ollama-model-training-5060ti/training_data/text/db0d74ee3eb2ba5542f0943f7b8e994e1f3211b7a93aee04b5bfd56525c663f3.txt

BEST
LOSER
WINS
BEST
LOSER
WINS
Why Normal Thinking Never
Wins the Trading Game
Tom Hougaard

HARRIMAN HOUSE LTD
3 Viceroy Court
Bedford Road
Petersfield
Hampshire
GU32 3LJ
GREAT BRITAIN
Tel: +44 (0)1730 233870
Email: enquiries@harriman-house.com
Website: harriman.house
First published in 2022.
Copyright © Tom Hougaard
The right of Tom Hougaard to be identified as the Author has been asserted in accordance with the
Copyright, Design and Patents Act 1988.
Paperback ISBN: 978-0-85719-822-8
eBook ISBN: 978-0-85719-823-5
British Library Cataloguing in Publication Data
A CIP catalogue record for this book can be obtained from the British Library.
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which it is published without the prior written consent of the Publisher.
Whilst every effort has been made to ensure that information in this book is accurate, no liability can
be accepted for any loss incurred in any way whatsoever by any person relying solely on the
information contained herein.
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To the girl at the Bloomberg terminal
CONTENTS
Dear Markets
Preface
Introduction
Liar’s Poker
The Trading Floor
Everyone Is a Chart Expert
The Curse of Patterns
Fighting My Humanness
Disgust
The Drifter Mind
Trading Through a Slump
Embracing Failure
Best Loser Wins
The Ideal Mindset
About the Author
DEAR MARKETS
FROM THE MOMENT I first came across you, I have been fascinated by you. I
probably even fell in love with you. I was too young to know what that
meant, no more than ten years old. You were featured in a national
newspaper – a competition of sorts.
I was too young to play with you, so I observed. Time was not on my side. I
was born a few decades too soon to participate in trading like it is possible
today. I had to go and live my early life and you went about yours.
When you went through the devastating bear market of 1973, I was just
learning to walk. When you roared with anger during the crash of 1987, I
was just finishing school. When you took the first steps towards the epic
1990s bull market I was almost ready. But not quite there yet.
So, you sent me a message that would change my life, and I took you up on
the invitation, leaving everything behind me to pursue you. I studied you at
university, two degrees in fact. I toiled for hours and hours, trying to
understand you through the eyes of the conventional economic thinkers,
through the eyes of Nobel Prize recipients, and through the eyes of well-
meaning journalists and experts.
I wish you could have told me back then not to bother. You are not an
equation to be solved. You are far more complex than a model could ever
capture. Over and over, you prove yourself to be the elusive mistress that no
one every truly understands. You are everywhere and you are nowhere.
Universal laws do not apply to you.
My love for you was deep. You gave me so much joy. I gave you my all.
You were there when I woke up, and you were there when I went to sleep.
You have elevated me when I was fluid, rewarded me beyond my wildest
dreams when I was flexible. You have punished me when I was rigid and
stubborn, taking all your gifts back – with interest.
And boy did I pursue you. I pursued you like a lovestruck teenager. I
approached you from all angles, from Fibonacci ratios to Keltner Channels,
to Bollinger Bands, to Trident strategies, as well as mythical vibrations of
Gann and Murry Math.
I developed models of the tide swell in the Hudson River to see if you
responded to that. I printed out thousands and thousands of charts, applying
lines and circles, trying to find a way to dance with you so that my feet
didn’t get stamped on so much.
I had sore toes, my love. Sometimes my toes were so sore that I had to go to
the beach and just throw stones in the water for hours on end, angry that
you didn’t want to do the tango with me.
You gave me sleepless nights. You gave me tears in my eyes, anger in my
body, hurt in my soul, and yet I couldn’t let you go. I knew there was more
to it, and I knew I had to keep looking.
I gave you everything because you made me feel alive. You gave me a
purpose. You gave me challenges so hard even a drill sergeant would have
to give you a nod of respect. And I will always love you for it. You kept me
on my toes, like a parent wanting only the best for their child.
But you made the lessons obscure. You designed it to look easy. But it was
never easy. You made everyone believe that you could be danced with
through models, through equations, through indicators, through
conventional thinking and through logic. But often there is little logic to
you. And I struggled to dance with you for years, until one day by chance
you told me your secret. You told me to stop trying to understand you. You
told me to understand myself.
I stopped trading. I took the time to understand myself, and I came back.
And when I returned to the dance floor, you welcomed me with open arms,
smiled, and said, “Welcome back, I see you get it now. Did you bring the
band-aids?”
And I did. Best loser wins.
PREFACE
HOW YOU FEEL about failure will to a very large degree define your growth and
your life trajectory, in virtually every aspect of your life.
You may want to close this book and think about that for a while. It is quite
frightening how deep that sentence is.
What 99% of traders do not realise is that they are looking for answers in
the wrong places. Knowledge of technicals, fundamentals, indicators, ratios,
patterns and trend lines… well, everyone knows about them – and everyone
loses, except the 1%.
What do the 1% do that the 99% is not doing?
What am I doing, enabling me to have the success in trading that I have,
which the others are not doing?
The answer is as simple as it is complex. I am an outstanding loser.
The best loser wins.
I have conditioned my mind to lose without anxiety, without loss of mental
equilibrium, without emotional attachment, and without fostering feelings
of resentment or desire to get even.
It is because of how my mind works that I am able to trade in the way that I
do. My knowledge of technical analysis is average at best. My knowledge
of myself is what sets me apart.
The true measure of your growth as a human being is not what you know,
but rather what you do with what you know.
I wrote this book to describe how I transformed myself into the trader I am
today, and how I was able to bridge the gap between what I knew I was
capable of, and what I actually achieved.
INTRODUCTION
MY NAME IS Tom Hougaard. I am 52 years old. Thirty years ago, I left my
native Denmark. I wanted to trade the financial markets and I wanted to do
it in London.
I had an idea of what I needed to do to become a trader. I got a BSc in
Economics and MSc in Money, Banking and Finance. I thought I had
everything I needed to become a trader: the right kind of education; a good
work ethic; and passion for the markets.
I was wrong.
On paper, I was qualified to navigate the financial markets. In reality,
educational qualifications mean little in the dog-eat-dog world of trading.
This book describes the journey I went through to get to where I am today.
Where am I today?
As I type this, I have not had a losing day in 39 trading days. I run a
Telegram trading channel, where my followers witnessed me make
£325,000 in the last month alone – in real time, with real-time entries,
money management, position sizing, and ultimately the exit of the position.
No time delays. No lag. All done before their eyes – time stamped.
This book dispels the myths of what it takes to be a home trader, or any
trader for that matter. It has been a journey that saw me initially pursue the
path that everyone else takes – a lot of books about a lot of indicators,
patterns and ratios – before finally realising that the real answer to the
elusive quest for trading profits was right inside of me all along. It truly was
the last place I ever thought of looking.
A PROMISING BEGINNING
After completing my university degrees, I started working for JPMorgan
Chase. It wasn’t a trading job, but it was close enough. Then in 2000 I
became a home trader for a year and a half. It only lasted 18 months
because I ran out of money.
I had befriended the staff at the broker I traded with. They hired me as a
financial analyst. I say analyst, but I was a glorified media whore. My
mandate was to get the brokerage seen on TV and my credentials were an
understanding of technical analysis.
I started that job in the summer of 2001. My first customer-facing
experience was when the CEO brought me to Royal Ascot – a significant
event in the social calendar of the rich and famous. It is a horse racing
event, mixed with champagne, funny-looking hats and big cigars.
Only the best and most lucrative clients were invited to this VIP event. On
board the executive coach taking the prestigious clients to Ascot, I was
introduced as the new financial analyst. “Ask him anything,” declared the
CEO.
One client asked me what I thought of Marconi. Marconi was a member of
the FTSE 100. It had seen better days. It had declined from 1,200 pence to
450 pence over the preceding 12 months.
“Do you think Marconi is cheap?” asked a pharmacist from Luton.
I didn’t know it at the time, but my answer – and a similar one on TV a few
months later – would eventually get me fired from my job. Even if I had
known, I would not have changed my answer:
Marconi is garbage, gentlemen. Why are you chasing stocks that have
fallen in price? The stock market is not like a supermarket, where it
makes sense to buy toilet paper when there is a sale on.
Sure, it makes sense to buy toilet paper at a 50% discount, but it makes
no sense to buy a stock that has fallen more than 50%. Concepts like
‘cheap’ and ‘expensive’ may work in the world of Saturday grocery
shopping, but not in the financial markets.
My answer hung in the air like a morbid joke at a funeral. I had barely
finished my verdict before I noticed the death stare from my boss. All these
clients were long Marconi and they would go on to lose fortunes. Later that
year I was on CNBC and I was asked to do a chart analysis of Marconi.
By that point Marconi had fallen to 32 pence – from 1,200 pence. And still
people were buying it. I suggested that on the basis of the chart pattern,
Marconi would go to zero.
A few newspaper outlets picked up on the story and a few days later I was
called to the offices of Sporting Index. The CEO wanted to ask me if it was
possible to get these Marconi comments deleted from “that internet”.
Marconi went to zero and I was asked to find another job. Fortunately, City
Index hired me the same day I left Financial Spreads. I spent seven years on
the trading floor at City Index. In 2009 I was made redundant and I have
been a private trader ever since.
I have spent the last 12 years of my life perfecting my craft. I am what
brokers call a high-stake trader. The average stake size amongst retail
traders is about £10 per point risk. I risk anywhere from £100 per point to
£3,500 per point.
On volatile days I have traded in excess of £250 million in notional value. I
once made a little more than £17,000 in less than seven seconds. One time I
lost £29,000 in eight seconds.
That kind of stake size sharpens the senses. Yes, it is a great life when it
goes well, but a very challenging one when adversity sets in.
This book describes my journey from an unemployed financial broker in
February 2009 to the high-stake trader that I am today. But it is not a
conventional trading book.
JUST ANOTHER TRADING BOOK?
The world does not need more trading books. So, I decided not to write one.
I know enough about technical analysis to write a few books. I also know
that technical analysis does not make you a rich trader. It doesn’t even make
you a good trader.
I had no ambitions of wanting to write a book, but one day, while I was
watching a documentary on YouTube, an advert appeared on my monitor. I
recognised the face immediately.
It was a guy who once attended a few speeches I gave on technical analysis,
while I was working as a trader at City Index in London. Now he appeared
in an advert, promising to reveal the secrets to the financial markets through
his courses.
The advert proudly declared that if you wanted to learn to trade like a pro,
then this course was what you needed.
As it happened, a friend of mine had attended the course. It took place over
a weekend in some plush offices in London. The place was packed and the
hopefuls hung on every word of this self-proclaimed guru as he took them
through one chart after another.
There was no critical thinking present. No one questioned his claims.
Everyone left that office building on Sunday night thinking they would
make a small fortune by the coming Friday.
I saw the course notes. It was hundreds of pages of regurgitated material
from a standard textbook on technical analysis. There was no original
thought behind it. There were no new contributions to the field of technical
analysis.
Anyone with half an afternoon at their disposal could find the same material
free of charge on the internet. More importantly, my friend told me, the
guru never missed an opportunity over the weekend to pitch additional
products such as personal mentoring and the advanced course.
THOSE WHO CAN, DO
There is a saying that those who can, do. And those who can’t, teach.
I don’t agree with that. There are many people who “can” and who also
“do”. One is not exclusive of the other. Many great “do’ers” see it as part of
their life mission to pass on knowledge to those around them. When I
worked at City Index, I might not have been an oracle of technical analysis,
but I certainly knew more than most of our clients. For that reason I gave
technical analysis lessons most evenings to our clients and the many white
label clients that City Index had, such as Barclays Bank, Hargreaves
Lansdown and TD Waterhouse.
I truly enjoy passing on knowledge and I did the best I could with the
knowledge I had. However, what I didn’t realise back then was that
technical analysis is rather pointless unless it is combined with behavioural
response training.
My main beef with the many gurus teaching outrageously expensive
weekend courses is their outcome focus. They are driving their agenda by
the use of external stimuli, such as portraying themselves in a helicopter or
on a private jet, and they portray trading as an easy profession to master, or
one where there is a secret to be learned, and once in possession of this
coveted secret you become your own ATM. Rarely if EVER will these
gurus risk their reputation by disclosing their trades in real time. It is always
after the fact. We never hear about their losing trades. This gives the illusion
that losing is a mere inconvenience you experience from time to time when
trading.
It is only when you sit down in front of the screen on Monday morning,
after your overpriced weekend course on trading, and the market is moving
in front of you, and you don’t have the after the fact chart in front of you,
that you realise this game is not as easy as the guru told you during the
weekend course.
I have written a book that is an antidote to all the rubbish that is being
peddled in the trading arena by charlatans who are 99% marketing and 1%
trading. They preach their message to unsuspecting people – who sadly
believe them – with neither the teacher nor the student realising that they
only got 10% of the story.
More importantly, I have written a book which is all about the aspect of
trading they never teach you, and how to get to the top of the trading
pyramid.
While writing this book, I saw an advert for a technical analysis course in
my home country, Denmark. Only the year before, the person running the
course had lost 35% of their trading capital on a copy trader account for
their followers, before closing the account.
That is the problem with technical analysis. It is very easy to learn, but it
should not be touted as the path to untold riches in the financial markets.
The gurus appear on adverts suggesting that all you need to make money
from the market is to learn technical analysis.
I wish it was that easy, but it isn’t.
IF NOT TECHNICAL ANALYSIS, THEN
WHAT?
There is a law in Europe that states that brokers offering trading services to
retail clients must disclose what percentage of their clients lose money.
I looked up the major players in the industry. According to their websites,
around 80% of their clients lose money.
I called one broker to ask how this number was calculated. The number is
adjusted quarterly. The broker compares the account balances of its clients
from the prior quarter and simply takes the percentage of accounts that have
a lower balance than three months earlier.
If the answer to the trading quest was to study technical analysis, then you
would not have default rates of 80%. Incidentally, the guru who gave a
weekend course to my friend happens to also own a brokerage that he refers
all his attendees to. I looked up its default rate.
More than 80%!
So, either his clients are just awful traders, or he is an awful teacher.
I will come to the rescue of both camps and state that to become a profitable
trader, you need much more than just technical analysis under your belt.
That is why I wrote this book – to describe the path I have taken to get
where I am today. Over the last 20 years I have read many books on
technical analysis and trading techniques. I personally find most of them
boring and pointless.
All I see in these trading books is one perfect chart example after another. It
creates an illusion in the mind of the reader. They absorb these conceited
tales, written by traders who espouse the same material as everyone else –
material that bears little resemblance to the real trading world. It leaves the
reader blindsided to the reality of the trading arena.
Of course, there are exceptions. There are some good books written on
techniques and strategies, but most of them are garbage because the author
suffers under the illusion that he or she should only show perfect trading
examples.
They perpetuate the illusion that trading is an easy endeavour. I think it is
fair to say that with a failure rate around 80%, there is absolutely nothing
easy about trading.
I dare say that if technical analysis as a subject was comparable to
something like dentistry, the vocation would be terminated on account of
the 80% failure rate. You don’t have a 80% failure rate amongst dentists.
THE MILLION VIEWS YOUTUBE
TALK
I was invited by one of the biggest brokers in the world to give a talk about
the life of a home trader. They filmed the event, which lasted a few hours. I
gave the speech a provocative title:
Normal Does Not Make Money
The broker emailed me last year to say that my video had received five
times more views than their second-best video, and that it had now
surpassed one million views on YouTube.
This gave me the confidence to push ahead with the book project, because I
could see that my message resonated with an audience that wanted to move
beyond the conventional teachings in trading.
Although this is not a book about trading techniques, I am not arguing that
you can do without technical analysis, or some form of analysis. There must
be some rhyme or reason to your entries and exits, and your stop-loss
placement.
However, I am also arguing that techniques alone will not make you rich.
Analysis alone will not get you to where you want to be. I imagine you
want trading to give you a meaningful side income or perhaps even be your
main income.
I am arguing that a normal human being, displaying normal thinking
patterns and traits, will never stand a chance of making money trading. In
other words, normal won’t cut it.
One of the best books ever written on trading is Reminiscences of a Stock
Operator. There is not a single mention of trading techniques in that book.
Let’s face it, we can all learn to walk a tightrope suspended one foot off the
ground. However, can you walk across that same tightrope when it is
suspended 100 feet off the ground?
In the same vein, we can all trade bravely and aggressively when we are
trading one lot, but can you trade with absolute clarity and emotional
detachment when you are trading a 10-lot or a 100-lot?
I can’t guarantee you will trade 100-lots, but I will describe the process that
got me to trade that kind of size.
I am leaving no stone unturned. I have described every facet of life as a
trader, from the mundaneness to the excitement, and I have described the
exact steps I take every day, week, month and year, to ensure that I am up to
the job.
And let me immediately make an important declaration: I am not going to
sugar-coat my message. It is an insanely difficult profession, one that is
beyond the apparent mental abilities of almost everybody, yet at the same
time a profession that will reward you with wealth beyond your
imagination, once you understand how this game really should be played.
This book describes how to play the game of trading.
Now you know the end destination. If you don’t like the sound of it, now is
a good time to put down the book and go to the YouTube and TikTok videos
and watch the Ferrari-driving 20-year-old trading coaches tell you how it is
all done.
If, however, you want lasting change – not only in your trading, but in how
you live your life – then stay with me. Your transformation into a consistent
trader will permeate other parts of your life. It will give you a deep
understanding of who you are and what you can do to better yourself. The
end result is not just more money on your trading account, but a more
harmonious and exciting life journey.
LIAR’S POKER
MY JOURNEY AS a trader started when I came across a book called Liar’s Poker.
I was home from school with flu and my dad brought me some books from
the library. Liar’s Poker was one of them.
It is a period piece, written by Michael Lewis, the man behind the book The
Big Short, which was made into a Hollywood blockbuster.
In Liar’s Poker, Lewis describes life as a bond trader during the excesses of
the 1980s. In his own words it was meant to serve as a warning to future
generations about the gluttony of the finance industry, as well as a warning
to young people wanting to work in the financial industry.
I think it had the opposite effect. I suspect thousands of young men and
women like me read the book and thought to themselves that Wall Street
was the place to be.
The book describes a young man travelling from America to Britain to
study at a London university and subsequently being hired to work for an
American investment bank. It describes what it was like to work on a
trading floor and observe some of the big traders there.
I was hooked, and I knew trading would be my vocation. I have since read
many other trading books that are perhaps more specific about trading than
Liar’s Poker, but as a starter book, I could not have asked for anything
better.
My life changed after reading that book. It was a wake-up call. I went from
being a skateboard-loving football fanatic, to being a focused and driven
individual. I had found my calling.
I started applying to university degree courses around Europe. I already had
a job at a pension fund as an office trainee. After reading the book, I knew
that would not be my end destination.
I got accepted to a university in Britain for the following year, but I had a
problem. There was no funding. I had to pay my own way. I worked all
hours, day and night. During the day I would work at the pension fund, then
in the evening I would skate five miles to an amusement park to work there
until 1 am.
I absorbed as much information as I could from the Danish finance pages. I
would read English books to improve my language skills.
My family was less than supportive. On the big day of departure, I had to
make my own way to the airport. They eventually came around and shared
my trials and tribulations throughout the years. My sister once told me she
chewed her nails the first time she saw me on TV. She was so nervous I
would freeze on air.
MY FIRST BIG TRADE
There is a saying in the financial markets that perfectly sums up my first
brush with speculation. Don’t confuse talent with luck. I was blind to the
ways of the financial markets, but I got incredibly lucky.
It was September 1992. I had just been accepted to my university. I had
worked hard to earn enough money to finance the tuition fees and living
expenses for three years, although I was a little short. I figured I would
work through the holidays to make up for the shortfall.
As I was packing up my home and preparing myself to journey to the
United Kingdom for my first year as a university student, there was a
proverbial hurricane blowing through the currency markets.
The UK was a member of the European Exchange Rate Mechanism (ERM).
This was a system introduced by the European Economic Community to
reduce exchange rate variability and achieve monetary stability in Europe.
The UK joined the ERM in 1990, but by 1992 the UK was in a recession.
The Bank of England found it more and more difficult to honour their
commitment to maintain the British pound within a tight band against other
currencies in Europe. Speculators were actively betting against the pound,
thinking that it was heavily overvalued.
As I was walking to my local bank in Denmark with my savings, looking to
exchange my Danish kroner for British pounds, a major drama was
unfolding in the financial markets. It was called Black Wednesday.
On 16 September 1992 the British government was forced to withdraw the
pound from the ERM after a failed attempt to keep the pound above the
lower currency exchange limit mandated by the ERM.
I found the following information about Black Wednesday on Wikipedia. It
sets the tone well for what I was about to experience, and what caused a
massive windfall for a 22-year-old aspiring trader:
Soros’ Quantum Fund began a massive sell-off of pounds on Tuesday,
15 September 1992. The Exchange Rate Mechanism stated that the
Bank of England was required to accept any offers to sell pounds.
However, the Bank of England only accepted orders during the trading
day. When the markets opened in London the next morning, the Bank
of England began their attempt to prop up their currency as per the
decision made by Norman Lamont and Robin Leigh-Pemberton, the
then Chancellor of the Exchequer and Governor of the Bank of
England respectively.
They began buying orders to the amount of 300 million pounds twice
before 8:30 am to little effect. The Bank of England’s intervention was
ineffective because Soros’ Quantum Fund was dumping pounds far
faster. The Bank of England continued to buy, and Quantum continued
to sell until Lamont told Prime Minister John Major that their pound
purchasing was failing to produce results.
At 10:30 am on 16 September, the British government announced a
rise in the base interest rate from an already high 10%, to 12% to tempt
speculators to buy pounds. Despite this and a promise later the same
day to raise base rates again to 15%, dealers kept selling pounds,
convinced that the government would not stick with its promise.
By 7:00 that evening, Norman Lamont, then Chancellor, announced
Britain would leave the ERM and rates would remain at the new level
of 12%; however, on the next day the interest rate was back on 10%.
This was of course all unbeknownst to me, yet it had a material impact on
my studies. Had I walked down to the bank just a few days earlier I would
have had to pay close to 12 Danish kroner for one pound. By sheer luck I
walked straight into, and benefited from, one of the biggest modern-day
currency crashes, and I was able to convert my Danish kroner at an
exchange rate of about 9 kroner to the pound.
I made an extra £4,000 from my savings. My annual budget with tuition and
lodging was £2,500. ‘Uncle George’ made my university education debt
free.
Although the day was called Black Wednesday, many historians argue it
was a Golden Wednesday, because the cheaper pound attracted investment.
It set the stage for an economic growth spurt in the United Kingdom.
THE PRICE OF A HOTDOG IN PARIS
I wasn’t the only one who made a life-changing amount of money that day.
George Soros made a billion dollars. It cemented his name as one of the
greatest speculators of all time.
And he wasn’t the only one who had noticed stark value differences
between the European currencies before that fatal day in September 1992.
Another trader had too. Actually he wasn’t a trader at all. He owned a
printing company in East London. We shall call him the Englishman.
When I started working in the City of London, I heard the story of a client
who had been holidaying in France. During a visit to Paris, he found
himself buying a hotdog at a corner stand, down by the Eiffel Tower.
When it came to pay for the goods, the price for the hotdog was so shocking
to our Englishman that he was thinking the hotdog stand owner was trying
to cheat him.
He was assured that this was the prevailing price for a hotdog in Paris. He
decided to buy another hotdog somewhere else, just to make sure he had not
been cheated the first time around. The outcome was the same.
Our Englishman was laying the foundation for one of the greatest single-
man bets in the history of the retail trading industry. He walked into a
supermarket in Paris and started making a note of the prices for food, drink
and other household items.
Back in London our Englishman compared the French prices to the prices
for the same goods in his local supermarket, and he concluded that the
French franc was hugely overvalued. He called his financial trading house,
and spoke to a young broker, who was later to become my boss.
My boss loved to tell the story of how his client managed to turn a £5,000
account deposit into an £8m (that is eight million pounds!) profit. He
relentlessly pursued the idea that the French franc was hopelessly
overvalued, and he profited hugely from it.
The reason for sharing this anecdote is not merely to tell you a good story,
but also to prepare you for what this book is all about. You see, this might
have been a great story, had it not been for the fact that the client later went
on to lose all of that money, and then some.
Isn’t successful trading all about making the money and holding on to it as
well?
What 99% of people do not realise is that when you win, there are things
happening in your brain chemistry, which – if left unnoticed and unchecked
– will have a detrimental effect on your decision making.
ECONOMIC THEORY AND
ECONOMIC HISTORY
Studying at university taught me what there was to learn about economic
theory. It taught me how the financial markets were put together and how
current economic theory tried to make sense of the world around us.
However, it didn’t teach me how to trade. It didn’t teach me how
momentum, psychology and sentiment have a major influence on the
financial markets. My degree course did little to prepare me for the real
world. I thought that taking a master’s degree would change that, and while
it was a little more industry relevant, I still felt the market was a big
mystery to me.
The idea that you can test variables within an economic system by holding
other components constant didn’t sit well with me. I am not sure I was
consciously mindful of it then, but I saw the world differently.
I didn’t think that the markets were efficient. I had a strong belief that the
markets were anything but rational. The markets are driven by humans, and
if there is something humans are not, it is rational or logical when exposed
to stress.
RICH MAN’S PANIC
I enjoyed studying economic history more than I enjoyed studying
economic models. One of the pivotal moments came when studying the rich
man’s panic of 1903 and the panic of 1907. Bernard Baruch, a famed Wall
Street speculator, made a substantial amount of money by correctly
anticipating the consequences of a failed corner of a railroad stock.
A corner is when a group of people or a syndicate inflates the price of a
stock in order to create a buzz, thus trying to entice more gullible investors
to join the bandwagon, and then offloads the stock to the latecomers. Today
it would be called a pump and dump. Just think GameStop!
What made an impression on me was how Bernard Baruch anticipated the
sequence of events. He started to sell short a broad range of popular stocks
because he reasoned that the syndicate would have to raise money to keep
their ill-fated corner alive. He was right. The general market declined
rapidly. The Dow Jones Index fell 49% in a few months, and Baruch
profited from it.
From then onwards I found it difficult to study economic models. I found
them rigid and too theoretical in concept. I felt they made fallible
assumptions. They argued that humans always act rationally.
But mankind most certainly does not always act rationally. As I write this
page, I am looking at my quote monitor. The Dow Jones is called down 500
points. The DAX Index is already down 250 points. “Why is that?” I hear
you ask. It is because there is a serious virus called coronavirus spreading
through the world. Some 80 people have died already.
The market is not so concerned about the 80 people. The market is
concerned it is going to get worse. The markets are ALL about perception,
sprinkled with economic reality. I don’t understand the fundamentals behind
a virus, and I don’t need to.
My job is NOT to understand the implications of a virus. My job is to
understand the players in the market and what they are feeling. They are
scared, and I have spotted their fear. So of course I am short. I am not short
the market because I think a virus is going to wreak havoc on the global
economy. I am short because I think they think something terrible is about
to happen.
Whatever happens, my job is to read the sentiment and to keep my own
emotions in check.
That is essentially what I am going to teach you in this book. I am aligned
with reason when it comes to explaining bull markets and bear markets. The
health of the underlying economy will drive a market up or down. However,
as a day trader I need to have a mental flexibility that is never described or
accounted for in economic theory.
I also need to know “when to hold, and when to fold,” as Kenny Rodgers
sings in ‘The Gambler’. Am I a gambler? If I say yes, you might think there
is no difference between me and the guy who visits a casino for a bit of
excitement.
What if I were to tell you that I make more money than the average
professional football player, and I do so not because I am gifted with special
abilities to read the markets, but because I have learned to control my
emotions?
I am not an unemotional sociopath. I feel. I love. I cry. I ache. I mourn. I
laugh. I smile. You can be a nice guy and still finish on top. But you do
need to learn to think differently than the 99% does, when you are trading.
We will get to that soon enough.
JPMORGAN CHASE
After my graduation I interviewed for many graduate jobs within the
banking and finance industry. I didn’t get my dream job, working as a
trainee trader, but I did get a good job working for Chase Manhattan Bank,
later called JPMorgan Chase.
It was an invaluable experience. I arrived with a bagful of enthusiasm.
Working for an American investment bank was probably the best thing that
could have happened to me.
I was able to channel my enthusiasm for the financial markets into my
work. I worked with portfolio analysis and performance benchmarking,
which meant I was able to observe the financial markets unfold before my
eyes every single day.
I happened to sit right next to a Bloomberg terminal. I loved that machine. I
would often sneak into the office building on Saturdays and Sundays to
devour analysis and trading stories, and download data.
The great thing about working for an American bank is that there is a very
different work ethic to typical European companies. This may have changed
in the last 20 years, but when I was working at JPMorgan we were literally
allowed to work as many hours of overtime as we wanted.
I worked for JPM for close to three years, and in those three years I never
had a month where I didn’t do at least 40 hours’ overtime. You got used to
working long hours with focus because the job required forensic attention to
detail.
By the time I left the bank, I was a hardened and seasoned workaholic. I
don’t say that with pride, but I don’t think there is any point in hiding the
fact that the reason for my success was not due to immense intelligence, but
rather my work ethic. I just worked longer hours than the others. I made the
sacrifice for what I wanted.
My attitude reminds me of the ethos of Navy Seals, the American special
forces unit: anything in life worth doing is worth overdoing. Moderation is
for cowards.
My dream finally did come true, when I walked onto a trading floor for the
first time.
THE TRADING FLOOR
WALKING ONTO A trading floor is a special experience. I vividly remember being
interviewed for a trading job after my university graduation. This took place
on the trading floor of Handelsbanken, the Scandinavian bank, and the guy
who interviewed me was the head of trading.
I could tell that he was intensely focused on something else, and I was an
inconvenient distraction. I have been in that situation many times in my
trading life. Having a big position on in the market and then having to deal
with the trivialities of the world outside of trading can be a peculiar
experience.
Boxing Day 2018 is a great example. I was trading the biggest one-day rally
in the history of the Dow Jones Index, while eating Christmas pudding. I
had to hide my mobile phones under the dinner table so as not to offend my
host, and I had to fake numerous trips to the toilet so I could watch the chart
on one phone and the broker platform on another.
I arrived at the trading floor of Financial Spreads with a very different
attitude to most of my colleagues. As I know many of them will read this
book, I owe it to them to explain that I am not accusing them of being lazy.
I had lots to learn, including the fact that when the markets are quiet, there
really isn’t much for brokers to do.
What I found was that people would sit around and read the newspapers or
comic books. If the phone didn’t ring, you could hardly force a broker to do
anything. I think this was the biggest culture shock I experienced – the
contrast between a normal office job and a trading floor.
Working on a trading floor is intimidating at first. As the months go by, you
become immune to the money changing hands. It is all just numbers on a
screen. I once walked in at 6 am to find that a Russian client was on a
margin call for $10m. I quickly calculated that it would take me 133 years
on my current salary to make $10m. By 7 am he had wired the funds over.
This was a private trader. I was in awe. Inspired.
There is a unique atmosphere present on a trading floor. When it is busy, it
is nothing short of a gigantic melting pot of human emotions. I once saw a
colleague of mine kick his PC so hard – repeatedly – that IT engineers had
to come and replace it.
It is hard to fathom that the financial markets are a complex mechanism if
you just look at what is happening on a trading floor. It reminds you more
of a local market stall on a busy Saturday morning in any given town
anywhere in the world, where one stall owner is trying to out-voice the
next.
When you witness the raw, uncensored emotions that unfold before your
eyes on the trading floor, it is difficult to see how that fits into a finely tuned
global economic environment that makes up the very fabric of our modern
society and civilisation.
Impulse buying, panic selling, holding on to losses, refusing to admit
defeat, greed, stupidity, stubbornness, despair, tears, abject depression,
exhilaration and excitement are all on display here, and all in quick
succession of each other.
I worked for Financial Spreads for a year, and was then asked to leave. The
same day I was headhunted to City Index, which was owned by ICAP – the
biggest US government bond broker in the world.
City Index had about 25,000 clients, of which 3,000 were active most days.
These clients would trade currencies, commodities, stock indices, individual
stocks, options, bonds and anything in between. I must have witnessed tens
of millions of trades in my career, executed by thousands of people. Very
few, if any, of them stood out, and if they stood out it was for all the wrong
reasons. For every success story, I can tell you ten horror stories.
NO MEMORY OF THE GREAT
TRADERS
I recently spoke to a friend of mine, who is the CEO of a trading company
in London. I asked him if there were traders who had stood out during his
30 years working on trading floors. He said that over the years he had
witnessed many bizarre things, but in terms of good traders, he had seen
very few.
Here is a man who has spent his entire adult life on trading floors, yet he is
incapable of remembering people who did well. We are talking about a
percentage of successful traders so infinitesimally small that it makes you
wonder why anyone would want to trade in the first place, or if anyone
could ever get good at this profession. The conversation with him went as
follows.
Tom: You have worked in the contract for difference (CFD) industry for 30 years. You must
have seen some good traders along the way. Can you tell me about them?
CEO: I wish I could. I have seen many people make a lot of money, but very few managed to
keep the money. I started in the industry at a time when CFD trading was not a mainstream
tool. It was mostly very wealthy people or people who worked in the industry that had CFD
accounts. These clients back then often traded as part of an old boys’ club kind of network. It
meant they mostly traded specific shares and some commodities. Back then trading was
nowhere near as prolific as it is today.
Tom: Were they good traders?
CEO: No, I would not say they were. We had clients who were well-known personalities in
the City, and their personal trading was often atrocious, even though they were hedge fund
traders or fund managers. It was almost as if they lost their discipline when trading their own
money. I am certain they would not be allowed to trade for their clients in the manner they
traded for themselves.
Today we have far more smaller traders, but the pattern is remarkably similar between a small
trader and a large trader. Almost all clients have more winning trades than losing trades. As
such you could argue that they are good traders.
However, they tend to lose more, much more, on their losing trades than they win on their
winning trades. The ratio is that for every pound they win, they lose about £1.66.
Tom: How does a CFD broker make money out of that?
CEO: Well, believe it or not, we want our clients to win. I have a network of contacts in the
CFD industry. I regularly meet with CEOs of competing companies. Although we are
competitors, and we would do anything to outmanoeuvre a competitor, we do have one shared
wish. We wish our clients would trade better.
We try our best to help them. We give them every tool under the sun. We give them favourable
spreads, and we give them news services. We give them sophisticated charting packages. We
give them data. We give them analytical tools to measure their performance.
In short, we do absolutely everything we can to ensure they have all the tools they need to
make money. And then we let them trade. The problem is that most smaller accounts tend to
lose within a short space of time.
Trust me when I say I wish it was different. I don’t know what more we as brokers can do for
our clients. We prefer clients to make money because there is clear evidence that those who
trade and win, carry on trading. That is better for business.
The truth of the matter is that you can clearly see the difference between a consistently
profitable trader and a normal trader. Their approach is very different.
Tom: How can you tell whether someone knows what they are doing?
CEO: There are a multitude of parameters that we may look at. If I have to narrow it down to
the five most important factors, it would be these:
1. Account size.
2. Trade frequency.
3. Ratio of time spent holding winning trades versus losing trades.
4. Adding to winning or adding to losing trades.
5. Trading with a stop-loss.
Someone who opens an account with anything less than £100 will, with a very high degree of
certainty, lose that money, sadly. Someone who trades everything and anything, i.e.,
overtrading, will eventually lose their money.
Anyone who is unable to hold on to their winners, but holds on to their losing trades, will
eventually lose their money.
Anyone who adds to their winning trades will catch our attention (positively), but anyone
adding to their losing trades will, with near certainty, lose their account deposit at some point.
Anyone trading without a stop-loss will follow that path too. We sadly see it all the time.
As you can see, as brokers we do everything we can to help people make money, but people
are people, which means they will find a way to self-sabotage.
CONDITIONS 20 YEARS AGO
I keep an eye on all brokers, to make sure I trade with the best and cheapest.
Why would I pay 1.5 in spread if I can pay 1 in spread? That is simple
economics. I run a business, and I want to spend as little on transaction
costs as possible.
One of my favourite instruments to trade is the German DAX Index. Today
when I trade, I pay a 0.9 point spread in the DAX.
However, when I started trading some 20 years ago, the spread intraday in
the DAX was 6 to 8 points. I remember vividly trading the Dow intraday.
You had to pay an 8-point spread in the Dow for the intraday product.
If you wanted to trade the quarterly contract the spread was 16 points. This
was at a time when the Dow was trading around 10,000. Today I am trading
the Dow with a 1-point spread and the Dow is now trading around 35,000.
You are much better off trading in 2020 than you were trading in 1999. It
was much harder to make money trading back then. The market has to
move significantly less in your favour before you are at breakeven now,
compared to 1999.
Another major advantage that people who start trading today have is the
tools available from the brokers. Look at virtually any trading platform
today, and you will see the length brokers go to in order to help you make
money.
You have access to hundreds of technical studies. You have access to instant
news flow. You have the option to be trained through online material and
webinars. You have access to Level 2 data for stocks all over the world.
You have decent bid-ask spreads. If an institutional trader from 30 years ago
saw the tools that you are trading with today, he or she would be green with
envy.
You have at your disposal every single conceivable analytical tool available
from the vast resource pool of technical indicators. You have Bollinger
Bands, you have Keltner Channels, you have moving averages. You have
tools that I have never even heard of or used myself.
Suffice it to say, every broker in the world has spared no expense in their
effort to provide you with every opportunity to make as much money as you
possibly can out of the markets.
But it matters nothing. Most people will fail. The failure rate is
astronomical in the trading industry. No one is immune to statistics.
NORMAL IS A LOSER
There is something inherently wrong with the approach of people who are
trading. We have to assume that most people in society are normal, well-
adjusted human beings. Their pattern of behaviour, while leaving room for
personality, is most likely very similar.
From cradle to grave, from morning to night, from one year to the next, the
average person is engaged in a remarkably similar pattern: pattern of
thought, pattern of action, pattern of hopes and dreams, fears and
insecurities. We call that person normal.
If normal is the familiar pattern, and if normal is opening an account with a
CFD broker and proceeding to lose the money (sooner or later), then normal
is simply a representative of everyone else. Everyone who is normal will
end up losing.
Is that a push too far? Let us look at the evidence. Let us take a look at the
norm for a typical CFD trader in the retail trading space.
Even though your broker makes all the tools under the sun available to you,
no one is immune to the statistics of the financial markets. Unless you have
gone through some sort of structured training, or you have been schooled by
someone who is walking the path you yourself want to walk, or you give
this endeavour some serious thought, you will most likely fail in the
financial markets.
Look at any broker website in the European Union, and you will see the
failure rate. Brokers are obliged by law to post this on the front page of
their website. Here are some of the biggest and most well-known CFD
brokers in the world, and their failure rates:
BROKER FAILURE RATE
IG Markets 75%
Markets.com 89%
CMC Markets 75%
Saxo Bank 74%
FX PRO 77%
Rates correct as of 7 November 2019.
I know you like to think you are different. However, in the eyes of the
financial markets, you are statistically like everyone else.
You can look at the top ten brokers of the world and the statistics do not
change. You can look at CMC Markets, you can look at IG Markets, you
can look at Gain Capital, or you can look at any one of the top tier or
second tier CFD brokers. No one will have a failure rate less than 70%.
NORMAL IS NOT GOOD ENOUGH
Tools do not make you a top trader. Techniques do not make you a top
trader. If you want to be a good trader, if you want to achieve the level of
success that you know is possible, you immediately need to stop thinking
that the path to riches in trading has anything to do with the tools or
techniques you are using.
Yes, of course you need a strategy. Yes, you need a plan. Yes, you need to
understand the markets. So, what is this book all about, if it is not about
tools and strategies?
Well, let me address that question from a different perspective. Let me
address it from the perspective of the people who work in the industry as
brokers and sales traders and as marketing people.
Do they trade?
I would say it is likely they do not. Yet, traders are taking advice, guidance
and training from them; they being guided by people who are no better at
trading than they are.
It reminds me of Fred Schwed’s book, Where Are the Customers’ Yachts?,
in which he says that Wall Street is the only place in the world where people
who arrive to work by train and bus give advice to people who arrive by
limousine and helicopter (slightly paraphrased for a more modern touch).
Traders are being guided by people who can’t trade!
WRONG FOCUS
When you go to trading shows, read trading magazines or look at the online
education materials on broker websites, 100% of the focus is on what I call
How To:
•How do I scalp?
•How do I swing trade?
•How do I day trade?
•How do I trend follow?
•How do I trade the foreign exchange (FX) market?
•How do I use Ichimoku charts?
•How do I trade with moving average convergence divergence
(MACD) or stochastics?
This is perfectly normal. The trade shows and magazines are geared
towards providing the solutions that most people believe they need in order
to make money in the financial markets. The brokers are following the same
path. They provide the information that they think traders need and that
traders think they need.
Newcomers to the industry of trading are often guided by the very people
who are likely to set them off on the wrong path. They are led to believe
that it is all about technique and strategy – no one is preparing them for the
fact that it isn’t strategy that will set them apart from other traders.
It is how traders think about their strategy – and their ability to follow the
strategy – that will set them apart.
Do you not wonder if this is the right path for you? Do you not wonder
about the futility of dedicating all your resources to one pursuit, when
virtually everyone who walked that path before you has failed?
You should. You really should ask yourself what makes you different to the
90% of traders that do not make money. If you are normal – as in you do
what everyone else is doing – then you won’t make it.
NORMAL WON’T CUT IT
The organisers of one of these trade shows invited me to give a talk. This
show was in London, and I was told I could talk about whatever I wanted. I
decided to give a talk about the disastrous failure rate in the trading
industry.
My argument is that if 90% of all CFD accounts lose money, the problem is
a human problem. I feel I am making a reasonable assumption when I say
that everyone opening a CFD account is a normal person with a normal way
of thinking. There must be something inherently wrong in the way normal
people think and act that makes trading so unsuccessful for them.
IT SHOULD BE EASIER THAN EVER
TO MAKE MONEY TRADING
I mentioned previously how small today’s bid-ask spreads are compared to
20 years ago. Therefore, it should be easier than ever for traders to make
money. However, it isn’t.
People are still struggling to make money trading. My main premise of this
book is to get to the bottom of this conundrum. The approach I have taken
is centred around the following facts:
1. It has never been easier to trade. The IT infrastructure is superb for
traders.
2. The spreads have never been lower.
3. The margins have never been more favourable.
4. The tools have never been so readily available.
5. The brokers have never done as much for their clients as they do
now.
6. The stock indices have never been higher, meaning there is
volatility.
To reiterate, I assume that people who open trading accounts are normal,
well-adjusted human beings – without using this as a slight or an insult –
who are perfectly capable of functioning within society.
The questions I want to ask, and answer, are these: what does normal
behaviour look like? How can I avoid being normal when I trade? If we
assume that 80–90% of people trading are normal people, I want to avoid
acting like they do.
ARE YOU NORMAL?
My argument, provocative as it is, asks an essential question: are you
thinking like everyone else is thinking and approaching trading like
everyone else is approaching trading?
If so, you will have a problem.
If you think like everyone else, is it so strange that you get the results that
everyone else gets?
Let us take a look at what normal behaviour is.
Normal behaviour is to engage in a never-ending cycle of education,
looking for the next new edge. I knew from the moment I read Liar’s Poker
that I wanted to be a trader, but I never had any formal training in how a
good trader behaves. Why should I? I was always told that a good trader
buys low and sells high. But every time I bought low, it always went lower
and lower. So what kind of advice was that?
And yet this is the advice we listen to when we start. This is the benchmark,
and if this is the benchmark, then it is a miracle that it is only 90% that are
losing. It should be 100%, because buying low and selling high is a sure
recipe for ruin.
People will attend weekend courses hoping to learn secrets. People will
study and learn to use tools such as candlestick analysis, stochastics,
Relative Strength Index (RSI), MACD and moving averages. The list goes
on and on. All of this is normal behaviour in a nutshell.
EVEN THE BIBLE IS WRONG
Even the bible of technical analysis doesn’t do much to help a person on
their way, once the initial learning curve is over.
The bible of technical analysis was authored by Robert D. Edwards and
John Magee. The book is called Technical Analysis of Stock Trends, and it
has sold millions of copies since its first printing in 1948.
What most readers don’t realise, however, is that Edwards and Magee were
not the real creators of modern technical analysis. Rather, it was a little-
known technical analyst named Richard W. Schabacker.
A brilliant market technician, Schabacker codified almost everything there
was to know about technical analysis up to his time – which included such
pioneering work as the Dow theory of Charles Dow.
Between 1930 and 1937, Schabacker taught several courses to serious Wall
Street traders and investors. Unfortunately, he died in 1938 when he was
not even 40 years old.
Shortly before his death, Schabacker gave a mimeographed copy of his
lessons to his brother-in-law, Robert D. Edwards, who rewrote
Schabacker’s lessons with the help of his collaborator, John F. Magee, an
MIT-trained engineer.
As a result, it was not Schabacker who received credit for the original
compilation of technical analysis, but Edwards and Magee, whose work
became a perennial bestseller.
Let me be clear: reading a book like Technical Analysis of Stock Trends is a
must, but please don’t think that it will make you a professional, profitable
trader, any more than reading a manual on tennis will enable you to
compete with Rafa Nadal.
I see newcomers make classic mistakes after reading books on technical
analysis. They will study indicators such as RSI and stochastics, and they
will excitedly declare that a market is ‘overbought’ or ‘oversold’.
What they don’t realise is that ‘overbought’ is an emotional expression for a
psychological conceptualisation of ‘expensive’. The people reading a
stochastics chart are led to believe – through a mathematical manipulation
of data – that the market is now expensive, and it should be shorted.
The same can be said for ‘oversold’. It is another way for the mind to tell
you that the market is cheap, and that there is value associated with it.
I’ll give you an example. Yesterday was a particularly bearish day in the
Dow Jones Index and the German DAX 40 Index. I was short all day and I
had one of my better days, all verified and documented on my Telegram
channel. It was 1 October 2019.
Towards the end of the day, when the Dow Index was falling even lower, a
student of mine contacted me and asked me a very alarming question. The
conversation was in Danish, and I have translated it here.
“Tom, have you seen the stochastics indicator? It is deeply in ‘oversold’
territory. Do you think it is a good idea to buy now, ahead of the close?”
I reply: “Hmm, I am short… maybe you should ask someone else.”
He goes on to express his absolute shock that I am short, and a little later he
goes on to state that he has bought the Dow at 25,590.
Of course, when there is a buyer, there is a seller. However, I am not
convinced that buying the Dow Jones Index ten minutes before the close, on
a day where it has fallen 400 points, is a good idea.
It reminds me of the kind of thinking I would have done 20 years ago. Not
today though. If I buy the Dow on a weak day, just before the close, it is to
close a short position. I value my sleep too much to carry a position
overnight.
I said to him: “You had all day to find a short entry. What are you hoping to
achieve by being a buyer now? Are you thinking that because it has fallen
400 points, now it is cheap, and maybe just before the close, you may see
some buying of these cheap stocks?”
I used to think like that too. That was when I was not profitable.
The Dow didn’t rally into the close. There was no bounce. I am sure my
student didn’t lose a lot. It wasn’t so much his wallet I was concerned about
– it was his way of thinking.
That is what this book is about. It is about making you think the right way
about the market. That is where the 80–90% of losing traders tend to go
wrong.
CLOSE THE SCHOOL
If trading was a school, it would be closed. No school or university could
function if 90% of its students failed their exams.
We are all pretty much normal people. We fit in and function well within
the fabric of modern society. If every person engaged in trading is a normal
human being – and I assume they are, meaning they are well-functioning,
intelligent, considerate, hard-working – then why is there a 90% failure rate
in our industry?
That doesn’t make any sense at all. Usually when people work hard at
something they will succeed, or they will see some degree of success. That
doesn’t appear to be the case with trading. Other professions do not have a
90% failure rate.
If you go to the dentist, and you are told there is a 90% chance he will not
be able to fix your teeth, you are out of there like a shot. Yet, those are the
odds that face a private trader. But it doesn’t have to be like that.
As traders, we tend to engage in a never-ending, predictable cycle. We trade
well for a while. We are happy. Our discipline weakens. We lose money. We
strengthen our resolve, and we get more education. We do well for a while.
We lose money. We stop – sometimes for a while, sometimes permanently.
Sound familiar?
The sad part about this cycle is that everybody has good spells in trading.
Everybody has periods when they make money. Everybody has their
moments. I am sure you have too.
So what happens? What happens is that 99% of people do not know how to
lose. The emotions they experience when they lose cause them to act in a
manner which is not in their own best interest.
Emotions are response driven. Say you hear a funny joke, and you laugh out
loud. That is an emotion. When you hear the joke the next time, you don’t
laugh. Your mind has become habituated to the joke.
When you fall in love with a beautiful man or woman you experience
strong emotions, and your inner life is in beautiful turmoil. When you see
that person, you just want to express your love for him or her, and be united
with them, gaze into their eyes.
As time goes by, your loving turmoil is replaced with a sense of calm. You
love being around them, but the feelings of passion are less pronounced
than they were in the beginning. You have become habituated to the other
person.
A free solo climber, climbing intimidating rock surfaces without ropes, is
faced with severe consequences if they lose their grip. They acclimatise
their minds through years of practice, so that their amygdala – the
emotional response centre of the mind – is not firing on all cylinders when
they are climbing. They are calm.
An elite solider is scared to death the first time he is in a combat situation.
That is why his first combat situation will be a simulation. And the next
one. And the next one. And little by little, his fear is trained out of him,
through the use of repetition, breathing awareness and habituation.
For every hour you spend on technical analysis, you must set aside at least
25% of that time for what I call internal analysis. You need to know what
your weaknesses are. You need to know what your strengths are. You need
to know what you are good at, and you need to know what you are not good
at.
If you don’t spend time trying to improve these things, how will you get
better? Very few people, if any, will engage in that level of introspection in
order to gain the results they want. If making money trading is your goal,
and 99% of people lose, and 99% of people think analysis and strategies are
the key to trading profits, you can be 100% sure that strategies and analysis
are not the key to trading profits.
43 MILLION TRADES ANALYSED
There is a piece of research that makes for very interesting reading. It was
the brainchild of an analyst called David Rodriguez, and it is brilliant.
Rodriguez worked for a major FX broker, and he attempted to find out why
there was such a high failure rate amongst its clients trading currencies. The
broker had some 25,000 people who traded FX daily.
Rodriguez investigated all the trades executed over a 15-month period. The
number of trades was truly staggering. The 25,000 people executed close to
43 million trades. From a statistical point of view, that created a statistically
significant and immensely interesting sample space to investigate.
Specifically, Rodriguez and his colleagues looked at the number of winning
trades. I would like to give you an opportunity now to think about how
many trades were winning trades and how many trades were losing trades.
You can represent it as a percentage of the overall 43 million trades.
If you feel it has any influence on the answer you want to give, I can tell
you that most of the trades were executed in Euro Dollar, Sterling Dollar,
Dollar Swiss and Dollar Yen.
However, the vast majority of the trades were executed in Euro Dollar,
where the spread is very tight. Unfortunately, that doesn’t seem to make
much of a difference to the outcome.
62% of all the trades by the broker’s clients ended in a profit. That is a little
more than six out of ten trades. That’s a good hit rate. A trader with a hit
rate of six out of ten should be able to make money from trading.
Of course, it does depend greatly on how much he wins when he wins and
how much he loses when he loses. Therein lies the problem for the 25,000
people.
They were very successful in terms of hit rate. Yet when you look at how
much they made on average per trade and how much they lost on average
per trade, you soon realise that they had a major problem. When they won,
they made about 43 pips. When they lost, they lost about 78 pips.
There’s nothing wrong with having a system where you lose more on your
losing trades than you win on your winning trades. However, it does require
that you have a sufficiently high hit rate in order to absorb the losing trades.
A colleague of mine, a professional trader from South Africa who trades at
a hedge fund, has a hit rate of about 25%. I tell his story in greater detail
later in the book, but let me explain the term hit rate in the context of his
hedge fund.
When his hedge fund loses on a trade, they lose 1X. When they win, they
win as high as 25X. It stands to reason that my friend is immensely
profitable even though he doesn’t have a convincing hit rate, at least not
from a traditional perspective.
What I find particularly interesting is how much bad advice there is in the
trading industry. You will often hear traders talk about risk-to-reward ratio,
which in itself is fairly innocent, unless the trader takes it literally and
applies it on a trade-by-trade basis.
When I call out trades in my live TraderTom Telegram group, I will always
announce a stop-loss. Always! However, I often get asked if I have a target
in mind. The answer is quite often a little sarcastic: “No, my crystal ball is
out for repairs,” or if I am particularly grumpy and tired, I will be rude and
say, “Sorry amigo, but do I look like a fortune teller to you?”
Yes, I know – that isn’t very polite. I’m sorry. Ignoring my blatant inability
to be polite when I am faced with the same question for the 450th time,
there is a deeper meaning to me not calling targets on my trades. It has a lot
to do with risk versus reward.
RISK VERSUS REWARD
I personally find the whole risk-to-reward concept enormously flawed, but
since I am the only one who ever talks about it, I accept that I am probably
wrong. Still, hear me out.
How on earth do I know what my reward will be? I literally do not know.
Even if I pretended to know – say, by using a measured move calculation or
a Fibonacci extension – I know myself well enough to know that I will have
added to my trade along the way. When it got to my target, I would not
close it, because that is my philosophy.
I would kick myself if I closed a trade at my target, and then it went even
further. I would rather give away some of my open profits than miss out on
potentially even more profits.
Now I am probably making a big fuss out of nothing, but targets are not for
me. I want to see what the market will give me. I am prepared to accept that
this may mean I will give away some of my open profits. I have lost count
of the number of times I have had a 100-point winner in the Dow, which
then turned into a zero.
A week before writing this (all documented of course) I had one such
winner, which turned into a big fat zero. Some less-than-happy traders
confronted me in my live trading room as to why I had not taken my profits.
It is difficult to explain, but it is all to do with pain.
It gives me much less pain to kiss a 100-point winner goodbye than it does
to take my 100 points, only to see the market moving even more in my
favour.
It is because of this philosophy that I am at times able to make 400–500-
point gains, as I did today. It is one or the other. I don’t think you can have
the best of both worlds!
INTERVIEW WITH CNN
In an interview with CNN some years ago, I was asked about the traits of
winning traders. In this very candid interview, I highlighted a few points
that I felt differentiated the winning traders from the losing traders. It was
based upon my experiences from observing millions of trades by retail
traders, while I was on the brokerage trading floor. Here are the main
differences I identified:
1. TRYING TO FIND THE LOW
When the market is trending lower, whether intraday or over a longer time
frame, there seems to be a tendency for retail traders to attempt to find the
low of the move.
Whether that is out of a desire to buy cheap, or because they use ineffective
tools, I simply don’t know. What I do know is that this trait is immensely
damaging to anyone’s trading account.
Winning traders seem to be much more trusting of the prevailing trend. This
attitude adjustment may seem trivial, but it literally makes the difference
between the winning trader and the losing trader.
Over time the losing trader will repeat his distrust in the prevailing trend
and will take positions against it. He will do so because from an emotional
standpoint it appears as if he is buying a market that is cheap or selling
short a market that is expensive.
This is emotionally satisfying, like buying toilet paper at a 50% discount
from the local supermarket, but the financial markets are not supermarkets.
There is no ‘cheap’. There is no ‘expensive’. There is just the prevailing
price.
The winning trader, however, is not emotionally attached to an idea of
‘cheap’ or ‘expensive’. He is focused on this moment right now, and in this
moment right now the market is trending, and he trusts this trend and can
unemotionally join this trend without internal discomfort.
2. TRYING TO FIND THE HIGH
The opposite also holds true. When the market is trending higher, traders
tend to want to find a place to sell short. Although it must be said that
people are generally better at jumping on board a market that has already
risen than they are at jumping on board with a short position in a market
that has already fallen significantly.
If the market has moved higher by a significant amount, especially in the
very short term, retail traders tend to want to fade the rising prices, i.e., they
look to establish short positions. Again, this is probably the result of a
distorted view of things being cheap and things being expensive.
3. THINKING EVERY SMALL COUNTER-MOVE AGAINST
A TREND IS THE START OF A NEW TREND
I have sat on a trading floor through the darkest days of the financial
markets. For example, 15 September 2008, when Lehman Brothers was
declared bankrupt, the Dow Jones Index fell 4.5%.
Throughout that trading day, there were two attempts to rally. Both failed. It
was tragic to see how many clients tried to buy the low of the day, only to
see the Dow move lower and lower.
Whenever there was a single green candle on the 5-minute chart that day,
we saw the buy order flow into our position monitors on the trading floor. It
seemed as if the clients were possessed by the notion that a low was near,
and that they had to be the one buying it.
The low didn’t come that day. Nor the next day.
This is a common trait amongst traders. They think that every single little
counter reaction against the trend is the beginning of a new trend. More
fortunes have been lost trying to catch the lows in a falling market than in
all wars put together (okay, this is an unsubstantiated statement made for
emphasis, but please don’t attempt to catch lows).
It seems obvious to me that newcomers and probably also some seasoned
traders – profitable or unprofitable – believe that successful trading is all
about charts.
This belief is a detriment to their accounts, because no one ever took the
time to tell them otherwise. No one told them, or thought to tell them, or
knew enough to tell them, that actually focusing all your time on your
charts is a mistaken strategy. We’ll look at this further in the next chapter.
EVERYONE IS A CHART EXPERT
I ONCE DECLARED IN an article that you can learn the basics of technical analysis
over a weekend. I may have exaggerated a little – but only a little.
I know without an inkling of doubt that a chart expert does not equate to a
trading expert. I have seen so many of my trading friends build impressive
libraries of technical indicators and acquire knowledge about both known
and obscure technical indicators. But it didn’t translate into making more
money. When it comes to charts, less can be more.
Charts can be as simple or as complicated as you want. There seems to be a
tendency amongst traders to make charting more complicated than it really
needs to be. I have seen many new traders plaster their charts with so many
tools that they can barely see the price chart itself.
It surprises many people, especially newcomers, when they see my chart
screens. There is not a single indicator on them. Not a single one. I might be
old fashioned, but I don’t need these extra tools.
My job as a trader is to find low-risk trading setups. My approach to trading
is not centred around any other tool than price itself. All indicators – more
or less – are built from time and price. Therefore, the indicator is a
distortion of the reality I am seeing right in front of me.
The markets can be range bound, or the markets can trend. Some indicators
work well in ranging markets. These usually perform terribly in trending
markets. Other indicators work well in trending markets, but are dreadful to
use in range-bound markets.
As a famous trader friend of mine, Tepid2, once said on the now-defunct
trader feed Avid Trader: “Indicators – they all work some of the time, but
none of them work all of the time.”
I think that many of the 90% of people that lose money trading may very
well have excellent chart reading abilities. They can read charts very well,
and they understand patterns too.
However, I happen to think there is much more to trading than knowing a
head and shoulder formation, a bar chart pattern or a Fibonacci ratio.
I have seen outstanding traders juggle millions of pounds worth of stock
index futures contracts using nothing but a simple ten-minute chart. In fact,
I do that myself every single trading day.
I truly believe that what separates the 1% from the 99% is how they think
when they are in a trade, how they handle their emotions when they trade.
That is not to say that there is no merit to learning the craft of chart reading.
I know from my own experience that chart reading is an absolute must for
my decision making, but that is only a small part of the whole trading
picture.
The proliferation of gurus selling trading courses is evidence there is a
demand to learn the art and craft of trading. I suspect the ‘shortcut’ of a
weekend course is a much more appealing proposition than spending that
time reading books.
If a guru holding a weekend course on trading claims that you will be
qualified to trade “like the millionaire professionals” by the Sunday night,
then the unsuspecting will select that option. It is perfectly natural to expect
a human being to drift down the path of least resistance.
Learning any new skill takes time. So when you see an advert saying “learn
a new language in 30 days”, you might not believe it consciously, but
subconsciously you want to believe it, because people love shortcuts.
Similarly, a diet book that promises you will lose 5kg in a year is unlikely
to sell as well as one promising you will lose 5kg in two weeks.
My philosophy to life is different from so many other people’s. This is the
reason I have what so many people dream of. I will choose the path of most
resistance, because I know I need to stay clear of the opinion of the 99%.
If you think I am conceited, then you are thoroughly mistaken. I have no
inflated view of myself. Quite the contrary. I decide carefully what I want,
and then I work towards it. This book reflects that ethos.
You truly can be a master trader. You truly can live in the house you desire,
with the cars you desire in the drive. BUT you must believe me when I say
that in order to get what you want, you need to think like the 1%. In fact,
you don’t even need to think like the 1%. You just need to not think like the
99%.
The following trade is a good example of how mindset trumps technical
analysis any day of the week. In this example I short the German DAX 30
Index.
I get stopped out for a loss. I kick myself, because my stop-loss gets
exceeded by a point or so, only to reverse back in my favour. My stop was
too tight. Rather than lose my composure, I dismiss it.
Let me pause for a second. Do you know why some athletes let out a shout
of frustration when they are not performing well? I thought about it for a
while, after I saw Serena Williams shout when she lost an important point
in a Wimbledon tennis final.
I think they let out a cry because it is a way to reset the mind, to come back
into balance and get into the zone again. The act of letting out a cry helps
them get rid of the frustration and find their inner peace and balance again.
I re-enter a short position at 14,479.80. The screenshot below is from the
time of the trade.
    AmountOpen PriceCurrent PriceOpen P/L
Germany 30Sell 200
12479.812478.5
€ 260.00
Wall Street 30Sell 200 27044 27046 −$500.00
The chart at the time of the trade looks as shown in Figure 1.
Figure 1
Source: eSignal (esignal.com)
The DAX had gapped up. Did you know that only 48% of all gaps get filled
on the same trading day?
By the third trading day after the gap, 76% of gaps were filled. Why am I
telling you this? Don’t believe trading books stating that all gaps get filled.
They do not!
I short the DAX because the second bar on the chart is an inside bar – from
the first ten-minute bar at the open. The third bar closes below the lowest
point of the inside bar. Now I have a sell signal, because the first bar’s high
is at the same price as a prior high – a double top. I have a stop-loss in
place. I have done my job as a trader. I have identified a low-risk entry
point, and I have placed my stop-loss.
At this point in time, I am at the mercy of the markets. Maybe this will be a
great trade. Maybe it won’t. Who knows? No one knows. Before I carry on,
I would like to ask YOU a question. It is a question for you to ponder upon.
Say you believe in the whole risk-to-reward argument, and you decide that
you have a 40-point profit target. You decide upon a 40-point profit target
because you risked 20 points. So, you argue that risk-to-reward is 2:1, two
units of profit for one unit of risk, which sounds good.
It all sounds great, and there is virtually no textbook on trading that would
argue against it. But I am arguing against it. I want to ask you some simple
questions.
If you make 40 points on this short position, and the market continues in
your favour, how will you feel? How will you feel if a few hours later you
see the market down a further 100 points from your exit?
I think the risk-to-reward concept has been designed by an academic who
does not understand risk and the mind’s association with risk. I think this
academic has created a method to keep his mind at peace, in order to avoid
pain.
Fifty minutes later the DAX is filling the gap. This is shown in Figure 2.
The position is in profit.
Figure 2

Source: eSignal (esignal.com)
A colleague of mine has followed my trade. The chart is looking good for
us. We are in a conversation about the trade. It goes like this:
Friend: I am tempted to take my profit. Do you have a target for this trade?
Tom: Amigo, I don’t trade with targets. Let’s see what the market will give us. Stop-loss is at
breakeven. We can’t lose.
Friend: Yes, I know. But yesterday was a poor day of trading. I lost 150 points. I read the
market poorly. I had an idea, and the idea didn’t work out. Either way, I lost 150 points. If I
close my DAX position right now, I can make up for the lost trade this morning, and I can
recover a lot of the points lost yesterday.
What do you think?
Tom: I think you are trading yesterday’s experience. You haven’t wiped the mind-slate clean.
You are not present. You are focused on the past. You are trying to get back to an emotional
equilibrium. You are in a state of imbalance because you are unable to shake the loss from
yesterday. As a result, you are not judging the trade on its own merit, but on the merit of a past
trade. You are not seeing the world as it is. You are seeing it as you are.
I understand it is a soothing thought to close the trade. However, we are not trading to break
even. We are trading to make money.
Can you appreciate that trading is a mind game? It is a game of nerves. My
friend was understandably shaken from his loss yesterday. He carried the
loss over to the next day. It affected his decision making.
Back in 2007 I was invited to the Wimbledon tennis final. My friend was a
big name in the media industry, and none other than Ralph Lauren had
invited her to the tennis final – with a guest. So, there I was in the VIP tent,
and I got to sit next to Luke Donald, who at the time was one of the best
golfers in the world.
He is a softly spoken man, and very polite. We got talking about Tiger
Woods, and I asked him a pretty to-the-point question about competing with
Tiger.
“Is Tiger Woods a better golfer than you?”
I found his answer so incredibly insightful that I never forgot it. He said:
I don’t think Tiger is a better golfer than me, if you measure it in how
well we putt, or how far we hit the ball, but Tiger Woods does have an
amazing ability to forget his mistakes and move on.
For example, we can be on the 15th and both make a bad putt. By the
time we get to tee up on the 16th, it is as if Tiger has wiped his mind of
whatever happened on the 15th, and he is totally in the moment.
I, on the other hand, will still deal with the mistake I made on the 15th,
and it will affect my performance on the 16th.
That is a truly insightful perspective of what really separates the very best
in a chosen field. It is the mind, and what it processes at any given moment
in time. Is it working with you or against you?
COGNITIVE DISSONANCE
My friend is having a ping-pong dialogue in his head, arguing for and
against taking profits. I am no stranger to that conversation. I may have
many years of trading experience, but I still have those thoughts in my
head. I am just mindful of them when they arrive. When they do, I focus on
the chart and what it is telling me. I don’t look at the profit and loss (P&L).
What my friend is experiencing is known as cognitive dissonance. In the
field of psychology, cognitive dissonance is the mental discomfort –
psychological stress – experienced by an individual who simultaneously
holds two contradictory beliefs or ideas in their head.
This discomfort is triggered by a situation in which a person’s belief clashes
with new evidence contradicting that belief. When confronted with facts
that contradict beliefs, ideals, and values, people will try to find a way to
resolve the contradiction to reduce their discomfort.
The best way for your rational mind to resolve the discomfort of a
profitable position is to close it. The best way for the rational mind to
resolve the discomfort of a losing position is to let it run.
In his 1957 book, A Theory of Cognitive Dissonance, author Leon Festinger
proposed that human beings strive for internal psychological consistency to
function mentally in the real world. He says that a person who experiences
internal inconsistency tends to become psychologically uncomfortable and
is motivated to reduce the cognitive dissonance.
One way to achieve the goal of reducing the discomfort is by making
changes to justify the stressful behaviour, either by adding new
unsubstantiated or irrelevant information to the cognition, or by avoiding
circumstances and contradictory information likely to increase the
magnitude of the cognitive dissonance.
In my friend’s case, he is conflicted. He is associating pain with the
performance of yesterday. He has an opportunity to eradicate the pain by
closing his profitable position right now. The way he justifies this reasoning
is by ignoring the information the market is giving him about his position.
The market participants agree that the market should be sold short, but
instead of acknowledging this, he is ignoring it.
From a logical point of view, this all makes sense. From an emotional point
of view, this is an inconsistent approach to trading. Our trades from
yesterday have no bearing on the markets today.
It is a new day. It is a new set of circumstances. Yet to most people’s minds,
the two trading days are connected. To our minds we are continuing today
what we did yesterday. “Why wouldn’t we be?” we tell ourselves.
Are you telling me that you can ‘reset’ your emotions every morning? Are
you telling me that you can go to bed at night after a blazing row with your
loved ones, and wake up reset and emotionally in equilibrium?
I doubt it; at least, not without a conscious effort. It is for this reason that I
warm up ahead of the trading day by going through a process. We cover that
later in the book. It is, after all, what the book is about. It is a recipe book
for methods to avoid the pitfalls that the 90% experience.
Now, what is the source of my friend’s turmoil? It is fear. Pure and simple.
He is afraid he will lose what he has made on paper. He is desperate to get
back to an emotional state where he is at peace. He is no longer trading the
charts. He is no longer trading the markets. He is trading his own mental
wellbeing.
FEAR
My friend is fearful. He is afraid that the money he lost yesterday will not
be offset by the good trade he has going now. He is afraid that the profits he
is currently experiencing will diminish, or in the worst case disappear.
He acknowledges that he can’t lose on the trade. The stop-loss is now at
breakeven. Unfortunately, that gives him little comfort.
I once saw a quote that made me smile: everything you ever wanted lives
on the other side of fear. Yet fear is a necessity in our lives. The human
brain is a product of millions of years of evolution, and we are hardwired
with instincts that helped our ancestors to survive. We need fear to ensure
survival in certain situations, but many of the fears that we carry are not
appropriate for our trading.
Our minds have a primary function, which is to protect us against pain. If
you introduce big drastic changes in your life, you are likely going to come
face to face with that pain. A clever way to build staying power during
change is to introduce that change slowly.
Say you set yourself the ambitious target of running a marathon. You
achieve this goal by building up your body and mind for the task. Trading
big size is exactly the same process. You need to give your mind time to
learn to handle the mental anguish that comes from losing when the stakes
are bigger.
There is no point in comparing yourself with others. Sure, take inspiration
from others; but know this is a personal journey, and your job is to achieve
an equilibrium mindset, no matter what size you are trading.
PHILIPPE PETIT
I saw a documentary about Philippe Petit a long time ago. Petit was a
French artist who strapped a wire between the two World Trade Center
buildings and then walked across it – several times.
What struck me about the incredible feat was the preparation.
It took Philippe some seven years of physical and mental training to
accomplish the feat. Did you think he just set off and hoped for the best?
No. In fact his original training height was quite modest compared to the
altitudes he would eventually reach.
Philippe Petit is a fascinating character; he is someone who has had to deal
with fear at a level beyond that which the rest of us have. I have learned a
lot about fear and identifying my own shortcomings by studying his
approach to his craft.
VISUALISATION
“Before my high-wire walk across the Seine to the second story of the
Eiffel Tower, the seven-hundred-yard-long inclined cable looked so steep,
the shadow of fear so real, I worried. Had there been an error in rigging
calculations?”
How does Petit overcome these doubts?
With a simple visualisation exercise.
“On the spot I vanquished my anxiety by imagining the best outcome: my
victorious last step above a cheering crowd of 250,000.”
Added to this, Petit exaggerates his fears. Rather than try to muscle through
or outwit fear, he suggests taming it by building it up so that when you are
finally faced with your fear, you will be disappointed by how mundane the
threat really is:
A clever tool in the arsenal to destroy fear: if a nightmare taps you on
the shoulder, do not turn around immediately expecting to be scared.
Pause and expect more, exaggerate.
Be ready to be very afraid, to scream in terror. The more delirious your
expectation, the safer you will be when you see that reality is much
less horrifying than what you had envisioned. Now turn around. See?
It was not that bad – and you’re already smiling.
He goes on to say that he has fears like everyone else. In particular, he talks
about his dislike of spiders:
On the ground I profess to know no fear, but I lie. I will confess, with
self-mockery, to arachnophobia and cynophobia [fear of dogs].
Because I see fear as an absence of knowledge, it would be simple for
me to conquer such silly terrors.
“I am too busy these days,” I’ll say, “but when I decide it’s time to get
rid of my aversion to animals with too many legs (or not enough legs
—snakes are not my friends, either), I know exactly how to proceed.”
I will read science reports, watch documentaries, visit the zoo. I will
interview spider-wranglers (is there such a profession?) to discover
how these creatures evolved, how they hunt, mate, sleep, and, most
importantly, what frightens the hairy, scary beast. Then, like James
Bond, I won’t have any problem having a tarantula dance on my
forearm.
Petit’s walk remains one of the most fabled – and stunning – acts of public
art ever. He says there was no why behind the act. To quote his own words:
To me, it is really simple. Life should be lived on the edge of life. You
have to exercise rebellion, to refuse to tape yourself to rules, to refuse
your own success, to refuse to repeat yourself, to see every day, every
year, every idea as a true challenge, and then you are going to live your
life on a tightrope.
THE EGO, AND WONDERFUL
FAILURE
I am not a fan of clichés. They display a lack of original thought. I am quite
cynical towards those who peddle clichés. It doesn’t sit well with me to hear
people say that I should run my profits and cut my losses. Yes, but how do I
deal with the fear of running my profits?
It doesn’t sit well with me when a female friend tells me she is in an
abusive relationship, and another friend chirps in and dismissively states
that the solution is to “just leave the bastard.” It is a platitude. It is factually
true, but it is nonsense, nevertheless.
When a solution is obvious, the problem is rarely the only problem. You
might as well tell an alcoholic to just stop drinking. There is a reason he is
drinking, and there is a reason he is struggling to stop.
Does failure exist? I come from a home where you rarely received praise
for your achievements. They were expected. The failures, on the other hand,
were pointed out – and not in a constructive manner.
I had to retrain my mind to stop being afraid of making mistakes. I used to
have a favourite saying as a child: “It is not my fault”. Today the buck stops
with me every time. It is always my fault. I am good at making mistakes, so
that I can learn from them.
Failure is a friend in life – if you tell your mind that it is okay to fail. I
participate in a radio programme about trading and investments. The focal
point of the show is the competition between two other traders and me.
The competition is always fierce, and every week we are questioned about
the content of our portfolios. My trading style is quite black and white. If I
think the market is headed lower, I will buy some put options or some bear
certificates, and vice-versa if I am bullish.
I learned a long time ago that the best way to shut down a journalist is to be
100% honest. So, when the radio host baits me by saying “Uhm Tom, you
got that one wrong, huh?”, the worst thing I can do is to start defending
myself. If I start making excuses or argue a defensive stance, I simply pour
petrol on that fire.
It is such a great metaphor for life. Own up to your errors and be done with
it. So, when the radio host is trying to engage in a line of questioning aimed
at getting me to defend myself, I always double down in the opposite
direction by saying something like, “Oh my lord, I don’t think I could have
been more wrong, even if I tried,” or “Oh boy, even a five-year-old could
have done better than me.”
TRADING MIND UPSIDE-DOWN
From my research into the behaviour of our clients during my years at City
Index, I concluded that the overwhelming majority had an unhealthy mental
thought pattern. They would feel fear at times where there was no reason to
be fearful. This would manifest during times in which their positions were
making money.
However I manipulate the argument, it is still a fear of losing. In this case it
is the fear of losing the profits accrued on paper.
When the clients were in losing positions, they would be reluctant to realise
the loss. It was as if they had the attitude that as long as the position was
open, it might still come good. As I see it, they opted to replace fear with
hope. They hoped the losing position would come back to breakeven.
Going back to the DAX example, my friend hung on to the trade. I did my
best to guide him through the pain. He moved his stop-loss down. It meant
he had some profits to show for it, if the market moved back up again.
In my experience if you can guide a person through a successful trade,
where he or she holds on to the trade, you will begin to create the right kind
of neuro-associations. The trader will experience the thrill of holding on to
a trade. They will experience the joy of locking in more and more profits.
My friend was over the moon with the development of the chart. However,
it was quite clear that he was constantly looking for reasons to take profit.
The thought of leaving money on the table did not sit well with him at all.
To his credit he held on to the trade, spurred on by my conviction that the
market showed nothing but weakness. We were soon rewarded by a sudden
liquidity vacuum. I try not to get excited when the market is giving me a
windfall. However, at times even I will have to fist pump the air, even
though I am alone in my office.
The whole trade sequence is displayed in the time-stamped records in my
Telegram channel under 1 October 2019. See Figure 3.
Figure 3
Source: eSignal (esignal.com)
ELON MUSK
I am not a fan of Tesla. This is due to the fact I shorted it and lost big. Yes, I
know. What a silly argument, considering Teslas are seemingly good cars.
I am a fan of Elon Musk, however. We are bound to make mistakes in life,
but mistakes are like fuel for the rocket of improvement. Talking of rockets,
how do you think people like Elon Musk handle failure?
He is trying to accomplish incredible, life-changing things – things like the
electrification of automobiles and the colonisation of space – and he does it
while the whole world is watching.
For him the possibility of failure is ever present. Not only that, but when he
fails it becomes spectacular headline news. Yet Musk just keeps on going
and going, doing things that are extremely risky but also extremely
important.
How does he handle his fear of failure? Does he even fear failure at all, or is
he somehow hardwired with resilience again this form of anxiety?
Apparently not. Musk has publicly stated he feels fear quite strongly. So
how does he keep going despite this terror?
There are two main elements to Musk’s ability to overcome his fears. The
first is an overwhelming passion for his projects. He admits that SpaceX
was an insane venture, but he had a compelling reason for pushing ahead:
I had concluded that if something didn’t happen to improve rocket
technology, we’d be stuck on earth forever. People sometimes think
technology just automatically gets better every year but actually it
doesn’t. It only gets better if smart people work like crazy to make it
better.
By itself, technology, if people don’t work at it, actually will decline.
Look at, say, ancient Egypt, where they were able to build these
incredible pyramids and then they basically forgot how to build
pyramids… There are many such examples in history... entropy is not
on your side.
Elon Musk was not prepared to sit idly by and watch history repeat itself.
The second element is what Musk calls fatalism. Just focusing on why
you’re taking a scary risk isn’t always enough to overcome hesitation. It
wasn’t for Musk:
Something that can be helpful is fatalism, to some degree. If you just
accept the probabilities, then that diminishes fear. When starting
SpaceX, I thought the odds of success were less than ten percent and I
just accepted that actually probably I would just lose everything. But
that maybe we would make some progress.
He is not the only one to use this approach. Visualising the worst-case
scenario can make us appreciate objectively what we are trying to achieve.
Facing our fears removes their power over us.
Have I digressed too far from the trading journey ahead?
I don’t think so. I draw inspiration from many sources, both in and outside
of the trading world: Kobe Bryant, Rafa Nadal, Cristiano Ronaldo, Sergio
Ramos and Charlie Munger, to name a few.
Very different people, yet all obsessed with the journey, the enrichment of
their lives and the perfection of their craft. Studying their approach to their
work suggests they found the thing they would love to do even if they
didn’t get paid for it. I am sure they are businessmen too, and I am sure they
keep an eye on the dollars coming in. However, it feels like they perform
their craft for the love of it.
DO YOU WANT IT BAD?
How bad do you want it? Is this journey for you? I don’t know. Only you
can answer that. Permit me to ask you a question: what is the alternative?
You are reading these pages because you want to trade well. Perhaps you
have been in my live trading room, and you have seen what my trading
philosophy is doing for me. You want to learn more. I applaud that.
Perhaps it is time to acknowledge trading for what it is? It is a great way to
expose all your flaws. It is a great way to highlight your strengths. Through
my trading and my research, I have uncovered weaknesses in my character.
For me, the side benefit of earning a living from trading the financial
markets is the character traits it instils in me. I am more patient than ever. I
am much more focused and disciplined than I was before.
Failure is one of our greatest learning tools.
TIMES OF DOUBT
Do you really want to trade profitably? I have had to answer that a few
times in my career. I have had to make some sacrifices along the way. I
have been called out once by a coach who felt my effort was insincere.
I recently found myself having dinner with a friend. I have known him for
15 years. I met him when I gave a speech somewhere in the North of
England. My friend had asked if he could consult with me while I was in
Manchester to give a talk about trading, and naturally I agreed.
As we ate, he became very animated. At one point he knocked over a glass
of water while expressing his frustration with his trading. It was difficult to
really pinpoint what the problem was in his trading, because he never made
any specific reference to a problem.
It was clear to me that he really was in distress and wanted help, but I was
unable to figure out in what capacity my help should come. So, I offered
him help in the one area that I felt was appropriate. I offered to go over his
trading statements. As I see it, that is the only way I can really help
someone. It is a lot of work, but at least I am getting a sense of who he is as
a trader.
As we said our goodbyes, he told me he would send over his statements. I
confirmed, and said I would look forward to hearing from him. As I write
this, he has not emailed me. He has not written to me on message apps.
Silence. Not a word.
If I am offered help in an area where I desperately want to excel, and the
help comes from a friend who is an expert in the area, I will respond as
soon as I can, if not immediately. As of some four to five days later, I
haven’t heard a peep.
How badly do you think he wants this? How desperate do you think he is? I
question how much he really wants this. I have observed this pattern on
several occasions. The student claims to be really keen, but in reality it is
mere words.
It reminds me of a conversation that the famous trader Ed Seykota had with
another brilliant trader and friend. The friend told Ed that he intended to
coach a losing trader into a winning trader by teaching him some important
pointers that were missing from his trading.
Ed Seykota paused for a second, and then said that the friend would fail to
teach the student anything. He said that a losing trader is not going to wish
to transform himself. That is the sort of thing that only winning traders do.
We can all ask for guidance from someone who is better than us. As the
saying goes, you only get better by playing a better opponent. I have guided
many that were already well on their way to trading with confidence. I
merely refined and suggested.
Whether I will hear from my friend or not remains unknown. What is
known is that many people open trading accounts in the hope of making
money. Their effort is disproportional to their expectations, and their results
are aligned with their effort. They simply don’t work hard enough.
Before I move on to the next topic, I want to warn you: I am a trader who
uses charts, but that doesn’t mean that I believe charts are responsible for
my profitable trading. I once read that technical analysts are afraid of
heights. That is another way of saying that they are unable to let their
winners run, because they keep seeing overhead resistance.
I have called the next chapter ‘The Curse of Patterns’, because I believe
fully that as much as patterns help us, they also make our trading lives
difficult. In the search for patterns, we see things that are simply not there.
THE CURSE OF PATTERNS
IF YOU STRIP away the time and price axis of a chart, you will likely be unable to
differentiate between a five-minute chart and an hourly chart.
In a sense, that is good news. It means we can perfect our craft and then
find a time frame that suits our trading temper. The trader with the ability to
focus for long stretches of time will find the one-minute chart and the five-
minute chart provide ample opportunity to make money.
The trader with time constraints will probably favour a longer time frame
such as the hourly chart or the four-hour chart. It means he or she doesn’t
have to check the chart so frequently.
Charts are far superior to fundamental analysis when it comes to entry
points and exit points, and I can use the same tools, irrespective of what
time frame I am trading on.
Am I opposed to fundamental macroanalysis? I would be a fool if I
dismissed the fundamentals. The two should not be in opposing camps.
They should walk hand in hand, as they complement each other and make
up for each other’s flaws.
Now, I would not go so far as to say that chart analysis is the Holy Grail.
Yes, I have made a lot of money from trading charts, but it was not my
ability to read a chart that made me a wealthy trader.
I don’t believe that there is a Holy Grail when it comes to trading, and I
certainly don’t believe that chart analysis is the Holy Grail.
PATTERNICITY
Apophenia is a Latin word that, translated into English, means patternicity.
This is a behaviour centred around seeing things that aren’t there; the
tendency to perceive meaningful patterns and connections amongst
unrelated events. Patternicity is often a harmless diversion. However, it can
be used to support a belief that is otherwise lacking in evidence, like a
conspiracy theory.
Our minds tend to seek out the information that confirms the bias that we
have already decided upon. Therefore, to be completely objective in chart
analysis is virtually impossible.
My early mentor Bryce Gilmore once commented on this fact. He said to
me, “Tom, you only see in the markets and on charts what you have trained
your eyes to see.”
Another perspective of such wisdom was expressed by Anaïs Nin. She said,
“We don’t see things as they are, we see them as we are.”
“What is the relevance to trading?” I hear you say. I had a friend a long time
ago who had made a lot of money trading. Nick was a great trader, right up
until 2004.
He started reading and believing some writers and contributors on Zero
Hedge and he turned bearish on the stock market. He kept shorting. But the
market kept going up. He just could not accept that there was no more
downside after the bear market of 2000–2003. He didn’t see the market as it
was. He saw it as he was. He was negative. He had read that the bear
market would continue. He stopped trading what he saw, and he let his
opinion cloud his objectivity.
Nick no longer trades.
I didn’t want to write a book on charts. There are so many books on
technical analysis, written by people who I doubt trade full time. I think
they tell themselves that because they have a trading account and because
they trade from time to time, they are qualified to write books on trading.
Although I trade full time, I really don’t think I could add anything new to
the world of charting. Charting didn’t make me money. Indicators never
made me money. Ratios and bands never filled my bank account.
As I am about to post some charts, I want to point out to you that it is to
prove a point, rather than to educate you on the merits of technical analysis.
THE TREND LINE FANATICAL
In the early stages of our chart journey, we come across trend lines. Trend
lines are easy to use, and they give the appearance of a great trading
strategy, especially when we do it after the fact.
Figure 4 shows a naked chart. The diligent chartist begins to draw trend
lines. He or she has the full overview of the day.
Figure 4
Source: eSignal (esignal.com)
Remember, the brain will have as its prime objective – I repeat, PRIME
OBJECTIVE – to avoid you experiencing pain. A losing trade equals pain.
So, the brain sends a signal to the eyes to ignore the setups that do not
work. This selection bias creates a distorted image of the validity of trend
lines.
You can replace trend lines with any other analytical tool from your
charting package, and the bias will remain in place: Fibonacci, Bollinger
Bands, Keltner Channels, etc.
Your eyes will only see what they want to see. At best they may see the
losing trades, but they glance over them, diminishing their significance.
The result is predictable. The researcher will end up with a chart that looks
like the one in Figure 5. It has a lot of trend line setups that all result in
great trades.
Figure 5
Source: eSignal (esignal.com)
There are no losing trades. Every single trade results in meaningful profits.
Such is the power of our subconscious.
Cynical traders (people like me) will notice things other traders miss – not
because others don’t have the ability to see them, but because they don’t
want to. See Figure 6.
Figure 6
Source: eSignal (esignal.com)
If you are in a research position, and you draw enough of these trend lines
after the fact, you’re most likely going to conclude that trend lines are
nothing short of a fantastic tool, perhaps the Holy Grail.
There is nothing wrong with trend lines, but they will not make you rich.
What will make you rich is how you think when you trade. If you think like
everyone else, then your results will be like everyone else’s.
Don’t you want to make money? Don’t you want to separate yourself from
the herd? Then realise that trading profitably has nothing to do with the
instrument you use.
In order to prove to you how pointless it is to research tools, I would like to
introduce you to two of the world’s most esteemed traders, Larry Pesavento
and Larry Williams.
LARRY PESAVENTO VERSUS LARRY
WILLIAMS
The two Larrys are both in their senior years. They are both Americans, and
incidentally they are friends. Both of them have enjoyed trading careers
spanning decades. Both of them have made their living from trading.
Larry Pesavento is famous for his use of patterns and Fibonacci ratios.
Larry Williams is famous for his pattern recognition setups. Both have
written several books on their chosen tools.
In a workshop I organised back in 2005, Larry Williams – who was one of
the speakers – showed statistics from the S&P 500 Index, which depicted
all the major retracements on an hourly chart spanning a decade.
As you can imagine, there was virtually every single conceivable
percentage retracement on display. What did not stand out, though, was
61.8% or 38.2% – the two prominent Fibonacci ratios. Sure, they were
there, but they were surrounded by masses of other percentages.
Yes, it turns out the magical growth sequence of Fibonacci does not, after
all, rule the market. So how come it works for Larry Pesavento? The answer
is simple: it doesn’t have to work all the time to make it a profitable
strategy.
In Oslo, Norway, in 2016 I gave a talk on Fibonacci ratios. For the talk I
had researched all occurrences in which the German DAX Index retraced
78.6% – the square root of 0.618 – and I proved that although the 78.6%
retracement had a hit rate of 20%, it could still be a useful strategy. You had
to risk very little and go for big pay-outs for it to work.
S&P 500 & FIBONACCI
The S&P 500 enjoyed an 11% rally during the summer months of 2021. The
index rallied from 4,050 to 4,550. Along the way, as you can see on the next
chart, there were three significant retracements. The role of the Fibonacci
sequence is to enable us to buy into retracements at favourable retracement
ratios, such as 38.2% retracement, 61.8% retracement, or even 78.6%
retracement. See Figure 7.
Figure 7
Source: eSignal (esignal.com)
What I am going to show you now is a simple demonstration of the power
of hype and selection bias. See Figure 8.
Figure 8
Source: eSignal (esignal.com)
Fibonacci ratios are one of the best-known tools in the trading arena. There
is not a single one of these three major retracements in the S&P 500 Index
that is identified by either 38.2%, 61,8% or even 78.6% ratios.
In fact, two ratios seem to come up more frequently: 43% retracement and
74% retracement. I put that down to randomness. Yes, such is the power of
our belief system.
We want to believe there is a magical growth sequence to the way the
financial markets expand and contract. We want to believe that there is a
universal order to the markets, dictated by a higher deity who created the
universe using the mathematical sequence of what we know as Fibonacci.
And it works just often enough to keep the believers believing. This is the
danger of charts. When we research, we are looking for something to get us
in on the long side, so we never miss a rally; or we look for something to
make us sell short, so we never miss a short sell. We enter with a bias.
This is apophenia in play. Beware!
DIVORCE RATES IN SPAIN
The definition of ignorance is a lack of knowledge or information. You can
be a smart individual but be ignorant in some areas. For example, I am
rather ignorant when it comes to, say, soulmates and flat Earth theory. You
could argue that I am ignorant because I am not interested, or I don’t
believe in it.
Fair point. Specifically, on the point of finding your soulmate – the one-
and-only whom you will spend eternity with, the person who is perfect for
you in every shape or form – well, I don’t believe they are real.
You see, as ignorant as I am in the ways of love, I can read statistics, and on
that basis, I am supposed to conclude that soulmates have better chances of
finding each other in certain countries? I don’t think so!
For example, there are certainly not many self-confessed soulmates in Spain
or Luxembourg. Did you know that there is a 65% divorce rate in Spain and
an 87% divorce rate in Luxembourg?
There’s only a 42% divorce rate in the UK. Does that mean that you have a
higher chance of finding your soulmate if you live on the British Isles than
in Spain?
Plenty of people believe that the sun’s heavenly position relative to
randomly defined stellar constellations at the time of my birth somehow
affects my personality.
There are also people who believe that the markets are an equation to be
solved, a code to be cracked. All of those people are delusional, or to put it
more politely, they are ignorant.
THE FRAUD OF THE CANDLESTICK
GURU
In order to avoid a lawsuit, I have blanked out the name of the central
character in the following story. When candlestick charts became a hot topic
in the 1990s, one person – who had been instrumental in the propagation of
their use – was sitting in a restaurant somewhere in the world with another
high-profile trader and me.
The central character had at the time published books on the use of
candlestick charts. As we sat in the restaurant, I asked him if he believed
that some of these patterns had to be identified by different names, when
they were practically identical.
For example, I argued, the Harami pattern and the Harami Cross pattern are
to all intents and purposes identical, except the Harami Cross pattern has no
body, while the Harami pattern has one. However, they are both inside bar
patterns.
It seemed to me like a deliberate attempt to inflate the number of patterns,
for purely commercial reasons rather than for legitimate trading reasons.
Many of the patterns are near identical but have different names.
I asked him if he had a favourite pattern he used, or a selection of preferred
patterns he stuck to, and if so, what time frame he traded them on.
He answered that he wasn’t trading the patterns. Not only that, but he also
conceded that he didn’t trade at all.
I don’t know how you feel about that, but it doesn’t sit very well with me. I
immediately cut all ties with the gentleman. I felt as if his only mission was
to invent as many patterns as he possibly could, in order to fill pages in
books and courses, and create alerts on his trading software.
Am I arguing that candlestick charts are worthless? No. I just don’t believe
that there is statistical relevance to all the patterns.
I am not alone. A handful of academic research articles suggest the same.
Here is the conclusion from one such article, ‘A Statistical Analysis of the
Predictive Power of Japanese Candlesticks’, written by Mohamed
Jamaloodeen, Adrian Heinz and Lissa Pollacia, and published in the
Journal of International & Interdisciplinary Business Research in June
2018:
Japanese Candlesticks is a technique for plotting past price action of a
specific underlying such as a stock, index or commodity using open,
high, low and close prices. These candlesticks create patterns believed
to forecast future price movement. Although the candles’ popularity
has increased rapidly over the last decade, there is still little statistical
evidence about their effectiveness over a large number of occurrences.
In this work, we analyze the predictive power of the Shooting Star and
Hammer patterns using over six decades of historical data of the S&P
500 Index. In our studies, we found out that historically these patterns
have offered little forecasting reliability when using closing prices.
In another work by Piyapas Tharavanij, Vasan Siraprapasiri and Kittichai
Rajchamaha, the researchers conclude the following:
This article investigates the profitability of candlestick patterns. The
holding periods are one, three, five, and ten days. This study tests the
predictive power of bullish and bearish candlestick reversal patterns
both without technical filtering and with technical filtering (stochastics
[%D], Relative Strength Index [RSI], Money Flow Index [MFI]) by
applying the skewness adjusted t test and the binomial test.
The statistical analysis finds little use of both bullish and bearish
candlestick reversal patterns since the mean returns of most patterns
are not statistically different from zero.
Even the ones with statistically significant returns do have high risks in
terms of standard deviations. The binomial test results also indicate
that candlestick patterns cannot reliably predict market directions. In
addition, this article finds that filtering by %D, RSI, or MFI generally
does not increase profitability nor prediction accuracy of candlestick
patterns.
TRADERS BEWARE
Brokers and educators have put the cart before the horse. They make us
think that learning as many patterns as we possibly can will increase our
chances of trading success. This is simply not true. The more patterns we
know, the more we are inclined to talk ourselves out of good positions.
There is nothing wrong with technical analysis and patterns, and candle
formation and indicators and ratios and bands. Yes, I don’t believe in many
of them, because they are subjective and don’t hold up under real scrutiny.
But then again, trading is so subjective anyway that we don’t need to be
right very much to make a good living from trading.
AN OLD FOX TELLS
My friend Trevor Neil ran a hedge fund that had a 25% hit rate on their
trades. I want to tell you his story here to give you some deeper insight into
how some of the best professional traders work and think. I hope you will
find it illuminating.
It should also serve as a reminder that there are many ways to make money
in the market. Your job is not to follow someone, but to find a way that you
like, that resonates with you and who you are and what you like to do.
The story starts with me asking Trevor a question. I knew that he had been
associated with Tom DeMark and his Sequential indicator. Tom DeMark is
something of a legend within the technical analysis world.
I happen to have met DeMark myself at a Bloomberg lunch many years
ago. He seemed like a nice guy, although I had very little to ask him, as I
was unfamiliar with his work. You see, his work was only available to those
who had a Bloomberg terminal.
The Bloomberg terminal at that time was some $25,000 a year. Today,
though, Tom DeMark’s work is available on many trading platforms, in
case you are interested.
I asked Trevor about the Sequential indicator, and his eyes lit up. He told
me a story about how he and his friend had decided that there was an edge
to be gained from trading the Sequential indicator on a very short-term time
frame.
They moved to South Africa and started trading South African shares on a
one-minute chart. I have never heard of a professional outfit, with
significant funds under management, trade on such a short time frame.
However, that is not what impressed me most about the story. What
impressed me most was how they managed to make money on what other
traders would consider an abysmal hit rate.
Most people believe that you have to deploy a trading strategy that has a hit
rate better than 50%. Trevor told me that their results varied. There were
times when they were hot, and there were times when they were not.
When they were hot, the hit rate would push 40%. When they were not, the
hit rate was down in the mid-20s.
Overall, though, they had in their hands a tool that generated about 25–30
winning trades out of every 100 trades placed. They were wildly successful.
They traded the fund for a handful of years, then they returned the capital to
the investors. They had made their money, and as neither of them were
spring chickens, they decided enough was enough. It was time to go home
and spend quality time with their families. Had they been younger, they
probably would have continued.
Now I don’t know about you, but I like the story. It reaffirms the idea that I
have about trading. How you think when you trade is much more important
than whether your strategy has a hit rate in the 50s or in the 70s or in the
90s.
While the story is not conclusive evidence that anyone can make money
trading, as long as they have the proper money management rules and the
required patience, it is a brilliant anecdote of two traders being able to make
money even though – from a conventional point of view – their strategy on
paper should not have generated a profit.
So, what was the secret?
Well, the answer is simple. Although they lost 75 out of 100 trades, those 25
winning trades more than surpassed in profits what the 75 trades generated
in losses. Trevor told me that they expected to make 25 times in profit what
the risk was. He also told me that when they executed a trade, they expected
it to work immediately. So, I grilled him a little bit on that point.
“What do you mean you expected it to work immediately?” I said. He said
he meant exactly that: when they executed a trade, they expected the trade
to begin to work immediately. If they had bought at 50, they would not
want it to go to 48. If it went to 48, they would stop themselves out.
It meant they had plenty of small losses. Their back-testing had shown that
if the strategy was to be traded correctly, it would work immediately. If it
didn’t work immediately, the strategy called for the position to be closed.
BELIEVE AND ACT
When you can act and perform without any fear of consequences and
repercussions, you are trading from an ideal state. When you consider how
many people lose money overall in trading, you logically have to conclude
that achieving this state is not an easy undertaking. It would be foolish to
think that this state of mind comes easily or even naturally. It doesn’t.
I once sat and traded for a few months with a guy from Germany. He
possessed an almost superhuman ability to do nothing. His patience was
unrivalled. While we traded together I made it a sport to be as patient as he
was.
It was fun and, dare I say, somewhat painful. I missed many a good trade,
but the ones I took outweighed all the others.
You must be patient with yourself. You must be able to let your knowledge
settle and mature within you. If you trade small size now, but you want to
trade bigger size in the future, then that journey will most likely be anything
but linear.
It will be a journey of progress and setbacks. It will be a journey of progress
and status quo. I can guarantee you that. You have to grow into the trader
you dream of becoming.
You must be patient with your trade entries. You must be patient with
yourself. If you can bring those two qualities to the table, then the rest will
solve itself in time. You will grow your trade size at a pace where your
mind will not be alarmed or fearful.
I discuss this in much greater detail towards the end of the book. Otherwise,
I am just like the well-meaning friend who says to my alcoholic friend,
“Well, just stop drinking.”
Sure, if only it were that easy. Likewise, me saying to you “Just have more
patience” is about as helpful as a hog roast at a vegan convention.
One macro trader I deeply admire is Greg Coffey, an outstanding London
hedge fund trader. In a piece in a newspaper one client described him as
“humble and arrogant in equal measures – the perfect trader”.
The piece went on to describe that Coffey had an absolute conviction on his
trades, to the point of being arrogant, but he was equally quick to be humble
when the trades didn’t work out well.
Remember this saying:
It is not what you know that kills you. It is what you think you know, but
which just isn’t so, that kills you.
THE NATURE OF THE GAME
The game never changes, and it never will. Algorithms won’t change the
game. Laws won’t change the game. Because this is an inner game, and you
need to spend time – maybe not as much time as you do on charts, but a
huge amount of time – contemplating what human qualities you are
bringing to the game of trading.
Moving in the right direction comes from knowledge of yourself and an
understanding of the markets. The game never changes. The players change,
of course. We all grow old and die, and we are replaced with fresh blood.
Sadly, people don’t change, unless they make an out-of-the-ordinary effort
to do so.
We have a reptile mind, which is not fond of change. “Hey, if it ain’t broke,
why do you want to fix it?” Well, because it is broken. I am not making
money how I know I can, so I want to change that. If that means I have to
learn to live under a different paradigm, and have a different perspective on
fear and hope, so be it.
THE ROLE OF CHARTS
You can’t create a master painting with just one colour. You don’t create a
Michelin-star meal with just one ingredient. And you most certainly do not
create a viable business as a trader by only focusing on charts.
The role of the chart is to give you a visual representation of the thoughts of
other market participants. It enables me to be much more specific in my
entry and exit criteria than, say, a fundamental trader.
However, it is easy to get seduced by the randomness of charts. Over time,
though, it is not your chart reading skills that will decide the number of
zeros on your trading account.
Controlling your mind is no easy task. Your reflex mind will jump to
conclusions before your conscious, reflective mind has had a moment to
really consider your response.
The sole purpose of this book is to provide you with the right tools to
program your mind to be a trader – a profitable one.
Our minds are feeble creatures, if left unchecked. Whenever I give a talk
about the role of psychology in trading, I always show people the logo of
Federal Express, and then I ask them: “Where is the arrow?”
In case you didn’t know already, take a look at the FedEx logo – there is an
arrow hidden between the ‘E’ and the ‘x’.
The coordination between the eyes and the mind is fascinating. The eyes
can see one thing, while the reactive impulse mind tells us that we are
seeing something else.
It is only through observance and training that we become mindful of our
tendency to believe what we immediately think we see.
Consider the following image. Which square on this chequerboard is darker,
A or B?
You might be surprised to learn that both squares are exactly the same shade
of grey, though it is very likely that your mind told you that square A is
darker. Published by MIT professor Edward H. Adelson in 1995, this optical
illusion perfectly demonstrates how the mind can misinterpret information
passed to it by the eyes.
Another example you may have encountered before is a little harder to
demonstrate in this book, but I will explain how it played out in the speech I
gave – which gave me the impetus to write this book. It is a mind-flexibility
exercise.
I showed the audience a simple image: a red square. I asked them to call out
the colour of the image. “Red!” they shouted in unison.
Simple enough, right? I then removed the red square and revealed a yellow
one. Same result: “Yellow!”
I swapped in a green square. “Green!” they cried.
Red. Yellow. Green. So far, so good.
The audience didn’t even need to think about it; that is how dominant the
automatic response system is.
Then we moved onto the trickier bit. I showed the audience an image of the
word red written in blue ink, and asked what colour that image was.
A lot of them called out “Red!”
I showed them yellow written in red ink. Some called out “Red!” but I heard
far more shouts of “Yellow!”
We repeated this process with a series of colour names written in ink of a
different colour. Over time, the audience responses became more
consistently accurate. Through a humorous exercise I established that our
eyes and minds do not necessarily work in a coordinated manner. Our brain,
seeing the word red, wants us to say “red” – even when the answer to the
question is “blue”. It is as if we consciously need to stop the brain from
jumping to conclusions.
This is an important trait in trading, because we often see things that are
literally not there.
Charts do not work as well in real time as after the fact. Unfortunately, you
have to believe and act.
If you struggle with that after a few failed trades, then that is your brain
trying to protect you against pain. You will begin to second guess your
signals, and you will sabotage your own best interests. I have been there. I
have done it. And I have the cure.
GOOD TRADING GOES AGAINST
HUMAN NATURE
When I make speeches about trading, in person or on YouTube, I often talk
about the concepts of value and price. What is something worth?
I think my old car is worth £10,000. The car dealer feels it is worth £8,000.
Who do you think is going to win that argument, if I am keen to sell?
What something is worth is an emotional, biased statement. Price, on the
other hand, is where buyers and sellers meet. It doesn’t make much sense to
say that something is worth more.
You can anticipate that something will be worth more or less in the future. I
mean, that is the essence of the mechanics of my job. Psychology aside, I
buy in the hope that whatever I buy will rise in price.
Heraclitus, the pre-Socratic Greek philosopher, said: “No man ever steps in
the same river twice, for it’s not the same river and he’s not the same man.”
That is important to bear in mind as a speculator, because the market
changes constantly.
Mankind has an ambivalent attitude to change. We want change, because
otherwise our lives become mundane and boring; but if the change is thrust
upon us, rather than driven by motivation and enthusiasm, then we tend to
resent it.
The first time I became aware of the importance of mindset in trading was
upon reading a book about the trading life of an anonymous trader called
Phantom of the Pit. It is a free book. You can find it with my own notes on
www.tradertom.com – in the resource section.
In the book the mystery trader argues that behaviour modification is the
single most important concept in trading. The ability to change one’s mind
without causing a mental disequilibrium is the single most important ability
for a trader.
Running a live Telegram trading channel means I am constantly asked
questions – the majority of them from inexperienced traders. One persistent
question I get asked is: “Why are you trading against the trend?”
When I get asked such a question, I smile, because it is both a naïve and
innocent question. It is naïve because any trader can be accused of trading
against the trend.
It simply depends on the time frame you are looking at. If you are a five-
minute candle trader, you don’t care that the trend on the weekly chart is
down. You care about the trend of the five-minute chart.
Another reason why it is naïve is because the whole construct of technical
analysis is fraught with contradictions.
Think about it.
You are asked to follow the trend; but what happens when you sell a double
top? You are betting against the trend. The same can be argued for a double
bottom. You are buying a market that is moving down.
THIRTY YEARS OF DATA
I am a day trader. My speciality is stock indices such as the Dow Jones
Index. I looked at the statistics of closing prices in the index over the last 30
years. That equates to roughly 7,500 trading days. I wanted to know how
often the Dow Index closed higher for the day and how often it closed
lower for the day compared to the previous day’s closing price.
I had an idea that, since the Dow Index over the last 30 years had risen from
3,300 to nearly 36,000, you could expect more positive closing prices than
negative closing prices. I was wrong in that assumption.
Over the last 30 years only 50.4% of all closing prices were higher than the
previous day’s closing price. This means the distribution of plus days and
minus days in the Dow Index is evenly distributed.
The ramifications of this statistic is that day traders like me can’t rely too
much on the trend on the higher time frame, because virtually anything can
happen down on the five-minute chart.
The challenge traders face can be summed up very easily, in a Heraclitus-
style explanation. When we shop for a pint of milk, we know that milk is a
uniform product. It doesn’t matter where on God’s green earth you shop for
a pint of milk. Milk is milk.
Hence, if milk costs twice as much in one supermarket as opposed to
another supermarket, you can again rightly conclude that a pint of milk is
expensive in one supermarket, and it is cheap in the other supermarket.
However, a share, or a currency, or a share index, is like a river. It is in
constant transformation. The transformation is the result of the interaction
of traders and investors.
Their action is the result of their opinions about the future. You may agree
with their opinions, or you may disagree; but to say that the majority are
wrong is counterproductive to efficient money-making in the markets.
There are many part-time traders who are incredibly successful in their
other careers but struggle when it comes to trading. What we have to do to
succeed in the world of trading is significantly different to what we have to
do to succeed in the world outside of it.
For example, if you go into a supermarket to buy dinner, and you see that
there is a special offer on chicken, you will be inclined to take advantage of
this offer. If chicken is offered at half price, then you might be thinking that
this is a great price, and you will want to buy some supply for the freezer.
Our human nature is such that we love a bargain. We love to seek out good
offers and take advantage of them. It fills us with a sense of joy to know we
have bought something which is cheap.
Just yesterday I went shopping and there was an aisle with discounted
items. Everything was half price or less. I bought soap and washing liquid
and detergent for the next 12 months.
As I filled the trolley, I laughed to myself, mostly because I knew that I
would go on to write a chapter about this very behaviour. It felt great to
save 70% on stuff I knew I would buy anyway at some point during the
year.
Let’s face it, we can save a lot of money if we shop contrary to the trend.
If at all possible, I tend to buy my winter jackets when there is a heatwave
outside. That is when the shops want to get rid of these items, to make
space for the summer clothes.
Conversely, I love to buy my summer clothing when there is six feet of
snow outside. I know it is not normal to do that, and maybe that is why I
like doing it. I love a bargain. I don’t think I am alone in loving to buy
cheap.
As I said earlier, the world of trading is diametrically opposed to the world
outside trading. The traits I display as a human being outside my world of
trading don’t serve me well in the world of trading. This is not just me I am
talking about. This is people in general.
Our minds struggle to separate the world of trading from the world of
general consumer behaviour. Let’s look at the differences.
SUPERMARKET BARGAIN
When I see something in the supermarket that is cheaper than it was before,
or that gives me a discount for buying more than one item, I am attracted to
buying it. My action is driven by a subconscious drive towards pleasure.
My action is that of a rational consumer who will seek out the cheapest
products. The supermarket knows this, and they will tailor their offering to
maximise my spending.
My behaviour is driven towards maximising my pleasure – within my
budget constraint. When I do so, it gives me a sensation of well-being.
FINANCIAL MARKET BARGAIN
When I see the FTSE Index falling in price during the day, my mind
associates falling prices with value and becoming cheap.
If I act on the impulse, one of two things will happen:
1. My feeling of value is confirmed. The market begins to rise.
2. My feeling of value is not confirmed. The market continues to fall.
My argument is perhaps provocative, but no matter what happens next, I
will end up losing – even if I win on the trade.
If I buy with no good reason other than my mind sending me an impulse to
say the market is cheap, I will lose if the market continues lower. And why
would the market not continue lower? That is the premise of technical
analysis. Trends persist. The market suffers from inertia, meaning that
whatever it is doing now, the odds are above 50% it will continue to do.
If I buy, and the market begins to rise, I will eventually lose anyway,
because I have now taught my mind that it is okay to stick my hand out and
catch the proverbial falling knife.
I have created a pattern in my mind that associates buying falling asset
prices with pleasure, because I had success with it at some point.
As a side note: when I began taking trading very seriously, I would review
my trades when the day was over. I would print out the chart and plot my
trades onto it. I realised that some eight out of ten trades were impulse
trades. I began to become much more conscious of my trades. As I
proceeded down that path, I became more and more profitable. The fewer
impulse trades I had, the more money I made, and the more satisfaction I
derived from my job.
SELF-ANALYSIS
Through analysis of my trading behaviour – meticulously logging my trades
on a chart after the trading day was over – I came to the realisation that I
was a prolific value trader. I would repeatedly short rising markets. I would
repeatedly buy falling markets.
It helps me to remind myself daily that when I am buying, someone else is
shorting or getting out of a long position. A significant factor to my trading
success, going from being a losing trader to a winning trader, was the
realisation that there are no bargains in the financial markets.
SUPERMARKET SUBSTITUTES
When I am shopping for something in the supermarket, and I discover a
product has gone up in price, or a product that used to be on offer is no
longer on offer, my mind will associate this with pain. My mind will direct
me towards a substitute. This is perfectly rational human behaviour.
My sister and I laugh about this phenomenon. She lives in Germany and
frequently travels with the airline EasyJet from Berlin. She puts it so
eloquently, when she says, “I will get up in the middle of the night for a 5
am flight, if it means I can save myself €25.”
I think many of us can recognise this trait.
FINANCIAL MARKET SUBSTITUTES
If something has gone up in price in the financial markets, then it means
there is demand for it. It may seem expensive, but it merely reflects the
equilibrium point between buyers and sellers.
I struggled with this for years. I argued it was expensive, and this faulty
view was compounded by the technical indicators I was using.
Indicators like stochastics would suggest a market was overbought or
oversold. Those are other words for cheap and expensive. It is for this
reason I am no longer trading with any kind of technical indicators. My
charts are 100% naked.
The perverseness of the financial markets is that it generally makes sense to
buy something because it is more expensive today than it was yesterday.
DEALING WITH ADVERSITY
When I experience difficult situations in my life, I will be patient and work
on resolving them. Through my work and my resolve, I hope I will be able
to solve the problem. I may even use force on the issue or use my authority
to solve the problem.
No amount of hard work, resolve or prayer will turn a bad trading position
into a good position. Either the market agrees with you or it doesn’t. It
doesn’t matter how rich you are; how big and powerful you are. If the
market disagrees, it disagrees.
The market can only hurt you if you let it hurt you. The market will rally.
The market will fall. Whether you are on board or not, making money or
not, is inconsequential to the market. It knows nothing about you.
When you make money, you make money because you are aligned with the
market. The market itself is nothing more than the combined force of all the
market players. They, like you, are looking to make money from trading.
Unfortunately, we can’t all make money. I came to realise, after years of
suffering, that I had to change my relationship – not with the market, but
with how I reacted to what the market did.
Much of that process was undoing my life values and beliefs when it came
to the trading world. In the normal world, when I don’t get my will, I will
work hard at convincing the other party to see things my way. I am very
persuasive, and I usually get things how I want them.
While that may be a trait that helped me in the real world, it is a trait that
was detrimental to my trading performance. The market doesn’t care about
your position. It doesn’t care if you are long or short or on the side lines.
The market has no feelings about you or your position.
The essence of my argument is that many of the traits we display as
perfectly normal people don’t serve us well in the world of trading.
I think all the successful traders I know have gone through a transformation
process. Some were gradual. Others talk about a specific situation which
acted as a catapult to success.
Some became so disgusted with themselves, they decided that they were
going to either follow the rules or quit trading altogether.
THE INNOCENCE OF OBJECTIVE
OBSERVATION
A very good friend of mine, Dr David Paul, describes his own
transformation in the following story.
I have a PhD in mechanical engineering. I have worked for De Beers. I invented a mining drill
which made me a fortune. I have had my own mining company. So, it is fair to say that I came
into the markets with a lot of confidence, and a lot of money at my disposal.
I started investing money in the 1980s. It was easy to make money in the stock market then.
All you had to do was buy shares and then sit and wait. While I waited, I started doing
programming on the early computers. I eventually created my own share selection software. It
was incredibly sophisticated software for its time.
On this particular day in question the software called for the market to rise very strongly. So,
at the open of trading I phoned my broker and placed a very large buy order.
And sure enough, the market did what my software had said it would do. It started moving
higher. I was naturally happy that the analysis was correct and that I was making money. I held
on because the software predicted the rise would continue, only much more strongly.
A short while later, however, the market began to drop. I was naturally a little surprised but
knew that it must be just a temporary aberration and a good chance to buy a little more before
the market really took off. So, I did. I bought some more. And yet the market continued to
drop. And drop. And drop.
I began to get a little worried, so I phoned my broker and all my trading friends to see if there
was any reason for this deviation. They too were at a loss to explain why the market was
down. Their analysis had suggested the market would rally strongly. All the newsletters
suggested that we were in the middle of a major wave three in Elliott Wave Analysis terms,
and everything pointed to higher prices.
I felt somewhat better having spoken to my friends and my broker about the situation, and I
was sure that this was just an aberration, so I decided to buy a little bit more at these cheaper
price levels. The market bounced for a while, and I felt pretty good about having bought some
more at what I thought would be the lows of the day.
The market then began to head lower again, and I began to get really concerned, even a little
scared. It was quite a big position I had accumulated.
Just then my wife walked into my office to ask what I wanted for dinner that night. She must
have sensed that I was distracted or in discomfort, and she walked over to my desk and looked
at the trading screen. “Is anything the matter, dear?” she asked. She can be so sweet.
“No, my love, just working. My software says this market should go up.” I pointed at the
screen. “The software has never been wrong, and I have spoken to the brokers and to my
friends, and they all say that this market should be going up, but it is going down.”
She looked at the screen with the market and said, “Is this the market you are trading in?”
“Yes,” I said. “I really don’t understand why it keeps moving lower. I am sure it will move up
very soon.”
“But it is not moving up right now, is it?” she said.
I got a little impatient with her, and I said, “No dear, but what you don’t understand is that the
software and the Elliott Wave Count are in agreement, and the market absolutely has to go
up.”
“Oh well, you are right, I don’t know anything about this software or the Elliott thing, but it
just doesn’t seem to be going up right now, does it?”
I distinctly remember taking a deep breath. I said to the woman I love but who had now begun
to irritate me, “No dear, but just as soon as this passes, it will start to go up. It absolutely has
to. I think this is just an AB=CD formation. The software says so. The broker says so. My
trading friends say so. The Elliott Count says so. There is no way that all these people and my
software could be wrong.”
“Ok, I am sorry, you are right; I don’t understand your software or the Elliott thing or what the
broker is talking about. All I see is that this market right now is going down, isn’t it?”
I stopped staring at the screen for a second, and I looked up at my wife. “Could you please
repeat what you just said?”
She looked at me puzzled, and said, “Well, I am just saying that right now, right at this
moment, right here right now, this market is moving down, isn’t it?”
And then it hit me like a thunderbolt. I wasn’t trading the market. I was trading my opinion. I
began to laugh, because I felt for the first time that I knew what had to be done to make money
in the market. I understood that the very thing I was trying to avoid was the very thing that was
killing me right now. I was trying to avoid losing trades at all cost, and now I was in a trade
that was losing me – only because I refused to listen to what the market was trying to tell me.
I realised in that moment that I had to learn to lose in order to win. It was as simple as that. I
wasn’t trading the market. I was reinforcing my ego through the market.
I picked up the phone, called my broker and sold out all my long positions. Furthermore, I sold
a large number of contracts short as well. And sure enough, the market continued – down and
down and down.
My trading life changed that day. I no longer paid so much attention to expert theories, and I
stopped guessing where the market was going. I started trading the markets. It was a
revelation. I started making lots of money. I realised that some of the stuff I had read was
outright wrong and detrimental to my trading.
For example, we have all read the axiom of ‘buy low and sell high’. I changed that to ‘sell low
and cover lower’ and ‘buy high and sell higher’.
SURRENDER
When I asked David to sum up his experience, he said to me:
Look at your own life. You love to surf. You wait for the waves, and
you paddle into their energy flow, and you ride the wave. How is that
any different to what we do as traders?
When you are out there, sitting outside the impact zone, waiting to
paddle in, you don’t paddle when there are no waves. You are patient.
When the right size wave builds ups, you get ready. You are one with
the sea. You roll with its flow. You surrender.
To succeed in the markets, we must surrender. Every single individual on
planet Earth has a great deal of time, money and value tied up in what we
know, and it is unthinkable to even consider surrendering all this perceived
knowledge.
The purpose of my trading and your trading is not to be proven right and
bolster our egos. Our job is to make money. If that means we come to the
market with an opinion, and we are proven right, so be it.
If it means we have to change our opinion because the market dictates it, so
be it. A more spiritual person than I would perhaps express this as “empty
your mind and let the market guide you”.
THERE IS A LOT LESS TO TRADING
THAN MEETS THE EYE
The fact is that our complicated human minds have a great deal of trouble
processing information that is simple. Unless it is complex to the tenth
degree, our minds tend to pass it over. We think that something simple can’t
be profitable.
What is your aim? The simple answer should be to make money. In the past
I was so preoccupied with what should happen. But to make money we
must be focused on what is happening right here, right now.
When I started writing this book, I wanted to keep it practical. I had no
interest in trying to pass myself off as a trader therapist or a psychologist,
because I am not. I wanted it to show the true nature of what trading is,
written by someone who has skin in the game, and who has both scars and
medals to show for it.
If the last few pages have been a little too theoretical for your liking, I
would like to describe a real-life case study – one that was captured on
video (my way of telling you that this is an authentic story) by Round the
Clock Trader in July 2019.
I want to explain what I mean by going into the market with an open mind
and an empty cup. I bought an index after a double bottom. Everything
looked pretty good. I was long from 12,808 and I had bought again at
12,818. Then it happened: the index plummeted. My five-minute chart
showed three major lows (I call these get out bars, when I am trading
against their direction, or add to bars, when I am on the right side of them).
I was wrong being long.
I got out of my long position and reversed my position to short, relatively
early on in the downward spiral of the index. There were some 500 traders
attending the event, and what pleased me most about the outcomes was not
that I lost on my first trade, or that I won my money back soon after. What
pleased me most was that I did not stubbornly hold on to a losing trade, and
that I had the mental freedom to move from being long the market to now
being short the market.
When I started trading, there was no chance in hell I would have done what
I did there. I would have held on and held on to that losing position. “I
know I am right,” I would have said; except I wasn’t, and I wasn’t making
money.
The most critical point came when my new short position showed a profit
which was equal to what I had lost on the long position. My mind
desperately wanted me to bring balance to its emotions. What better way to
do that than to offset the loss from the first trade? Well, in the words of my
greatest trading hero, Charlie DiFrancesca, “Good trading means
combatting the emotions that make us human.” Let’s take a look at how we
can do that.
FIGHTING MY HUMANNESS
WHAT IS NORMAL behaviour amongst retail traders? We know that 80–90% of all
retail traders engage in the same self-destructive behavioural pattern.
We know that some 90% of traders do not make money consistently trading
CFDs or spread betting or in futures markets. It is probably also fair to
assume that those 80–90% of traders are intelligent, ambitious, self-
motivated human beings, who like to create their own luck and forge their
own way in life.
I have never met anyone who started trading because they thought it was
the same as playing the lottery. Virtually every person I have ever met who
was interested in trading and who wanted to learn more about trading has
been a self-starter, entrepreneur, or student at an institution of further
education.
Therefore, it’s a fallacy to say trading attracts the wrong kind of people. It
attracts the right kind of people. It attracts those who have a chance of
succeeding at it.
I think it attracts the kind of people who are not fooled by the get-rich-quick
schemes. I doubt many traders buy lottery tickets, purely on account of the
odds being rubbish, and traders understanding that all too well.
Nevertheless, something is wrong.
Something is wrong when 90% of people fail. In the following table I have
identified a handful of behavioural patterns that I think are detrimental to
traders. The most frequently observed behaviour is the inability to take a
loss.
What is the reason for not taking a loss? I argue there is one reason we tell
ourselves, and then there is another, real reason. The real reason is always
the same.
Action Conscious Reason Subconscious Reason
1.I am letting my loss runI am hoping Avoid pain
2.I am letting my loss runIndicator/Fib/etc., says soAvoid pain
3.I am taking my profits You can’t go broke taking a
profit
Avoid pain
4.I am winning, so I am
reducing my stake
I want to take it easy nowAvoid pain
5.I am losing, so I am increasing
my stake
I am trying to get back to
where I was
Get rid of pain
6.I made my points for today, so
I stop
I am afraid to lose what I madeAvoid pain
7.I am trading without real
conviction
I am bored/scared of missing
out
Avoid pain of boredom or pain of
missing out
Hope features high on the list of reasons. As the saying goes, hope dies last.
Our minds seem ill equipped to engage in risk management. Our minds
have one primary objective: to protect us against perceived or real pain.
During the process of running an open position that is producing a loss, our
subconscious mind is telling our conscious mind to keep the position open.
It will mask this message as well as it can, in order to protect the ego, which
is more fragile than the state of your trading account.
If this sounds too airy-fairy, on account of the use of words like ego and
subconscious, let’s explore the same argument using a different language.
AVOIDING PAIN
As long as a losing position is open, there is hope that the position will turn
positive. The moment you close the position, and you crystallise the loss,
the pain of the loss becomes real.
I accept there are many permutations to the situation of handling a losing
trade. Some will argue that the very act of closing a losing trade is the point
when you can stop agonising over the open loss and open yourself up to
other trade options. I personally agree with this argument. When I have a
losing position and I no longer believe in it, the worst I can do to myself
and my psyche is to begin to hope. I don’t feel free in my thinking and in
my market perspective when an open losing position is beaming at me on
my open position monitor. When I close the position, I feel free again, and I
am opening myself up to taking in market information from an
opportunistic frame of mind.
However, my primary argument is that the reason we are hoping has little to
do with hope itself and everything to do with avoiding pain.
How many times did I see clients sit on losing positions for ages? I saw
them deposit more money every time their losing position received a
margin call. A margin call is when the broker demands more money to keep
your position open. They just didn’t want to take the loss.
To compound my confusion, how many times did I see the position come
good again, and the client close the position as soon as it did? I saw it
frequently. They didn’t hold on to the position because they believed in the
position. They held on to the position because they could not stand being
wrong.
The moment they were relieved of their pain of the losing position, they got
out – for nothing. They were so relieved to have avoided the pain of being
wrong that they completely ignored the fact that the market was now
actually agreeing with them.
They weren’t trading the financial market. They were trading their
emotions, responding to how they felt. When they felt relief that the
position had come good again, they now associated a tremendous amount of
pain with the thought of having to relive this anxiety once more.
As a result of this association, they closed the position. They felt relieved at
the thought of not having to go through this anxiety again.
If you are taking your profits early under the excuse that ‘you can’t go
broke taking a profit’, you are reacting to your mind warning you against
future pain.
If you are on a winning streak, and you reduce your stake size, you are
essentially anticipating the pain of losing some of your gains. You are now
rationalising your way to avoid the pain, even though nothing painful has
actually happened.
I want to reiterate the last paragraph. If you are in doubt whether you are
trading from an opportunistic frame of mind or a fear-based frame of mind,
then answer this simple question: when you are winning, are you increasing
your trading size or decreasing your trading size?
You see, the vast majority of traders will decrease their trading size when
things are going well, because they are afraid their winning streak will
eventually run out. The flip side to that coin is that they might even increase
their trading size during a trading slump, so they can win back the lost
money.
As Greg De Riba, an S&P 500 pit trader of superior quality, said in the
movie Floored: “99% still don’t get it – when they win, they start betting
less. Bet more!”
Perceived pain or real pain matters not to the subconscious. It will be
treated with the same response and the same emotions.
When the pain is real, i.e., real pain has manifested itself in body and mind
because of a trading loss, there is no end to the lengths our ego will go to in
its efforts to make the money back. This is the primary driver behind the
argument of ‘when wrong, double up’.
During a losing streak we tell ourselves that we are ever so close to winning
again, so the natural conclusion must be to double up in order to regain
what has been lost.
The real (subconscious) reason for doubling up on a losing trade is to
attempt to get rid of the pain. Now we are not trying to avoid pain; we are
dealing with existing pain, and we are trying to get back to that state of
equilibrium where we were pain free.
ACT WITHOUT FEAR
You learn a lot from observing millions of trades. If you want to stand a
genuine chance of making money as a trader from the financial markets, I
believe with every string of DNA within me, with every fibre in my body,
that you need to change the way you think about fear and pain and hope.
William Blake said that “He who desires, but acts not, breeds pestilence”. I
have worked tirelessly towards being able to act without fear and hesitation.
The true measure of your growth as a human being is not what you know,
but rather what you do with the things you know.
What do I mean by that?
Have you ever seen a chart pattern, and your first impulse was to buy or sell
short, but then – without warning – the very next thought was one of fear?
It was a thought you had no control over. It just exploded into the forefront
of your mind.
I have experienced that at times in my career. When it happens, I know I
need to reset somehow. Maybe I need to meditate. Maybe I need to sleep.
Maybe I need to eat or go for a walk. I know that something is blocking me,
and I need to resolve it.
My free creative mind instructed me to do something, but my fear instinct
immediately cautioned me not to follow through, because I might lose.
It doesn’t really matter whether you were right not to trade, or whether the
position would have lost you money or made you money. Those are
afterthoughts (rationalisations or justifications). We can file those under
anecdotal evidence, or evidence that has no merit. We all have an uncle who
smoked until he was 90 with no negative effects – anecdotal evidence – but
that does not justify the argument for smoking.
If my free mind argues for a position, and my fear mind argues about the
consequences of failing on that trade, then I am essentially arguing with
myself. The posh term for this phenomenon is cognitive dissonance.
My trades need to flow from a point of freedom of expression. Trades
conducted from a perspective of fear or greed will not lead to good decision
making.
My advice: stop trading and start contemplating. What is going on? When I
experience cognitive dissonance, it is for one or both of the following
reasons:
1. I have trading fatigue (or physical fatigue – ever heard the saying
‘fatigue makes cowards of us all’?).
2. I haven’t done my preparation well enough.
HOW DOES SHE DANCE?
Have you ever seen a market that was in freefall, and you were reluctant to
sell short because you were afraid you might lose? My basic aim with this
book is not to rid you of these fears. Fear will always be part of our lives.
My aim is to make you understand why you feel that fear and how to
process it, so you can take the trade.
I accept that I am a human ruled by emotions. I understand that I can’t
escape emotions, and nor should I try to escape them. Rather I want to help
you understand your fear, why it is there, and how to become friends with
it.
Earlier in the book I wrote about Philippe Petit, the man who walked across
a wire suspended between the Twin Towers. He is afraid of spiders. Yes, it
sounds silly, doesn’t it? His approach to dealing with fear is worth
repeating.
He would do everything in his power to understand the nature of his fear of
spiders. He would study spiders. He would learn everything there was to
know about spiders. Through his study he would come to appreciate the
nature of his fear.
How does that translate into the world of trading? Let’s take a practical
example. I am trading the FTSE 100 Index. My stake size is around £300 a
point for a starter position. Now I have to find the best entry points and the
best exit points.
But what do I do if I am afraid? What do I do if I am scared to place my
trades because I am not sure what the market is capable of doing?
The greater understanding you have of your opponent, the better you are
able to understand what she is doing. I use the word opponent here, but
really, the market, she is my friend. I want to dance with her. But I am
afraid of making a fool of myself. So, I study her moves.
I haven’t seen other traders do what I do, so I argue this is a novel way of
analysing the markets. Whether it is a new approach or not doesn’t matter.
What matters is that I get a sense of what my dancing partner is capable of
doing. What can I expect from her price behaviour? Is it erratic? Is it
smooth?
Observe the chart in Figure 9.
Figure 9
Source: eSignal (esignal.com)
We are all chart experts after the fact. However, studying past pricing
behaviour gives me a strong indication of what I can expect for the trading
day. You may see a market that initially rallies, makes a double top, and
then declines.
Let me show you the chart in Figure 9 from another vantage point – see
Figure 10.
Figure 10
Source: eSignal (esignal.com)
As part of my quest to trade without fear, I break down the chart into its
smallest components. I see the first wave up is 24 points. I see the
retracement is 9 points down. I see an attempt to make new highs, but it
only rallies 6 points. I see a deeper retracement of 12 points. I see an 8-
point rally, a 3-point retracement and another 11-point rally.
The retracements lower are between 9 and 12 points, with the exception
of one move of 17 points. You may argue that this is great (said with
sarcasm), if you had known about it before the trading session started. Well,
you did. Let me show you the day before, in Figure 11.
Figure 11
Source: eSignal (esignal.com)
The retracements lower are between 7 and 12 points, with the exception
of one move that was 14 points.
My approach to a non-fearful trading style is a combination of emotional
discipline, mental warm-up, and knowledge of what the market can do.
While these two trading days are different in outcome, their behaviour is
not altogether different.
I would go into the trading day armed with the following knowledge:
1. Deep retracements and outright moves tend to be around 10 points.
2. Small retracements against a strong trend are around 3–7 points.
Knowing this, combined with an understanding of basic price patterns, I can
develop an entry strategy aimed at risking as little as possible. For example,
on the previous chart, after the market has pushed higher for a move of +11,
I wait to buy a retracement. I know that most retracements are around 7 to
12 points, with the last three of them being 8, 7 and 10.
So now I am looking to buy. Say I buy at the point where the market has
retraced −7 points; I may be fearful that the market will move against me.
My knowledge of the immediate past suggests that the market is unlikely to
move more than −12 points in a retracement. I therefore place my stop-loss
at an appropriate distance away, based on the past behaviour.
The discipline to wait for the right entry, combined with the knowledge of
past price behaviour, will set you apart from the majority of traders. They
are unlikely to have done the same level of preparation.
Through your preparation (and I admit, I speak for myself now), you are
working through the issues your fear mind can throw at you. Your fear mind
might say “What if I lose?” If it does, the answer is that if the market moves
beyond −12 points your position is probably wrong, and your stop-loss will
handle your exit.
When I lend a helping hand to struggling traders via my Telegram channel,
the first thing I ask them is do they write down their trades? By that I don’t
mean write the particular trade entry on a piece of paper. I mean, do they
plot their trade entries on a chart once the trading day is over?
I have included a couple of examples from my own trading diary to serve as
a visual reference guide. See Figures 12 and 13. I use these to warm up in
the morning ahead of the trading day. I have selected random files from my
old trading days, and I will relive those moments, both the terrible ones – to
get me fired up on how not to trade today – as well at the good ones for
inspiration.
Figure 12
Figure 13
By observing my past behaviour, I am able to reinforce my good points
while being mindful of my weak points. I will observe the disastrous
consequences of my hasty trading decisions and my impulses. I will
observe trades where I didn’t let my profits run. I will in essence torment
myself by looking at my bad trades because I know this will act as a
positive catalyst.
Incidentally, I am not the only one who works like that. I read that Michael
Jordan and Cristiano Ronaldo thrive on negative talk about them and their
performance. They take that on board, and it acts as fuel to propel them to
greater achievements. Unfortunately, no one writes about Tom Hougaard
and his trading, so I recreate the situation by putting myself through my
past bad trades.
NOT ALONE
The disastrous, impulsive patterns I saw most frequently on the trading
floor fell into two categories:
1. Clients executed a long position in markets that they thought looked
cheap. More often than not they bought into established downtrends.
2. Clients executed a short position in markets that they felt had rallied
by too much. To them it looked as if the market couldn’t move any
higher.
I don’t blame you if you think I am making this up. Surely, traders can’t be
engaged in this kind of behaviour in an enlightened era like the one we live
in, where information flows so freely?
To prove my point, I went to the IG Client Sentiment Report from 26
October 2021. IG Markets is a broker that has been around for some time.
Their client base is global, and as such their sentiment report represents the
trade positions of a large segment of the retail trading community.
Before I show you the sentiment report for stock indices, I want to tell you
that as I type this, on the day of the sentiment report, stock indices all over
the world made fresh new all-time highs. The FTSE 100 Index in the UK
traded at levels not seen for years. In the US the Dow Index traded at levels
never seen before.
So, you would imagine that if my observations were inaccurate, the bias on
the sentiment report would call for people being bullish the market.
You would be wrong. Sadly, I was right about traders’ behaviour. 71.39% of
all Dow Index positions were short positions – on a day when the Dow
made fresh new all-time highs. Things were not much better for the DAX
Index or the FTSE Index.
Symbol Net-Long (%)Net-Short (%)
Germany 30
37.04 62.96
FTSE 100
30.60 69.40
US 500
39.85 60.15
Wall Street
28.61 71.39
This is why the 90% lose. We don’t see the market for what it is. We see it
as we are. A chart is only as illuminating as our ability to keep out
preconceived ideas of the direction of the market.
We are not losing money over time because we don’t know enough about
technical analysis or the markets as a whole. We lose money because we
refuse to accept what is right in front of us.
My basic premise is that people:
1. think the wrong way before they get into a trade, and
2. think the wrong way when they are in a trade.
It reminds me of the late Mark Douglas, a phenomenal light in the trading
industry and an inspiration to thousands of people, when he said that good
traders “think differently from everyone else” at the start of his book
Trading in the Zone.
I have coined my own phrase. I argue that people are fearful when they
should be hopeful, and they are hopeful when they should be fearful. I
would like to illustrate that by use of an example.
Imagine you have bought German DAX Index at 15,510 and the market is
now trading up at 15,525. Instead of thinking that the market may be on a
tear – and may go on to offer you many more points – you begin to fear that
the points you have already earned will be taken away from you.
Hence my saying: you should be hopeful in a situation like this, but instead
you are fearful. You are afraid that the points will be taken away from you.
You are not thinking about how many points this position may end up
making you. Your focus is on fear rather than opportunity.
The opposite holds true when you are in a losing position. You are now
hoping that the market will turn around. Your sole objective is to get rid of
your pain, and instead of being afraid that you’re going to lose even more,
you now hope that you can reach a position in which you will lose less.
Every tick in your favour is celebrated. Every tick against you is ignored.
If you want to trade well, you need to turn this on its head. You need to
teach your brain to be hopeful (about profits) when it is wrongly fearful
(about losing the profits). You need to teach your brain to be fearful (about
losses) when it is mistakenly hopeful (about the position turning positive).
It starts with being mindful of this behaviour. Perhaps a conversation with a
student of mine can further clarify what I am talking about.
CONVERSATION WITH A STUDENT
In the following conversation, my student and I are discussing a long
position I have running in Sterling Dollar.
Student: It feels like gambling.
Tom: Please explain.
Student: Well, I have 40 pips in profit, but you will not let me take the profit.
Tom: I won’t stop you from taking the profit, but if you ask for my opinion, you should let the
position run. You might want to consider the following scenarios, and then ask yourself how
you would feel in each case:
1. Run position and you get stopped out for nothing.
2. Run position and it explodes higher.
3. Close position and it explodes higher.
4. Close position and it reverses.
Student: I think it is best to close the position and secure the profits, rather than risk that the
market will take the profits away from me.
Tom: How would you then feel if the market exploded higher – in your favour?
Student: I would be disappointed, but I could always jump back in again.
Tom: If you jumped back in, you would have to pay commission again or at least the spread,
and you would have missed the explosive move. The only way you would profit from the
explosive move is if you were already in the move.
Student: Yes, but at least I would be playing for momentum to continue.
Tom: That is true, but you are already in a position where the momentum is on your side.
Student: I guess I just don’t want to see my profits disappear.
And there you have it – in a nutshell. People are hopeful when they are
losing money. They are fearful when they are making money. I believe this
is how the 90% think. It is the reason why – in a study of 25,000 traders –
they won more often than they lost, but they lost 66% more on their average
loss than they gained on their average win.
When the trader is confronted with a loss, they hope it will turn around. The
operative word here is hope. When they are confronted with a profitable
position, they are afraid the profit will disappear. The operative word in this
scenario is fear.
My student naïvely thought he could jump back in again, but he would
undoubtedly have had to do so at a worse price than the exit price of his
profitable position.
So, the trader holds onto the position until a point at which the pain finally
becomes too much, then closes the position. Unfortunately, this threshold
tends to be further down the road than the threshold of hope.
This is what you need to focus on.
This is what you need to work on constantly to change your pattern. I will
not state whether it will be easy to do or difficult to do. It just is. There is no
point in going any further in speculation if you can’t get yourself to do what
you must do, even though it feels uncomfortable.
You must be aware that in trading we tend to chase hope a lot further down
the road of misery than we are prepared to follow the road of opportunity. It
is just the way we are put together. You must be aware of this and have a
plan for combatting your natural behaviour.
However, I must warn you. Your mind is like a muscle. This is not a one-off
quick fix any more than doing 100 push-ups once will make you look like
Captain America for the rest of your life.
Atrophy is not just something that happens to bodies. It also affects our
minds. You need to strengthen that mind of yours through repetition. I
present my own training regime at the end of the book, although I am
actually describing it piece by piece as we move through the book.
THE NOT-SO-NORMAL BEHAVIOUR
What is not-so-normal behaviour? Well, firstly, I am all too aware of the
shortcomings most people display when they are trading: running a loss,
cutting short the profitable positions, over-trading, trading for excitement
and entertainment.
But this is already known to most – if not all – people, so the not-so-normal
behaviour goes somewhat beyond that. It is very rare that we ask ourselves
why we do what we do. Why do I trade when I do? Why do I take profits
when I do?
I think it’s time to bring in the words of a relatively unknown trader (but
one who was hugely respected by his peers). He was a pit trader at the
Chicago Board of Trade (CBOT), and his name was Charlie DiFrancesca,
also known as ‘Charlie D’.
MY HERO
Charlie DiFrancesca arrived at the floor of the CBOT with a dream and a
small account. He had a background in competitive college football –
American style – but otherwise there was nothing about this guy that would
indicate he would go on to become the biggest trader in the US Treasury
bond pit in Chicago.
He had a rough start. He barely traded in the first six months on the floor.
He just stood there and observed. Then one afternoon something clicked,
and he traded up a storm for two hours, making himself $5,000. From then
onwards there was no stopping Charlie D. He became a legend in the
trading pit until his untimely death.
In William D. Falloon’s biography of Charlie D., the great trader says:
The time you know you’ve become a good trader is that first day you
were able to win by holding and adding to a winning position. There
are many people here (in the trading pit) that have traded for a long
time, and who have never added to a winner.
Adding to winning trades is an absolute key trait of the successful trader. It
reinforces correct behaviour. It serves as an antidote to the temptation of
wanting to take profit. When I am in a profitable position, I have trained my
mind to ask, “How can I make my position bigger?” rather than dwelling on
the idea of taking profits.
Charlie D. goes on to talk about his own mentor, Everett Klipp, who taught
him about correct trading:
Unfortunately, it’s only human nature to want to cut your winning
trades. Say I am long at 6, and the market goes 7 bid, our mind
instantly thinks get me out with a profit. That’s human nature. It is also
human nature to ride the losses. I am stuck. I won’t close. I will wait.
ADDING EPIPHANY
In 2007 I met a person who was going to radically change my way of
trading. It all came about by chance. I had come back from a lunch break
and a colleague of mine returned from a meeting with an educational
company. This educational company taught technical analysis and they
were pitching their products to my colleague, who happened to be the head
of marketing.
What you need to know about my colleague is that he was the most
obnoxious East End London guy you could possibly imagine. He was brash,
obnoxious (I know, I said that twice), and arrogant, and no one could tell
him anything he didn’t already know.
Yet somehow this educational company had gotten his attention. He spoke
glowingly about a gentleman called Dr David Paul, who had taken him
through some basic technical analysis.
He showed me the technical analysis, and it was basic. Yet there was
something about the course material, which I had been given a copy of, that
told me that I needed to engage in a conversation with this gentleman.
It turned out that Dr David Paul had a two-day trading course coming up in
Johannesburg. So a few days later I booked myself onto a flight. It was one
of the only times I have ever participated in formal training on the topic of
technical analysis.
I have mentioned him before, but I’ll describe him a little more now. There
is something incredibly humble about Dr David Paul, despite everything he
has accomplished. He has a PhD in mechanical engineering. He used his
immense abilities to invent a drill for miners in South Africa. This was no
ordinary drill. It was the kind that sucks gas out of the ground as it drills,
and thus saves lives by more or less eradicating the occurrence of
explosions.
David Paul spent much of his time investing and trading. He made himself
a wealthy man. On the second day of the course David said something that
would change my perspective on trading.
He said something along the lines of this: “When you are in a winning
position, instead of thinking where to get out, why don’t you think about
where to get in more?”
He basically told me to turn everything upside down. Most traders with a
profit will begin to contemplate where to take half the profit. Next, they will
begin to contemplate where to take the next half of the profit.
David argued that this was what the 90% would do. He didn’t use those
exact words, but he did argue that if you want to make money trading, you
need to do that which the majority finds difficult to do. The first time you
try it, you may fall flat on your face. That is to be expected, but the next
time it might be a little easier, and the next time a little easier again.
DO WHAT IS HARD
David was essentially arguing that when you are in a winning position you
should put pressure on your position. The argument for doing so was
something he himself had observed when the market really began to trend.
I have tried to put a different spin on his words. When you want what you
want more than you fear what you want, you will have it. You want profits
in your trading. You probably have a good instinct about trading. You
probably also realise by now that it is your thinking that causes your
problems, rather than your knowledge about the financial markets.
If the 90% of traders are engaged with taking half profits and letting the
other half run, maybe the right thing to do is to double up on your position,
or perhaps conservatively add a little to the position, when everyone else is
taking half the profits. At least this is what I read between the lines, as I sat
in that hotel conference room in Johannesburg.
When the workshop was over I walked across the street and locked myself
into my hotel room. I sat down and waited. The Dow Index was trending. I
waited for a retracement. Then I waited for a five-minute bar to close above
the high of the prior five-minute bar.
Then I bought. Ten minutes later I added to my first position. Twenty
minutes later I closed at a double top. It was the most satisfying trading
moment in my life. A whole new world had opened up to me.
Depending on your experience level, you may or may not be able to answer
this question: why is it easier to add to a losing position than a winning
position? I have wondered about that myself many times.
You decide that you want to buy the DAX at 12,325. The market then
moves down to 12,315 and you are tempted to add to the position.
Why?
Why is it easier to add to a losing position than to a winning position?
Well, for starters, you would have loved to have bought at 12,315 rather
than 12,325 because you would have gotten a better entry price. Therefore,
buying again at 12,315 makes sense from an economics point of view. That
is plain simple logic.
There is a chance that you have a stop-loss in mind, and there is a chance
that you have a target in mind. Now you have an opportunity to have the
same stop-loss as before, but you have 10 points less risk, and you have
more profit potential.
You have also created a better average price, so the market has to move
fewer points in your favour before you are at breakeven.
Simple and logical – something our minds love.
However, you will now also have added to your position exposure, and the
market has told you that you are wrong, at least right now. It was easy to do
the wrong thing because we attach a value to the market. When the market
gives an opportunity to increase the value of our trade, it will seem
compelling to us.
So why is it difficult to add to a winning trade?
If I bought at 12,325, and the market is moving in my favour, I am relieved.
Now other emotions will enter the consciousness. There will be greed. You
want to make more. There will be fear. You want to protect what you have
made.
When the market reaches 12,345, you will be thinking that if you buy more
now, you have increased your average price to 12,335. It means that the
market will only have to move 10 points against you before your position
will be at breakeven, rather than in profit.
The key point here is: what is your mind dwelling on?
When we add to a losing position, we decide to dwell on the potential for
bigger profits. We decide not to dwell on the fact that the market is telling
us we are wrong. We decide not to dwell on the fact we have just doubled
our risk.
When we add to a winning position, we decide to dwell on the fact that the
market may take our profits away, because we have now decreased our
average price. We decide not to dwell on the fact that the market is
corroborating with us.
Put simply, the market disagrees with us, but we have faith that the market
is wrong, and we add to a losing position; or the market agrees with us by
showing a profit, but we doubt the market is right, so we don’t add to our
winning position.
It doesn’t quite make sense, does it? And yet, this is what the majority of
traders are doing all the time. Adding to a winning position can be
uncomfortable to begin with. No one is saying you have to double up on
your trading size the first time you add to a winning position. You could add
just a little bit.
ADDING STRATEGIES
There are two ways you can add to your winning trades. You can use a
same-size principle, by which you keep adding the same size. Say you buy
ten lots to begin with, and then you add ten more lots at a higher price, and
so on.
That is a risky way of trading. Instead you could use a second principle, by
which your first position is the biggest position, and subsequent positions
are smaller. So your first position might be ten lots, but the subsequent
positions might be five lots.
When I trade, I pretty much always use the same-size principle, but I urge
you to use the second principle until you are comfortable with adding to
winning trades.
BUILDING NEW PATHWAYS
The purpose of adding to winning trades is at its heart an attempt to fight
your normal human behaviour. In the beginning it is not about adding to
your profitability. That will come later. The purpose is to stop you from
taking half profits.
By adding to the winning trade, by thinking, “How can I make more when I
am right?” rather than thinking, “Where should I take profit?” you are
building a new way of thinking about trading.
Do you remember what Mark Douglas said in the opening lines of Trading
in the Zone? In trading, consistent winners “think differently from everyone
else”. When you start to think, “Where can I add to my winning trades?”
you are beginning to think differently. From then onwards, it becomes a
matter of habit. You have built a new neurological pathway in your mind, or
at least taken meaningful steps in the right direction.
CONTROLLING RISK
How do you control risk when you add to winning trades? This is a question
I am often asked. The answer is the same whether you are adding to a
winning or a losing trade: you place a stop-loss.
Some who receive this answer will say, “But if I get stopped out on an add-
on on a profitable trade, then I will have lost profits from the original trade
as well.”
Yes, that is true; but isn’t it better to get stopped out of a trade where you
have some profits to cushion your loss, rather than having added to a losing
trade, where you are now feeling the full force of the loss? At least when
you add to a winning trade, the market is currently agreeing with you.
I have just bought the Dow at 26,629. My stop-loss is 26,590. The Dow has
already rallied from a base of 26,569, so I might be a little late to the party,
but that doesn’t bother me.
Many a good trade has been missed by those arriving too late to the party.
As long as I have a stop-loss in place, I am fine to join a momentum move,
even one that has been moving for a while.
The Dow prints 26,649, and I buy once more. I am adding to my winning
position. Now my stop-loss on the first position I bought has been moved to
reflect the fact that I have taken on more risk. My first stop-loss is now at
26,629. The stop-loss on my second position is also 26,629.
At this point, two things can happen. Ideally, the market will carry on
moving higher, and every point move is now making me twice as much as
if I had only one position.
The less appealing alternative is that the market moves against me, and I
will get stopped out of the first position at breakeven, and I will lose 20
points on the second position.
There is no magic to it. It is a philosophy, and it is born out of a desire to
not be normal. The normal thing to do is to close half your position and let
the other half run.
Why would you do that? Why would you have the market agree with you,
but you only ride it with half a stake?
That is what the 90% are doing, and I don’t want to do what the 90% are
doing, no matter how logical it may seem. They are wrong over time, and I
want to be right over time!
It is such a crucial point I am attempting to get across to you, right here and
right now. I don’t know what is going to happen over the course of one
trade. Anything can happen. However, I do know what will happen –
statistically speaking – over the course of 100 trades.
Over the course of one trade, you may win, or you may lose. Over the
course of one coin flip, you may get a head or you may get a tail, and you
may get five tails in a row, but you will still end up – statistically speaking –
with a 50/50 outcome when you throw the coin 100 times.
The same applies to trades. You may be on a hot run, and have nothing but
winning trades on your screen, but over time it will even itself out.
Therefore, it is vitally important you don’t think too much about the
outcome of one trade, but rather the outcome of 100 trades.
The outcome of one trade is random. The outcome of 100 trades is
predictable. It is for this reason that our behaviour needs to be the same for
every trade we execute, whether we like it or not. By applying the same
correct behaviour to every trade, we are virtually guaranteed to be
profitable.
What is the correct behaviour? Well, why don’t we observe what everyone
else is doing, and then do the opposite of what they are doing?
The basic premise is that the majority of people who trade end up losing
money. That is our starting point. Now we observe what those people do. I
have been doing that for ten years. Here is what I observed:
1. THEY DON’T ADD TO WINNERS
They don’t add to winning trades. So, to be profitable, add to winning
trades, whether you add a little or you double up. Start slowly, add a little.
2. THEY DON’T USE A STOP-LOSS
They don’t like to use a stop-loss, because that would crystallise the pain of
the loss. As long as the position is open, there is hope. So, to be profitable
over time, use a stop-loss. Use a stop-loss on your first position and on
subsequent positions.
3. THEY ADD TO LOSING TRADES
We all love a bargain at the local supermarket, don’t we? And by all means,
continue to shop for bargains at the local supermarket; but do not do it in
the financial markets by buying more, just because you can buy it at a
cheaper price than the first time you bought it.
While you may get lucky from time to time, this is one of the main traits of
losing traders. Remember, we are focused on establishing the behaviour that
will ensure we will be profitable over time.
4. THEY TAKE HALF PROFITS
This one is going to be tough to argue, so bear with me. I know so many
traders – even people who have traded for decades longer than I have – who
advocate taking half profits. Their thinking goes along this pathway:
I will risk 20 points.
I will take half profits at 20 points and move stop-loss on the other half
to breakeven.
I will take the other half profit at 40 points.
It sounds so compelling. You close half the position, so if the market turns
around, at least you will have made 20 points on half the position. I can
understand the thinking behind it.
The problem I have with this strategy is that it never gives you the home-
run trades that you need to sustain yourself in this business. You will never
be on board the big moves because you have always limited yourself.
I have two fundamental arguments against taking half profits:
1. The market agrees with you. Let it ride.
2. Since I don’t believe in the risk-to-reward argument, because no
human being can know in advance what their reward will be without
limiting themselves, I don’t believe that taking half profits is the right
way to trade.
RISK TO REWARD
Did I just say that I don’t believe in the whole risk-to-reward argument?
Yes, that is correct. I do not. I believe in defining my risk. I don’t believe in
defining my reward.
When I am about to execute a trade, there is only one variable I have
meaningful control over: how much money/points/pips will I risk on this
trade?
Anything else is pure guess work. How much I will make will depend on
the market. It will not depend on me, unless I put a limit on my profits. A
very wise old trader once told me that losers spend their time thinking how
much they will make, while winners spend their time thinking about how
much they will lose.
The only variable I am in control of, as a point-and-click trader (as opposed
to one who uses an algorithm), is how much I can lose on a trade.
Observing hundreds of millions of trades over a decade, executed by an
army of well-meaning traders doing their best to make a profit, I have come
to the conclusion that setting a limit on your profits is not the way forward.
If I buy the FTSE 100 Index at 7,240 with a stop-loss at 7,235, and a take-
profit target at 7,250, I am sure I will be happy if the FTSE goes to 7,250
and reverses back down again. However, how will I feel if the FTSE moves
to 7,260, or 7,270, or higher?
Of course, there are exceptions to this rule. I may genuinely want to get out
at 7,250 because I feel there is overhead resistance at this area. It may even
be an area where I would want to sell short the market. I may also put in a
take-profit order at 7,250 because I may not be able to follow the market as
closely on this particular trade.
But generally, I do not work with targets because a target will limit my
profit, particularly on days where the market is in a runaway mode. With
this in mind, I would like to show you an example of a decision I made, and
how it ended up costing me dearly.
HOW NOT TO DO IT
The DAX gapped up, as shown in Figure 14. I know from statistics that
48% of all gaps get filled on the same day they occur. Considering that 90%
of daily highs and lows occur in the first hour and a half of the trading day,
I felt reasonably good about shorting the DAX on the low bar, indicated by
the arrow. The stop-loss was close to the high of the day. The risk was 35
DAX points.
Figure 14
Source: eSignal (esignal.com)
As shown in Figure 15, instead of continuing lower, the DAX Index
consolidates and moves higher, and it eventually takes out my stop-loss. I
am now at −35 points.
Figure 15
Source: eSignal (esignal.com)
The previous pattern does suggest higher prices to come. Yes, it looks like a
double top sell; but on a gap up day, the odds are higher of continuation
than of a reversal. Remember the saying, “In bull markets, resistance is
often broken, and in bear markets support rarely holds.” Well, you can
replace bull markets with bull trends, and bear markets with bear trends.
In Figure 16, I execute a long position on the close of the bar, as it closes
above my stop-loss. It is in reality a stop and reverse situation. I am stopped
out of my short position, and as a result of it, I am going long.
Figure 16
Source: eSignal (esignal.com)
The market moves into a consolidation, and eventually breaks higher. I add
to my long position, as show in Figure 17. So far everything looks okay.
Figure 17
Source: eSignal (esignal.com)
Then I make a mistake. I am at this point able to close the position with a
profit that exceeds the loss I made earlier.
Do you see what I am doing wrong now? I am not trading the chart. I am
trading my account. I am trading my state of mind. I am trying to get rid of
the pain from my previous trade. You can see this in Figure 18.
Figure 18
Source: eSignal (esignal.com)
Much to my disappointment, I admit I close my long position for no other
reason than being able to offset the prior loss. I talk myself out of the
position rather than just moving my stop-loss higher. It is not until my
review of my trading day that I really come to realise what I have done.
For now the market is not entirely in disagreement with me. For the next
two hours the market trades sideways. The longer a market moves from a
trending market into a sideways market, the less the prior trend matters. At
least that is what I tell myself.
Then as the US markets opens the DAX Index moves higher, and I am not
on board. You may not yet see the subtle point I am making here, so let me
point it out to you.
I do not belong to the brigade of traders who believe that “you can’t go
broke taking a profit.” I do think you can go broke taking a profit, if it
means you never have really big profit days because you are unable to let
profits run.
Simple as that!
Figure 19 shows what happened after my exit. While I don’t insist on
perfect trading, I review my trades religiously to pick up on errors creeping
into the inner workings of my trading mind. Am I maintaining my
discipline? Am I adding to winners? Am I impulsive?
Figure 19
Source: eSignal (esignal.com)
You may look at the chart and think I did okay. I look at the chart and I
wonder why I got out. The pain of having missed out on the rally towards
the end of the day was greater than the pleasure from making back what I
had lost earlier in the day.
PRESSING WINNERS
Adding to winners is habitual for me. I have new and experienced traders
following me on YouTube and Telegram exclaiming they want to know how
I do it.
One simple way of doing it is to look over the prior trading days, and come
up with a number of points at which you will want to add to your position.
For example, you may look at Euro Dollar and conclude you want to add to
your position at every 10-pip interval.
I went about my approach in a different manner. I think it is best illustrated
through the use of a theoretical explanation.
I want to trade the FTSE 100 Index, and I am looking for an approach to
adding to my winning trades. How do I go about doing that?
STEP 1
I need to establish what the historical volatility is in this index. I use a
measure called Average True Range (ATR). When using it I carefully
differentiate between periods in which I don’t want to trade the product, and
those in which I do want to trade the product.
For example, the volatility of the FTSE Index on a five-minute chart during
the night could be around 4 points, while the volatility on a five-minute
chart at the open at 8 am GMT is around 14 points. That is a significant
difference.
Say for the sake of argument that I have established that the volatility is
equal to 10 pips/10 points where I day trade the FTSE Index on the time
frame I prefer to trade.
We call that value N.
N = 10
My stop-loss is 2 × N.
STEP 2
Establish how much money you want to risk on a trade. This is a percentage
function of your account value. Say you have £10,000 in your trading
account, and you decide you want to risk 2% of the account.
Hence 2% of £10,000 = £200.
STEP 3
Now I establish my trading size unit, which is essentially how big my
trading size is.
If N = 10
Risk = 2N
Monetary Risk = £200
Then my trading size unit will be £200 / 20 = £10
STEP 4
I can then argue that I want to add to my position at every ½N. I think this
is where your own research should come into play. However, for the sake of
the argument, I will take you through an example, based on the numbers
above.
EXAMPLE
I buy the FTSE Index at 7,500.
My stop is 20 points.
My risk is £10 per point.
My add-on is at every ½N. This means I add at every 5-point increment.
The FTSE Index now trades at 7,505. I buy one more unit, meaning I am
now buying £10 a point at 7,505.
I now have two open positions:
Long 7,500 with stop-loss at 7,480.
Long at 7,505 with stop-loss at 7,485.
As you can quickly gather, this will cause a bigger loss than anticipated if I
do not move my stop-loss up on the first position.
Before I enter the second position, I have already planned to move my stop-
loss up by ½N. I will move the stop-loss up on the first position by 5 points.
This means that the stop-losses on the first and second positions are
identical. My total risk is now 35 points.
As I hope you can see, this way of trading can quickly materialise a larger
loss than perhaps you had wanted it to. It is for this reason I urge you to
consider variations of this method, such as adding with smaller stake size
on the second, third and fourth positions.
You may ask, “Why add at all?”
Because by adding, I am actively combatting the brain’s proclivity to
scaling down risk. Our brains want to take profit. I am doing the opposite. I
am adding to my position.
REAL-LIFE EXAMPLE
The following chart shows the Dow Jones Index on a trend day. I define a
trend day as a day when the market opens at the high or the low of the day,
and closes at the low or the high of the day.
The problem with trend days is that you won’t know it was a trend day until
the day is over. So, you have to make an assumption, based around what
you see on the chart, about whether you think it is a trend day.
I have researched the price action behaviour of the Dow Jones Index over
18 years. I have identified a handful of first hour patterns, which I believe
are precursors for trend days. One of those patterns is a gap down after a
gap up day, where the gap down is not filled within the first hour.
Figure 20 shows a positive Thursday. The trade I want to show you took
place on the Friday. Friday is notorious for producing lasting trends, often
leading to trend days, especially on Fridays at the beginning or end of the
month.
Figure 20
Source: eSignal (esignal.com)
I have also included a screenshot of my trading monitor.
Wall Street 3,000.0
25419.625135.9
kr851,150.00
 
500.0
25458
25135.9
kr161,500.00
 
700.0
25455
25135.9
kr224,000.00
 
350.0
25469
25135.9
kr116,725.00
 
450.0
25455
25135.9
kr143,775.00
 
200.0
25441
25135.9
kr61,100.00
 
300.0
25329
25135.9
kr58,050.00
 
250.0
25356
25135.9
kr55,250.00
 
125.0
25258
25135.9
kr15,312.50
 
125.0
25259
25135.9
kr15,437.50
The top line shows my overall exposure. It states I am short 3,000 in Wall
Street. My average entry is 25,419.6. The current price is 25,135.9. The
3,000 means I am short 3,000 Danish kroner per point, which equates to
about 500 US dollars per point movement in the Dow.
So, for every point the Dow Index drops, I make 3000 kroner, and vice
versa. For every point it rallies, I lose 3000 kroner. At the time of the screen
shot I am in profit by 851,000 kroner.
Below my total exposure, you see each of the entries, which add up to
3,000.
If you look at the previous chart, you will see the numbers 1, 2, and 3.
Those are points where I am adding to my position.
At Point 1 on the chart, I start selling short. I scale into my short position
over five entries. Those are the first five entries you see below my total
exposure.
At Point 2, I add more short positions. I do so because the market is weak,
and I am certain a trend day is developing. I add about 25% more to my
short position at Point 2. At Point 3, I add about 10% more to my short
position
As the market moves lower, I add to my positions, as I have been trained to
do. I move my stop-loss down as well. What you are unable to see on the
chart is that initially the market moved against me.
What I am doing here is critical to your understanding of fear. I have been
under water on my position, and now I am finally making money. My brain
has had to endure pain during the loss period, and I am now being sent
signals from my mind to relieve my brain of the pain it felt during the
losing period (15 minutes earlier).
I counteract this pain by actively doing the very thing that causes me pain. I
am embracing the discomfort by compounding it. This is required if I am to
actively engage in behaviour that is the opposite of the 90%’s. You will
notice that my add-on is not a big position. Yet, it serves to reinforce the
right kind of behaviour.
The Dow falls strongly. I am in the safe zone now. My core position cannot
be threatened. My stops are placed at breakeven. However, I am still
prepared to let this trade turn into an insignificant trade (small profit trade)
in the hope that it will turn into a significant trade.
You must find your own level of risk temperance. Once I was asked “If you
keep adding to your trades, when do you take profits?” That is a great
question. I use the charts to take profits. If I double bottom on a chart, and I
am short, then I might be tempted to take profit.
Alternatively – and this is a really good trick – I will place my stop-loss
where I would want to get into the market, but in the other direction. For
example, in this case, if I am short the Dow Jones Index I might place my
stop-loss at the price level where I would turn into a buyer of the index.
Although I am 100 points in profit, I am by no means relaxing. I am adding
to my position again and again, in smaller increments, in order to reinforce
the right behaviour.
The trade had the potential to turn into a spectacular trade. It didn’t. The
Dow bounced strongly (before falling again), and although I made a profit,
it was not the amount you see on the screenshot.
That is very important for me to get across to you, because I think it is
important that you establish some criteria for how much of your paper
profits you are prepared to give away in order to capture the really big days.
There are days when I come to work, and I just want to capture 20–30
points, and then be done. Not every day has hundreds of points available in
it.
Then there are days when the market starts out very strongly or very
weakly, and you think to yourself, “This could be a really big day.”
I have a philosophy to trading that means I am prepared to sacrifice profits
in order to discover how big the profit can get. If you don’t have that
philosophy, you will never discover how big the profit can get.
If you always think of potential targets, using technical analysis, you are
most likely just talking your way out of a good trade. You might be using
technical measures to time your exit, but I don’t subscribe to this method.
There is a reason for that. When the market is trending, and I am on board
the trend with a position, I hope that the market will close that night at its
strongest/weakest for the day.
It happens on at least 20% of all trading days in stock indices. Yes, I have
had plenty of disappointments, but I have had sufficient stellar days to make
it part of my philosophy.
DAX INDEX – TRADING EXAMPLE
Let me show you another example of a trade where I added to my positions.
However, this time I will show you what I saw at the time of the trade. See
Figure 21.
Figure 21
Source: eSignal (esignal.com)
I am not on board the first push down. I look at the rebound for an
opportunity to short the DAX Index. On the next image you can see my
initial position entries highlighted in box 1.

DAX finally caves in and resumes its downtrend, as shown in Figure 22.
You can see my subsequent short entries in box 2. There are a couple of
things I would like you to see here:
Figure 22
Source: eSignal (esignal.com)
1. I am not afraid to sell short something that has already fallen in
price. This is consistent with what the majority of people do not want
to do.
2. I scale into the position in this example, and I add aggressively to
my short position once my position is in profit.
I urge you to contemplate how you can introduce the element of adding to
winners into your trading. I am not interested in rewriting your trading plan.
I am not interested in turning you into a copy of me. I am interested in
trying to make you understand the value of pain in trading, as a barometer
for adding to positions.
If it is uncomfortable, then it is probably the right thing to do.
I will repeat something I mentioned earlier. I think you should give serious
contemplation to the question of why people in general find it easier to add
to a losing trade than a winning trade.
I don’t ever want to be accused of glorifying trading. It is a risky
proposition. Twenty years ago most brokers in Europe didn’t have what we
today know as negative balance protection. Today, it is a legal requirement.
It means that you can’t lose more money than is available on your trading
account.
You can still lose a lot more than you anticipate, especially if you add to
positions, like I do.
As you become better at trading, you will want to trade bigger and bigger
size, and the market on a big position doesn’t have to change direction by a
lot before you give away a big portion of your open profits.
If you want proof of that, here it is. This was a perfectly good-looking DAX
position which turned from being very profitable to showing a significant
loss. It starts well with a short position at 11,288. I then add to the position
as the DAX Index falls. Then the market reverses, and I add a little more at
the old top.
At the point of the screenshot I am short 4,500 kroner per point, and I am
losing 25 points. I close the position shortly after for a loss.
4,500.0
11289.411314.0
kr−110,5100.00
300.011288.311314.0
kr−7,710.00
350.011286.811314.0
kr−9,520.00
400.011285.211314.0
kr−11,520.00
500.011285.011314.0
kr−14,500.00
500.011279.011314.0
kr−17,500.00
500.011274.811314.0
kr−19,600.00
450.011295.211314.0
kr−8,460.00
500.011293.211314.0
kr−10,400.00
500.011292.711314.0
kr−10,650.00
500.011312.711314.0
kr650.00
UNCOMFORTABLE
There are no shortcuts in the trading industry, any more than there are
shortcuts in, say, professional sports. I expect to get uncomfortable during
the trading. At times it feels like the minutes last for hours. My impatience
to do something is raging within me. I am battling my own emotions more
than I am battling the markets.
Finally, when I am in a position, my mind has something to occupy itself
with. Be careful what you ask for! Maybe the position is showing a loss, so
now I am battling my subconscious mind, which wants the position to run a
little longer.
My conscious mind has a stop-loss, but my subconscious mind wants to me
to remove it. It doesn’t want to lose.
It could be the position is going well. Now my subconscious wants me to
take my profits. It loves the gratification of a good profit. So, I am battling
it whether I am winning or losing on my trades.
The key to victory starts with being mindful of the existence of two brains.
The ability to anticipate your enemy’s next move is crucial. The
subconscious brain is a rather simple beast. It just wants to avoid pain.
For the subconscious brain there are two pains in trading. There is the pain
of seeing a profit. When it sees a profit, it wants you to close it because then
it doesn’t have to deal with the pain of seeing the profit disappear. Then
there is the pain of loss. When the subconscious brain sees a loss, it wants
you to hold on to the position a little longer and a little longer. Otherwise, it
will have to deal with taking the loss. As long as the position is open, there
is always hope.
In a nutshell, what separates the 10% of winners from the 90% of losers is
which brain they are listening to. It took me many years to realise this. I
developed a system for my mind, a training program that enabled me to
withstand the influences of the emotional subconscious brain on my trading
decisions.
During the Round the Clock Trader event referred to previously, a guest
asked me if I wasn’t afraid that the market would turn back up the moment I
went short.
Who do you think was really asking that question? It was the part of his
mind controlled by fear. Of course, the market might very well turn around.
I would lie if I said that had never happened. It probably happens five times
out of ten. So, the real question to be asked is this:
what would cause you more pain?
1. You sell short and the market reverses back up.
2. You do nothing and the market reverses back up.
3. You sell short and the market continues lower.
4. You do nothing and the market continues lower.
OPTION 1
I sell short and the darn market moves against me again. It is annoying, but
the stop-loss will take care of my exit. At least I can say that I followed my
plan.
OPTION 2
I do nothing and the market moves back up. I might be happy, but I have
just trained my mind not to follow the plan, and I was rewarded for it.
I was rewarded by not selling short, which would have lost me money, and
my mind is now congratulating me for my excellent chart reading skills, but
for all the wrong reasons.
OPTION 3
I sell short, like I am supposed to, and the market follows through to the
downside. Instead of clapping my small paws in joy, I am proactive, and I
add to my winning trade. I am doing absolutely everything I am meant to
do.
OPTION 4
I decide not to follow the plan of shorting, and the market moves
aggressively lower. I would have made all the lost money back from the
first trade, but I do not.
I can’t speak for you, but I will tell you how I feel about it. It causes me
more emotional pain to miss a move because I didn’t follow through on my
plan than when I followed through with my plan.
WHAT IS TOO FAR?
Another question that came in after the short trade was this: “Were you not
concerned that the market had already moved too far? Do you not think you
had already missed the boat?”
The person who asked this question is most likely the same person who
would not buy the DAX because it had already rallied 1% on the day.
This is the supermarket analogy all over. We seek out bargains, but we
avoid buying items that have risen in price.
It is a mental illusion. You can’t say the DAX is too expensive just because
it has rallied 1% on the day. We do not want to buy something that is
already going up. We would rather wait until it comes down again to buy it,
because then it is cheaper.
Similarly, we do not want to sell short something that is already going
down. We want to wait for it to rise again and sell it when it is higher (more
expensive) because it gives us better value.
In principle, I don’t disagree with these statements, but here is the flaw: that
is what everyone else wants to do, and the majority tend to be wrong.
Correction: they don’t tend to be wrong; they are wrong. Sure, they are
right 60% of the time, but when they are wrong they are really wrong. How
do you know where the top or the bottom is? I have seen a lot of trading
systems, but none of them had an acceptable success ratio of predicting tops
or bottoms.
This is why I say that you should buy strength and you should sell
weakness. Buy high, sell higher; sell low, buy back lower. Will I miss the
absolute turning points? Yes, I will. Top pickers and bottom pickers soon
become cotton pickers.
When I am distressed about profits disappearing, I remind myself of the
story of a US super trader whose reputation for doing the right thing under
pressure is legendary. His name is Paul Tudor Jones.
He was once watching the market and, as it had been rising all morning, he
had been buying steadily. He was long several hundred contracts showing a
good profit.
Suddenly the market jolted lower for no apparent reason. Without blinking,
he sold out all his long positions, and as the market continued to fall, he
started to sell short the market too. One of his colleagues who didn’t know
he had commenced shorting the market commented on the fall and said this
was a good chance to start buying.
The conversation, edited for expletives, went on as follows:
“Are you mad?” said Paul.
“What do you mean?” said the colleague.
“You must be mad. The market has just broken 100 points in 15 minutes,
and you are looking to buy it?”
“Well, what would you do?”
“Let’s put it this way, I am certainly not looking to buy it here.”
“Well, would you sell them short here?”
“Of course I would!”
“But they have come down so far.”
“Exactly, that’s the point.”
“Right,” said the colleague. “Well just how far would the market have to
fall before you started to buy it?”
“As long as it is going down, why would I buy it?”
“Because it’s so cheap, it’s an absolute bargain. It’s 100 points cheaper than
it was 15 minutes ago.”
“Forget cheap. Forget expensive. It’s just numbers on a page.”
“But I don’t understand. If it kept going down, where would you try and
buy it?”
“If it kept going down, I’d want to be selling it, not buying it. If it kept
going down, I would sell it down to zero.”
“And if it was going up?”
If it kept going up, I’d buy it to infinity.”
I absolutely love this story. Having seen Paul Tudor Jones trade, you sense
his energy, his intensity and determination, and his utter conviction in
whatever he does. He doesn’t just say, “Sell short.” He shouts, “Sell short!”
stamps his feet and swings his hands.
I admire his mental agility – flowing from being convinced on the long side
to turning the position to the short side. Sadly, this is one trait that is hard to
acquire. I know some traders with decades of trading experience who are
unable to flip the switch and go from being long to being short.
FINDING A LOW
Trying to find the low in a stock can be a costly affair. We all make
mistakes, but how costly is the mistake going to be? I remember very
vividly watching a CNBC show called Mad Money, during the financial
crisis in 2008.
On the show Jim Cramer received an email from a viewer asking about the
health of Bear Stearns. Now I am sure that if Mr Cramer had an opportunity
to go back in time he would most certainly amend what he said in that
broadcast.
He basically shouted at the screen, saying that Bear Stearns was fine. But a
few days later Bear Stearns was gone, done and dusted, never to be seen
again.
You may recall my first brush with meeting clients back in 2001. I gave
them the not-so-welcome advice to get the hell out of their Marconi shares.
Would you believe it if I told you that history repeated itself in 2007?
It is easy to be swayed by a supermarket mentality when we are trading. As
I mentioned previously in the book, when we go into a supermarket, we are
drawn towards the special offers. When I look at my shopping basket from
this weekend, I see things that I wouldn’t normally buy.
Of course, I would need these things at some point or another. We all need
toilet paper. We all need dishwasher tablets, and we all need hand soap. The
reason why they were in my shopping basket this week was because they
were on offer. Who can resist a 50% discount?
But a 50% discount in a supermarket is not the same thing as a 50%
discount in the financial markets. Many clients of City Index, the broker I
worked at for more than eight years, came face to face with this reality
during the financial crisis from 2007 to 2009.
In 2006, after having done very little for years, a stock called Northern
Rock went on a tear. It rallied 50% in months. There was no real interest
from City Index clients in the stock during the rally phase.
However, when it began to slide back down again afterwards, the interest
rose. It was as if Northern Rock had the same effect on investors that half-
price toilet paper has on shoppers in a supermarket.
Northern Rock became quite a lively traded stock. The more Northern Rock
fell in price, the more people got interested in the stock. At one point I
received a phone call on a Saturday morning at home. At this point
Northern Rock had slipped from 1200 pence down to around 500 pence.
The person on the other end of the phone was a stranger to me. He had
picked up my business card at one of the talks I had given on technical
analysis. He apologised for calling me so early on a Saturday morning, but
he and his friend had decided to invest in Northern Rock. They had decided
to get the opinion of a professional, just to double check whether it was a
good idea.
Apart from being rather annoyed at being woken up at 7 am on a Saturday
by a stranger, I was also annoyed with the question. At this point Northern
Rock was in freefall. I roughly said the following to the stranger:
Look, I don’t know what is going on with Northern Rock, but there is
something horribly wrong. Although the general market is declining
too, Northern Rock is declining much more.
What I am afraid of is that there is something amiss that we don’t
know about, and it has yet to be known to the market. It feels as if
someone somewhere knows something is horribly wrong, and they are
selling out while they can.
I told him that I had many clients who had said exactly what he was saying
now, but about Marconi five years earlier. Fortunes were lost by clients who
kept buying Marconi, even though it was falling and falling, because they
engaged in bargain hunting. It had been horrible to see the losses our most
valuable clients endured simply because they did not want to admit they
were on the wrong side of a bad share.
I said to him: “From a trader’s perspective, you are engaging in a very
dangerous activity. If you buy Northern Rock now, it will be very difficult
for you to have a meaningful stop-loss. You are essentially trying to catch
the falling knife. You talk as if Northern Rock is the only bank in the world
worth investing in.
“You talk about Northern Rock as if it couldn’t go bust. You talk about it as
if the fact that it is 200 years old means that things couldn’t get worse
before they get better. You even said it yourself: Northern Rock is too big to
fail. It means you are already to some extent aware of the danger here.” I
asked him if he remembered Barings Bank. He did.
“There is a second reason why I don’t think it’s a good idea you buy
Northern Rock,” I continued. “Let’s say you are fortunate enough to witness
a turnaround in the fortunes of Northern Rock. You will have trained your
mind to think that it is perfectly okay to buy into things that are falling. This
works perfectly in a supermarket. Toilet paper has a practical use. Soap has
a practical use, so when you are provided with an opportunity to purchase
these items at a 50% discount, you should do it.
“However, to believe that the financial markets offer discounts akin to what
you’re seeing in a supermarket is ludicrous. The financial markets are not a
supermarket with special offers.”
Eventually Northern Rock went bust. The British government had to
guarantee customers’ savings. That didn’t stop panic scenes as people
queued up to get their money out.
THINKING RIGHT
As you read this anecdote, you might think it could never happen to you.
Perhaps you are right. I am not going to suggest otherwise, but I would like
to ask you a simple question.
Imagine you have two investments, Investment A and Investment B. Each
investment had equal starting value of $100,000.
Investment A is doing well. It is up 50%.
Investment B on the other hand is not performing. It is down 50%.
You are now in a situation where you need $50,000. What do you do?
1. Close a third of Investment A to raise $50,000?
2. Close investment B to raise $50,000?
When I asked this question to a group of investors at a conference in
Copenhagen recently, the overwhelming majority opted for option 1. They
would close enough of investment A to raise the $50,000.
Why do you think that is? Why do you think people close the investment
that is doing well?
My theory is it all boils doing to how people react to taking a loss. Are they
able to take a loss and move on? Or are they so averse to taking a loss
because as long as the position is open, there is hope it will come good
again?
Of course, it is impossible to say exactly how you would react in this
situation, but I don’t have to rely on fictitious examples to get an answer. If
you recall the chapter where I spoke about the 43 million trades executed by
25,000 traders, you will remember that those traders lost more on their
losing trades than they won on their winning trades.
Emotionally, a loss is clearly felt much harder than a win. Otherwise, there
would be no reason for this anomaly. Human beings postpone making
decisions that will cause pain. It is the reason why we let losing trades run.
We want the instant gratification, but we want to delay the pain. Hope dies
last. As long as the losing position is open, there is hope.
THE JUNKIE AND THE CEO
I use an analogy to illustrate the concept I have just explained: it is akin to
firing the CEO of a successful Fortune 500 company and betting your
money on the junkie turning his life around.
Crude? Yes. The junkie might turn his life around, but I think the odds of
the CEO continuing his successful run are higher than those of the junkie
turning a corner for the better.
That is why I am arguing that trading is so much more than technical
analysis. That is why I am arguing that we need to learn to handle losses a
lot better than the general population does, because they handle them very
poorly, and as a result they are generally unable to make money from
speculation.
CONTROL YOUR MIND – CONTROL
YOUR FUTURE
I am not a masochist. Nothing could be further from the truth. If I do tend to
dwell on pain, it is more a reflection of pain’s role in the context of trading
profitably. What I’m attempting to do is a difficult endeavour. I’m trying to
explain why 90% of all people fail in achieving their hopes and dreams
when it comes to trading.
When so many people commit the same mistakes over and over, there must
be a deeper meaning that has yet to be uncovered. Naturally I’m hoping that
by now you will have a much greater understanding of what it is that is
going wrong.
My own motto is: control your mind – control your future. Doing so
requires constant vigilance. You have to own your life. If you don’t own it,
you are not the boss. You have to take full responsibility for everything that
you do.
You must be the master of your own kingdom. You can’t walk through life
with your eyes half shut. You have to walk through life with your eyes fully
open. You have to know what you are getting into – be prepared. You have
to take possession of your life.
This is a thought process you have to constantly reaffirm. Our minds tend to
drift. There are so many distractions in life, so much superficial noise that
doesn’t bring substance but that our brains are attracted to nonetheless. The
brain would rather look at Facebook and YouTube than sit in quiet
contemplation.
The drifter brain needs to be controlled through daily vigilance, whether it
be through a mantra or meditation or whatever you decide suits you best. As
a famous doctor once said when asked what exercise is best for us humans:
“It’s the one you do”. It doesn’t matter whether you meditate or write a
diary or do whatever other practice you choose to centre yourself, so long
as you do it.
There needs to be a regular time in your day where you remind yourself of
your purpose, of who you are. The world is full of temptations that distort a
healthy self image. The temptations take us away from who we are by
telling us that who we are is not enough.
But you are enough.
Being a good trader really has little to do with tools and charts. It has a lot
to do with fighting our humanness. If you really want to trade the markets
using leverage, engaging in high-octane speculation, you have to learn to
desensitise your normal emotional response mechanism to fear, greed and
other delightful human reactions. You have to fight your humanness.
DISGUST
MANY YEARS AGO, when I was just a young man, I had a girlfriend. She was my
first real girlfriend, and I was her first real boyfriend. We were young, and
we were very much in love.
My girlfriend was a little round bodily, which I found very attractive. She,
however, did not like her body image, so she began to diet. She had dieted
before, but had always failed to sustain a weight loss plan. Now she was in
love, and her motivation shifted into another gear. The weight loss became
quite dramatic, and it led me and her family down a path that pains me to
write about.
Anorexia is a serious psychiatric disorder, but (and forgive me for using a
tragic story to illustrate a point about behavioural change) it is an
interesting motivational phenomenon.
We are hardwired to eat. We need no training to eat. Yet somehow this
hardwired pattern is overridden by a social motivation: the desire not to be
overweight. This force, this motivation, is so strong in patients with an
eating disorder that it proves to be impervious to both medical and
psychological treatment.
What is the basis for this powerful motivation? It isn’t chanting, and it isn’t
positive self-talk. As I understand it, my girlfriend was motivated by love,
but more importantly by disgust. She was disgusted by anything that looked
and felt fat and overweight. This force was so strong it could disrupt her
hardwired pattern of eating food.
As humans we are driven forward by forces. Those forces can be born out
of a desire to move away from something, or they can be born out of a
desire to move towards something. I happen to be a person who is primarily
motivated to move away from something.
I grew up in a wealthy part of Denmark, and I attended a school for the
well-to-do. Then my parents divorced, and I went from living in a big house
with an enormous garden to living in a one-bedroom flat, where my father
would sleep on a pull-out sofa bed in the living room.
I was a young boy at a time when all my school friends wore Levi’s denims
and Lacoste shirts. There was no money for that in my life, and it created a
sense of inferiority in me.
As soon as I was old enough, I started taking afterschool jobs in order to
earn money. What did I spend it on? You guessed it. Brand clothes.
I also became a prolific hoarder of money, a saver, if you like. I took great
pride in depositing my wage cheques in the bank and seeing my account
balance grow. I moved away from poverty.
In my belief system and in my experience, away-oriented goal setting is a
much stronger motivational force than towards-oriented, but I accept that
this is an individual preference. You can test for yourself where your
preference lies, using a simplistic scenario. What would compel you to lose
weight more: a picture of you in perfect shape or a picture of you where you
are obese?
I asked my circle of friends what they would prefer, and all agreed that they
would find the obese picture a stronger motivator than the perfect picture,
although a few did comment that they would probably still like to have
both. Fair point.
I believe that disgust is a much stronger emotion than joy or happiness. We
all have reasons to be happy every day, but we tend to forget that. However,
disgust is not something we are likely to forget.
You won’t forget the rotten milk you drank by mistake, nor will you forget
the client of yours who had such repugnant breath that you nearly threw up.
Ed Seykota once said that everybody gets what they want from the markets.
When I read that, I dismissed it. I wanted to win, but I wasn’t winning, so I
clearly wasn’t getting what I wanted. End of story.
It annoyed me that he had said that. The thought of never being able to trade
profitably consumed me. I had spent so much time studying, researching,
testing, formulating plans, calculating ratios that I really didn’t know what
more I could do.
If you look around in your life, you are likely to be able to find examples of
dramatic changes induced by disgust. What gets a person to finally commit
to a goal is reaching the point of disgust. I got disgusted with my trading
over a long period of time. The pattern was always the same:
1. Trade like a wizard.
2. Become over-confident.
3. Blow up the account.
I became so sick of it. Positive intentions, sticky notes with mantras on my
trading monitor, and self-help exercises don’t possess nearly the
motivational force of physical disgust with oneself.
If disgust can turn eating into a behaviour to be avoided, and if disgust can
turn an alcoholic’s drinking into a thing of the past, then disgust can also
turn you into the trader you would be proud of looking at in the mirror.
I am sorry if I have shocked you. Those of you who know me well will
probably be taken back by my extreme steps to ensure my pattern of
behaviour in the trading arena is exemplary.
I am not going back to the rollercoaster ride I was on in my early trading
days. I was so disgusted with the amount of money I lost. It was
embarrassing.
We are most apt to change a pattern once we become truly disgusted by it.
Would you continue to do business with someone who violated your trust
and stole money from you? No, you’d become so disgusted with such a
dishonest character that you would cut all ties with them.
Well, that person is you when your own patterns violate your contract with
yourself and cause you to lose money consistently. Once you become truly
disgusted with your own patterns, you’ll shun them altogether.
A trader is losing and continues to lose because he doesn’t want to change.
Change is hard work. I began plotting my trades on the chart when the day
was over. I put a marker where my entry was and where my exit was. It was
horrible. It was like incriminating yourself over and over. I was disgusted
with my recklessness.
I had to face up to the fact that I was actually an awful trader. I was like the
guy who could recite the entire technical analysis syllabus for the Master
Technician exam, but I could not stop myself from
1. Overtrading out of boredom.
2. Overtrading out of anger and a desire to get revenge.
3. Impatient trading – jumping the gun.
4. Trading against the trend – trying to catch the low of the day.
5. Fearful trading – by cutting my winners short out of fear the profit
would disappear.
6. Constantly averaging in lower and lower – i.e., adding to losing
trades.
ALCOHOL
When you are a successful trader, you make good money. My friend and
trader mentor Larry Pesavento instilled in me the passion for passing on.
Larry himself is an inspiring trader, but his passion for helping others is
equally admirable.
One project I support is to help people dealing with alcohol issues. I do so
by offering anyone who sincerely desires to quit drinking a book that helped
me truly understand the nature of the addiction trap.
I developed a drinking problem in the aftermath of a painful breakup. I
drank to forget. I was in love. I was a fool. She left me. I started drinking.
The problem was that I didn’t seem to be able to stop myself from drinking.
This carried on for many months. I could not stop myself from drinking, so
I sought out help. I remember vividly standing up at an Alcoholics
Anonymous (AA) meeting saying, “My name is Tom Hougaard. I am an
alcoholic.”
It was horrible, but at the same time it was relieving. I felt like a fraud. I felt
there was inconsistency in my life. I was outwardly a success. I had two
cars. One was a luxury SUV, the other an Audi R8. I lived in a nice part of
town, overlooking the sea. What did I have to be unhappy about? Well, for
one, I had no control over myself and my drinking.
Standing at an AA meeting is like being stripped naked for the whole world
to see. They see your fat ass, your tiny willy, your saggy boobs, your
cellulite, your scars, your spots, your pimples, your swellings, your bald
head and whatever bodily imperfections you can imagine. It is absolutely
everything you don’t want, and you have a hall full of eyes watching you.
But by the end of the exercise you realise the truth. You break yourself
down so that you can survive, so that you can be reborn as the person that
you really want to be. A fresh start. Vanity thrown on the rubbish pile. Clean
canvas. Here I am. This is me.
The walls are ready to be decorated however you want. Exactly the same
model is used to train elite soldiers. They are pushed beyond their breaking
point. Then they are put back together again, stronger, wiser and with an
unshakable faith in their own strength, their own abilities and their
determination to get a job done – no matter what.
No one in their right mind enjoys exposing themselves like this. It is why
we get defensive. It is why we fight our corner. Our identity is being
questioned. Call it ego, call it identity, call it what you want, but no one
likes having their intelligence questioned. It is a lot less painful to continue
down the known path than to stop, evaluate, and turn around.
There is only a slight, nagging pain when you choose to continue down the
known path, and you can soothe your inner pain by reminding yourself that
you are not alone. There is power in numbers, even when everyone is
wrong. But you soon find yourself being disgusted by your own lack of
progress, your own inability to stop the behaviour that is troubling you.
Attending AA meetings was rock bottom for me. I evaluated. I got honest
with myself. The pain was relentless because everything was new, and I felt
naked, very alone and exposed.
And yet, that is power! There is power in being honest. There is power in
standing up and saying to the world and yourself: “This is who I am, and I
don’t like it! In fact I hate it. I am embarrassed by it, but it is what it is. It is
a clean slate. It is a fresh start. It is like a forest fire. It clears the debris.
New growth can start.”
I have not touched alcohol for six years and I know I never will. It wasn’t
the AA that finally helped me; it was healthy living advocate Jason Vale. I
have never met the man, but I want to thank him for setting my life on a
good path. I am certain that no one has bought more copies of his book
about alcohol dependency than I have. I send them to people all over the
world.
Jason describes better than anyone the trap of alcohol. Reading his book
helped me understand the nature of addiction on an entirely different level,
and I found it easy to stop drinking from day one!
You may ask what this has to do with trading. Rightly so. The answer is
simple: if you have some trading experience, and it is not turning out to be
how you want it to be, you have a choice. You can carry on, thinking that
things will change. I can tell you they won’t, but you will probably not
listen to me.
Or you can take my advice. You did after all make it all the way to this
section of the book, so maybe there is room for improvement. You can strip
yourself naked (metaphorically speaking), and get honest with yourself.
You can stop trading, and start reviewing. You can begin to understand what
it is you are consistently doing that causes you not to make money trading.
Take yourself apart, clean up the process, take on board my guidance for the
mental side of trading, put yourself back together again, fund a small
account and start with an entirely fresh mindset and approach.
THE DRIFTER MIND
HOW OUR MINDS work is fascinating. The brain can be our best friend or our
worst enemy. When I give talks in public, my own life mantra is written on
virtually every PowerPoint page of any presentation I give.
Control your mind – control your future.
You have to want to do what you do. You can live a life that is authentic to
your soul, or you can live the life you think people want you to live.
You can be authentic and own your life and take responsibility for
everything you do. If you don’t take ownership of your life, you are not the
boss. You have to take full responsibility for everything that you do.
Why would you live life any other way?
Why be subservient? You must be the master of your own kingdom. But
brace yourself. You will be forced to make many difficult decisions, and
you cannot count on your mind to back you up if your determination
wanders a little.
You can’t just walk through your life with your eyes half open. You have to
know where you are going. You have to take possession of your life. It
would be nice if you could rely on your friends and family, but when it
comes to your life’s journey, you are on your own. It is your responsibility.
Part of that journey, including your trading journey, is to discover your
weaknesses. You have to know where your mind lets you down. For the
vast majority of people in the world, this will include their mind’s tendency
to wander.
You see, all of us know what to do. All of us have the knowledge to do what
needs to be done, but the path from knowledge to action, where we
implement our knowledge, is elusive for many people in many areas of their
lives.
Your mind will drift. This is unfortunate but perfectly natural. The solution
is trivial, and it is powerful. You have to constantly reaffirm your purpose.
Whether you meditate or talk to yourself while you brush your teeth in the
morning, there needs to be some period in your day when you remember
your purpose. There must be a time to remind yourself where you want to
go, what you want to do.
One thing I can’t always rely on is my ability to act in my own best self-
interest. My mind needs constant guidance and direction. I don’t know why
that is, but it is. I suspect the majority of the population of the planet is put
together like I am. They just haven’t realised it yet, so they drift through
life, rather than taking charge. This doesn’t mean they can’t be financially
successful, but wouldn’t it be nice to be both financially and spiritually
fulfilled? Your job after all is that thing that you do the most, outside of
sleeping.
I am a professional trader. I cannot afford to go into the trading ring without
being 100% mentally prepared. My profession is a mind game like nothing
else. If I want to win, I have to focus on what is important now. So Ed
Seykota was right, much to my chagrin. I did get what I deserved, because I
was only good at one part of the game. I was good at the technical part.
I don’t like this metaphor, but being good at the technical part of trading is
like being good at putting together a sniper rifle; what good does that do
you when you go into combat and you don’t know how to handle yourself?
I actively take control of my inner world. I have to give myself enough
confidence to reassure myself that I have enough to go out and kick ass in
the markets every day.
To make that challenge even more real, I post my trades for the world to
see. I have never consciously thought about why I do that, until someone
recently asked me. I realised that I do it because it keeps me accountable. It
keeps me focused.
I have been as lost as they come. I tell you that not to inspire you to get lost,
nor to evoke sympathy, nor to tell a tale of rags-to-riches, but to make sure
you understand that exposing your weaknesses will be a good thing.
Your mind is a tool. If you let it delude you into thinking all is well, you
will not get the success you want in trading or in life.
Losing and failing might be a knock to the ego, but it is rocket fuel for
growth. It sounds like I am trying to write a self-help manual for
procrastination, a bestselling inspirational book. But I am describing
honesty. When you are honest with yourself, in the company of yourself, or
on a podium in front of 40 alcoholics, or whatever the setting may be, you
just took a step that 99% of the population don’t ever contemplate taking.
You already started the journey to winning.
So, the journey starts with technical knowledge acquisition and continues
indefinitely with the constant evolution of both the technical and mental
training.
Technical training is part of my day-to-day job, but the mental part needs
more dedicated focus, otherwise it gets lost in the noise of the outside
world. I need dedicated time to give that brain of mine a workout.
I want to show you one of the mental warmup images that I go through
before the trading day starts. It gives me the visual evidence I need to act in
a manner that is aligned with what I am trying to achieve.
This example happened a while ago, but it could happen any day of the
week if I don’t mentally prepare myself. Figure 23 tells the tale in all its
glory.
Figure 23
I short a double top off the open. I am so certain that my research is right.
The market will fall.
I don’t have a problem with the first short position. I have a problem with
the four subsequent ones. I could even forgive myself for the last one,
because at least I am shorting weakness. This is unstructured and
undisciplined trading. I don’t care how certain I am of something
happening. If it isn’t happening, don’t pursue it as if it is. Showing you is so
embarrassing!
This is part of my preparation. It has been the most useful tool to build
mental stamina and discipline. It reminds me of everything that is weak in
me. It reminds me of how my mind, if left unchecked and untrained, will go
on a rampage to seek excitement and gratification.
One of the best ways to increase profits is to use goalsetting and
visualisations to align the conscious and subconscious with making profits.
I use fear to achieve my goals. I imagine trading a size which even in my
mind makes me uncomfortable.
I sit quietly in my bed or in my office. The world is quiet, and if it isn’t, I
stick a pair of earplugs in my ears. I imagine I am trading, and the market is
moving against me. I see myself cut the loss.
I imagine I bought the XYZ, and I see it going my way. I feel the brain
sending me signals to close the position to crystallise the profit. I see myself
doing nothing, as I continue to watch the profit increase and decrease.
I see a big profit turn into a small profit. I smile and accept it, and I move
on, telling myself it is okay. I place my brain under as much stress as I can
with imagined scenarios. I am long and the market is going my way, and a
sudden news story breaks the market.
I observe my fear shooting through the roof as my P&L turns into a
bloodbath. I see myself closing the positions and going in the opposite
direction. I see myself not getting unhinged just because the market is
moving against me.
I cannot guarantee that this approach will work for everyone. Perhaps you
think it is brilliant, or at least could be useful after a few personal tweaks. It
works for me because I learn visually. I get the message when I see it
visually. If you tell me not to trade against the trend, it will not mean any
more to me than when a cat meows. But show me a chart with my trades
plotted on, with me trading against the trend (better yet, show me
repeatedly), and I get the message.
This is my therapy. This is like seeing a psychologist every morning. I get
fired up. The therapist expands my mind and my horizon. The goal is to
remind myself of what behaviour I want to enact. It is about making
changes and keeping the changes.
So what makes me think this will work for you? Behaviour is patterned.
How we think, feel, and act has a pattern to it, and that patterning is what
makes us who we are. The sum total of our patterns is our personality.
Sometimes our patterns interfere with our goals and dreams in life. They
prevent us from being who we want to be or accomplishing what we want
to accomplish. We are sometimes our own worst enemy, and we seemingly
can’t stop ourselves when we are in the moment.
A person can know very well that they have anger issues, and yet be unable
to prevent themself from lashing out. Another might have eating issues, and
yet can’t exercise the needed restraint in the moment of eating.
A trader is fighting the trend all day and his account is suffering, but he
can’t stop himself. He is simply incapable of turning his position and trade
in the direction of the trend. Only afterwards is he disgusted with himself.
The purpose of my warm-up is not to take away everything that is bad in
our lives in one swift move. The purpose is not to guarantee I won’t mess
up. The purpose is to focus on what I want to achieve or become, while
being mindful of the things that will most certainly sabotage my goals.
The wonderful part is that I am almost certainly guaranteed success if I
avoid the failures. I was guaranteed success with my weight goal if I could
cut out all the Coca-Cola I drank. I just had to be mindful of that, and the
pounds began to come off. I didn’t have to do anything else.
I don’t have to be certain that my trade is going to work out. I just have to
be aware that my mind wants to do things that are not in my own best
interest. So, I don’t add to my losing trades. That in itself means I just need
to be mindful of the one variable I can control.
My action in the morning is about changing the patterns that do not serve
me. This started by observing another very successful trader and asking
myself what was holding me back from becoming him.
My technical abilities were just as good as his. I don’t think he was
financially much better off than I was, but he was seemingly fearless. How
could I become fearless in trading? Did I even want to be fearless?
I came to the conclusion that the trader I wanted to become was patient but
aggressive when the time was right. It was like Federer playing in the
Wimbledon final in 2007: he was patient until just the right moment, and
then played with focused aggression.
After that it was a question of reminding myself of that goal every day, and
several times a day if necessary. That is how habits are built: through
repetition.
As I grow wiser to the ways of life, I realise that there is a lot of truth to
John Lennon’s words, “Life is what happens to you while you’re busy
making other plans.” We become so engaged in our day-to-day life, with
responsibilities at work and home, that the big picture of our lives stays in
the background.
Day after day, year after year we busy ourselves with work and routines,
only to realise later in life that opportunities have passed us by. So, the first
question to address in a change process is: “What do you want to change?”
Or, stated otherwise: “How would you like your life to be different?”
My answer? I want to dedicate time to trading well, to combat my natural
inclinations that stand between me and successful trading. I want to prepare
my mind every morning through a series of meditations and visual
exercises.
To achieve this I will train my mind to act calmly through visualising
myself in difficult situations. I will focus on my breath. I will calmly put
myself through stressful situations to ensure I would react how I want to
react if the circumstances were real.
Making changes entails far more than simply engaging in positive thinking
or getting positive images in your head. I didn’t want positive images. I
wanted a portrait of the dire hell I would reside in if I didn’t change. This
may seem like a negative state of being, but it really isn’t. It is immensely
positive, albeit a rather tense way of getting what you want.
As the saying goes: “The end justifies the means.” I have turned
conventional thinking on its head. I do so because I know what compels me
more. Roses don’t compel me. Thorns compel me to action.
Consider the market itself. It is not so unlike us in its behaviour (because
we are the market). It climbs the wall of worry, but it slides down the slope
of hope. It might be a Wall Street saying, but it says a whole lot more about
humans than it says about the markets. All I have done is used fear and
disgust as my protagonist – my major motivator.
GETTING BACK IN THE GAME
I was surfing in a town outside Biarritz, France, in 1996. I was literally in
over my head. The waves were twice as big as anything I had ever handled
before. I tried to drop in a few times, but the waves were too fast, and the
lip was so steep.
Finally, I got myself positioned for a wave, but I was too far into the impact
zone, and instead of gliding into the energy path of the wave, it literally
knocked me out. I just remember everything going black. Luckily for me
someone spotted me and pulled me out of the water. Eight lives left.
I was back in the water that afternoon. I was too stupid and ignorant to
consider what had happened. Ignorance is bliss. It is only now that I can
appreciate my behaviour. Sure, you took a hit, but you are okay. Do you
want to sit on the beach and mope all day or do you want to get back in the
game?
Here’s an example illustrating the importance of getting back in the game.
I am writing this the day after a particularly challenging and volatile trading
session. It was one of those days that will stick in your my mind for reasons
that will shortly become apparent.
Over the last week oil has dictated the mood of the stock indices. Naturally,
I expected to see the same behaviour on Friday. The Dow started off with a
200-point rally at the open.
However, 30 minutes into the trading session, it seemed to lose momentum.
Oil on the other hand was in full-blown panic. I started shorting Dow,
expecting it to follow oil.
In Figure 24, Dow is on the left, and oil is on the right. Both are five-minute
charts, and both show the entirety of the trading session from about noon
until late evening.
Figure 24
I expected the Dow to follow oil, and it did, but not for long. It seemed to
pause, as if it suddenly had a mind of its own. By mid-afternoon oil had
dropped almost $2 – more than 5% – in little over an hour. The Dow,
however, wasn’t moving lower with it. It held. I took my Dow short
position off with a loss, and I reversed to long.
As soon as I had done that, the Dow dropped 50 points, and oil dropped
even lower. I began to wonder if I had simply been too quick to reverse my
position, and I decided to close my long position. By now I was convinced
the Dow had merely delayed its inevitable fall. I went short again. In
hindsight that turned out to be near the low of the day (after the open).
Just 15 minutes later the Dow made new highs for the day. I closed my
short position and scratched my head. I had gone short at the first low and I
had closed at the second high. I had gone long at the second high, and I had
closed at the second low. I had gone short at the second low, and I had just
stopped myself out at the new highs for the day.
I took a moment to reflect. Was I trading with a plan? Was I betting on a
relationship between oil and the Dow Index that might not be there
anymore?
Just then my best trader friend called, and we spoke briefly. I said to him,
“What does it mean when the Dow makes new highs on a Friday evening,
even though oil is plummeting?”
Saying it out loud helped me to get some perspective. It was the last day of
the month, which often brings aggressive buying or selling in the market.
Remember it was also a Friday, which has a tendency to bring about trend
days. I started buying, reluctantly. The market went higher. I bought some
more, careful to move the stop-loss up as the markets moved higher. I kept
an eye on oil. It was recovering nicely.
With 60 minutes to go (and no dinner), the Dow made a new high for the
day; and I know from my statistics that you should not short a market that
makes new highs for the day in the final hour.
By then I began to add more to my position. I was now betting on a classic
trend day finish. On those days the market closes right at the high tick of
the day.
It would have been easy to throw in the towel after the three failed attempts
to get on board a move in the market. The effect would have been the same
as stopping the game of throwing coins just because you have had three of a
kind in a row.
I hear about people who stop trading because they have three losing trades
in a row. That is a flawed approach if you understand the markets. If you
are ill, or you are weighed down by emotional circumstances, then you stop
trading. If you are otherwise able, you don’t stop trading just because you
have lost three times in a row.
As I type this, I look back at my trading before the Friday. I had lost on
every other day that week. It is rare, but I had four losing days in a row. I
don’t even remember when that last happened.
In the movie Floored, the trader Greg Riba puts it so elegantly, albeit in his
own way:
I swear to god that 99% still don’t get it. When they are winning, they
start betting less. Bet more. I mean, if there is one roll that you can
make a hundred thousand dollars on, let it ride. If you roll three sixes
in a row, let it ride. Let the winners ride.
Greg Riba should know. He was said to be one of the best S&P 500 futures
pit traders ever. Why do people bet less when they are winning and bet
more when they are losing?
Fear.
TRADING THROUGH A SLUMP
I HAVE A FRIEND who was suicidal because of the losses he sustained. He called
me to say that he was standing at a railroad bridge. I don’t think it was his
intention to end his life. I think he needed someone to talk to.
Some would argue that a chapter of this nature does not belong in a trading
book. I think people who have lost significant amounts of money will find it
reassuring that the focus isn’t one-sided.
Either way, while I have plenty of positive memories from my trading
career, I also have memories that can only be described as dark.
I had a friend called Adam. I no longer know of his whereabouts. He owes
me £20,000 – money I doubt I will ever see. Adam was a brilliant trader.
Absolutely brilliant. Until it all unravelled for him.
Adam and his brother worked on the factory floor for their father’s thriving
business. During the 1990s Adam became interested in trading. Over the
ensuing years he developed a system for trading stock indices using a 30-
minute chart. He told me it was inspired in part by George Taylor’s book
The Taylor Trading Technique.
It was a simple but very effective strategy. It required Adam to check the
charts every 30 minutes, and if the parameters were right he would execute
a trade. Otherwise he would leave it alone until the next 30-minute period
was up, at which point he would check the charts again.
Adam became so adept at trading the 30-minute chart that he soon made
much more money trading than he did managing his father’s factory. He
decided to sell his share of the factory to his brother and focus all his energy
on trading. Adam did well. Really well.
I traded with Adam on many occasions in my house or online. He possessed
a supernatural patience. I have personally never seen a person stare at a
screen from the open of the US market to the close of the US market and
not trade once. Yet that was the norm for Adam if there was no signal.
Amazing patience.
I believe that Adam’s patience and pattern-reading ability made him the
supertrader that he was. He lived the life of the supertrader too. He ordered
a custom-built house. He travelled first class to exotic holiday destinations
with his loving wife and children.
However, all supertraders will go through bumpy terrain at some point or
another. It is not a question of if it will happen – because it will – but a
question of how badly it will affect them when it inevitably does.
For Adam the bumpy road caused him to lose everything. His trading
account, his wife and his house. I stepped in when Adam was living on the
streets in Manchester, suicidal and penniless. I did what I could – but Adam
didn’t want my help, and I lost contact with him.
It started with a bad loss, and it escalated into a complete blow-out. Adam
had seen a pattern on a Friday night, and he had gone maximum short the
market. At the close he was well in the money, and he decided to keep the
position over the weekend.
Unfortunately for Adam, this was the weekend when the American special
forces finally captured Saddam Hussein. The financial markets cheered at
the good news. I guess naïvely they thought that the Middle East powder
keg would settle down once Saddam had been captured. That Sunday night
the American markets opened limit up!
Limit up is a situation where the market is unable to move any higher until
the stock market opens at 9.30 am in New York. Adam was short, but he
was unable to close his short position because when the market is limit up
you can’t buy, which is what you need to do to close a short position.
Adam was awake when the phone call came. It was his futures broker.
Adam was informed of his options: deposit more money on the account or
risk being closed out once the future market came out of limit up. Adam
didn’t have any available capital. It was a long night and a long day until
the market finally opened at 2.30 am (Adam lived in the UK).
The market opened and stocks soared. The broker liquidated his position
because he was in breach of the margin requirement. The account had stood
at close to £750,000. Now there was only £400,000 on the account.
You may say that £400,000 is also a decent pot of money to trade with, but
something short circuited in his mind. He saw the market soar that day, and
he saw his position being liquidated. Unfortunately, he also saw how the
market came all the way back to his entry point.
You see, once the good news had been digested by the market, there was a
feeling that this probably wasn’t such great news after all. The Dow Index
came all the way back, giving up all the gains for the day.
Adam felt the broker had cheated him. He felt as if he had been forced to
liquidate. He felt that the broker had acted too hastily. He tried to complain,
but his claim was rejected.
He then tried to make up for the lost money through trading, but his head
wasn’t right. He began to second guess his system and double up on trades.
Then his builder demanded payment for his house. Adam had paid a
deposit, but now he couldn’t make full and final payment. He lost the
deposit and the house.
Adam was unable to stop his own downfall. So was his family. He began a
pattern of lying and withholding information for his own gain. The last time
I heard from Adam was when he cheated me out of a fair sum of money,
only to disappear. I haven’t seen him since.
Sadly, this is not an isolated story. I have had to cut short a business trip
while working in the London because my boss called me back to the office.
There was a client in our reception crying his eyes out because he had lost
£750,000 trading forex. He was afraid to go home and tell his wife about it.
He begged my boss to lend him money so that he could trade again and
hopefully make the money back.
You may think that this individual lacks the moral fortitude to trade. You
may even think less of him because of his apparent lack of dignity. What if I
were to tell you that he was a renowned surgeon in a prestigious private
London clinic?
Education means very little in this industry. It doesn’t matter where you
went to school or what your day job is. If you don’t know how to handle a
losing trade, and then a winning trade, you will not go very far in this arena.
It is for this reason that I tell people to spend less time on technical analysis
and more time on self-analysis.
Successful trading can mean just making a good living. I got a message
from a close friend of mine. He trades full time. He has been doing it for 15
years and, unlike so many other hopefuls, managed to make a success of it.
He has made himself a good living over the years.
I don’t know many traders who like to talk about what they earn from their
trading. When I spoke to my friend about it, he told me he had made about
the same as if he had a well-paid managerial job in the City. However, he
had no commute, and he had time to be there for his children when they
came home from school.
To me, my friend is an example of a person who made trading work for
him. He had not made himself rich in the process, but he had paid the bills,
put food on the table for his family, taken them on holidays, and bought a
nice family car.
There seems to be an inclination to describe trading as the venue for making
untold riches. Yes, the potential is always there, but with bigger reward
comes bigger risk. You can’t catch big fish in shallow waters.
However, my friend was tiring from the long hours, and he called me to
talk. He asked me if I had ever had enough of the endless hours of watching
the screens.
I immediately responded, “No, and if you feel like that, you have to stop
trading and take a break from it all.” We spoke for a while that night on the
phone.
He told me that now that the kids were older, they wanted to hang out with
friends rather than their old dad. His wife worked full time too. It meant he
was often alone in the house from early morning until later afternoon, and it
began to bother him.
I helped him get a few job interviews and he secured himself a job as a
broker in London, on account of his in-depth understanding of the markets
and his ability to understand what clients are going through in their trading.
A fairly innocent story, I am sure you would argue; so why am I telling you
about my friend? Well, I am telling you the story for several reasons.
The first reason is that trading can be a very lonely business. It has never
bothered me, but I have the deepest of sympathy for those who feel lonely
while trading. I am not sociable, don’t drink or smoke, can’t stand watching
a football match (that excludes me from a lot of male social activities) and
prefer my own company; but even I like to pick up the phone from time to
time and just shoot the breeze with a friend.
When I worked in the City, I would at times stick my head into my boss’s
office, who always had a minute to say hi and catch up on life. If you one
day decide to make a go of trading full time, you may experience a twinge
of sadness that you no longer have the odd chat with a work colleague.
I recommend that you take a week or two’s holiday and try full-time trading
before you hand in your notice to your boss and begin your full-time online
trading job. It will give you a taster of what your day will look like.
The second reason I told you the story about my friend is to make sure you
realise that a pause from trading is not the end of trading. The markets will
always be there.
My friend will no doubt be back to trading full-time one day. In the
meantime, he is enjoying a new life where he is helping others achieve what
they want from trading.
The third reason I am telling you this story is because I would love to see
you succeed, but I think it is important you understand that trading may not
offer you the rainbow you had hoped for. But does it have to?
Could it not just offer you a good income, where you are working on your
own terms and perhaps doing something that you find immensely
interesting? Does it have to result in owning a beachfront property in
Barbados?
Sure, if you get there, I am happy for you, and you should be proud of
yourself. However, if you don’t get there, but you still manage to pay your
bills and put money aside for the sweet things in life as if you were the
recipient of a monthly pay cheque, then to me you have done what the 99%
of the population do not dare to do.
They dare not take a chance on their dreams. If you can make a living from
it, be it a decent living or a great living, then you really are something out
of the ordinary.
And trust me when I say that once you understand trading better, you will
also come to understand what makes you work optimally in the trading
arena, and that is when being a trader gets really fun.
Eight months ago, I went through a tough time. It happened during the
month of May. I started strongly, and then the wheels started falling off. I
was up some £200,000 on the month, and it started to unravel.
It started with a loss of £33,000. Often when I have a bad day, I will come
roaring back the day after, but I didn’t. I lost another £9,000 the day after.
Then came the weekend – not a moment too soon.
Monday started where Friday had left off, in spite of all my preparation and
introspection over the weekend. I lost another £38,000. Before the week
was over, I had lost more than 50% of the gains for the month.
More disturbingly, I felt completely lost. I had no idea why I was losing. I
wasn’t tired. I was sleeping well. I had no emotional issues that occupied
my focus. I was just not performing.
I have endured hard times before. Progress has at times been slow. Setbacks
have been frequent. Setbacks are always lurking. My goal is to stay in the
game until I don’t want to spend all my waking mental energy on the
markets.
As you can perhaps gather, this is a deeply personal journey for me. It is
often a mentally draining journey, where I feel I am not making any
progress. What made it worse for me was that a really good friend of mine –
also a trader, and probably the best private trader the world has never heard
of – was having a great run.
We have always been brutally honest with each other. I think therein lies the
strength of our friendship. I will tell him point blank, “I am jealous of you. I
feel bad that I am jealous of you, because you are my closest friend, and I
would give you my last dollar, but right now I am shooting blanks. I am
haemorrhaging money.”
I told him I had a huge position on. It was literally the biggest position I
have ever carried. Each point was worth £4,000. That equates to 400 FTSE
futures contracts. I was so certain the FTSE would fall.
I have seen the pattern so many times: big fall off the open – two to three
bars of five-minute duration of rebound – and then new lows.
But it didn’t. Not that day. It rallied. And he was long. I was short. It was
immensely painful. It took me to a place I didn’t want to visit. A place of
envy, resentment and despair.
“You know Tom, you are lucky.” My thoughts were interrupted by my
girlfriend. It was as if she knew what I was thinking. “Not everyone has
someone who is better than them, and who they stay up at night wondering
how to beat. Not everyone is Mozart versus Salieri. You should be happy.
So you lost. But what have you gained? Don’t you know that he feels the
same as you do? He desperately wants to beat you – for no other reason that
you bring out the best in each other.”
She carried on: “You know, my old professor Peele, I told you about him…
brilliant man. Do you know what made him brilliant? His colleague –
Professor Kyle – they were best friends and neither of them would ever
acknowledge that they were insanely jealous of each other, yet they were
the two most brilliant minds anyone could wish to learn from. You should
really count your blessings that you have someone who you so badly want
to beat. It is really not a curse. It is a blessing. What do you think would
happen if your idols stopped trading?”
If they stopped, I thought, who would I beat then? I always loved beating
my old high score, and I did today, in size; but she was right. I am not just
trading to make money; I am trading to push myself into those places where
I am not comfortable.
I was once in a restaurant in Porto Cristo, having dinner with my son. I
happened to look over my shoulder and I saw Rafa Nadal having a late
meal with his friends. It was great to witness a world-famous tennis star just
shooting the breeze with his old friends.
A few days later we visited his tennis academy. Rafa was training. It was
hot as Hell that day. He trained like his life depended on it. He was out
there pouring his heart out – in the blazing heat – just to get better.
Why do you think he was doing that? It is for the same reason that someone
like Matthew McConaughey – during his Oscar acceptance speech in 2014
– said, “There are three things that I need each day: one, I need something
to look up to; two, I need something to look forward to; three, I need
something to chase.”
I am writing this because I think being open about what drives us is healthy.
There will come a point in your career as a financial trader where you will
go through a slump. When it happens, it might serve you well to step back
and think deeply about why you are so drawn to this game.
And when it happens, I hope you will turn to these pages. I hope they will
remind you why you are doing what you are doing.
What my slump taught me was to slow down. If you do not slow down and
let the knowledge mature, then you will take a huge loss, which will dent
your confidence.
Not every trade is the World Cup final. Not every trading session is the final
exam of the final year, the culmination of four years of relentless studies.
Everyone has setbacks. Kobe. Rafa. Federer. You. Me.
And – all slumps end.
Slumps are inevitable. You are bearish and the market goes up. You are
bullish, the market goes down. It happens to us all. Every one of us.
Is there a key to escaping a slump? No.
Why should I throw old, worn clichés at you? Why should I tell you to stay
calm and work your way through it? Why don’t I just tell you that it is
horrible to go through, but it will end – if you persist?
I wrote this chapter over several weeks. When I started it, I was not in a
slump. Then the slump arrived, and I described it. As I type these words, I
have had a fantastic trading morning. Am I out of the slump? Who knows? I
do not know what I am doing differently to what I did when the slump set
in.
I am simply following the process I always follow. I am a process-oriented
trader. The markets determine the outcome. I have little control over that. I
have faith. I believe that my process will carry me through the highs and the
lows of trading.
EMBRACING FAILURE
THE LATE MARK Douglas argued that successful trading is a question of
accepting risk and thinking differently.
The Market Wizard trader Ed Seykota put it another way. “A losing trader
can do little to transform himself into a winning trader. A losing trader is not
going to want to transform himself. That’s the kind of thing winning traders
do.”
When I read that passage the first time, I was not mature enough to
understand its importance. When I started trading for myself, I began to
appreciate its depth and wisdom.
As I began trading bigger and bigger size, I realised that my journey from a
low-stakes trader to a high-stakes trader was not the result of evolution.
Sure, I got better the more I traded, but remember this: Practice does not
make perfect. It merely makes it permanent. Only through a dedicated
approach to practice, with a specific attention to finding your mistakes, will
you improve. Otherwise you just are just cementing your unprofitable
behaviour.
BECOMING A DIFFERENT PERSON
Being anxious and fearful is a reflection of an unknown situation. Through
exposure – over and over – our minds come to accept the new reality and
through that exposure become accustomed to it.
You think there is a hack that will all of a sudden take you from trading £10
a point to £100 a point? You think there is some book you can read, or some
course you can take, or a pill you can ingest that will take you from being
an average-stake trader to a high-stake trader?
Well, not quite. But there are certainly ways you can accelerate your
progress. It is a question of priority. I am not some hardcore monk with no
life and a never-ending commitment to pushing myself into those cold, dark
corners where I dance with uncertainty until my emotions are stunted and I
essentially become a psychopath with no fear.
But I am committed. I want to explore my weaknesses. I am reasonably
attuned to my mind and body, and I know that left to my own devices I can
quickly spiral into self-destructive behaviour.
I had a painful breakup with a loved one, and I turned to food and alcohol.
Sure, I think we all do things like that. Even Bridget Jones (I love movies)
ate her way through a tub of ice cream in one sitting when she was dumped
by the love of her life.
But you move on. You get off the sofa. You turn off the TV and throw the
ice cream bucket in the bin, and you say, “Okay, so I made a mistake. I will
own it.”
How you feel about failure will to a very large degree define your growth
and the trajectory of virtually every aspect of your life. You may want to
close the book and think about that for a while. It is quite frightening how
deep that sentence is.
A significant part of your success as a trader is correlated to your
relationship with failing. If you see failure as the endgame, then you won’t
make it as a trader. I have colleagues who will stop trading if they have
three losing trades in a row. What kind of attitude is that? You think Kobe
Bryant – the absolute superman of basketball – had that attitude? You think
during a game he would make three misses and then ask the coach to be
replaced by someone else?
KOBE BRYANT – THE BIGGEST
FAILURE
While we are on the topic of Kobe Bryant, I want to tell you a story about
him, which I read in a paper – sadly after Kobe passed away in a tragic
accident.
After the accident, most obituaries focused on Bryant’s amazing
achievements and trophies won, but Andy Bull from the Guardian wrote
about Kobe Bryant from a different vantage point.
The headline of the article sums it up well: “Bryant’s success story began
with working to conquer the fear of failure.”
It seems Kobe Bryant intuitively knew that, in order to be a great player, he
needed to conquer his fear of failing. The article goes on to tell the story of
a game in May 1997. It was Kobe’s first season for the LA Lakers, his
rookie season. He made four crucial errors inside five minutes, which some
say cost his team the game.
That night, the story goes, Bryant stayed up shooting hoops privately and
alone. He was still at it when the sun came up. I know this feels a little
sugar-sweet; it has a David versus Goliath feel to it. But there is more to
this than meets the eye.
On the surface, it reads that Kobe Bryant was beaten in that game and he
followed it with a punishing all-night session. To me the story tells of a man
who night-after-night confronted his fear of failure by repeatedly trying. He
became used to sometimes failing temporarily, and yet he kept at it.
Bull concludes by saying, “He missed more shots than any other player in
history. Bryant was willing to encounter failure in every game he played.”
It is not the first story I have read about an all-American great, someone
who confronted the fear of being wrong, in order to be proven right. Babe
Ruth, the American baseball player, held home run records for decades. At
the same time, he went by the nickname King of Strikeouts. If the term itself
doesn’t give it away, let me explain: a home run is great; a strikeout is the
very opposite.
I found the story resonated with traders all over the world who seek out
systems and strategies aimed at eliminating losing trades.
As I write this on a quiet trading day on 1 June 2020, I look over my trading
statistics for the month of May. I made a total of 1,513 points. Yet out of the
137 trades I executed, I lost on 66 of them, won on 53 of them, and broke
even on 18 of them (where stop-loss was moved to entry point).
If I gauged my success according to some of the hyped-up system sellers on
the internet who promise a 95% (or better) hit rate on trades, I am an abject
failure. I mean, I was less than 50/50 in May.
Yet, somehow, I still managed to make a decent return for the month. How
do you explain that? The answer is found in the erroneous belief that the
more winning trades you have, the better a trader you are. That is plainly
and simply wrong.
One of the popular clichés in the trading world is that you can’t go broke
taking a profit. Oh, hell yes you can. If you are unable to let your profits
run, you will never make money trading. While basketball and trading
differ on this point, if I were afraid to lose, I would never have had a
profitable month.
STATISTICS DO NOT MAKE SENSE
We know that 90% of traders lose. We also know from the FX trading
sample of 25,000 traders that most trading accounts have more winning
trades than losing trades. This does not make sense. How can we reconcile
those two facts?
The answer is found if you read between the lines of the story of Kobe
Bryant. If you are in a losing position, you are essentially wrong. However,
unlike a shot in a basketball game, where you immediately know when you
are right or wrong, in trading there is always the hope that the trade will
come back in your favour.
Hope is what keeps people in trades long after they should have closed
them. As the saying goes, hope dies last. So true, and so detrimental to
traders. How do I deal with hope and fear in my trading?
I tend to only feel hope when I am in a trade. I hope my position will come
good. I hope the market will move in my favour.
Fear, however, is felt in more situations. I can feel fear when I am in a trade.
But I can also feel fear when I am not in a trade. That is a subtle but
important distinction between hope and fear.
Hope tends to be reserved for the activity of being in the trade, while fear
manifests itself both when I am in a trade and when I am not in a trade. I
can be fearful that the market will move ahead without me, or I can be
afraid that I have closed my position too soon – which could also rightly be
classified as regret.
While I intend to write in much more depth about my trading regime at the
end of the book, I will describe my approach briefly now.
I deal with fear when I am in a trade by having an exit strategy. I have a
stop-loss, which defines the size of my loss. I have accepted this loss before
I started the trading day. It is part of my trading plan.
I will have mentally prepared in the morning, ahead of the trading day. I
will have sat quietly, contemplating what I am about to do. I will have
subjected my mind to images of me losing. I will have calmed my mind,
when it experienced these imagined losses, so as to negotiate away any
feelings of anxiety and regret, as well as desires to get revenge and get
even.
I will have dealt with hope by accepting that my stop-loss will define my
exit. Maybe I will win. Maybe I will not win. Before the trading day started
I will have gone through mental exercises that saw me enter the market,
observe the market move against me, negotiate with my fear brain and the
impulse urges it sent to my conscious awareness.
By the start of the trading day I will already have seen myself win and lose,
add to positions, and patiently wait for the right setup. By the time the bell
rings, opening the market for trading, I am mentally warmed up. I am ready
to fail without losing my composure.
MY COMPETITIVE SON
I have a fascination with reading about the lives of high-performance
soldiers. I love reading about the trials and tribulations of the SAS and
Navy Seals. My son shares this interest. In particular, we are fascinated with
the free-diving part of the training.
One of the obstacles that these elite warriors have to pass is the 50-metre
underwater free-dive. Do you think there is a shortcut to diving 50 metres
under water?
Take it from someone who has swum 46 metres under water, there is no
shortcut. I practised and practised while on holiday with my son. There
happened to a 50-metre swimming pool in the complex we were staying at.
Being the competitive spirits that both my son and I are, he set out first on
our initial attempt. He made it a little less than halfway. Now I had a goal,
and I made it almost to the halfway line. I beat him by an inch or two.
We spoke about how we could get better, and we agreed that we needed to
focus more on our preparation before the swim. So next we sat on the edge
of the pool, and we focused on filling our lungs with oxygen and
oxygenating our bodies.
Gradually we got better and better. Then we realised that if we swam less
frantically while underwater, we would expend less oxygen. Our focus
shifted to staying calm and taking rhythmic strokes.
By the end of the seven-day holiday, I came within a few strokes of 50
metres. My son was a metre or two behind me. Passing this test is one of
the major stumbling blocks for aspiring Navy Seals. I am not saying that
my son or I are Navy Seal material, but I am saying that there is no way you
are going to swim 50 metres under water without relentless practice.
We worked on it. Then we evaluated our process. We didn’t actually focus
on the outcome at all. We just did everything we could to make the process
as efficient as possible. Does that remind you of something? If you have a
goal that you want to make X amount of money a day, or a certain amount
of pips or points, you might be sabotaging your chances of making a lot of
money. You are outcome-oriented. You would benefit immensely from
shifting your focus to being process orientated.
BEST LOSER WINS
THE TIME HAS come to get more specific. We can skirt around the issue forever,
or we can decide to get our hands dirty and get down to the business of
creating a finely tuned trading mind.
What you become in life is dependent on the decisions you make and how
you react to decisions made on your behalf.
At Stanford University, Steve Jobs, standing at the podium in front of the
class of 2005, gave the new graduates their commencement speech – advice
on how to live life. It went something like this:
Remembering that you’re going to die is the best way I know to avoid
the trap of thinking you have something to lose. You are already naked.
There is no reason not to follow your heart.
Few can walk the walk when money is on the line. The main contributor to
not having the life you want is fear. Most play this game called life safely
within the boundaries they set while growing up, boundaries built by
avoiding pain and anxiety.
I am often asked if I know the secret to becoming a good trader. I think
many novices believe that I know some really good trading setups. They’re
not entirely wrong; yes, I know some great setups, but they still only work –
at best – about 70% of the time. I am still wrong 30 times out of 100.
I am not where I am in the trading world because of my IQ. I’ll tell you that
immediately. I am here because of my relationship with pain. Our brains
hate the idea of losing something that is valuable to us. The brain will
abandon all rational thought and make some really poor decisions trying to
avoid losing something that has value.
I am a profitable trader. Is that because I possess superior charting abilities?
No. Of course not. There are many brilliant chartists who can’t trade.
Is it because I have a superior system? No, there are many great systems but
most will still only have a 60% strike rate.
Is it because I have friends in high places that feed me insider information?
No. Did you not read my book? I am socially reclusive, and I certainly do
not have friends in high places.
I have no secrets. I have no special abilities, with the possible exception of
one. Do you want to know why I am so good at trading?
I am exceptionally good at losing. When speculating in financial markets,
the best loser wins. Don’t underestimate these four words.
Though it may go against the conditioning that life and the modern world
have programmed you with, success in financial market speculation is not
about being the best, coming first, or winning.
Instead, it’s about losing. Your relationship with fear and adversity will to a
very high degree define your life.
And that’s why I win. I win because I’m really good at losing. In trading,
unlike life, it’s the best loser that wins. Do you think a dentist, or a doctor
would be in business if they had a 60% win rate? Of course not. But a trader
can thrive and prosper on that kind of success rate – as long as they are
prepared for it. Most are not.
MANY ARE CALLED…
Trading attracts many people who shouldn’t be traders. They are led to
believe that trading is easy. Maybe a broker is tempting them; I’m sure
you’ve seen the broker advertisements where a calm, confident actor
knowingly pressing buttons in front of a bedazzling array of screens, then
walks away victorious with a confident smirk.
If you look at the trading industry, we are led to believe it is all about the
tools. Hang on – do you think I can play tennis like Roger Federer just
because I have a Wilson Pro tennis racket?
It’s an illusion. How do I know? Because, for years, I was an insider
working at one of the largest financial market brokers in London.
Why do so many people lose? Statistically speaking, it should be
impossible for so many people to lose. If the market is random – and most
of the time, market movement is indeed random – why do 90% of clients
consistently lose a 50:50 bet?
The answer is as simple as it is complex. It isn’t the market-beating them.
They are beating themselves. I wasn’t always a successful trader either. To
become successful, I had to break down the barrier that separates the many
from the few, in a business where there is no instruction manual, and where
the lesson comes after the test.
It didn’t take me long as a broker to notice our clients’ trading behaviour.
As a group, traders are predictable. Or, more accurately, their outcome is
predictable, because everyone is doing the same thing.
I watched thousands of traders execute millions of trades. Their behaviour
became predictable, almost as if they were connected together in one hive
mind. Week after week, month after month, year in, year out, when they
were making a loss they hoped the market would give them back their
losses, yet when they were making a profit they feared the market would
take it away.
They were fearful when they should have been hopeful. They were hopeful
when, in fact, they should have been fearful.
These human experiences helped make me the trader I am today. Watching
them struggle, I realised they were searching in the wrong place.
The answer they were so desperate to find is not found in the external. It’s
not found in the software, or in any of the tools. Instead, I realised, the
answer is to be found inside the self.
TUNING MY MIND
In the silence of the early morning, I’m in my office, preparing for the day’s
trading. It is a minimalistic office. Depending on where I am, there are
either two or four screens. That is it. There are no special monitors or water-
cooled PCs.
My secret ingredient is a couple of files on my hard drive. There is my
PowerPoint presentation on one screen. There is a Microsoft Word
document on another.
The PowerPoint file is my cue. At game time, before I begin to trade, it’s
time to become someone else. In the movie Gladiator, why does Maximus
Decimus Meridius rub dirt on his hands before combat?
It’s a ritual.
He must immunise himself before battle, to feel nothing, to become an
instrument of death, indestructible, so that he can survive another day.
Rubbing dirt on his hands is his ritual of leaving his old self behind. Every
day from 5 am until 9 pm, even late into the night, I am battling myself.
Trading is a battle of the self.
The PowerPoint file contains old trades, mistakes, triumphs, inspirations,
and warnings visually arranged to prepare me for the day ahead.
I need to become something else; otherwise, I will not make money. This is
why trading looks simple when looked at from the outside, but it’s not easy
because trading successfully goes counter to virtually every piece of DNA
stored in your body.
In the 1960s, neuroscientist Paul MacLean proposed the human brain has
evolved with three areas of function: the reptile brain, the limbic brain, and
the neocortex.
So, who’s really in charge when you are trading?
It’s your reptile brain, your base self, that’s really in charge. When you are
startled, and you react, perhaps you detect a wobble in your stomach, a
vibration in the lower back – that’s your reptile mind preparing you for
survival, triggering a fight-or-flight response.
Will you run, or will you fight? Your subconscious reptile mind has only
one function, and that is to protect you. It does this whether you want it to
or not.
And this is a problem, because to be successful as a trader you need to be
very good at losing. This means constant conflict with your built-in
subconscious protection system.
A system that protected you from death as a caveman guarantees you’ll not
survive as a trader – unless you can learn to overcome it. And overcoming it
begins with accepting pain.
One exercise I use in the morning is closing my eyes and playing out a
scenario. I imagine I lose a large amount of money. I will often use an
amount that has some significance to me, such as the cost of my last car, or
the cost of my son’s college tuition, or the size of a memorable loss.
Say for the sake of the argument that I have opted to meditate on losing
£78,000. I will see myself losing the amount. I will let it sit there – in my
consciousness. I will let it take hold. I will imagine what I will not be able
to buy because of the loss. I will make it as emotionally vivid as I can.
Now I will turn the table. I will now imagine that I am winning the same
amount. I will imagine that I am winning the £78,000. What will happen is
that my emotional response system will not allow me to feel a reciprocal
sense of joy to the misery I felt earlier.
Neurobiology has shown we experience a financial loss 250% more
intensely than an equivalent financial gain. After going through this
exercise of feeling pain and then not feeling pleasure, I then swap back to
feeling the loss again.
The purpose of the exercise is to align my feelings of gain and loss. In truth,
I don’t really want to feel anything – I have found that if I get overly happy
about a win, I tend to get overly sad about a loss. I don’t want that.
I am not a dentist who has a win rate of 99.99%. I am a bloody trader, who
has to live with being wrong around 50% of the time. It is exhausting to feel
joy and pain many times a day. I prefer not to feel anything at all, rather
than going through that emotional roller coaster.
I win. Move on.
I lose. Move on.
By adopting this attitude and by warming up my subconscious mind, I am
able to flow in and out of winning and losing trades, day in and day out,
without it affecting my strategy.
Pain is inevitable to some degree in life. Someone lets you down, you feel
pain. Someone hurts you emotionally or physically, you feel pain.
In life, outside of trading, one way to deal with the pain is to talk to
someone. As the saying goes, a problem shared is a problem halved.
Why a painful experience feels less potent after we have shared it with a
friend I don’t know. Maybe the act of verbalising the disappointment puts
the problem into a healthier perspective.
Either way, you feel better, and the pain subsides.
But when I’m trading, while the majority look to run away and rid
themselves of pain, I do the opposite. I run towards it. I embrace it. I don’t
want to share my pain. I want to hold on to it. I need it.
Whether you are new to trading and speculation, or you have years of
experience, you should give this question some serious thought:
If you want to be a success in a field where 90% or more fail, how do you
think you should approach this task?
Trading looks easy on the outside, but in reality it’s much more challenging
than people expect – because we are hardwired to do the opposite of what
we should be doing. This is why 90 out of every 100 people end up losing.
The road to consistency, success, and enlightenment in trading begins in the
last place you’d ever think to look. Inside yourself.
THE KEY
So, here it is. What follows is the key that will unlock the door to your
success, the key to breaking down the barrier between the life you want and
the life you are leading now.
If you want to succeed in an endeavour where 90% are failing, you have
two choices. You can study the large 90% losing group and do the opposite
of what they do, or you can replicate what the 10% do.
If you are not as successful as you want to be, sooner or later you need to
change your behaviour. It doesn’t matter if you’ve been trading
unsuccessfully for three months or 30 years, you are much closer to success
than you realise.
The 90% fail because they interpret the pain messages received
automatically from our reptile brain without any modification.
You need to learn to recode your brain’s messages when pain comes
knocking. Instead of reacting and running away, a small group of consistent
traders, the 10%, hold fast and run towards the danger – not away from it.
The 10% succeed because they have learned to flip the switch.
FLIP THE SWITCH
This will feel very uncomfortable, but it is a discomfort you must accept
and embrace if you want to succeed in the game of financial speculation. It
is the reason why trading looks simple but is not easy.
The paradox of trading is this: by doing what the 90% cannot do, you will
become successful. In other words, I expect to be uncomfortable. I expect
my trading to cause me anxiety. I am waiting for it.
I can sum it up in a few sentences:
1. I assume I am wrong – until proven otherwise.
2. I expect to be uncomfortable.
3. I add when I am right.
4. I never add when I am wrong.
ASSUME YOU ARE WRONG
Remember, I’ve watched thousands of traders execute millions of trades,
and I noticed when most traders enter into a position they assume they are
right. In a business where 90% of people fail, your recoding process begins
by flipping that switch.
I will assume that I will quickly have to get rid of a losing trade. My
confidence in this action is not centred around my ability to select the right
setup. That is what the 90% will do.
Instead, my confidence is centred around trusting I will get rid of a trade
that is not performing. I trust myself to know that if this trade does not work
out, there will be another one coming shortly.
Do you see how I have flipped the switch on my thinking? I am thinking
differently to the 90%. I will assume I am wrong until the market proves me
right.
Flip the switch!
When the 90% of traders execute trades, they experience emotions, which
originate from their pain centre. Now it’s only a question of time before
their emotionally driven pain threshold centre sends them a false signal,
causing them to lose. It is a never-ending rollercoaster ride of
disappointment, lost money and pain.
When I trade, I assume I am wrong. I enter a trade, and the trade moves in
my favour. I am trading my account size or the available profit – I am
trading the market because I understand the size of my profit is irrelevant to
the market.
I know my P&L has no influence on the market. I know that my brain’s
automatic pain receptor will kick in causing an inbuilt safety reflex to
register pain.
I am subject to the same built-in automatic pain receptor as everyone else,
but the difference lies in how I handle the pain. Instead of giving in to it,
instead of being ruled by my emotional responses, I have flipped the switch.
I have trained myself to expect the pain.
I am aware of the pain. It is there. It is real, but I accept it. I have
encountered it in training over and over. It no longer acts as a debilitating
force in my life. I have trained the fear of out my decision making.
EXPECT TO BE UNCOMFORTABLE
How can you have a good time while you are uncomfortable? Logic will
say it is not possible. Well, for starters, I think all humans come alive when
we strive. We toil in the garden, we work out, we study for an exam. I think
it is perfectly possible to be uncomfortable while enjoying a challenging
process. As a trading position grows in profit, instead of giving into the fear
it will be taken away from me, I flip the switch, using my mental warm-up,
my training exercises and visualisation of trend days where the market just
goes higher and higher all day.
I flip the switch in my mind from negative mental imagery to positive
mental imagery. I see myself riding this monster momentum wave. I see
myself being at the forefront of every tick higher.
The 90% will focus on what they want to avoid. I focus on what I want to
achieve. The 90% give in to their fears. I expect my fears to come in
abundance, and I have a plan for counteracting them. I see a different
image.
And when I am losing?
Well, I already expected to lose anyway, so the market disagreeing with my
trade will not be associated with pain or fear. I expected it. I have accepted
my loss already.
I don’t entertain the idea of compounding my mistake by adding to my
losing position. I have trained that trait out of my mind. It doesn’t even
enter my mind anymore. My mind knows I want to be big when I am right,
and I want to be small when I am wrong.
Emotions kill trading accounts. It isn’t the lack of knowledge that’s
stopping you from winning big. It’s the way you handle yourself when you
are in a trade.
I spent a decade observing traders lose money. They were intelligent people
who often had great hit ratios, but they couldn’t lose well.
After reading this far, if you remember only one thing, remember this: in
trading, unlike life, the best loser wins.
THE IDEAL MINDSET
THERE IS AN ideal way to think as a trader. There is an ideal mindset – one that
is flexible to the extreme. It does not care about winning. It does not care
about losing. It is a carefree state of mind, but it still acts in your best
interest.
The ideal trading mindset has no fear. If you are alarmed by this statement,
then pause for a second. The ideal mindset may have no fear, but the ideal
mindset is still acting in your best interest. The ideal mindset might be
fearless, but it is not reckless.
Fear plays a significant role in explaining why people lose the game of
trading. This fear can manifest itself in several ways. It can be the fear of
not being in the market and missing a good move. It can be the fear of
staying in the market for too long and seeing the open profits disappear.
Can you acquire an ideal mindset? Yes. Without a doubt. You may have to
grow into it. You may have to begin a period of significant introspection
and get to know thyself. I will discuss how to get to know yourself as a
trader shortly.
The ideal trader mindset does exist, and you can train yourself towards this
state of thinking and believing. When you arrive at this state, it means you
are able to perceive information from the markets without feeling
threatened or fearful.
Does it mean you will never lose? No. You will have losing trades just like
everyone else. However, the ideal trading mindset is as at peace with losing
trades, as it is with winning trades. Neither will impact your ability to
unemotionally and dispassionately perceive market information in a non-
threatening frame of mind. Your emotional state will stay in balance.
Every trader has experienced periods of being in the zone, of being balmed
by the soothing feeling of the ideal mindset. It often happens when certain
circumstances are present. For me personally, I experience that sense of
calm whenever I am trading while on holiday.
One story stands out. I was on holiday for 14 days, and I traded every day
from my holiday home. I was totally at peace, trading only when the market
really spoke to me. Otherwise, I was at the pool relaxing in the sun.
When I returned to the trading floor, my boss came out and said, “Someone
is on fire!” and clapped. Fourteen days later I had given away all my
holiday profits. I remember the story so vividly because it happened to be
one of the catalysts that led me to seek a deeper understanding of myself as
a trader.
HARD-CODED DNA
The ideal mindset does exist, but few traders have it consistently. When we
do not operate from a frame of mind of the ideal mindset, we are afraid of
something. This fear is a manifestation of a lack of trust. We do not trust
ourselves to do what we have to do without hesitation, without reservation
or internal conflict or argument.
Our mind is the problem. Our mind’s core objective is to keep us alive and
avoid pain. We are automatically wired to think in a way that keeps us alive.
This thought pattern is hard-coded into our DNA. It might keep us alive, but
it makes trading difficult.
The very thing that keeps us alive is the very thing that makes trading an
incredibly difficult proposition, until you have learned how to counter your
hard-coding.
The issues we face largely fall into two categories:
1. We associate this moment with another moment, whether we are
conscious of it or not.
2. We have a mind wired to avoid pain.
We have learned to associate in order to benefit from experiences.
Association (connecting past moments with the present moment) and pain
avoidance do not go hand in hand with trading.
Why do I say this? Why do I say that association and pain avoidance are
detrimental to profitable trading? I say so because in trading each moment
is unique, and anything can happen. Trading is the equivalent of a coin-flip
game. Since the win ratio of many professional traders – including myself –
is not far from 50/50, the coin-flip analogy is even more appropriate than
you might think.
If you play a game of heads and tails, you are probably not too concerned
about the outcome. Over time it will play itself out quite predictably. You
will win 50%. You will lose 50%. If you developed a system where you lost
a unit on your losses, and you made 1.5 units on your wins, you have
yourself a good business.
Trading is just like that in many respects. You don’t judge your system on
the merit of one trade. You judge it over many trades. We do so because
even a game of heads and tails will show an uneven distribution, even if the
outcome over 100 flips is 50/50. As my friend David Paul once said, “There
is randomness in the outcome of one, but there is order in the outcome of
100.” He was talking about the coin-flip scenario.
I once flipped a coin 100 times, and I wrote down the result on a piece of
paper. I witnessed 15 heads in a row. At one point I stopped and looked at
the coin, as if to see whether there were obvious flaws to it. There weren’t.
If you had 15 losing trades in a row, I imagine your mental state would
suffer. If you had 15 winning trades in a row, you may feel invincible.
The market will do what the market will do. It doesn’t care about you or
your position. It doesn’t care if you are in the market or on the side-lines. If
you have 15 winners in a row, it doesn’t care. If you have 15 losers in a row,
it doesn’t care.
You can’t make the argument that just because you have lost on a trade you
are now closer to winning. By doing so, you are doing exactly what we
need to learn not to do. Every moment is unique. Just because you had 15
heads in a row does not mean the odds of a head are less on the 16th throw.
They are still 50/50.
Why? Because there is complete randomness in the outcome of one. That is
another way of saying that every moment is unique. However, over time the
law of averages will come into play, and over 100 throws, you will
experience 50 heads and 50 tails.
However, while you may understand this academically, and even logically,
there is a good chance you will not understand this emotionally, especially
if you just had 15 winners or 15 losers in a row. Therein lies the difference
between the trained mind and the untrained mind. I will steadily guide you
towards the trained mind, so that you do not succumb to fear.
PERCEIVING INFORMATION
Information on its own has no power over us. It is our belief system and the
energy we give to the information that decide its potency. If you receive an
email from an unknown person saying, “You are a dead man,” the chances
are your emotional reaction will be very different than if you received an
email saying, “Du er en død mand.”
The message is the same. One is in English, the other Danish. On its own,
the sentence is merely a construct of letters put together. Once it is decoded
by the brain, it is assigned an emotional charge. The sentence is
meaningless. It is how we interpret the sentence that causes the emotional
response.
So, imagine a mindset where you can perceive the market information
purely from an opportunistic point of view. You are not threatened by the
information. You are not thinking, “Oh God, why am I not in this move?”
You are not thinking, “Why am I in this move?” You merely observe and
decide from a frame of mind that sees opportunities. It does not see threats.
The market moves up and down in ticks all day. They form patterns, which
we trade on. These ticks up and down are just ticks. If you have a position
on, however, these ticks take on a life and meaning of their own. They
validate you, or they diminish you. That is not how you want to trade. That
is not an ideal mindset.
FOCUS AND ATTRACT
What we focus on is what we attract. I believe in that, so it is true for me.
The fear we experience causes us to focus on the object of our fear so that
we end up creating the very experience we’re trying to avoid.
I want to give you a simple example of the mind seeking information as a
result of what your focus is on. You bought yourself a new car. It is a yellow
Volkswagen Beetle. As you drive your new car, you begin to notice other
Volkswagen Beetles. You never did that before. Your mind has opened a
filter, allowing information about Beetles into your consciousness.
What we focus on is what we attract. The trader who has a position on in
the market will focus on the price movements (the ticks) that move in his or
her favour because they relieve pain and give pleasure. Movements against
the position create pain.
You might be thinking I am stating the obvious. You are right. My point
was not to state the obvious, but to point out that this state of mind is not
open to other possibilities. The more fear we experience, the less
information the mind will focus on. It will narrow its focus. It will stop you
from perceiving alternative options.
I run a live trading channel, where I trade in real time. When I trade
publicly, one type of scenario I am most proud of is that in which I accept I
have misread the market, and I change my position. For example, I may
have pushed the short side on the Dow Jones Index, and the market is
moving against me. I accept I am wrong. I close my position. I open a trade
in the opposite direction.
It requires a tremendous amount of self-belief to do this when you are
trading big size. What helps me in situations of this type is to recite a
mantra I have created: “Focus on the process. Focus on what you can
control.” I have developed a belief system that allows me to encourage this
kind of flexibility.
This kind of mindset is possible for you too. When I set out, I wanted to
create a mindset that allowed me to perceive information without fear. That
is the ideal mindset. It takes time to create it, but your rewards are directly
correlated to your effort. Don’t expect a eureka moment. Expect to get
better and better gradually.
BELIEFS
Our beliefs determine how we react to information. We were born with a
clean slate, and our beliefs are taught and adopted. We were taught what to
think. We also had experiences that shaped our beliefs.
I will get personal for a second. I felt my mother and father abandoned me
at a young age. They divorced and I became the object of their fighting. I
see now how that shaped my beliefs, which in turn influenced my choices
in life and the decisions I made. The moment I was old enough to take
charge of my own destiny, I saved up as much money as I could so that I
could say goodbye to that toxic environment and leave my home country.
How does this relate to trading? Trading gives us unlimited potential to
express ourselves. We can open a trading account, and away we go. You are
your own boss. There are no rules. There are no limits. Do what you want.
You are no longer influenced or guided by your parents. The world is your
oyster. You have total freedom to do what you want to do, when you want
to do it.
We tend not to want to operate under rules. After all, much of our young
adulthood is spent rebelling against parents giving us rules. Trading is a
rule-free environment. Unfortunately, the result is quite astounding. Traders
have free will, and 90% of them will have a belief system that leads them to
failure.
In order to prosper in trading, we need a combination of being able to
operate under trading rules while not feeling we are being held back,
because ultimately, we want to experience total freedom. Essentially, what
it boils down to is creating a mindset that always acts in your own best
interest. It is a mindset that allows you to see opportunities. It knows your
weaknesses and what to be mindful of. It allows you to receive information
without being threatened by the information.
You can operate from a carefree state of mind. I have created a blueprint for
a carefree trading mind. I have changed my beliefs about trading. That is
the message at the heart of this book – to change how we think, especially
how we think about losing. It is to explain my mindset and teach you the
mindset.
The old way of thinking is still there. It will always be there. It is part of
your personality. But the old belief has no charge anymore. It is faded,
diffused. Just because you have said goodbye to an old belief does not mean
it isn’t still in your memory.
I will give you a childish example. We used to believe in Santa Claus. We
used to believe if we were good, he would come and visit us to leave us
presents. Does it bother you that he is not real? Of course not. You have
diffused the emotional charge of being deceived. Your life is no worse off. I
have the same sentiment about my old trading beliefs. I am not missing out.
I am thriving on a new mindset. I used to think I couldn’t live without a
cigarette after a meal. Now I can’t imagine a life where I stick a cigarette in
my mouth. I eat every day, and I never have an urge to smoke. Once I could
not imagine a life without a smoke. Now I can’t believe I was ever hooked
on it. It took me a little more than a week to re-program my mind. The same
will happen to you as you apply my blueprint for the ideal trading mindset.
My biggest belief I had to overcome in trading was the associations I made
when I was confronted with losses. I had to learn how to disassociate losses
from feelings of failure or feelings of wanting to extract revenge on the
market to create a state of mental equilibrium. Achieving that was a
momentous leap for my trading performance.
THE BOOK OF TRUTHS
I want to move the narrative towards the practical element of creating the
right mindset. You can only dance around the fire for so long. Let’s get
down to brass tacks. Let’s get specific.
I once saw a sign that said, “The best views come after the hardest climbs.”
Proverbs have a way of simplifying complex messages, but they are hit-
and-run in their nature. They don’t tell you how to do it.
How do I climb the mountain? Telling us to “Just Do It” might be well
intentioned, but falls disastrously short of a meaningful description of how
to climb the damn mountain. In a similar vein, to be told to just “run your
profits” and “cut your losses” falls disastrously short of providing a
meaningful guide to achieving these noble trading goals.
When I started trading, I had the right credentials. On paper I was
academically destined to do well. Emotionally, though, I was like everyone
else. I was not making money. I should say I wasn’t making meaningful
money. I lost more on bad days than I made on good days. Granted I had
more good days than bad days, but the bad days would set me back
significantly, to the point where I might as well go and get a job. It would
have paid better than my trading did.
I didn’t question what I brought to the game beyond chart preparation. I
showed up. I traded. I studied charts. That was it. I thought that was all
there was to it. If it didn’t go well, then I had to do more of it.
However, I never looked inwards. Then something happened. I read the
research (described earlier in the book) on the 25,000 traders executing 43
million trades, and I thought to myself, I am just like them. They all
believed they would be profitable. Practically none of them were.
It prompted me to start thinking about trading holistically. I had been
obsessed with techniques. I had a belief that more is better when it came to
technical analysis. Yet, I was not seeing the results I wanted.
It got me thinking about thinking and about what I believed. More
importantly, I began to wonder if what I considered to be my beliefs were
actually helping me to become a better trader. So far, they had not.
Your beliefs create your world. How you see the world is a result of what
you believe in. Some beliefs are easy to identify. I believe we should look
after the environment, so I make sure I recycle. That is an example of a
belief. That was an easy example. How are your beliefs shaping your
trading performance? Are you even aware of what your trading beliefs are?
Your trading performance is a function of your belief system, and only by
dissecting your trading performance are you able to uncover what your
belief system is. There is an easy way to discover your trading beliefs.
Although I say it is easy, it is also hard work.
A friend of mine wanted to improve his surfing, so he hired a friend to
video him for a few hours during a surf session. He watched himself surf
and he was able to identify his issues. He needed to strengthen his core
muscles and he needed to trust his wave selection rather than being half
committed, as he often was on many waves.
In a similar way, I decided I needed to relive my trades to truly figure out
what my problem was. So, I downloaded my trading results into an Excel
spreadsheet and went to work. I meticulously went through the trades. I
split my trades up into many different categories, with many of them
appearing in more than one category.
There were trades I held for days. There were trades I held for seconds.
There were trades I executed in the mornings. There were trades I executed
in the afternoons and evenings.
I recommend you read my assessment of my own trading, and you repeat it
on your own trading. It is a vital step in understanding who you are and
how you interact with the markets. Once you have done that, you will create
what I call the Book of Truths.
Above all, be honest with yourself, as I was. If you are not honest with
yourself, you will not be rewarded with consistency in trading. The courage
to be honest with yourself is its own reward.
Here goes:
1. I had periods where my win rate exceeded 85%.
2. My average profitable trade was less than my average losing trade.
3. I was a winning trader, but my big losses were seriously denting my
overall P&L.
4. I traded well in the first half of the day.
5. I traded well in the first three to four days of the week.
6. I often gave away much of my profit from the morning session
when I traded in the afternoon.
7. I often gave away much of my weekly profit on Fridays.
8. I would do very well on range-bound days.
9. I would almost always miss trend days, and I would often fight
them.
10. My biggest losses came from fighting trending moves.
The breakdown of my performance was incredibly cathartic. I took great
pleasure in reviewing my own mistakes, because it felt like I was actually
meaningfully moving towards a better version of myself.
I took a very time-consuming decision to put all of my trades on the
relevant charts. I created a PowerPoint containing every trade to give me
visual imagery of my performance. This is the Book of Truths.
I will argue that this process stood out as the single most beneficial practical
exercise in enhancing my performance. I was, and I am, confronted daily
with all my flaws, and I have a visual representation of those flaws. It
seems as if the act of portraying a loss in a visual representation is a much
more powerful tool for change than merely writing “Don’t trade without a
stop-loss” on a Post-It Note and taping it to your screen.
I use the PowerPoint file to warm up every morning before trading begins. I
am reminded of the things I am good at and the things that tend to be my
downfall. It has become an integral part of my process, to ensure I am
acting in my own best self-interest.
When I started the process of visually recalling my old trades, my old hurts,
my old successes, I felt an empowering surge to replicate what I was good
at and avoid what I was bad it. I immediately began to trade differently. I
immediately saw measurable improvements in my trading. The results were
immediate, even if I had to get used to the new way of thinking. I made
more money.
I became much more trusting of the markets. I trusted that I would be given
an opportunity to make money every day. As odd as it sounds, I began to
trade less, and I started to make more money. Sure, I wasn’t perfect from
day one. I am not perfect today either. In fact, one of my beliefs is don’t
insist on perfection in trading.
One truth I came face to face with was less is more. There was a clear
relationship between the time of the day and my profitability. I was
nowhere near as profitable in the afternoons as I was in the mornings.
Would I make more money if I just traded mornings? The statistics said yes.
My heart said no. I wanted to trade, and I felt (or rather my belief dictated) I
had to trade in the afternoons. How else could I call myself a trader if I only
traded part time? It was a process of trial and error.
This was the immediate benefit from the Book of Truths, but I didn’t stop
there. I began to seriously question my motivation for trading. I argue that
in a business like trading, where 90% fail to make a positive return on their
trading account, the only way to separate yourself from the masses is to
acknowledge that your mind is either your best friend or your worst enemy.
If you don’t prepare your mind ahead of the game, and you experience
adversity during the game, your mind will most likely work against your
prime objective. Your prime objective is not to make money. Your prime
objective is to follow the strategy you have developed. More importantly,
your prime objective is to follow the process you have designed for
yourself. If you follow the process, the outcome will take care of itself.
I don’t set goals. I just focus on my process. I am a process-oriented trader.
I don’t think being overtly goal oriented will help you achieve your goals.
Of course, the goal is to win. But a mind subjected to adversity is a mind in
stress. A stressed mind needs structure and process. Otherwise, it will
succumb to feelings of fear, revenge and desperation, and the decisions it
makes will originate from these feelings. Who wants to make decisions
about the wellbeing of their financial health based on fear or stress?
The mind needs guidance. I read about an American football coach who,
during the half-time break, gave specialised talks designed to re-awaken the
imagination of the players on his team. One time his team had taken a
beating in the first half of the game. During the break in the locker room the
coach put on a special video he had prepared. It showed some of the
greatest comebacks in football history.
The purpose of the video was to give the players a path out of their stressed
state. It gave them mental imagery of what was possible. Coupled with the
right kind of motivation, encouraging the players to focus on the process,
staying present in the moment, waiting for the right opportunity and trusting
the process, their minds had gone from being stressed to being prepared.
I want to remind you that the first part of my trading life was spent on a
trading floor, observing traders – thousands of them – go about their daily
lives. I am adamant in my claim that those who were behind at half-time
had no mental tools to help themselves, and as a result tended to dig the
hole they were in deeper and deeper, as the day wore on.
LEAVING THE OLD SELF
Remember how Maximus ritualistically rubs dirt on his hands before
combat in the movie Gladiator? How, through this symbol of mental
preparation, he was leaving his old self behind? Well, I too have to leave
my old self behind. I too have to become someone else for the day. Charlie
Di Francesca, the legendary bond trader in the pits in Chicago, said that
good trading goes against normal human instinct. To succeed you have to
get used to being uncomfortable.
Trading is a battle of the self. Every morning I have to shed my skin and
become someone else. The Book of Truths is key to my transformation. It
arouses a desire to do better than the old pattern of behaviour. I am certain
that had I not taken the steps to focus on my mental game and confront
myself daily with my old behaviour, I would not be where I am today.
I argue this to be the case based on my observations of diaries. One of the
catalysts for my trading transformation came from tidying up my old office
cabinets. I found old trading diaries in which I had meticulously described
my trading day. As I read through the diaries, which spanned a decade, I
saw how desperate I was to make trading work for me.
I saw how day after day I promised myself not to add to losing trades – how
I promised myself not to trade well from Monday to Thursday and then lose
it all on Friday – how I promised myself I would stick to one setup, and so
on.
As I read page after page of trials and tribulations (but mostly trials), I
realised that the Tom whose words I was reading was in real pain, but he
was not transforming. He was repeating the same mistakes day after day.
He might have been increasingly technically competent, as his studies took
him deeper and deeper into expert territory of technical analysis, but he kept
making the same mistakes when his mind became stressed.
As I have said before, it was not an epiphany. My change came slowly. It
was a gradual realisation that all my chart studies didn’t move me
meaningfully towards the goals I wanted to accomplish. Rather, they merely
distracted me from the real problem, which was my behaviour when things
did not go to plan. Instead of focusing on the process and having tools to
get me to operate from a stress-free mind, I succumbed to foolish trading,
intending to make back the lost ground. My mind desperately wanted to get
rid of the pain of having lost money, and its solution was to chase every
movement in the market recklessly. And all I did was dig the hole deeper
and deeper.
The Book of Truths will give you up-close, face-to-face time with your own
shortcomings. It made me realise what my faults were. I also started
plotting my good trades. I felt it was necessary not just to remind myself of
the behaviour I wanted to avoid. I should also remind myself of the
behaviour I wanted to strive towards.
The charts I use to prepare for each trading day, to warm up, are my old
trades plotted on a chart. That way I can emotionally relive the trades and
reinforce the behaviour that is good for me and remind myself what my
weak points are.
AN EXAMPLE
Friday 4 March 2022 was an extremely volatile trading day. A colleague
pointed out to me that Brent Oil was soaring. I looked at the chart, shown in
Figure 25, and I thought, “Wow, it really is.”
Figure 25
I bought the first retracement on this ten-minute chart. Now there is nothing
wrong with this entry. I am trading with trend, but as I look back at the
trade, I acknowledge that at that precise moment in time I was not trading
from an emotionally stable point of view. I was eager to get on board a
move, based purely on the opinion of another trader.
So, I just bought it without much thought to it. And I had no stop loss in
mind. I just put an arbitrary stop loss, for safety. See Figure 26.
Figure 26
This is the power of the Book of Truths. I want to remind myself of things
like that. I want to remind myself, in the morning, before the trading starts,
that Tom Hougaard trades best when he is calm and is not caught up in an
emotional whirlpool of excitement and a brain awash with adrenaline and
dopamine.
I looked at my trading monitor and saw my position losing me money. I
reminded myself that, although I got caught up in the emotions of another
trader (one that I respect), I am not him. I am me. I closed the trade, and
then I waited. I had made an impulsive trade – an emotional trade without a
real plan or a real setup. I wasn’t annoyed so much with the losing trade as
much as I was annoyed with suddenly being impulsive and acting without
truly thinking. I could have spent 30 seconds thinking it through and the
outcome would have been very different.
I calmed myself down, and I thoroughly analysed the chart, and I decided
upon a better entry point. I used my process – the tools that work for me.
And then this pattern in Figure 27 showed up. It was late in the day, and I
was prepared for a restful evening after a long trading week. I bought Brent,
and I held it.
Figure 27
The setup is simply a Harmonic Retracement. The first retracement and the
second retracement are identical. It gives razor-sharp entries, where it is
easy to control your risk.
I want to remind myself of the things I do well. I want to remind myself of
the things I can be prone to when I am not calm. I want to do that ahead of
the open. I accept that I will never be perfect. I will at times still make
stupid Brent Oil trades on a Friday afternoon because a friend of mine is
telling me of his success; but I like to think that like a missile I will self-
coordinate as new data becomes apparent, and I like to think that my mental
preparation makes my mistakes short lived.
TRUST
My review of my trades revealed that I didn’t trust myself or the markets.
Profitable trading requires trust. If you don’t believe it can happen, you
should not even start. If you don’t trust, then you will not make money.
Therefore, before you start trading again, you have to work on your beliefs
about yourself and the markets.
As I see it, trust falls into two categories.
TRUST YOURSELF
You have to trust that you already have all the tools you need to make a
living from trading. Yes, you need to acquire a certain competence level in
the field of technical analysis (or whatever edge you use to make trading
decisions).
I continue to study technical analysis, and I do so to improve my
understanding of the ever-changing nature of the markets I trade, but it is
not technical analysis that will make me money. It is trusting that I already
have all the skills I need to make money consistently.
The reason why I was not more successful in my early trading was not
because I didn’t know enough about technical analysis. It was because I
thought the only thing I needed was technical analysis. However, that was,
and is, simply not true.
I had not focused my time and attention on matters outside of technical
analysis. My focus was not on the right things. My technical savvy was not
matched by an emotional maturity, because I had not spent time working on
that side of my game.
You need to trust that you already have all that you need. Otherwise, you
will not bridge the gap between what you know you can achieve and what
you are achieving. You need to believe. The belief comes from doing. I will
address that in a moment.
TRUST MARKETS
The second trust consideration is the trust in the markets. When I go to
work in the morning, it would be great if the perfect setup manifested itself
before my eyes right at the opening bell. However, it rarely does.
I use a five-minute and a ten-minute chart as my primary trading time
frame. A typical trading session runs over ten hours for me. That means I
will be confronted with a total of 120 candles/bars of five-minute duration.
As a result of my review of my trading performance, I came to a realisation.
I didn’t trust the market would give me the opportunities I needed to make
money. It was a debilitating belief.
I set out to prove that I was wrong in that belief by reviewing ten years’
worth of intra-day data from the handful of products that I traded most
frequently. Now I wasn’t just studying for the sake of identifying patterns. I
studied to prove that the technical analysis setups that served me well
would repeat every day.
I arrived at a new set of beliefs. I came to believe I can trust the market to
give me an opportunity to make money every day. I came to trust the fact
that at least two or three of those five-minute candles would produce a great
trade entry.
I came to trust that the market would give me a perfect entry point, such as
a double top in a higher time frame downtrend or a continuation signal. In
conclusion, I shaped a new belief around the evidence that I laid bare
through my research. I came to accept that I can produce a good living from
trading, from waiting for those ideal setups.
But those ideal setups don’t necessarily materialise when I want them to, in
the time frame I have at my disposal to trade. I need something else beyond
trust.
Trust is a vital part of the journey to making the markets your playground,
but it is not the only component. I needed to work on another part of my
behaviour. I would often tire before the afternoon trading session. I would
often tire as the week progressed. This led to poor decisions, which can be
directly attributed to boredom and impatience.
PATIENCE
I realised that my patience was my weakness. However, there is more than
one kind of patience. For example, a mother teaching her young child to
read may experience a sense of impatience, but the mother will remind
herself that eventually all children learn how to read.
The impatience that a parent may experience is mitigated by the perceived
time horizon to reach the end goal. We know our children will learn basic
reading skills, as long as we persist. We simply have to maintain our
patience as our little ones inch their way towards the desired skill.
You can’t argue that patience is a quality directly transferable from
parenting to trading. As a parent you can tell yourself you will patiently
work towards your child being able to read. However, you can’t say that
you will patiently wait for the market to hit your desired entry point,
because it might not hit your desired entry point.
As a result, you will experience emotions that a parent doesn’t. You will
experience a fear that the market will move without you. You will be fearful
that the market will not give you an opportunity to jump on board. Without
the right kind of conditioning, you will act upon these fear impulses.
Had I not gone through all the data I had, I would not have been so assured
in my decision to wait for the right setup. I accept my process is thorough,
but with that preparation comes significant financial reward.
Without a doubt, one of the greatest flaws I saw traders exhibit during my
decade on a London trading floor was the idea that it is too late to join the
trend. It was a common occurrence during trend days to witness clients
continuously try to find the low of the day.
On those days our clients lost the most. If the market was rallying, they
would either do nothing, or they would try to find a place to sell short. If the
market was falling, they would do nothing; but more likely they would try
to find the low of the day and buy.
Considering the action was so common across such a large group of
individuals, I conclude that there is an inherent trading flaw in our thinking
which makes us want to go against the trend. I have previously mentioned
this supermarket mentality, which compels us to seek value.
Another reason this behaviour is commonplace is because of the prolific use
of chart indicators that display what is technically known as overbought and
oversold price levels. The use of overbought and oversold indicators has a
terrible track record in trending markets.
To my mind patience is a skillset that can make the difference between
being an abject failure or a wizard. I used the word skillset because I believe
that patience can be developed.
I developed my patience in trading using two methods. Both are practical in
nature, but they are very different in their application. One is a proactive
exercise. One is a reflective exercise.
EXPANDING MY FIELD OF
INFORMATION
The proactive exercise evolved around the concept of expanding the field of
information. I print out the charts of my favourite markets every night,
while the trading session is still fresh in my mind. For example, I will print
out the DAX Index chart and the FTSE Index chart on both a five-minute
chart and a ten-minute chart.
The reason I am printing out two time frames is because of perspective. I
found that my use of the five-minute chart prompted overtrading. By
considering the ten-minute chart I am forcing myself to slow down my
decision making. This act of slowing down my time perspective also
strengthens my patience. I see things on a ten-minute chart that give me a
greater clarity than if I had seen them on a five-minute chart alone.
Patience, however, is not a quality that is easy to come by. I am a man in
my 50s. Over my lifespan the world has pandered to the impatient. When I
was a child, if my family ran out of milk on a Sunday afternoon I would
have to wait until Monday morning before I could purchase another bottle.
Everything was shut on a Sunday.
Forgive me if I sound like a relic. I am really not. I love technological
advances. So many wonderful things flow from our advancement of living,
but the flipside of the coin is that we as a species have also become
impatient.
That is important to remember when you set out on a trading journey. Not
long ago, I read about a gentleman called Navinder Sarao, a trader who
became synonymous with the infamous 2010 flash crash. In the book Flash
Crash, by Liam Vaughan, it becomes apparent that some of the primary
skills that Navinder possessed were focus and patience. According to the
book, Navinder Sarao would hide himself away from the other traders he
worked with, so as not to be disturbed. He needed quiet around him to
exercise focus and patience.
The exercise of printing out the specific charts every day instils in me faith
that every day the market will give me an opportunity to make good trades.
The exercise is also an opportunity for me to discover new behaviour in the
market and continuously train my mind and eyes to spot patterns. I happen
to believe that you only see things you have trained your eyes to see.
IMAGERY AND BREATHING
The second exercise is hard to begin with. Some call this exercise
meditation. Some call it visual imagery. I don’t have a name for it, but I
know what I want to achieve. I want to calm down my mind. Depending on
the mood I am in, I will use one of the following tools to keep my mind
trained for the task of being a high-stake day trader.
I sit quietly in a comfortable position, and I observe my breath. I breathe in
for seven seconds, and I breathe out for 11. I repeat. I will do as much or as
little as I need to feel calm coming over me. Sometimes it takes five
minutes. Sometimes it takes 15 minutes.
The purpose of the exercise is simply to calm my mind. Through the use of
breathing exercises I have been able to increase my attention span
significantly. I was hesitant at first. I was even hesitant to write about it. It
has that taste of a new-age fad. The reality is that calming your mind
through breathwork is used extensively by high-performance athletes. I read
extensively on the topic of meditation amongst Formula 1 drivers. It was
both a surprise and a relief that ultra-competitive sportsmen and women,
people I admire and am inspired by, are turning their sight inwards to
improve their edge.
I have to be upfront with you. I have no formal training in meditation or
imagery. I simply trust and let myself be guided by what enters my head.
My mental imagery is designed to place myself in physically dangerous
situations. I may be face to face with an alligator. I may climb a steep rock
face. I may surf a monstrous swell. The exercise is simple. I want to elevate
my pulse through imagery. Then I want to consciously focus on my breath
and simply accept the situation for what it is. The aim is to confront the
imagery and remain calm.
Once I am calm, I see myself trading the absolute biggest stake size I am
allowed by my broker. I see the market move against me, and I visualise my
P&L go deeply into negative. I feel my pulse elevate, and I focus on
calming it down. I repeat this process over and over.
I see myself riding a trend higher and higher. I see my P&L grow larger and
larger. I am waiting for my mind to tell me to take profit. Then I stop the
tape and flip the switch. I calm my mind down, and I see myself looking at
my P&L dispassionately. I calm my breath until I am able to simply observe
my profit grow larger and larger as I trend with the market, higher and
higher. The goal is simply to be, to be an unemotional observer of the
market. The goal is to act without fear, without hope, without anything but
an objective assessment of the price action.
ASK FOR HELP
I believe that beliefs shape our lives. I believe not all my beliefs are
beneficial to the life I want to live. I accept they are there, and as my self-
knowledge evolves I address them to the best of my ability. I have come up
with this back-to-front idea of how to address my beliefs.
It evolves around the old saying, “I will believe it when I see it.” How about
turning it on its head to say, “I will see it when I believe it”? This argues
that you must believe before you can see. Many of our beliefs have been
part of our construct since our formative years. They are not going to go
away without a fight. Of course you might decide not to fight them, but to
accept them.
I call this process Ask for Help. I sit with a blank piece of paper, and I pose
a question. It could be, “Why am I afraid to join a down-trend after it
already started?” I write down everything that appears in my mind. I sit
with my eyes closed and I observe my thoughts. I do not censor myself. I
just sit and ask and listen and write down.
I may write for 10–20 minutes. What often appears on paper are thoughts
straight out of the psych ward. It scares me at times how brutally to the
point and honest the answers can be. It can be quite horrifying to read the
things the subconscious mind brings up. I don’t judge. I accept.
When I am working with my beliefs, fighting those beliefs will not work. I
think giving negative energy to a belief will only cause it to fight for its life.
The only thing that works is complete acceptance. I accept what is there. I
understand it. It allows me to retire it. I diffuse it. If I approach it from a
perspective of “I hate this belief”, it will enforce and entrench itself.
Say I have a belief about trading that suggests I need to make my money
quickly. I need to get in on the move first thing in the morning. If I want to
diffuse this belief, because I have strong evidence to suggest it is
destructive to my trading account, I will ask for help. I will accept the
belief. I will diffuse its negative energy, and I will replace it with positive
energy. I will reinforce a new belief such as “I will wait for the first ten-
minute bar to complete before I make a decision to trade”.
Unfortunately, beliefs do not have the power to dismantle themselves. All
beliefs demand expression. Desire and willingness to ask questions from a
sincere space, with a sincere mindset, will give you answers.
When I use the Ask for Help process, I know it is complete when I can distil
my question into a short one-sentence answer. Then I know I have
condensed the exercise into its lowest common denominator, and I have
diffused whatever belief I had that didn’t serve me. The old memory will
always be there, but the context has changed from negative to positive.
It is important for me to remind you that money is a by-product of the ideal
trading mindset. You are creating a process that will guarantee an optimal
mindset for your trading life. The essence of good trading lies squarely in
how we think and perceive information about the markets. It has everything
to do with how we think and how we live our lives.
Today I spoke to a friend of mine. We had not spoken in a while. I consider
him a very close friend, and it was a joy to reconnect. As he spoke, I
listened intently. You have two ears and one mouth. Use them in that
proportion. He was talking animatedly about his trading and how well it
was going. In between the stream of sentences, I picked up on a sentence
that spoke volumes: “I am still working on increasing my trading size.”
I thought long and hard about that sentence, knowing I was going to write
this final chapter today. My friend first spoke to me about increasing his
trading size back in 2015. Today it is 2022. He has spent seven years talking
about increasing his trading size. What does that tell you about his desire to
increase his trading size? Do you think there might be a misalignment
between what he says he wants, and what he is actually doing to get what
he wants?
I often tell my children this. Do what you have to do, so that you can do
what you want to do. I tell them to make up their minds what they want but
think very long and hard about it first. If you say you want something, and
then you do nothing about it, then you can be damn certain there is a
misalignment between your conscious and your subconscious. When I am
faced with a situation like that, I use the Ask for Help exercise, and I always
get a brutally honest answer. The most common answer I get is: “Actually
you say want it, but you don’t!”
The idea of deciding what you want can undo a lifetime of negative energy
surrounding your beliefs and your belief system. The power of making up
your mind will remove all negative energy surrounding a belief system. I
have come to accept that many people do not want to do that. We fall in
love with our drama. We cling on to our drama because it validates us and
gives us attention.
When I am out of sorts, angry, frustrated, I ask questions and work my way
backwards. I work my way to the source of the problem. Anger is often a
self-defence mechanism. If I am angry, I need to know what the underlying
belief for the anger is. So, I ask.
I am often told I am very disciplined. This is not true. The word itself is an
oxymoron. Discipline implies the use of force and will. My action flows
from a love of what I do. I don’t have to apply will to do what I do. Those
who are self-disciplined don’t think of themselves as self-disciplined. They
are just expressing themselves in harmony with their own dreams and goals
and desires.
When you watch spiritual movies like The Secret and listen to self-help
tapes, you get this sense that the universe is a menu, and you can help
yourself to whatever you want. I find that to be one of the most distressing
aspects of the self-help industry, be it neurolinguistic programming or Law
of Attraction or whatever name the latest fad goes by.
I have stood in an auditorium and listened to motivational speakers make
their audience shout out whatever grievances are holding them back, and
then push the audience towards their private island retreat for untold sums. I
never believed in it. I don’t believe anyone ever achieved anything
spectacular without putting in a massive amount of effort. I know I put in
the effort. I know that everything I do on a daily basis is the result of grit
and determination. I am not talented. I am hard working. I am not gifted. I
am determined. I am not lucky. I am persistent.
TWENTY TRADES
My friend Dr David Paul gave me an exercise, which at its heart is designed
to strengthen the process of your trading. It is as simple as it is difficult.
Your job is to execute 20 trades, as the signals appear.
One by one, you take every trade signal as it comes. The purpose of the
exercise is not actually to make money. You will probably break even, and
that is fine. The purpose of the exercise is to smoke out your internal
conflicts and your unresolved emotions.
It has at its core the idea that if you can execute 20 trades without any kind
of conflict, you are trading from a carefree and fearless frame of mind. This
means you are trading from the perspective that:
1. Anything can happen – and you are emotionally detached from the
outcome.
2. Every moment is unique – and you are no longer drawing
associations between this moment and another moment. You are pain
free.
3. There is a random distribution of wins and losses – you accept the
outcome as if it were a coin-flip exercise.
4. You don’t have to know what will happen next to make money – so
you trust the process, and you focus on controlling the only variable
you truly can control, which is how much you want to risk on this
trade.
The purpose of the exercise is to add energy to your beliefs. Until you can
do that without conflict and unresolved thoughts and conflicting energy
issues, the negative charge will not dissipate.
How do you know when you are successful? When you can trade without
any conflicting or competing thoughts. The results are not important during
the exercise. This a process exercise. You may have to repeat the 20 trades
over and over until you come to a point where you find that you are firing
off trades without fear, without hesitation, without connecting this moment
with a past moment, and you accept the outcome dispassionately. When you
arrive there, you really have arrived!
DISASSOCIATION
A friend called. She had put up a post on a social media outlet, and her post
was very ill received. She endured a torrent of abuse for what was a well-
intentioned post. She called me for help. I read her post and the slew of
abusive comments. To me, however, they were just words. They were
words without energy.
I dispassionately read the posts, and then I explained to her what to do. As
traders we need to work towards being as dispassionate about our trading as
I was about her social media post. The more we work on this, the better we
will trade. Some will argue against me. Remember, I am writing this from
the perspective of what works for me.
How do you do trade dispassionately? How do you disassociate yourself
from feeling anything when you are trading? Well, that is what my exercises
take care of. If you want to be able to receive information from the market,
without feeling threatened, it will not happen by itself. I believe working on
what you think and how you respond and evaluate your responses will
improve your trading in measures you would struggle to appreciate right
now.
I once sped down the autobahn doing 186 miles an hour. Yes, it was
reckless. Whilst doing it, I wasn’t wondering if there was milk in the fridge
or if I had remembered to floss my teeth this morning. I was in the moment.
Focused. That is what I want to bring to my trading every day.
Every moment is unique. That does not mean we have to act like a formless
blob with no memory of the past. There will always be some degree of
correspondence. However, just because I was rejected by a girl the first time
I invited her for a dance does not mean I will be rejected the next time. But
my mind might think so, so I may have an argument with my conscious
thinking and my subconscious beliefs.
My rational mind might say, “The next girl will say yes to a dance.” My
subconscious mind, unbeknownst to me, might say, “No way amigo, give
up, she will never dance with you.” If you have a moment of doubt before
venturing over to ask the lucky lady, you know you are not aligned. When I
experience this in my trading, I will Ask for Help, or I will use imagery to
resolve whatever is going on in my head.
MIND LOOP
My training involves accepting pain and making it part of my existence
through habit and repetition, so that my degree of pain tolerance is
expanded. I also have to train my mind about expectations, and how to deal
with unrealised expectations.
This requires a tenacious effort, through journalling, mental imagery, and
asking for help. You may quite rightly ask, “Does it work?” I think it does.
It has revolutionised my trading. As I type these words, in March 2022, I
have not had a losing day since September 2021. That is nearly seven
months without a single losing day.
I don’t think this should be celebrated. I am not writing this to show off in
any shape or form. The intention is to inspire you to take the mental side of
trading almost as seriously as the technical side. If I were to describe the
beliefs that are the foundation for my trading, they would resemble a
flowchart, one where the entire mindset ecosystem forms a loop.
My trust (in the markets and in myself) supports my patience. My patience
(that a setup will materialise) feeds my confidence. My confidence (that I
will win) dictates my inner dialogue. My inner dialogue (what I tell myself
while I am trading) supports my process-oriented mindset. The process
enables me to stay focused in this moment. I support this loop with my
mental exercises. They feed, nourish and sustain the loop.
I am a process-oriented trader. I do not believe in goal setting. There are no
Post-It Notes on my monitor reminding me how much I want to make today
or this month or year. I have no monetary goals or pip/point goals. I will
take what the market will give me. I never trade with targets.
By being utterly focused on the process as opposed to being outcome
oriented, I ensure that I am staying present. When you are present, you
don’t connect past moments with this moment or future moments. You are
right here, right now.
Being present is what some would call mindfulness. I call it focus. I call it
concentration. I call it knowing what I want. I want to win. That is my
overriding motive for trading – to win. I want to win, but I don’t mind
losing.
However, I know that if I forget all about winning, and I focus on the
process, I will win. It is an idiosyncratic conundrum that for a long time I
just could not believe and give into. How can I win if I am not focused on
the goal at all times?
It took me almost a decade to figure out that process is everything. Don’t
focus on the goal. Sure, know what the goal is, but focus on the process.
Trust the process. I built my trading life around this mind loop. How does
the loop look?
I trust. The research underpins the trust. The trust supports the patience. The
patience is underpinned by the mental exercises, and it nourishes my
confidence. My internal dialogue is driven by a process-oriented mindset,
fuelled by my confidence. I focus on what I can control – my mindset, my
risk approach – and I let the market do what it wants to do. Whatever it
does, does not fuel the fearful side of my mind. That has been trained away.
I am not afraid of the market. The only thing I am afraid of is that I do
something stupid in the market. As I trust myself, this does not happen.
I trust that I have the skills to make money, and I trust that the market will
give me opportunities to make money. This trust has been nurtured and
strengthened by my intense study of market charts for the time period I
desire to trade. The trust is further strengthened by continuous dedication to
my vocational skillset.
My patience flows from my trust in the market and in myself. I have built
an emotional connection between trust and patience. I trust the setups will
come, if I am patient. If I am patient, I will win. Winning means more than
anything else to me. If I am not patient, I will not win. I will do anything to
win. Therefore, the trust overrides any emotional impatience that may arise
in my mind, because I trust that if I miss this signal, there will be another
one coming.
My confidence comes from continuously working on my game. I don’t
learn technical analysis once. I learn all the time. Some markets move.
Some markets are dead. Some markets require larger stops. Some require
you to trade with orders because they move so fast. The markets are forever
changing, and I change with them.
My inner dialogue stems from the trust and the patience and the confidence.
Of course, yours truly has bad trading days. I just don’t let it bother me. I
am grounded in this moment. I focus on the process. That is all I can do. I
can’t dictate to the market what it must do. I must be like water, and flow. I
must flow with the market. I don’t fight the market. I flow with the market.
“Just flow,” I tell myself.
This is what lies behind the process. I never expect to be comfortable when
I am trading. If I am comfortable, I know I am not pushing the boundaries
of what I am capable of. I know that to get the best out of myself I need to
be a little uncomfortable. I will give you an example.
I sold short the Dow Index in my Telegram channel (timestamped for
authenticity and verification). I have marked my entry point in Figure 28.
Initially, the market moves against me. Then it turns and trends lower. As it
trends lower, I am mindful of my mind saying, “Take profit.” That voice
used to be much louder. Now I am so focused on the process that the voice
is no longer heard. I focus on the process, not on the outcome.
Figure 28
However, at one point I have 200 points in profit and the market sits at an
old low. I have to accept that there is a real possibility the market will
rebound from there, and much of my 200-point profit will disappear. That is
being uncomfortable. I accept it and decide to let the position ride.
Do you know why I let it ride? Because I know myself well enough to
accept that if I took profit, and the market then continued lower, I would
feel awful. The pain of seeing a market giving you even more profit when
you are not on board is much greater than the pain of seeing some of your
paper profit disappear – to me at least!
This time it worked. Tomorrow it might not work. I have to trust the process
will sustain me over the long run and be less concerned about the outcome
of a single event. Remember, there is complete randomness in the outcome
of one event, but over hundreds of observations there is no randomness.
A trading life is not defined by what we do every now and then, but by what
we do over and over. You will never be able to trade without having losing
trades. The whole purpose for giving this book the title it has, Best Loser
Wins, is to illustrate this point right from the beginning. The one who is best
able to lose will win the game of trading.
The survey of 25,000 traders executing 43 million FX trades over a 15-
month period illustrates this point perfectly. Overall, they had more winning
trades than losing trades. Out of those 43 million trades, up to 61% of them
were winners, depending on what currency pair they traded.
What does that tell you?
It tells you that those 25,000 traders have a good grasp on the markets and
where to place their trades. It tells you that if they were somehow able to
operate with a 1:1 risk-to-reward ratio, they would win 61 out of 100 and
lose 39 out of 100. That is a winning formula. That creates a net positive
trade flow of 22. That is a business model that has an integral foundation.
The problem is that the survey shows that when they win, they win on
average 43 pips. When they lose, they lose on average 83 pips. In other
words, they lose twice as much (almost) on their losing trade than they
make on their winning trades.
Let’s say 100 trades are executed.
61 winners at 43 pips = 2,623 pips
39 losers at 83 pips = 3,237 pips
What does that tell you?
It tells you that they are good at picking winners, but when they are faced
with a losing trade, they don’t have the mental discipline to cut the loss.
What does that tell you?
It tells you that they need to work on their mental game so that they are
better equipped to handle losses. Their minds are most likely wired to
associate pain with taking a loss. The mind has at its core a mandate to
protect you against pain – physical as well as mental pain, perceived pain
and real pain.
FINAL WORDS
Your path to becoming a profitable trader lies not in better understanding
the markets, but in better understanding your mind. Your mind and how you
operate it will dictate the level of success you have as a trader.
I am going to go out on a limb and tell you something about you. People
reading this book could have fallen into one of two categories, but I doubt
it. I doubt that new traders, who have never traded before, will ever
gravitate towards a book like mine.
They are more likely to buy books that have titles like Mastering Trading or
Trade Your Way to Financial Independence. This kind of book will be 300
pages of technical analysis and most likely not contain a single mention of
losing trades. It will contain page after page of perfect chart examples.
This book, I speculate, will be read by the people who previously bought
the sort of book mentioned above, but have come to the realisation that the
gap between where they are now and where they know they can be can only
be bridged by a better mindset.
The advantage I have in writing this book is that I don’t have to establish
my credentials. I have a four-year public track record, timestamped and
readily available for anyone to read. I post my broker trades in Excel format
on my website and in my Telegram channel daily. There are plenty of bad
trades in that track record, I assure you, but somehow I still manage to
make money overall, and quite significantly so.
Therefore, the focus now needs to be on the actual steps I have taken – and
still take – to ensure I stay at the top of my game. That is where you are
headed now.
I want to finish the book on a note which is important to me. I have
described a process that works for me. It is based around my particular
beliefs. Those beliefs are the result of my particular life circumstances.
I believe that beliefs are defined by one’s own desires and needs. As a result
of my desire to be a profitable trader, and my need to create financial
stability in my life, I have acquired beliefs that are consistent with this goal.
That said, I accept that my way is not the only way. I don’t describe the
way. I describe my way. Whatever you decide is right for you is right for
you. Trust it.
I periodically suffer from verbal diarrhoea on the mental aspect of trading. I
post my musings on both www.BestLoserWins.com as well as on my
website www.TraderTom.com
Have a wonderful journey.
With love.
Tom Hougaard
ABOUT THE AUTHOR
TOM HOUGAARD studied economics and finance at two universities in the United
Kingdom, and then went on to work for JPMorgan Chase before spending
the next ten years in the City of London as a chief market strategist for a
CFD broker. He has given thousands of TV and radio interviews on the
state of the market and has educated tens of thousands of clients on trading
strategies. Since 2009 he has traded for himself.
Tom has self-published several works on trading psychology, price action
and product knowledge.
You can follow Tom’s trading via Telegram and YouTube. You can view his
trading results at www.tradertom.com
Table of Contents
Cover
Title
Copyright
Dedication
Contents
Dear Markets
Preface
Introduction
Liar’s Poker
The Trading Floor
Everyone Is a Chart Expert
The Curse of Patterns
Fighting My Humanness
Disgust
The Drifter Mind
Trading Through a Slump
Embracing Failure
Best Loser Wins
The Ideal Mindset
About the Author