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The Traders Mindset

So far the Apprenticed Investor series has discussed a lot of don’ts. Don’t do this, don’t do that; avoid talking to these kinds of traders; don’t say or think these kinds of things.

Well, it’s time to shift gears, and since trading is an active enterprise, I’ll discuss some things you should do. I plan to expand on these ideas significantly in future episodes.

Taken together, the following 10 rules will not only help you with the philosophical grounding necessary for thoughtful — and successful — investing, they will help you avoid some of the more common mistakes made by investors and traders early in their careers.

This is the “Zen of Trading;” It is more than an overview — it’s an investment philosophy that can help you develop an investing framework of your own.

1. Have a Comprehensive Plan: Whether you are an investor or active trader, you must have a plan. Too many investors have no strategy at all — they merely react to each twitch of the market on the fly. If you fail to plan, goes the saying, then you plan to fail.
Consider how Roger Clemens approaches a game. He studies his opponent, constructs his game plan and goes to work.

Investors should write up a business plan, as if they were asking a Venture Capitalist for start-up money; just because you are the angel investor doesn’t mean you should skip the planning stages.

2. Expect to Be Wrong: We’ve discussed this previously, but it is such a key aspect of successful investing that it bears repeating. You will be wrong, you will be wrong often and, occasionally, you will be spectacularly wrong.
Michael Jordan has a fabulous perspective on the subject: “I’ve missed more than 9,000 shots in my career. I’ve lost almost 300 games. Twenty six times, I’ve been trusted to take the game-winning shot and missed. I’ve failed over and over and over again in my life. And that is why I succeed.”

Jordan was the greatest ball player of all time, and not only because of his superb physical skills: He understood the nature and importance of failure, and placed it appropriately within a larger framework of the game.

The best investors have no ego tied up in a trade. Those who refuse to recognize the simple truism of “being wrong often” end up giving away unacceptable amounts of capital. Stubborn pride and lack of risk management allow egotists to stay in stocks down 30%, 40% or 50% — or worse.

 

3. Predetermine Stops Before Opening Any Position: Sign a “prenuptial agreement” with every stock you participate in: When it hits some point you have determined before you purchased it, that’s it, you’re out, end of story. Once you have come to understand that you will be frequently wrong, it becomes much easier to use stop-losses and sell targets.
This is true regardless of your methodology: It may be below support or beneath a moving average, or perhaps you prefer a specific percentage amount. Some people use the prior month’s low. But whatever your stop-loss method is, stick to it religiously. Why? The prenup means you are making the exit decision before you are in a trade — while you are still neutral and objective.

4. Follow Discipline Religiously: The greatest rules in the world are worthless if you do not have the personal discipline to see them through. I can recall every single time I broke a trading rule of my own, and it invariably cost me money.
RealMoney’s Chartman, Gary B. Smith, slavishly follows his discipline, and he notes that every time some hedge fund — chock full of Nobel Laureates and Ivy League whiz kids — blows up, the mea culpa is the same: If only we hadn’t overrode the system.

In Jack Schwager’s seminal book Market Wizards, the single most important theme repeated by each of the wizards was the importance of discipline. (more…)

8 Steps for Traders

1. Find Your Strength.  It is important that the trader determine what type of market, trending or consolidating, best suits their own personality and strength.  The best traders stay focused on one or the other and master it.

2. Know Your Market.  You should know your market when trading.  In other words, know the levels of support/resistance;  know how the instrument you trade moves with the general market; know who is likely to be on the other side and what they are thinking; and “the terrain of any market includes the “long-term charts”

3.  Prepare Your Order.  Know when to get into a trade and why and know when to get out of a trade and why.  Just like a secret agent who will “never enter a room without knowing how to get out of it in a hurry”

4.  Placing Your Order.  Once you have adequately prepared for a trade, it is then necessary to be ready to place the trade when the time is right.  Here “patience is the key…you must be able to wait for the market to tell you when the moment is right.  Wait for the market to generate the action; don’t force it”

5.  Sticking With Your Plan.  This is probably the hardest part about trading.  Once you enter the battlefield (enter a trade), the emotions of fear, ecstasy, greed, and sheer excitement can then take over and cause you to forget your well prepared plans for entry and exit.  You must enter a “Zen-like mental state” where you remain in control of your emotions.  Not doing so could spell disaster.

6. Identify When You Are Wrong.  “It is crucial to your survival to identify in advance whether your view might be wrong and to determine what price level, when broken, would be in support of the consensus view; therefore, you are building up your ability to defend the occasional probes against you”

7.  Holding On To Your Winning Positions.  Set a trailing stop when your trade is moving in your direction thereby locking in profits while allowing the trade to work toward its maximum potential.  “A trailing stop loss keeps you in the war, keeps you in tune with the war, and, most important, leaves you in full readiness to instantly strike again”

8.  Focus On Your Next Trade.  This is the most important step and is saved for last.  This step simply says to start anew with each new trade.  No matter if you won, lost, or broke even on the last trade, the next trade is a new one.  “You do indeed need to be starting every single trade fresh and alert without any baggage from the previous encounter”

The Zen of Trading

So far the Apprenticed Investor series has discussed a lot of don’ts. Don’t do this, don’t do that; avoid talking to these kinds of traders; don’t say or think these kinds of things.

Well, it’s time to shift gears, and since trading is an active enterprise, I’ll discuss some things you should do. I plan to expand on these ideas significantly in future episodes.

Taken together, the following 10 rules will not only help you with the philosophical grounding necessary for thoughtful — and successful — investing, they will help you avoid some of the more common mistakes made by investors and traders early in their careers.

This is the “Zen of Trading;” It is more than an overview — it’s an investment philosophy that can help you develop an investing framework of your own.

1. Have a Comprehensive Plan: Whether you are an investor or active trader, you must have a plan. Too many investors have no strategy at all — they merely react to each twitch of the market on the fly. If you fail to plan, goes the saying, then you plan to fail.
Consider how Roger Clemens approaches a game. He studies his opponent, constructs his game plan and goes to work.

Investors should write up a business plan, as if they were asking a Venture Capitalist for start-up money; just because you are the angel investor doesn’t mean you should skip the planning stages.

2. Expect to Be Wrong: We’ve discussed this previously, but it is such a key aspect of successful investing that it bears repeating. You will be wrong, you will be wrong often and, occasionally, you will be spectacularly wrong.
Michael Jordan has a fabulous perspective on the subject: “I’ve missed more than 9,000 shots in my career. I’ve lost almost 300 games. Twenty six times, I’ve been trusted to take the game-winning shot and missed. I’ve failed over and over and over again in my life. And that is why I succeed.”

Jordan was the greatest ball player of all time, and not only because of his superb physical skills: He understood the nature and importance of failure, and placed it appropriately within a larger framework of the game.

The best investors have no ego tied up in a trade. Those who refuse to recognize the simple truism of “being wrong often” end up giving away unacceptable amounts of capital. Stubborn pride and lack of risk management allow egotists to stay in stocks down 30%, 40% or 50% — or worse.

 

3. Predetermine Stops Before Opening Any Position: Sign a “prenuptial agreement” with every stock you participate in: When it hits some point you have determined before you purchased it, that’s it, you’re out, end of story. Once you have come to understand that you will be frequently wrong, it becomes much easier to use stop-losses and sell targets.
This is true regardless of your methodology: It may be below support or beneath a moving average, or perhaps you prefer a specific percentage amount. Some people use the prior month’s low. But whatever your stop-loss method is, stick to it religiously. Why? The prenup means you are making the exit decision before you are in a trade — while you are still neutral and objective.

4. Follow Discipline Religiously: The greatest rules in the world are worthless if you do not have the personal discipline to see them through. I can recall every single time I broke a trading rule of my own, and it invariably cost me money.
RealMoney’s Chartman, Gary B. Smith, slavishly follows his discipline, and he notes that every time some hedge fund — chock full of Nobel Laureates and Ivy League whiz kids — blows up, the mea culpa is the same: If only we hadn’t overrode the system.

In Jack Schwager’s seminal book Market Wizards, the single most important theme repeated by each of the wizards was the importance of discipline.

5. Keep Your Emotion In Check: Emotion is the enemy of investors, and that’s why you must have a methodology that relies on objective data points, and not gut instinct. The purpose of Rules 1, 2 and 3 is to eliminate the impact of the natural human response to stress — fear and panic — and to avoid the flip side of the coin — greed.
Remember, we, as a species, were never “hard-wired” for the capital markets. Our instinctive “fight or flight response” did not evolve to deal with crossing moving averages or CEOs resigning or restated earnings.

This evolutionary emotional baggage is why we want to sell at the bottom and chase stocks at the top. The money-making trade — buying when there’s blood in the streets, and selling when everyone else is clamoring to buy — goes against every instinct you have. It requires a detached objectivity simply not possible when trading on emotion.

6. Take Responsibility: Many folks believe “the game is fixed.” To them, I say: get over it. Stop whining and take the proper responsibility for your trades, your losses and yourself.
Your knowledge of the game-rigging gives you an edge. So use your hard-won knowledge to make money.

We have a national culture of blame-passing, and it infected investing long ago. Enron did not cause your losses, and neither did stock-touting analysts, or talking heads on CNBC. You did, and the sooner you accept this, the better off you will be.

A Chinese proverb is particularly insightful as applied to trading: “He who blames others has a long way to go on his journey. He who blames himself is halfway there. He who blames no one has arrived.”

7. Constantly Improve: Investing is so competitive that you cannot afford to stand still. Investors should constantly seek to raise their skill level by learning as much as possible about the markets, the economy, trading technologies and various schools of investing thought. But whatever you read, you must do so with a keenly skeptical eye, while retaining an open mind (‘taint easy to do).
One way to constantly improve is to find something for which you have a peculiar natural proclivity for and develop that gift. It may be moving averages, or position sizing, or MACD, or Bollinger Bands or the Arms index. Perhaps you have an expertise in some aspect of technology, or a particular sector.

This is essential because a developed expertise yields ancillary benefits. It bleeds over into everything else, with net positive results. The specific area of expertise you own does not matter as much as having one. Those of you who have been trading for a while will know exactly what I am referring to.

8. Change Is Constant: Heraclitus was a Greek philosopher best known for his “Doctrine of Flux”: “The only constant is change.”
That doctrine is especially true in the markets. Therefore, as you constantly upgrade your skills, you must remain supple enough to adapt to an ever-changing field of play.

Human nature — especially in herds — is unchanging. But these behaviors must be contemplated within their larger context. Add a new element — PCs, lower trading costs, the Internet, vast amounts of cheap data, even CNBC — and you introduce a new factor that impacts all the players on the field.

As conditions change, you must decipher how they impact your strategy, your emotions and your trading — and adjust accordingly.

9. Learn to Short/Hedge Stocks: Short is not a four-letter word. Successful traders learn to play both sides of the fence. That’s less controversial today than it was as the market was first falling apart, but it is no less true.
When a particular strategy isn’t working, the market is telling you something. Thoughtful traders must consider whether there are bigger issues than their own trading mechanics when they enter a losing streak.

In Law School, students learn they have to be ready to argue either side of a case. You never truly knew a case until you could argue both for and against it. Only when you were able to see its warts could you truly appreciate the beauty.

The trading corollary is that you should never own a stock unless you know what makes it an attractive short. Each buy and sell decision should be an argument pro and con.

The market is cyclical; count on a bear market every four years or so. Unless you plan on sitting out for 18 to 24 months once or twice each decade — as much as four years out of 10 — you better learn to either short stocks or hedge long positions.

10. Understand Sector Strength and Market Trend: This rule generates the most “pushback” of any on the list, because it’s so counter-intuitive: Stock selection matters less than you think.
Studies have convincingly demonstrated that about 30% of a stock’s progress is determined by the company itself; a stock’s sector is equal to at least another 30% (if not more). The overall direction of the market is an even bigger factor, counting for some 40%.

If you own the best company in the wrong sector, or buy the greatest stock when the broader market is going the other way — both positions are likely to be losers. But if you see a strong sector, the market trend will help out even the weakest stock in the bunch.

So that’s the 10 rules I call the “Zen of Trading.”

Investing skills are worthless without a broader framework in which to practice them. The above rules will provide you with that frame of reference. They were as true 100 years ago as they will be true 100 years from now. Those who develop a plan and an investment philosophy are on the path to achieving trading success.

Lifestyle & Improvement

  • Make 2011 your best year ever (Paints With Numbers)

  • A guide to inner peace (Zen Habits)

  • What would you do if you knew you were going to die today? (James Altucher)

  • Don’t have enough time to do the things you want? 80 ways to steal back time (Open)

  • 10 tips for re-energizing your day, every day (Open)

  • Don’t forget your daily dose of aspirin (Bloomberg)

  • 32 ways to love ourselves (James Altucher)

The Battle is With Yourself

“Years of experience eventually teach you that your main battle, always, is with yourself — your propensity for errors, for rationalizing marginal hands into good hands, lack of concentration, misreading other players, emotional eruptions, impatience, and so on. Your opponents are merely dim outlines that come and go. Few of them ever reach the exalted heights of damage that you can inflict on yourself.”

– Larry Phillips, Zen and the Art of Poker

Many great traders have expressed some version of the opinion, “Your greatest opponent is yourself.” Do you agree?

If so, what are the implications?

On the positive side, if “we have met the enemy and he is us,” as Pogo once said, what does that say about growth opportunity?

If you had perfect discipline, perfect motivation, and perfect emotional control, how good (or great) a trader could you be? 

Warrior Trading : Clifford Bennett

warriror tradingThese eight steps are intended as a guide to the new trader and a reminder to the experienced.

1. Find Your Strength.  It is important that the trader determine what type of market, trending or consolidating, best suits their own personality and strength.  The best traders stay focused on one or the other and master it.
 
2. Know Your Market.  You should know your market when trading.  In other words, know the levels of support/resistance;  know how the instrument you trade moves with the general market; know who is likely to be on the other side and what they are thinking; and “the terrain of any market includes the “long-term charts” (140).
 
3.  Prepare Your Order.  Know when to get into a trade and why and know when to get out of a trade and why.  Just like a secret agent who will “never enter a room without knowing how to get out of it in a hurry” (142).
 
4.  Placing Your Order.  Once you have adequately prepared for a trade, it is then necessary to be ready to place the trade when the time is right.  Here “patience is the key…you must be able to wait for the market to tell you when the moment is right.  Wait for the market to generate the action; don’t force it” (143).
 
5.  Sticking With Your Plan.  This is probably the hardest part about trading.  Once you enter the battlefield (enter a trade), the emotions of fear, ecstasy, greed, and sheer excitement can then take over and cause you to forget your well prepared plans for entry and exit.  You must enter a “Zen-like mental state” where you remain in control of your emotions.  Not doing so could spell disaster. (more…)

The Zen of Trading

This is the “Zen of Trading;” It is more than an overview — it’s an investment philosophy that can help you develop an investing framework of your own.

1. Have a Comprehensive Plan: Whether you are an investor or active trader, you must have a plan. Too many investors have no strategy at all — they merely react to each twitch of the market on the fly. If you fail to plan, goes the saying, then you plan to fail.
Consider how Roger Clemens approaches a game. He studies his opponent, constructs his game plan and goes to work.

Investors should write up a business plan, as if they were asking a Venture Capitalist for start-up money; just because you are the angel investor doesn’t mean you should skip the planning stages.

2. Expect to Be Wrong: We’ve discussed this previously, but it is such a key aspect of successful investing that it bears repeating. You will be wrong, you will be wrong often and, occasionally, you will be spectacularly wrong.
Michael Jordan has a fabulous perspective on the subject: “I’ve missed more than 9,000 shots in my career. I’ve lost almost 300 games. Twenty six times, I’ve been trusted to take the game-winning shot and missed. I’ve failed over and over and over again in my life. And that is why I succeed.”

Jordan was the greatest ball player of all time, and not only because of his superb physical skills: He understood the nature and importance of failure, and placed it appropriately within a larger framework of the game.

The best investors have no ego tied up in a trade. Those who refuse to recognize the simple truism of “being wrong often” end up giving away unacceptable amounts of capital. Stubborn pride and lack of risk management allow egotists to stay in stocks down 30%, 40% or 50% — or worse.

 

3. Predetermine Stops Before Opening Any Position: Sign a “prenuptial agreement” with every stock you participate in: When it hits some point you have determined before you purchased it, that’s it, you’re out, end of story. Once you have come to understand that you will be frequently wrong, it becomes much easier to use stop-losses and sell targets.
This is true regardless of your methodology: It may be below support or beneath a moving average, or perhaps you prefer a specific percentage amount. Some people use the prior month’s low. But whatever your stop-loss method is, stick to it religiously. Why? The prenup means you are making the exit decision before you are in a trade — while you are still neutral and objective.

4. Follow Discipline Religiously: The greatest rules in the world are worthless if you do not have the personal discipline to see them through. I can recall every single time I broke a trading rule of my own, and it invariably cost me money.
RealMoney’s Chartman, Gary B. Smith, slavishly follows his discipline, and he notes that every time some hedge fund — chock full of Nobel Laureates and Ivy League whiz kids — blows up, the mea culpa is the same: If only we hadn’t overrode the system.

In Jack Schwager’s seminal book Market Wizards, the single most important theme repeated by each of the wizards was the importance of discipline. (more…)

The Battle is With Yourself

Years of experience eventually teach you that your main battle, always, is with yourself — your propensity for errors, for rationalizing marginal hands into good hands, lack of concentration, misreading other players, emotional eruptions, impatience, and so on. Your opponents are merely dim outlines that come and go. Few of them ever reach the exalted heights of damage that you can inflict on yourself.”

– Larry Phillips, Zen and the Art of Poker

Many great traders have expressed some version of the opinion, “Your greatest opponent is yourself.” Do you agree?

If so, what are the implications?

On the positive side, if “we have met the enemy and he is us,” as Pogo once said, what does that say about growth opportunity?

If you had perfect discipline, perfect motivation, and perfect emotional control, how good (or great) a trader could you be? 

An Investment Poem

The newfound opportunity arises softly at first

Like pearl shaped dew drops on a tea leaf

Quite unexpected but fast entranced and immersed

Her presence over the former solitude brings relief

More precious than any amount of money or power

More beautiful than the most stunning of jewels

You cannot appreciate the sweet without the sour

The kind of perfect pattern that makes investors drool

Finding shares to short are most difficult to borrow

But who would bet against an investment with so much potential?

Elation is now the norm starting yesterday, today and tomorrow

The biggest challenge lay in exercising prudential

Potentially an addicted lost cause am I

An investor who has witnessed too many ups and downs

Is it possible to stay grounded or is my destiny the sky?

Disciplined I promise to be, carefully soaking in the sights and sounds

Because true greatness only comes around every so often

Where your hands can’t help but shake and you feel it in your gut

The time is now, the place is here — this is Zen

As nature intended, this squirrel has found his nut