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Rambo teaches trading

Because we are shaped by our environment, it is important to remember that the longer we spend in the company of the market, so our perception of the market (eg: as an ecosystem, a battlefield, an unequal competition between players, a fight, etc) becomes important in defining us around the edges.

Sarah Miller: You know you never told us your name.
John Rambo: John.
Sarah Miller: Lived here a long time?
John Rambo: Long Time.

He who would fight monsters must take care not to become one. – Nieztsche

Six Insights for Disciplined Trading

1) Trading is a probability game.  You can’t be a perfectionist and expect to be a great trader. Your losses (that you hope will return to breakeven) will kill you.

2) Jumping in too soon or getting in too late.  These mistakes come from traders not having a well-defined plan of how they will enter the market.  This positions the trader as a reactive trader instead of a proactive trader, which increase the level of emotion the trader will feel in reacting to market movements.  A written plan helps make a trader more systematic and objective, and reduces the risk that emotions will cause the trader to deviate from his plan.

3) Not taking profits on winners and letting winners turn to losers.  Again this is a function of not having a properly thought-out plan.  Entries are easy but exits are hard.  You must have a plan for how you will exit the market, both on your winners and your losers.  Then your job as a trader becomes to execute your plan precisely.

4) Great traders don’t place their own expectations on to the market’s behavior.  Poor traders expect the market to give them something.  When conditions change, a smart trader will recognize that, and take what the market gives. 

5) Emotional pain comes from expectations not being realized.  When you expect something, and it doesn’t deliver as expected, what occurs? Disappointment.  By not having expectations of the market, you are not setting yourself up for this inner turmoil.  Douglas states that the market doesn’t generate pain or pleasure inherently; the market only generates upticks and downticks.  It is how we perceive and respond to these upticks and downticks that determine how we feel.  This perception and feeling is a function of our beliefs.  If you’re still feeling pain when taking a loss according to your plan, you are still experiencing a belief that your loss is somehow a negative reflection on you personally. 

6) The Four Major Fears – fear of losing money, being wrong, missing out, leaving money on the tableAll of these fears result from thinking you know what will happen next. Your trading plan must approach trading as a probabilities game, where you know in advance you will win some and lose some, but that the odds will be in your favor over time.  If you approach trading thinking that you can’t take a loss, then take three losses in a row (which is to be expected in most trading methods), you will be emotionally devastated and will give up on your plan.

Trading commandments

ten_commandments1.) Respect the price action but never defer to it.

Our eyes are valuable tools when trading, but if we deferred to the flickering ticks, stocks would be “better” up and “worse” down. That’s backward logic.

2.) Discipline trumps conviction.

No matter how strongly you feel on a given position, you must defer to the principles of discipline when trading. Always try to define your risk and never believe you’re smarter than the market.

3.) Opportunities are made up easier than losses.

It’s not necessary to play every day; it’s only necessary to have a high winning percentage on the trades you choose to make. Sometimes the ability not to trade is as important as trading ability.

4.) Emotion is the enemy when trading.

Emotional decisions have a way of coming back to haunt you. If you’re personally attached to a position, your decision-making process will be flawed. Take a deep breath before risking your hard-earned coin. See related link.

5.) Zig when others zag.

Sell hope, buy despair and take the other side of emotional disconnects. If you can’t find the sheep in the herd, chances are you’re it. (more…)

Perceptions in Trading -Anirudh Sethi

Image result for PerceptionsPerceptions are a normal part of daily life. It is normal to have a perception of someone, something or a situation, but this perception is often judgmental. One tends to allow feelings, emotions and looks to affect the perception. Despite being a normal and inherent part of human psychology, perceptions can be highly problematic if left uncontrolled in the case of traders.

A trader cannot allow perceptions to cloud his/her judgement and decisions. Perceptions can be deceiving and they thus need to be kept in check as they could lead to erroneous decisions.

In a perfect world, a trader will manage to be completely rational. He/she would be able to assess all facts so as to base decisions and choices on sound information and data. Such a perfect scenario would not allow emotions, perceptions and feelings to come into the picture. As a result the decision making process and the resultant decisions should be ideal. However this is an unreal scenario as we all know that this is not possible in a real world. This is what makes trading psychology so interesting, and yet so complicated and complex. However one should consider this in a positive way as it after all lies at the foundation of why the market and the life of a trader is so challenging and exciting.

The basic idea is to try to keep perceptions under control as much as possible. Despite all efforts though, even seasoned traders may find it hard to be veyr rational at times. One cannot forget that there is tension, pressure, emotion and various other aspects which come into play while a trader is trying to make up his/her mind about the best and the safest course of action. (more…)

Trade What You See?

Trade what you see” is a common mantra among short-term traders who formulate their trade ideas from charts. But do we process information from charts in accurate and non-biased ways?
An interesting set of studies reported in the 2003 Journal of Behavioral Finance suggest that perceptual biases in what we see can skew our trading and investment decisions.
Specifically, when investors see a chart that has a salient high point, they are more likely to want to buy that stock. When the chart depicts a salient low point, they are more apt to sell. In the words of the authors, “expectations about future prices assimilated to extreme past prices.”
The authors found that, when a chart contained a highly noticeable high point, traders listed more favorable features of the stock; when the chart depicted a salient low, more negative aspects of the stock were emphasized. Their analyses suggest that charts affect investors by providing them with enhanced access to either positive or negative information about the stock. In other words, our processing of the chart creates a selective bias in retrieval, leading us to view shares in artificially positive or negative ways.
It isn’t too far from the authors’ finding to a broader psychological hypothesis that *any* highly salient feature of a trading situation may skew information retrieval, perception, and action. For instance, the salient information may be a recent large gain or loss; a dramatic market move; or a piece of news. Trading what we see might be dangerous for the same reason that it is dangerous to trade what we hear or what we feel. 
When one facet of a situation becomes highly salient to us, we overweight it in our perception and information processing. Our ability to view the entire situation in perspective is compromised. What is most obvious in a chart–or in our minds–may not be an accurate reflection of underlying supply and demand in a marketplace.

Quotes on Psychology

The most important single factor in shaping security markets is public psychology. – Gerald Loeb

Wall Street never changes. The pockets change, the suckers change, the stocks change, but Wall Street never changes because human nature never changes. – Jesse Livermore

There is nothing more important than your emotional balance. – Jesse Livermore

There are styles in securities as there are in clothes. A security may be undervalued, but if it is also out of style it is of little interest to the speculator. He is, therefore, compelled to study the psychology of the stock market as well as the elements of real value. – Phil Carret

When events have thinking participants, the subject matter is no longer confined to facts but also includes the participants’ perceptions.  The chain of causation does not lead directly from fact to fact but from fact to perception and from perception to fact. – George Soros

Trading Truths

  1. It’s all about risk management … never risk what you can’t comfortably lose.
  2. Never fall in love with a stock.
  3. To be succesfull in trading; study, understand and practice. The rest is easier.
  4. Always start by assuming your analysis is WRONG and that people much smarter and with more recent information are already positioned opposite you.
  5. Never take on a position larger than your comfort zone. (Don’t overtrade)
  6. Patience. never chase a stock.
  7. Before entering the trade very think carefully what will make you wrong, write it down clearly and put it infront of you where you trade, and when your wrong get out happy you’ve followed your trading discipline.
  8. Buy strength, sell weakness. Most traders are essentially counter-trend; most traders lose.
  9. No one ever went broke taking a profit!
  10. Once you find a good one, hang on unless of course they do you wrong.
  11. Never add to a losing position! (Unless scaling in was part of the plan).
  12. Whenever you think you’ve found the key to the lock, they’ll change the lock.
  13. Do not overtrade.
  14. Trade price not perception.
  15. Know the difference between stocks that you want to stay married to and those that are just a fling.
  16. The only sure way to make a small fortune is to start with a large one.
  17. and to paraphrase Will Rogers: Buy only stocks that will go up. Don’t buy the ones that don’t go up. “THIS is GAMBLING.”

  18. Cut your losses quickly and you may have a chance. (more…)

Rules for Shorting

Basic Rules for Shorting Stocks

1. Shorting Momentum names is dangerous: Unless you are Superman, never step in front of a speeding locomotive

2. Valuation alone is insufficient reason to get short a stock — History teaches us that cheap stocks can get cheaper, dear stocks can get more expensive

3. ALWAYS work with a pre-determined loss – either a physical or mental stop loss — Never leave yourself open to infinite losses

4. Fundamentals tell you WHY to short something, not WHEN to short it. ALWAYS have some technical confirmation before shorting. Make a short selling wish list, then WAIT for technical confirmation. (We use Money Flow, Short Term Trend lines, Institutional Ownership, Analyst Ratings).

5. It is tough to be a contrarian: During Bull and Bear cycles, the Crowd IS the market.

You have to figure out two things:
…a) When the crowd is wrong — Doug Kass calls it “Variant Perception”
…b) When the crowd starts to get an inkling they are wrong

At the turns — not the major trends — is where contrarians clean up.

6. Look for Over-owned, Over-loved stocks: 95% Institutional ownership, All buys or Strong Buys (no sells), and 700% gains over the past few years are reasons to put names on your short selling wish list.  (That is how my partner Kevin Lane found and shorted Enron and Tyco back in the 1990s).

7. Beware the “Crowded Short“– they tend to become targets of the squeeze!

8. You can use Options to either juice your short returns, or pre-define your risk capital (options)

The 10 trading commandments

1.) Respect the price action but never defer to it.

Our eyes are valuable tools when trading, but if we deferred to the flickering ticks, stocks would be “better” up and “worse” down. That’s backward logic.

2.) Discipline trumps conviction.

No matter how strongly you feel on a given position, you must defer to the principles of discipline when trading. Always try to define your risk and never believe you’re smarter than the market.

3.) Opportunities are made up easier than losses.

It’s not necessary to play every day; it’s only necessary to have a high winning percentage on the trades you choose to make. Sometimes the ability not to trade is as important as trading ability.

4.) Emotion is the enemy when trading.

Emotional decisions have a way of coming back to haunt you. If you’re personally attached to a position, your decision-making process will be flawed. Take a deep breath before risking your hard-earned coin. See related link.

5.) Zig when others zag.

Sell hope, buy despair and take the other side of emotional disconnects. If you can’t find the sheep in the herd, chances are you’re it.

6.) Adapt your style to the market.

Different investment approaches are warranted at different junctures, and applying the right methodology is half the battle. Map a plan before stepping on the field so your time horizon and risk profile are in sync.

7.) Maximize your reward relative to your risk.

If you’re patient and pick your spots, edges will emerge that provide an advantageous risk/reward. There is usually one easy trade per session if you let it show itself.

8.) Perception is reality in the marketplace.

Identifying the prevalent psychology is necessary when assimilating the trading dynamic. It’s not what is, it’s what’s perceived to be that dictates the price action.

9.) When unsure, trade “in between.”

When in doubt, sit it out. Your risk profile should always be an extension of your thought process and when unsure, trade smaller until you establish a rhythm.

10.) Don’t let your bad trades turn into investments.

Rationalization has no place in trading. If you put on a position for a catalyst and it passes, take the risk off — win, lose or draw. Good traders know how to make money but great traders know how to take a loss.

There are obviously more rules but I’ve found these to be common threads through the years. Where you stand is a function of where you sit. So please understand that some of these guidelines may not apply to your particular approach.

As always, I share my process with hopes it adds value to yours. Find a style that works for you, always allow for a margin of error and trade to win, never trade “not to lose.”

And remember — any trader worth his or her salt has endured periods of pain but if we learn from those mistakes, they’ll morph into lessons. For if there wasn’t risk in this profession, it would be called “winning,” not “trading.”

Willingness to Make Mistakes

“[Michael Marcus] also taught me one other thing that is absolutely critical: You have to be willing to make mistakes regularly; there is nothing wrong with it. [He] taught me about making your best judgment, being wrong, making your next best judgment, being wrong, making your third best judgment, and then doubling your money.”

– Bruce Kovner, Market Wizards

Bruce Kovner, now retired, is one of the all-time trading greats.

His observation is strikingly similar to the Soros observation (paraphrase): “It doesn’t matter how often you are right or wrong — what matters is how much you make when you are right, versus how much you lose when you are wrong.”

In many ways trading is remarkably different from any other profession. Imagine if doctors, lawyers, or company executives were encouraged to “make mistakes” on a regular basis. (They do make mistakes of course. They just can’t admit them, let alone be open about them.) (more…)

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