Gems of Jesse Livermore

The desire for constant action irrespective of underlying conditions is responsible for many losses in Wall Street even among the professionals, who feel that they must take home some money every day, as though they were working for regular wages.

I don’t know whether I make myself plain, but I never lose my temper over the stock market. I never argue with the tape. Getting sore at the market doesn’t get you anywhere.

Cognitive Biases That Affect Traders

Humans have weaknesses that hamper their trading capabilities. Many were developed in ancient times and were important for survival. I will enumerate the most important:
1) Loss Aversion: the strong tendency for people to prefer avoiding losses over acquiring gains

2) Sunk Cost Effect: The tendency to treat money that already has been committed or spent as more valuable than money that may be spent in the future

3) Disposition Effect: the tendency for people to lock in gains and ride losses

4) Outcome Bias: The tendency to judge a decision by its outcome rather then by the quality of the decision at the time it was made

5) Recency Bias: the tendency to weigh recent data or experience more than earlier data or experience

6) Anchoring: the tendency to rely too heavily, or anchor, on readily available information (more…)

Achieving Success

Achieving SuccessIf you wish to be a successful futures or options investor, you must learn to control your losses. No talent that you develop as a trader will ever be as important to you as this. The formula for success in futures and options trading is: X (AP) – Y (AL) = SUCCESS OR FAILURE (X) is the number of profits that you have. (AP) is your average profit per trade. (Y) is the number of losses that you have. (AL) is your average loss per trade. You multiply the number of profits you have times the average of your profits to arrive at your total profits. You multiply the number of losses that you have times the average of your losses to arrive at your total losses. X (AP) equals total profits. Y (AL) equals total losses. Total profits minus total losses equals success or failure. Of this formula, the two most important letters to you are (AL). Why is the (AL) so important in your effort to achieve success. It is important because (AL) is the only element of this formula that you can control. Think about it for a while and you will see what I mean.

Avoiding Trading Mistakes

In Jack Schwager’s New Market Wizards, William Eckhardt said that one mistake traders make is putting too much importance on any single trade. His suggestion was to remember that any one trade is just a small part of the bigger picture and needs to be treated dispassionately. When the individual trade becomes too important, we tend to do things to make the trade work, for example we take profits too quickly or we let losses go in hopes of a return to profitability.

"Unlearning" A Lifetime Of Lessons

unlearning-sign6When it comes to market timing, you’ve got to UNLEARN responses that you’ve spent your whole life learning. Market timing isn’t about you. It is just a strategy that works over time. In other fields, probability plays little if any role. You put in effort, make sure you meet the expectations of the people who pay you, and you’re a success. In the traditional workplace, it makes sense to put a little ego and pride into your work. Your effort and talent often have a direct payoff. But with market timing, the odds can go against you, no matter how much work you put in. The perfect trade can go wrong. That’s hard to accept for most people because it means that being a successful (profitable) market timer or trader, to some extent, is just a matter of the odds randomly working in your favor. But there is good logic behind this randomness. And a successful timing or trading strategy uses this logic to profit. A successful timing strategy will exit losses quickly. It will not stay with a bullish or bearish position to sooth the ego of the strategy’s designer. It will also stay with a successful trade and not exit quickly to lock in a profit. That may feel good for a day, but if the profitable trend lasts two, three, five times longer, you have lost out on a huge profit. Recognizing that odds are part of trading takes some of the glory out of it. But on the other hand, understanding odds helps you cope with inevitable drawdowns.

3 Simple Techniques

Once you sort through all the trading jargon and strategies, making a good stock trade is much easier than people tend to make it. In other words, most people make stock trading harder than it needs to be.

After all, when trading we are generally dealing with thousands of dollars per holding, so it can be easy for traders to continually second guess and put pressure on themselves before finally pulling the trigger.

Below are 3 simple techniques that will having you making good stock trades more often than not.

  1. Create an entry point – Where is a good spot to buy the stock? Based on your strategy, this could be after a breakout, after a pullback, and so on. Once you choose an entry style stick to it and use it every time.
  2. Create a failure point – This is also know as creating stop losses. Basically determine the eject button before entering the stock. Based on your analysis, this should be the price where the trade is considered a bust when it falls below that price.
  3. Create a price target – It is easy to say a stock will go up, but when do you know when to sell? Are you necessarily tying up your capital in a stock that already saw its boost? By creating a price target before entering a stock, you better utilize your capital as you collect gains and move on to the next stock.

That’s it! Yes, it is really that simple, by determining these 3 critical points, the hardest part of stock trading should be deciding how to spend all that money you made.

Continue to tweak and perfect your criteria for determining these critical points, and eventually you’ll master a surefire trading system.

Market is like an Ocean

oceanThe market is like an ocean – it moves up and down regardless of what you want. You may feel joy when you buy a stock and it explodes in a rally. You may feel drenched with fear when you go short but the market rises and your equity melts with every uptick. These feelings have nothing to do with the market – they exist only inside you.

The market does not know you exist. You can do nothing to influence it. You can only control your behavior.

The ocean does not care about your welfare, but it has no wish to hurt you either. You may feel joy on a sunny day, when a gentle wind pushes your sailboat where you want it to go. You may feel panic on a stormy day when the ocean pushes your boat toward the rocks. Your feelings about the ocean exist only in your mind. They threaten your survival when you let your feelings rather than intellect control your behavior.

A sailor cannot control the ocean, but he can control himself. He studies currents and weather patterns. He learns safe sailing techniques and gains experience. He knows when to sail and when to stay in the harbor. A successful sailor uses his intelligence.

An ocean can be useful – you can fish in it and use its surface to get to other islands. An ocean can be dangerous – you can drown in it. The more rational your approach, the more likely you are to get what you want. When you act out your emotions, you cannot focus on the reality of the ocean.

A trader has to study trends and reversals in the market the way a sailor studies the ocean. He must trade on a small scale while learning to handle himself in the market. You can never control the market but you can learn to control yourself.

A beginner who has a string of profitable trades often feels he can walk on water. He starts taking wild risks and blows up his account. On the other hand, an amateur who takes several losses in a row often feels so demoralized that he cannot place an order even when his system gives him a strong signal to buy or sell. If trading makes you feel elated or frightened, you cannot fully use your intellect. When joy sweeps you off your feet, you will make irrational trades and lose. When fear grips you, you’ll miss profitable trades.

A professional trader uses his head and stays calm. Only amateurs become excited or depressed because of their trades. Emotional reactions are a luxury that you cannot afford in the markets.

Profile Of The Successful Trader

Trading is being young, imperfect, and human – not old, exacting, and scientific. It is not a set of techniques, but a commitment. You are to be an information processor. Not a swami. Not a guru. An information processor.

Participating in the markets can only develop your trading skills. You need to become a part of the markets, to know the state of the markets at any given time, and most importantly, to know yourself. You need to be patient, confident, and mentally tough.

Good traders offer no excuses, make no complaints. They live willingly with the vagaries of life and the markets.

In the early stages of your trading career, pay attention not only to whether you should buy or sell but also to how you have executed your trading ideas. You will learn more from your trades this way.

Never assume that the unreasonable or the unexpected cannot happen. It can. It does. It will.

Remember, you can learn a lot about trading from your mistakes. When you make a mistake – and you will – do not dwell on the negatives. Learn from the mistake and keep going.

Never forget that markets are made up of people. Think constantly about what others are doing, what they might do in the current circumstances, or what they might do when those circumstances change. Remember that, whenever you buy and hope to sell higher, the person you sell to will have to see the same opportunity at that higher price to be induced to buy.

Traders who lose follow one of several typical patterns. Some repeatedly suffer individual large losses that wipe out earlier gains or greatly increase a small loss. Others experience brief periods during which their trading wheels fall off: they lose discipline and control and make a series of bad trades as a result.
Wise traders make many small trades, remain involved, and constantly maintain and sharpen their feel for he market. For all of their work, they hope to receive some profit, even if it is small in terms of dollars. In addition, continual participation allows them to sense and recognize the few real opportunities when they arise. These generate large rewards that make the effort of trading truly worthwhile.

At the end of the chapter he lists specific observations that have a high enough probability of reoccurring he considers them rules:

  • If you find yourself holding a winning position, adding up your profits, and confidently projecting larger gains on the horizon, you are probably better off exiting the trade. The odds are that the trade has run its course.
  • When entering a trade with a market order and your fill is clearly better than expected, odds are it will end up being a losing trade. Good fill, bad trade. Get out!
  • If all your ‘trading buddies’ agree with your expectations regarding the next big move, it probably will not work out. If everyone’s conviction level is as strong as the consensus, do the opposite.

Trader’s Emotions

The hardest thing about trading is not the math, the method, or the stock picking. It is dealing with the emotions that arise with trading itself. From the stress of actually entering a trade, to the fear of losing the paper profits that you are holding in a winning trade, how you deal with those emotions will determine your success more than any one thing.

To manage your emotions first of all you must trade a system and method you truly believe will be a winner in the long term.

You must understand that every trade is not a winner and not blame yourself for equity draw downs if you are trading with discipline.

Do not bet your entire account on any one trade, in fact risking only 1% of your total capital on any one trade is the best thing you can do for your stress levels and risk of ruin odds.

With that in place here are some examples of emotional equations to better understand why you feel certain emotions strongly in your trading:

Despair = Losing Money – Trading Better

Do not despair look at your losses as part of doing business and as paying tuition fees to the markets.

Disappointment = Expectations – Reality (more…)

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