over fist for 12 monthsrunning or make nothing, in fact lose money, for the first 6 or 7 months of the year then hit the jackpot.One never knows in this world of roller coasters what will happen.That is why commodity fund managers take a flat percentage of the assets under management. Thatway, they have steady income to offset their costs, despite the typical 20 percent of the profits they charge.They, like anyone else, need to have a consistent income stream.To my way of thinking, most of you should not quit your jobs and become traders. Your job, as bad asit might be, is your security, your source of income, the guaranteed Christmas. Yes, I know you don't likeyour job, but you know what? I don't like mine every day either. It is no piece of cake getting beat up in themarkets for 2 to 3 months. It is no joy to have a series of bad market calls in a newsletter where everyone cansee the errors of my way-errors my enemies love to magnify and my best friends chuckle over.But, none of that matters. In my world, I know you don't have to like it, you just have to do it. Thatmeans I must continue following a system, even while it is in a drawdown losing money, I must use stopswhen I don't feel like it, and I must keep telling myself Christmas may be delayed this year. What is more, Ihad better budget and plan my personal life accordingly; I must have enough cash to get me through anextended Christmas drought. And finally, if I do get lucky and find Christmas comes this year in January orFebruary, I sure as heck can't expect it will be Christmas every day until December 25. There are no straightpaths to heaven, my account equity is not a straight-up line, it is a meandering backroad that encountersplenty of peaks and valleys. That is why I never know when Christmas will come. I just know if I do theright things, eventually Santa will find my chimney.
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If You Have an Advantage in the Game, the Longer You Play the Greater Your ChancesAre of WinningIf you know you have an advantage in the game, you know that at some point you will be collectingthe chips, that Christmas will come.This is a vital concept for all speculators, it is a concept to build a belief system on, but the conceptitself cannot be built on a belief. Casinos don't operate on a belief. They operate, run their business, on puremath; they know that eventually the laws of the wheel or dice will prevail. Thus they keep the wheelsspinning. They don't mind waiting, they don't stop. They also play 24 hours for a reason; the longer you playtheir negative expectation game, the more certain they are of getting your money.I guess that is why I have always been amused by people who think they can go to Las Vegas to tap thecasino's bank. Casinos look at you and me as fodder for their bank accounts, and judging from the size of themegahotels as well as stock performance, they are on the right side of the ledger.As traders, we must realize that time is our ally. Legal contracts say time is of the essence; that maybe so when it comes to performance of obligations, but time is not of the essence when it comes to tradingbecause, given an advantage in a game, the more time that elapses the more certain your eventual winnings.Casinos don't close for another reason; the players won't quit. Players overtrade, in our vernacular.We are not casinos but we can sure learn a great deal from them. We need to know for sure that ourapproach has a statistical advantage in the game. You need to test, to prove your strategy. You cannot justassume what you are doing will make money because you are so darn smart or good looking. Once youhave proven through research that your approach works, it is then just a question of backing yourconvictions by following the system.
Press Your Winners Not Your LosersThis is the most important underlying rule of speculation. Losers do the opposite: they increase thesize of their bets when losing and decrease their bets when winning! Losers see a guy lose all his money ata slot machine and rush in to take his place!Winners look for positive streaks and press their advantage. I vividly recall a string of 18 winningtrades in a row in the S&P 500 on a hot line I used to do. After 3 winning trades in a row, 75 percent of thesubscribers would not take the next trades; after 6 wInners in a row, no one took any more trades!
168What is going on here is that the human mind cannot stand success and seemingly loves failure.People fear that winnings will turn into failure. whereas they apparently have more hope that failure willturn into success. so they willingly invest or speculate following losses.The truth is success is the result of strings of winning trades, and to succeed you must not stopbecause you have been successful. Press the winnings. Failure is the result of strings of losing trades; themost certain indication that a system is failing is that it is experiencing strings of losses greater than seen inthe past, exactly what the typical speculator is seeking to take advantage of! Admittedly, there is wisdom inwaiting for short-term failure to start investing in a long-term successful system, but there is no wisdom atall in stopping because something has been "too successful”Press your winnings, gang, not your losses.
Success Kills-Affluence Is DangerousAlthough we must, and will, press our winnings, we cannot let success go to our heads becauseaffluence leads to overconfidence, which in turn lead, to not following the rules that led to our success.I have heard countless stories from traders who started following my approach and did very well, insome cases making over $100,000, then gave it all back. When pressed on what happened, the bottom line isalways the same, the speculator confused luck and consistent application of valid rules with ego and egoprevailed.Their ego told them they had finally arrived, they had enough money to take chances and didn't needthe basics anymore. They were in charge! Thus they got into a "damn the torpedoes-full steam ahead"mode. No longer were stops so important, and since they were now trading too many positions or too manymarkets, when the hits came they were big. Too big-it was wipeout time.How is this cured? There is a simple concept that I keep telling myself. you dance with the person youbrought to the dance. Don't change because you see some other beautiful system or trading approach. If youare making money, stay with it, same rules, same logic, don't tinker. It has never been me that has made themoney trading, it has been my following of some well tested and proven systems or methodology. On myown, on your own, flying by the seat of your pants, you are headed for a crack-up. The more ego you involveand the further you stray from the operating rules of speculation the sooner the crash, and the morespectacular.
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Confidence, Fear, and AggressivenessThe meek will never make it as speculators so they had better have an inheritance.The three traits speculators must learn to manage within themselves are confidence, fear, andaggressiveness: I will discuss them in this order.Confidence. You need have some confidence but not too much. The confidence comes from yourstudy of the market and not from your feelings about yourself. Forget that entire warm fuzzy inner-childgood feeling about your self-confidence. What you need is confidence based on experience and research thatallows you to take correct action without choking when it is time to place a trade. Losers choke. Winnersfeel nervous about the trade, but they have enough confidence in the approach they are using, notthemselves, that they place the trade.Without confidence, you will never be able to pull the trigger and take your trades, especially duringtumultuous market times, which is usually when the best trades pop up out of nowhere.The meek probably do inherit the earth because they sure as heck are not going to make any money on theirown as speculators. The inner assurance I have seen in big-time commodity traders is inspirational. Itsessence is not pluck or conceit, nor a sense of self-possession. What is at the core of their confidence is trustor faith that things will work out.Winning traders see or believe in the future, to that extent they are full of faith. I believe in God, andthat good prevails, that all things do work out favorably. If I don't let God down, I will not be let down. Mybelief that God prevails gives me the trust in the future to have enough confidence to trade when others failto take action. I know my life will work out okay, that I have never doubted for an instant. Fear can belimiting, to the point a trader does not believe in the future.We Have More to Fear than Fear Itself. President Roosevelt had it all wrong about fear. That shouldcome as no surprise, he single-handedly screwed up this great country more than any other leader ever haswith his New Deal socialism and welfare state programs. Worse yet, he persuaded the masses and themedia that his programs got us out of the Great Depression. Sure, like America would not have recoveredor grown without him' ' I will never forget campaigning for the United States Senate in the general electionand knocking on doors in a heavily Democratic district. Behind one of those doors was a wizened lady of atleast 80 whose vote I asked for only to have her tell me she didn't vote. When I asked why, she said, "I
170voted only once in my life, that was for FDR, and after seeing what he did, I told myself that if I was dumbenough to vote for that son of a bitch, I should never vote again”.Fear is a powerful force to help speculators perform at their peak. The best example of the use of fearthat I know was expressed by Royce Gracie. You may not know who Royce Gracie is so let me tell you abit about him.Gracie is a world-class athlete, he is the guy in those Ultimate Fight pay for view TV shows. In caseyou haven't seen one, they are for-real fights, no boxing gloves and just about anything is legal fromkicking to gouging. This is for real violence. What is interesting about Gracie is that in over 100 fights hehas never been beaten. That is never as in never, ever. By anyone, boxers, kickers, elbow punchers, Taikickers. No one has been able to beat this guy.Considering that most of these would-be tough guys weigh from 225 to 300 pounds, Gracie'saccomplished victories are even more awesome when you find out he weighs about 180 pounds and looksbetter in a Mr. Rogers sweater than fighting attire. You would never know the guy is a giant killer. Since Iam fascinated with fighters and winners (they have a lot in common with speculators), I have followed thisguy's career and listened intently to his words of wisdom.In one interview, these television thugs were asked if they felt any fear going onto these fightsbecause, after all, they are real-guys have been maimed, lost their sight, broken bones, suffered numeroussevere concussions, and at least one fighter has died. All the tough guys machine-gunned out their malemacho line about having no fear of anyone or anything.That is all of them but Gracie. He freely admitted he is scared to death every time he enters the ring.He went on to say he uses that fear to his advantage as it enables him to respect his opponent and not takereckless action or deviate from his personal fighting style. "Without fear," he said, "you cannot win as fearpumps me up for the fight but also assures that I will not lose control. What we do is very dangerous; mybest protection is to be afraid so I protect myself in all the ways of my craft."Like Gracie, I have an immense fear of trading, I have seen people wiped out, losing all they ownedfrom poor speculation. Some went bankrupt, some really did go crazy, and several killed themselves. Isuspect all these people had one thing in common: they did not fear the markets.I think you need to fear the markets and fear yourself.Although the markets are frightening, the emotions you and I interject into trading are downrightscary. Without fear, there is no respect; if you do not respect the markets and fear yourself, you willbecome one more dead body on the long trail of commodity market casualties scattered across the land.
The Right Dosage of Fear and Confidence Create Aggressiveness. There comes a time in every trader'slife, about once a week in fact, when you have to get aggressive, either in protecting yourself or assertingyour market expectations. It is kind of like that eye of the Tiger thing in the old Rocky movie. Unless youhave a killer instinct, you had better fold your tent and go home. This is not a business for passive peoplewho seemingly don't care whether they win or lose, people who lack that cutting edge to pick up achallenge and proceed.I don't mean hostility as most people usually envision aggressiveness. Winning traders have a certainboldness to their action, and that boldness is the culmination of confidence, fear, and aggressiveness. In thisbattle for speculative profits, a well-thought-out plan with boldness will go a long way toward carrying theday.
Chapter 13
Money ManagementThe Keysto the Kingdom
The creation of a speculators' wealth comes from how they manage.Their money, not some magical, mysterious system or alchemist’s secrets. Successful trading makesmoney, successful trading proper money, management can create immense wealth.
Here it is, the most important chapter in this book, the most important chapter in my life, the mostvaluable thoughts I can transfer from me to you. I have nothing of more value that I could possibly giveyou than what you are about to learn. This is not an overstatement.What I am going to explain, is the formula I have used to take small amounts of money like $2,000 toover S40,000, S10,000 to $110.000 and $10,000 to $1,100,000. These were not hypothetical victories; weare not talking Monday morning quarterbacking-we are talking real time. real money, real profits that youcan spend to buy all the luxuries of life.Until you use a money management approach, you will be a two-bit speculator, making some moneyhere, losing some there, but never making a big score. The brass ring of commodity trading -will always beout of your grasp as you sashay from one trade to another. picking up dollars but not amassing wealth
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172The truly shocking thing about money management is how few people want to hear about it or learn thecorrect formulas. When I am at a dinner or cocktail party, invariably the conversation turns to the markets.People want hot tips, or to know how I have been able to make a living without working. They want mysecret. As if there is one!The public or noneducated speculator thinks there is magic to trading, that somewhere, someplacesomeone has a magic decoder ring that correctly signals market action.Nothing could be further from the truth. Money is made in this business by getting an advantage in thegame, working that advantage on a consistent basis, and coupling this with a consistent approach to howmuch of your bankroll you have behind each trade.
Most