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attachment is now a more internal conﬂict inside the trader and shows adramatic form of inﬂexibility.
In this case, a trader is unwilling to see objectively, and the cash lossis ignored while at the same time risk exposure is willingly increased. Allother  common-sense  concerns  that  at  any  other  time  a  trader  wouldagree were in the best interest of his account are completely discarded.The trader is actively participating in his own demise. Somewhere insidethe trader there is a conﬂict, and that conﬂict has nothing to do with mar-ket price action or the net order ﬂow. It has to do with the trader’s ownunwillingness to protect the account, his need to be right, his hope thatthe  market  will  come  back,  or  any  other  justiﬁcation  process  he  mightuse for holding on to a losing trade in the ﬁrst place. But instead of sim-ply holding a loser past a certain point, in this case the trader actively in-creases his risk.
If we stop and use a clear head when we trade, what beneﬁt could wereceive by willingly increasing our risk and our cash loss? There is no ben-eﬁt whatsoever as far as our long-term trading success is concerned. Whythen do some traders add to losing positions?
The  reasoning  behind  “Never  add  to  a  loser”  is  very  simple:  Don’tthrow good money after bad. The only way you or any trader could be inthe position of adding to a losing position is if there was a failure to deﬁnethe risk before the trade was done in the ﬁrst place. Rather than accept areasonable loss and learn the lesson that loss has to teach you the trader,the trader now makes a conscious and deliberate act based not on the factof  the  net  order  ﬂow  but  on  the  trader’s  own  emotional  need  for  some-thing. That need may be a need to get back a loss, a need to ﬁght with themarket, a need for the market to pay a proﬁt, a need to make a car pay-ment, or any number of little ways of saying the same thing. By adding to aloser, the trader is complicating the process of cutting a loss, thereby mak-ing his situation more difﬁcult, but this act is based on something the mar-ket has no knowledge of to begin with: the trader’s own emotional need.
Remember, the market moves only because of the net order ﬂow im-balance. Once you have executed and are now in a position, you are nolonger in control of the net result to your equity. If you are not on the cor-rect side of the net order-ﬂow as far as your chosen position is concerned,your account will accrue a cash debit until either you liquidate or the netorder ﬂow turns in your favor. If the net order-ﬂow never turns in your fa-vor it is possible you could run out of margin funds before the price actionstabilizes. By doing anything other than liquidating, you are increasing therisk that you will suffer ruin. Adding to a losing position is actually pyra-miding your  loss!  As  an  intelligent  individual,  how  ridiculous  does  thissound to you? What trader would willingly put himself in the poorhouse ata geometrically faster rate?
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As a serious trader looking to master your game, you cannot affordto allow emotional or perceived psychological needs to inﬂuence yourwillingness  to  protect  yourself.  The  reason  you  must  never  add  to  aloser  under  any  circumstances  is  because  the  probability  of  being  onthe  correct  side  of  the  order  ﬂow  has  already become  evident  due  tothe open-trade loss you are already holding. You are on the losing sideto begin with; you haven’t seen it right, and that fact alone, in and of it-self says “liquidate”—nothing else. Failure to liquidate means a biggerloss. Adding to the loser means an even bigger loss. How is that in yourbest interest?
Ask yourself exactly why you feel the desire to add to an existing loss.If you take a step back and think it through, the reason will most likely besome form of emotional attachment to the trade results and some form ofunwillingness  to  do  the  right  thing.  Adding  to  a  loser  is  a  symptom  of  abigger  problem  the  trader  has:  no  real  control  over  his  feelings  or  emo-tions. A trader in that position is an accident waiting to happen.
Some traders make the mistake of deﬁning a losing trade as a functionof cash debit. By that I mean, an entry execution is followed by a liquida-tion execution and the two prices marked into the trading account yield anet negative dollar amount. I think it is far more beneﬁcial for you to rede-ﬁne the concept of a loss to include more focus on the issue of personaldiscipline.
If you ﬁnd yourself executing into a market for some reason and, onfurther  evaluation  of  your  actions,  you  come  to  the  conclusion  that  youare doing the wrong thing for you personally, then you need to liquidate toexit the market immediately. If you have broken a trading rule, if you havedone a trade because of something you normally wouldn’t trust as an indi-cator, if you have emotionally wanted a proﬁt, or whatever other misstepyou may have made, you are most likely taking more risk than you other-wise  would  have.  Ruthlessly  liquidating  to  protect  yourself  is  your  bestoption, even if the trade has an open-trade proﬁt at that point. A losingtrade can be any trade done for any reason if your personal discipline hasbeen broken in order to make that trade.
Once you redeﬁne a losing trade from the standpoint of your personaldiscipline and not as a change in your cash balance, you are in a positionto learn what you need to learn from your ﬁrst loss—how to  effectivelyparticipate  on  the  right  side.  The  issue  of  adding  to  a  loser  is  never  inquestion because you aren’t trading from a ﬁnancial focus to begin with.You are trading from the focus of discipline to do the proper thing all thetime. You will not be tempted to add to your loser because you will havecut the loss by liquidating. You can always get back in, so there is no needto hold something that isn’t working and certainly no need to make mat-ters worse by adding to something that isn’t working.
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Fundamentally,  making  this  rule  work  means  admitting  to  yourselfthat you need something to control your emotional bias as it creates yoururge  to  action.  You  need  to  confront  the  possibility  that  you  personallyhave  a  “something”  somewhere  in  your  thinking  and  recognize  that  thatparticular little something has nothing to do with successful trading. Thenext  time  that  particular  little  something  shows  up  for  trading,  you  willhave already decided that you are not going to break your discipline to-day. The urge to add to a loser is a signal to liquidate because somethingis not right with me today. If something is not right with you, the trader,that has nothing to do with market structure or where the net order ﬂowis. If you aren’t seeing it correctly today, that is clearly shown by an open-trade loss to begin with. At that point you liquidate.
Making Rule #7 work will lead to never breaking Rule #8. The only dif-
ference between the two is the trader’s depth of attachment to the trade.
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RULE #9
Don’tOvertrade
I will say this again, I never made my money bytrading; I made my money by sitting tight.
—Jesse Livermore
Overtrading is the deﬁnitive symptom of the net losing trader. All the
other  errors  that  can  increase  the  net  outﬂow  of  trading  capitalfrom  a  trading  account  can  be  found  when  you  examine  theamount of executions done overtime. Could you say that adding to a los-ing trade is overtrading? Isn’t it true that too many trades are often doneby failing to deﬁne a risk?
As I mentioned in the Introduction, most of the trading rules we arefamiliar with need to be examined from the perspective of the psychologyeither helping us develop or preventing us from developing. Many peoplearrive at Rule #9, “Don’t overtrade,” as a wake-up call only after it is toolate. To make this rule work we need to understand that it is a guidelinethat  will  help  us  prevent  blowing  ourselves  out  of  the  water.  In  reality,overtrading can be many things, but one thing is certain: Ignoring the poten-tial we have to overtrade will almost surely put us in the position wherewe have overtraded—and by the time we wake up to this fact, our equityis gone.
Part of the problem we as traders seem to have is processing the volu-minous amount of market information and opportunity base that is avail-able  to  us.  At  this  critical  point  in  monetary  evolution,  the  ﬁnancialmarkets are exponentially growing in both size and complexity. In additionto the explosive growth across virtually all sectors of money management
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services, the evolution of communication is also growing at a phenomenalrate. At the time of this writing, any individual with reasonable means lo-cated in a developed area has instant access to almost any other indi-vidual,  source  of  information,  or  market  center  anywhere  in  the  worldinstantaneously via the Internet, cell phone, or television. I live and work indowntown  Chicago,  but  if  I  wanted  to  I  could  have  complete  access  toeverything I have now from a sailboat in the Caribbean or a mountaintop inIndia; and so could you. As traders we are no longer limited by distance orconnectivity to any market or information base. If we perceive that an op-portunity exists in an area somewhere on the other side of the world fromour home, we can choose from an almost unlimited number of ways to ex-ploit that opportunity and an equally unlimited information ﬂow to managethat opportunity.
A key to cutting our losses is selecting which opportunities are thebest proﬁt potential for us personally and if the truth were told, we re-ally  need  only  one  market.  The  fact  that  we  can  actively  participateglobally  at  any  moment  contributes  at  least  in  part  to  the  problem  ofovertrading.
Many traders make the mistake of thinking that the term overtradingcan only mean excessive trading in a particular market. Although that isone  aspect  of  it  and  needs  to  be  addressed  as  part  of  your  loss-controlstrategy,  it  would  be  far  more  accurate  to  rephrase  this  rule  as  “Don’tovercommit.”  It  really  doesn’t  matter  precisely  what  that  means  for  youdirectly, but as a serious student of lasting trade success, you must makechoices about how to allocate your limited resources. No one has unlim-ited capital and no one has unlimited mental or emotional resources. Yes,you  must  have  controls  on  your  behavior  to  prevent  excessive  tradingwithin one market, but you must also narrow your focus down to a spe-ciﬁc number of markets and the reasons you trade them. It is unreason-able  to  think  you  will  perform  equally  well  in  all  markets  across  allopportunities.
Without  a  solid  understanding  of  each  particular  market  and  howeach is structured, you will run the risk of having losses you cannot ex-plain  to  yourself.  Worse  yet,  because  you  cannot  easily  ﬁnd  the  cause of  your  lack  of  proﬁtability  in  one  particular  market,  you  will  mostlikely  continue  to  have  losses  in  that  market.  Many  traders  have  com-plained of net losing years or ﬂat years while showing closed proﬁts inone  market  against  closed  losses  in  another.  The  common  complaintgoes something like, “If only I hadn’t traded in crude oil! I made six ﬁg-ures in the S&Ps!”
Learning  to  stop  overtrading  requires  a  willingness  to  limit  your  op-portunity base while simultaneously maximizing your effectiveness in themarkets you will trade. It does no long-term good for your trading account
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to have signiﬁcant gains in one market offset by losses in another. Addi-tionally, overtrading is a symptom of a trader’s impatience with the oppor-tunity he has selected or frustration over the results he has achieved. Nolong-term  successful  trader  ever  complains  about  opportunity  or  howlong it takes to develop. Such a trader has learned that certain times arebetter  for  executing  than  others,  and  that  no  matter  what,  it  will  takesome  amount  of  time  to  see  results.  If  nothing  is  happening  today,  thennothing is happening today. The market that trader is working in simplydoesn’t  have  a  lot  to  offer  at  this  particular  time.  The  wise  trader  is  notconcerned  with  that  issue  because  he  knows  how  to  trade  that  marketand he doesn’t have his focus degraded by trying to put effort into sevendifferent places which he can’t exploit as effectively as he can one.
Because we as traders have so many choices and so much informationavailable to us, we are tempted to think all perceived opportunities will re-main  actual opportunities  for  us  personally,  simply  because  we  have  ac-cess to something we ordinarily may have never known about before. Wethink that access to information is a de facto source of opportunity, whenin  reality  our  own  ability  to  manage  opportunity  and  information  ﬂow  isthe real key to our long-term success. One aspect of making the rule “Don’tovertrade” work for you directly is to narrow your focus to the best possi-ble  market  opportunities  for  you  personally  and  limit  your  informationﬂow to only the critical information needed to exploit that number of mar-ket opportunities.
As  an  example,  if  you  cannot  understand  why  China  is  the  fourth-largest economy in the world today but won’t revalue their currency to re-duce their trade surplus, then buying a China-based mutual fund for yourlong-term  IRA  stock  account  may  not  be  a  good  move,  even  though  thatfund meets your basic criteria for risk/reward ratio and has four conﬁrm-ing technical indicators that you have come to trust well. Letting that tradego  because  you  don’t  have  time  to  understand  global  economics  wellenough to know when it will be time to liquidate that trade might save youa signiﬁcant amount of capital should you miss something along the way.The fact that you can follow the Hang Sang index in real time and get Eng-lish-translation market commentary twice a day from Hong Kong does notmean  you  will  be  able  to  put  it  together  well  enough  to  effectively  tradethat  opportunity  from  your  home  in  the  United  States.  It  is  tempting  tothink you can, but you might be overtrading your limited resources if youcan’t. A 40% loss in something you don’t understand rips the bottom out oftwo solid years in a “beat the S&P 500” trade you found. I am not saying itis a bad idea to consider globalizing your opportunity base. I am saying it isa bad idea to spread yourself too thin just because you can.
The common understanding of the rule “don’t overtrade” is related tomultiple executions within an existing market you currently trade in. This
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rule is designed to prevent you from exposing yourself to excessive low-probability trades. The most common symptom of breaking this rule is ex-ecuting multiple times from roughly the same area on the same side, butalso taking multiple losses. Basically, you make six or seven trades fromthe long side, for example, and have ﬁve individual losses and a net loss onthe day. To make matters worse, if you would have just sat tight on the ﬁrstposition for the whole day, you would have had a nice gain by the close.
Overtrading  (as  deﬁned  by  multiple  executions)  is  a  function  of  notunderstanding your time frame properly, not following your rules to beginwith,  or  not  following  your  trade  system  properly.  When  the  traderchooses  to  do  something  he  ordinarily  wouldn’t  do,  he  is  showing  hisemotional attachment to his results instead of maintaining a focused be-havior congruent with his discipline. Overtrading is a symptom of attach-ment, as is all consistently losing trading behavior.
To make this rule work for you, create a baseline of behavior that isconsistent with your trading system and your trading plan. It really doesn’tmatter  what  that  baseline  is  initially,  but  you  have  to  create  it  as  anindependent set of behavior controls, separate from your trading systemor plan. For example, if you are using an execution system that makes atrade  call  about  once  a  day,  and  you  are  using  that  system  properly,  itwould be rare for you to have four executions to initiate in a single day ina single market. If you ﬁnd you are executing more aggressively than thesystem actually tells you to, then you are overtrading. It is not a subjectiveor emotional set of data; it is a factual set of results that says, “You are notfollowing the rules today.” It doesn’t matter if your system is a moving av-erage crossover signal with a 15-minute moving average convergence di-vergence  (MACD)  conﬁrmation;  if  you  aren’t  following  it,  you  actuallyhave no system. And it doesn’t matter if your trade plan calls for you totake a break after two consecutive winning weeks and take your family todinner with some of your proﬁts; you aren’t going to have any proﬁts.
The symptom of overtrading is often subtle so that by the time youare willing to admit you are doing it, the damage is done. Therefore, tomake this rule work you have to choose ahead of time to put controls onyour behavior before you overtrade. You must write yourself a few rulesthat  lead  to  preventing overtrading,  not  helping  you  recover  after  youhave  done  the  damage.  That  rule  set  is  unique  to  you—it  is  a  factor  ofyour particular systemized approach and what it would look like if youweren’t following it.
The  key  to  making  this  rule  work  for  you  is  to  ask  yourself  what  itwould  look  like  if  you  were  actually  overtrading,  based  on  the  uniqueprobabilities inherent in your trade system being compromised. Once youhave that data, you must create a rule that would prevent that happening,if  you  follow  it.  In  many  cases,  traders  do  not  really  know  what  their
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trade  system  probabilities  are  and  therefore  can’t  really  get  the  data  toknow what overtrading would look like. Overtrading is not as simple as“trading too much.” If your system has a 55% probability of a winner butgets two-thirds of those trades on a Monday, you would be overtrading ifyou did a large number of trades on a Friday; so for you and your system,the deﬁnition of overtrading is not necessarily relative to the total tradescreated by that system. In this case, the rule “Don’t overtrade” might meannot trading more than twice on a Friday, but that wouldn’t apply on Mon-day. Maybe Monday’s rule would be “Don’t trade more than eight times.”
Gathering  the  data  to  exploit  your  system’s  inherent  probabilities  isone  thing,  but  putting  controls  on  your  behavior  when  you  are  outsidethose  parameters  depends  on  your  knowing  the  difference.  In  any  case,your  trading  plan  is  worthless  if  your  systemized  approach  is  not  beingfollowed properly. The rule “Don’t overtrade” is a call for you to get gooddata  and  then  implement  it  into  your  trading  plan.  That  includes  bothknowing which opportunities to trade in the ﬁrst place, and being willingto admit that you may be not be exploiting those opportunities as well asyou could. Both sides of the overtrading issue are about reducing risk ex-posure until you have the data to make a signiﬁcant improvement to yourmarket presence. The goal, of course, is to gather both the data and thewill to follow your rules before burning through all your capital.
Following Rule #9 can boil down to answering this question as hon-
estly as you can:
“How  well  do  I  know  what  I  am  doing,  and  am  I  willing  to  admit  Idon’t?” If the answer to that question is anything other than “I know ex-actly and I don’t need to change anything,” you are most likely overtradingin some form or another. You are either trading too many markets for you,trading without knowing your exact probabilities, or doing a little of both.Reducing your exposure or knowing when to stop executing (or a little ofboth)  depends  on  your  willingness  to  control  yourself.  Unwillingness  tocontrol  your  behavior  is  what  leads  to  breaking  every  other  rule.  Over-trading is the most important symptom to look for. We ﬁnd out how badwe have the problem next in Part III, “Letting Proﬁts Run.”
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PART III
Letting Proﬁts Run
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RULE #10
Keep GoodRecords andReview Them
Mistakes are a fact of life: It is the response to theerror that counts.
—Nikki Giovanni, Forbes Thoughts 
on Opportunity
M any traders experience an initial level of success easily right at
the start of their trading. They open their ﬁrst account and be-gin trading, maybe with a very simple approach, and with only ahandful of trades they earn a substantial gain in a short period of time.Naturally, it would be easy for the trader to make the assumption, “Thisis easy!”
Of  course  you  know  the  rest  of  the  story.  Over  time  this  particulartrader loses his initial winnings and then proceeds to lose some or all ofhis  initial  balance  just  as  quickly.  Some  traders  repeat  this  process  overand  over  again  with  a  new  trading  stake  and  a  new  system.  It  is  verytempting  to  think  the  problem  was  the  system  used  the  ﬁrst  time,  ormaybe the amount of capital wasn’t big enough to take advantage of thesystem’s full potential and probabilities. It is very easy for people to makethe  erroneous  assumption  that  they  know  what  they  are  doing  only  be-cause they have a little early success at something.
Very few traders want to admit that much of their beginning successis  due  completely  to  luck.  But  the  fact  of  the  matter  is  if  you  did knowwhat you were doing or had really found the perfect system, you wouldhave  a  consistent  positive  result  no  matter  what  the  market  conditionsare. Some people are better at this game than others, and their success
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is  the  result  of  a  programmed  and  proactive  methodology  involvingevery possible advantage a trader can ﬁnd that can be applied with ﬂaw-less discipline.
To  accumulate  consistent  and  signiﬁcant  proﬁtability  requires  doingsome  things  that  at  ﬁrst  may  not  seem  valuable.  But  true  professionaltraders will tell you that getting to the point of solid success that can beconsistently duplicated in any market requires perfect application of skilland knowledge.
So where do you get the knowledge and how do you acquire the skill?In this part of the book, we are discussing the rules for letting proﬁtsrun. Most traders feel that a proper discussion of letting proﬁts run wouldbe  market-related  and  include  lots  of  details  on  stop-loss  placement,adding to open positions, expanding time frames, and so forth. But in myview, the most signiﬁcant part of getting more money out of your winningtrades is to know exactly how you created them and then duplicate thatsuccess more often. If you do not know exactly how you created a win-ning trade and then know exactly how you can duplicate that winning be-havior  again  and  again,  your  gains  are  at  best  limited  or,  at  worst,completely due to luck. You must know what you are doing right and whatyou  can  improve.  This  is  more  than  a  vague  agreement  you  have  withyourself; this is a matter of getting data. The pathway to more consistentproﬁts is record keeping.Why record keeping?Think  of  a  book  that  you  were  required  to  read  during  your  collegeyears.  No  matter  what  your  initial  response  to  your  course  load  or  evenyour particular interest in your course work, you were not going to pass anycourse unless you absorbed the material required by your teacher and coulddemonstrate  to  his  satisfaction  that  you  had  that  knowledge  inside  yourhead. You were required to read that book, make critical distinctions aboutthe point the author was trying to make, and then you would be given a test;and if you failed the test you got no credit for the course. That is a fact.
In the world of the markets the process is really not materially dif-ferent. You need certain knowledge and if you can’t pass the test (tradesuccessfully),  you  get  no  credit  for  the  course  (you  don’t  make  anymoney).  To  make  things  a  bit  more  complicated,  you  have  probablyguessed that there is a book or two you will need to read to acquire theknowledge  you  need  to  pass  the  test.  The  twist  is  that  you write  thebook you need to read.
Record keeping is your most important asset in your quest to masterthe skill of letting proﬁts run. By compiling a complete and accurate writtenrecord  of  your  personal  trade  approach,  an  accurate  accounting  of  yourmental and emotional state, and the actual record of how well you are fol-lowing your trade system and your trade plan, you create a huge database
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of information you can now use to learn from your own actions what youare doing that works and what you are doing that needs to be improved oreven eliminated from your behavior. By critically reviewing things like yourrecords of execution for entry and exit, when you made a change in yourposition, trades you didn’t take, your notes about your thinking, and so on,you have the hard data required for you to ascertain what you were doingand  what  you  were  not  doing.  Your  records  are  a  factual  accounting  ofwhat happened, leading to the results you now have. You can see by studyexactly how you created a winner or loser at a particular date and time. Youcan see similarities and inadequacies. You can understand parts of your ac-tions and how easy it might be to change some behavior that usually leadsto a loss or cuts a proﬁt short. In short, you have the data you need to criti-cally  examine  in  order  to  pass  the  test  required  to  receive  credit  for  theclass—to pull the most money out of the market.
The true and lasting beneﬁt of accurate record keeping is the ability toobserve from the outside your behavior as it actually is when you trade.As you compile more and more data about your actual behavior and seeclearly how that differs from your desired behavior, you create a source ofinformation  that  can  assist  you  in  modifying your  behavior.  In  the  ﬁnalanalysis, your actual behavior is what creates your actual results. If youare willing to admit that it is your behavior that creates a larger loss, cutsa  proﬁt  short,  hesitates  at  the  best  entry  or  exit  point,  then  you  have  achoice to modify your behavior and increase your probability of success.You have the ability to see clearly where in your behavior you are doingthings that lead to losses and where in your behavior you are cutting yourwinners short. After that point you can now create rules to modify yourbehavior and those rules are the same ones we discuss here, with one im-portant distinction: You now know where the problem is for you person-ally and you now know you can ﬁx it.
In my view, accurate record keeping is not as simple as “writing every-thing down.” I think you will achieve more lasting success as a trader ifyou  know  what  you  need  to  keep  records  of  and  exactly  what  you  arelooking for inside that data. Gathering hard data in the arena of trading isboth an inner and outer process. You need to accurately record all