ations. I saw many of these traders taking the same journey I had taken.
KEYING IN ON THOSE AROUND MEAs I observed other traders, I saw that they went through different stagesof trading. Their beliefs about the market all seemed to stem from a misunderstanding of it. They heard certain remarks from commercials, brokers, and the financial media. But they had a hard time adjusting theirbeliefs to market reality. I realized that any successful learning processmust start with correcting those beliefs. Teachers who instill the rightmindset in their students do more good for the students than does theteacher who only teaches a trading system.
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First, let me define a belief from my perspective. A belief is a feeling or concept, within any individual, about some future outcome, basedon past experiences or memory. We all have past experiences from earlychildhood all the way up to 5 minutes ago, and these experiences shapeour beliefs about the future.In general we all hold certain beliefs about life. For instance, theharder we work and the more effort we put in, the more money we willmake. The less we work, the less money we will make. The person whoworks three jobs will make more than the couch potato. But the problemis that this belief does not hold true in trading. It takes virtually no effortto trade stocks. Anyone can buy and sell stocks and have winners andlosers with no effort at all. I remember telling my daughter, who was thirteen at the time, a bit about what I was doing at the office. She noticed thegreen and red numbers and figured that when she saw green, she wouldbuy. When she saw red, she would sell. It sounded so logical to me that Ijust had to smile. Once a simple observation is learned, with no effort, aperson would buy and sell stocks with no reason or thought. Some ofthose trades would make money and some would not.When new traders come to the marketplace, ready to trade stocks,they buy here and sell there based on opinions or systems they don’t reallyunderstand. This is a good reason why many do not stick around for toolong. They make trades, winning and losing, with no effort at all. If theywin more in the beginning, they believe that trading is easy, a piece ofcake. How hard could it be? You just buy here and sell there. It’s not untila string of losses, or one great loss, comes along that they begin to redefine their thought process. If traders lose and lose, their belief is that trading is impossible, no one can do it. Once they encounter a string ofwinners, or a big win, then their belief begins to change to thinking thatmaybe it is possible. They had an initial belief, based on some criteria, orstring of memories. Once a different criterion was placed in the experience pool, the belief became somehow distorted or was changed.I started trading, making and losing money with no effort. I continued, lost money with no effort (it doesn’t take any effort to not press thesell button). I continued, learning all I could about the market and myself(considerable effort). I am here now, trading again with basically minimal“effort.”
NOT EVERYONE GETS AN A FOR EFFORTWhat is the difference between my beginnings, when I traded with noeffort, and where I am now, trading with minimal effort? I traded with no
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effort from the beginning because I did not feel fear. There was nothingto tell me that there was something to be afraid of. You learned of a fewof my horror stories and they certainly instilled fear in me. I learned riskand management principles, and I geared my inner self to trading. Now Ihave nothing to fear again. I don’t believe that the market can take morefrom me than I’m willing to give it. It’s interesting how a beginner and anexperienced trader can have the same belief yet a different understandingof the market.The biggest difference at the beginning stage was the lack of responsibility—the beginners’ belief that trading is based on “the market making and taking their money.” Experienced traders know that it is they whoare accountable for their trading and the money they risk and make oneach individual trade. Beginners will never become professionals withoutbeing accountable for their own actions. Trading has nothing to do withwhat the market “does to you.”Another aspect of this belief adjustment relates to my Russianfriend. She tried to learn a certain system from a trading service. Systemsare not “one size fits all” entities. There are numerous systems and numerous books about systems. And I’m sure there are many more to come. “IfI can just find the right system, trading will be a piece of cake.” We knowthis to be false, since no system provides consistent winners from individual to individual. If a system existed that provided winners to all whoused it, there would be far more traders making a very good living. Butthe fact is that 90 percent of traders lose money. Within a group of tradersapplying the same system, one trader makes more money than another,and some don’t make money at all. The system is the same, so why are theprofits different? Trading again is about us and is just a reflection of whowe are at any given moment. Let me illustrate. You are in the stock, andit makes a couple ticks in your favor. Are you confident and calm? If youare, then you will let it run, allowing the profit to develop. Are you a coward, or do you feel unsure? If either is true, you will take your profits prematurely. Your position is moving against you—are you a cold-bloodedtrader willing to accept the risk even before you put on the trade? Or doyou feel like you just can’t accept monetary loss? If this is the case, thenyou are going to take your stop loss in the first case, and you will be subjected to a horrible emotional spiral in the second.We see simple market movement every day. The market moves upand down, as aggregate shifts of demand and supply lean to one side orthe other. This happens at all price levels. The basis for movement is whatwe as traders try to define and profit from. Some see it on a tape-readingplatform, some by technical analysis, and some don’t use anything (they
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make it up as they go along). The last kind are my favorite kind of traders.They try to buy and sell a stock based solely on opinion, and then try tohide behind the word intuition. I believe in intuition a great deal, but notwhen it’s used to mask a lack of skill in stock trading. When I first broughtup a chart of a stock, I saw a hill. I didn’t see support and resistance. Ididn’t see capitulation events. I didn’t see euphoric events. I didn’t seeaccumulations. I saw a hill. Why? Because there was nothing from previous experience to tell me what that hill meant, what moves within thathill were made up of.
YOU DECIDE YOUR FATE; THE MARKET DOESN’TThose who think that the market provides profit and loss are mistaken.You and the choices you make decide this. If you accept the notion thatthe market dictates your profit and loss to any degree outside your parameters, you lose control of your trading. The market is neutral. It willgo up and down regardless of your position. It’s you who engages and disengages, making a profit or loss. The market doesn’t know who you are,nor does it care. It goes up, making emotional longs happy and emotionalshorts unhappy. Vice versa with downward moves. Emotional trading is akiller of traders. The idea is that you, at this very moment, have some feeling within you about yourself, your trading. Either you made money thismorning and are eager to trade again because you feel confident, or youdidn’t make money this morning and are feeling frustrated and ready togive up today. Or you might have made a profit and are willing to rest thisafternoon, or you lost money and are ready for revenge this afternoon, asif the market owes you something. The markets owe us nothing.Many people might wonder, “But if the market does what it does,then how do I still have control? The market moved to make me moneyor lose my money.” We still have to hit the exit button, right? How manytimes early on in our careers do we have a great profit, only to turn it intoa loss? How many times do we have a small loss turn into a larger one?The point is that we are still the ones who make the decisions for entry andexit, and that’s what we are in control of—our decisions.The market doesn’t care about us. If you believe that the market istrying to hurt you, you’re misguided. The market isn’t something to be atwar with; it’s something to move with. When you do, you regain control.When you regain control, what is there to fear? If there is nothing to fear,then you can make quick decisions for both entry and exit. Even if youdon’t profit, if you trade unemotionally, where each uptick or downtick isneither euphoria nor pain, then you trade successfully. The idea is not to
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get rid of all your emotions. I don’t think it’s even possible. The idea is todistance your trading decisions from your emotions. Understand that mosttraders experience the same set of emotions, and most of them lose.Doesn’t this tell you that you need to learn to stop your emotions fromgoverning your trades? Even more than that—you can use your emotionsas a mirror to reveal what the majority thinks and feels, thus effectivelyallowing you to exploit the fear and greed of others. And, again, in orderto be able to do it, you have to be emotionally detached; you need to bean objective observer of everything, including your own emotions.
ADDITIONAL IMPORTANT BELIEFSOne of the worst problems I had in the earlier stages of my career was listening to the opinions of others about my position. For example, when Iwent long in a stock and then heard someone mention that the marketshould sell now, I became anxious and eager to get out of my position.If the market cannot hurt us, then other traders’ opinions of stockmovement can’t either. We enter a trade based on our own experience andperception. We don’t enter a stock and then immediately exit becausesomeone suggests it’s a bad idea. This is like cheating off the paper ofanother student, changing your answer from the right one to the wrongone because you think the other student knows more than you. If we makea choice in entering a trade, knowing that the market cannot hurt us outside of our predefined risks, then we shouldn’t let an outside opinionchange our minds so fast.The biggest problem I see with traders’ application of their systemsis that the systems tend to create the illusion of certainty and predictability. Systems do not tell the future. They simply provide us with signals forentry and exit. Systems offer a probability of success, not a certainty.Once all the traders see an obvious pattern, there cannot be a profitable outcome. The majority can’t win in the market over time. The market can’t exist this way. When traders’ beliefs aren’t close to marketreality, they will continue to allow us to feed off their misguided notions.Fortunately these beliefs will never change, because the market neverchanges.One of the most common beliefs is that the more we learn about aparticular stock or company, the better we can read the price movement.Many times throughout the early learning stage of my trading, I fell preyto the notion that I “had” to know what the market was going to do or whatan individual stock was going to do. For example, the market maker,PUNK, was selling an amazing number of shares at $20. What did it
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mean, and what happens next? NDX is under 1900; what does it do next?Eventually my answer came to be, “I don’t know. You can’t possiblyknow. No one knows. And you know what? I can trade successfully without knowing!”
TRADING IS NOT A NEED-TO-KNOW BUSINESSAs I talk with other traders throughout their training process, I am oftenasked, “I need to know. Otherwise how can I trade?” This is the majorquestion traders have to answer. The answer can be found in the generalapproach to the market and in the understanding of its mechanics.Let’s take a simple situation and determine whether it is possibleto know all the factors that will impact future action. If it is, would thisknowledge really help us to foresee what the market will do? Let’s goback to the market maker example. PUNK is selling a healthy numberof shares at $20. The buyers hit him with continuous orders, and theorders get filled, yet PUNK is still there. The trader then thinks, “OK,how do I figure out how much is for sale because I can’t trade notknowing it.”Is it really possible to know how many shares PUNK has to dump?It’s virtually impossible. Let’s assume that he has an order from a bigclient and sells for the client. Sometimes even the market maker does notknow the size of an entire order! Many times a client will not give thewhole order to the same market maker. The client will split the order upto see who can get the best price, and possibly route remaining shares tothe better of the market makers. Or the client might be trying to avoid letting the word out about a huge position change. There are a whole slew ofthings a client can do with an order.For argument’s sake, let’s assume that in some mysterious way thetrader actually has information about what the client is doing. Now thetrader knows for sure that PUNK has 3 million shares to dump. Does thisknowledge help the trader see what happens next? No, because the tradercannot know how many shares buyers are willing to buy. If they want 10million shares, the stock will most likely go up after PUNK is done. Ifthey want 500,000 shares, the stock price will most likely drop when thebuyers are done.Let’s make the next step in our unrealistic assumptions and pretendthat our trader knows that buyers want 5 million shares. This still won’thelp the trader because the market is not static; it’s changing all the time.When PUNK is done, how can we know that other market makers won’tmove to the same price with their liquidity, because they just got a call
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from their client? Or, how can we know that buyers won’t change theirmind after they bought 2 million shares and decide to wait out a bit to getshares at lower prices or maybe limit their exposure for now?
MAKING THE ODDS EVENNow let’s pretend that we are conspiracy-theory idiots and that we reallythink everything in the market can be known or figured out. We knoweverything I’ve already discussed. It still won’t help! As the stock pricesmove, the balance of power changes, and new forces become interested intaking or liquidating positions. I know that people in their right mindswould never suggest that anyone could ever possibly know all the currentintentions of all market participants, and I also know how the intentionswill change as prices change.As you can see, the very nature of the market is uncertainty. Thereis no such thing as “know.” The market works in probabilities, not certainties. This is what makes trading so challenging, and it is what makestrading different from many other careers. Engineers calculate and applylearned methods and know how a construction is going to act under certain circumstances. They don’t have to deal with wondering whether abridge will hold if a certain amount of pressure is applied. They had better know it will hold. Our entire system of education is built on thisapproach. We gather information, analyze it, make conclusions based onfacts, make a decision based on knowledge, and finally act on this decision, getting the result we determined in advance.What happens to people who try to trade using this kind ofapproach? Naturally, they attempt to gather as much information aboutthe markets as possible. Then the information is analyzed. The tradersnow feel armed. They act on this information according to the analysis.Then they observe that despite their preparation, results are random.Sometimes the market acts as they thought it would, and sometimes itdoesn’t. Naturally, traders next decide that their information is not enoughor that their method of analysis is not perfect. They delve further, applying new systems and new indicators, thereby making their analysis moreand more complicated. All this activity convinces the traders that they areon the verge of finally figuring it all out.We all, I am fairly sure, went through this vicious cycle in whicheach new piece of information seemed to be the missing piece of the puzzle. If a trader takes this journey, frustration is unavoidable. What happenshere is that traders are trying to apply a method that has nothing to do withthe way the market works. This methodology of collecting, analyzing, and
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concluding works in the environment of certainties, and the market is notsuch an environment.Our next question naturally is, “How am I supposed to trade withconfidence if I can’t know anything about what happens next?”
MAKING THE PROBABILITIES WORK FOR YOUWe are supposed to go with the odds of probabilities. Every time we puton a trade, we accept that this trade and any other can be a loser no matter how good it looks. That’s how we get rid of frustration caused by thefact that our brilliant analysis took us nowhere. If the loss is assumed andaccepted in advance, it comes as no surprise. It’s just one of the scenarioswe can foresee. This is the key. Instead of thinking that the market is definitely going to do this or that, think in terms of if the market does this,then I will do that. You need several scenarios in if-then terms. Now youare protected from frustration because you never tried to predict anything.No prediction—no surprise—no frustration.It’s unusual for human beings to think like this, which is exactly whyfew traders succeed. The minority learns to think like this. The majorityeither never does or never even realizes that a different way of thinking isnecessary. The majority seeks certainty to no avail, trying to find it inmythical inside knowledge or in trading systems. When I make a successful trade, does it mean that I knew it going to happen? No. I did notguess, either. I saw familiar price and volume action with a recognizablesetup. I knew all the possible outcomes of this setup. If the stock movedthrough $20, then it was most likely to go higher. If $20 was never broken, then the trigger for the entry was never given, so I would do nothing.If it moved through $20 but then lost to $19.75 on pullback, then it’sweaker than I thought, and this would be a stop loss. I have a set of scenarios based on the range, on the trend, and on the support and resistancelevels. As soon as the stock shows a break out of the range, violating theresistance in the direction of the overall trend, a buy is triggered.Do I know what the stock is going to do after that? Of course not.No one does. I react to a scenario I have prepared in advance and that istriggered by market action. The market gives me a signal, and I go withit, letting the market do its thing and reacting on what it does. For me thisis the only way to approach trading. Don’t ask why and don’t try to predict, meaning don’t try to figure out why this or that movement occurs. Itdoesn’t matter. You need to spot the movement, to categorize it, and toexploit it if it fits into a set of familiar scenarios. That’s all there is to trading, aside from mental preparation. If you feel the urge to know why
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something happens, then you should understand that you want to be ananalyst, not a trader. By the way, many brilliant analysts make very poortraders.
TAKING STOCK OF IT ALLTo sum up, the market is merely a by-product of the actions and intentionsof all its participants. As prices move and events happen, those intentionschange all the time. Thus, it is impossible by definition to know what themarket will do next. Trading is not about knowing, figuring things out,and so forth. Trading is about acting in familiar situations on familiarsignals.Learning to trade requires two things. The first is that set of familiarsituations and signals, which is not too hard to learn or to teach. In thisregard trading is not rocket science. The second is adopting the unusualmindset that allows us to act in an uncertain and highly liquid environment. This is obviously harder since trading is a somewhat esoteric field.It’s not easy to learn the mindset, the mental state, the discipline. You canexplain these things, but can you teach someone how to achieve them? Inmy opinion, yes. For example, samurai fighting techniques and martialarts are based on a specific mindset. And there are teachers and students.Such skills require a different kind of teaching, not the one we find inschool. It’s not enough to just tell the student what to do. The teachersmust be able to demonstrate what must be done. At the very least theyhave to have once been successful at what they are teaching. Without thefirst-hand knowledge and experience, the teachers will have nothing to telltheir students about the hardest to learn and most vital element—correctmindset.People who teach trading must demonstrate the correct approach.And at the same time, this process of learning requires strong dedicationand sincere desire from the student. I don’t believe the people who say,“You can’t teach trading; one either learns it or not.” However, as withanything, you can show and explain, but you can’t make anyone do theright things. We need to accept the fact that not everyone can be taught todo this. After all, we all have different psychological profiles, and tradingrequires such an unusual attitude toward risk and an unconventional stateof mind. There must be a certain percentage of people who are just not cutout for it.There is one more aspect to learning this profession. No matter howintensive your educational process may be, you still need a lot of personalexperience. Many good trading habits come to a trader only through the
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process of actual trading. You hear many times that you need to hold yourstops, and you do realize the importance of this. Yet knowing this doesn’tmean that you are going to take the right action when you face a losingtrade. Going through certain experiences is an irreplaceable part of a trading education. The beginning stages of trading are hard because they arealmost inevitably sprinkled with losses. It’s imperative to keep them assmall as possible, because so many traders run out of capital before theyget a real chance to learn. You have to grind it out, survive this period ofthe learning curve. And it could be really long, often a year or two, possibly longer, and very seldom less than a year. I don’t mean to suggest thatafter you have gone through this stage, you know everything there is toknow. The market will always offer new challenges, and you will alwaysfind something new to deal with. But this provides an opportunity for youto refine your skill.
CHAPTER 5
The Trader’s CircleBridging the Gap between Art and Science
Most people refer to the journey a trader takes as a learning curve. Letme step away from the “curve” portion of this phrase and focus on trading as a progression into one’s self. As we discuss earlier, trading isn’t alogical 1  1  2 or a mechanical “all you have to do is see this systemand you win.” Traders need to think in a different paradigm, one thatincludes mechanical information with mental strengthening.Mechanical information is easy. Anyone can read a few books,observe a few trading sites, and learn a trading system. Every professional trader knows what a cup-and-handle formation is, whatBollinger Bands are, what Fibonacci lines are, and so on. Professionalsmay not use all these things (there are only so many indicators that onecan use), but they have a general understanding of their purpose andtheir relevancy. Furthermore, professionals do not negate mechanicalideas. Rather they accept them as complementary and assume that theyare based on reality, and not illusions created by passing fads and corrections, where in a few months, the mechanics no longer work. I haveseen numerous examples of where a bull market strategy no longerworks in 2000–2002 and might very well not work for the next coupleof years.Mental strengthening is not easy. It’s especially difficult for thosewho think that trading is purely mechanical and nonartistic. Traders suchas these continue to try to prove that if you find the right system, youwill be successful. These traders often contradict themselves as they talkof emotional control, egoless trading, trading what you see, and crowd
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psychology. However, if everything were purely mechanical, then therewould be no need to discuss any of these issues. Furthermore, if everything were purely mechanical, then everyone using the system would perceive the market in the same way. If there are 1000 traders using a system,why can’t all of them actually make money?Clearly, trading does have artistic aspects. Well-known physicistYakov Zeldovich said it best, “Science has one answer where art hasmany.” To illustrate, imagine a stone, a simple stone. When an engineeror a math professor or a carpenter look at it, what is it they see? Just ashapeless stone, right? But when a sculptor looks at it, he or she sees abeautiful masterpiece. Let’s have two sculptors look at the same stone.Will they see the same thing? Of course not. Each will have his or her ownidea of what shape the stone will take. Similarly, two traders don’t see thesame trade in the same market action. It is how artists apply themselvesthat defines what comes out of a shapeless stone. And it’s how tradersapply their personality that defines what kind of trades they make. Wecan’t shape the market in the same way a sculptor shapes the stone, but inboth cases we have something that we need to apply our vision to andextract what we want from it. The subject of our artistic work is ourtrade—this is what we shape in a way that is governed by our skill, ourperception, and our vision. Later we provide examples of how traders seedifferent ways to play the same setup. All those ways can be valid, as arevalid different works of art seen by the sculptors in the same originalshapeless stone.There is a fine line between flexibility and the tendency to changeyour approach as soon as your system produces a loss. After all, we arewired in a way that makes it hard to repeat doing the same thing when weknow it doesn’t work. But that is exactly what a good system assumes usto do. You have to endure a string of losses sometimes in order to allowprobabilities to work in your favor, because you can’t know which tradeis going to end your losing streak. At the same time, when you see themarket changing its tune in a way that requires significant adjustment, youneed to make the adjustment, or you are destined to stay with a losingstrategy indefinitely. This is one more side to trading where art plays a bigrole.My partner and I both use tape-reading principles to define themajority of our exit and entry plans. We both are very close to marketreality and have emotional control in our trading. We complement eachother. Yet, we can look at the same stock and have two totally differentideas on where that stock is moving. This proves that mechanical setups
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by themselves offer only the raw material for something deeper and moreimportant.
STRENGTHEN THE MIND AS WELL AS THE SYSTEMTraders must condition their mental processes to enable them to createsynergy between mechanical strategies and the mental capacity to followthrough on the signals of exit and entry.If we think of trading as a circle, then the beginning stage is one spoton the circle. The circle represents something tangible because traders canmove around on the circle to different phases of trading regardless ofwhether they are professionals or beginners. Some new traders have characteristics that are more developed than those of professional traders.Conversely, some characteristics in professionals seem more related tobeginners. This is further evidence that mechanical trading leaves outmuch of what is important. Ego, emotion, anger, and revenge can befound in a trader of any level if the trader allows it.The goal of newer traders should be to get as close to reality as theycan, but not too close lest they feel that they have everything all workedout. When they feel they have it all figured out, traits of new traders comeback to haunt them and create drawdown periods. The goal of the traderis to develop an unemotional, egoless, and clear perception of stock market reality. Getting from the first part of the circle to the last part and staying there is an extremely difficult process, which is the reason whytraders’ success ratios are low. As I’ve noted before, only the minority issuccessful.For example, in sports, we have little league baseball in whicheveryone can participate. High school teams have tryouts, and only thebetter players are selected. College takes the cream of that crop, and eventually professional sports takes the best of the best. The minority succeeds. There are numerous examples of how the minority succeeds. Oneof the things that contributes to the success of members of the minority isthat they don’t think like the majority.This is how, in tape-reading principles and trading, what you see,not what you think, allows you to become the minority. There are fourstages—newer trader, developing trader, striving trader, and realitytrader—that take you from majority thought to minority success. Thesewere the stages I went through and that I see others go through all the time.As a newer trader, I traded on what I thought. My opinion ruled myworld. I had no real understanding of how tape principles (accumula-
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tion/distribution) governed the market’s behavior. I did not seek out anytype of system that provides structure to the chaos of price movement. Iused phrases like, “Day traders ran that stock past our stop.” “When youthink a stock is too high, then it’s time to short.” “Market makers are aconspiracy group existing to take a stand against my position.” “If youwant to make money, just do the opposite of what I do.” (This last one ismy favorite since it proves minority versus majority thinking in an indirect manner.)I usually had mixed results, much about which you have alreadyread. There was a string of losses or wins, but I did not make a profit consistently over time. The market was a constant struggle. Jealousy, anger,frustration, and fear of failure were what I experienced as this type oftrader. Even more interesting is the fact that all these emotions were creating distortions in my perception of the market without my being awareof it. I had no idea that mental change was necessary in order to get mecloser to the last phase of the trading circle.
FINDING OUT MORE ABOUT MYSELFWhen I moved from a newer trader to a developing trader, I began to realize that there are ways to bring structure to chaos through systems andprinciples. I started to relax a bit more. Feelings of frustration and angerbegan to give way to little bits of hope and “trading eurekas” in my head.I started seeing market realities. My initial thoughts about how the marketworks began to break down as the walls of illusion crumbled. I started toquestion things I had often heard. For instance, market makers weren’treally a conspiracy. Now trading the market became less of a struggle. Ibegan to see how market discounting worked. And I understood whyAristotle couldn’t have succeeded in the market (everything is a fuzzyprobability, not a logical certainty).At that time, I also started playing a little psychological game withmyself. I would either get down on myself or be happy with myself aseach trade closed. I was having trouble disassociating my trading from myself-worth. So I came up with the trick I mentioned. When I came to thecomputer to trade every day, I viewed myself as someone other than meat the computer trading. I would act as this other person’s mentor, watching what he was doing, reviewing his trading, and helping him to be a better trader. When he was trading well, I was just his admirer. I separatedmyself from this trader. Therefore, any trade he made, he made. It hadnothing to do with me. I was there only to watch what he was doing.Eventually, I became that detached observer, and that detachment is
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essential to a trader’s state of mind. Since then, emotion and ego haveceased to be part of my trading plan.However, my trading results didn’t really get me to the point whereI could make a living. I was still in a fear of failure, since I wasn’t sure Icould support my family as well as meet all of Canada’s requirements forcitizenship. It was a heavy burden to know that at any