and over again. If we fail to keep a proper stop and wind up with a much bigger stop than we should, then we paid too much for the lesson.However, unlike the example with college, we are given the opportunity to assign the price to the education, and we have deliberately chosen topay the higher price! Was it a smart decision?This is the first element of our self-tuning:Do not pay more than we can afford!The market is an eternal educator, but it’s kind enough to let us payas much as we choose to. Education is on sale when the stock hits our predetermined stop level. It won’t be on sale in a minute, so why should wewait?The second element of our self-tuning is not thinking of money whenwe’re in a trade. We shouldn’t count what we lose or gain with each tick.The market doesn’t care if we lose or how much we lose. Focusing onmoney just takes us farther from emotional balance while clouding ourjudgment. Monitor what the market does, not how our account is affected.
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PART ONE A Trader’s Journey
The subject of our job is market movement.We have to respond to market movement. The third element of ourself-tuning is our perception of ourself when we take the loss. If we come tothe market with the notion that, in order to win, we have to know what themarket does every minute or hour, then how will we perceive ourself when themarket does the opposite of what we expect? As a fool? As a loser?Nobody wants to be a fool or a loser. That’s where our ego takes overimmediately. It tries to save us from this unpleasant feeling. The next stepnaturally will be to think, “I am not a loser. Those sellers are the losers. Thestock will reverse in a minute, and they will be crying. I will be celebrating.”See how the ego takes us farther from the territory, making us believeour map is correct? There is a way to avoid this. We need to change theoriginal belief with which we approach the market. Let’s look at our thinking process if we come to the market with the idea that, “I don’t have toknow what the market does next.” What I do have to know is “What will Ido in any scenario that the market offers?”By thinking like this:1. We have already accepted and assumed the stop-loss possibility. It nolonger comes as an unpleasant surprise for us.2. We have admitted from the very beginning that the market is bigger thanwe are and cannot be controlled or predicted by us. With this understanding, our ego will be quiet because nothing triggers it.3. We don’t feel like a fool when the market goes against us. Why wouldwe feel like that if we never thought we were able to outsmart the market in the first place?4. We don’t feel like a loser when the market goes against us. Why shouldwe feel like that if we never thought that a winner has to be right everytime?We can see how changing our original belief reverses the way we feeland act. Realize and accept the fact that the market is an ocean. Swim withit; use its current, its ebb, and its flow. But don’t think that we can changethe direction of the current or that we can know all the currents that exist.When we find that the current is taking us in an undesirable direction, weswim out of it and look for another current, instead of waiting for it toreverse.The next very important element in our self-tuning is our perceptionof our trading as a whole. At the end of the day many great active traderscan’t list the stocks they played, whereas newbies remember each detail ofeach trade for weeks and months to come. Newer traders perceive eachtrade as unique and outstanding. If the trade fails, it feels like a disaster. Ifthe trade works out, it feels like a huge victory.
CHAPTER 2 Turnaround
27
A stop loss limits the pullbacks!When such significance is assigned to each trade, it becomes hard forthe trader to accept the stop. Accept that our account cannot go up witheach trade taken, just as no stock goes straight up. All have their retreats.The trend is what matters. If our account is on an uptrend, what else do weneed? We need one more thing. We need our pullbacks, or drawdowns, tobe as shallow as possible. But that’s exactly what a stop loss does.If we can look at our trading as a whole instead of looking at eachtrade separately, then we will feel compelled to apply a stop loss in orderto limit the retreat.Compare the following two patterns:0.50, 0.65, −0.25, 0.35, −0.10, 1.25, −0.15. This is an uptrend withthree shallow pullbacks stopped early.0.50, 0.60, −1, 0.30, −1.50, 1.10, −1. This is not an uptrend. It’s anerratic, supervolatile, jumping-around centerline. We don’t want to playany stock that moves this way, and we don’t want our account to look likethis.We need deep, tight self-control that will allow us to apply stop losseswith no hesitation. There are certain tricks we can use in order to correctour behavior. In an interview with a great trader, I read a confession of awoman who had incredible discipline in applying the stop. When askedhow she managed to achieve it, she said, “I am a very religious person. Ibelieve God doesn’t want me to lose money. I might upset Him if I do. Iapply a tight stop loss and I am in accordance with what I believe in.”Define the major asset to protect by stop loss and protectthis asset religiously.Find the motivation, the trigger, the valuable asset that can’t be jeopardized. It might be something different for each of us. For example, somemay find it helpful to think of our family for whom we want to prosper. Astop loss is our way to protect the prosperity of our family. It could be thecar of our dreams. A stop loss takes us closer to the amount of money weneed in order to buy it. It could be our mortgage, or any number of things.Be creative with this mindset and find all the tricks that are possibleto make it a loss-cutting machine. The market will reward us immensely.
COMING AROUND THE MOUNTAINThis was a turning point for me. I learned plenty of lessons the hard way,and I had the distinct feeling that I was turning the corner in my trading.
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PART ONE A Trader’s Journey
During the summer of 1998, my account made two trips from $10,000 to$17,000 and right back down. It looked like I almost had it right. Thensomething important got away from me again.Both times, the movements up and down were slow, with no bigwins or losses. I knew I could make it. I just needed to stop thosedrawbacks.When my account reached $17,000 for the third time, a point thatwas a ceiling for me twice, I stopped trading for a week. I needed to breakthe pattern, to get rid of the feeling that I faced some monetary barrier. AllI did during that week was observe and rest. It was an attempt to forgetthat amount that I couldn’t get past. I needed to stop thinking of moneyand just concentrate on trading itself. It worked. The next week I brokethis barrier and made another thousand.This was an exciting and encouraging moment. I began to feel thatall my hard work and all the realizations about both the market and myselffinally started paying off. I did everything I could to not let the excitementtake over and make my trading careless. In a few weeks of careful trading, small stops and slow advancing, I finally saw my trading accountreaching over $20,000. At the moment when it broke over $21,000, I didwhat I dreamed of doing for months. I withdrew some money from thetrading account, leaving $20,000 in it. From then on, I allowed my trading account to grow slowly while rewarding myself with some money ona regular basis.
CHAPTER 3
The First Profitable YearCharting Success
I
decided to draw a chart of my trading account movement. The purposewas to create a certain psychological environment for myself. I realizedthat when I failed to break $17,000 twice, I perceived this number as abarrier. I have no idea why $17,000 was this barrier. I realized that on achart of my account movement it looked like a resistance that needed tobe broken. I wanted this chart to look like uptrending stock in which forany setback the price bounces to the upside off a lower support. In orderto create this feeling of the upside from where I was and to limit the drawbacks, I started to withdraw the money from my trading account as soonas it would hit the upper envelope of the ascending channel. This trickallowed me to maintain the feeling of an uptrend. It might seem esotericand artificial, but it worked, and I was happy with anything that did. Sincetrading is a mental game to a great degree, it becomes necessary to usemental tricks. It has been said often that in trading we are our own worstenemies. So it seems only logical to me that, in order to win, we need tofind the way to defeat this internal foe. I don’t believe it could be done bysimply commanding oneself to do the right thing and to stop doing thewrong thing. If it was that simple, nobody would have any troubles winning in the markets.If I hit the lower support and went lower by just $100, I wouldimmediately take a day off and regroup. If, on the opposite side, I wasbreaking a higher envelope, then I was pressing harder and trading moreaggressively. That was the right way to manage the risk: slowing downand decreasing activity when I was experiencing a setback and pushingharder when I was hot. This helped me to keep setbacks very shallow. I
29
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PART ONE A Trader’s Journey
30
kept share size to 1000 or less, and stops mostly around $0.25 during thisphase of my trading.
USING A TRADING JOURNALCharting my account movement was not the only tool I used to monitormy trading. I also started tracking my trading results in a journal, whichhelped me spot and prevent problems in the early stages. This journalserved me as a kind of mirror in which I could see where my tradingmindset deviated from the right direction. I often hear people advisingothers to keep a trading journal. Over the years, I have seen many versions of them. One aspect of many of them, which I’ve found quitequestionable, is recommendations to write down the trader’s feelingsand thoughts at the moment of trade initiation and during its development. I don’t think this is a good idea. Here is why. A trading journal fillstwo major purposes. The first is to help the trader develop a collection ofstatistics. This is the obvious purpose of a journal since these statisticshelp traders see which setups work consistently and where the systemfails.The other purpose is to determine by analyzing these trading statistics what is happening in a trader’s mind. However, most mental changesand developments occur subconsciously. It’s hardly something we realizeand recognize while we’re trading. Any attempt to write this kind of thingdown will most likely lock us into the mindset of “what we think wethink.” For example, if problems with our mindset lie below the consciouslevel, then how would writing down these things help us determine wherewe go wrong? We would most likely write down not what really happenedin our mind but merely repeat that same erroneous thinking process thattook us nowhere during the trade. Instead, my approach led to an objective take on my reactions and allowed me to analyze my weaknesses. Thisjournal served as a window into the inner world of a trader’s mind.I tracked:Number of trades per dayNumber of winners Number of losers Winners/losers ratio Average winning trade size in terms of points Average losing trade size in terms of points Number of points per day
CHAPTER 3 The First Profitable Year
31
Number of Trades per DayKeeping track of the number of trades per day may seem simple and not tooinformative. But look at it from this point of view. How many trades do youdo in a winning day? In a losing day? The rule says to act more aggressivelywhen you’re on a winning streak and to decrease activity when you’re on alosing streak. Many traders do exactly the opposite. When losing, they try toget it back, to take revenge. And the result is usually not good. In this situation our trades may depend on our wishes rather than on real opportunities.
Winners/Losers RatioIf a trader sees the winners/losers ratio below 50 percent, something iswrong, assuming that the reward-to-risk scenario doesn’t allow for trading under 50 percent. My system won’t allow the ratio to be under 50 percent. It tells me that I am probably overtrading, trying to squeezesomething out of a juiceless trade. Also, my understanding of marketdynamics and patterns is not quite right, and it’s time to go back to papertrading. A ratio of 50 percent or higher seems fine, as long as winners arebigger than losers.
Average Winner and Average LoserThe average winner and the average loser show us whether we have followed the basic rule of cut our losers quickly and let our profits run. Eachtrader has a level of comfort, with respect to stops, depending on his orher risk tolerance, the kind of stocks played, expectations, and so on.When we look at our average loser for a month, we can see whether wemanaged to keep our stops as small as we wanted. If an average winner istoo small, it tells us that we do many scalps or have problems staying in awinning trade. Different combinations of these statistics give us differentangles. For example, a big number of trades combined with a low winners/losers ratio means that many low-percentage trades were picked.Table 3.1 illustrates an example of such a journal with analysis. It istaken from a real week of trading. I selected a volatile, losing week(before commissions), to show how I acted to spot the problem using thenumbers shown.“Trades” in this table refers to round-trips (trades bought and sold).Flat trades are excluded. I purposely ignored the impact of commissions;I wanted to see what was going on in my mind, not just calculate my monetary achievements.
PART ONE A Trader’s Journey
32
YABLE 3.1Traing StatisticNo. of
No. of
No. of
W/L
Average
Average
trades
winners
losers
ratio
winners*
losers*
Total*
Mon.
12
8
(3)
2.7
.35
(.173)
2.28
Tues.Wed.
1511
82
(6)(6)
1.30.3
.25.23
(.237)(.273)
0.58(2.10)
Thurs.
18
8
(8)
1
.156
(.22)
(0.512)
Fri.
10
6
(2)
3
.23
(.156)
1.068
Total
66
32
(25)
1.3
1.316
* At the time the trades occurred, the numbers were in fractions. I converted them tocents so that readers who are accustomed to decimals could understand thenumbers easily.
Monday: As you can see Monday was a very nice day. There was a goodpercentage of winners (67 percent), and a not bad winner/loser ratio(2.7/1, which is fairly decent for a scalper).Tuesday: Tuesday was not that great. The percentage of winners droppedto 53 percent, and the ratio went almost flat. Taking commissions intoaccount, Tuesday was a slightly losing day, most likely resulting fromoverconfidence after a very nice start to the week. The number of tradeswent up too—a possible sign of reckless picking.Wednesday: Wednesday was a total disaster. Over 50 percent of mytrades were losers, and the losing trades averaged more than the winningones. Apparently I was trying to press hard to resume my winning streakthat was interrupted by a sluggish Tuesday. Losses were not cut effectively. Did I try to hold despite the market telling me to get out?Thursday: Whoa! Look at this sucker’s reaction to a losing day! The number of trades is way up—revenge trading, pushing hard instead of becoming less aggressive while on a losing streak. There are an equal number oflosers and winners—churning, trying to jump on everything that moveswith fairly random results. Winners are small—I got scared and startedtaking any profits, just to win? Losers are still bigger than winners—misplaced hope, “Maybe it’s going back to my entry.”Friday: Friday is somewhat better. I evidently attempted to pull myselftogether. I didn’t trade aggressively—lowest number of trades for theweek. I was more selective with my plays, which could constitute a notbad day but could not save the week. I made 66 trades, 132 tickets plus
CHAPTER 3 The First Profitable Year
33
some unavoidable partial fills, $20 per ticket (usual commissions at thattime), down almost $1500 for the week.As this kind of analysis built up, I was able to see the problem as itjust appeared. Familiar patterns of my behavior became visible to me atearly stages thanks to the tables I created. For instance, I already knewthat I tended to overtrade after a losing day. I had to keep myself fromdoing that by effectively improving my reactions. I could track my reactions when I was on a winning streak and spot the moment when I wasgetting too reckless. All this monitoring gave me a good look withinmyself. As a result, I became constantly aware of my inner state and coulddiagnose a problem just in time to prevent it from getting worse.
USING YOUR CHART OF YOUR ACCOUNTLet’s take a deeper look at how to use the chart of your account. I usemine in many different ways. First I match the chart of my portfolio equityto the Nasdaq chart. If I see them going together, it may possibly meanthat the bull market works for me, and that my thoughts are not relevantto my success. There is a good chance that a bear market will take myportfolio down. You can see such a situation in Figure 3.1.As I viewed this situation, I decided to stay put and sharply decreasemy activity during a down market to reduce my drawbacks. I would alsoanalyze to determine whether I was fighting the market. For example, am
25002000
COMPX
1500Account100050001 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
FIGURE 3.1The comparison of market and account movements.
PART ONE A Trader’s Journey
34
4000350030002500
Sharp Spike, Time to Get CautiousSetback
20001500
Steady Growth
10005000
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
FIGURE 3.2A sharp spike usually precedes a setback.
I trying to go long no matter what, buying false breakouts while the trendis down? This could be the case if my account was drifting down at thesame time as the market drifted down. Therefore, I would need to adjustmy strategy and listen to the market more carefully.If I saw my account steadily moving up, I would become moreaggressive since I would realize that I was in tune with the market. But ifI saw sharp upward movement, an almost vertical line, I would start backing away to avoid or smooth out a setback that usually follows a sharpspike. My experience shows that this kind of spike rarely continues formore than 3 days in a row. (See Figure 3.2.)Another situation I faced frequently was that my portfolio equitywould reach a certain number and then inevitably drop, like a stock thatcannot penetrate the resistance level. This situation is illustrated in Figure3.3. It’s most likely some kind of psychological barrier. How do I dealwith it? A variety of ways are described in some of the books devoted totraders’ psychology. A solution might turn out to be simple (for instance,taking some amount of money out of the trading account when it reachesthat upper level again). This would allow me to trick my mind into thinking that my account was at a low envelope (800–850 in Figure 3.3)instead of an upper line (1200 in Figure 3.3), which presented resistance.This kind of analysis can give great insight into what’s happeningwithin us and serve as a troubleshooting of sorts. We will get back to thetroubleshooting theme later.My quest for a trading system resulted in a much more solidapproach than simply pure scalping. Even my scalps were not based ononly Level 2 strength, as in strong bids and thin offers. I started to get a
CHAPTER 3 The First Profitable Year
35
1400120010008006004002000
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21
FIGURE 3.3Account resistance caused by a psychological barrier.
good feel for what Jesse Livermore meant when he talked about smartmoney playing against the public and how to differentiate their footprints.Rereading old books devoted to this topic and careful market observationsled to a trading system that was becoming more and more clear for me. Iwas adding new principles to it, learning to read the volume hints. Theway prices changed and the pace of those changes were no longer a greatmystery. There were apparent clues on the tape.In many instances I was able to see stages of stock movement, suchas slow accumulation followed by an increased volume and a faster priceadvance. Then I saw when the public discovered the stock, and themovement was becoming almost hysterical. That was the moment whenall the shares that had been accumulated during the first stages weredumped into a volume and price explosion. I learned to take the positionduring the first stages when I could spot it and wait for the crowd to comein and take the shares off my hands. That was incredibly exciting. Insteadof blind wandering, I was now trading on the right side. I was not part ofthe crowd anymore, but I was using the crowd’s emotions.At the same time, scars from my big losses constantly reminded meabout the risk involved. I was avoiding overnight positions, and my riskwas strictly limited. I realized that such strict limitations were holding meback, but I could not afford any losses. Slow, steady growth was what Iwanted.In a few months, my trading account reached $25,000, and I was taking money out of it on a regular basis. By adding the amount I took out tothe amount I kept in, I was able to see that I had recouped my losses.
PART ONE A Trader’s Journey
36
IMAGINARY FRIENDS ARE IMPORTANT PEOPLE TOOIn early 1999, I incorporated one more trick into my mental tune-up. InChapter 2, I talked about how I taught myself to keep stops. I wrote theletter to myself as a teacher to student. I went farther now. I created amodel trader in my mind. I thought through all his traits as a trader. Hewas the master that I wanted to become. I was not the one who was trading; he was doing the trading. I was merely an observer, an admirer. Ican’t tell you what a huge help this trick was. It allowed me to staydetached emotionally because I was just an observer. In some cases Iwould give him final approval for a trade, after making sure that his tradematched my system criteria and wasn’t prompted by emotions.My model trader was cold-blooded, calm, and humorous in a cool,dry way. He was absolutely disciplined, and totally focused and relaxed atthe same time. So was I; it’s easy to relax when you are watching someone else trade. My tension went away completely once I started doing this.Trading became fun! There was no ego involved anymore. If the modelmade some stupid mistake, I just laughed at him. He knew he was beingwatched, and this made him cut his losses very quickly. I cannot tell youhow much this trick has helped me. It resolved plenty of problems I hadpreviously experienced with emotional control. Instead of attempting toget rid of my emotions (as if that were possible!), I found my way aroundthem: I detached myself from my emotions enough to not act under theirinfluence.Does this all sound crazy? Sure it does, but trading is a crazy business! It requires an unusual state of mind, so that unusual tricks arejustified.In October 1999 I finished the third year of my trading. My resultswere spectacular. I took $10,000 up to $70,000, keeping just $25,000 inmy account and withdrawing everything above that. That was a 700 percent annual return. At that time my immigration case was finalized, and Ibecame a Canadian resident. I felt more confident than ever. I knew thatmy success was not just luck. It was a careful approach and a valid trading system. And, most important of all, it was the correct trading mindset.The next year confirmed that as I took my account to over $200,000, stillkeeping the same amount of money for trading. Trading what I saw, notwhat I thought, was what I managed to do in my actual trading.
CHAPTER 4
Learning to Trade for a Living
Let’s take an in-depth look at learning to trade. This topic is the subject ofa completely separate chapter for two reasons. First, somehow many beginners feel that they can just jump in and start making money. Some thinkthey can learn trading in 2–3 months. Can you imagine any serious profession that could be learned in such amount of time? Trading is certainly notthe easiest of professions. In fact, it is the opposite: I have heard many people say that this is the toughest endeavor they have ever undertaken.The second reason is that before you start learning, you must knowwhat you must learn. Far too many traders think that in order to trade successfully, they need to learn about indicators. They believe that they onlyhave to find the “one that works” or some magic combination of them.Then they think they have the key to the bank. This is a big mistake. Thisapproach leads beginning traders to believe that there are secrets knownto the top traders, and, if they only could get ahold of those secrets, theycould make money easily. I am confident there are no magic bullets, nogreat secrets hidden from the trading masses. So in this chapter I discussdifferent aspects of the process of learning.I always find it interesting when some traders talk about their hugegains or profits, but never much about their losses. On the other hand,some traders like to tell horror stories. After all, what doesn’t kill youmakes you stronger! This is an interesting dichotomy, as trading is aboutprofits and losses, not just profits. It is easy to spot the worst traders in anycrowd; they are the ones who talk only about their profits. Successfultraders don’t have to prove anything to anyone and they are 100 percentresponsible for their own trading. They know that the successful tradeis the one that worked as planned, which means the knowledge needed37
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PART ONE A Trader’s Journey
38
for the trade was actually acquired already. It is the losing trade that carries the lesson to be learned. No matter which method you follow forlearning, the market will always be your main teacher—and its lessons areserved in the form of losses.
LEARN OR YOU ARE BANKRUPTI have met quite a few traders who have never even tried to learn. Theythought they could use stock-picking services or newsletters, and tradetheir picks without deep understanding. I don’t know any of them whocould make money consistently. Pure followers of stock pickers willnever be around long. Traders have to be their own leaders in order to survive. Furthermore, stock pickers rarely tell you how they pick stocks;they’d rather you just pay for their insight. Let’s face it, followers don’ttrade for a living. Followers exist for a while as they continue in theirlearning phase. But they have to emerge as leaders for themselves if theyare to be traders that are worth their salt. The only kind of stock-pickingservice I would recognize as valid would be the one where the leaderexplains the reasoning for the play so that the traders can follow it, checkif they are comfortable with it, make sure the risk is acceptable, and so on.In this case it’s not about following anymore. It’s a normal process oflearning in which a teacher shares knowledge and experience.Among the traders I have communicated with are a few who wentthrough the process of learning along with me. Problems they encounteredare quite typical and instructive. For example, one particular trader, awoman from Russia, was easily one of the most intelligent people I’veever come across. As intelligent as she was, she still experienced many ofthe same problems as I did when I was learning to trade. She took a bit ofa different route, however. She started with a trading outfit that taughttraders. She spent many months with this outfit to no avail. Much of heraccount was depleted, the same as mine was. For all I know, the systemoffered could be sound, but the method of teaching was missing much ofwhat trading is really about. No system offers profits to everyone. Somesystems don’t offer profits to anyone. This is another interesting aspect ofselling in America: “If I can’t make money using it, I can make moneyselling it.” Fortunately, I learned to trade without having to pay for something from someone that wasn’t proven reliable. I paid the market for myeducation instead, and what a great teacher it was! Relentless too.After a few months and a lot of capital spent, the woman began tolisten a bit more to what I was saying. After I began to take my profits togreat heights, I wanted to share with her some of the principles that had
CHAPTER 4 Learning to Trade for a Living
39
brought me my success. Some traders listened; some didn’t. Some evenwent so far as to dismiss me and my ideas. But, as a trader, I didn’t care.My account profits spoke for themselves. I don’t have to prove anythingto anyone who doesn’t care to accept what I say. I don’t need to fight withpeople to make them see my point.The woman’s intelligence helped bring her closer to trading reality.She and I would trade together almost every day from this point on. Shetold me of her trades and listened to my opinions of them. I wouldn’t somuch offer her a trading strategy as a deeper look into why the stockswere moving the way they did. I didn’t realize it at the time, but this waswhen I began to really refine my principles of trading. I began to applysome structure what it was that was working for me. Previously, theseprinciples were simply ideas that were distributed in an illogical mannerthroughout my head. Now, they began to take shape. So while she waslearning from me, I was progressing as well. It worked for both of us.Even more important, we often talked about the state of mind of a trader,and I tried to put into words everything I learned about tradingpsychology.Her trading account stopped taking wild rides up and down. Instead,her account grew steadily and slowly. She put her own spin on mymethod, and it worked well for her. I have seen this many times: The mostsuccessful students are those who find their own slant on the approachthey are being taught. They apply their personality to the system theystudy and produce their own version of the system. That’s their edge anda comfort zone for them.Eventually, we began talking openly about other traders. From thesesmall trade reviews, I began to see interesting parallels between me andthem. They were all going through the stages of learning curve that I hadjust gone through. They asked the same questions and experienced the samesitu