Gold  comes  quickly  to  the  one  who  does  not  hesi-tate to save one coin in ten.
—First of the Five Laws of Gold from the book
The Richest Man in Babylon
I n  the  book  The  Richest  Man  in  Babylon,  by  George  S.  Clason  (New
York: Dutton, 1989), the story is told of how a young man wishing tobecome  rich  learns  the  ﬁve  laws  of  gold.  All  ﬁve  laws  are  incrediblywise and simple; I am amazed that people are still poor with this kind ofknowledge available. The ﬁrst law is the cornerstone to wealth accumula-tion and this one law in and of itself will lead to wealth even if you don’tfollow the other laws.
In  the  story,  the  rich  merchant  teaching  the  young  man  tells  howthe source or size of a man’s income is not important to building wealth;it is only important that a part of that income be regularly set aside andput to work. I can tell you from personal experience that my entire trad-ing  changed  for  the  better  when  I  applied  this  rule  to  my  trading  ac-counts.  There  is  something  about  obeying  the  tried-and-true  laws  ofwealth  and  money  that  make  the  issue  of  trading  as  the  source  ofwealth less important.
You might get rich from trading, but you don’t have to if you followcertain timeless principles while you earn proﬁts of any size from yourtrading. It is a mistake to think that because the markets have unlim-ited proﬁt potential you  personally will accumulate unlimited proﬁts.It  is  better  to  accept  the  possibility  that  you  will  earn  a  very  nice  in-come or a nice piece of the pie; but what you do with the accumulated
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proﬁts  you  have  achieved  is  much  more  signiﬁcant  for  your  overallsuccess.
Rather than spend a lot of time on the basics of wealth accumulation, Iam  going  to  assume  that  your  intention  with  this  book  is  to  get  a  betteredge for your trading. Part of that edge is creating trading rules that willwork for you. If you look closely at the underlying psychology behind win-ning  trading  rules,  there  is  a  subtle,  implied  consciousness  that  they  allseem  to  point  to.  That  consciousness  is  nonattachment.  All  winningtraders have as part of their market presence or daily discipline an awak-ened knowledge that pretty much anything can happen at any moment. Ifthat  results  in  an  adverse  move  to  their  market  position,  they  will  ruth-lessly liquidate. If something unexpected happens that pushes a trade fur-ther in proﬁts, they might aggressively add to the position. When a trade isnot performing as anticipated, they will liquidate or lighten up. Basically,most winning traders are not attached to any particular result, price area,proﬁt/loss ratio, or even any one market. Winning traders know that any-thing can and does happen, and that if they have any kind of internal com-mitment  to  any  part  of  the  trading  experience  they  have  a  higherprobability of losing money. That nonattachment extends to their accountbalance, and this is why regular withdrawals from your account are a veryhealthy thing for your trading.
This  rule  is  about  maintaining  a  strong  market  presence.  A  strongmarket presence should be thought of as a whole picture. There are a lotof things that can affect trading, and many of those things are not directlyrelated  to  the  markets  themselves.  For  example,  if  you  have  a  conﬂictwith your spouse and your emotions are in turmoil, it is very likely thatyou would incur a loss if you initiated a new position. Something from theoutside  world  is  pressing  in  on  your  inner  world.  Stop  and  think  abouthow people you know have made poor choices when they have been sub-ject to something that upset them. Trading is no different. To maintain astrong market presence you must reduce or eliminate outside pressures,as they might disrupt your thinking or emotions. Included in that pictureis the issue of what to do with money earned from trading.
Obviously, you need to be a net winning trader to follow this rule. Ifyou aren’t a net winning trader at this point, it is still a good idea to con-sider removing money from your account from time to time. Money is a vi-tal  and  necessary  part  of  our  day-to-day  lives,  and  as  such,  it  should  bemoved around occasionally as our world changes. The surest way to gobroke is to put your money in one place and leave it there forever. Moneyneeds  to  be  used  to  be  valuable.  Opportunities  change,  people  change,things that were great investments in the past are no longer good today;money works hardest for you when you are moving it around to take ad-vantage of the changes around you.
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If you take the point of view that most winning traders do, you will ﬁndyour trading improves when your trading plan includes withdrawing fundson a regular basis. You really don’t need a huge chunk of money in yourtrading  account  to  exploit  market  inequalities.  Most  of  us  can  focus  ononly so many markets at one time anyway, so having gains pile up and justsit there is pointless. I know that many traders take the point of view thatmore cash in their account means they can trade larger. You might be sur-prised to learn that most long-term successful traders don’t load up. Mostsuccessful traders are very careful about increasing their base trading size.Instead, when their account balance reaches a certain number, they simplywithdraw  their  gains.  Most  do  it  as  a  measure  of  self-protection;  theyworked very hard for those gains and don’t want to risk giving it back.
These traders also know, usually from past experience, that increas-ing their trade size has resulted in a larger ebb and ﬂow to their balance.Many  simply  can’t  emotionally  negotiate  that  big  of  a  changing  balanceday-to-day. These traders are content to trade a certain size and do it verywell.  Withdrawing  money  regularly  prevents  the  temptation  to  changesomething that is obviously working for them.
Additionally, what are we doing this for, anyway? Isn’t the whole pointof trading to get rich? I know it is for me. I think whatever trading repre-sents for you personally, somewhere in that point of view is the issue ofwhat to do with the money. Many traders make the mistake of having noreal ﬁnancial goal to work toward. Goal setting is an important method tomonitor  actual  progress  on  improving  your  personal  ﬁnancial  position.Assuming  you  have  some  ﬁnancial  goals  you  are  working  toward,  don’tmake the mistake of thinking you will attain them all at once when yourtrading  balance  reaches  a  certain  point.  It  is  wiser  to  break  those  goalsdown into mileposts and make a contribution toward them on a regularbasis as your trading account grows.
For example, I have a friend who withdraws a certain amount of hisgains every quarter and puts them in bank certiﬁcates of deposit. He doesn’tcare  about  the  interest  that  is  paid;  he  does  this  so  that  he  can’t  get  hishands on the money easily or lose it quickly from overtrading (which hehas a tendency to do). He lives in a modest apartment and he is looking toput  50%  down  on  a  condominium.  This  particular  trader  has  blown  outmore than once, and his rules now include, “Once I have a certain gain, itgoes  in  the  bank  toward  owning  a  home.”  When  this  trader  withdrawsmoney, he is validating his sense of purpose and progress. He feels goodabout working toward ﬁnancial independence and security as he deﬁnesit. He is happier and more focused, which leads to a better market pres-ence. Better market presence, better trade results—they go hand in hand.Withdrawing  money  and  putting  it  somewhere  is  only  part  of  thestory. I think you will maintain a much better market focus if you also take
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a portion of your gains and do something that is personally very reward-ing  for  you.  When  we  as  traders  have  invested  a  year  of  our  lives  andmaintained a sharp edge during that time, sacriﬁced things to make a niceproﬁt over time, we owe it to ourselves to reward ourselves in some waythat is deeply satisfying. There is a very powerful sense of satisfaction thatcomes when we stop to enjoy the fruits of our labors and invest in our per-sonal happiness. I don’t think it really matters what form this takes, justthat we do it for ourselves regularly.
I think this needs to be done no matter what level you are at in yourtrader development. If you are trading a $2,000 balance and earn a $500gain during the quarter, I think you should take $100 and buy yourself din-ner or something. I think it is crucial for us as traders to invest back intoourselves  when  we  are  achieving  the  success  we  have;  God  knows  wehave earned it. Trading can be a brutal experience, and when we are onthe winning side, we should enjoy that success a bit. Of course, it shouldgo without saying that spending every dollar earned from the markets isnot a good idea. You need to ﬁnd a balance between enjoying your successand saving.
In the ﬁnal analysis, the rule “Withdraw equity regularly” is about theprocess of non-attachment to the markets. It is a daily battle for many ofus  to  hold  rather  loosely  to  our  trades  and  their  results.  When  you  holdloosely to your account balance as well, I think you are completing the bigpicture of what the markets ultimately mean to you personally. How youchoose to deﬁne ﬁnancial freedom is up to you. For me, just knowing thatI have complete control of my ﬁnances and I don’t answer to anyone is ahuge  part  of  it.  I  really  don’t  care  anymore  about  material  things  like  Iused to. I take money from my accounts regularly and make secure invest-ments, I support a few charities, and I enjoy a lot of fun stuff. To me that isfreedom. I don’t think I could maintain that sense of freedom or daily bal-ance if I had a huge cash balance in my trading accounts going back to theday I started. What good does that do?
Your trading results when they are cash credits must mean somethingto you personally. Take that cash and use it; move it around and increaseyour  opportunity  base.  Make  a  few  long-term  secure  investments,  buy  avacation  home,  take  your  spouse  to  Europe  for  a  month;  do  somethingpositive with those gains and you will be a sharper trader for it.
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RULE #23
Be aContrarian
Buy when there is blood in the streets . . .
—J. P. Morgan
Every  trader  has  most  likely  had  the  experience  of  planning  out  a
trade, waiting for the point he feels is the right price/time relation-ship, executing, and then seeing the market go the other way almostinstantly. In maybe only a few seconds the market has taken a large chunkof equity away. If this has happened to you, you know the feeling of confu-sion  and  sometimes  anger  that  results—all  that  preparation  and  workgone out the window.
Many  traders  attempt  to  analyze  the  result  and  look  for  a  way  theycould have seen that situation coming ahead of time. Other traders try toﬁgure out how they could have seen the other side and put the oppositetrade out instead of their ﬁrst choice. In my view, all of these responses tothe result are leading to worse trader performance. Analysis of the marketcan only go so far to begin with and the fact is, the loss most likely camebecause  you  were  following  the  crowd.  True,  you  may  not  have  knownyou were following the crowd at the time but that is what contrary think-ing is all about.
Many  ﬁne  books  have  been  written  on  crowd  behavior.  I  have  in-cluded a few titles in the Recommended Reading section of this book. Idon’t  think  we  need  to  go  deeply  into  the  psychology  of  crowds  in  thisshort rule, but I do think it is worth noting that all markets are crowds. Asa trader looking to build a strong market presence, you really don’t need
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to become an expert on crowd behavior. You only need to know what thecrowd behavior is most likely to be at some point.
What motivates the crowd? I have spent a lot of time getting my think-ing around the concept of markets as a crowd, and I think I can say withsome certainty that a market is in reality nothing more than an expressionof  three  basic  emotions:  fear,  greed,  and  hope.  The  other  things  thattraders  feel  compelled  to  focus  on  as  a  support  system  to  create  conﬁ-dence all boil down to a reason to hope, a reason to get paid, and a reasonto pursue a proﬁt with less fear. But the underlying emotional structure ofthe  market  is  based  on  the  need  to  avoid  pain  and  the  desire  to  makemoney.  This  is  why  traders  are  tempted  to  hope  a  market  comes  backwhen they are holding losses, why they hope a market continues furthertheir way, why they get out if the market starts taking away an open-tradeproﬁt, why they hesitate to do the right thing at the right time, and all theother various behaviors that increase probabilities of net losses. The bot-tom  line  to  all  of  this  is  trader  behavior,  and  that  behavior  is  driven  bythese three emotions.
Net winning traders still have these emotions, but they have one thingthe losing trader does not: a deeper understanding of the crowd they par-ticipate in. Net winning traders also know that their behavior must be dif-ferent  from  the  crowd’s  behavior.  This  difference  in  behavior  is  theessential part of contrary thinking.
Almost  all  winning  traders  have  controls  on  their  behavior.  That  iswhat this book is really all about: giving traders a clearer understanding ofwhere they need to focus their thinking and behavior. Creating your per-sonal daily trade rules comes from an adequate understanding of the psy-chology  you  need  in  order  to  achieve  net  winning  performance.  Netwinning  traders  experience  all  the  same  emotions  as  losing  traders,  buttheir behavior controls prevent those emotions from becoming losing be-haviors. One of the absolute best controls you can develop is the propen-sity to stop thinking like the market crowd to begin with.
Most discussions of contrary thinking seem to focus more on learningto be bullish when the market is bearish, or vice versa. Actually, that is auseful  tool,  but  I  am  not  going  to  have  that  discussion.  I  am  suggestingthat  contrary  thinking  is  more  about  understanding  that  the  crowd  isthinking along certain lines and you need to think along a different line.Sometimes  that  means  you  need  to  be  looking  at  the  bullish  scenariowhen  the  market  is  declining;  sometimes  it  means  you  need  to  fade  thenews; sometimes you need to stay away for a time.
The crowd behavior will almost always be driven by fear, greed, andhope, and those emotions are stimulated in the crowd by price action orthe  absence  of  price  action.  Remember,  the  prices  mean something  to
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each participant. When that meaning becomes an urge to action, a traderesults. For example, if a market is declining against someone’s open long,that means a trader is losing money. He wants to avoid that pain, so hewill either hope the market reverses or get out if he fears a further pricedecline. Once that urge gets strong enough, the trader will liquidate. Whatdoes that kind of behavior look like in the actual market price action?
In your day-to-day analysis of the market, you would do better if youlistened closely to the personal meanings you associate with price action.For example, most traders tend to use the word strong to attach meaningto a market rising in price. Weak describes a declining market. Now, if youlook closely at what you are doing when you attach meaning to a price di-rection, you have more clues as to how other traders, too, are most likelyobserving price action. In other words, the crowd believes the market isstrong when prices are rising. What do you do with a strong market? Youbuy it, of course; strong is good.
At some point in this strong market the available universe of potentialbuyers  will  have  come  to  that  same  conclusion  and  have  placed  them-selves at risk. They will have bought a position, correct? Now the marketfails to advance. The buyer is afraid the strong market will now weakenand the potential exists for a loss. This fear now drives the buyer to sell,creating  a  self-fulﬁlling  prophecy.  If  this  whole  dance  happens  withenough  participants  then  the  previously  strong  market  now  becomesweak and prices decline. The buyer has a loss—but the seller who let himin is the winner.
To be that winning seller is not as simple as being bearish when every-body is bullish; it’s more a process of knowing enough about average emo-tional thinking and how that will stimulate someone to do something. Inthe  markets,  you  are  looking  for  the  point  where  that  has  already  hap-pened. When the market has run out of buyers, it is physically impossiblefor  that  market  to  continue  to  advance—all  the  force  that  could  be  ex-erted  on  the  buy  side  has  already  happened.  All  it  takes  is  one  seller  tostart the ball rolling the other way.
But in either case, the market is neither strong nor weak; it is simply amachine, processing orders in one direction or the other. What you are at-tempting to do is take advantage of the changing net order ﬂow. That netorder  ﬂow  is  created  by  the  actions  of  each  crowd  participant.  As  eachcrowd participant comes to a conclusion and executes, the market is pre-set to go the other way sooner or later under some time frame; those initi-ating  orders  must  eventually  be  offset  with  a  liquidating  order  from  theother side. Contrary thinking is about understanding that the crowd is do-ing one thing from the net perspective every day and that they will have todo  the  other  thing  eventually,  maybe  in  a  time  frame  you  can  see  right
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now. In other words, once everybody has entered the market, they mustleave the market sooner or later. You as a successful trader are attemptingto be just ahead of that change in the net order ﬂow; most likely that willmean a buy order when everyone is selling, or a sell order when everyoneis buying. Contrary thinking is about being in the right place at the righttime to exploit the crowd thinking.
It is important to remember that most people can come to a conclu-sion that is fairly accurate. Accurate thinking is not the same thing as ac-curate  behavior.  Many  traders  with  only  average  understanding  offundamental  and  technical  considerations  can  call  a  market.  I  am  surethat you personally have come to the conclusion that a market was bull-ish or bearish, and that conclusion proved over time to be the right one.Calling a market is not the hard part, in my opinion; the hard part is buy-ing  or  selling  at  the  best  times  to  capture  the  move.  I  am  certain  thatsome of my readers have been 100% correct on a market but didn’t makethe potential gain for their account, or even had losses. The issue there isnot the understanding of market potential; it is the lack of understandingregarding crowd behavior.
Most traders are not very skilled in reading the crowd well enough toknow when the market is due to move the other way against the mostlyright market call. In other words, wait for the correction or conﬁrmationbefore entering the position; and that is often at the point when the earlytrader is liquidating with an early loss. Just knowing the underlying mar-ket  potential  is  not  enough  to  get  in  a  winning  position.  You  must  alsothink  differently  about  the  same  conclusion  the  average  market  partici-pant has come to. If everyone is bullish and the market is indeed rising,everyone is thinking the same thing: Get long, buy a pullback. But therewill be a certain percent of bullish traders who will be washed out on thatcorrection for various reasons and actually have a loss, even though theywere right about the market. You want to be a buyer from those traderswhen they sell off their poorly set longs.
Knowing  that  potential  going  in  every  day  is  how  you  exploit  thecrowd’s behavior, and that is contrary thinking. Contrary thinking is notcoming to a conclusion that is different from other traders. It is not beingbullish when everyone is bearish. Contrary thinking is about understand-ing  the  game  so  well  that  you  know  when  it  is  time  to  go  against  thecrowd. Your thinking process starts in a different place and you are notlooking  to  be  a  bull  or  a  bear  in  any  market.  You  are  attempting  to  out-think a crowd that does very little thinking in the ﬁrst place. Sometimesthat means you buy an upside breakout because you know the short hashis stops up there; sometimes you sell into a rally because you know thecrowd is buying the news; sometimes you stand aside because you knowthe  bulls  and  bears  are  whipsawing  themselves  and  you  need  to  let  the
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dust  settle.  Contrary  thinking  is  more  about  thinking  beyond emotionalbehavior,  and  then  having  the  courage  to  exploit  it  without  making  thesame mistake the crowd is making. In other words, you execute againstthe crowd when the time is right, and then you don’t panic, scare yourselfout, cut a proﬁt short, or hope the market comes back if you are losing.You control your actions fully by discipline, but those actions come from acompletely other kind of conﬁdence.
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RULE #24
All MarketsAre Bearish
Pssssttt  . . .  want  to  know  a  secret?  There  is  nosuch thing as a bull market!
—Attributed to Jesse Livermore, 
1921, a raging bear
K nowledge is power. In the trading environment there are different
kinds of knowledge, and some knowledge is more powerful thanothers.  The  most  powerful  kind  of  knowledge  remains  knowingthe  net  order  ﬂow;  everything  else  is  more  along  the  lines  of  helpful information.
During  the  process  of  gaining  the  knowledge  I  needed  in  order  toknow which knowledge is really useful, I had to make a lot of observa-tions. Those observations were of people, people’s behavior, trade fun-damentals,  technical  study,  and  general  market  conditions.  Over  theyears, I have seen a lot of strange things as a full-time trader. I supposethere are hundreds of stories I could tell you about blowouts, blunders,quick  fortunes  made  or  lost,  unbelievable  risks  taken  or  ignored—allsorts of things. I have had my share of wild rides, and as any seasonedtrader  can  tell  you,  any  trader’s  results  are  100%  personal.  We  createthem  and  no  one  else  is  responsible  for  them.  We  hope  for  consistentpositive  results,  but  until  we  discover  our  personal  winning  trademethod, we will have losses.
As we get more educated, as we get the knowledge we need, we dis-cover  how  many  of  our  losses  were  avoidable.  As  the  stories  that  areour  personal  trade  results  get  created,  and  as  we  develop  better  skill,
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we realize how many of our negative results are self-created. There arecountless  different  ways  to  lose  money.  Of  course,  the  absolute  worstkind of loss is the one where we simply did not do our homework. Forwhatever reason, we chose a trade, executed, and had a loss, but thatloss was completely avoidable. If we had just known what we needed toknow, we might have avoided that loss.
Part of getting that practical kind of knowledge is a very ﬁrm under-standing of basic market structure. Basic market structure is like a play-ing ﬁeld. To use a sports illustration, a football ﬁeld is where the game isplayed.  The  game  is  dynamic  and  subject  to  rules  that  both  sides  mustplay by, but the playing ﬁeld itself provides the basic structure.
One of the most important pieces of information you can possess aspart  of  your  trading  knowledge  is  the  fact  that  bull  markets  are  aberra-tions. All markets are inherently bearish. If you want to reduce the num-ber  of  trade  conclusions  you  come  to  that  are  losing  conclusions,  youneed to understand that coming to a bullish conclusion needs a lot of sup-port. A bullish conclusion has a certain degree of extra risk. You would dobetter over the life of your trading if you started each hypothesis from thepoint of view that the market in question will be under net selling pressurein  most  cases.  A  bullish  market  conclusion  or  trade  hypothesis  needs  atremendous amount of veriﬁcation and support because in most cases thebullish potential cannot overcome net selling pressure long enough for aconsistent bull market to develop. Just knowing that all markets are bear-ish will save you a lot of time and money, because there will never be asmany quality long trades as there are short trades. You will prevent a lot ofneedless losses in your account when you are suspicious of bullish con-clusions in the ﬁrst place.
I need to make sure we are all on the same page as far as an under-standing  of  the  maxim  “All  markets  are  bearish.”  For  the  purpose  oftrading, equities could be excluded from this assumption because equi-ties are not a zero-sum transaction for the most part. I think of equitiesas a game of musical chairs, whereas futures, options, and FOREX are atug of war. Equities can pass from one owner to another regardless ofwhether  the  share  drops  in  value,  pays  a  dividend,  is  repurchased  bythe issuer, gets absorbed by another company, and so on. Equities willoften be bought and held for decades. There are a lot of reasons to ownequities  besides  the  net  change  in  the  share  price.  A  bull  market  instocks happens when more money is pumped into the market, not whenshorts offset.
The zero-sum transaction market is a completely different animal. Ex-actly 50% of all contracts traded will be offset at a loss; there is no otherway for the market to function. Whoever holds the losing contract has aloss—even in a bull market there will be shorts that cover at a loss and
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longs that cover at a loss. But there is one important distinction that zero-sum markets have that no other market has: A certain part of the executedtrades will never be offset.
For the most part, zero-sum markets are comprised of two separateand distinct participants who have two very different, competing desires.They use the market for vastly different reasons. These two participantsare the speculator and the hedger. For the sake of illustration, let’s use asimple consumable commodity to document the net bearish nature of thezero-sum market. Every year, a new crop of corn is planted and harvested.Corn is consumed every day and eventually, if no new corn was plantedand harvested, we would run out of corn. For the sake of this illustration Iwant you to set aside all the unique particulars you know about the Cornmarket. Forget all about the fundamentals, technicals, oscillators or indi-cators, historical prices of Corn—everything. The only thing I want you tofocus  on  is  the  closed  universe  of  actual  executed  trades  and  what  thatmeans from a net perspective.
The hedger is the individual who grows Corn and sells it, probably afarmer.  The  purpose  of  the  Corn  futures  market—the  only  reason  it  ex-ists—is for this farmer to exploit a high price at which he can sell his corn,often before he even grows it. As a farmer, if I am uncertain that the cur-rent high price will still be around when it comes time to harvest and sellthe