The New Trading for a Living

Psychology, Discipline, Trading Tools and Systems, Risk Control, Trade Management

Alexander Elder

• Publisher: Wiley
• Year: 2014
• ISBN:
  9781118963678
• Edition: 1
• Topic: Betriebswirtschaft
• Subtopic: Finanzwesen

The best-selling trading book of all time — updated for the new era

The New Trading for a Living updates a modern classic, popular worldwide among both private and institutional traders. This revised and expanded edition brings time-tested concepts in gear with today's fast-moving markets, adding new studies and techniques for the modern trader.

This classic guide teaches a calm and disciplined approach to the markets. It emphasizes risk management along with self-management and provides clear rules for both. The New Trading for a Living includes templates for rating stock picks, creating trade plans, and rating your own readiness to trade. It provides the knowledge, perspective, and tools for developing your own effective trading system.

All charts in this book are new and in full color, with clear comments on rules and techniques. The clarity of this book's language, its practical illustrations and generous sharing of the essential skills have made it a model for the industry—often imitated but never duplicated. Both new and experienced traders will appreciate its insights and the calm, systematic approach to modern markets.

The New Trading for a Living will become an even more valuable resource than the author's previous books:

• Overcome barriers to success and develop stronger discipline
• Identify asymmetrical market zones, where rewards are higher and risks lower
• Master money management as you set entries, targets and stops
• Use a record-keeping system that will make you into your own teacher

Successful trading is based on knowledge, focus, and discipline. The New Trading for a Living will lift your trading to a higher level by sharing classic wisdom along with modern market tools.

PART 1

Individual Psychology

■ 4. Why Trade?

Trading appears deceptively easy. A beginner may cautiously enter the market, win a few times, and start feeling brilliant and invincible. That's when he starts taking wild risks and ends up with bad losses.

People trade for many reasons—some rational and many irrational. Trading offers an opportunity to make a lot of money in a hurry. Money symbolizes freedom to many people, even though they often don't know what to do with it.

If you know how to trade, you can make your own hours, live and work anywhere you please, and never answer to a boss. Trading is a fascinating game: chess, poker, and a video game rolled into one. Trading attracts people who love challenges.

It attracts risk-takers and repels those who avoid risk. An average person gets up in the morning, goes to work, has a lunch break, returns home, has a beer and dinner, watches TV, and goes to sleep. If he makes a few extra dollars, he puts them into a savings account. A trader keeps odd hours and puts his capital at risk. Many traders are loners who abandon the certainties of the routine and take a leap into the unknown.

Self-Fulfillment

Many people have an innate drive to achieve their personal best, to develop their abilities to the fullest. This drive, along with the pleasure of the game and the lure of money, propels traders to challenge the markets.

Good traders tend to be hardworking and shrewd people, open to new ideas. The goal of a good trader, paradoxically, is not to make money. His goal is to trade well. If he trades right, money follows almost as an afterthought. Successful traders keep honing their skills as they try to reach their personal best.

A professional trader from Texas invited me to his office and said: “If you sit across the table from me while I day-trade, you won't be able to tell whether I am $2,000 ahead or $2,000 behind on that day.” He has risen to a level where winning does not elate him and losing does not deflate him. He is so focused on trading right and improving his skills that money no longer influences his emotions.

The trouble with self-fulfillment is that many people have self-destructive streaks. Accident-prone drivers keep destroying their cars, and self-destructive traders keep destroying their accounts. Markets offer vast opportunities for self-sabotage, as well as for self-fulfillment. Acting out your internal conflicts in the marketplace is a very expensive proposition.

Traders who are not at peace with themselves often try to fulfill their contradictory wishes in the markets. If you don't know where you are going, you'll wind up somewhere you never wanted to be.

■ 5. Reality versus Fantasy

If a friend with little farming experience told you that he planned to feed himself with food grown on a quarter-acre (1,000 square meters) plot, you'd expect him to go hungry. One can squeeze only so much from a small piece of land. There is, however, a field in which grown-ups let their fantasies fly—in trading.

A former employee told me that he planned to support himself trading a $6,000 account. When I tried to show him the futility of his plan, he quickly changed the topic. He was a bright analyst, but refused to see that his “intensive farming” plan was suicidal. In his desperate effort to succeed, he'd have to take on large positions—and the slightest wiggle of the market will quickly put him out of business.

A successful trader is a realist. He knows his abilities and limitations. He sees what's happening in the markets and knows how to react. He analyzes the markets without cutting corners, observes himself, and makes realistic plans. A professional trader cannot afford illusions.

Once an amateur takes a few hits and gets a few margin calls, he swings from cocky to fearful and starts developing strange ideas about the markets. Losers buy, sell, or avoid trades due to their fantastic ideas. They act like children who are afraid to pass a cemetery or look under their bed at night because they are afraid of ghosts. The unstructured environment of the market makes it easy to develop fantasies.

Most people who grow up in Western civilization have several similar fantasies. They are so widespread that when I studied at the New York Psychoanalytic Institute, there was a course called “Universal Fantasies.” For example, many people have a fantasy in childhood that they were adopted. This fantasy seems to explain the unfriendly and impersonal world. It consoles a child but prevents him from being aware of a reality he'd rather not see—that his parents aren't that good. Our fantasies influence our behavior, even if we aren't consciously aware of them.

In talking to hundreds of traders, I keep hearing several universal fantasies. They distort reality and stand in the way of trading success. A successful trader must identify his fantasies and get rid of them.

The Brain Myth

Losers who suffer from the “brain myth” will tell you, “I lost because I didn't know trading secrets.” Many have a fantasy that successful traders have some secret knowledge. That fantasy helps support a lively market in advisory services and ready-made trading systems.

A demoralized trader may whip out his credit card to buy access to “trading secrets.” He may send money to a charlatan for a $3,000 “can't miss,” backtested, computerized trading system. When that system self-destructs, he'll pull out his almost-maxed-out credit card again for a “scientific manual” that explains how he can stop losing and begin winning by contemplating the moon, the stars, or even Uranus.

At an investment club we used to have in New York, I often ran into a famous financial astrologer. He often asked for free admission because he couldn't afford to pay a modest fee for the meeting and a meal. His main source of income remains collecting money for astrological trading predictions from hopeful amateurs.

Losers don't realize that trading is intellectually fairly simple. It is nowhere near as demanding as taking out an appendix, building a bridge, or trying a case in court. Good traders are shrewd, but few are intellectuals. Many have never been to college, and some have dropped out of high school.

Intelligent and hardworking people who have succeeded in their careers often feel drawn to trading.

Why do they fail so often? What separates winners from losers isn't intelligence or secrets, and certainly not education.

The Undercapitalization Myth

Many losers think that they would trade successfully if they had a bigger account.

People destroy their accounts either by a string of losses or a single abysmally bad trade. Often, after the loser is sold out, unable to meet a margin call, the market reverses and moves in the direction he expected. He starts fuming: had he survived another week, he would have made a fortune instead of losing!

Such people look at market reversals that come too late and think that those turns confirm their methods. They may go back to work and earn, save, or borrow enough money to open another small account. History repeats itself: The loser gets wiped out, the market reverses and “proves” him right, but only too late—he's been sold out again. That's when the fantasy is born: “If only I had a bigger account, I could have stayed in the market longer and won.”

Some losers raise money from relatives and friends by showing them a paper track record. It seems to prove that they would have won big, if only they had had more money to work with. But even if they raise more money, they lose that, too—as if the market were laughing at them!

A loser is not undercapitalized—his mind is underdeveloped. A loser can destroy a big account almost as quickly as a small one. An acquaintance of mine once blew out over 200 million dollars in a day. His broker sold him out—and then the market turned. He sued the broker and said to me: “If only I had a bigger account….” Apparently an account with $200 million wasn't big enough.

A loser's true problem is not account size but overtrading and sloppy money management. He takes risks that are too big for his account size, however small or big. No matter how good his system may be, a streak of bad trades is sure to put him out of business.

Amateurs neither expect to lose nor are prepared to manage losing trades. Calling themselves undercapitalized is a cop-out that helps them avoid two painful truths: their lack of a realistic money management plan and lack of discipline.

A trader who wants to survive and prosper must control losses. You do that by risking only a tiny fraction of your equity on any single trade (see Section Nine, “Risk Management”). Learn from cheap mistakes in a small account.

The one advantage of a large trading account is that the price of equipment and services represents a smaller percentage of your money. The owner of a million-dollar fund who spends $5,000 on classes is only ½ percent behind the game. The same expenditure would represent a deadly 25 percent of equity for a trader with a $20,000 account.

The Autopilot Myth

Traders who believe in the autopilot myth think that the pursuit of wealth can be automated. Some people try to develop an automatic trading system, while others buy systems from vendors. Men who have spent years honing their skills as lawyers, doctors, or businessmen plunk down thousands of dollars for canned competence. Most are driven by greed, laziness, and mathematical illiteracy.

Systems used to be written on sheets of paper, but now they get downloaded on a computer. Some are primitive; others are elaborate, with built-in optimization and even money management rules. Many traders spend thousands of dollars searching for magic that will turn a few pages of computer code into an endless stream of money. People who pay for automatic trading systems are like medieval knights who paid alchemists for the secret of turning base metals into gold.

Complex human activities do not lend themselves to automation. Computerized learning systems have not replaced teachers, and programs for doing taxes haven't created unemployment among accountants. Most human activities call for an exercise of judgment; machines and systems can help but not replace humans.

Had there been a successful automatic trading system, its purchaser could move to Tahiti and spend the rest of his life at leisure, supported by a stream of checks from his broker. So far, the only people who've made money from trading systems are their sellers. They form a small but colorful cottage industry. If the...