andfinally listen.
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Appendix A
For Traders OnlyLooking in the MirrorSpeculation: From the Latin root verb “speculari,” meaning “to observe.”It implies unbiased assessment of conditions and leaves the final resultof any conflict, action, or effort to be free of any committed outcome.—Anonymous
A
t the beginning of this book, I told you this is not another“how-to” book on trading. This is my personal story of how Ifinally came to be a permanent success at trading. When themanuscript was finished, and after I paid “Ghostwriter X” what hethought was a huge check, I was at the point of deciding if I shouldactually publish this. It was at this point that I gave the issue of tradingitself more thought. The people who are naturally drawn to this type ofbook are going to be, for the most part, in the business of trading115
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somehow. I don’t think this will ever be read by anyone who is in cropdusting. So I thought in fairness to you spending some of the moneythat you will probably lose anyway, I offer you a better shot at gettingmine. I will be on the other side of some of those trades. Fair enough?Here are some things relating to the actual part of execution, bothinitiation of a position and liquidation of that position. Also, I want toshare some thoughts on maintaining a strong market presence.These are only words. They have all been said before in some formor another. This isn’t “new” in that respect. I want you to look at theseinsights from a new perspective; hopefully the one I have come tounderstand and presented throughout this book. Even if you came tounderstand the point of view I hold, you will see it in a unique way.Find a way to “look” at what is happening like I do. That is when thisinformation is really useful. Then let your own expression of that perspective control the execution of your trading. Let that be the art formyou create. Do it better than I can, so I can learn from the new realitythat you are creating, that I have never seen before. I’m looking for thatevery day. Please be there. I’m getting bored with what I find now.One last qualifier: I tried to “teach” trading for a period of time. Ihave no intention of ever doing it again. If you think I am trying to“teach” you anything, I will hunt you down and have your head for apaperweight. Better stop now if you think that is what you will find here.Here you go. Try to take my money.If you are losing a tug of war with a tiger, give him the rope before hegets to your arm.You can always buy a new rope.—Sufi WisdomCut your losses, @#%$ for brains. Live to trade another day. Youare wrong today. Try tomorrow. The markets will never end. Go dosomething else for a while. Write a book for Christ’s sake. Someonewill buy it.The fault, dear Brutus, is not in our stars, but in ourselves, that weare underlings.—William Shakespeare, Julius Caesar (I, ii, 140–141)Who twisted your arm to do this trade? Who called the floor and said,“Get me in?” Who clicked the “Enter Order” button? Take 100 percent
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responsibility for your results, no matter what they are. The more youblame, the more you lose.Write down everything you do and look at your ratios. Knowwhat you average gain/loss is. Know your percentage of winners tolosers. When you trade write down why you did the trade. On a regular basis review these notes and ask yourself what the quality of yourthoughts really was at the time. The more you kid yourself, the moreyou lose. Attempt to improve your gains by 10 percent and reduceyour losses by 5 percent on some time frame of your choosing. If youare half right you will improve your net gains by 7.5 percent or moreon a regular basis.The market is always right. If you lost, you missed something. Thatsomething is inside your head. What is it?Never trade without a stop. Ask yourself why it is okay, just thistime, not to place a stop. What is that something?Let profits run. If you think it is time to get out, ask yourself whyyou think it is time. Let the market decide that, not that something thatsays it is time to get out. Who knows how far it might go?Never add to a loser. Ask yourself why you feel the “need” to do so.The market does not know you have any position on.Your first loss is yourbest loss.Take a new look at it.Take a break. Do anything but add to it.Always remember that 90 percent of people who trade lose. Only10 percent win, but they have all the money. One hundred percent ofcontracts traded fall between the two. Therefore, 90 percent of the sizeis controlled by 10 percent of the people. Who are those people? Whatare they thinking? If a hundred “one-lot” traders are working againstone “hundred-lot” trader, how did he get to be that big? Was it from hislosses? Always consider what the large traders are doing, but that theycan be wrong too. The small guy does have his day. Remember that.If you want steak, but can only afford chicken, a cow will be yourundoing.—ProverbDon’t trade more than a reasonable size. Don’t “load up.” Only veryexperienced traders know how to do this. They got that way from aproven method that works for them. Until you get there, and knowyou are there, you will meet your Waterloo when you do so. I will be
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there, or someone just like me. I will also rent you a car so you don’thave to walk back to Paris to get more money. Please come back. Iwould like the continuing pleasure of removing that new money fromyou as well.Go with your “gut.”Your subconscious mind has the ability to formassociations and reach conclusions for you. It oftentimes will knowsomething your waking mind doesn’t. It is trying to tell you something.Please listen.You must learn how to differentiate a gut intuition from atestosterone-fueled ambition. Otherwise, you will have no testosteroneat all.Never listen to what anyone else is talking about regarding theirtrading. They “talk” their position because they want you to validatetheir point of view. They don’t know why they did the trade in thefirst place. Or they want to “help” you in some manner with yourown trading. Never tell anyone what you are doing in any market.Let them wonder. The more you listen to what others say, think, ordo, the less clear your own thinking will be. Since I am crystal clearin my thinking and I want to take your money, the more I like itwhen your thinking is fuzzy.Find someone in the office that is always losing. Carefully observewhat he does and how he justifies his positions. Observe his train ofthought. This is different than listening to what he says as I describeabove. Find this critical difference and exploit it. Be polite whendoing this so that you always have this advantage. When he quits andgoes somewhere else, either maintain the relationship or start a newone with his replacement if you can. This will become a never endingsource of information about the loser’s thinking. You only need to findone because they all think the same way. It is a “shortcut” to the top ifyou can find it.How do I know this? I’ll tell you. One of the honest men I met inthis business showed me. It was Christmas and he stopped at my deskbefore leaving the office for the holidays. He dropped $5,000 in cashon my desk and said, “Thank you.” I thought he was joking. He sat twodesks away from me. He would listen to how I worked my trades andwould occasionally ask for my “help” on his trades. He was taking theother side of my trades almost like clockwork. I was losing so consistently it was a sure bet. I made him a fortune. Talk about an eye-opener.
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My sense of pride was so shattered for a while that I wouldn’t talk tohim. He understood that and never teased or derided me for what Iwas trying to do. He was a man of honor. When he passed away I didn’tknow about it. I heard through the grapevine. The fact I couldn’t honorhim on his last trade really hurt me. He taught me a hard lesson, butI learned it.Stay away from women when you are losing. If you are a womantrader, stay away from men. At certain times the relationship betweenmen and women is similar to being long or short against the other market participant. The critical component that isn’t working will sometimes have come from your opposite in some fashion. Until you areback on, the “whatever it is” that isn’t working will be reinforced by theopposite sex. “I’m losing in the markets, honey.” “But what about ourvacation plans?” Get the picture? God help you if you are married atthis time.Your money is MINE.Don’t look for tops or bottoms, anticipate them. Tops have a distinctive “look” to them. There are two ways the top happens. The bestkind is an all-time or near all-time high.Look for huge volume. This is turnover; lots of people getting inand out. Look for a big range when this happens. If you have unlimitedcourage, pick a price and hang on. If you have a lot, but not an unlimited amount of courage, sell on the close and hang on. If you have agood dose of courage, but with a streak of caution, wait for the nextday’s attempt to match or exceed the previous day’s high, and sell whenthe price slides back through the day’s opening range, and hang on. Ifyou have, say, an average amount of courage, sell the second days closeand hang on. If you have no courage at all, why are you trading? In anycase, look for open interest to drop on the big day, or the big week, themarket is finished. Once you have your position, take a vacation for amonth.You will make huge money if your skill in timing this event hasbeen tested. The market will break and it might take some time for thisto occur. Maybe it will go south for years. Stay with it.The second kind of high is a consolidation high. Prices stay within abasic area for some time before going south. Afterwards, they rally hugeto re-test. Wait for the re-test, then sell. Do this on rising open interest.This is the loser hoping to buy cheap one last time so that he doesn’tmiss the new highs he is certain will occur. When prices get back to the
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highs, consider offering him the opportunity to unburden himself for theresponsibility of his bank account. Selling highs is dangerous in any casebecause you won’t know it was the absolute high until prices finally drop.That might take time. But the clues that this is inevitable are there. Sooneror later any market must top. Is this a top or the top? What are thoseclues?It is exactly the same for bottoms. Just turn the chart upside downand you will see what I mean. Markets that are at an important lowprice take time to distribute. This means they crash and just sit there.Or they trend to a bottom and just sit there. Anybody who could haveentered on the buy side has run out of money trying to pick the actualbottom and is now so discouraged he will need time, maybe lots of it,to get his courage up to try again. The potential seller is afraid of a rally.The selling hedger will deliver his higher-priced goods anyway so thathe doesn’t have to buy to get out. Therefore, the market just sits whilethe bulk of the market participants do nothing and watch. The wholeshow starts when one large buyer or lots of little ones start buying.There are only the late shorts to take on the approaching horsemen oftheir impending apocalypse. Some of the early longs sell, cutting theirprofits short. Don’t worry, they will be back. Hence a rally that fallsback, but never a new low because the buyers are so convinced that thespike means the beginning of a move they don’t liquidate. They createdthe potential for a self-fulfilling prophecy. As long as they believe thatas a group, they won’t sell.Start listening when all the “fundamentalists” begin raving that thoseprices aren’t “justified” just yet. Watch for the hedgers on the buy sidegetting in at that point. Now it’s time to join the fun, maybe.If you have read this critical distinction correctly, here’s anotherclue: The commission houses start offering it to the public. Watch whattheir advertising says. They prefer to market a trade to the public fromthe long side. But one word of caution: If this market has been in asteady climb before the commission houses are in, it will correct. Theyare late. Maybe not forever, but there might be enough of a correctionto wash you out, or at least them. Some of the clients that are earlyenough might even make money on this one. That’s okay, they’re justholding it for me until I find them. Maybe I should charge interest onthe loan.
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Range trading is sure money. Enter in the top or bottom 5 to10 percent of the range. Place your stop outside the range and wait.Liquidate and reverse at the same point the other way.Do this forever until one protective stop or the other is hit. Then takea break. Wait for more clues before doing anything. What does a rangelook like? How do you know a range has been established? How do youknow the range is over and the market is moving to a new equilibrium?How do you know when a market is due to break out of a range?Never trade shortly before or shortly after some major life event,expected or not. If you get a phone call your parents have just died in aplane crash, or something that for you is equally major, liquidate everything you are holding and deal with it. Don’t get back in until you areover it. You will not be in any frame of reference to understand priceaction when you can’t think straight. You will miss something and lose.The only exception is a planned trade that is winning and your stopsto lock in a permanent profit are outside the range of a limit move forthe day in question. If you are getting married, or your kids are startingcollege, or you are buying a house, or some major planned event, youhave the same problem. In any case, I’m looking for you to believe thatyou are capable of handling it all by continuing to place yourself at risk.I need a bigger yacht anyway.Everyone reads the news. Try observing how often a market fadesa major piece of news. This is a clue to its real nature, not the expectednature. Try observing how the market behaves the day after the news.Never anticipate any news. News, reports, or numbers are always factored in to the price before they are out in some way. Of that you canbe certain. How is the news factored in? If a piece of news comes outthat was unexpected and the market does nothing, what does that tellyou? What does it mean for a market to “do nothing”? What does a“nothing day” have to look like for it to qualify as a “nothing day”? Asa side note, I know of one trader who made his fortune exploiting thisone skill. Whatever the Wall Street Journal commodity news section hadfor the headline that day, he would wait all day and fade that news onthe close. He would run a $500 per contract protective stop and wait.He had somewhere around 80 percent winners for an average gain ofsomewhere around $500 each. I don’t think he ever traded bigger than a20-lot his entire career. Do the math.
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If you just scored a huge win, you might want to reduce your positionsize for a period of time. Large amounts of success can sometimes cloudyour thinking or cause you to get slightly complacent with your “research”into the nature of price action.You are a bit more susceptible to losses perhaps. Always reduce your trade size during a period of losses.That way youcan always afford another beer to cry into.Train your body as well as your mind. You are in a winner-take-allbattlefield. You must have every advantage you can find. Find the bestbalance for you between enjoying life and slowly ending it.This will provide a more consistent starting point every day. When your mind is sharpyou function better.Your mind lives inside your body. If you aren’t eatingright or exercising regularly, your mind will suffer at some point. By theway, I’m counting on your lack of discipline.Put aside a portion of your winnings when you have them. Thereis a freedom of mind that comes when you know that no matter whatkind of damage you do to yourself for a short time you can always paythe mortgage and the bills. You will create all kinds of problems foryourself if you spend it all, all the time. There is a tendency to expectmarket profits to support your lifestyle when in reality it is your lifestyle that leads to profits. Be sensitive to this. Find a happy mediumbetween saving and spending. At some point you won’t know how tospend it all anyway and it will just sit there until your wife gets half.Never lose your sense of balance. It doesn’t matter how you do that.Once your sense of balance goes, so does your money. You will think ithad wings. How do you create balance in your life? What is balance?When a market keeps moving only one way, day after day it seems,and the ranges are modest, be ready to move. All those winners willget nervous at some point. Where is that point? What does it looklike? If you are one of those winners, how do you think about thoseprofits? At what point are you nervous? A retracement is inevitable. Ifyou have done your homework, this is where you add to that winner and take all. All markets retrace before the big move. Pay attention.If you are wrong, always place your “GFO” (get the f— out) stop atthe break-even price on the entire position and watch it like a hawk.If you have correctly interpreted what must happen next, you will dovery well. If the market doesn’t rebound, be very nimble and considertotally reversing. Markets set up big moves like this. If it is not one way,
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it will be the other. Run with it. If you think you have earned the skill,plunge for all you are worth. If you don’t have the skill, well, there isalways Vegas. Too bad you don’t have any money left to join me.If you trade futures, always remember all markets are “bearish.”Their function is to provide the producer of that commodity with away to exploit higher prices, which he will sell into. If he is not doingthat, it is because he expects higher prices first before he sells. This initself is an advantage that you should learn to exploit. But he is always aseller eventually. Once he does this, he is the ONLY market participantwho is under no obligation to get out by becoming a buyer. He maydeliver against the position. Therefore, the speculator who buys andsells is the net force on the market. At some point there will be an inequality when the initiating buyer must become the seller to get out. Ifthe hedger sells, the initiating speculative seller sells, and the liquidatingspeculative buyer becomes a seller to get out; that market is under threetimes the selling pressure it would normally be under; especially if theold shorts decide to press their advantage and add to their positions.This is why markets will always break faster than they rally.You will nothave a lot of time to join the party. To exploit this, you must be vigilant and ready to move. And I mean now. There are not many buyersout there. Most of them are small shorts covering too soon. That meansone-lots. If you can’t see this eventual inequality developing and time itfairly well, it’s better to let it go.You will end up selling it into the hole.Market orders or resting stops will get filled way below what you seeon the screen. Wait for the next one. Otherwise, I’d like to thank you inadvance for my new airplane.Options are hedging instruments. People trade them like speculativevehicles, but they were originally developed as a low-cost way to protectsomething. Ninety-eight percent of all held options expire worthless ifthey have traded anytime for any strike price. The reason this is the caseis very simple. The market will only be at one price at expiration anyway and the people who sell them, or write them, have enough presence of mind to write most of them on the side of the market thatprices are moving away from as well as buy them back after the premium has dried up. If you are speculating with options, you have twothings working against you, time and price. The market might “getthere” eventually, but you will find it is there after the strike you are
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holding has, more often than not, expired. You need big moves to fightthe time decay, even if you are holding an “in the money” option. It isbetter use of your money to use options to protect open trade futuresprofits. The reason is simple. If you are long, and the market is movingyour way, puts get cheaper. It is the same for calls against shorts. Thereare times you can buy a put or call against your futures for next to nothing if it has only a week or two before it expires.Sometimes that is cheap insurance if you expect some big report;you think the market might be vulnerable to large price swings andyou don’t want to risk getting stopped out; or just want to take sometime off while holding something that is working.Writing options is a complicated thing. Why make this harder than ithas to be? There are at least 30 different ways to combine the writing ofoptions on either side of a market, or both at the same time. To profit, themarket must still move in an intended manner. I’m the only guy I haveever met, besides a full-time option pit trader, who can explain what an“inverse-ratio back spread” is. Some of the pit traders don’t even knowwhat that is. Almost all of these complicated ways to profit are used byhedge funds or professional money managers. If you intend to exploitoption-writing strategies to achieve profits with your trading, you needto become at least as expert on it as they are. In any case, without a soundunderstanding of the market that you are doing this against, trying tocapture time decay might mean equity decay. Be very careful when addingoptions to your mix—not everyone can be a bookie.Jesse Livermore said it all. Find and absorb everything you can abouthim. If you find something new, please share it with the rest of us.Prices are continually in motion, even when the markets are closed.They are this way because all the losers are studying them from thepoint of view of “Okay that’s over. What does this mean?” Then theyform their conclusions while the market is closed to “do such andsuch at this point” or “I’ll wait for the open, see what happens, thendo such and such,” and so on. The end result is when the market doessomething, anything “unexpected,” they have to reinterpret what thatmeans in real time. They then place orders or execute against their“original plan.” The end result is that the force of the buying and selling had its first belief structure while the market was closed. When itis closed and the loser says, “I better just get out,” he can’t do that, so
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his tension builds and he chooses to execute at the first opportunity hecan, which is the open. This rush of orders placed in the last 10 to 15minutes before the open is what causes gaps. Gaps are a good indication that the loser is getting out. Conversely, if he decides “I have toget in,” it can also mean he is setting himself up for a loss in a day ortwo. Gaps often show you “key” points for you to consider. It is forthis reason that you should consider any opening price as slightly moreindicative of the nature of the market than the close. But the close hasequal significance from the point of view that when the loser is waitingto get in, he will tend to view any closing price as “strong” or “weak.”He will then make his trade decision at night waiting for the market toopen. So in effect the pressure on prices was preordained the previousnight. If you combine this relationship between the open, close, andgaps, watch to see how news is factored in. You can then begin to seehow the thinking of the loser shows itself a day or two ahead of thenews and then be able to correctly anticipate how to place your position the day of the news—waiting for the inevitable move to wherethe loser’s stops must be. This ability is a real art. But then again, younever studied art, right?The average market participant operates in a time frame of 72hours or less. That is because they all expected to make money “rightnow.” Where is this rhythm showing up in the ebb and flow of priceaction? Most losers exit their position in that time frame. First, if theirtrade is “not working,” they get tired of waiting for the gain that didn’tcome. The pressure of being in a loser is building to the “I better justget out” point for him. Also, the average loser will wait to exit a position until the loss is somewhere between 60 percent to equal of theinitiating margin requirement amount against him. Why do you thinkthe exchange sets them to be those amounts anyway? Partly becausethat amount always is enough price movement on a chart for almostany chart reader to see he is wrong and decide to quit. If you wanta good idea where stops are building for the liquidation point, simply calculate what initial margin would mean in price action fromthe point you believed the loser got in at. For example, if you think theloser came in on the buy side of corn at $2.75, and initial margin is$600, then his sell stops are about the $2.63 level, or fairly close. Ergo,your best buy point.
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Also plot ahead about 72 hours for that to happen. As the $2.63area is reached (assuming you are seeing it right), observe how muchtime this actually took. If it happened in less than two trading sessions, be careful. If a loser gets spanked too fast, he has a tendencyto “stay out until things settle down.” That means he will take moretime to get his courage up for an attempt to get his money back.If your price is reached in three or four sessions, he is simply frustrated. Now he wants to just get it back, so he immediately executesaccording to his trade plan. For some reason the loser doesn’t seemto mind if a loss takes the right amount of time to play itself out,but if it happens too fast, then he is cautious. The same is true fora winning position. If it happens too fast, the loser mentality tendsto “just take it” and wait “for things to settle down a bit.” It seemsthat there is a time frame for either losses or occasional gains thatmust be just right for them as a group to be able to function wellunder. I don’t understand it, it just is. Can you find that rhythm? Ifnot, I’ll find you. You will be sorry you ever thought you knew whatyou were doing. That’s okay, go borrow some money from your richuncle. I’ll just wait right here until you get back. No rush. Take yourtime. Make sure to build a strong case for yourself; bring all thosecharts for him to look at.Until you really have a handle on finding the loser and feastingon his ever-dwindling trading stake, try not to hold a position over aweekend. Anything can happen in the minds of the losing group whensomething truly unexpected happens, especially if it is on a Fridaynight or Saturday morning. This group will stew about what it meansto them personally for 48 hours. This will create a huge order imbalance on Monday morning. Unless you have a good lead on this market, or are fortunate enough to have positioned yourself properly forthe inevitable panic, you will be in the losing group without knowing.Three weeks of profits can go up in smoke in 10 minutes. If you are onthe right side and you have a windfall, don’t add to the position or takeyour profits. Wait until Tuesday’s trade. If this event has truly convertedthe perception of the market, a reversal is in the works because all thewinners will bail too. Hence, the market is seeking to attract everyoneback into the game.You are probably out anyway if you are using goodmoney management. But if it is a knee-jerk reaction kind of thing you
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will be able to add to the position with almost certain probability ofhigher profits. In other words, nail the coffin shut and bury him.Also regarding weekends, Friday’s closing price trades at somepoint on Monday approximately 92 percent of the time. Just reenterthe position when your liquidating price trades on Monday. Your netequity position will remain the same and, if nothing has changed withthe structure of the market, then you can continue to let the profitrun. If something truly unexpected did happen to the mind of themarket, you will be flat during that time. Plus you will not have toreevaluate the position in real time when it is temporarily workingagainst you, creating confusion on your already fragile ability to dothis anyway. You do keep a box of Kleenex in the office, don’t you? Ihate it when they cry.Page 60 and 61 (the first two pages of Chapter 5), Reminiscences of aStock Operator, paperback edition, by Edwin Lefevre, referring to “LarryLivingston”—read this very carefully. Remember this part was writtenabout an observation made before World War I.“All the world’s a stage, and all the men and women merely players.”What do you think Bill meant by that?Speaking of paperweights, the apparent function of a paperweightis clear. Its real function is to validate a critical distinction in the mindof its owner. How is this so? People used paperweights to hold downpapers in case they blew off the surface they were on. Which surface?Most likely a desk or table. Why is this? Those papers were crucial inthe mind of someone who wanted those papers available for some reason while he was seated in front of them. Or he didn’t want to get upand walk around the surface in question; otherwise there would be noconflict. Therefore, some task was being done at the time that neededto be free of interruption. Perhaps work. What causes papers to blowaway? Some kind of atmospheric force. Since a surface where work isdone is usually indoors, then it stands to reason that either a windowwas open or a fan was blowing.Consider then that a paperweight would be a necessary component of every desk so placed in proximity to a window if the windowneeded to be open for long periods of time. Why would a window inthe workplace need to be open for an extended period of time? Therecan be only a few distinctions in this case. The person seated at the
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desk was either too hot at the time and wanted a breeze; the personneeded access through the window for a reason of his own; or something was in the air that this person wanted out such as smoke. In anycase, whether intentionally or unintentionally, this person was expecting air to possibly upset his papers and chose to find a solution to hisproblem.In the