"What is the difference between a winning trader and a losing trader?"

Jesse Livermore Lesson Two
Do not depend your analysis solely on “insider information.” Jesse Livermore learned this lesson the hard way – twice in all. The first lesson was moderately costly; the second lesson was to cost him his entire fortune:
Livermore had always been skeptical about the dependability on “insider information.” After all, why would top management tell outsiders that he was selling shares in his own company because he thinks business will be bad going forward (these were the days before insider-trading was made illegal)? Telling outsiders would only add more selling pressure to the stock, and vice-versa. The legendary trader, Bernard Baruch, had always maintained that insider information was useless, and that a person was doing him a favor if he would keep the insider information to himself and not reveal it to him. Livermore got his first real lesson sometime after he closed out his profitable short position in Union Pacific right before the 1906 San Francisco Earthquake. After three days of tape-watching, he concluded that the shares of Union Pacific were being accumulated. He started to accumulate shares in Union Pacific as well – only to be stopped by Ed Hutton, the great New York financier and owner of the E.F. Hutton brokerage house, and a personal friend. Hutton told Livermore that he had inside information and that the insiders have set up a pool and were dumping shares to him at a furious rate. Sooner or later, Union Pacific is going to tank. Despite his own beliefs and the reinforcements of all those beliefs from years of tape-watching, Livermore liquidated his 5,000 shares of Union Pacific at $162 – making only $10,000 in the process. The next day, the company announced a 10% dividend and the shares shot up by an additional ten points. The opportunity cost? $50,000 in additional profits which would be equivalent to over one million dollars today. Livermore did not get upset or emotional, but after this incident, he swore that he will never listen to insider information again and that he will only trust his tape-watching skills and instincts from now on.


The second lesson that was handed down to Livermore did not strictly involve insider information, although it was pretty darn close to it. It also taught Livermore a little about himself – his gullibility and his succumbing to another man's sale skills even though he practically knew all the facts of a product (in this case, it was the cotton industry). Let me clarify. This happened soon after the Panic of 1907 – when Livermore was trading successfully at a peak level and soon after he made a small fortune by nearly cornering the cotton market. Some weeks before, a man named Percy Thomas (who was also know as the “Cotton King”) had gone bankrupt in trying to corner the Cotton market, and hearing Livermore's exploits, Thomas would seek him out and ask Livermore to be his partner. Livermore refused to be Thomas' partner since he had always played a lone hand. However, Thomas was a man of knowledge (particularly in the cotton market, of course – where he supposedly had “spies” that would report crop conditions and the like to him as soon as they could) and a great charmer, and Livermore was soon put under his spell. Prior to Livermore meeting Thomas, Livermore was short cotton. After a month of listening to Thomas and falling under his spell, Livermore covered his short position and went long. This was the beginning of Livermore's downfall. With his judgment clouded, Livermore continued to average down on his long position even as Cotton fell. He even sold out his profitable wheat position in order to maintain his margin requirements in cotton and to even buy more cotton on the way down. After realizing what had happened, Livermore soon sold out – with a stake of only $300,000 left – 10% of what he had only some months ago. Livermore sold his apartment and his yacht and tried to recoup his losses in the stock market. By this time, however, his emotions were running wild and his trading skills were shot. Soon thereafter, Livermore was broke once again – not only losing his remaining stake of $300,000 – but now, he was in debt to the tune of over one million dollars. Livermore would ultimately establish himself once again, but this lesson further reinforced his beliefs that he should always play a lone hand, and that he should never tell anyone what he was doing or ask otherwise.

Jesse Livermore Lesson Three
The need to continuously evolve in the stock market. This was initially discussed in lesson one, but I believe this theme is important enough to warrant its own bullet point (no pun intended). In fact, this is probably the most important lesson that could be taught from Jesse Livermore's experience. The most popular rules such as “cutting your losses” and “don't put all your eggs in one basket” have often been cited, but what if one wants to be able to make money in the stock market over the long run? To this I say: “One needs to continuously evolve in the stock market to survive and to flourish.” This is definitely applicable to everyday life and one's career (if one is not a trader or investor) as well.

Jesse Livermore has been able to successfully trade the stock and commodity markets over a period of more than thirty years not only because of his intelligence, cool-headedness, trading skills, and his far-sightedness. He was able to do this successfully for such a long period of time primarily because he was able to evolve. He adopted a more long-term, buy-and-hold-like strategy when he shifted his trading from the bucket shops to the New York Stock Exchange. He was also eager to learn something new everyday. He was also flexible – whether on the long or short side or just being in cash. He figured out when there were opportunities in the stock market, and figured out what strategy to adopt and when there were not. He also made friends with very successful people – whether they were businesspeople or great financiers.

This is actually the heart of this commentary: the need to continuously evolve. In his ground-breaking work “Common Stocks and Uncommon Profits,” originally published in 1958, Philip A Fisher remarked that times have changed and that the way to make the most money over the long-run is to find great stocks and hold them for the long-run through thick and thin. The old way of speculating and making money by catching the inflection points of boom and bust cycles was gone with the advent of the Federal Reserve and the maturing of the SEC and the new regulations. I believe Jesse Livermore failed to see that. By the end of 1929, he had successfully maneuvered his way out of the Great Crash with a cash horde of over $100 million – becoming of the richest men in America. When Franklin Roosevelt came into office in 1932 – taking his “brain-trust” with him – and with the creation of the SEC in 1934, the stock and commodity markets adopted a different character – a character which Livermore had never seen in his entire life and a character which America had never seen before either. There is no documented history of the trades that Livermore during that time – all we knew is that he went bankrupt for the final time in his life during the 1930s and was never able to successfully make a comeback. Some say he lost his fortune going long sugar futures before FDR put a ceiling on the sugar price. Some say he lost his fortune going long after the crash and didn't get out in time – thinking that the 1929 “dip” would be one of the many similar busts that America had endured during the 19th century and the early parts of the 20th century before the creation of the Federal Reserve. The message is clear, however. The character of the market changed in a big way, and Livermore was not flexible enough to go along for the ride – despite the fact that he had successfully evolved his strategies and trading styles many times before in the past.

This is not unsimilar to the period immediately before the technology bubble burst in the spring of 2000. At the time, I stated that the technical indicators that were so successful in the late 1990s would not work anymore – primarily because that we were entering a secular bear market. Few believed me at the time. They continued to use their oversold technical indicators, buying technology stocks during the many dips along the way. They failed to evolve. Warren Buffett had mentioned in the past that only when the tide turns would it be obvious to see who was swimming naked.

The idea of evolution in the stock market continues to hold true today. In fact, with the advent of globalization and information technology, it is now even more imperative to evolve since trends can change much more quickly. Information is now instantaneous. Investors will need to be more nimble. Whereas Philip Fisher emphasized that timing was not too essential in the purchase of stocks in 1958, this has all changed today. Witness the meteoric rise and fall of Taser – all in a short time span of 12 months! Also witness the huge amount of cash that has been sitting on the balance sheet of Warren Buffett's Berkshire Hathaway over the last 24 months. Yes, the company has grown bigger, but as a percentage of total net worth, the amount of cash that Warren Buffett is currently holding is unprecedented. Ten years ago, Buffett would have been able to find opportunities to put this cash to work. Buffett had always been a great timer in the stock market (he had always had the great ability to evolve), and I believe he will be putting all his cash to work once he finds the best time to buy equities, bonds or whole companies. In a weird way, Livermore's trading/timing strategies may have been revived. The point is: Today, the timing of the stock market and individual stocks is all the more essential. And MarketThoughts.com is here to help. While the analyses of individual stocks and industries continues to be important today (and sites such as the Motley Fool does a good job of it), we also believe that the ability to time the stock market on at least the intermediate-term basis (and the ability to adapt to a different style of trading and to recognize which asset class to buy) is going to become more essential down the road. Through our twice-a-week commentaries and our DJIA Timing System, we will seek to complement our analyses of businesses, individual stocks and industries, with our proprietary technical indicators and our timing skills in the stock market.

I will continue to use this thread to post what I believe to be nuggets that can possibly help a person overcome some of the challenges we all go through. You wont here any stocks or market action talk here. I’ll post until I feel it is time to stop. I do think the info is important to your success.

Henry To, CFA
Chartered Financial Analyst
Investing & Economy

On Jesse Livermore And His Legacy - Part 1 of 2 - Henry To, CFA

I am choosing to write a short biography of Jesse Livermore and his trading philosophies. Livermore was a great trader and speculator – always willing to learn, study and open to new ideas. He was also an eccentric man, unparalleled in his dedication to always gaining an advantage over all other traders and investors. So why Livermore? Is it because of the glamour of discussing such a man? No. Why not Gann? Or Buffet? Was there some type of “secret recipe” for his successes in both the stock and the commodities market?
Definitely not. I am choosing to discuss Livermore because I believe that the legacy left by Livermore is a very important and instructive legacy for the novice, the amateur, and even the professional trader. His teachings all throughout his books and biographies were all about basic trading philosophies such as trend-following, buying and holding in a bull market, industry analyses, following the leaders, identifying pivot points, and of course, risk management. All this did not come easily. It took Livermore literally years to nearly perfect his system and methods, and it requires intensive studying and effort in order to execute and to stay disciplined. This is what Livermore has emphasized all throughout his writings – that the stock market is not for the lazy nor the uninitiated. If one really wants to succeed in making money in the stock market over the long haul, then one will need to put in the necessary time and effort – not only in the studying of the stock market, but in the studying of one's own psychology and tolerances as well.

A more subtle but if not more important question for professional traders to ask is: If Livermore was so great, why did he ultimately lose his fortune again during the Great Depression and why was he not able to make a “comeback” again? This and the fact that Livermore had periodically suffered from depression throughout his life finally led to his suicide in 1940. What went wrong? Traders would often cite his lack of risk management, but I think it goes deeper than that. Perhaps he was getting older and lost his drive, but I believe there is a more important underlying theme and lesson to all this. I will discuss this in later paragraphs.

Early on, Jesse Livermore learned that in order to succeed in life, one needs to put in a great deal of time and effort to an endeavor that one enjoys doing. Of course, it didn't hurt that Livermore also had a great genius with crunching numbers and a great discipline for keeping records. It also didn't hurt in that Livermore was always willing to learn and was always receptive to new ideas. As a young lad, he chose the stock and commodities market as a way to keep score and to make his fortune, and this is what he did until the day that he died.

Livermore was a self-made man. He ran away from home at the age of only 14 and subsequently went to work as a quotation boy in Boston. He quickly learned the art of “reading the tape” and from here, he proceeded to trade in the bucket shops – and was so successful that he was practically banned from trading in all the major bucket shops in Boston. From the bucket shops, he relocated to New York and started trading on the Big Board in the office of E. F. Hutton. This was in the year 1897. By that time, Livermore had already gained a reputation as the “Boy Plunger” in all the bucket shops in Boston. He was only 20 years old.

Trading “legitimately” on the NYSE taught Jesse Livermore his first major lesson in how to consistently make money in the stock market. How? Within six months of opening his account in a legitimate brokerage firm, he had lost all his money – all $2,500 of it – approximately the equivalent of $60,000 in today's dollars. The average person will most probably swear off stock market speculation forever if he was to lose his entire fortune in the endeavor, but not so for Livermore. Of course, he was depressed. Any emotional being would be depressed on losing his entire fortune. But this unfortunate development only motivated Livermore to study his mistakes more carefully. He was able to beat the game in the bucket shops, so why not on the Big Board?

There are many lessons to be learned here. Let's start with the first lesson. Please note that I am not going to list them in any particular order. Each trader/speculator has to deal with their own trading flaws – some lessons may be more applicable than others to one trader but the same lessons may not apply to another type of trader – especially so if he has conquered them.

Jesse Livermore Lesson One
Livermore had no prior trading experience except for his trading experience in the bucket shops. His first mistake was his belief that he could directly apply his prior system of trading to trading in actual stocks on the New York Stock Exchange as well.

What were the differences? Why couldn't he directly apply his system of trading in the bucket shops to trading on the NYSE as well? Livermore studied the differences intently – major money and his future career were at stake here. He learned several things about the art of speculation. Among them were:

The greatest amount of money is made following the major trends – not in the day-to-day fluctuations of a stock or in a particular commodity. This fact was later compounded by his experience during the 1901 bull market. He had always been able to call significant bottoms in the stock market and had always be able to initiate long positions at the most opportune time. And yet, he would always sell his long positions after only making 10% or 20% hoping he will be able to get back in at lower prices. This usually does not happen. He eventually learned that in order to make money in the stock market, one will need to adopt a buy and hold strategy in a bull market and only sell when the bull market is on its last legs.


Livermore had a significant execution disadvantage by taking his actual business to the NYSE. Not only does he have go pay a high commission (compared to virtually none in the bucket shops although he got a severe handicap when he did trade there), there was also a significant delay between the time he places his order to when the order was actually executed. This disadvantage is severely magnified when one traded as often as Livermore did in his early days as a trader on the NYSE. Livermore was handed down the ultimate lesson in the art of execution during the final day of the Northern Pacific Corner on May 9, 1901. Livermore had anticipated a huge downside move in the morning and a subsequent one-day upside reversal. He was right, of course, but he ultimately lost his entire stake of $50,000 that day. Because of the huge volume during that day, the tape was nearly two hours behind; his brokers (who were very able) did place an order to short U.S. Steel and Santa Fe in the morning, but those orders did not get executed until two hours later. By then, both Steel and Santa Fe had already fallen by over two dozen points. When Livermore ultimately covered, he did so at levels that were two dozen points higher. This one-day plunder cost him his entire stake which it took him a long time to build up.

While his tape-reading skills were still important, they were not as important as studying the fundamentals of each company and the credit conditions of the stock market and the economy. His first successful “raid” on the stock market based on his sound, fundamental studies occurred during the Panic of 1907. As credit conditions tightened and as a number of businesses and Wall Street brokerages went bankrupt during the summer, Livermore could sense that something was wrong – despite the hopes of the public as evident in the still-rising stock market. Sooner or later, Livermore concluded, there will be a huge break of epic proportions. Livermore continued to establish his short positions, and by October, the decline of the stock market started accelerating with the collapse of the Knickerbocker Trust in New York City and Westinghouse Electric. J.P. Morgan eventually stepped in to avert the collapse of the banking system and the New York Stock Exchange, but only after Livermore managed to make more than one million dollars by shorting the most popular stocks (and covering on a plea from J.P. Morgan himself) in the stock market.
There are many lessons to be learned here by professional and amateur investors alike. While I have always maintained that the majority of traders and investors in the stock market usually under-perform the stock market, it is doubly true that virtually all traders who focus on the short-term eventually lose their capital. The successful daytraders are a rare breed – and the successful ones can only expect to obtain a return of 10% to 12% a year, at best. The amateur trader who expects a first-year 100% return by daytrading stocks just does not have a chance.

A more subtle lesson to be learned is the idea of evolution – evolving one's style to not only fit one's personality, but evolve to the point so that it will fit the market's personality as well. What made Livermore so successful during the first thirty years of the 20th century was this: Not only was he multi-talented in the traditional sense (his skills in analyzing long-term trends and fundamentals were as good as his skills in tape-reading and in daytrading), he was also multi-talented in the sense that he was able to evolve with the market very successfully. He had always been flexible in either trading the long side or short side – and he was also able to sit out in a market that was devoid of activity as well.

Money Management & Risk Control - Part 3
The key to not going broke is to respect risk, take small positions that wont allow you to blow out. You must always keep in mind that in trading you are only playing the odds. You may have a setup that is correct 75% of the time but each trade is a random event. It doesn't take into account the last trade. If you have a 75% system, you can still be wrong 10 times in a row, and if you trade for any amount of time it will happen.

I once thought I had a foolproof way to make money at roulette. I would bet on black and red. I would sit at the table, and after the ball had landed on black or red 5 times in a row I would start to bet on the opposite color (so if it were 5 reds in a row I would start to bet on black) Then, if I was wrong, I would go ahead and double down, meaning that if my starting bet is $1, the next time I will be $2, then $4, then $8, then $16 etc... Eventually I would win, and would come out $1 ahead. So I am 13 years old and really thinking I have the Holy Grail. If its so easy for a 13 year old to figure out, why is it that all the casinos are not out of business and we are all millionaires. Simple. It does not work.

If we are flipping coins heads has a 50% chance of turning up on each roll, and so does tails. But each flip is independent of the last. The last coin toss has nothing to do with the one before it. It's a random event. There is a certain chance heads will occur on this roll, or that tails will. But which of them it is that comes up is a random occurrence. Each time you flip a coin it is one flip of a coin amongst the billions of times coins have been flipped. That's why you can roll 100 heads in a row if you do it long enough. That's why the first time I played roulette black came up 19 times in a row and I went home defeated.

Trading is the same. We have a certain percentage of our trades that will work out, and a certain percentage that will not. But your next trade has nothing to do with your last one. So even if you have the world's most accurate method, over time you will go broke if you don't practice good money management and risk control.

Money Management & Risk Control
by Brandon Fredrickson
Here are a few quotes from some great traders and investors.

" I haven't met a rich technician" Jim Rogers.
"I always laugh at people who say "I've never met a rich technician" I love that! Its such an arrogant, nonsensical response. I used fundamentals for 9 years and got rich as a technician" Mary Schwartz.
"Diversify your investments" John Templeton.
"Diversification is a hedge for ignorance" William O'Neil.
"Don't bottom fish" Peter Lynch.
"Don't try to buy at the bottom or sell at the top" Bernard Baruch
"Maybe the trend is your friend for a few minutes in Chicago, but for the most part it is rarely a way to get rich" Jim Rogers.
"I believe the very best money is made at the market turns. Everyone says you get killed trying to pick tops and bottoms and you make all your money by playing the trend in the middle. Well for twelve years I have been missing the meat in the middle but I have made a lot of money at tops and bottoms." Paul Tudor Jones.
So here we have a group of guys who have collectively taken billions of dollars out of the market and they don't agree on a damn thing regarding how to make money. Not one. So what is a person to do? Is there anything they do agree on? Just one:
"My basic advise is don't lose money" Jim Rogers.
"I'm more concerned about controlling the downside. Learn to take the losses. The most important thing about making money is not to let your losses get out of hand." Marty Schwartz.
"I'm always thinking about losing money as opposed to making money. Don't focus on making money, focus on protecting what you have" Paul Tudor Jones.
"Rule number one of investing is never lose money. Rule number two is never forget rule number 1" Warren Buffet.
Money Management & Risk Control - Part 2
There really are a lot of ways to make money in the market. There are tons of seminars you can pay for that will tell you "How I made $1 quadrillion dollars in the stock market" and its sister book "How I Double my Money Every Hour" is available in many different forms too for only $29.95. All of these will tell you some patterns that will work sometimes and won't others. Some might have you going long with Jimmy Rogers, while others will have you doing it with Bernard Baruch, but when it gets right down to it the most critical part of making money, is not losing much. Your always going to take stops and lose some. But you don't want to lose much, because you won't make a penny tomorrow if you go broke today.

One of the most common mistakes traders will make is that of "risking the whole wad". There is not a faster way to have bad things happen to you than to do this. Studies have been done that suggest the most you should risk on any one trade is 2%. And most pros will tell you that is way too much and they risk 1/4 % to 1% on each trade. The idea here is that no one trades is going to really effect you either way. You're not going to get rich, but your also not going to have to sell the house, as has happened to people.

One other benefit of small positions is that it allows you some freedom from worry. If you are risking a fairly small amount, your not going to get shaken out. You're also not going to find yourself in a position where you say "Shesh, I can't lose this much money" and you turn bad trade into a terrible investment. So, if you are serious about this, if you want to make it long term you will practice sound money control. Before you ever enter a trade, the first thing you should ask yourself is how much am I risking here because, remember that while we are here to make money, we won't make any if we go broke.

Why Traders Lose

Brett Steenbarger put together a list of "common reasons why traders (and most other human beings!) fall short of being fully intentional":

1. Environmental distractions and boredom cause a lack of focus - All of us have limits to our attention span and these are easily taxed during quiet times in the market;

2. Fatigue and mental overload create a loss of concentration - The demands of watching the screen hour after hour make it difficult to be sharp, creating fatigue effects that are well-known to pilots, car drivers, and soldiers;

3. Overconfidence follows a string of successes - It is common for traders to attribute success to skill and failure to situational, external factors. As a result, a string of even random wins can lead traders to become overconfident and veer from trading plans--especially by trading too frequently and/or trading excessive size;

4. Unwillingness to accept losses - This leads traders to alter their trade plans after trades have gone into the red, turning what were meant to be short-term trades into longer-term holds and transforming trades with small size into large trades by adding to losers;

5. Loss of confidence in one's trading plan/strategy because it has not been adequately tested and battle-tested - It is difficult to tolerate even normal drawdowns unless you have confidence in your methods. This confidence does not come from mere positive self-talk. Rather, it is a function of testing your methods (historically and in real-time) and seeing in your own experience that they truly work;

6. Personality traits that lead to impulsivity and low frustration tolerance in stressful situations - Psychological research suggests that some individuals are more impulsive than others and less conscientious about adhering to plans and intentions. These personality traits often are accompanied by stimulation-seeking and a high degree of risk tolerance: a deadly combination.

7. Situational performance pressures - These include trading slumps and increased personal expenses that change how traders trade and lead them to place P/L ahead of making good trades. By worrying too much about how much money they make, traders can no longer follow markets with a clear head;

8. Trading positions that are excessive for the account size - This is much more common than is usually acknowledged. It creates exaggerated P/L swings and emotional reactions that interfere with cool, calm planful behavior;

9. Not having a clearly defined trading plan/strategy in the first place - Interestingly, many traders do not consider themselves to be discretionary traders, but in fact do not have a firm, explicit set of trading rules that they follow. It is difficult to be consistent with a plan (and to evaluate your consistency), if you don't have the plan clearly laid out;

10. Trading a time frame, style, or market that does not match your talents, skills, risk tolerance, and personality - All too often, traders veer from their plans because those plans are ones that they feel they *should* follow, but that don't truly come naturally to them. These departures from discipline are actually unconscious attempts to trade in a style that is more in tune with the trader's skills and talents.

Source: Brett Steenbarger

[spikefader]

great stuff, Runner! I love this thread!

You said it. Thanks, Runner.

[jiesen]

great stuff, Runner! I love this thread!

Why position sizing matters
By Teresa Lo


Size Matters

It was a long time ago, in a bull market far, far away. In the early 1980s, I was attending university, a teenager with a steady flow of income from fashion modeling. After considering the options available for my savings, I began my adventure in the capital markets by buying mutual funds simply because stocks were fundamentally cheap.

As the broad market indices marched skywards in the mid-1980s, stocks became severely overvalued. Fundamental analysis became less useful. By then, I had graduated and joined a brokerage firm. On October 19, 1987, I forever gave up on the idea of holding on for the long-term.

This is my twentieth year in the business. I still remember my first day at the second brokerage firm I ever worked in, a place called Brink, Hudson & Lefever Ltd. There was no Mr. Brink, no Mr. Hudson, but Gus, the grandson of Mr. Lefever, was still there, by then an old man himself.

As I did the new-employee walkabout, I noticed most of the folks in the bullpen had much in common. After I shook hands with a person, my boss would give me a quick backgrounder. Without exception, each one was a used to be, long past his glory days. I resolved on the spot that I would never end up in the same place.

I worked at Brink, Hudson & Lefever for only a few months. I gave myself a promotion by signing on as a stockbroker at a blue chip firm. Gus died some years later, presumably still glued to the ticker. BHL passed into history when the firm where I finished out my career ate it for breakfast one morning.

The evolution from the teenage mutual fund investor to a professional trader was a long one. In all, I spent twelve years toiling at brokerage firms before I set up my own shop. While I gained experience in sales and corporate finance on the job, what I learned about trading came mostly from observing clients and brokers vaporize accounts. I turned to books as well, but most of them were disappointing. My background was in the sciences and as such, I was able to identify facts that were nothing more than thinly veiled dogma and theories that could not even qualify as theses.

Position Sizing is Critical

In this business, it is necessary to think for yourself, act independently, and take advice from others with a very large grain of salt. That said, market participants tend to align themselves with one of two camps. The first one, fundamental research, tends to focus predominantly on analysis and selection criteria: the what. The second one, technical analysis, concerns itself with the when; timing is regarded by many to be the sole province of chartists.

In my opinion, the most important, albeit the most ignored and overlooked step, is how much. Investors refer to asset allocation while traders often call it money management. Regardless of your time horizon or analytical approach, position sizing may well be the crucial factor when it comes to profitability. At best, those who ignore this issue will underperform. At worst, they predestine themselves to leave the game broke. Appropriate position size is a shining example of the best defense is a good offense .

Traders and investors have a single goal: to take risks that justify the rewards. We must never forget that the market is a zero-sum game. For every winner, there must be a loser. Those that approach the market with all three bases covered are more likely to come out ahead than those who do not. In particular, proper position size can eliminate deadly financial fumbles. Money is simply the byproduct of a good overall strategy, the trophy of a game well-played.

Principles of Position Sizing

For my money management algorithm, I use a stop loss that accounts for the volatility and price of the stock. Avoid fixed percent trailing stops since some positions are more volatile than others. Avoid a fixed dollar stop for the same reason. Proper stop placement is very important. Equalize the volatility and price of the stock. For example, a $100 stock that fluctuates $2 per day is equivalent to a $50 stock that fluctuates $1 per day. A $10 stock that fluctuates 50 cents per day is equivalent to a $100 stock that fluctuates $5.00 per day. Limit the risk per trade to a certain percent of my account equity. I never exceed one percent risk. Let's look at an example. If an account has $5,000 in it, the distance between the entry price and the exit price should be no more than $50 when the trade is opened. Implement an anti-martingale betting strategy. When the account is growing, bet more. When the account is shrinking, bet less. If the hypothetical account makes $200 on the first trade, the balance becomes $5,200. On the next trade, one percent would be $52. If the hypothetical account is stopped out for a $50 loss on the first trade, the balance becomes $4,950. On the next trade, one percent would be $49.50.

Runner,
Good stuff. What if a baseball player quit the game because he struck out 7 of every 10 times he came to bat even though he hit a single, a double, and a triple the rest of the time? He could make millions , but is ruined by dwelling on failure. 50% sounds great to me, maybe 40%.

----------billyjoe

You’re absolutely on target Billyjoe. I think we all have PRIDE and if this is not kept in check it can ruin us in the trading world and in life in general. Hey we all should not be afraid of a losing trade. Provided we followed our plans. It is amazing how we all only wish to reveal that winning trade. I guess this might be human nature. Anyway we all will get spanked every now and then and this is just a fact of this game. We feel like we are “DA MAN” when we get a little. I’m the first to admit this and just as a day is long the market has a way of bring use back down to earth when our heads get to big.

[billyjoe]

Runner,
Good stuff. What if a baseball player quit the game because he struck out 7 of every 10 times he came to bat even though he hit a single, a double, and a triple the rest of the time? He could make millions , but is ruined by dwelling on failure. 50% sounds great to me, maybe 40%.

----------billyjoe

Resistance to Issues

By Van K. Tharp, Ph.D.

When Jack Schwager visited Ed Seykota to interview him for his book Market Wizards, Jack found that he was the person being interviewed, not Ed. Jack would start to say things and Ed would indicate how the assumptions behind Jack’s questions revealed his psychological issues. As a result, Jack returned to New York with no interview. Instead, he mailed a set of questions to Ed to answer. Again, Ed turned the questions around into Jack’s issues. However, once they’d done this process about five times, the result was one of the best interviews in Market Wizards.

Ed’s approach is full of danger as a teaching tool. Socrates, who was well known for turning questions back on people, which is called the Socratic method of teaching, was poisoned. And Socrates didn’t usually enter into the most dangerous of areas—asking questions about the psychological assumptions behind what people do. Most people don’t want to know their issues. Indeed, they interpret anything designed to get you to look inward as a real threat.

Let me give you an example.

How do I develop a system in which I can be right at least 60% of the time?

Van: You seem to have a fascination with being right?

What do you mean? I just asked a reasonable question can’t you answer it.

Van: What if you could make money being right 40% of the time? Would that be acceptable?

You’re not answering my question. I want to know how to develop a system that’s designed to be right 60% of the time. But I will answer the last question—no I want to be right 60% of the time or better.

Van: I was looking at the assumption under your question. You seem to have a strong need to be right. You’d probably be a much better trader if you didn’t have that need. What would happen if you were wrong? How would you feel if you were wrong?

How can I learn anything? Why are you asking all of these silly questions? I’m not interested in being wrong, I’m interested in being right. Understood? You want to turn everything into a psychological issue. Not everything is psychological. It’s really hard to learn anything from you when you are always throwing out all of this psychological stuff. Can’t you just answer a simple question?

That’s an example of resistance to the issue. Neither of us gets anywhere. But what if the conversation went a little differently?

How do I develop a system in which I can be right at least 60% of the time?

Van: You seem to have a fascination with being right?

Well, I do like to be right, naturally, doesn’t everybody?

Van: Why do you want to be right?

Well, I’ve always worked to do a good job, to get good grades, and be successful. To accomplish that, you have to be right.

Van: Do you? What if you could be right 20% of the time and make huge profits – just because you cut your losses short and let your profits run? If you had eight 1R losses and two 10 R wins, you’d only be right 20% of the time, but you’d be ahead by 12R…that’s pretty good.

I never thought about it that way.

Van: So what if you just accepted losses when you got them, allowing them to be small losses and let your profits run when you have a good trade? Don’t you think that might be a good idea? And you’ll have trouble doing that if you want to be right all the time. For example, if you had nine 1-R gains and one 10R loss, you’d be right 90% of the time and still lose money.

Again, I never thought about it that way.

Van: So why don’t you just play around with the idea that you can be wrong and still be successful. Being right or wrong is a meaningless invention of your mind. Instead, what if you just developed a good system and practiced following it? A loss has nothing to do with being wrong. Instead, a loss has everything to do with following your system and not making a mistake. Doesn’t that put losses in a different framework?

When you start looking at yourself, you’ll find that there are lots of things that come up for you. You’ll start noticing the patterns that you repeat over and over again. And that’s one of the most valuable lessons you could ever learn.

So, let me ask you a simple question: How do you respond when someone turns what you say into a question about your psychological assumptions?

More Examples:

Q: What do you consider good performance in a system? How does my system compare?

Response: Why haven’t you set objectives? Do you have a need to be the best?

Q: I am considering purchasing a system. Does anyone have a recommendation for one that works that allows you to see code?

Response: What you really mean is that you don’t feel comfortable developing your own system. Why not?

Q: Here’s my strategy. What do you think of it?

Response: You appear to need other people’s approval to determine if your strategy is any good. Why? How about testing it to see if meets your objectives?

Many people think a move up on light volume is a bad thing. Rickard Arms calls this ease of movement. This means the stock is getting bid up. If volume is moving up on heavy volume lot of people buying and selling thus causing churning. Bottom line no right answer to the volume thing IMO…

October 17, 2006 Van Tharp
Trade Through "Mindfulness" Part 5
Putting the Process Before the Outcome

People can imagine themselves taking gradual steps, while great heights seem totally forbidding. Yet, when you take enough gradual steps, you’ll reach great heights.

If you are concerned with the final result—the outcome—then you will probably have problems attaining the outcome. However, if you concentrate on the process of getting to the outcome, then you are much more likely to arrive at your destination.

Every outcome is proceeded by a process. You will not make money trading unless you follow a predetermined plan and continually stick to that plan. That’s why you should pat yourself on the back every day if you can honestly say that you totally followed your rules throughout the day. Every "market wizard" arrives at that stature by taking one trade at a time. The primary difference between that person and the average trader is that the market wizard probably continued to follow his plan every single day.

Van Tharp

Concentrating on Profits Will Lead to Losses


Have you ever wondered why you can paper trade successfully, but fail miserably when real money is at stake? The reason is simple: the trader who concentrates on profits will have difficulty winning, as will the investor who concentrates on losses.

When investors concentrate on the rewards of what they are doing, their behavior becomes rigid and less accurate. They become results oriented rather than solution oriented, which means they are more active and more careless.

In fact, many traders, when reflecting on their previous trading activity, realize they would have become better traders sooner without the hindrance of early success. Early profits teach bad habits that are extremely difficult to unlearn.

The solution? Concentrate on doing your best, not on your immediate profit and loss. Have a set of rules to guide you in the market and concentrate on following those rules.