Posts in Category: Trading

How to profit & still lose

ES 03-14 (5 Min)  2_13_2014 - VikramThis is the story of how I made $1762.50 yesterday in a demo trade in the E-mini S&P [CME:ESH14], while failing as a trend-follower and a trader. If I, or you, look just at the final profit, we’ll be missing the story.

The markets do allow you to recover from stupid mistakes sometimes. That doesn’t mean I should turn it into a habit or a “system.”

Note: This example comes from the demo account NinjaTrader kindly provides me to test trading ideas and keep an eye on how our calls perform. The usual disclaimer applies (see the footer of the page). In a demo, you don’t feel the same pain as with real money. Then again, I’ve had losing trades where after a while, I became numb to the numbers.

It’s your mind’s way of protecting you from the pain, and it was part of the story yesterday. Again, please don’t see this as an example of how to recover from a mistake profitably, even if a lot of trading gurus would sell it to you as exactly that. It’s an example of ego and stupidity and needless suffering. You don’t want to trade like this.

Since most of the key steps to the $1762.50 are on the chart, I’ll just highlight a few points. The morning started nicely with a couple of quick one- and two-tick scalps, which added up to $62.50 in profit, before commissions and fees. My goal was to show that you could do quite well taking a lot of small profits, if you were not yet confident enough to do a big swing trade.

I like pitchforks almost as much as this guy

And yes, that is how my charts look. The lines are prices that have been significant in the past and which the market is likely to remember. Look how beautifully the market hugged the middle tine of that large red pitchfork! And respected 1817, 1814.50, and 1811 as support and resistance. [SNP:^GSPC] Those levels acted as magnets, as they did last month.

At the beginning of the big rally, before the 8:30 AM CT open, I “sold the rally” a couple of times for small profits totaling $62.50. It was quick and easy and so I imposed my idea on the market that the market would and should go down. First big mistake: telling the market what to do.

Then, I ignored the uptrend, ignored my own super-secret proprietary indicators, and stayed short as the market took back most of my $62.50. I could have gotten out and kept half of it, but I didn’t. Being right was more important to me than keeping whatever money I could from leaving my account.

I used what is called “dollar-cost averaging” to increase the price from which I was effectively short. For example, if I get short from 10 and the market goes against me up past 20, I could sell a second contract at 20 and thus be short 2 contracts at 15. Sounds smart, right?

No. It was my way of fooling myself that I was being clever. But the simple question is this: the market was in a clear uptrend. Deciding to be long and profit from that trend was so easy “even a caveman could do it.” And here I was, trying to push back the tide. Why?

That the market did eventually turn my way and yield a profit is beside the point. I left more money on the table than I put in my account, all because I fought the trend instead of following it.

Look at the missed opportunities. $1000 on the first up rally, another several hundred back down, then the perfect Fibonacci correction. And my MACD and moving averages were showing them as well. (Oops, I just revealed my secret formula…) I ignored it all.

Instead of blending with what the market was doing, I was dancing to a different tune and the two did not harmonize.

I failed to do the thing I know works: listen to the market, shut up, don’t question it, and just follow the trend. As Jack Broz, who will be back next week, told me, “If you have a method you trust, then just trust it.” Reminds me of one of my favorite Springsteen lyrics: “God have mercy on the man who doubts what he’s sure of.”

Fair Value, the great overlooked market force. (Also, robots)

In this morning’s “Our View,” CEO Danny Riley mentions “something so basic that most traders don’t even look at it: premium levels, fair value (FV) and volume.” For months, I’d heard Danny mention buy and sell programs and premium. I put the fair value into our daily report and looked back at premium and price history. And as often happens, I was also thinking about robots.

Fair value premium is the major driver of price action

If you watch CNBC with the volume up, you’ve heard them say “fair value” every morning, when they quote the pre-open S&P 500 futures [^GSPC:SNP].

If you’re like me, you probably thought “fair value” was something like the blue book price for a used car. And you might have thought about whether stocks and index futures were overpriced or a bargain.

Little did I know fair value premium is the major driver of price action in index futures. China’s PMI, the Fed, housing prices, unemployment—they may affect investors’ feelings about where the long-term value is.

But it’s the premium between fair value and futures that moves the price up and down the ladder, tick by tick. Why? Robots, of course. (More on that below.)

And since funds and banks use futures to hedge their portfolios, as in the recent rotation into tech stocks, fair value plays a big role in the stock market as well.

Premium and index arbitrage

To put it simply, a difference between the current futures price and fair value constitutes a premium. If futures is above fair value, then you sell the futures and buy the cash S&P. If futures is below fair value, then it’s a bargain; sell the cash and buy the futures. Then you liquidate the spread and keep the difference as profit.

You’re probably saying, I’ve never done that kind of trade. You probably haven’t. You may also be saying, sometimes that premium is just a few points or ticks. You’d have to be really fast to profit. Yes, you would. Maybe faster than humans can be.

Learning from the robots

60% to 75% of trades are done by index arbitrage buy and sell programs, algorithms that trade the difference between the actual current price and the future price, selling the higher one and buying the lower. To do this, they (and other algos) lay down buy and sell stops–often months in advance–and then run them when the time comes. This is how a small move turns into a run, as it did Friday.

So what can mere humans do against the droid army? Keep being human, but learn one thing from the bots. They do what they plan to do.


When their stop is hit, they exit. When the market meets their entry conditions, they pull the trigger without hesitation. They don’t fantasize about big winners or let a loss make them go back and analyze their childhoods.

They trade like, well, machines, knowing that losing is part of succeeding and being just as willing to take losses as profits, as long as their edge gives them profit that exceeds the loss. Otherwise, unlike humans, they stop trading.

I’ll say it again: there is no holy grail of investing or trading. You are the holy grail.

Finally, the money part

Fair Value

Last Friday morning, futures were 10 full points below fair value before the open. And had been negative 10 of 15 days this year. That was enough to tell you how the day was likely to go. Wasn’t it?

One more thing: remember that robots, even more than humans, remember price levels of significance, where there was a lot of volume and a lot of time spent.

Those levels act as magnets on humans and perhaps even more on algorithms programmed to mirror human desire.

So is it any wonder the drop stopped on the red trendline? And will you be surprised when it drops to 1750 or 1715?

Let’s put some things together. The Friday-Monday rule says that Monday will continue Friday’s momentum.

And the Asian markets traded sharply lower. (My Asia Sunday Rule says that Asia will start a trend and then hand it off to the US to continue or will start and finish a move and let the US digest it.)

And the S&P futures has been below or at fair value most of the night but are now 5.46 points above as of 7 AM CT. Do these things suggest how today will probably go? A bounce and then continuation of the downtrend seems likely.

The next level down is in the low 1760s. I hesitate to write that because some of you will just short from Random Point A to Random Point B, lose money, and be sad. I hope you won’t do that. But then again, everybody gets what they want from the market.

New Year’s resolutions for traders and investors

  1. sun-saluteAttend to your body. Make exercise and nutrition a priority, so you are calm and alert. No matter what the markets and life are doing on a given day, you know one thing, you’ll be in your body when you face them. Making sure you are sharp-witted and unshakeable is the one thing you can always control. So control it.
    You don’t have to do anything fancy. Take a little walk. Do a Sun Salute; yoga has been shown to improve brain function. I have an app on my phone that guides me through an increasing number of pushups (I started with one and I can do 25 now).
    And to make it a priority, do it first thing in the morning. You’ll start the day with a personal victory and feel great.
    Notice that I didn’t say diet. It’s a horrible word. Try “nutrition,” instead.
    No really, try it now. Say, “I’m on a diet.” And now say, “I make sure to get good nutrition.” Which feels better?
    Another difference is that instead of worrying about how you look to others, you start to enjoy how your body moves and feels. That’s vital, especially in a job that involves the highly unnatural act of sitting in a chair staring at a screen for hours.
  2. Start with gratitude. Whether you day trade or you’re researching longer-term investments or trades, first take thirty seconds to write down three things you are thankful for. Thank youIf it’s hard to think of any, start small, ridiculously small—but true. I’m thankful for my new shampoo. I’m thankful I filled up gas yesterday.
    Start trading with an attitude of abundance, not scarcity. Good things are flowing towards you in an endless stream. All you have to do is get out of their way.
  3. Do not overtrade. Take breaks, step away. There is always another opportunity to profit. Part of an abundance mindset is knowing that opportunity is in limitless supply as well. You’ve heard the old sayings: Standing aside is taking a position. When in doubt, stay out.
  4. Don’t trade in times of family crisis or emotional stress. I learned this one from our friend Marty “PitBull” Schwartz, one of the original Market Wizards. Here’s the famous video.
    run-awayActually, I learned this a few years ago, the hard way. After a profitable spring and summer, I was ready to take the rest of the year off. Then I had an argument with a loved one and sat down to trade the next morning. I very quickly had to change my plans for the rest of the year. It was demoralizing, far beyond the change in my account balance.
    Don’t use trading to hide from life. You are capable of dealing with the rough spots. And the markets will be there once you’ve taken a step towards resolving whatever conflict is going on.
    There’s always going to be conflict in a world of unique individuals. The trick is not to let them make you lose focus and lose sight of the big picture. (You do know what the big picture is, don’t you? Hint: it’s not money.)
  5. Always use stops. Yeah, yeah, “tell me something I don’t know,” right? But if you’re like most people (and me) too often you set a stop and then find some reason to move it. And then you look back after the loss and you can’t even remember how that reasoning ever made sense. Sound familiar?
    trader regretPlan your stops before you buy or sell. It’s part of the work. Then do the math. It’s cheaper to get stopped out and lose the commission than to lose another tic. (If your commission is more than tic value, maybe you should talk to your broker.)
    Do it in simulation over and over—getting out with the small, controlled loss—until it becomes instinct. Until you don’t feel a pinch of regret but the calm of relief.
    Pay the commission. It’s the price of the ticket. It’s cheaper than staying with a losing trade that is no longer satisfying you.
    While you’re doing the math, calculate this as well. Don’t just compare the loss to zero, the cost of standing aside. Compare it to the gain you could make being on the other side.
    Hands up if you’ve ever looked back at a losing trade and then thought about how much you’d have made if you had just reversed your position? It’s easy to do the math then. The trick is to do the math when it can still save you.

It’s worth remembering that part of the reason you take the loss is because some part of you, deep down, still thinks you don’t deserve the money.

That profitable trading is something other people get to do consistently and you only get to read about and experience occasionally. You’re still on the outside with your nose pressed against the window.

If that’s even a little bit true, then go back to resolutions 1 and 2. Get yourself physically energetic so you are calm and alert and at peace.

Then focus on gratitude and the abundance you already have. Say thank you for even the tiniest things: a good parking space, a smile from a stranger, finding money in a pants pocket while doing laundry.

Only from an abundance mindset can you watch money go away from you, in the form of a controlled loss or an act of charity or any expenditure, and immediately be able to say with sincerity and enthusiasm, “There’s plenty more where that came from.”

Here’s wishing us all a healthy, abundant, profitable, and happy 2014. It’s going to be fun.

A profitable calm: meditation for investors and traders

What if someone stood next to you as you traded or made investment decisions, saying terrible things to you? “What if you lose money?” “You’ve failed before and you’ll fail again.” “What makes you think you can do this?” “Another big loss and you’ll be devastated and alone.” Wouldn’t you throw that person out? Wouldn’t you take control of what people say to you as you work?

Would you be able to listen to any positive message or even just concentrate on your work? No, you’d be too busy reacting to the negativity from that person.

How about the opposite? A good mentor like in our trading room, a friend who says, “Don’t worry, you’ll get it next time,” and “Never give up,” and “It’s just money. You’re bigger than any profit or loss you might experience.” If you had such a friend, wouldn’t you keep her nearby, tell her to keep whispering in your ear?[pullquote]

How to meditate:

1. Repeat one action: breathing in and out, repeating a word or phrase
2. Any time another thought comes, just say, “Oh, that’s just my mind, thinking thoughts.” Let the thought float past.
3. Return your mind to just repeating the one action: another breath, the word again.
4. Continue bringing your mind back every time a thought floats by until you reach the time you committed to.
That’s it. Every form of meditation new or ancient is a version of this. There is no other.[/pullquote]

Now what if that person were you, yourself? We all face this inner struggle to remain confident and focused. It’s your highest priority–not your trading platform or which indicator or system or trading room you choose. Your thoughts and emotions are Job #1. You can’t control the markets or the Fed or other people. The only thing you can control is your own mind.

As more people realize this truth, meditation is fast becoming a standard part of business training and practice. Top business schools are including meditation courses, and meditation rooms and workshops are a routine part of company cultures.

Investors and traders, whose business is buying and selling risk, benefit from meditation in ways that can transform not only their profitability, but their ability to enjoy their work and the life it makes possible. Here are just a few reasons to incorporate meditation into your daily trading and work routine.

All the cool kids do it

Many successful people credit their success to meditation (and its religious cousin, prayer). Bond trading master Bill Gross of PIMCO leaves the trading floor every day to do yoga and meditate; Ray Dalio, founder of the $130 billion hedge fund  Bridgewater, says meditation helps him manage the chaos that comes with his job.

He also says it just feels good, which it does. The list of successful people who rely on meditation is long, and includes Tiger Woods, Rupert Murdoch, Bill Ford, Oprah Winfrey, Steve Jobs, Russell Simmons and Tony Robbins.

You don’t meditate just so you can be in a meditative mood while trading. Not everyone wants to be. The same way you don’t do pushups so you can do pushups while trading. Although a surprising number of traders do. You meditate to make your mind ready for the slings and arrows of the rest of the day.

Meditating feels great

Remember, people didn’t invent meditation because they were trying to be spiritual. They did it because it felt good, because it helped them think better and manage stress. All the dressing up and terminology came later.

Working across from the Board of Trade, you see plenty of people trying various mood-altering remedies, to deal with the ups and downs, the losses and gains. Bars have customers even before the close of trading. And some closed offices emit incense smoke and it’s a safe bet they are not devout Hindus or Buddhists inside.

It’s not only the downs of our financial and personal lives that are stressful. Our systems are wired for something called homeostasis. It’s like an internal thermostat that keeps our emotional temperature constant. This is why a wedding or lottery win can be as stressful as an illness or death in the family. My first big profit, an option trade in which I took 12,000 to over 100,000 in a couple of months, was so disconcerting that when I saw an ad for, an organization committed to fighting poverty, I just gave them the whole thing. Damn Bono.

Many of us meditate just because it feels so pleasurable, like a massage from the inside out. It can be hard at first. Some compare it to trying to harness wild horses. but after 10 good minutes of meditation, your body and mind undergo a chemical change.

It’s the opposite of the fight-or-flight response, something Harvard Medical School researchers call the relaxation response. Your body reduces stress hormones and increases happiness chemicals like serotonin. Another benefit is increased neuroplasticity, the ability of the brain to change in the face of changed circumstances. In the post-credit crisis economy, nothing is more vital. Other clinically proven benefits: better blood pressure control than hypertension drugs, better sleep, better skin.

Meditation leads to unshakable self-confidence


That one action that you repeat can be almost anything that isn’t harmful: running, walking, giving a massage, sex. I once got to secretly watch a great meditation master practicing. You know who he is. He used to live here in Chicago.

He still had his hair back then. I had just finished PE class and found the main gym closed. Someone told me the Bulls had reserved the Rice gym for practice before they faced the Rockets. No one was watching, so I snuck in. He was alone, shooting free throws. I quietly sat in the bleachers, wondering when I’d get caught.

He had the same pattern every time: bounce twice, pause, a little dip in the knees and then…swoosh. Then he would walk (not run) to get the ball. He only had one ball. Then he repeated the process.

He rarely missed, but when he did, he didn’t react. When he touched the rim, he didn’t react. When it was nothin’ but net, he didn’t react. He just went and got the ball, dribbled it back, and then: bounce twice, pause, dip, shoot.

He started a run of successful shots, ten, eleven. But instead of feeling my heart racing, I felt wonderfully calm, as though Michael’s detachment from the result had infected me. If I close my eyes, I can still remember the feeling. Somewhere around 17, I think, he bounced off the rim. He got the ball and came back.

Now I don’t know if he just noticed me then, or if he’d known I was there the whole time. He bounced twice, held the ball, then turned to me, smiled, and winked. Then he sank the shot. I took that as a sign to leave. There was no more to see.

A year after that, I was in Japan, studying aikido. In my three years there I meditated with great martial artists, kendo masters, Zen priests, even ninjas. Yep, actual ninjas. I have never seen a more powerful meditation than those ten minutes I spent with Michael Jordan.

Meditation is a way of proving to the only person you need to prove anything to, yourself, that you are the master of your thoughts and emotions. To do this is a great statement of self-worth, which may be why it’s so helpful in increasing your net worth.

Buy bonds, short Boehner

Bill Gross, CEO of the world’s largest bond fund, Pacific Investment Management, has made the rounds of financial news saying that PIMCO has bought several billion dollars’ worth of short-term Treasury bonds. He also told Bloomberg that the government was not going to default, period. He said what most have come to believe and what the market has almost certainly already priced in.

House Speaker Boehner looks ever more likely to suffer the same fate as his predecessor, Newt Gingrich, who lost the support of both Main Street and Wall Street and was seen as putting politics first. Sadly, Boehner was still in the game even as people were furloughed, poor elderly people lost their daily Meals on Wheels, and perhaps most sadly, 30 children with cancer were turned away from an experimental new treatment by an unfunded National Institutes of Health. Despite all that, the House GOP gets respect in some quarters for standing up for principle.

Official portrait of United States House Speak...

Official portrait of United States House Speaker (R-Ohio). (Photo credit: Wikipedia)

Until some started asking, what principle? That lost the voters (who might still matter despite Citizens v United and the legalized bribery it has created). But now, as Gross pointed out, the shutdown is already having a ripple effect that will harm U.S. exports, freeze up credit, and lower fourth-quarter earnings. Now it’s about money, and the people are beginning to see the shutdown the way markets already do: as an expensive nuisance. If John Boehner were a stock, people wouldn’t just stop buying shares, they would be selling him short.

Bonds are part of a web

In the interview above with Bloomberg’s Trish Regan, he explained in detail how the markets are a web and equities can be affected, the strength of alternative “safe havens” like the German Bund can be affected, and so on. His complicated replay may have seemed to most investors like they were getting caught in a web of information overload.

Right now it’s hard to distinguish fact from opinion, especially when someone as authoritative as Gross has his game face on and is talking up his multi-billion-dollar bond purchase. Hard to distinguish fact from opinion, certainty from prediction, calculation from guessing, or wishing, or hoping. It’s hard to know what the truth is.

As a result, it’s very hard to trade. The relatively small volumes and range-bound price action reinforce what floor traders in Chicago and New York have been saying, that a lot of the smart money is simply taking a break and not in the markets.

[pullquote]We fall back on the truth, of course. And the only truth is price.[/pullquote]Don’t believe for a second this is because of disgust at Congress or the president or Washington in general. Disgust has been priced in. The Republicans’ willingness to play games with the economy to get their way is priced in. President Obama’s refusal to negotiate on denying Obamacare to uninsured people for an extra year or two — already priced in.

The market has already decided where it will go and the orders are sitting in the plans of the collective, waiting to be executed. All the smart money that has left didn’t just leave. If this is like every shutdown before, they put in their buy and sell stops (mostly buy, the chart suggests) and they are sitting there waiting for the market to come to them. This is true of stocks and bonds.

So what’s a dumb, old-fashioned technical trader like me supposed to do when even the explanation of the web of interconnected market forces is information overload? We fall back on the truth, of course. And the only truth is price.

ZB 12-13 (60 Min)  10_7_2013

So what do the price charts of the Treasury bonds (ZBZ13) tell us? Let’s start by zooming out a little to a 60-minute chart. We have a double bottom with a clear break above the high between the two bottom points. That signals the start of a real uptrend.

How far up will that trend go? We see that it reached a 50% retracement of the previous drop that began in June. Then it stopped and has moved sideways, with slightly higher highs, for nine trading days. In the nine days prior to Sept. 25, bonds jumped from below 130 to this range.

Even if you didn’t follow the news, you’d have to know there was some unusual circumstance stalling the uptrend at this level instead of letting the market continue up to the Fibonacci 61.8% level at 134’20. This is an artificial hesitation. A fictional reason to stop here and enjoy the view for this long.

Of course there is the chance of bonds dropping, especially if a default becomes real. But even then, traders know that Treasury Secretary Jack Lew can simply continue paying the bills and make it a default in name only.

ZB 12-13 (15 Min)  10_7_2013

Let’s zoom in to the 15 minute chart and see if PIMCO did its investors a service in buying so many bond futures. Don’t make the simple needlessly complicated. If you were looking at this afresh, without any thought of what the government or other investors and traders are doing or what the TV people are saying — heck, if you didn’t even know what market you were looking at and believed as I and most successful traders do, that a chart is a chart — would you say the trend is up or down?

Up, obviously. Would you say there’s a clear sign that the market has topped here and then remained in a sideways channel at the top?

That’s rather unusual. What we most likely have—and let’s remind ourselves we are always dealing in probabilities — is a market waiting to go up further, at least to 134’20 and probably well beyond. You have an uptrend marked by higher highs and higher lows since Sept. 7, with little correction waves in between.

And now you have a sideways channel that isn’t precisely sideways but keeps finding slightly higher highs.

You really don’t need to know much else. Do what you do to manage emotion and enter into trades with confidence, have your checklist handy, write down your entry and exit plans and how you will set stop losses and control risk, then do what price is telling you to do.

Price is the only truth. Listen to the markets when they tell you the truth. Give up the need to tell the market what it should do or what you need it to do. The market isn’t listening. It’s talking to you. Tune out the noise and propaganda from Washington and everywhere else, including your own mind, and listen to the market. It will tell you how to trade it.

So did PIMCO’s Bill Gross make a good decision buying all those bond futures? It looks that way. Whatever impressive and complex analysis he gave Bloomberg and CNBC, in the end he decided that the trend was his friend.

Trading mistake #3: Forgetting you’re the hero of your story

Today’s trading advice is: see your failures as chapters in a larger story of success. Good traders see their work as part of a meaningful life and a higher purpose. You can’t trade confidently if you live in self-doubt and anxiety.

The original Mr. Top Step

The original Mr. Top Step

The thing is, planning for the success itself is easy. It’s pleasant to look forward to prosperity, respect, advancement. What’s hard is accepting, and even planning for, the setbacks and failures that are inevitably part of a well-lived life. If success is the opposite of failure, then is the key to success avoiding failure? How do you avoid failure?

The answer: set very low expectations for yourself. For example, last night I set the goal of eating dinner and watching TV by myself. Despite the challenges, I achieved my goal. Singlehandedly. If I fill my weekly schedule with similar items, by Friday I’ll have checked off a long list of mundane and pointless tasks and feel ever-so accomplished and successful.

I could design a whole life in which my ladder to success is more of a gentle slope dotted with easy milestones: have job most of the time, live in enclosed structure with indoor plumbing, enjoy relationship with not entirely repulsive significant other who is firmly resigned to the fact that I’m the best she can get.

Above all, ask yourself, am I the hero of my own life story?

Not the stuff of great novels, but entirely within my grasp. If this vision of a modest, easily-achieved, not entirely objectionable life doesn’t fire your imagination, ask yourself why. Why do we seek a life of challenge? Why flirt with risk? Why do we get inspired by quotes like the one from Helen Keller, who said, “Life is either a daring adventure or nothing”?

Is it ego? Do we all have an inner Napoleon (or an inner Madonna) who craves conquest and fame? Or is it more positive? Is our ambition something good, not only for ourselves but for the world?

The stories we tell for inspiration are never stories of self-doubt and settling for what is practical. The great stories are of heroes daring the impossible, or possibly impossible, enduring hardship and humiliation, growing and adapting with creativity and humor, but never, never giving up. Those are the stories we cherish. I urge you to think about what sort of story you are living. Above all, ask yourself, am I the hero of my own life story?

I believe we all have a right to see ourselves as the heroes of our own stories. Not the victim of circumstance, not a comic side character, not a villain waiting to be exposed, but the hero. When you think that way, you can remember that in every hero story, there are parts where the hero struggles: Cinderella sitting among the ashes, humiliated, alone, her true worth unrecognized.

And you need that part of the story to be there. If the story went: Cinderella was popular, rich, and never had any problems, and then she met a prince and lived happily ever after—well, nobody wants to watch that movie! You might want to live it. But then again, deep down, no you wouldn’t. It’s the struggle that makes the success mean something. It’s the essential part of the story.

When a friend of mine was going through a severe illness, I shared this idea with her, and asked her to write the story of her life, but with her as the hero, not the victim. I wanted her to see that if you only look at the chapter in which the awful stuff is happening, you might see it as just an ugly, sad story of a victim suffering. She was living that chapter then, and you can imagine she felt like a victim. She felt like a failure. She asked “Why me?” as anyone would. But writing is wonderful therapy, and this time she rewrote her story, so that the horrible chapter she was going through—her body failing her, her husband leaving her, etc.—was part of a larger whole—a story of which she was the hero and, indeed, the author, or perhaps co-author.

I knew something interesting was happening when she asked if she could make the story a fable. I said sure. Then she said, and I quote, “Can I be a fairy princess?”

Now, she was a high-powered executive, who lives in suits and leads a large organization. When I read her story, it was funny and touching, but nearly half of it was very detailed descriptions of what she, as a fairy princess, would be wearing. I said, “This is mostly costume changes! What about the important stuff?”

To which she replied, “What I’m wearing is the important stuff!”

But there was also a plot, and though the events were the same, it had gone from the story of a victim suffering, to that of a hero struggling. That is the key difference.

As I said, every great story has setbacks, heartaches, periods of great suffering. We put up with them because we know that at the end of the tale, those dark chapters lead to the eventual successes and without them, the hero’s successes wouldn’t mean anything.

When you are facing one of the dark chapters—in life or in trading—remember that you have the choice, to see that episode as one of a victim suffering meaninglessly, or a hero struggling meaningfully and creatively in the midst of a noble quest.

I hope you can see why this relates to trading and investing. Lots of people can teach you how to do it (and a number of them are at But only you can teach yourself why you must do it. Only you can decide that you are the hero of your own story and trading well is part of your quest.

7 Worst Trading Mistakes #2: Failure to take quick, small losses

You are going to face failure in life. So fail fast, learn from it, and try not to fail the same way again.

Failing fast and well is one of the keys to success.

Failure-as-learning-opportunityTrading works the same. Losses are a part of any successful trading strategy. The question is, how will you take your losses? Take them fast, take them as lessons, and take them with detachment.

Failure to profit comes from failure to take quick, small losses.

There are two ways to take losses badly in the markets. The first way is to hold on to a trade that’s going against you, long past any mental or actual stops that you had in your plan. You’re stealing money from your own account and handing it over to someone else. All because you can’t stand the idea that you might have been wrong.

You hate that idea so much you’ll pay money not to face it. You hate being wrong more than you love making money.

Well, that just doesn’t make sense. And yet we all have done it. Such is the power of an unchecked ego.

The second way is to overtrade. Keep jumping in and getting stopped out. You lose money and your broker collects commission. A good broker will stop you. Mine will, because in the long run, he makes money only if I prosper.

I wish there was a fancy, mystical cure I could offer you to cure yourself of this. But the cure is simple: just be aware that it’s happening.

Focus on how it feels in your body, the battle between the voice that says, “Just hold on a little longer, it’ll turn around, you’ll make it all back plus more,” and the voice that says, “We can’t afford this! We should have gotten out three points ago. But it’s too late now. I guess it can’t get much worse.”

Except, of course, that it can get worse. Lucky for us, there are other questions besides “Can’t we just hold on a little more and be proven right?” and “Can we afford it?”

Your mind will focus on whatever you put in front of it. So ask your mind a more useful question.

When a market starts going against you, ask yourself, “Would I do the same trade at this point?” Keep asking at every tick. If the answer remains yes, stay in the trade. The minute the answer is “No, I wouldn’t enter the trade here,” get out. Quickly. Run away and live to fight another day. There is no shame in taking a small, quick loss.

There is no shame in taking a small, quick loss. Make that your mantra.

Or at least remember that it is embarrassingly stupid to take a large loss after a long period of hoping and praying. Pray for guidance before the trade. Pray out of gratitude afterwards. But don’t pray while you’re holding on to a losing trade, unless it’s to ask God to forgive your stupidity.

OK, what if you have deep pockets and can take a large drawdown? If that works for you, great. But let’s say you’re long and the market has a huge drop. Wouldn’t it be better to short that drop? Again, ask yourself, “Would I enter into a long position at this point?” If your mind answers, “Of course not, I’d short this move,” then why aren’t you short?

Even if you’re strictly a buy-and-hold investor, it still makes sense to get out, wait, and then buy at the lower price once the trend is clearly upward again. More money, less heartburn.

Finally, don’t just make your stop a dollar amount. At first, you have to give the trade room to breathe and develop a trend. Then you can tighten up your stops. In your plan, before you enter the trade, find a level of support or resistance or a tested trendline and use that as your stop. Why? The market doesn’t know or care about the size of your account or your risk tolerance. It does remember and care about its own price levels.

Once you’ve found that price level, one which is significant to the market and affordable to your account, then honor your promise to yourself to stick to your plan.

Do it quickly. Do it ruthlessly. Do it before your ego has time to get a word in edgewise. Take the small, quick loss. You can always get back in, but only if you still have money.

It is your ability to take small losses quickly and without emotion, and not your ability to find insanely profitable trades, that will make you rich. It’s the only thing that ever has.

7 worst trading mistakes #1: Don’t overtrade

Crouching TigerYou’ll often hear traders saying to each other, “Don’t overtrade.” And often they’ll say it with a sad look and a shake of their heads. They may even invoke Ida, the goddess of regretful, retroactive afterthoughts. As in, “I wish I’da…”

Every trader has a story of a day they just got into the overtrading frenzy. If they were lucky, they got out because they came to their senses. Not so lucky, they got out when the money ran out.

They kept getting in and out of trades, chasing the market, seeing themselves get stopped out only to find they were right all along. Their timing was just off. Sound familiar?

Well, as in most things, timing is everything. You can’t have good timing when you are too eager. It’s like pulling a cake out of the oven before it’s done. All the ingredients are there. It’s just not ready.

We often hear that voice in our heads that sees a problem and says, “Don’t just sit there! Do something!” We have to learn to counter that urge with the equally important, “Don’t just do something! Sit there.”

And what do you do while you’re just sitting there? You’re studying your quarry, the way any good predator does before it leaps. When you watch a lion or tiger hunting on TV, you mostly see the pause and then the dramatic strike when it takes down its prey.

What you don’t see, because it would make for very boring TV, is the hours, even days of patient stalking. This is the real work of trading. Looking at charts, identifying price levels, planning entry and exit criteria, and then waiting for the market to come to you.

One mark of a great warrior is that he fights on his own terms or fights not at all.

—Sun Tzu, The Art of War

It helps if you keep your life in balance, so trading doesn’t become a hiding place from challenges you don’t want to face. You know, the important parts of your life. If trading is the best part of your day, stop trading. Go make your life better.

When you come back, the markets will still be there. And unlike the people who matter, they won’t have missed you a bit, however much you might have missed trading them. You are nothing to the markets. A tiny drop of added liquidity.

So you come back and you don’t have so much of that burning need to trade. It’s not the only good part of your day. In fact, it gets in the way of the good parts. But you do it because you’re good at it and it brings you money.

You come back, and you start again doing the work. You study charts, look at relevant news and information, identify price levels, plan your entry and exit criteria, and then wait for the market to meet your conditions.

Then you strike, like a predator, focused and confident and ruthless. Some traders only do a couple of trades a day. They save on commissions as well as stress hormones. And a couple of good trades is all you need.

In fact, some traders only do a few trades a year. I almost did that in 2008. By May I had made enough in options to take at least the summer if not the rest of the year off. Then in September I took up trading again. And I made one of the biggest mistakes. I traded the day after a big argument. With someone I love. My mother. Never trade after fighting with your mother. I should make that a separate trading mistake article, it’s so obvious and important.

When you’re not in the market, which should be most of the time, you do the work. The work includes studying the market, widening your view to monthly, weekly, and daily charts, then zooming in again. Do this especially after a loss, because you’ve already paid the tuition and you deserve to get an education from it so you don’t repeat the mistake.

Otherwise, the only lesson your brain will take from it is a false one: that you’re a lousy trader and there’s nothing you can do about it.

It’s addictive—the rush of adrenaline and hormones and neurotransmitters, the feeling of total focus, the way time seems altered, the way that all other problems seem to recede for a while. That’s why we’re willing to pay so much for that drug. But simply being aware that it’s happening is often all you need to control and master it.

If you feel you just have to trade, that’s a good sign that you shouldn’t.

Your trading mindset: A helpful thought experiment

YODAImagine a visitor from the future came to you and said, “I can tell you for certain that you will be a successful trader. I’ve seen the future and the results of your trading. You will profit in a way that is consistent and enjoyable and doesn’t depend on luck.”

Would you be glad to hear that?

Now, what if that visitor from the future then says, “Not only have I seen the end result, I’ve also seen the process that gets you there, and you will have to make some adjustments along the way. Is that all right with you?”

If you’d tell her yes, continue reading.

She then says, “You have a habit of being right about the market’s direction, but wrong about when to enter. You will have to carefully review the trades you have made, identify where you entered too early or too late, and change your timing. Are you willing to do that? Remember, I’ve seen your future and you do become a successful trader.”

If you’d tell her yes, continue reading.

What if she then says, “The easiest way to look back and review your trading and the thoughts and feelings that were going on is to keep a trading journal. Most successful traders keep one. Is that OK with you as well?”

If you’d tell her yes, continue reading.

Now what if she then says, “You also sometimes hold on to trades too long, hoping to milk every last dollar out of the move. Instead you teach yourself to stick to an exit plan and not be too greedy. I’m just telling you what’s on the path to that absolutely guaranteed success I’ve seen in your future. Is that OK with you?”

If you’d tell her yes, continue reading.

Now, what if she says, “You also sometimes fail to pull the trigger in time, and end up chasing the market and failing to profit even though you were right. You learn eventually to trust yourself. It’s not an easy path, but you do learn eventually. On that path to certain success I told you about. Is that OK?”What are you pretending not to know?

If you’d tell her yes…read on.

Then she looks you in the eye and says, “You finally learn, after a paying a lot of tuition to the school of painful experience, to have a plan and stick to it! Can you see yourself doing that? Remember, I’ve seen that successful future and the path to it is paved with carefully laid plans, executed with discipline and professionalism. Are you ready to become that kind of trader?”

If you would take a deep breath and say yes to that…well, read on.

Now, what if she says, “And the hardest part is that you need to unlearn some of the things you’ve been programmed to believe about money and about yourself. It’s not going to make people love you more, for example. You take a while to learn that, but eventually you do and it’s a big relief. Also, your parents, bless them, drilled a whole lot of guilt into you about whether you deserved success. You have to unlearn that, too. And there’s one more thing. It’s a big one …

To become great at anything, including trading, you have to come to terms with a powerful and difficult question, “What are you pretending not to know?” Are you prepared to do that? Because that’s what the future holds for you, at least that future that leads to you becoming a successful and happy trader. Is that path still OK with you? Because if it isn’t, you can still walk away from that path by not doing these things.”

If you’re still reading, then I assume you would have said yes to that imaginary visitor from the future. And that you’d be willing to make those adjustments along the path to a guaranteed, 100% certain future as a successful and happy trader. Ask yourself again: Would you like, no, love such a future if someone could come back in time and tell you for sure that it was waiting for you?

And would you be willing to make those adjustments in your thinking and trading that the visitor from the future listed, along the way to that guaranteed happy and successful future?

Then answer one final question: How is that different from the reality you are living in now?

The 6-year-old who called S&P 1701 back in April

We’re midway in our special Opening Print series of Fall 2013 Outlook commentaries from experts. We’ve heard from successful working trader-educators about harmonic patterns, technical analysis, and pivots. We’ve gotten perspectives on the stock market from traders in bonds and forex. I even put in my two cents’ worth. (That two cents is now significantly overvalued thanks to the price inflation conspiracy by JPM, Glencore, and Goldman.)

I wrote that trend-following lies at the heart of any successful trading method. Perhaps because of my bias, I saw nothing but a series of trend following methods from our wide range of trading experts.

A first-grader predicts the stock market rally

It reminded me of something that happened in mid-April of this year, when my nephew was only six and finishing up first grade. He came to my room one evening to say goodnight and see if he could sneak some screen time before bed. I had a chart of the E-mini up and I asked him where he thought the line on the chart was going to go. That’s when he did something fascinating.

ES-09-13-Daily-8_20_2012-8_20_2013.jpgWith his thumb and forefinger he measured out the corners of a rectangle, then measured out the same distance three times. He stood on my knees—Ouch!—looked down at me, and declared, “It will go to 700 and a thousand!”

“You mean one thousand seven hundred?”

“That’s what I said!” He turned back to the screen, did it again, and said, “No wait, 700 and a thousand and one.”

“Are you sure?” I asked.

“Uh, yeah. Before your birthday.” Then he added, “Can I play Minecraft?”

“No screen time on school nights,” I said. He hugged me and went to read The Hobbit. I went immediately to the screen and measured out with my fingers. They landed on August 2, before my birthday on the 15th. The median of the price bar that day, between the open at 1698 and the close of 1704.25? 1701.

See the forest, not just the trees

He followed the trend, which is and has been up since the beginning of the Obama administration. That’s not a political jab. Along with everything else the president inherited from George W. Bush was the upturn following the worst of the credit crisis. President Obama can’t and doesn’t take credit for that.  In fact, stocks have been on an uptrend since before he was born.SPX1960s.png

My nephew was able, in his 6-year-old’s way, to see the forest and not the trees. He saw a clear uptrend because summer was still a blank area of the chart, uncluttered by fluctuations and corrections. He didn’t predict the big dip of June. Neither did a lot of us.

Don’t leave money on the table or risk losses to finance your ego

But once the June correction was happening, it was only those with poor judgement and those with very deep pockets (and maybe a few with both) who simply held onto their long positions and rode it out. It’s not just that it was needless risk. There was money to be made shorting that nice big dip.

If you held onto your longs just to prove you were right, you were inflating the price of your own ego-satisfaction, much the way those banks inflated the price of aluminum. Goldman and their partners literally had the delivery trucks drive in circles from one warehouse to another. We drive our minds in circles, finding yet more bogus reasons why the market is just about to turn around and prove us right. Meanwhile, we’re leaving real money on the table.

A simpler, better way to catch both the long- and short-term trends

There’s a simpler way to be long in the longer term and short in the shorter term. As with everything on this site, this is a hypothetical statement and not meant to influence you to actually buy or sell any financial product such as a futures contract or option. Here’s the secret to being long in the longer term and short in the shorter term: be long calls, and then short the rallies once the short-term trend is clearly down for a little while.

I know I’ve disappointed those of you who want a buy-here-sell-here set of instructions instead of a story and advice about the attitudes of a confident trader, whatever his or her method. You can find consistently good recommendations in Danny’s morning call, though even there you can see him talking about attitude and confidence, and not focusing so much on the trees that you can’t see the forest.

Many ways to apply a few important principles

There are many ways to be long: buy out-of-the-money calls outright (which I love for the leverage), sell puts (though you wouldn’t do this if you’re shorting futures), or do bull call spreads, perhaps with a naked leg. A March 2014 1800 call bought on April 15 or so for under $500 was worth over $1600 on June 1.

And there are several ways to be short futures: scalping, taking one or two positions a day and holding for a few hours, or doing a multi-day swing trade. The hardest part of all of these is planning your exits, both the profit-taking one and the loss-taking, account-saving one. If you haven’t planned for how you will lose money (fast, early, and small fits the bill) you haven’t planned your trade. Trading includes losing, and therefore you must lose skillfully.

With all of these choices, I can’t tell you, nor can anyone else including our working professionals, how you should trade your money. That’s your job. Seriously, that is the job. It beats flipping burgers and waiting tables, trust me. Take the principles that guide all of us who consistently trade well and find your own way to apply them.

Does the method you’re using to trade right now feel right? Does it suit your temperament? I like calm, a leisurely pace, and risk control. I don’t like gambling, excessive risk, or too much adrenaline and testosterone. That’s why I like options. That’s why I day trade best when it becomes like meditation, relaxed, aware, and unemotional.

So is my nephew a trading prodigy? Maybe, but he didn’t have an exit strategy, one that guided both how he’ll take profits and how he’ll take losses. Which means for now, he’s just a smart kid. You and I, on the other hand, are or want to be professionals.

Tomorrow we’ll resume the rest of our Fall Outlook series. If you like what you read, click on the author’s name and read more of his or her work and consider signing up for their trading advisories or joining us in the IM-Pro chat room for a free two-week trial.

That’s all for now. I think I’ll go read The Hobbit and go to bed.