A
good read and points to keep in mind for traders.
1. Stay in the Center
This is about staying centered in body and mind.
Professional traders see what they do as a business, not a fun hobby. If you
want fun and excitement, go to Las Vegas. If you want to make money in the
markets, get serious about it.
Nearly all the traders who were covered in Jack
Schwager’s brilliant Market Wizards series mentioned the importance of
remaining emotionally neutral during gains and losses. This is an essential
trait that any trader must master before they can be consistently successful.
A good trader has a system which they follow.
When you win, your system gets validated. When you lose money, you need to
check to make sure that your system is still relevant for the market. If it is,
then you must remain confident and keep to your system until it starts to bear
fruit. Flip-flopping due to emotional swings is a sure path to the poor house.
Emotional control is your shield against Mr.
Market’s manic-depressive mood swings.
2.
Empty Sword
This principle is about learning to make the far
come near. No one can make the market do anything. The market is the boss.
Sure, some manipulators can drive a particular stock or commodity up or down in
price, but they can only do it when the price momentum allows for it. If a
stock is weak and there are few buyers, then a speculator can be the catalyst
for selling pressure. But that same speculator can’t do that if the stock is
shooting higher as a flood of buyers pour money into it. You can only take what
the market gives.
One successful trader said that only one out of
20 of his ideas were clear winners. The secret is to cut losses quickly on
losing trades to keep enough capital available for that one big success, as can
be seen though George Soros’ philosophy to build long-term capital through
preservation of capital and via home runs. Stanley Druckenmiller has stated
that it’s not whether you are right or wrong that counts, but it’s how much you
make when you are right and how much you lose when you are wrong that matters.
Jesse Livermore repeatedly stressed how you need to ride winning stocks and cut
losers quickly.
Preserve your cash as best you can when you are
wrong, and swing for the fences when you have a winning position. That is the
way to build great long term returns.
3.
Cut-off Self
This is about not trying to beat the market.
Stay with a system and let that tell you whether you should enter or exit a
position. When you are just going with gut feelings or on other people’s
opinions, you will lose far more than you win.
Ed Seykota and others have said that they make
money when they trust their systems. They lose money when they think they are
smarter and try to do things on their own. Commodities trader, Richard Dennis,
said that he could publish his trading rules in the newspaper and that almost
no one would use them, because most people get caught up in the excitement of
trading. He also said that people could come up with trading systems that were
80% as good as the ones that he used, but it wouldn’t matter because people
would have trouble sticking with them.
If you have developed a proven, tested way to
make money in the markets, then stick with it and get out of the way. Your job
is to help create rules for risk management and to constantly test the validity
of your system in an ever-changing market.
Don’t be a gunslinger. Discipline is the key.
4.
Harmonize the Hara and the Senaka
This states that the martial artist should use
their body in a unified and rhythmic way. When it comes to trading, this means
that you should not rely on any one indicator when making a decision on buying
or selling. There are a multitude of tools that can be used to create a far
more accurate and clearer picture of what is going on with a stock or in the
market as a whole.
If the RSI on a stock seems oversold, check the
MACD and Money flow Indices. Is volume confirming the move? Did the price
breakthrough a major moving average? Where are the support and resistance
levels? What has the stock done on previous occasions at similar inflection
points? Has there been any major news on the company or commodity? Are insiders
buying or selling?
There are so many things that can be taken into
consideration and the more things that you can find that are pointing in the
same direction, the clearer to outlook for the security will be. Take the time
and do the work.
There
is no easy way to (legally) make money in the markets. Roll up your sleeves, do
the work, and increase the odds that you are right.
5.
Forget Your Body
This is about not rigidly sticking to a
particular stance or position. It is about being flexible and not having any
problem with exiting a position when it turns sour. Too many traders become
emotionally attached or enamored with a stock, commodity or an outcome. When
this happens they become blinded to important changes are unable to adapt when
the market changes and they lose money.
Even Warren Buffett, who says his time horizon
for keeping a good stock is forever, dumps that same stock when the fundamentals
change. Be nimble and know when the time comes for cutting a position. It all
depends on your time horizon and your risk tolerance.
When all the indicators were screaming higher
inflation and stock market turbulence in the 1970s, it was a great time to buy
gold. When things went parabolic and Volcker came in and raised interest rates,
it was a clear sign to get out. Trading is a business, and traders do their
best when the trades they make are emotionless and boring. If things start to
get exciting for you, then it could be a sign that something is wrong with your
trading philosophy.
If you think Bernake is evil and destroying the
economy, that’s fine. Just don’t make trades based on your anger. Call your
representative in Congress and vent instead. Being cool, level-headed, and
trading on facts are much better than trading based on trying to be
ideologically right. The facts will set you free.
Don’t get married to your positions and always
be ready to change your mind. Remember, hope is a terrible investment strategy.
6.
Greet Your Opponent
Risk management is probably the most important
aspect of trading. Know when to fight and when to run. Even before you
implement a trade you should have a price point in mind that will invalidate
your hypothesis. If that price (your stop) is reached, just get out and move on
even if you have a loss.
Livermore always said that whenever he got into
a winning trade, it usually made money for him from the start. He also spoke
about how every uptrend has its natural reactions (when a stock would
consolidate in price and move down) and this was to be expected. He was always
on the lookout for abnormal downdrafts, though. When the market gives you a
warning sign, get out a look for reasons later. Remember: the market will often
make moves before the facts come out and are known.
Always have tight stops on your trades and only
risk an amount that you are comfortable with on any single trade. One trader
once said that if you have trouble sleeping at night due to a position that you
own, you are in too deep and you should scale it down to a ‘sleep level’.
Set your stops either as a percentage trailing
stop or have a set price that, if the stock falls below that level, sell it. Be
cold and ruthless about it. If the price bounces back and things look good
again, you can always buy back later. Some traders say that you should never
risk more than 5% of your equity on any single trade. Others cut their losses
if they end up being down 10% in one month. You need to find what you are
comfortable with and stick to it.
When
you see an opportunity, take it. When you see a threat, know when to retreat.
7.
Practice by Yourself
A serious trader needs to follow these
guidelines every day without fail. They need to practice and improve themselves
and not just rest on their laurels, so to speak. Good traders adapt and are
constantly learning. Keep a trading journal on all of your trades. Why did you
think that this was a good trade? Why did you decide to get out? What happened
after you bought it? This will help you find patterns and shed light on where
your strengths and weaknesses lie. Maybe you habitually make the same mistake
over and over, but can’t see it? Maybe you have missed many opportunities at
riding a winner because you fear losing your 5% gain? Never assume that your
logic and reasoning is perfect. If you are losing money, you are doing
something wrong.
Bad traders keep making the same mistakes over
and over again. Only Good traders learn from their mistakes and strive to
become better. There is no place for ego if you want to make money on your
trades. The best traders are humble.
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