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PERSONALACCOUNTABILITY ANDTRADING ATTITUDEOne of the most common errors that traders can face in trading is following their egos. Ego is one of the most destructive forces within atrader’s mindset when trading. One’s ego manifests itself in a way thateveryone else is wrong and, given enough time, they will realize it. Egoswill also lead traders to believe that events in the market that offer a negative response, whether in a wider than accepted loss or uncontrollabletrade, are someone else’s fault. The lack of accountability by a traderbecause of their inflated egos eventually gets the better of them. The market will always find a way to crush someone’s ego either by a huge lossor by a string of losses when traders fail to admit they are wrong andtake accountability for being wrong by cutting losses immediately.No matter how logical traders try to make the market seem, thereis one common theme: that the market does what it does. The more sensea person tries to make out of the situations that occur in the market everyday, the more confused they become, unless there is a real understanding about several issues of the market. Market Makers have agendas eachand everyday. Institutions have their plans laid out. Market technicians,analysts, fund managers, hedge fund owners, insurance companies, andmany more participants have many opinions about the market’s valuation and where stocks and the market indices should be. There is clearlyno way to ascertain each and everyday what is happening in the marketas it is happening. This lack of certainty creates a lot of fear and stress innewer traders.
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Throughout our youth, we have been taught to seek the truth, to seesomething that happens and try to explain it. The market doesn’t workin such a way. Traders see something happen and they have to reactbefore the information is “figured out.” Throughout this book, we haveseen numerous examples of when the street finally figures out a trendor a stock move, it is nearly over. Continuously trying to figure out whythings happened can certainly benefit us for the future, but in the sensethat trading is “of the moment,” constant guesswork about what just happened leads many traders on the wrong path. They are so adamant aboutwhat just occurred that they are willing to accept any and all explanations about that event.Seeking this truth isn’t necessarily a negative thing, but what people come up with to explain these events is certainly suspect at best.Literally thousands of false interpretations are made about the marketevery year. Those traders that don’t know any better simply believe thisinformation on faith because the information seems logical. It is a trader’sjob to set forth goals to learn about market information in a manner inwhich they can filter out the misinformation from the market.When traders first realize that the information that they were givenis wrong, it normally is at the point when a loss is made on a trade. Thetrader blames the source of the information or some other external forceas to why a negative result came about from the information that theyperceived to be true. Instead of finding out the reality of the situation,the trader displaces responsibility and accountability elsewhere. In thisprocess, a trader learns nothing and progresses no further in his owntrading. Put accountability where it belongs, within you.The market is never wrong. I start examining a person’s ego whenI see a trader in a losing position that is clearly against the trend or themarket and they refuse to acknowledge the loss of the trade. Their mindset is such that they are right and the market is wrong. If anyone thinksthey are larger than the market, that they are smarter or more correct thanthe market, they had better re-evaluate their egos or cease to participatein the market. Conversely, the market doesn’t know who you are. Itdoesn’t know how much you owe on your car, house, or boat. It doesn’tknow that you have three kids and a spouse to support. It doesn’t know,nor does it care. The market simply exists to exchange money from thelosers to the winners.Which scenario happens the most over time is up to you and howyou decide to trade it. It depends on whether your stubbornness in incorrect thinking is corrected or if you can’t accept loss no matter how muchis lost in a losing position. The market will reward those traders that can
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stick to a discipline that works for them and punish those that fail todevelop and adhere to a set of guidelines. With the market so unforgiving in this fashion, the accountability has to be within you. You need totrust yourself and your abilities. If you succeed, you have no one to thankbut yourself. If you fail, you have no one else to blame. Trading decisionsreside in you. Learn to develop this trust in yourself and stay accountable for all your decisions and actions.When a trader begins to trust in him- or herself, to take responsibility for the trade, he or she can begin to work much better on stop lossissues as well. We talked earlier about fear and the inability to keep a stoploss. Although there are technological limitations to keeping a stop loss,the most important is the inability to act upon a stop loss price. Manynewer traders do this for fear of loss and shame that they associate witha loss. Seasoned traders view a stop loss as a positive as it protects theircapital base from wider than desired losses. The transition from fear ofloss to an emotionless loss taken to prevent this possibility of a widerdecrease in portfolio funds stems from taking responsibility in the trade.They no longer respond to the ego in the trade, but rather they employa mindless stop response to exit the trade immediately. When exiting thetrade for a loss, there is no sense of shame, loss, frustration, or anger.There is just a sense of complacency that the trade didn’t offer a widerthan desired loss, and the next opportunity that comes along is taken.The more accountable a trader becomes to himself, the more he is ableto learn about his own methodologies and even more about himself asa trader.If a trader responds well to a trading discipline and matches its criteria for exit and entry without emotion or lack of accountability, he canbegin to assess its validity on its own merits. He can decide how muchloss and profit the method employed was actually doing. The results areright there to be reviewed. No emotions are attached to the profit or lossmade, and therefore the viability of a trader using this method can beassessed. If the methodology is showing a reasonable trading style withgood discipline principles, the next step in a trader’s progress is to moveto his mechanical approach to his intuitive approach. A lack of accountability whether through an ego or other emotional barrier will limit atrader’s feel in the markets. This lack of feel either in the overall markettrend or in a stock itself will ultimately be a detriment to a trader’sprogress.If a trade is relatively safe, the setup is the same, and all other variables point to a buy, the trader needs to define that feeling withinhimself of why that trade wasn’t entered. Many call this approach an
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intuitive one. In order to profit over the long term, a trader has to bringthe results of a trade to a level where it is a decision that is manifestedfrom within. The trader acts on his own belief and exits in the same fashion. Many years of mechanical understanding, being around othertraders, feeling the markets, and participating develops this mechanicalapproach and ties it into impulses that the mind can develop for a traderto follow. If this is cluttered with external negative information such asMarket Maker manipulation and the evilness of the market itself, atrader does not stand a chance from learning the true and underlying reasons for what has just happened to him. A person can’t move along lifeblaming everyone else and everything else for personal loss. There is nodifference in trading. The responsibility lies within each trader individually and his actions must demand a response from this responsibility.
TRADING ATTITUDEIt is uncanny how many traders refuse to accept the trend that is occurring either in the market or in their respective positions. They fight thesetrends over and over until the position takes too much of a loss to bearand they exit with that realized loss. Worse yet, I see traders holding losing positions, waiting for the market to return this position to profitability. The first scenario stems from breaking the rules of stop lossmanagement, while the latter scenario stems from simple ego. They feelthe market is wrong and, given enough time, the market will come to itssenses. Either way, they have a constant struggle within the markets aswell as within themselves that hinders progress. Instead of followingtheir beliefs on trends and taking small losses or riding gains, they simply enter a position at a specific time period. If the trade goes their way,they believe themselves to be great traders, that what happened wasexactly what was expected. If they are wrong, they do not exit but rathertell themselves the position will at some point become profitable anywaybecause they know better.Tell that to those holding CORL and BAMM in the ’40s and ETYSfrom the ’70s. Rather than fighting the trend, a trader needs to know howto change with the market and follow the trend. During times when yourindicators are proving you wrong is the time to exit. Although I certainlybelieve strongly in a trader’s intuition, there has to be a point that thetrader takes action to stop the bleeding even if the belief is strongenough. There is no sense in owning a position that has wiped out50 pecent of your portfolio because of a strong feeling, especially if your
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market indicators are showing you something that confirms the reasonto exit.Changing with the market comes from many years of experience.Newer traders have the most difficult time changing with the marketbecause they do not have a feel for the markets. There is no experienceof market moves, no understanding of what drives markets, and no abilities to follow their beliefs based on limited knowledge. Many professional traders have a feel of where the market is headed and are able tobuild upon positions based on this feel. Before traders can understandthis level of feeling, they must spend years working on the mechanicalideas presented to them within their trading system. Whether it is shortterm trading or even investing, there has to be an understanding andexperience derived from a trader’s interaction from the markets. Themore familiar the mechanics become over time, the more a trader can actautomatically on market opportunities.Markets change constantly. It is a dynamic environment that showschanging indicators, patterns, and moves, but it is based on a few common things. These are things like fear, greed, panic, and disagreement ofvalue. These underlying aspects to the markets cause volatility and constant change. Traders will continue to trade their patterns and indicatorsuntil they no longer work. In this sense, a trader will cease to exist if hedoes not learn to adapt to the changing of his patterns and indicators relative to his belief system. A trader must be just as dynamic as the market but with a set of rules that enables him to profit handsomely whenhe is right and cut losses immediately when he is wrong.Traders gain this ability by years of hard work. The notion that atrader can trade for one or two hours a day and play golf the rest of theday sounds nice, but if a trader really wants to be consistent over time,he needs to dedicate himself to his progress. The idea is not to becomea part of the market, but rather to let the market become a part of you.Once the market is inside you, you will gain that feeling that is neededto change with the markets. Getting to this point takes many years to doso and it is a process that never ends due to the dynamic nature of themarket.You can become more in touch with the mechanical sides of trading in some very simple ways while you are learning. Once you beginto make the mechanical side of your trading more automated, the bridgeto your mental state can start to develop. The most obvious start is for atrader to associate himself with better traders. At the beginning, this isn’ta very hard step. However, I am surprised at how many traders comeinto the trading game with their pre-conceived ideas and are unwilling
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to accept any information from colleagues. They figured that they hadbeen around the markets long enough that they had nothing to learn orbe taught. They found out months later that they needed to expand theirwillingness to participate with those more knowledgeable than them.The idea behind this association is to build a trust with that individual to teach you the mechanics behind trading and to correct any misinformation behind market moves or other aspects of trading that issuspect in chat rooms or bulletin boards. Once a trader begins to understand relatively simple aspects of trading, they have a foundation bywhich to accept or reject further information stemming from their current knowledge base. Once they get a reasonable sense of the markets,they need to begin to build some expectations for the future both withinthemselves as well as their chosen system.Many traders fail to plan their strategy in the beginning. This canbe seen in poor planning of their capital base or their willingness to jumpright in the market with their money without understanding why theyare entering the market in the first place. Remember that there are nominor leagues in trading. You step up to the plate with your money inhand and the best traders in the world are happy to take it if you let them.Market Makers and professional traders are trained over many years totrade the markets. They have more knowledge than you and are able tocapitalize richly on this knowledge. This is where a trader must againdevote and commit to trading as a profession. A trader must carefullytrack his or her system on a daily basis. There needs to be a foundationfor the system being utilized that fits you and how you feel about themarkets. Regardless if the trading system is scalping, short-term trading,or momentum trading, you must carefully keep track of the way that system provides opportunity throughout the day. A trader needs to get a feelfor different periods of the day as some may provide more opportunitythan others.When tracking the macro-momentum of the markets, I want toknow if the market has been moving up or down. I want to determinethe breadth of the market relative to the total volume. If I see a strongmove to the upside but there is no volume conviction, then I will be morecautious the next day to see if that market move can be confirmed.Conversely, if the market is falling fast on low volume, then I’m moreinclined to not trust its true direction. If the underlying market indicators such as breadth and volume support what the stock move showed,I’m more inclined to trust it. If not, then I’m looking to see somethingthat will confirm it. If there is nothing to confirm the trend, then I’m skeptical at best for any positions that I may be holding. Each day I look at
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the macro by how strong the market pace is relative to the move that isbeing made at that point in time. I want to know how strong the buyingand selling is near the open, mid-day, and into the close. Furthermore, Iwant to apply this to my patterns to see if there is a correlated affect onmy patterns.For example, I want to know whether my gainer category is showing me enough strength in the market to be aggressive when looking forbottoms or if I should be more inclined to go short. I want to know if thetrend is selling so that if the gainer category is strong, but the macro isshowing me negativity, I can be more cautious. If the market ends theday on strong selling and the next morning I don’t see a lot of value buying, I will be expecting more selling the next morning that would makeme cautious to be aggressive early in the gainer group. Unless the stocksare gapping down the next morning on strong pre-market volume thatmay bring in value buying at the open, I will be looking to short into anyruns on stocks and continue to follow the downtrend on this selling.Conversely, if the macro ended the day positively and my gainer patternis showing me signs of strength, then I will be more inclined to be aggressive off the bottoms early and back off shorting the group. What I amdoing is finding the macro flow of the market and applying it to the moremicro sense of stock action to participate. When I’m right and the stockis following the flow that I am experiencing from tracking the patternsand the macro, I will be rewarded. If, for some reason, the market is notshowing me what I believe to be true, I will not fight the market, butrather take a stop loss immediately to protect my capital until I am ableto get back into the feel for the trend again.If you notice that I am not being stubborn in my trend decisions, Iam changing with the market trend as it changes, profiting from the following of the trend. The dumper pattern will also show me signs of achange. When the pattern is strong and when stocks are making only onebottom early and then rising fast in the morning or even slowly throughout the day, I will be more aggressive on the bottoms and back off shorting this category. When the pattern shows me a weakness, either due toreal nervousness in the market or continuous multi-bottoms, I will bemore inclined to back off the first bottoms and look to go short if valuebuyers aren’t attacking these negative overreactions to the downside. Intimes of great speculation and nervousness, stocks can be cut in half onone of these overreactions.I want to track this pattern to see how confident value buyers are inthese time periods so that I can develop a feel for whether the stock willbegin a rise early or show more weakness. By developing this experience
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and knowledge on how specific categories and patterns are reacting relative to their respective markets, I can begin to take the mechanicalapproach of this tracking and apply it to the feel that I derive from yearsof watching these patterns and indicators. If we simply trade the markets for two hours a day, we do not develop this feel. Conversely, if wedo not trade these markets consistently, we lose that feel as we are unableto change with the markets because we aren’t giving our attention andtime to doing so.I talked with one trader who recently returned from a three-monthvacation after having one of his most successful years of trading. He cameback after this vacation and had a real problem trying to develop this feelfor the market again. He felt that the market dynamics had changed somuch in three months that the market was no longer a part of him andhe had to redevelop this relationship with the market. Time and commitment to the markets are essential to keep the edge of this market feelas well as to allow it to expand in order to aid in your progress as a trader.Understanding your patterns and how they may relate to the macrotrend in the markets allows you to pick your entry and exit pointsaccordingly. There are days that you can feel when to enter the marketand get the best intra-day price available. When you are wrong, you simply take the loss and re-evaluate what the market is telling you to do.When you are right, you continue with your feel until the feel changesand you need to exit the position. This is true for both long and shortpositions in the market. Knowing when to enter and exit will eventuallybe defined upon your experience of the market and the automatedprocess of acting on these feelings. The feelings are derived from yearsof experience trading the markets, so trust them. Act on them.When you just can’t seem to get in sync with the markets, whenyour indicators are constantly stopping you out of trades, and yourbeliefs are in conflict with what the reality of the market is, this is a goodtime to step back from your trading to re-evaluate. Many traders I knowsurprisingly get more aggressive in these time periods trying to get thefeel for the market. They are trying to win back those losses with moreaggressive trading. The problem is that the underlying cause for thelosses hasn’t been rectified. Until this problem finds itself a solution, thesame mistakes will be made, leading to more loss. If the market isextremely narrow or the indicators are not confirming your beliefs, thisis a time to be more passive in your trading. If there is uncertainty withinyou and your trading plan, the idea is step back and find the problem.Take a step back and find that zone again where the market is once againa part of you. Until this time, do not be aggressive.
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When you can feel yourself in sync with the markets in such a waythat the indicators and beliefs within yourself are working together intandem, this is the time to be aggressive. This is the time to let theautomation of what you know to be true come out in the markets andtake advantage of the opportunities being presented. This type of trading environment is incredibly exciting as you begin to reap rewards foryour patience. Obviously, not every trade will yield a profit, but thetrends will be followed and the profits built up over time should outweigh the losses being taken in catching that trend. However, there is thatfear of the reappearance of the ego, the idea that nothing can hurt youand this can lead to reckless trading again. I’ve often found myself trading very well at certain times, but I’ve had to almost step back and askmyself if this is just too much at one time.I’ve had to beat my ego back into submission to keep my concentration on the markets, to enjoy the game of trading rather than therewards it was bringing me. I know that if I get out of control, the market will find its way to retake the profits that I had just made. I don’tknow if I’ve ever been too aggressive in the market, but I’m aware of thetroubles that it can cause when I’m losing aggressively, as well as profiting aggressively. Obviously, the latter I can deal with better, but I mustbe aware to keep my mind clear on why I was profiting in this mannerso as not to clutter the reasons for this progress and not end its ability tokeep me going in this direction.This is a purely mental state that pure mechanical traders will failto understand. In most cases, newer traders using a purely mechanicalapproach will end up losing their hard-earned profits in this manner asthey feel invincible from the markets. They will increase lot sizes, tradeout of the feel, break rules, and end up losing most of what they madefrom market prior to this. Know when to be aggressive and when to bepassive. Developing this feel from years of understanding the mechanical system will aid in this progress.
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MOMENTUM INVESTINGIn this section, I will discuss what I call the best of both worlds. It combines the short-term techniques of momentum trading with long-termmethods of investing. It is meant to be completely separate from the previous chapters and can be used to fine-tune your long-term trades.Many people think just because I am a short-term momentum trader thatI have no interest in long-term trading. Nothing could be further fromthe truth.
HOW AND WHY I BEGAN THISLONGER-TERM APPROACHA few months ago I went looking for a manager to handle my retirementaccount as I was too busy to give it much attention and I was tired ofgaining only money market percentage increases. After interviewing afew, and asking how they did compared to the Standard & Poor’s 500, Isoon realized that they intended to diversify me under the table with thesame type of general plan with minimal gains that they have touted formany years. After mulling over the expenses and their lack of real direction, I decided to simply do a few longer-term momentum trades per yearon my own and reasoned that I should come out better than what I wasbeing offered. So began my long-term trading career.As a momentum trader, I am in a very good position to spotdaily momentum and can use my flexibility to gain profits. Most moneymanaged funds lack flexibility and so they wind up diversifying until theprofits are watered down by the accumulation of dogs. They really makemoney based on their reasons for the trades and not the trades themselves. They have golden tongues for investment spiel, but most cannotCopyright © 2002 by Mtrader.com.Click here for Terms of Use.
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beat the S&P index. The ones that do usually get into cycles before theyoccur but are then destined to ride them down as interest wanes and profits fade.A recent example of this was seen in the biotech sector. After risingto phenomenal heights, it hit the skids, wiping out profits fast and furiously. “Why not sell the high?” you ask. Few money managers can timethe market that well, and most hold long-term. The more they trade, thehigher they drive up commissions, expenses, and tax liabilities, so theyare forced into an inflexible long-term approach. They depend on a “rising tide floating all boats.” So I strongly feel that anyone willing to educate themselves about momentum and to actively take charge of theirown investments will have much more profitable results as they takeadvantage of the market momentum.I needed to overcome a few pitfalls in making the transition fromdaytrading to momentum investing. It was a time of trial and error getting the right combinations together and finding my way into this newterritory. The first thing I realized is that my daytrading background oriented me too closely to the short term. I had to constantly fight theimpulse to take .50-point profits. I had to learn to let my stocks breatheand develop more slowly into larger potential. I was in it, after all, forthe long term. The second thing I found was that some of my long-termtrades were no longer breathing and needed some mouth-to-mouthresuscitation. I had to learn to identify and separate those plays developing slowly from those going nowhere.I find investing in momentum plays just as exciting and emotionalas daytrading. I have found a new respect for the investor who is ableto buy and hold and not obsess over their portfolio. Because of themomentum trader in me, I can be obsessive at times, so I play very smallshares to ensure I don’t obsess over every trade. In this market with allits fluctuations and uncertainty, I now feel the daytraders have it mucheasier than the investors. They are in and out of trades within a fewhours, ending the day in cash, and don’t care what the market does thenext day. Investing ain’t easy!I came to the conclusion rather quickly though that momentumplays were the most profitable way to trade my retirement accountwhile still not over-burdening my time. I began trading a couple timesa week and increasing my portfolio at a rate where my gains after a couple months exceeded what I was hoping for at the end of the year.
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THE PRINCIPLES OF MOMENTUM IN INVESTINGWhen stocks move, they tend to oscillate up and down in waves. We callthese waves “momentum.” The waves do not move uniformly, however.They will either oscillate in an up-turning trend, making gradual newhighs and higher lows, or they will oscillate in a downward trend, making gradual new lows with each turn. Imagine it is like a ball making tinybounces up a staircase, and then down a staircase. In daytrading, we aretaking advantage of each bounce the ball makes. In momentum investing, we are taking that time frame a bit longer, and taking advantage ofthe staircase, rather than each bounce of the ball. Momentum investingis similar to the principles of momentum trading, taking advantage ofshort-term movements. The exception being you let your trades ride untilthey run out of steam or until you have sufficient profits. You ride thetrade until the ball loses momentum and arrives at the top of the staircase.To accurately judge this momentum, a momentum player must beaware of the general principles of momentum: selling creates value . . .value creates buying . . . buyers create profits . . . profits create selling.The quicker the action occurs, the more predictable the action. Stocks donot move on their own; people move stocks as they react to potential. Thefaster the potential presents itself, the faster the reactions will occur. I callit the principle of “time and movement,” as previously discussed in thebook.The principle of “time and movement,” which is the basis ofmomentum trading, means that generally when you see 20-percent ormore in a short period of time, that movement will then be counteractedto, also within a short-term period of time. The faster a stock moves upor down by 20-percent, the more predictable it becomes in its actions andcounteractions, and it is then described as having momentum. This principle applies to both daytrading and longer-term momentum plays ondifferent time-scales.So we first identify momentum in a large movement up or down.This creates increasing incentive, and near the 20-percent mark, we lookfor reactions to that incentive. We then jump onto that wave for as longas it flows. At the tops, as profit-taking incentive increases, we then havea choice to sell or hold for an even longer-term trend. Understanding theprinciples of “time and movement” and momentum will help you tomake your decisions.
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For example, when the Nasdaq hit its recent bottom after the crashat 3040, I began looking for reactions to the growing incentive in the values created. I then began adding positions as I identified momentumcoming into individual stocks and the buyers coming in stronger duringthe day’s trading, indicating the counter-reaction was beginning. Cisco,(CSCO) is a stable market leader and often a good one to watch for general market indication (see Figure 14-1). At the market bottom, CSCOcame off a low of 50 and climbed nicely up to $60 in a few days on oneheck of a nice rally.Value hunters reacted to the value that was created in a short periodof time during its quick drop to 50. At 60 then, we have a choice of exiting with the profits of the short-term momentum or holding as a longterm investment.A few further keys can be used to unlock your understanding ofmomentum stocks, such as trading volume, the news event that beganthe momentum, the intra-day range, the gap up on the day of the newsif it began prior to the market open, and also the ending value in com-
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parison with the high and low. This criteria is the same as for daytradesin the Gainer category, as discussed earlier.
MOMENTUM INVESTMENT CANDIDATESIt is important to compare daily charts of the stocks you are consideringwith a daily chart of the market to assess whether they are market followers or acting on their own momentum. We want only those stocks thatare participating in the general market and moving with the general market direction. For example, if the market has pulled back and I am seeing the first day of good buying with many of my leaders ending the daystrong, I will look at charts for stocks that were obviously pulling backand climbing right in line with the market. I call them “participators,”and they become good candidates to buy if you expect the marketmomentum to continue upward for a day or two. I like to do scans thatpick the bottom dwellers on the first day they end above the mid-rangepoint with increased volume.Those are candidates to do well if the market is inclining, becausevalue has been found by traders.When considering a long-term investment, it is necessary to firstestablish a long-term bias. In other words, is the market climbing in thenext few years or declining? That is your first and most important decision to make, and no one knows for sure. You can look at the history ofthe stock market and build a better case for an inclining market than fora declining one. In momentum investing, we begin exactly the same way,with an established bias. The short-term trend must also be determinedwhen entering positions and the further you miss the upward momentum, the longer you have to wait for your positions to turn around andparticipate in the inclining market. When you enter a long positionbecause the stock is under momentum, should the market then turnagainst you, the stock will also turn against you and you will be forcedto ride it down until the market turns once again. But it will come back,if it is a market participator, when the market comes back. The nice thingabout an investor is they have time to wait it out. It will lock up yourcapital, however, if you accumulate too many positions at market tops.Once you enter your position, you are now an investor. One thingyou must get in your head at the very outset is that you have a good stockwith positive momentum. If the market dips, your stock will go down,but when the market recovers, your stock will too. This position shouldbe a very small part of your total portfolio. The law of participationmeans that your stock will follow the leaders and the general market. If
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the market dips, your stock