moment I mighthave to leave the country. While most people could simply quit tradingand go find a job, any job, I didn’t have this luxury. Therefore, whentraders do finally quit and go out whining that they have to go find a job,I have sympathy for them, of course, but I can’t help thinking, “Try quitting your job and leaving your country!”
GETTING THROUGH THE STAGESWhen I finally got to the stage of striving trader, I had told myself that Ihad to make this work. I had no alternative. I was always used to havingbackup plans, and, for the first time in my life, I didn’t feel as if I reallyhad one. I had to make trading work. I started to work on my understanding of true market reality. I was no longer a slave to common thought. Iwas beginning to understand and work on thinking the way the minoritythinks. I now understood how to use common thought for my benefit, thatis, to profit off the majority and to position myself on the side of smartmoney.For example, market makers were no longer a group of conspiracyplayers. They exist to provide liquidity to stocks and often fight each othermore than they try to hurt us. We are last on their list for trading intentions. This is just one example of my adjustment in thought. I wasn’t atwar with the market makers. I was happy they were there to sell me sharesand buy my shares when I felt it necessary for them to do so. I started todevelop a stable portfolio (a plateau, if you will), which eventually took aslow uptrend. I used tape reading and other market principles such as fundamental analysis or technical analysis effectively and in a complementary way. Books, friends’ ideas, research of ideas, and so on were allbecoming a part of my arsenal. I was using them to get closer to the truereality of the market.
THE FINAL STAGEWhen I finally got to the stage I call a reality trader, I found myself in theultimate state of trading, which allowed me to take my $10,000 to over$200,000 in just 20 months. I accomplished this with consistency—no
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huge wins or major drawdowns. My unemotional and egoless self allowedme a true and clear perception of market events and created the edgeneeded to trade profitably.I believe that the first two stages of the circle were the hardest. I cansee this same struggle in other traders. The market is a struggle, stockaction is unclear, opinions are formed, executions are impossible, and soon. If there was a problem, this was the stage in which we’d find it. I askedmyself why all these traders who were posting gains were entering hereand there, exiting here and there. I had no understanding of what theywere doing. I remember almost being angry with financial TV personalities because all they had to do was report the news. And they got paidhandsomely for it, while I was having to trade to make a living. Yet Ichose to trade for a living. It was just another example of how far fromreality many new traders are.Now that I’m at the last stage, a reality trader, I realize that the hardest phase is actually the third phase, that of a striving trader. It is easy tobe new traders. They allow ego and common thought to dictate their trading. They feel that it is okay to be far from market reality.As a new trader, I was being fed information for the benefit of others, not my own. I was told that a certain stock was a strong buy; it wastargeted to go another 50 points higher. I was told to hold on; it wouldalways come back. “Don’t stop out. A loss is a loss only if you take it.”Look at the price of New World Restaurant Group (Nasdaq: NWCI) inFigure 5.1.My friend bought this stock because he was told it was going to bethe next Starbucks, and he believed it. He jokes to me that he still owns itas a memento of his stupidity.I never understood how traders could lose money and not seem to bebothered by it because they were in good company. It appeared that losing money was fine as they belonged to the club. The traders’ job is toread stock action correctly so that financial rewards allow them to be thepersons they want to be, not because they want to feel comfortable infinancial destruction. Yet, I see this all the time as newer traders struggleto get through the learning phase.If you are trading like a newer trader and have this mindset, youmight as well buy and sell stock arbitrarily. If you lose, it’s the market’s fault. If you win, then your confidence creates a false sense ofsecurity. Worse, you allow random successes to reinforce habits thataren’t conducive to long-term success. Averaging down, justifications,and turning intraday trading strategies into long-term investing strategies are just another way to rationalize a losing position: “Oh well, it
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FIGURE 5.1New World Restaurant Group (NWCI) stock. (Used with permission of CBS MarketWatch.)
goes into my retirement account.” I want my retirement account to befilled with more winners rather than a bunch of losers. I’ve never beena big fan of mixing trading strategies from intraday to long-terminvestments.Consistency isn’t found in these stages because traders are not seeing reality. There is no accountability and little pressure. They trade whatthey think. They focus on money. It was not until I got to be a strivingtrader that I realized that price and volume are what matter. Tradersshould read price action, not guess or predict market value. Money comesas a reward for a trade well read. Our risk is reading it wrong. We still takeaccountability for that trade.
COMPLETING THE CIRCLETraders in the newer trader phase need to build on a foundation of incorrect assumptions and false thought processes. Then later, when they seethe reality, they are able to tell the difference. It is the same idea as competing against the best to make you better. Once you improve, you can see
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your earlier faults and therefore be less inclined to repeat your mistakes.As I progress from year to year I laugh at my inadequacies from the yearbefore. If I ever evaluate my trading and don’t see problems from the previous year, I will quit trading for a while because it means that my ego hasgotten the better of me.Unfortunately, I see traders I’ve known for years trading the sameway today as they did years ago. Their accounts bleed, but they continueunchanged. They let their blindness to market reality feed their ego. Themarket eventually finds a way to separate the mule from its nourishment.Developing traders break out of this mold in a positive way. Theybegin to see some tools such as charts or “trading systems” that they seeothers using profitably. This gives them a little hope that they can do thisas well. They see the trade setups, the postings of traders, the participation, the records, and so forth. This creates a little confidence. But thesefactors don’t break down the walls that most traders have. There is stillplenty of emotion, ego, overthinking, and wrong perceptions of stockmarket reality. Traders still think that mechanical trading is all they need.They don’t understand yet that when traders are successful, the reason isusually mental. They have limited ideas about risk evaluation and moneymanagement.During this phase, traders usually come to the point that they eitherdecide to give up or take the next step. If they make it past the newer stageof trading, this next stage is the one where the market does its second cutfrom the team. Traders understand that while some structure begins tocome into trading, there is still plenty that is not working right.My friend who bought NWCI, interestingly enough, made the transition from a developing trader to a striving trader without consciouslydoing so. I told him to read the trading classic, Reminiscences of a StockOperator, which completely changed his perceptions of the marketHe told me that as he was reading this book while flying back fromCalifornia. His reading led him to understand that he had more to learn. Ifeel that in every successful trader’s life, there is an event or a progressionof key events that turns one’s mind around from common thinking tominority or “out of the box” thinking. It wasn’t until he read the book thathe really began to make the transition into the next part of the tradingcircle.He was a trader for one of the trading services I was using as ameans of finding trading ideas. He was a young man, in his mid-twenties,sharp, but with a bit of an ego that always kept him at arm’s length fromme. However, he drew my attention by an interesting contradictionbetween his apparent abilities on one hand and his misguided approach to
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the market on the other. He was obviously very bright and capable oflearning quickly. I saw him trading for this or that reason, winning andlosing. When he lost, he would change his trading plans again and againwith each new breakthrough of understanding. He was able to see whatworked and didn’t work for him. Although he learned trading basics veryquickly, his coworkers and work environment were pushing him in thewrong direction.He used the formal approach of attempting to apply simple logic tomarket movements—the same old “good news, bad news, too low thentime to buy, too high then time to short.” It was interesting to observe himoutgrow this approach. At one point, to my amusement, he tried applyinga system called “momentum” trading. I could never understand how trading tops and bottoms, in effect, reversals, could be construed as momentum trading. He had a breakthrough to reality when he figured outfor himself that momentum should refer to trading in the direction ofthe trend. This realization allowed him to see a whole new world ofopportunities.I could see his thoughts and trades begin to change ever so slightly,moving away from the strategy that he was struggling to find peace with.The service he worked for wouldn’t allow methodology that contradictedits foundation to be traded, much less taught. He could see he was in adead end. He didn’t want to limit his trading progress, and I could see hewas conflicted when he discussed trades with others in class or after class.This is when I noticed a change. His class discussions migrated to realism.He talked about basic mindset issues that he was using as he approachedthe day. It was these subtle changes that drew my interest. I was not in aposition to try to reorient him since he was working for a company thatdemanded strict adherence to guidelines.At one point, he decided that his traditional brokerage firm wasn’tappropriate for day trading. He switched to a direct-access brokerage,placing some of his trading funds with an outfit that I was using at the timeto test out its reliability and usefulness.
DISCOVERING THE SATISFACTION OF TEACHINGIt was at this point in his trading that our personal discussion began toexpand. At first, he asked me about the functionality of the software andits features. After he became a bit more familiar with the software, hemoved his attention to the execution functionality. I was a recognizedexpert in the field of order routing. He knew this and came to me for someadvice on one function or another, such as routing rules like the ISLD
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crossing/locking quotes problem that seems to plague many traders andthe SOES 5-minute rule. There were a ton of them, and our conversationwas mainly about getting him up to speed on them. Furthermore, the functions were always changing. And because the service leader wasn’t daytrading, he didn’t keep up with the changing execution environmentenough to help. Therefore, almost by default, I was the logical choice forhelp on execution technique.Our brief discussions here and there did not lead anywhere for awhile because superficial exchanges were not enough to get a dialoguegoing. Most of his questions about functionality required a minimalresponse, and he did not yet want information about my specific tradingstyle. Then, as fate would have it, he was about to hit a major blowup, asmost traders do, that would push him in the direction in which he neededto go. He was playing his usual top/bottom, false momentum strategy,and, this time, it almost killed him.He had bought a stock, one of the major players, and saw it move inhis general direction for a bit off the low of what he considered to be asupport area. At this point, he began to see the profit dwindle and eventually turn it into a small loss. Then the stock got away from him, the market began to tank, and he was looking at a margin call. This error didn’thave so much to do with his trading methodology as it did with his trading mindset. However, if his stock was experiencing a true momentum,instead of going long off that low, then the base made near that low, whenfailed, would have given him a beautiful short setup that could have led toa profit. So his general approach to the market, being against trends, in hisown words to me later, caused this snafu.However, it was this snafu that led to a much better dialoguebetween us. His problem, at this point, was how to regain his confidence,not his money. This is where we really began to make the connectionbetween his appetite for knowledge and my desire to offer all that I hadlearned from my own experiences.He knew that he had to look for alternative strategies in order toavoid going through the same problem that he had just faced. At thispoint, he asked me how I kept my risk minimal and my consistency highenough to enable me to make a living doing what I was doing. This wasduring a period in which I was averaging 12–25 trades a day, with nolosing weeks or months. My desire to explain was equal to his desire tolearn.We began to talk about trading with the trend, about effective routing avenues, and eventually about more interesting issues such as trading
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intuition. I could see that his interest in the “voodoo” of the market piquedhis ambition to learn more. As I mentioned before, I suggested that heread a couple of books such as Reminiscences of a Stock Operator byLefèvre and The Intuitive Trader by Koppel. He read them and couldn’tbelieve how they brought him to the world of reality. This was the timewhen we started discussing my method of tape reading. It didn’t take himlong to see that my approach was connected to market reality, and itallowed him to break the barrier he had encountered in his trading. Hestudied my method with real enthusiasm, and his hard work broughtresults quickly. His personal trading improved greatly in just a fewmonths. He felt much more confident now. He was able to read the reality now.
REVELING IN THE TRIUMPH OF ANOTHER TRADEROne of my proudest moments came in May 2000. The market was reelingfrom the March 2000 highs and was taking a huge hit. I awoke to find ane-mail from my friend. He started by expressing his appreciation for thetime I spent with him. And he told me that his progression was due inlarge part to our numerous conversations. He told me that he and his wifehad discussed all the people that had helped him throughout his life.During their conversation, he noted to his wife that he felt he owed mesomething for my time and my guidance.He had put a check in the mail to me for 10 percent of his tradingprofits from the month of April as a sign of his appreciation. Mind you,this was a month that had wiped many out. Yet, because of the time wespent online, he had experienced one of his best months ever.In the beginning of my friend’s striving trader stage, Jesse Livermore, in a way, became his mentor through Reminiscences of a StockOperator, pretty much as Livermore was for me earlier. Livermore’sideas, his understanding, didn’t really teach a system. Rather, it taughtreality and how to think like a real trader. This was Livermore’s effort toremove all he thought he knew that came from ego, false perceptions,and the like. My friend began to read a lot about trading. He was in constant talks with those he trusted and was trading with everything he couldgather. He took in all the information he could from those who werewilling to give it to him. It’s because of this aggressiveness that he progressed through this striving trader stage very quickly. My friend didn’trealize just how quickly until I showed him these stages. There are peoplewho have minds you can unlock and inspire. My friend was one of those
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people. You could see his enjoyment in his progression, and I’m sure hecould see the same in me as I watched him grow.
REDISCOVERING THE CIRCLELet’s review the stages in the circle. New and developing traders find iteasy to trade with no effort, with random wins and losses. Striving tradersread all they can, ask all they can, develop all they can with their system,and so on. They spend a lot of time on developing the winning and correct trading attitude. I’m not talking about work as in endless research ofstock charts and trading journals, spending an inordinate amount of timeon trade reviews, tracking, and so forth.I’m talking about seeing reality and becoming a realistic trader. I’mtalking about working on getting rid of ego, emotion, and thoughts basedon illusion or an incorrect understanding of tape-reading principles. Allthe research you do by reading books, reviewing charts, and so on needsto be taken to deeper levels within you, thereby enabling you to understand why the market works the way it does. Self-control has to be learnedfor profit and for loss.There is an amazing amount of progress needed in this stage, and it’sup to the traders as to how fast they get through it. As we move throughthe stages of the newer trader to the reality trader, we can see why thethird stage is really the hardest, because it takes the most effort.As noted earlier, newer traders trade without much effort, buy andsell with basically no fear. Reality traders also trade without much effort,buy and sell with basically no fear. But the difference is that reality tradersunderstand that trading is more than just “buy and sell.” They understand that there are principles of tape reading that are complementary totechnical analysis and fundamental analysis, how these principles leadus to the footprints of the minority, and how they show us the crowdpsychology of the majority. They understand how to trade unemotionally, to trade what they see, not what they think. They understand thateveryone has a different perception of the market and that it’s this difference, when there is a shift in the aggregate of supply and demand, that dictates stock movement. They understand why the demands of tradingrequire a greater understanding of our mental capacity. They understandthat the market works randomly, that the best setup can fail, and that theworst can produce profit. They understand that a system is based on probabilities, which in turn inherits losses—nothing is right 100 percent of thetime.
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Reality traders understand that risk evaluations and money management enable them to trade the next trade. When their probability systemproduces a loss, they keep the loss small. They know not to average down,not to justify a loss, not to chase the market, not to. . . Basically, theyunderstand what not to do, and they don’t do it. Let me use once again anart analogy. There is a well-known saying by a famous sculptor thatexplains how he created his masterpieces. He said that he was just cuttingoff all that wasn’t needed and that what remained was the beautiful sculpture. In exactly the same way, traders get rid of everything that gets in theway, of everything that is not needed in terms of their system. Whatremains is a state-of-the-art trading system, and each successful tradebecomes a masterpiece.On a deeper level, a reality trader knows his rules, and he knowswhen to break his rules. He knows that he doesn’t answer to anyone. Hedoesn’t have to prove anything to anyone. Trading is his. Trading is hispassion, his life, and his reason for getting up in the morning. The bellrings for him. The market exists to provide him with funds to feed hisfamily, go to soccer games, play golf, take trips, and provide freedom. Hetrades against the best traders in the world and beats them. No one can rattle his cage, and no one can tell him about his business. He does everything he does, in trading and in life, based on the situations before him.And no one can knock him off his pedestal. He is the king of his own castle, and it’s a castle built on reality. This is the environment in which Iexist.One more thing about the trading circle. This circle should never beclosed. There is a point in many traders’ development when we feel wehave it all figured out and that we can close the circle. If we do this, thenwe are right back at the new trader stage. This often leads to drawdownperiods as our ego becomes more pronounced and our reality becomesdistorted again. We begin to integrate thought processes with the newtrader, and this leads to a string of losses or “dumb trades.” This happensto me every so often as I am trading. For example, during a range market,I was trying to trade trend setups. It cost me thousands of dollars. I wasfighting reality in this case and allowing something within me to want atrend rather than to play the range. This is proof that mechanical tradingisn’t the key. You have to be able to clearly identify what kind of day youare in, and you can do so only with clear mental strength based on truemarket reality.The longer we trade, the more will happen to us. If we ever close thecircle, we go right back to ego, misperceptions, and mistakes that new
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traders make. It is impossible to close this circle. For if we close it, ego,emotion, and trading what we think happens again.The market is our teacher. It teaches us new lessons each day. Itteaches me that I don’t have things all figured out. It teaches me that Ineed to stay a reality trader if I’m to make it, to keep my account in asteady uptrend. It teaches me that I am an eternal student and that, if I everclose the circle, I can expect the market to separate me from my moneyfaster than I can say “sucker.”
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’m often asked about my risk tolerance. This became especially important during the bear market of 2000–2002. It’s not an accident that trading has a fairly low rate of success, and market conditions often don’t helpat all. The ability to adjust to new markets is the strength in any trader. Inthe bear market that began in 2000, it became necessary to find a way tosurvive in this profession.First, traders have to form realistic expectations about their gains.The problem is that trading offers unlimited opportunities. And when youlook at market movements after the fact, it seems easy to make anyamount of money. When newcomers expect to make a couple of thousanddollars a day, they take enormous risks in order to achieve that goal.Established traders know that their primary purpose is to preservetheir trading capital. In order to do so, they have to limit risk. However,limiting risk also limits profit potential. One day I was watching a fewilliquid issues with a few of my friends. What I mean by illiquid is thatthere really aren’t many participants in this stock. There were about fourmarket makers, and a couple of ECNs (Electronic CommunicationsNetworks) would show up from time to time. The spread was wide, andthe depth of the stock was very thin. One of these issues caught my attention because it moved from just under $11 to over $15 in a matter of minutes. It was Qiao Xing Universal Telephone (Nasdaq: XING) (see Figure6.1). I watched this stock and its behavior and knew it wasn’t to betouched by professionals because of slippage concerns. If I was wrongwith my entry, risk was way outside of my parameters at the time.One really anxious trader who can never stay on the sidelines asked mewhy I wasn’t trading it. He was long 2000 shares and was happy to see that63
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FIGURE 6.1Example of short-term volatility. (Used with permission of CBS MarketWatch.)
the stock had climbed from his entry at near $12 to just over $14. He said tome, “Why didn’t you take position on it? You were in front of the computerthe entire day. You could see it.” While he was saying this to me, the stockwent from $14 back down to just under $11 again. But he refused to sell it.He ended up taking a considerable loss for the size of his portfolio. He madetwo mistakes. The first was not seeing the risk of this stock. The second wasnot taking the profit on such an extremely risky stock while he had it.All stocks move. But you don’t have to trade them all, especiallyones that trade in dollars a minute. It is hard to imagine anything morerisky than this monster with a huge spread and almost no volume. Ofcourse there was opportunity to profit, but this is what amateurs go after.As a trader, I know to manage my risk first, and there was no way to do iton that stock at that time.
PROS ASSESS RISK; AMATEURS ASSESS POTENTIALFor professionals, risk evaluation always comes first. If you are uncomfortable with the risk on any particular stock or trade, just stay away from
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it. The skill of staying away is one of the most important one could learn.Unfortunately, for many traders, this never sunk in. The market might notpresent any opportunities on a particular day. In such a situation, any tradewould be an attempt to squeeze blood from a stone. Furthermore, if themarket presents movements that are not readable by the system we use,any trade would be just gambling.The market might present readable opportunities without favorablereward/risk ratios, and any trade would be too great a risk from the perspective of risk management. In all cases such as these, the trader has tostay away. An urge to trade just for trading’s sake can lead to big lossesin the worst case or to slow bleeding with many stops in the best case.During 1998–2002 we went through all the markets one can imagine. Arunning market with incredibly strong uptrends, crashes, dull phases, slowsliding, and so on. And I went through each one unscathed, while manyof my colleagues were forced to stop trading altogether.The first market stage (a huge run-up) brought many people into themarket who thought it was easy. Their goal was to buy anything in sightand hold for double, triple, or even more profits. I don’t envy those whostarted their learning at that time. It was easy to believe that buying andholding are really all there is to it. Those were the salad days, to be sure,but not for everyone. I saw plenty of people trying to short the market allthe way up. One self-proclaimed great trader who admitted to not tradingany longer, kept calling the QQQ short, losing hundreds of points for thetraders who followed him. We only heard of him calling a great marketbottom. This is a sucker’s game. This is plenty of evidence that followingsomeone blindly will not make you a great trader.Traders were losing on the long side as well, because no stock goesin just one direction. Upward movement was interrupted by pullbacks.When traders tried to hold through those pullbacks, they sometimes gotburned badly. It happened in situations when volatility was too big forthem to handle and the risk taken was too big. This leads us to the nextimportant concept that needs to be understood for market survival.
YOU DON’T HAVE TO BE IN THE MIDDLE OF EVERY BATTLEIt’s not necessary for traders to trade everything. In fact, stocks that grabthe most attention are often the most dangerous. I remember in 2000 whenJDS Uniphase got dumped badly. It was the most dangerous stock in themarket that day, and many people lost big by trying to go with the hotaction. The same happened with Emulex in 2001 when a false pressrelease sent it down 60–80 points. Many feel that they have to take part
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in the action that the entire market is focused on. They go home, talk tofriends, and are asked, “Hey, there were such huge swings on ABCDtoday! Did you take advantage of them?” Answering “no” would makeone feel like a coward. But remember, as a trader, I don’t have to proveanything to anyone.Many people who look at the action after they get home from workask, “OK, we can’t get access to a computer. But you can. You see it allhappening. How come you don’t play?” Do not be tempted to look likepart of some elite class of traders. The hottest market action is where thebiggest risk is. Don’t trade for action; trade for profit. But keep in mindthat profit always goes with the possibility of loss. Evaluate the loss youmight take if things turn nasty and decide whether you can afford the riskand whether you want this risk and/or reward.Traders spend much more time in the ambush than they do in thebattle. They limit their risk by limiting their market exposure. The biggestproblem for traders is risking being thrown out of the game. I know atrader who lost his entire trading capital on a single trade. Whatever wedo and however strongly we feel about a trade, we must never risk ourentire capital on one trade. This doesn’t mean that we should ignore anyopportunity in which the risk is too big, even if the reward/risk ratio isgreat. We do have the ability to decrease the risk by decreasing our sharesize.Imagine a stock with a great upside of $20. We see that it moves insuch a way that if our entry is wrong, it would cost a $2 stop. Many cannot afford a loss of $2000. However, the 10/1 ratio is really tempting. Wecan still go for it if we take shares that put us in a position of affordablerisk. By decreasing our share size, we limit our profit potential. That’s theprice of risk control. Limiting risk and capital preservation go first. I neverfeel that I have to trade. I don’t feel bad if the market action happens without me, and I don’t go for profits if the risk is greater than I can afford. Bylearning this kind of restraint, we preserve our capital.During the late 1990s, it was astonishing to see how many tradersmistakenly thought they were experts in the medical field, in reading geological mining maps, or in some other profession that requires more studythan a simple company 10-Q quarterly report. Speculators are not aboutdetermining the future value of a company’s net worth. They are detachedobservers of the psychology of the market. Too often we see opinionsbased on the illusions of people who pretend to be something they are not.As I mentioned before, early stage speculators are born of the need forsome certainty. They want reliable patterns, proven and provided on abasis from which they can trade. Eventually they realize that simply fol-
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lowing systems and patterns does not provide the desired results. Sadly,more often than not, this leads to frustration rather than to a continuedquest for reality.
THE DICHOTOMY OF THE GUILTYThe belief that people fear what they are guilty of holds true for the market. An early speculator most likely is not a great trader and so believesthat no one is. This early stage is part of the learning process.Furthermore, these early speculators form opinions about subjects they donot understand. Their opinions may certainly sound reasonable, but thereality is that they may well be off base. For example, I have no idea aboutphysics, but I’m sure I could write a paper on gravity just from simpleobservation. I might even get a B grade on the paper, but would you trustme with the design of a plane?Forming opinions is the greatest threat to early speculators. The market has curtains. Unless we pull back that curtain, we will never see thereality. For example, let’s assume a trader is screaming about a company’snew product. This is not happening because he is excited that the productwill be great for humanity. He is excited because he wants to attract interest so that he can sell his shares at a better price. The trader wants to leadme down the path of excitement so that I would buy into the stock for hisbenefit, not mine.Taking this in the broader sense, the market wants to show me onething and hammer me with the opposite. The early specul