At first you thought it was going to be easy. You read the hype and hoopla that day trading would bring you the sun, moon, and stars. You opened an online account and jumped into trading with both feet. You scored on the first few trades. It seemed too easy to be true: You bought a stock. It went up. You sold at a profit. What you didn't realize, however, was that in 1999 the market as a whole was up. As the old saying goes, "A rising tide raises all boats." In this case, the market's upward surge brought the majority of stocks with it.
Then came the downturn. The Nasdaq Composite, the highflier that had posted nearly an 86 percent gain in 1999, ended 2000 with a loss of more than 39 percent. The Standard & Poor's 500-stock cash index (S&Ps), the benchmark for individual stock and fund performance, declined 10 percent from the close of 1999 to the close of 2000.
Even on the last trading day of the year-December 29, 2000-the Nasdaq Composite index dropped 63 points or 2.5 percent to 2493. Cisco Systems Inc. (CSCO) and Microsoft Corporation (MSFT) led the way downward, with Cisco trading off 1 3/8 at 38 3/16 and Microsoft down 1 5/16 at 43 1/4. ("U.S. Tech Stocks Fall on Final Trading Day of Year 2000," Reuters, December 29, 2000.)
Blame the "tech wreck," or recession fears, or overzealous activity efforts by the Federal Reserve in 1999 to curb a runaway economy. Whatever the reason, the market was down. Period.
As all traders know, you can't ignore the facts. The price on the screen is as immutable as the fingerprints on your own hands. You can't change the price by an act of will any more than you can make time stand still. And the fact was (and is) the much-touted new millennium raised far more questions about the new economy than Wall Street had answers. The suffix ".com" no longer was a license to print money (or raise it from eager venture capitalists). "Flight to quality" meant out of Nasdaq and its dominant tech sector and into household names. Even a surprise rate cut early in 2001 by the Federal Reserve wasn't enough to jump-start the markets and keep them running positively. As we write in first quarter 2001, the talk is of economic slowdown and the possibility of recession, with all eyes on Mr. Greenspan & Co. to bail us out. Markets and leading stocks continue to struggle. Traders who had ridden on the bulls' coattails are now nose-to-nose with the bear.
In the trading arena, a bear market is what separates the amateurs from the pros. Put another way, welcome to the trader's law of physics: What goes up must come down-often in gyrations and sometimes with ever-increasing volatility and for reasons that may confound you. The result can be panic and confusion. Fearful of losing money, the uninitiated cling to positions that move increasingly into the red-until they face a margin call on a deflated stock or the brokerage house yanks them out of a futures position.
Clearly, they have neglected the cardinal rule of trading: Always protect against losses. Profits take care of themselves.
In this book I will address not only the how-to's of technical analysis and trade execution, but, more important, the mental discipline that must be a part of every trade. You can never underestimate the mental side of trading, whether you're placing your first order through a broker or you've been trading successfully for years. Discipline is as much a part of my trading plan today as it was when I first walked onto the floor of the Chicago Mercantile Exchange 20 years ago.
It was a different world then. In 1981, stock index futures had not been launched as yet at the Chicago Mercantile Exchange, where I still trade today. I started out as a 22-year-old runner and clerk at the "Merc," an apprentice to Maury Kravitz, a major trader in those days at the exchange. After a few months, I became a broker, filling customer orders in the gold futures pit, a contract that is no longer traded in Chicago. Later, I traded for my own account and filled orders, since dual-trading was allowed at the Merc in those days.
It was a tough learning curve for me just as it was-and is-for every beginning trader. Your expectation is that you'll make money at this, because you want to make money. But don't be discouraged if you don't see any profit the first year. In fact, if you can just cover your cost of trading the first year, you should consider yourself a success. The most important lesson for you, particularly in the first year, is to learn how to take losses-quickly, with a clear head, and without panic. In my first year of trading, I was barely able to cover my costs. I had to take a job at night to support myself. I nearly gave up, I was so discouraged.
What I couldn't see then was that I was gaining a valuable education in the University of the Market that would serve me well over the years. Then, when a lucky out-trade (see Glossary) netted me a windfall of $57,000, I had ample capital for the first time. I headed to the hot new pit at the Merc-the S&P futures pit-and I never left. But I went to that market a wiser trader. I had withstood the test of the market. I had endured losses and kept my head when I made profit.
Today, I trade in the S&P pit on the floor of the Merc for an hour or two a day. Then, I trade or monitor my position at the screen at my Chicago-based trading firm, where I also run an educational and market commentary web site for traders, TeachTrade.com.
I've gone through a lot of change as a trader. But one thing that remains constant is the psychological side of trading. Trading is a mental game. The emotional and psychological aspects of trading can never be overlooked or underestimated. For one thing, there is the motivation of trading. (Yeah, you say to yourself, it's money, right?) Well, if it were only the money, then most of us would have found something else to do. If you doubt that, consider the failure rate of traders. In equities, those who try day trading last about six months. In futures, the average life span is about three months, although trading activity dwindles significantly in the latter two months.
The one thing I know about trading is that it's infectious. Once you've made a couple of trades and turned a profit, it gets into your blood. The most successful traders I've known live and breathe trading and the markets. The money is part of it, to be sure. But a bigger part is the adrenaline rush you get from the market. You can also tell this from the retail side of the trading business with average investors and speculators who trade through a broker. Many times beginning traders who try their hand at this will lose their capital, but they don't close their accounts. They leave a small amount to keep them open, and as soon as they get some more capital to trade, they try again.
Now, before you tell yourself that this won't happen to you, that you'll somehow beat the odds, remember that the success rate among traders is slim. The only way to improve your chances of survival-and there is no guarantee-is with education. That is the purpose of The Day Trader's Course.
Whether you trade stocks, futures, or even options, you must have a carefully executed plan. You shouldn't buy because you heard a tip at the health club or on television. Your trades ought to be the result of the execution of your plan. And if your trade goes against you, the next step is a reexamination of that plan to learn what went wrong and what you'll do differently next time.
The foundation of this plan is technical analysis, which will be addressed at length in later chapters. But the quality that must be developed and maintained-first, last, and always-is discipline. More than an analytical mind and the ability to make quick decisions, discipline is an attribute that will keep you in the trading game. Discipline allows you to make the best decisions based on the market conditions (not your ego, your need to make money, or your fear of loss). And discipline will allow you to execute your trades according to plan, including getting stopped out of a trade.
There are highs and lows in trading equivalent to those experienced in a competitive sporting event. When you're trading, it's the ultimate David versus Goliath situation, for it is truly you versus the market. Whether you're a one-lot trader or an institution swinging around 1,000-contract positions, you are still in competition with the marketplace at large. When you place that trade, you are putting everything on the line-not only the money involved in that trade, but your research and analysis, your decision-making process, and your execution. You will face the ego challenge of knowing that, at least some of the time, you will be wrong.
Each time you trade, you are weighing the success and/or failure of your plan. And if you do have a profitable trade, the challenge then becomes even harder: You must not allow your ego to be clouded by your financial success so that you can't keep a clear sight on your plan. What you savor is not the money that you've made, but rather the fact that you've successfully executed your plan. If you don't think this kind of successful challenge is the primary motivating factor, ask anyone who has launched or built a business. Entrepreneurs will tell you that the payoff was not the money they made, but the fact that they were successful in conceiving, developing, and merchandising an idea. And, as in trading, it all started with a plan.
The first step in drafting that plan begins long before the market opens and you sit down to trade. It begins with your psychological preparedness. You couldn't launch yourself into trading without this kind of conditioning any more than you'd set out for a cross-country run without stretching exercises. When I discuss trading, I use a lot of sports analogies because of the parallels of intensity, physical and mental demands, ego control, risks, and rewards. For traders, this preparation is a daily routine that will be a personal ritual.
For me, that means an hour workout in my home gym or, when the weather is fair, an hour at the golf course chipping balls onto the green. Your choice of preparation may be jogging, meditation, yoga, tai-chi, or whatever. But there must be an activity-I prefer a physical one-that tells your mind, "Okay, it's time to get ready for trading. The rest of my life has to be put aside for now."
You can't trade effectively during times of personal problems, disruptions, or distractions. If something is weighing on your mind-whether it's an illness in the family or even a positive event such as buying a new house or the birth of a child-it can and will affect your trading. If you can't sufficiently clear your mind, you won't be able to apply unwavering concentration to your trading. Better just to do your homework for that day, watching the market, studying the charts and indicators, than to put your money on the line. If you decide to trade, reduce your trade size so that you have less at risk. Don't bemoan the big money you could have made; be glad you had the discipline to limit your exposure.
The backbone of mental discipline is to focus on the trade, not the money. This isn't easy for the novice or even the professional trader. In fact, professional traders face a special breed of mental demon, born of their own successes. I've wrestled with these demons on more than one occasion.
The problem comes when you know you can make money, and a good deal of it, by trading. You've had five-figure and six-figure days. So when the money pressure is on, you think you can work your magic in the market. Your focus shifts from making a good trade to making good money. The result is almost always disaster. As we'll discuss in Chapter 5, you have to trade what the market gives you, which will play a large role in your profit potential on any given day.
What occurs is usually something like this: You go into the market saying, "I'm going to make a lot of money today." Or maybe you say, "I need to make a lot of money today," either to make up for previous losses, to put a down payment on a bigger house, or to buy that boat/car/vacation property/whatever that you've always wanted.
Complicating this factor is that you know you've had big days in the past. But, if you examine them, those big days were the result of market opportunities that you reaped for large profits. Put another way, you successfully executed a plan that, coupled with market conditions that you analyzed properly, yielded a profit.
But if those market conditions do not exist-if the market is thin in terms of volume or participation, rangebound, or quiet-then you may be forcing trades that won't materialize. You'll trade too big or too frequently and risk too much. Instead of big profits, you may end up with the exact opposite.
Your goal is to develop a positive mental attitude and to have confidence in your ability to make good trades and to move quickly beyond the losing trades.
In my career, I've seen so many talented young traders blow it because they lacked the discipline or the ability to take on risk. Either they took on too much risk and lost all their capital in one or a few trades, or they became the proverbial deer in the headlights when it came to risk. The underlying factor was they failed at the mental game of trading. The singular problem was a focus on the money and not on the trade. But admittedly, it's a tough lesson to become unemotional about money.
In my own experience there have been times when I've been up $17,000 and I'd like to make $3,000 more-just to have a nice round profit number of $20,000. So, I keep trading for the extra $3,000-even though the market may have quieted down and there are no longer that many opportunities to trade. When I'm on the floor, that absence of volume is palpable. When the market is busy, the S&P pit is packed with people-about 500 of them-all shouting, screaming, waving their arms, and gesturing wildly with their hands. When it's quiet, the noise level and activity are far less. And when it's dead ... well, I've seen times when traders have tossed a nerf football around the pit they're so bored.
When the market conditions don't warrant-on their own-an objective reason to trade, it's better to quit for the day. Sticking around just to make some more money is not a good motivation. There have been times when, trying to make another $3,000, I lose the $17,000 I had in the first place.
Then there are the days when I'm down, say, $15,000. I'll stay in
the pit to make it back, even though I know I should cut my losses,
take a break, and regroup. The temptation, even after all these years, is
to stay in the pit and keep trading to make it back-even though the
market conditions aren't there.
Continues...
Excerpted from The Day Trader's Course by Lewis Borsellino Patricia Crisafulli Excerpted by permission.
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