Trading for a Living (audiobook) - Dr. Alexander Elder

this is audible Wiley audio is pleased to present and trading for a little psychology trading tactics money management written by dr. Alexander elder director financial trading seminars incorporated read by Richard Davidson introduction trading the last frontier you can be free you can live and work anywhere in the world you can be independent from routine and not answer to anybody this is the life of a successful trader many aspire to this but few succeed an amateur looks at a quote screen and sees millions of dollars sparkle in front of his face he reaches for the money and loses he reaches again and loses more traders lose because the game is hard or out of ignorance or lack of discipline if any of these ail you I wrote this book for you in the summer of 1976 I drove from New York to California I threw a few books on psychiatry I was a first year psychiatric resident several histories and a paperback copy of Engels how to buy stocks into the trunk of my old Dodge little did I know that a dog-eared paperback world from a lawyer friend would in due time change the course of my life that friend incidentally had a perfect reverse golden touch any investment he touched went underwater but that's another story I go down the angle book in campgrounds across America finishing it on a Pacific Beach in La Jolla I had known nothing about the stock market and the idea of making money by thinking gripped me I had grown up in the Soviet Union in the days when it was in the words of a former US president an evil empire I hated the Soviet system and wanted to get out but immigration was forbidden I entered college at 16 graduated medical school at 22 completed my residency and then took a job as a ship's doctor now I could break free I jumped the Soviet ship in Abidjan Ivory Coast I ran to the US Embassy through the clogged dusty streets of an African port city chased by my ex crewmates the bureaucrats at the Embassy fumbled and almost handed me back to the Soviets I resisted and they put me in a safehouse and then on a plane to New York I landed at Kennedy Airport in February 1974 arriving from Africa was summer closed on my back and 25 dollars in my pocket I spoke some English but did not know a soul in this country I had no idea what stocks bonds futures or options were and sometimes got a queasy feeling just from looking at the American dollar bills in my wallet in the old country a handful of them could buy you three years in Siberia reading how to buy stocks opened a whole new world for me returning to New York I bought my first stock it was kinder care ever since then I have avidly studied the markets and invested in traded stocks options and now mostly futures my professional career proceeded on a separate track I completed a residency in psychiatry at a major University Hospital studied at the New York psychoanalytic Institute and served as book editor for the largest psychiatric newspaper in the United States these days I am busy trading and go to my psychiatric office across the street from Carnegie Hall only a few afternoons a week after the markets closed I loved practicing psychiatry but I spend most of my time in the markets learning to trade has been a long journey with soaring highs and aching lows in moving forward or in circles I repeatedly knocked my face against the wall and ran my trading account into the ground each time I returned to a hospital job put a snake together red thought did more testing and then started trading again my trading slowly improved but the breakthrough came when I realized that the key to winning was inside my head and not inside a computer psychiatry gave me the insight into trading that I will share with you psychology is the key you may base your trades on fundamental or technical analysis you may trade because of hunches about economic or political trends use inside information or simply hope remember how you felt the last time you placed an order were you anxious to jump in or afraid of losing did you procrastinate before picking up the phone when you closed out a trade did you feel elated or humiliated the feelings of thousands of traders merge into huge psychological tides that move the markets the majority of traders spend most of their time looking for good trades once they enter a trade they lose control and either squirm from pain or grin from pleasure they ride an emotional rollercoaster and miss the essential element of winning the management of their emotions their inability to manage themselves leads to poor money management of their accounts if your mind is not in gear with the markets or if you ignore changes in math psychology of crowds then you have no chance of making money trading all winning professionals know the enormous importance of psychology and trading all losing amateurs ignore it friends and clients who know that I am a psychiatrist often ask me whether this helps me as a trader good psychiatry and good trading have one important principle in common both focus on reality on seeing the world the way it is to live a healthy life you have to live with your eyes open to be a good trader you need to trade with your eyes open recognize real trends and turns and not waste time or energy on regrets and wishful thinking why do most traders lose and wash out of the markets emotional and thoughtless trading are two reasons but there is another markets are actually set up so that most traders must lose money the trading industry kills traders with commissions and slippage most amateurs cannot believe this just as medieval peasants could not believe that tiny invisible germs could kill them if you ignore slippage and deal with a broker who charges high Commission's you are acting like a peasant who drinks from a communal pool during a cholera epidemic you pay commissions for entering and exiting trades slippage is the difference between the price at which you place your order and the price at which it gets filled when you place a limit order it is filled at your price or not at all when you feel eager to enter or exit the market and give a market order it is often filled at a worse price than prevailed when you placed it the trading industry keeps draining huge amounts of money from the markets exchanges regulators brokers and advisers live off the markets while generations of traders keep washing out markets need a fresh supply of losers just as builders of the ancient pyramids of Egypt needed a fresh supply of slaves losers bring money into the markets which is necessary for the prosperity of the trading industry brokers exchanges and advisors run marketing campaigns to attract more losers to the markets some mentioned that Futures Trading is a zero-sum game they count on the fact that most people feel smarter than average and expect to win in a zero-sum game winners in a zero-sum game make as much as losers lose if you and I bet $10 on the direction of the next 100 point move in the Dow one of us will collect $10 and the other will lose $10 the person who is smarter should win this game over a period of time people buy the trading industry's propaganda about the zero-sum game take the bait and open trading accounts they do not realize that trading is a minus sum game winners receive less than what losers lose because the industry drains money from the market for example roulette in a casino is the - sum game because the casinos sweeps away 3% to 6% of all bets this makes roulette unwinnable in the long run you and I can get into a - sum game if we make the same $10 bet on the next 100 point move in the Dow but deal through brokers when we settle the loser is out 13 dollars and the winner collects only $7 while two brokers smile all the way to the bank commissions and slippage are two traders what death and taxes are to all of us they take some fun out of life and ultimately bring it to an end a trader must support his broker and the machinery of exchanges before he collects a dime being simply better-than-average is not good enough you have to be head and shoulders above the crowd to win a - sum game you can expect to pay a round-trip commission of anywhere from $12 to $100 for every futures contract you trade big traders who deal with discount houses pay less small traders who deal with full service brokers pay more amateurs ignore Commission's while dreaming of fat profits brokers argue that commissions are tiny relative to the value of underlying contracts to understand the role of commissions you need to compare them to your margin not to the value of the contract for example you may pay $30 to trade a single contract of corn 5,000 bushels worth approximately $10,000 a broker will say that the $30 commission is less than 1% of contract value in reality you have to deposit about $600 to trade a contract of corn a $30 commission represents 5% of margin this means you have to make 5% on the capital committed to the trade simply to break-even if you trade corn four times a year you will have to make a 20% annual profit to avoid losing money a very few people can do this many money managers would give their eyeteeth for 20% annual returns a small commission is not a nuisance it is a major barrier to success many amateurs generate 50% and more of their account size in commissions per year if they last that long even discounted commissions raise a tall barrier to successful trading I have heard brokers chuckle as they gossiped about clients who beat their brains out just to stay even with the game shop for the lowest possible Commission's do not be shy about bargaining for lower rates I have heard many brokers complain about a shortage of customers but not many customers complain about the shortage of brokers tell your broker it is in his best interest to charge you low commissions because you will survive and remain a client for a long time design a trading system that will trade less often slippage takes either piranha sized or shark sized bites out of your account whenever you enter and exit the markets slippage means having your orders filled at a different price than which existed when you placed an order it is like paying 30 cents for an apple in a grocery store even though the posted price is 29 cents there are three kinds of slippage common volatility based and criminal common slippage is due to a spread between buying and selling prices floor traders maintain two prices in the market the bid and the ask for example your broker may quote you 3:9 0.45 for June S&P 500 if you want to buy a contract at the market you'll have to pay at least three nine 0.50 if you want to sell at the market you will receive three nine 0.40 or less since each point is worth five dollars the ten point spread between bid and ask transfers $50 from your pocket to floor traders they charge you for the privilege of entering or exiting a trade the spread between bid and ask is legal it tends to be narrow in big liquid markets such as the S&P 500 and bonds and much wider in thinly traded markets such as orange juice and cocoa the exchanges claim that the spread is the price you pay for liquidity being able to trade whenever you wish electronic trading promises to cut slippage slippage Rises with market volatility floor traders can get away with more in fast moving markets when the market begins to run slippage goes through the roof when the S&P 500 rallies or drops you can get hit with a twenty to thirty point slippage and sometimes 100 points or more the third kind of slippage is caused by criminal activities of floor traders they have many ways of stealing money from customers some put their bad trades into your account and keep good trades for themselves this kind of activity and other criminal games were recently described in a book brokers bag men and moles by david greicy and Laurie Morse when a hundred men spend day after day standing shoulder-to-shoulder in a small pit they develop a camaraderie and us against them mentality floor traders have a nickname for outsiders which shows that they consider us less than human they call us paper as in his paper coming in today that is why you have to take steps to protect yourself to reduce slippage trade liquid markets and avoid thin and fast moving markets go long or short when the market is quiet use limit orders buy or sell at a specified price keep a record of prices at the time when you placed your order and have your broker fight the floor on your behalf when necessary slippage and commissions make trading similar to swimming in a shark-infested Lagoon let us compare an example from a broker sales pitch to what happens in the real world the party line goes like this a contract of gold futures covers 100 ounces of gold 5 individuals buy a contract each from someone who sells 5 contracts short gold falls 4 dollars and the buyers bail out losing 4 dollars per ounce or $400 per contract the intelligent trader who sold 5 contracts short covers his position and makes $400 per contract for a total of $2,000 in the real world however each loser has lost more than 400 dollars he paid at least a $25 round-trip commission and was probably hit with $20 slippage coming and going as a result each loser lost $465 per contract and as a group they lost 2325 dollars the winner who sold 5 contracts short probably paid a $15.00 round-trip commission and was hit with $10 slippage coming and going reducing his gain by $35 per contract or $175 for 5 contracts he pocketed only 1825 dollars the winner thought he made $2,000 but he received only 1800 $25 the losers thought they lost $2,000 but in fact they lost 2325 dollars in total fully five hundred dollars two thousand three hundred and twenty five minus one thousand eight hundred and twenty five was siphoned from the table the lion's share was pocketed by floor traders and brokers who took a much bigger cut than any casino or a racetrack would dare other expenses also drain traders money the cost of computers and data fees for advisory services and books including the one you are reading now all come out of your trading funds look for a broker with the cheapest Commission's and watch him like a hawk design a trading system that gives signals relatively infrequently and allows you to enter markets during quiet times individual psychology trading appears deceptively easy when a beginner wins he feels brilliant and invincible then he takes wild risks and loses everything 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 too many people even though they often do not know what to do with their freedom if you know how to trade you could make your own hours live and work wherever you please and never answer to a boss Trading is a fascinating intellectual pursuit chess poker and a crossword rolled into one trading attracts people who love puzzles and brainteasers trading attracts risk-takers and repels those who avoid risk an average person gets up in the morning goes to work as a lunch break returns home as 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 certainty of the present and take a leap into the unknown most 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 they are 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 trying to reach their personal best is more important to them than making money a successful New York trader said to me if I'd become half a percent smarter each year I'll be a genius by the time I die his drive to improve himself is the hallmark of a successful trader 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 two thousand dollars a head or two thousand dollars 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 a self-destructive streak accident-prone drivers keep destroying their cars and self-destructive traders keep destroying their accounts markets offer unlimited 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 market if you do not know where you are going you will wind up somewhere you never wanted to be trading psychology your feelings have an immediate impact on your account equity you may have a brilliant trading system but if you feel frightened arrogant or upset your account is sure to suffer when you recognize that a gambler is high or fear is clouding your mind stop trading your success or failure as a trader depends on controlling your emotions when you trade you compete against the sharpest minds in the world the field on which you compete has been slanted to ensure your failure if you allow your emotions to interfere with your trading the battle is over you are responsible for every trade that you make a trade begins when you decide to enter the market and ends only when you decide to take yourself out having a good trading system is not enough most traders with good systems wash out of the markets because psychologically they are not prepared to win markets offer enormous temptations like walking through a gold vault or through a harem markets evoke powerful greed for more gains and a great fear of losing what we've got those feelings cloud our perceptions of opportunities and dangers most amateurs feel like geniuses after a winning streak it is exciting to believe that you are so good you can bend your own rules and succeed that's when traders deviate from their rules and go into a self-destruct mode traders gain some knowledge they win their emotions kick in and their self-destruct most traders promptly their killings back to the markets the markets are full of rags to riches to rags stories the hallmark of a successful trader is his ability to accumulate equity you need to make trading as objective as possible keep a diary of all your trades with before-and-after charts keep a spreadsheet listing all your trades including commissions and slippage and maintain very strict money management rules you may have to devote as much energy to analyzing yourself as you do to analyzing the markets when I was learning out a trade I read every book on trading psychology I could find many writers offered sensible advice some stress discipline you cannot let the markets way you do not make decisions during trading hours plan a trade and trade a plan others stressed flexibility do not enter the market with any preconceived notions change your plans when markets change some experts suggested isolation no Business News no Wall Street Journal no listening to other traders just you and the markets others advised being open-minded keeping in touch with other traders and soaking up fresh ideas each piece of advice seemed to make sense but contradicted other equally sensible advice as a trader you are in the business of trading you need to define your business man's risk the maximum amount of money you will risk on any single trade there is no standard dollar amount just as there is no standard business an acceptable business men's risk depends first of all on the size of your trading account it also depends on your trading method and pain tolerance the concept of a businessman risk will change the way you manage your money a sensible trader never risks more than 2% of account equity on any trade for example if you have $30,000 in your account you may not risk more than $600 per trade and if you have $10,000 you may not risk more than $200 if your account is small limit yourself to trading less expensive markets or mini contracts if you see an attractive trade but your stop would have to be placed where more than 2 percent of equity would be at risk pass that trade avoid risking more than 2 percent on a trade the way a recovering alcoholic avoids bars if you are not sure how much to risk err on the side of caution if you blame excess Commission's on a broker and slippage on a floor trader you give up control of your trading life try to reduce both but take responsibility for them if you lose even a dollar more than your business means risk including commissions and slippage you are a loser do you keep good trading records poor record-keeping is a sure sign of a gambler and a loser good businessman keep good records your trading records must show the date and price of every entry and exit slippage commissions stops all adjustments of stops reasons for entering objectives for exiting maximum paper profit maximum paper loss after a stop was hit and any other necessary data if you bail out of a trade within your business men's risk it is normal business there is no bargaining no waiting for another tick no hoping for a change losing $1 more than your established businessman risk is like getting drunk getting into a brawl getting sick to your stomach on your way home and waking up in the gutter with a headache you would never want that to happen each trader has his own demons to exercise on the journey to becoming a successful professional here are several rules that worked for me as I grew from a wild amateur into an erratic semi-professional and finally into a professional trader you may change this list to suit your personality one decide that you are in the market for the long haul that is you want to be a trader even twenty years from now to learn as much as you can read and listen to experts but keep a degree of healthy skepticism about everything ask questions and do not accept experts at their word 3 do not get greedy and rush to trade take your time to learn the markets will be there with more good opportunities in the months and years ahead 4 develop a method for analyzing the market that is if a happens then be is likely to happen the markets have many dimensions use several analytic methods to confirm trades test everything on historical data and then in the markets using real money markets keep changing you need different tools for trading bull and bear markets and transitional periods as well as a method for telling the difference 5 develop a money management plan your first goal must be long-term survival your second goal a steady growth of capital and your third goal making high profits most traders put the third goal first and are unaware that goals 1 and 2 exist 6 be aware that a trader is the weakest link in any trading system go to a meeting of Alcoholics Anonymous to learn how to avoid losses or develop your own method for cutting out impulsive trades 7 winners think feel and act differently than losers you must look within yourself strip away your illusions and change your old ways of being thinking and acting change is but if you want to be a professional trader you have to work on changing your personality maths psychology wolf Street is named after a wall that kept farm animals from wandering away from the settlement at the tip of Manhattan the farming legacy lives on in the language of traders for animals are mentioned especially often on Wall Street bulls and bears hogs and sheep traders say Bulls make money Bears make money but hogs get slaughtered a bull fights by striking up with his horns the bull is a buyer a person who bets on a rally and profits from a rise in prices a bear fights by striking down with his paws a bear as a seller a person who bets on a decline and profits from a fall in prices hogs are greedy they get slaughtered when they trade to satisfy their greed some hogs buy or sell positions that are too large for them and get destroyed by a small adverse move other Hogs overstay their positions they keep waiting for profits to get bigger even after the trend reverses sheep are passive and fearful followers of trends tips and gurus they sometimes put on a bull's horns or a bearskin and try to Swagger you recognize them by their pitiful bleating when the market becomes volatile whenever the market is open Bulls are buying Bears are selling hogs and sheep get trampled underfoot and the undecided traders wait on the sidelines quote machines all over the world show a steady stream of quotes the latest prices for any trading vehicle thousands of eyes are focused on each price quote as people make trading decisions there are three groups of traders in the market buyers sellers and undecided traders ask is what a seller asks for his merchandise bid is what a buyer offers for that merchandise buyers and sellers are always in con select buyers want to pay as little as possible and sellers want to charge as much as possible if members of both groups insist on having their way no trade can take place no trade means no price only wishful quotes of buyers and sellers a seller has a choice to wait until prices rise or to accept a lower offer for his merchandise a buyer also has a choice to wait until prices come down or to offer to pay more to the sellers a trade occurs when there is a momentary meeting of two minds and eager bole agrees to a sellers terms and pays up or an eager bear agrees to a buyers terms and sells a little cheaper the presence of undecided traders puts pressure on both bulls and bears when a buyer and a seller bargain in private they may hey go at a leisurely pace the two must move much faster when they bargain at the exchange they know that they are surrounded by a crowd of other traders who may butt in on their deal at any moment the buyer knows that if he thinks for too long another trader can step in and snap away his bargain a seller knows that if he tries to hold out for a higher price another trader may step in and sell at a lower price the crowd of undecided traders makes buyers and sellers more anxious to accommodate their opponents a trade occurs when there is a meeting of two minds each tick on your quote screen represents a deal between a buyer and a seller buyers are buying because they expect prices to rise sellers are selling because they expect prices to fall buyers and sellers trade while surrounded by crowds of undecided traders they may become buyer's or seller's as prices change or as time passes buying by Bulls pushes markets up selling by bears pushes markets down and undecided traders make everything happen faster by creating a sense of urgency see in buyers and sellers traders come to the markets from all over the world in person via computers or through their brokers everybody has a chance to buy and to sell each price is a momentary consensus of value of all market participants expressed in action price is a psychological event a momentary balance of opinion between bulls and bears prices are created by masses of traders buyers sellers and undecided people the patterns of prices and volume reflect the mass psychology of the markets huge crowds converge on stock commodity and option exchanges either in person are represented by their brokers big money and little money smart money and dumb money institutional money and private money all meet on the exchange floor each price represents a momentary consensus of value between buyers sellers and undecided traders at the moment of transaction there is a crowd of traders behind every pattern in the chart book crowd consensus changes from moment to moment sometimes it gets established in a very low-key environment and at other times the environment turns wild prices move in small increments during quiet times when a crowd becomes either spooked or elated prices begin to jump imagine bidding for a life preserver aboard a sinking ship that's how prices leap when masses of traders become emotional about a trend and astute trader tries to enter the market during quiet times and take profits during wild times technical analysts study swings of mass psychology in the financial markets each trading session is a battle between bulls who make money when prices rise and bears who profit when prices fall the goal of technical analysts is to discover the balance of power tween bulls and bears and bet on the winning group if bulls are much stronger you should buy and hold if bears are much stronger you should sell and sell short if both camps are about equal in strength a wise trader stands aside he lets bullies fight with each other and puts on a trade only when he is reasonably sure who is likely to win prices volume and open interest reflect crowd behavior so do the indicators that are based on them this makes technical analysis similar to poll taking both combined science and art they are scientific to the extent that we use statistical methods and computers they are artistic to the extent that we use personal judgment to interpret our findings what is the reality behind market symbols prices numbers and graphs when you check prices in your newspaper watch quotes on your screen or plot an indicator on your chart what exactly are you looking at what is the market that you want to analyze and trade amateurs act as if the market is a giant happening a ball game in which they can join the professionals and make money traders from a scientific or engineering background often treat the market as a physical event they apply to it the principles of signal processing noise reduction and similar ideas by contrast all professional traders know full well what the market is it is a huge mass of people every trader tries to take money away from other traders by out guessing them on the probable direction of the market the members of the market crowd live on different continents they are united by modern telecommunications in the pursuit of profit at each other's expense the market is a huge crowd of people each member of the crowd tries to take money away from other members by outsmarting them the market is a uniquely harsh because everyone is against you and you are against everyone not only is the market harsh you have to pay high prices for entering and exiting it you have to jump over to high barriers commissions and slippage before you can collect a dime the moment you place an order you owe your broker a commission you are behind the game before you begin then floor traders try to hit you with slippage when your order arrives on the floor they try to take another bite out of your account when you exit your trade in trading you compete against some of the brightest minds in the world while fending off the piranhas of commissions and slippage private traders usually come to the market after a successful career in business or in the professions an average private futures trader in the United States is a 50 year old married college-educated man many futures traders own their own businesses and many have postgraduate degrees the two largest occupational groups among futures traders are farmers and engineers most people trade for partly rational partly irrational reasons rational reasons include the desire to earn a large return on capital irrational reasons include gambling and a search for excitement most traders are not aware of their irrational motives learning to trade takes hard work time energy and money few individuals rise to the level of professionals who can support themselves by trading professionals are extremely serious about what they do they satisfy their irrational goals outside the markets while amateurs act them out in the marketplace the major economic role of a trader is to support his broker to help him pay his mortgage and keep his children in private schools in addition the role of a speculator is to help companies raise capital in the stock market and to assume a price risk in the commodities markets allowing producers focus on production these lofty economic goals are far from a speculators mind when he gives an order to his broker institutions are responsible for a huge volume of trading their deep pockets give them several advantages they pay low institutional commissions they can afford to hire the best researchers brokers and traders some even strike back at floor traders who steal too much in slippage the spate of arrests and trials of Chicago floor traders in 1990 and 1991 began when Archer Daniels Midland a food processing firm brought in the FBI a friend of mine who heads the trading desk at a bank basis some of his decisions on a service provided by a group of former CIA officers they scan the media to detect early trends in society and send their reports to him my trader friend calls some of his best ideas from these reports the substantial annual fee for those experts is small potatoes for his firm compared with the millions of dollars at trades most private traders do not have such opportunities it is easier for institutions to buy the best research an acquaintance who used to trade successfully for a Wall Street investment bank found himself in trouble when he quit to trade for himself he discovered that a real-time quote system in his Park Avenue apartment in Manhattan did not give him news as fast as the Squawk Box on the trading floor of his old firm brokers from around the country used to call him with the latest ideas because they wanted his orders when you trade from your house you are never the first to hear the news he says some large firms have intelligence networks that enable them to act before the public one day when oil futures rallied in response to a fire on a platform in the North Sea I called a friend at an oil firm the market was frantic but he was relaxed he had bought oil futures half an hour before they exploded he had gotten a telex from an agent in the area of the fire well before the reports appeared on the news wire timely information is priceless but only a large company can afford an intelligence network the firms that deal in both futures and cash markets have two advantages they have true inside information and they are exempt from speculative position limits recently I visited an acquaintance at a multinational oil company after passing through security that was tighter than at Kennedy International Airport I walked through glass enclosed corridors clusters of men huddled around monitors trading oil products when I asked my host whether his traders were hedging or speculating he looked me straight in the eye and said yes I asked again and received the same answer companies crisscross the thin line between hedging and speculating based on inside information employees of trading firms have a psychological advantage they could be more relaxed because their own money is not at risk most individuals do not have the discipline to stop trading when they get on a losing streak but institutions impose discipline on traders a trader is given two limits how much he may risk on a single trade and the maximum amount he may lose in a month these limits work as stop-loss orders on a trader with all these advantages how can an individual trader compete against institutions and win first many institutional trading departments are poorly run second the Achilles heel of most institutions is that they often have to trade while an individual trader is free to trade or stay out of the market banks have to be active in the bond market and food processing companies have to be active in the grain market at almost any price an individual trader is free to wait for the best trading opportunities most private traders fritter away this advantage by over trading an individual who wants to succeed against the Giants must develop patience and eliminate greed remember your goal is to trade well not to trade often successful institutional traders receive raises and bonuses even a high bonus can feel puny to someone who earns many millions of dollars for his firm successful institutional traders often talk of quitting and going to trade for themselves most traders who leave institutions get caught up in the emotions of fear greed elation and panic when they start risking their own money they seldom do well trading for their own account another sign that psychology is at the root of trading success or failure the market crowd and you the market is a loosely organized crowd whose members bet that prices will rise or fall since each price represents the consensus of the crowd at the moment of transaction all traders are in effect betting on the future mood of the crowd that crowd keeps swinging from indifference to optimism or pessimism and from hope to fear most people do not follow their own trading plans because they let the crowd influence their feelings thoughts and actions bulls and bears battle in the market and the value of your investment sinks or soars depending on the actions of total strangers you cannot control the markets you can only decide whether and when to enter or exit trades most traders feel jittery when we enter a trade their judgment becomes clouded by emotions after they join the market crowd these crowd induced emotions make traders deviate from their trading plans and lose money Charles Makai the Scottish barrister wrote his classic book extraordinary popular delusions and the madness of crowds in 1841 he describes several mass manias including the tulip mania in Holland in 1634 and the South Seas investment bubble in England in 1720 the tulip craze began as a bull market in tulip bulbs the long bull market convinced the prosperous Dutch that tulips would continue to appreciate many of them abandoned their businesses to grow tulips trade them or become julep brokers banks accepted tulips as collateral and speculators profited finally that mania collapsed in waves of panic selling leaving many people destitute in the nation shocked Makai side men go mad in crowds and they come back to their senses slowly and one by one in 1897 Gustav Lovell a French philosopher and politician wrote the crowd one of the best books on mass psychology a trader who reads it today can see his reflection in a century-old mirror labore wrote that when people gather in a crowd whoever be the individuals that compose it however like or unlike be their mode of life their occupations their character or their intelligence the fact that they have been transformed into a crowd puts them in possession of a sort of collective mind which makes them feel think and act in a manner quite different from that in which each individual of them would feel think and act were he in a state of isolation people change when they join crowds they become more credulous and impulsive anxiously search for a leader and react to emotions instead of using their intellect an individual who becomes involved in a group becomes less capable of thinking for himself you need to base your trades on a carefully prepared trading plan and not jump in response to price changes it pays to write down your plan you need to know exactly under what conditions you will enter and exit a trade do not make decisions on the spur of the moment when you are vulnerable to being sucked into the crowd you can succeed in trading only when you think and act as an individual the weakest part of any trading system is the trader himself traders fail when they trade without a plan or deviate from their plans plans are created by reasoning individuals impulsive trades are made by sweaty group members you have to observe yourself and notice changes in your mental state as you trade write down your reasons for entering a trade and the rules for getting out of it including money management rules you must not change your plan while you have an open position sirens were sea creatures of Greek myths who sang so beautifully that sailors jumped overboard and drowned when Odysseus wanted to hear the sirens songs he ordered his men to tie him to the mast and to put wax in their own ears Odysseus heard the sirens songs but survived because he could not jump you ensure your survival is a trader when on a clear day you tie yourself to the mast of a trading plan and money management rules psychology of trends each price is the momentary consensus of value of all market participants it shows their latest vote on the value of a trading vehicle any trader can put in his two cents worth by giving an order to buy or to sell or by refusing to trade at the current level each bar on a chart reflects the battle between bulls and bears when Bulls feel strongly bullish they buy more eagerly and push markets up when bears feel strongly bearish they sell more active and push markets down each price reflects action or lack of action by all traders in the market charts are a window into math psychology when you analyze charts you analyze the behavior of traders technical indicators help make this analysis more objective technical analysis is applied social psychology it aims to recognize trends and changes in crowd behavior in order to make intelligent trading decisions ask most traders why prices went up and you are likely to get a stock answer more buyers than sellers this is not true the number of trading instruments such as stocks or futures bought and sold in any market is always equal if you want to buy a contract of Swiss francs someone has to sell it to you if you want to sell short a contract of the S&P 500 someone has to buy it from you the number of stocks bought and sold is equal in the stock market furthermore the number of long and short positions in the futures markets is always equal prices move up or down because of changes in the intensity of greed and fear among buyer's or seller's when the trend is up Bulls feel optimistic and do not mind paying a little extra they buy high because they expect prices to rise even higher Bears feel tense in an uptrend and they agree to sell only at a higher price when greedy and optimistic Bulls meet fearful and defensive bears the market rallies the stronger their feelings the sharper the rally the rally ends only when many Bulls lose their enthusiasm when prices slide Bears feel optimistic and do not quibble about selling short at lower prices Bulls are fearful and agree to buy only at a discount as long as bears feel like winners they continue to sell at lower prices the downtrend continues it ends when bears start feeling cautious and refused to sell at lower prices few traders act as purely rational human beings there is a great deal of emotional activity in the markets most market participants act on the principle of monkey-see monkey-do the waves of fear and greed sweep up bulls and bears markets rise because of greed among buyers and fear among short sellers Bulls normally like to buy on the cheap when they turn very bullish they become more concerned with not missing the rally than with getting a cheap price a rally continues as long as bulls are greedy enough to meet sellers demands the sharpness of a rally depends on how traders feel if buyers feel just a little stronger than sellers the market rises slowly when they feel much stronger than sellers the market rises fast it is the job of a technical analyst to find when buyers are strong and when they start running out of steam short sellers feel trapped by rising markets as their profits melt and turn into losses when short sellers rush to cover a rally becomes nearly vertical fear is a stronger emotion than greed and rallies driven by short-covering are especially shocked markets fall because of greed among bears and fear among bulls normally Bears prefer to sell short on rallies but if they expect to make a lot of money on a decline they don't mind shorting on the way down fearful buyers agree to buy only below the market as long as short sellers are willing to meet those demands and sell it a bid the decline continues as Bulls profits melt and turn into losses they panic and sell at almost any price they are so eager to get out that they hit the bids under the market markets can fall very fast when hit by panic selling buying by happy bulls and covering by fearful bears pushes up trends higher buyers feel rewarded while sellers feel punished both feel emotionally involved but few traders realize that they are creating the uptrend creating their own leader eventually a price shock occurs a major sale hits the market and there are not enough buyers to absorb it the uptrend takes a dive Bulls feel mistreated like children whose father hit them with a strap during a meal but Bears feel encouraged a price shock plants the seeds of an uptrend reversal even if the market recovers and reaches a new high bulls feel more skittish and bears become bolder this lack of cohesion in the dominant group and optimism among its opponents makes the uptrend ready to reverse several technical indicators identify tops by tracing a pattern called bearish divergence it occurs when prices reach a new high but the indicator reaches a lower high than it did on a previous rally bearish divergences mark the best shorting opportunities when the trend is down Bears feel like good children praised and rewarded for being smart they feel increasingly confident add to their positions and the Down trend continues new bears coming to the market most people admire winners and the financial media keep interviewing bears in bear markets Bulls lose money and Down trends and that makes them feel bad the Bulls dump their positions and many switch sides to join bears they're selling pushes markets lower after a while Bears grow confident and Bulls feel demoralized suddenly a price shock occurs a cluster of buy orders soaks up all available sell orders and lifts the market now bears feel like children whose father has lashed out at them in the midst of a happy meal a price shock plants seeds of a downtrends eventual reversal because bears become more fearful and Bulls grow bolder when a child begins to doubt that Santa Clause exists he seldom believes in Santa again even if bears recover and prices fall to a new low several technical indicators identify their weakness by tracing a pattern called a bullish divergence it occurs when prices fall to a new low but an indicator traces a more shallow bottom than during the previous decline an individual has a free will and his behavior is hard to predict group behavior is more primitive and easier to follow when you analyze markets you aniline is group behavior you need to identify the direction in which groups run and their changes groups suck us in and cloud our judgment the problem for most analysts is that they get caught in the mentality of the group's they analyze the longer a rally continues the more technicians get caught up in bullish sentiment ignore the danger signs and miss the reversal the longer a decline goes on the more technicians get caught up in bearish gloom and ignore bullish signs this is why it helps to have a written plan for analyzing the markets we have to decide in advance what indicators we will watch and how we will interpret them floor traders use several tools for tracking the quality and intensity of a crowds feelings they watch the crowds ability to break through recent support and resistance levels they keep an eye on the flow of paper customer orders that come to the floor in response to price changes floor traders listen to the changes in pitch and volume of The Roar on the exchange floor if you trade away from the floor you need other tools for analyzing crowd behavior your charts and indicators reflect math psychology and action a technical analyst is an applied social psychologist often armed with a computer technical analysts believe that prices reflect everything known about the market including all fundamental factors each price represents the consensus of value of all market participants large commercial interests and small speculators fundamental researchers technicians and gamblers technical analysis is a study of mass psychology it is partly a science and partly an art technicians use many scientific methods including mathematical concepts of game theory probabilities and so on many technicians use computers to track sophisticated indicators technical analysis is also an art the bars on a chart coalesce into patterns and formations when prices and indicators move they produce a sense of flow and rhythm a feeling of tension and beauty that helps you sense what is happening and how to trade individual behavior is complex diverse and difficult to predict group behavior is primitive technicians study the behavior patterns of market crowds they trade when they recognize a pattern that proceeded past market moves a tremendous volume of information pours out of the markets during trading hours changes in prices tell us about the battles of bulls and bears your job is to analyze this information and bet on the dominant market group dramatic forecasts are a marketing gimmick people who sell advisory services or raise money know that good calls attract paying customers while bad calls are quickly forgotten my phone rang while I was writing this chapter one of the famous gurus currently down on his luck told me that he identified a once-in-a-lifetime buying opportunity in a certain agricultural market he asked me to raise money for him and promised to multiply it a hundredfold in six months I do not know how many fools he hooked but dramatic forecasts have always been good for fleecing the public use your common sense when you analyze markets when some new development puzzles you compare it to life outside the markets for example indicators may give you buy signals in two markets should you buy the market that declined a lot before the buy signal or the one that declined a little compare this to what happens to a man after a fall if he falls down a flight of stairs he made us to himself off and run up again but if he falls out of a third-story window he's not going to run anytime soon he needs time to recover prices seldom rally very hard immediately after a bad decline successful trading stands on three pillars you need to analyze the balance of power between bulls and bears you need to practice good money management you need personal discipline to follow your trading plan and avoid getting high in the markets classical chart analysis Chartists study market action trying to identify recurrent price patterns their goal is to profit from trading when patterns recur most Chartists work with bar graphs showing high low and closing prices and volume some also watch opening prices and open interest point & figure charts track only price changes and ignore time volume and open interest classical charting requires only a pencil and paper it appeals to visually oriented people those who plot data by hand often develop a physical field for prices computers speed charting at a cost of losing some of that feel the biggest problem in charting is wishful thinking traders often convince themselves that a pattern is bullish or bearish depending on whether they want to buy or to sell chart patterns reflect the tides of greed and fear among traders this book focuses on daily charts but you can apply many of its principles to other data the rules for reading weekly daily hourly or intraday charts are very similar each price is a momentary consensus of value of all market participants expressed in action each price bar provides several pieces of information about the balance of power between bulls and bears the opening price of a daily or a weekly bar usually reflects the amateurs opinion of value they read morning papers find out what happened the day before and call their brokers with orders before going to work amateurs are especially active early in the day and early in the week traders who research the relationship between opening and closing prices for several decades found that opening prices most often occur near the high or the low of the daily bars buying or selling by amateurs early in the day creates an emotional extreme from which prices recoil later in the day in bull markets prices often make their low for the week on Monday or Tuesday on profit taking by amateurs than rally to a new high on Thursday or Friday in bear markets the high for the week is often set on Monday or Tuesday with a new low toward the end of the week on Thursday or Friday the closing prices of daily and weekly bars tend to reflect the actions of professional traders they watch the markets throughout the day respond to changes and become especially active near the close many of them take profits at that time to avoid carrying trades overnight professionals as a group usually trade against the amateurs they tend to buy lower openings sells short higher openings and unwind their positions as the day goes on traders need to pay attention to the relationship between opening and closing prices if prices closed higher than they opened then market professionals were probably more bullish than amateurs if prices closed lower than they opened then market professionals were probably more bearish than amateurs it pays to trade with the professionals and against the amateurs efficient markets random walk and nature's law efficient market theory is an academic notion that nobody can outperform the market because any price at any given moment incorporates all available information Warren Buffett one of the most successful investors of our century commented I think it's fascinating how the ruling orthodoxy can cause a lot of people to think the earth is flat investing in a market where people believe in efficiency is like playing bridge with someone who's been told it doesn't do any good to look at the cards the logical flaw of efficient market theory is that it equates knowledge with action people may have knowledge but the emotional pull of the crowd often leads them to trade irrationally a good analyst can detect repetitive patterns of crowd behavior on his charts and exploit them random walk theorists claim that market prices change at random of course there is a fair amount of randomness or noise in the markets just as there is randomness in any other crowd milling around an intelligent observer can identify repetitive behavior patterns of a crowd and make sensible bets on their continuation or reversal people have memories they remember past prices and their memories influence their buying and selling decisions memories help create support under the market and resistance above it random Walker's deny that memories of the past influence our behavior in the present as Milton Friedman has pointed out prices carry information about the availability of supply and the intensity of demand market participants use that information to make their buying and selling decisions for example consumers buy more merchandise when it is on sale and less when prices are high financial traders are just as capable of logical behavior as homemakers in a supermarket when prices are low bargain hunters step in a shortage can lead to a buying panic but high prices choke off demand nature's law is the rallying cry of a clutch of mystics who oppose random walkers in the financial markets mystics claim that there is a perfect order in the markets which they say move like clockwork in response to immutable natural laws RN Elliott even titled his last book nature's law the perfect order crowd gravitates to astrology and looks for links between prices and the movements of the planets most mystics try to hide their astrological bent but it is easy to draw them out of a shell next time someone talks to you about natural order in the markets ask him about astrology he will probably jump at the chance to come out of the closet and talk about the Stars those who believe in perfect order in the markets accept that tops and bottoms can be predicted far into the future amateurs love forecasts and mysticism provides a great marketing gimmick it helps sell courses trading systems and newsletters mystics random walk academics and efficient market theorists have one trait in common they are equally divorced from the reality of the markets extremists argue with one another but they think alike support and resistance a ball hits the floor and bounces it drops after it hits the ceiling support and resistance are like a floor and a ceiling with prices sandwiched between them understanding support and resistance is essential for understanding price trends and chart patterns rating their strengths helps you decide whether the trend is likely to continue or to reverse support is a price level where buying is strong enough to interrupt or reverse a downtrend when a downtrend hits support it bounces like a diver who hits the bottom and pushes away from it support is represented on a chart by a horizontal or near horizontal line connecting several bottoms resistance is a price level we're selling is strong enough to interrupt or reverse an uptrend when an uptrend hits resistance it stops or tumbles down like a man who hits his head on a branch while climbing a tree resistance is represented on a chart by a horizontal or near horizontal line connecting several tops minor support or resistance causes trends to pause while major supporter resistance causes them to reverse traders buy at support and sell at resistance making their effectiveness a self-fulfilling prophecy support and resistance exist because people have memories our memories prompt us to buy and sell at certain levels buying and selling by crowds of traders creates support and resistance if traders remember that prices have recently stopped falling and turned up from a certain level that are likely to buy when prices approach that level again if traders remember that an uptrend has recently reversed after rising to a certain peak they tend to sell and go short when prices approach that level again for example all major rallies in the stock market from 1966 until 1982 ended whenever the Dow Jones Industrial Average rallied to 950 or 1050 the resistance was so strong that traders named it a graveyard in the sky once the Bulls RAM the market through that level it became a major support area support and resistance exists because masses of traders feel pain and regret traders who hold losing positions feel intense pain losers are determined to get out as soon as the it gives them another chance traders who missed an opportunity feel regret and also wait for the market to give them a second chance feelings of pain and regret are mild and trading ranges where swings are small and losers do not get hurt too badly breakouts from trading ranges create intense pain and regret when the market stays flat for a while traders get used to buying at the lower edge of the range and shorting at the upper edge enough trends Bears who sold short feel pain and Bulls feel regret that they did not buy more both feel determined to buy if the market gives them a second chance the pain of bears and regret of bulls make them ready to buy creating support during reactions in an uptrend resistance is an area where Bulls feel pain Bears feel regret and both are ready to sell when prices break down from a trading range Bulls who bought feel pain feel trapped and wait for a rally to let them get out even bears regret that they have not shorted more and wait for a rally to give them a second chance to sell short Bulls pain and Bears regret create resistance a ceiling above the market in downtrends the strength of support and resistance depends on the strength of feelings among masses of traders a congestion area that has been hit by several trends is like a cratered battlefield its defenders have plenty of cover and an attacking force is likely to slow down the longer prices stay in a congestion zone the stronger the emotional commitment of bulls and bears to that area when prices approach that zone from above it serves as support when prices rally into it from below it acts as resistance a congestion area can reverse its role and serve as either support or resistance the strength of every support or resistance zone depends on three factors its length its height and the volume of trading that has taken face in it you can visualize these factors as the length the width and the depth of a congestion zone the longer a support or resistance area its length of time or the number of hits it took the stronger it is support and resistance like good wine become better with age a two-week trading range provides only minimal support or resistance a two-month range gives people time to become used to it and creates intermediate support or resistance while a two-year range becomes accepted as a standard of value and offers major support or resistance as support and resistance levels grow old they gradually become weaker losers keep washing out of the markets replaced by newcomers who do not have the same emotional commitment to old price levels people who lost money only recently remember full well what happened to them they are probably still in the market feeling pain and regret trying to get even people who made bad decisions several years ago are probably out of the markets and their memories matter less the strength of support and resistance increases each time that area is hit when traders see that prices have reversed at a certain level they tend to bet on a reversal the next time prices reach that level the taller the support and resistance zone the stronger it is at all congestion zone is like a tall fence around a property a congestion zone whose height equals one percent of current market value for points in the case of the S&P 500 at 400 provides only minor support or resistance a congestion zone that is 3% tall provides intermediate support or resistance and a congestion zone that is 7% tall or higher can grind down a major trend the greater the volume of trading in a support and resistance zone the stronger it is high volume in a congestion area shows active involvement by traders a sign of strong emotional commits low-volume shows that traders have little interest in transacting at that level a sign of weak support or resistance trading rules 1 whenever the trend you are riding approaches support or resistance tighten your protective stop a protective stop is an order to sell below the market when you are long or to cover shorts above the market when you are short this stop protects you from getting badly hurt by an adverse market move a trend reveals its health by how it acts when it hits support or resistance if it is strong enough to penetrate that zone it accelerates and your tight stop is not touched if a trend bounces away from support or resistance it reveals its weakness in that case your tight stop salvages a good chunk of profits to support and resistance are more important on long term charts than on short term charts weekly charts are more important than dailies a good trader keeps an eye on several time frames and defers to the longer one if the weekly trend is sailing through a clear zone the fact that the daily trend is hitting resistance is less important when a weekly trend approaches support or resistance you should be more inclined to act 3 support and resistance levels are useful for placing stop-loss and protect profit orders the bottom of a congestion area is the bottom line of support if you buy and place your stop below that level you give the uptrend plenty of room more cautious traders buy after an upside breakout and place a stop in the middle of a congestion area a true upside breakout should not be followed by a pullback into the range just as a rocket is not supposed to sink back to its launching pad reverse this procedure in downtrends many traders avoid placing stops at round numbers this superstition began with the off-the-cuff advice by Edwards and McGee avoid placing stops at round numbers because everybody was placing them there now if traders buy copper at 92 they place a stop at 89 point 75 rather than 90 when they sell a stock short at 76 they place a protective stop at 80 point 25 rather than 80 these days there are fewer stops at round numbers than at fractional numbers it is better to place your stops at logical levels round or not markets spend more time in trading ranges than they do in trends most breakouts from trading ranges are false breakouts they suck in trend followers just before prices return into the trading range a false breakout is the bane of amateurs but professional traders love them professionals expect prices to fluctuate without going very far most of the time they wait until an upside breakout stops reaching new highs or a downside breakout stops making new lows then they pounce they fade the breakout trade against it and place a protective stop at the latest extreme point it is a very tight stop and their risk is low while there is a big profit potential from a pull back into the congestion zone the risk reward ratio is so good that professionals can afford to be wrong half the time and still come out ahead of the game the best time to buy an upside breakout on a daily chart is when your analysis of the weekly chart suggests that a new uptrend is developing true breakouts are confirmed by heavy volume while false breakouts tend to have light volume true breakouts are confirmed when technical indicators reach new extreme highs or lows in the direction of the trend while false breakouts are often marked by divergences between prices and indicators traders try to profit from changes in prices buy low and sell high or sell short high and cover low even a quick look at a chart reveals that markets spend most of their time in trading ranges they spend less time in trends a trend exists when prices keep rising or falling over time in an uptrend each rally reaches a higher high than the preceding rally and each decline stops at a higher level than the preceding decline in a downtrend each decline Falls to a lower low than the preceding decline and each rally stops at a lower level than the preceding rally in a trading range most rally stop at about the same high and declines peter out at about the same low a trader needs to identify trends and trading ranges it is easier to trade during trends it is harder to make money when prices are flat unless you write options which requires a special skill trading in trends and in trading ranges calls for different tactics when you go long in an uptrend or sell short in a downtrend you have to give that trend the benefit of the doubt and not be shaken out easily it pays to buckle your seat belt and hang on for as long as the trend continues when you trade in a trading range you have to be nimble and close out your position at the slightest sign of a reversal another difference in trading tactics between trends and trading ranges is the handling of strengths and weakness you have to follow strength during trends by and up trends and sell short in down trends when prices are in a trading range you have to do the opposite by weakness and sell strength an uptrend emerges when bulls are stronger than bears and they're buying forces prices up if bears manage to push prices down Bulls return in force break the decline and force prices to a new high down trends occur when bears are stronger and they're selling pushes markets down when a flurry of buying lifts prices Bears sell short into that rally stop it and send prices to new lows when bulls and bears are equally strong or weak prices stay in a trading range when Bulls managed to push prices up bears sell short into that rally and prices fall bargain hunters step in and break the decline bears cover shorts they're buying fuels a minor rally and the cycle repeats a trading range is like a fight between two equally strong gangs they push one another back and forth on a street corner but neither can control the turf a trend is like a fight where a stronger gang chases the weaker gang down the street every once in a while the weaker gang stops and puts up a fight but then is forced to turn and run again prices in trading ranges go nowhere just as crowds spend most of their time and aimless milling markets spend more time in trading ranges than in trends because aimlessness is more common among people than purposeful action when a crowd becomes agitated it surges and creates a trend crowds do not stay excited for long they go back to meandering professionals tend to give the benefit of the doubt to trading ranges identifying trends and trading ranges is one of the hardest tasks in technical analysis it is easy to find them in the middle of a chart but the closer you get to the right edge the harder it gets trends and trading ranges clearly stand out on old charts experts show those charts at seminars and make it seem easy to catch trends trouble is your broker does not allow you to trade in the middle of the chart he says you must make your trading decisions at the hard right edge of the chart the past is fixed and easy to analyze the future is fluid and uncertain by the time you identify a trend a good chunk of it is gone nobody rings a bell when a trend dissolves into a trading range by the time you recognize that change you will lose some money trying to trade as if the market was still trending many chart patterns and indicator signals contradict one another the right edge of the chart you have to base your decisions on probabilities in an atmosphere of uncertainty most people cannot accept uncertainty they have a strong emotional need to be right they hang on to losing positions waiting for the market to turn and make them whole trying to be right in the market is very expensive professional traders get out of losing trades fast when the market deviates from your analysis you have to cut losses without fuss or emotions when you identify an uptrend and decide to buy you have to decide whether to buy immediately or wait for a dip if you buy fast you get in gear with the trend but your stops are likely to be farther away and you risk more if you wait for a dip you will risk less but we'll have four groups of competitors Long's who want to add to their positions shorts who want to get out even traders who never bought and traders who sold too early but are eager to buy the waiting area for a pullback is very crowded markets are not known for their charity and a deep pullback may well signal the beginning of a reversal this reasoning also applies to down trends waiting for pull backs while a trend is gathering steam is an amateur's game if the market is in a trading range and you are waiting for a breakout you have to decide whether to buy an anticipation of a breakout during a breakout or on a pullback after a valid breakout if you trade multiple positions you can buy a third in anticipation a third on a breakout and a third on a pullback whatever method you use there is one money management rule that will keep you out of the riskiest trades the distance from the entry point to the level of a protective stop should never be more than 2% of your account equity no matter how attractive a trade is pass it up if it requires a wider stop money management tactics are different in trends and trading ranges it pays to put on a smaller position in a trend but use a wider stop then you will be less likely to get shaken out by reactions while you keep risk under control you may put on a bigger position in a training range but use a tighter stop finding good entry points is extremely important in trading ranges you have to be very precise because the profit potential is so limited a trend is more forgiving of a sloppy entry as long as you trade in the direction of the trend old traders chuckle do not confuse brains with a bull market when you cannot tell whether the market is in a trend or in a trading range remember that professionals give the benefit of the doubt to trading ranges if you are not sure stand aside professionals love trading ranges because they can slide in and out of positions with little risk of being impaled on a trend since they pay low or no commissions and suffer little slippage it is profitable for them to trade in gently fluctuating markets those of us who trade away from the floor are better off trying to catch trends you can trade less frequently during trends and your account suffers less from commissions and slippage most traders ignore the fact that markets usually are both in a trend and in a trading range at the same time they pick one timeframe such as daily or hourly and look for trades on daily charts with their attention fixed on daily or hourly charts trends from other timeframes such as weekly or 10-minute trends keep sneaking up on them and wreaking havoc with their plans markets exist in several time frames simultaneously they exist on a ten-minute chart an hourly chart a daily chart a weekly chart and any other chart the market may look like a buy on a daily chart but a sell on a weekly chart and vice versa the signals in different time frames of the same market often contradict one another which of them will you follow when you are in doubt about a trend step back and examine the charts at a timeframe that is larger than the one you are trying to trade this search for a greater perspective is one of the key principles of the triple screen trading system a losing trader often thinks he would be better off if he had a real-time quote machine on his desk one of the universal fantasies of losers is that they would be winners if they could get their data faster and focused on a shorter time frame but they lose money even faster with a quote system when that happens some losers say they would be better off trading right on the exchange floor without any delay for data transmission but more than half of floor traders wash out in their first year being in the middle of the action does not do losers any good the conflicting signals in different time frames of the same market are one of the great puzzles in market analysis what looks like a trend on a daily chart may show up as a blip on a flat weekly chart what looks like a flat trading range on a daily chart shows rich up trends and down trends on an hourly chart and so on when professionals are in doubt they look at the big picture but amateurs focus on the short term charts trend lines charts reveal the actions of bulls and bears bottoms of declines show where bears stopped and Bulls regain control of the market peaks of rallies show where Bulls ran out of steam and Bears gained control a line connecting to nearby bottoms shows the lowest common denominator of bullish power a line that connects to nearby tops shows the lowest common denominator of the power of bears those lines are called trend lines traders use them to identify friends when prices rally draw an uptrend line across the bottoms when prices decline draw a downtrend line across the tops projecting those lines into the future helps anticipate buying and selling points the most important feature of a trend line is its angle it identifies the dominant market force when a trend line points up it shows that bulls are in control then it pays to buy with a protective stop below the trend line when a trend line points down it shows that bears are in control then it pays to sell short and protect your position with a stop above the trend line most Chartists draw a trend line through extreme high and low points but it is better to draw through the edges of congestion areas those edges show where the majority of traders have reversed direction technical analysis is pull taking and poll takers want to track opinions of masses not of a few extremists drawing trend lines through the edges of congestion areas is somewhat subjective you have to watch out for the temptation to slant your ruler panic dumping buy bulls at the bottoms and panic covering buy bears at the tops create extremes which appear as long tails on the charts you want to base your trend lines on the edges of congestion areas and not on tails because tails show little about the crowd other than its tendency to panic the extreme points are very important but not for drawing trend lines markets usually recoil from those tails offering opportunities to short-term traders a bar that looks like a finger sticking out of a tight chart pattern provides a valuable reference point for short-term traders markets constantly fluctuate seeking an area that generates the highest volume of trading a tale shows that a certain price has been rejected by the market it usually leads to a swing in the opposite direction as soon as you recognize a tail trade against it place your protective stop halfway through the tail if the market starts chewing its tail it is time to get out the single most important feature of a trendline is its slope when a trendline slants up bulls are in control and it pays to look for buying opportunities when a trendline slants down bears are in control and it pays to look for shorting opportunities you can rate to the importance of any trendline by examining five factors the timeframe of the trendline its length the number of times prices touch it its angle and volume the longer the time frame the more important the trendline a trim line on a weekly chart identifies a more important trend than a daily trendline a trendline on a daily chart identifies a more important trend than an hourly trendline and so on the longer the trend line the more valid it is a short trend line reflects mass behavior over a short period a longer trend line reflects mass behavior over a longer time the longer a trend continues the greater its inertia a major bull market may follow its trendline for several years the more contacts between prices and trendline the more valid that line when the trend is up a return to the trend line shows a rebellion among bears when the trend is down a rally to the trend line shows a rebellion by the Bulls when prices pulled back to a trendline and then bounce away from it you know that the dominant market group has beaten the rebels a preliminary trend line is drawn across only two points three points of contact make that line more valid four or five points of contact show that the dominant market crowd is firmly in control the angle between a trend line and horizontal-axis reflects the emotional intensity of the dominant market crowd a steep trend line shows that the dominant crowd is moving rapidly a relatively flat trend line shows that the dominant crowd is moving slowly a shallow trend line is likely to last longer like a turtle racing against a hare it pays to measure the angle of every trendline and write it down on your chart this can be done using a computer a protractor or a Chinese charting tool comparing angles of trend lines shows whether the dominant market crowd is becoming more bullish or bearish it is uncanny how often trend lines trace the same angle time and again in a given market it may be because the key players seldom change sometimes prices accelerate away from their trendline then you can draw a new steeper trendline it shows that a trend is speeding up becoming unsustainable when you draw a new steeper trendline tighten your stop place it immediately below the latest trend line and adjust that stop at every new bar the breaking of a steep trendline is usually followed by a sharp reversal when the trend is up volume normally expands when prices rally and shrinks when they decline this shows that rallies attract traders while declines leave them cold the opposite occurs in down trends volume expands on declines and shrinks on rallies a pullback on heavy volume threatens a trend line because it shows that the rebellious crowd is growing if volume expands when prices move in the direction of a trendline it confirms that trend line if volume shrinks when price is pulled back to a trendline it also confirms the trendline if volume expands when prices return to a trendline it warns of a potential break if volume shrinks when prices pull away from a trendline it warns that the trendline is in danger the breaking of a well-established trend line shows that the dominant market crowd has lost its power you have to be careful not to anticipate trading signals most traders lose money when they jump the gun a trendline is not a glass floor under the market one crack and it is gone it is more like a fence that bulls or bears can lean on they can even violate it a bit without toppling it the way animals shake a fence a trendline break is valid only if prices close on the other side of a trendline some traders insists that a trend line has to be penetrated by two or three percentage points of price after a very steep uptrend is broken prices often rally again retest their old high and touch their old uptrend line from below when that happens you have a near perfect shorting opportunity a combination of a double top a pullback to an old trendline and perhaps a bearish divergence from technical indicators the reverse also applies to down trends the neglected essentials volume volume represents the activity of traders and investors each unit of volume in the market reflects the action of two persons one trader sells a share and another buys a share or one buys a contract and another sells a contract daily volume is the number of contracts or shares traded in one day traders usually plot volume as a histogram vertical bars whose height reflects each day's volume they usually draw it underneath prices changes in volumes show how bulls and bears react to price swings changes in volume provide clues as to whether trends are likely to continue or to reverse some traders ignore volume they think the prices already reflect all information known to the market they say you get paid on nice and not on volume professionals on the other hand know that analyzing volume can help them understand markets deeper and trade better there are three ways to measure volume one the actual number of shares or contracts traded for example the New York Stock Exchange reports volume this way this is the most objective way of measuring volume to the number of trades that took place for example the London Stock Exchange reports volume this way this method is less objective because it does not distinguish between a hundred share trade and a 5000 share trade three tick volume is the number of price changes during a selected time such as ten minutes or an hour it is called tick volume because most changes equal one tick most futures exchanges in the United States do not report intraday volume and day traders use tick volume as its proxy volume reflects the degree of financial and emotional involvement as well as pain of market participants a trade begins with a financial commitment by two persons the decision to buy or sell may be rational but the act of buying or selling creates an emotional commitment in most people buyers and sellers crave to be right they scream at the market pray or use lucky talismans volume reflects the degree of emotional involvement among traders each tick takes money away from losers and gives it to winners when prices rise Long's make money and shorts lose when prices fall shorts gain and Long's lose winners feel happy and elated while losers feel depressed and angry whenever prices move about half the traders are hurting when prices rise bears are in pain and when prices fall Bulls suffer the greater the increase in volley the more pain in the market you can lose a great deal of money in a sleepy market such as corn where a one cent move costs only $50 if corn goes against you just a few cents a day the pain is easy to tolerate if you hang on those pennies can add up to thousands of dollars in losses sharp moves on the other hand make losers cut their losses in a panic once weak hands get shaken out the market is ready to reverse trends can last for a long time on moderate volume but can expire after a burst of volume who buys from a trader who sells his losing long position it may be a short seller taking profits and covering shorts it may be a bargain hunter who steps in because prices are too low that bottom picker assumes the position of a loser who washed out and he either catches the bottom or becomes the new loser who sells to a trader who buys to cover his losing short position it may be a savvy investor who takes profits on his long position it also may be a top picker who sells short because he thinks that prices are too high he assumes the position of a loser who covered his shorts and only the future will tell whether he is right or wrong when shorts give up during a rally they buy to cover and push the market higher prices rise flush out even more shorts and the rally feeds on itself when longs give up during a decline they sell and push the market lower falling prices flush out even more Long's and the decline feeds on itself losers who give up propel trends a trend that moves on steady volume is likely to continue steady volume shows that new losers replace those who wash out trends need a fresh supply of losers the way builders of the ancient pyramids needed a fresh supply of slaves falling volumes shows that the supply of losers is running low and a trend is ready to reverse it happens after enough losers catch on to how wrong they are old losers keep bailing out but fewer new losers come in falling vol gives a sign that the trend is about to reverse a burst of extremely high volume also gives a signal that a trend is nearing its end it shows that masses of losers are bailing out you can probably recall holding a losing trade longer than you should have once the pain becomes intolerable and you get out the trend reverses and the market goes the way you expected but without you this happens time and again because most amateurs react to stress similarly and bail out at about the same time professionals do not hang in while the market beats them up they close out losing trades fast and reverse or wait on the sidelines ready to reenter volume usually stays low in trading ranges because there is relatively little pain people feel comfortable with small price changes and trend las' markets seem to drag on forever a breakout is often marked by a dramatic increase in volume because losers run for the exits a breakout on low volume shows little emotional commitment to a new trend it indicates that prices are likely to return into their trading range rising volume during a rally shows that more buyers and short sellers are pouring in buyers are eager to buy even if they have to pay up and shorts are eager to sell to them rising volume shows that losers who leave are being replaced by a new crop of losers when volume shrinks during a rally it shows that Bulls are becoming less eager while bears are no longer running for cover the intelligent bears have left long ago followed by weak Bears who could not take the pain falling volume shows that fuel is being removed from the uptrend and it is ready to reverse when volume dries up during a decline it shows that bears are less eager to sell short while bulls are no longer running for the exits the intelligent bulls have sold long ago and the weak bulls have been shaken out falling volume shows that the remaining Bulls have a higher level of pain tolerance perhaps they have deeper pockets or bought later in the decline or both falling vol identifies an area in which a downtrend is likely to reverse this reasoning applies to long and short time frames as a rule of thumb if today's volume is higher than yesterday's volume then today's trend is likely to continue the terms high volume and low volume are relative what is low for IBM is high for Apple computer well what is low for gold is high for platinum and so on as a rule of thumb high volume for any given market is at least 25% above average for the past two weeks and low volume is at least 25% below average one high volume confirms trends if prices rise to a new peak and volume reaches a new high then prices are likely to retest or exceed that peak - if the market Falls to a new low and the volume reaches a new high that bottom is likely to be retested or exceeded a climax bottom is almost always retested on low volume offering an excellent buying opportunity 3 if volume shrinks while a trend continues that trend is ripe for a reversal when a market rises to a new peak on lower volume than its previous peak look for a shorting opportunity this technique does not work as well at market bottoms because the decline can persist on low volume there is a saying on Wall Street it takes buying to put stocks up but they can fall of their own weight for watch volume during react against the trend when an uptrend is punctuated by a decline volume often picks up at a flurry of profit-taking when the dip continues but volume shrinks it shows that bulls are no longer running or that selling pressure is spent when volume dries up it shows that the reaction is nearing an end and the uptrend is ready to resume this identifies a good buying opportunity major down trends are often punctuated by rallies which begin on heavy volume once weak Bears have been flushed out volume shrinks and gives a signal to sell short open interest open interest is the number of contracts held by buyers or owed by short sellers in a given market on a given day it shows the number of existing contracts open interest equals either a total long or a total short position stock market shares are traded for as long as a company stays in business as a separate unit futures and options traders on the other hand deal in contracts for a future delivery that expire at a set time a futures or options buyer who wants to accept delivery and a seller who wants to deliver have to wait until the first notice day this waiting period ensures that the numbers of contracts that are long and short are always equal in any case very few futures and options traders plan to deliver or to accept delivery most traders close out their positions before the first notice day open interest rises or Falls depending on whether new traders enter the market or old traders exited open interest rises only when a new buyer and a new seller and to the market their trade creates a new contract open interest falls when a trader who is long trades with someone who is short when both of them close out their positions open interests Falls by one contract because one contract disappears if a new bull buys from an old bull who is getting out of his long position open interest remains unchanged open interest also does not change when a new bear sells to an old bear who needs to buy because he is closing out his short position it takes one bull and one bear to create a futures or options contract a bull buy the contract if he is convinced that prices are going higher a bear sells short a contract if he is convinced that prices are going lower when the two trade open interest rises by one contract a single trade between one Bowl and one bear is unlikely to move the markets but when thousands of traders make their trades they propel or reverse market trends open interest reflects the intensity of conflict between bulls and bears it reflects the willingness of Long's to maintain long positions and the willingness of shorts to maintain short positions when bulls and bears do not expect the market to move in their favour they close out their positions and open interest shrinks there are two people on opposite sides of every trade one of them gets hurt when prices change if prices rally Bears get hurt if prices fall Bulls get hurt as long as the losers hope they hang on and open interest does not change arise and open interest shows that a crowd of confident bulls is facing down a crowd of equally confident bears it points to a growing disagreement between the two camps one group is sure to lose but as long as potential losers keep pouring in the trend will continue these ideas have been clearly put forth in LD bel Veals classic book charting commodity market price behavior bulls and bears keep adding to their positions as long as they strongly disagree about the future course of prices it takes conviction and disagreement to maintain trend rising open interest shows that the supply of losers is growing and the current trend is likely to persist if open interest increases during an uptrend it shows that longs are buying while bears are shorting because they believe that the market is too high they are likely to run for cover when the uptrend puts a squeeze on them and their buying will propel prices higher if open interest Rises during a downtrend it shows that shorts are aggressively selling while bottom tickers are buying those bargain hunters are likely to bail out when falling prices hurt them and their selling will push prices even lower an increase in open interest gives a green light to the existing trend when a bull is convinced that prices are going higher and decides to buy but a bear is afraid to sell short that bull can buy only from another bull who bought earlier and now wants to get out their trade creates no new contract and open interest stays unchanged when open interest stays flat during a rally it shows that the supply of losers has stopped growing when a bear is convinced that prices are going lower he wants to sell short if a bull is afraid to buy from him that bear can only sell to another bear who shorted earlier and now wants to cover and leave their trade creates no new contract and open interest does not change when open interest stays flat during a decline it shows that the supply of bottom Pickers is not growing whenever open interest flattens out it flashes a yellow light a warning that the trend is aging and the best gains are probably behind falling open interest shows that losers are bailing out while winners are taking profits when their disagreement decreases the trend is ripe for a reversal open interest falls when losers abandon hope and get out of the market without being replaced by new losers when a bull decides to get out of his long position and a bear decides to cover his short position the two may trade with one another when they do a contract disappears an open interest shrinks by one contract falling open interest shows that winners are cashing in and losers are giving up hope it flashes a red light it signals the end of a trend time most people conduct their lives as if they intend to live forever with no review of the past no real planning for the future and minimal learning from past mistakes Freud showed that the unconscious mind does not have a notion of time our deep-seated wishes remain largely unchanged throughout life when people join crowds their behavior becomes even more primitive and impulsive than when they are alone crowds pay no attention to time even though they are affected by its passage individuals are ruled by the calendar and the clock but crowds have no notion of time crowds act out their emotions as if they had all the time in the world most traders focus only on changes in prices and pay little attention to time this is just another sign of being caught up in mass mentality the awareness of time is a sign of civilization a thinking person is aware of time while someone who is acting impulsively is not a market analyst who pays attention to time is aware of a dimension hidden from the market crowd long-term price cycles are a fact of economic life for example the US stock market tends to run in 4-year cycles they exist because the ruling party inflates the economy going into the presidential election once every four years the party that wins the election deflate s' the economy when voters cannot take revenge at the polls flooding the economy with liquidity lifts the stock market and draining liquidity pushes it down this is why the two years before a presidential election tend to be bullish and the first 12 to 18 months following an election tend to be bearish major cycles in agricultural commodities are due to fundamental production factors coupled with the mass psychology of producers for example when livestock prices rise farmers breed more animals when those animals reach the market prices fall and producers cut back when the supply is absorbed scarcity pushes prices up breeders go to work again and the bull bear cycle repeats this cycle is shorter in hogs than in cattle because pigs breed faster than cows long-term cycles can help traders identify market tides instead most traders get themselves in trouble by trying to use short term cycles for precision timing and predicting minor turning points price peaks and valleys on the charts often seem to follow in an orderly manner traders reach for a pencil and a ruler measure distances between neighboring Peaks and project them into the future to forecast the next top then they measure distances between recent bottoms and extend them into the future to forecast the next low cycles put bread and butter on the tables of several experts who sell services forecasting highs and lows few of them realize that what appears like a cycle on the charts is often a figment of the imagination if you analyze price data using a mathematically rigorous program you will see that approximately 80% of what appears like cycles is simply market noise a human mind needs to find order in chaos and an illusion of order is better than no order for most people if you look at any river from the air it appears to have cycles swinging right and left every river meanders in its valley because water flows faster in its middle than near the shores creating turbulences that forced the river to turn looking for market cycles with a ruler and a pencil is like searching for water with a divining rod profits from an occasional success are erased by many losses due to unsoundmethods if you are serious about trading with cycles you need a mathematical method for finding them a farmer sews in spring harvests in late summer and uses the fall to get ready for winter there is a time to sow and a time to reap a time to bet on a warm trend and a time to get ready for a cold spell the concept of seasons can be applied to the financial markets a trader can use a farmers approach he should look to buy in spring sell in the summer go short in the fall and cover in winter just as the farmer pays attention to the vagaries of weather a trader needs to pay attention to the vagaries of the markets an autumn on the farm can be interrupted by an Indian summer and a market can stage a strong rally in autumn a sudden freeze can hit the fields in spring and the market can drop early in a bull move a trader needs to use his judgment and apply several indicators and techniques to avoid getting whipsawed the concept of indicator seasons focuses a traders attention on the passage of time in the market it helps you plan for the season ahead instead of jumping in response to other people's actions psychological indicators many private traders keep their market opinions to themselves but financial journalists and market letter writers spew them forth like open fire hydrants some writers are very bright but both groups as a whole have poor trading records financial journalists and letter writers overstay important trends and miss major turning points when these groups become bullish or bearish it pays to trade against them the behavior of groups is more primitive than in visual behavior consensus indicators also known as contrary opinion indicators are not as exact as trend following indicators or oscillators they simply draw your attention to the fact that a trend is ready to reverse when you get that message use technical indicators for more precise timing as long as the market crowd remains in conflict the trend can continue when the crowd reaches a strong consensus the trend is ready to reverse when the crowd becomes highly bullish it pays to get ready to sell when the crowd becomes strongly bearish it pays to get ready to buy the reason for trading against the extremes and consensus is rooted in the structure of the futures markets the number of contracts bought long and sold short is always equal for example if open interest in gold is 12,000 contracts then 12,000 contracts are long and 12,000 contracts are short while the number of long and short contracts is always equal the number of individuals who hold them keeps changing if the majority is bullish then the minority those who are short has more contracts per person than the Long's if the majority is bearish then the bullish minority has bigger positions per person if bullish consensus equals 50 percent then 50 percent of traders are long and 50 percent are short an average trader who is long holds as many contracts as an average trader who is short when bullish consensus reaches 80% it shows that 80 percent of traders are long and 20% are short since the sizes of total long and total short positions are always equal an average bear is short four times as many contracts as are held long by an average bull this means that an average bear has four times more money than an average bull the big money is on the short side of the market when bullish consensus falls to 20% it means that 20% of traders are long and 80% are short since the numbers of long and short contracts are always equal an average bull holds four times more contracts than are held by an average bear it shows that big money is on the long side of the market big money did not grow big by being stupid big traders tend to be more knowledgeable and successful than average otherwise they stop being big traders when big money gravitates to one side of the market think of trading in that direction to interpret bullish consensus in any market obtain at least 12 months of historical data on consensus and note the levels at which the market has turned in the past update these levels once every three months the next time the market consensus becomes highly bullish look for an opportunity to sell short using technical indicators when the consensus becomes very bearish look for a buying opportunity advisory opinion sometimes begins to change a week or two in advance of major trend reversals if bullish consensus ticks down from 78 to 76 or if it rises from 25 to 27 it shows that the savviest advisors are abandoning what looks like a winning trend this means that the trend is ready to reverse several government agencies and exchanges collect data on buying and selling by several groups of investors and traders they publish summary reports of actual trades commitments of money as well as ego it pays to trade with those groups that have a track record of success and bet against those with poor track records for example the Commodity Futures Trading Commission CFTC reports long and short positions of hedgers and big speculators hedgers the commercial producers and consumers of commodities are the most successful participants in the futures markets the Securities and Exchange Commission SEC reports purchases and sales by corporate insiders officers of publicly traded companies know when to buy or sell their company shares the New York Stock Exchange reports the number of shares bought sold and shorted by its members and by odd lot traders members are more successful than small-time speculators traders must report their positions to the CFTC after they reach certain levels called reporting levels at the time of this writing if you are long or short one hundred contracts of corn or three hundred contracts of the S&P 500 futures the CFTC classifies you as a big speculator brokers send reports on positions that reach reporting levels to the CFTC it compiles them and releases summaries once every two weeks the CFTC also sets up the maximum number of contracts called position limits that a speculator is allowed to hold in any given market at this time a speculator may not be net long or short more than 24 hundred contracts of corn or 500 contracts of the S&P 500 futures these limits are set to prevent very large speculators from accumulating positions that are big enough to bully the markets the CFTC divides all market participants into three groups commercials small speculators and large speculators commercials also known as hedgers are firms or individuals who deal in actual commodities in the normal course of business in theory they trade futures to hedge business risks for example a bank trades interest rate futures to hedge its loan portfolio or a food processing company trades wheat futures to offset the risks of buying grain hedgers post small margins and are exempt from speculative position limits large speculators are those traders whose positions reach reporting ervil's the CFTC reports buying and selling buy commercials and large speculators to find the positions of small traders you need to subtract the holdings of the first two groups from the open interest the divisions between hedgers big speculators and small speculators are somewhat artificial smart small traders grow into big traders dumb big traders become small traders and many hedgers speculate some market participants play games that distort the CFTC reports for example an acquaintance who owns a brokerage firm sometimes registers his wealthy speculator clients as edgers claiming they trade stock index and bond futures to hedge their stock and bond positions the commercials can legally speculate in the futures markets using inside information some of them are big enough to play futures markets against cash markets for example an oil firm may buy crude oil futures diverts several tankers and hold them off shore in order to tighten supplies and push futures prices up they can take profits on long positions go short and deliver several tankers at once to refiners in order to push crude futures down and cover shorts this manipulation is illegal and most firms hotly deny that it takes place as a group the commercials have the best track record in the futures markets they have inside information and are well capitalized it pays to follow them because they are successful in the long run the few exceptions such as orange juice hedgers only confirm this rule big speculators used to be highly successful as a group until a decade or so ago they used to be wealthy individuals who took careful risks with their own money today's big traders are commodity funds these trend-following behemoths do poorly as a group the masses of small traders are the proverbial wrong-way Corrigan x' of the markets it is not enough to know whether a certain group is short or long commercials are often short futures because many of them own physical commodities small traders are usually long reflecting their perennial optimism to draw valid conclusions from the CFTC reports you need to compare current positions to their historical norms trading systems the triple screen trading system the triple screen trading system was developed by this author and has been used for trading since 1985 it was first presented to the public in April 1986 in an article in futures magazine triple screen applies three tests or screens to every trade many trades that seem attractive at first are rejected by one or another screen those trades that pass the triple screen test have a higher degree of profitability triple screen combines trend following methods and counter trend techniques it analyzes all potential trades in several time frames triple screen is more than a trading system it is a method a style of trading beginners often look for a magic bullet a single indicator for making money if they get lucky for a while they feel as if they discovered the Royal Road to profits when the magic dies amateurs give back their profits with interest and go looking for another magic tool the markets are too complex to be analyzed with a single indicator different indicators give contradictory signals in the same market trend following indicators rise during up trends and give buy signals while oscillators become overbought and give sell signals trend following indicators turn down in down drains and give signals to sell short but oscillators become oversold and give by signals trend following indicators are profitable when markets are moving but lead to whipsaws in trading ranges oscillators are profitable in trading ranges but give premature and dangerous signals when the markets begin to trend traders say the trend is your friend and let your profits run they also say buy low sell high but why sell if the trend is up and how high is high some traders try to average out the votes of trend following indicators and oscillators it is easy to rig this vote if you use more trend following tools the vote will go one way and if you use more oscillators it will go the other way a trader can always find a group of indicators telling him what he wants to hear the triple screen trading system combines trend following indicators with oscillators it is designed to filter out their disadvantages while preserving their strengths another major dilemma is that the trend can be up and down at the same time depending on what charts who use a daily chart may show an uptrend while a weekly chart shows a downtrend and vice-versa a trader needs to handle conflicting signals in different time frames Charles Dow the author of the venerable Dow Theory stated at the turn of a century that the stock market had three trends the long-term trend lasted several years the intermediate trend several months and anything shorter than that was a minor trend Robert Rhea the great market technician of the 1930s compared the three market trends to a tide a wave and a ripple he believed that traders should trade in the direction of the market tide and take advantage of the waves but ignore the ripples times have changed and the markets have become more volatile traders need a more flexible definition of time frames the triple screen trading system is based on the observation that every time frame relates to the larger and shorter ones by approximately a factor of five each trader needs to decide which time frame he wants to trade triple screen calls that the intermediate time frame the long-term time frame is one order of magnitude longer the short-term time frame is one order of magnitude shorter for example if you want to carry a trade for several days or weeks then your intermediate time frame will be defined by the daily charts weekly charts are one order of magnitude longer and they determine the long-term timeframe hourly charts are one order of magnitude shorter and they determined the short-term timeframe day traders who hold their positions for less than an hour can use the same principle for them a 10 minute chart may define the intermediate time frame an hourly chart the long-term time frame and a 2 minute chart the short-term time frame triple screen demands that you examine the long term chart first it allows you to trade only in the direction of the tide the trend on the long-term chart it uses the waves that go against the tide for entering positions for example daily declines create buying opportunities when the weekly trend is up daily rallies provide shorting opportunities when the weekly trend is down first screen market tide triple screen begins by analyzing the long term chart one order of magnitude greater than the one you plan to trade most traders pay attention only to the daily charts with everybody watching the same few months of data if you begin by analyzing weekly charts your perspective will be 5 times later than that of your competitors a trader has three choices buy sell or stand aside the first screen of the triple screen trading system takes away one of those choices it acts as a sensor who permits you only to buy or stand aside during major uptrends it allows you only to sell short or stand aside during major downtrends you have to swim with the tide or stay out of the water second screen market wave the second screen identifies the wave that goes against the tide when the weekly trend is up daily declines point to buying opportunities when the weekly trend is down daily rallies point to shorting opportunities the second screen applies oscillators to the daily charts in order to identify deviations from the weekly trend oscillators give buy signals when markets decline and sell signals when markets rise the second screen of the triple screen trading system allows you to take only those daily signals that point in the direction of the weekly trend third screen intraday breakout the first screen of the triple screen trading system identifies market tide on a weekly chart the second screen identifies a wave that goes against that tide on a daily chart the third screen identifies the ripples in the direction of the tide it uses intraday price action to pinpoint entry points the third screen does not require a chart or an indicator it is a technique for entering the market after the first and second screens gave a signal to buy or sell short the third screen is called a trailing by stop technique in uptrend and a trailing sell stop technique in downtrend when the weekly trend is up in the daily trend is down trailing by stops catch upside breaker when the weekly trend is down and the daily trend is up trailing sell stops catch downside breakouts when the weekly trend is up and a daily oscillator declines it activates a trailing by stop technique place a buy order one tick above the high of the previous day if prices rally you will be stopped in long automatically when the rally takes out the previous day's high if prices continue to decline your buy stop will not be touched lower your buy order the next day to the level one tick above the latest price bar keep lowering your buy stop each day until stopped in or until the weekly indicator reverses and cancels its buy signal when the weekly trend is down wait for a rally in a daily oscillator to activate a trailing sell stop technique place an order to sell short one tick below the latest bars low as soon as the market turns down you will be stopped in on the short side if the rally continues keep raising your sell order daily the aim of a trailing sell stop technique is to catch an intraday downside breakout from a daily uptrend in the direction of a weekly downtrend proper money management is essential for successful trading a disciplined trader cuts these losses short and outperforms a loser who keeps hanging on and hoping the triple screen trading system calls for placing very tight stops as soon as you buy place a stop loss order one tick below the low of the trade day or the previous day whichever is lower once you sell short place a protective stop-loss one tick above the high of the trade day or the previous day whichever is higher move your stop to a break-even level as soon as the market moves in your favor afterwards the rule of thumb is to move your stop to protect approximately 50% of paper profits the reason for using such tight stops is the triple screen trades only in the direction of the tide if a trade does not work out fast it is a sign that something is fundamentally changing below the surface of the market then it is better to run fast the first loss is the best loss it allows you to re-examine the market from the safety of the sidelines conservative traders should go long or short on the first signal of the triple screen trading system and stay with that position until the major trend reverses or until stopped out active traders can use each new signal from the daily oscillator for pyramiding the original position a position trader should try and stay with a trade until the weekly trend reverses a short-term trader may take profits using signals from the second screen for example if a trader is long and force index becomes positive or stochastic rises to 70% he may sell and take profits and then look for another buying opportunity the triple screen trading system combines different time frames and several types of indicators it uses a trend following indicator with the long term charts and a short term oscillator with the intermediate charts it uses special entry techniques for buying or selling short it also uses tight money management rules channel trading systems prices often flow in channels the way rivers flow in valleys when a river touches the right edge of its valley it turns left when a river touches the left rim of its valley it turns right when traces rally they often seem to stop at an invisible ceiling when they fall they often seem to hit an invisible floor channels help traders identify buying selling opportunities and avoid bad trades channels parallel to trend lines are useful for long-term analysis especially on the weekly charts channels around moving averages are useful for short term analysis especially on daily and intraday charts channels whose width depends on volatility are good for caching early stages of major new trends support is where buyers buy with greater intensity than sellers sell resistance is where sellers sell with greater intensity than buyers buy channels show where to expect support and resistance in the future a channel slope identifies a markets trend when a channel lies flat you may trade all swings within its walls when a channel rises it pays to trade only from the long side buying at the lower wall and selling at the upper wall when a channel declines it pays to trade only from the short side shorting at the upper channel wall and covering at the lower wall when prices rise above the average consensus of value sellers see an opportunity to take profits on long positions or go short when they overpower the Bulls prices decline when prices fall below the moving average bargain hunters step in their buying and short covering by bears lifts prices and the cycle repeats when prices are near their moving average the market is fairly valued when prices are at or below the lower channel line the market is undervalued when prices are at or above the upper channel line the market is overvalued channels help traders find buying opportunities when the market is cheap and shorting opportunities when the market is dear the market is like a manic-depressive person when he reaches the height of mania he is ready to calm down and when he reaches the bottom of his depression his mood is ready to improve a channel marks the limits of mass optimism and pessimism it's upper line shows where bulls run out of steam and its lower line shows where bears become exhausted every animal fights harder closer to home the upper channel line shows where bears have their backs against the wall and fight off the Bulls the lower channel line shows where Bulls have their backs against the wall and fight off the Bears win a rally fails to reach the upper channel line it is a bearish sign it shows that bulls are becoming weaker if a rally shoots out of a channel and prices close above it it shows that the uptrend is strong the reverse rules apply in downtrends channels help traders who use them remain objective when others get swept up in bullish or bearish hysteria if prices touch the upper channel line you see that mass bullishness is being overdone and it is time to think about selling when everyone turns bearish but prices touched the lower channel line you know that it is time to think about buying instead of selling amateurs and market professionals handle channels differently amateurs bet on long shots they tend to buy upside break outs and sell short downside break outs when an amateur sees a breakout from a channel he hopes that a major new trend is about to begin and make him rich quick professionals trade against deviations and for a return to normalcy it is normal for prices to remain within channels most breakouts are exhaustion moves that are quickly aborted professionals like to fade them trade against them they sell short as soon as an upside breakout stalls and by when a downside breakout stops reaching new lows breakouts can produce spectacular gains for amateurs when a major new trend blows out of a channel amateurs occasionally win but it pays to trade with the professionals most breakouts are false and are followed by reversals risk management trading is so exciting that it often makes amateurs feel high a trade for them is like a ticket to a movie or a professional ballgame trading is a much more expensive entertainment than the cinema nobody can get high and make money at the same time emotional trading is the enemy of success greed and fear are bound to destroy a trader you need to use your intellect instead of trading on gut feeling a trader who gets giddy from profits is like a lawyer who starts counting cash in the middle of a trial a trader who gets upset at losses is like a surgeon who faints at the sight of blood a real professional does not get too excited about wins or losses the goal of a successful professional in any field is to reach his personal best to become the best doctor the best lawyer or the best trader money flows to them almost as an afterthought you need to concentrate on trading right and not on the money each trade has to be handled like a surgical procedure seriously soberly without sloppiness or shortcuts emotional traders want certain gains and turn down profitable wagers that involve uncertainty they go into risky Gamble's to avoid taking certain losses it is human nature to take profits quickly and postpone taking losses irrational behavior increases when people feel under pressure emotional trading destroys losers if you review your trading records you will see that the real damage to your account was done by a few large losses or by long strings of losses while trying to trade your way out of a hole good money management would have kept you out of the hole in the first place you can win only if you trade with a positive mathematical expectation a sensible trading system trading on hunches leads to disasters many traders act like drunks wandering through a casino going from game to game slippage and commissions destroy those who over trade the best trading systems are crude and robust they are made of a few elements the more complex the systems the more elements that can break traders love to optimize their systems using past data the trouble is your broker won't let you trade the past markets change and the ideal parameters from the past may be no good today try to deoptimization to bad conditions a robust system holds up well when markets change it is likely to beat a heavily optimized system in real world trading finally when you develop a good system don't mess with it design another one if you like to tinker as Robert rector put it most traders take a good system and destroy it by trying to make it into a perfect system once you have your trading system it is time to set the rules for money management suppose you and I bet a penny on a coin flip tails you win heads you lose suppose you have ten dollars of risk capital and I have $1 even though I have less money I have little to fear it would take a string of 100 losses to wipe me out we can play for a long time unless two brokers get between us and drain our capital by commissions and slippage the odds will dramatically change if you and I raised our bet to a quarter if I have only one dollar then a string of only four losses will destroy me if you have ten dollars you can afford to lose a quarter forty times in a row a series of four losses is likely to come much soon than 40 all other factors being equal the poorer of two traders is the first to go broke most amateurs think that other factors are far from equal they consider themselves brighter than the rest of us the trading industry works hard to reinforce that delusion telling traders that winners get the money lost by losers they try to hide the fact that trading is a minus sum game cocky amateurs take wild risks producing commissions for brokers and profits for floor traders when they blow themselves out of the market new suckers come in because hope springs eternal institutional traders as a group tend to be more successful than private traders they owe it to their bosses who enforce discipline if a trader loses more than his limit on a single trade he has fired for insubordination if he loses his monthly limit his trading privileges are suspended for the rest of the month that he becomes a gofer fetching other traders coffee if he loses his monthly limit several times in a row the company either fires or transfers him this system makes institutional traders avoid losses private traders have to be their own enforcers an amateur who opens a twenty thousand dollar trading account and expects to run it into a million in two years it's like a teenager who runs away to Hollywood to become a pop singer he may succeed but the exceptions only confirm the rule amateurs like to get rich quick but destroy themselves by taking wild risks they may succeed for a while but hang themselves given enough rope amateurs often ask me what percentage profit they can make an ually from trading the answer depends on their skills or lack of such and market conditions amateurs never ask a more important question how much will I lose before I stop trading and reevaluate myself my system and the markets if you focus on handling losses profits will take care of themselves a person who makes 25 percent profit annually is a king of Wall Street many top-flight money managers would give away their firstborn child to be able to top this a trader who can double his money in a year as a star as rare as a pop musician or a top athlete if you set modest goals for yourself and achieve them you can go very far if you can make 30 percent annually people will beg you to manage their money if you manage 10 million dollars not an outlandish amount in today's markets your management fee alone can run six percent of that or six hundred thousand dollars a year if you make a 30 percent profit you will keep 15 percent of it as an incentive fee another 450 thousand dollars you will earn over a million dollars a year trading without taking big risks keep these numbers in mind when you plan your next trade trade to establish the best track record with steady gains and small draw downs most traders get killed by one of two bullets ignorant or emotion amateurs act on hunches and stumble into trades that they should never take due to negative mathematical expectations those who survive the stage of virginal ignorant go on to design better systems when they become more confident they lift their heads out of the foxholes and the second bullet hits them confidence makes them greedy they risk too much money on a trade and a short string of losses blows them out of the market if you bet a quarter of your account on each trade your ruin is guaranteed you will be wiped out by a very short losing streak which happens even with excellent trading systems even if you bet a tenth of your account on a trade you will not survive much longer a professional cannot afford to lose more than a tiny percentage of his would he on a single trade an amateur has the same attitude toward training as an alcoholic has toward drinking he sets out to have a good time but winds up destroying himself extensive testing has shown that the maximum amount a trader may lose on a single trade without damaging his long-term prospects is 2% of his equity this limit includes slippage and commissions if you have a $20,000 account you may not risk more than $400 on any trade if you have $100,000 account you may not risk more than $2,000 on a trade but if you have only 10,000 dollars in your account then you can risk no more than $200 on a trade most amateurs shake their heads when they hear this many have small accounts and the 2 percent rule throws a monkey wrench into the dreams of quick profits most successful professionals on the other hand consider the 2 percent limit too high they do not allow themselves to risk more than 1% or 1.5% of their equity on any single trade the 2% rule puts a solid floor under the amount of damage the market can do to your account even a string of 5 or 6 losing trades will not your prospects in any case if you are trading to create the best track record you will not want to show more than a 6% or 8% monthly loss when you hit that limit stop trading for the rest of the month use this cooling-off period to re-examine yourself your methods and the markets the 2% rule keeps you out of riskier trades when your system gives an entry signal check to see where to place a logical stop if that would expose more than 2% of your account equity pass up that trade it pays to wait for trades that allow very close stops waiting for them reduces the excitement of trading but enhances profit potential you choose which of the two you really want the 2% rule helps you decide how many contracts to trade for example if you have $20,000 in your account you may risk up to $400 per trade if your system Flags an attractive trade with a $275 risk then you may trade only one contract if the risk is only $175 then you could afford to trade 2 contracts what about pyramiding increasing the size of your trading positions as a trade moves in your favor the 2% rule helps here too if you show profit on a trend following position you may add to it as long as your existing position is that a break-even level or better and the risk on the additional position does not exceed 2% of your equity the goal of a successful trader is to make the best trades money is secondary if it surprises you think how good professionals in any field operate good teachers doctors lawyers farmers and others make money but they do not count it while they work if they do the quality of their work suffers if you ask your doctor how much money he earned today he won't be able to answer and if he can you do not want him for a doctor ask your lawyer how much money he made today he may have a general idea that he put in some billable hours but not exactly how many dollars he made if he counts money while he works you do not want him for a lawyer a real pro devotes all his energy to practicing his craft the best he can not to counting money counting money in a trade flashes a red light a warning that you are about to lose because your emotions are kicking in and they will override your intellect that is why it is a good idea to get out of a trade if you cannot get money off your mind concentrate on quality on finding trades that make sense and having a money management plan that puts you in control focus on finding good entry points and avoid Gamble's then the money will follow almost as an afterthought you may count it later well after a trade is over a good trader must focus on finding and completing good trades a professional always studies the markets looks for opportunities hones his money management skills and so on if you ask him how much money he made on the current trade he will have only a general idea of being a little or a lot ahead of the game or a little behind he can never be a lot behind because of tight stops like other professionals he focuses on practicing his craft and polishing his skills he does not count money in a trade he knows that he will make money as long as he does what is right in the markets if you use indicators for finding trades use them also to get you out of trades if your indicators are in gear with the market when it is time to buy or go short use them to decide when it is time to sell or to cover a trader often becomes emotionally attached to a trade profits give people a high but even a loss can tingle the nerves like a scary of an exciting ride on a rollercoaster when those indicator signals that flagged a trade disappear get out of the market fast regardless of your feelings some traders try to establish profit targets they want to sell strength when prices hit resistance or buy weakness when prices reach support Elliot wave theory is the main method for trying to forecast reversal points RN Elliot wrote several articles about the stock market and a book nature's law he believed that every movement in the stock market could be broken into waves smaller waves and sub waves those waves explained every turning point and occasionally allowed him to make correct predictions those analysts who sell advisory services based on Elliott's methods always come up with so-called alternate counts they explain everything in hindsight but are not reliable in dealing with the future Fibonacci numbers and their ratios especially one point six one eight two point six one eight and four point two three six Express many relationships in nature as Trudy garland writes in her lucid book fascinating Fibonacci x' these numbers Express the ratios between the diameters of neighboring spirals in a seashell and in a galaxy the number of seeds in the adjacent rows of a sunflower and so on Elliott was the first to point out that these relationships also apply to the financial markets Toni Plummer describes in his book forecasting financial markets how he uses Fibonacci ratios to decide how far a breakout from a trading range is likely to carry he measures the height of a trading range trades in the direction of a breakout and then looks for reversal targets by multiplying the height of the range by Fibonacci numbers experienced traders combine profit targets with other technical studies they look for indicator signals at the projected turning points if indicators diverge from a trend that is approaching a target it reinforces the signal to get out trading on targets alone can be a tremendous ego boost but the markets are too complex to be handled with a few simple numbers setting stops serious traders place stops the moment they enter a trade as time passes stops need to be adjusted to reduce the amount of money at risk and to protect a bigger chunk of profit stops should be moved only one way in the direction of the trade we all like to hope that a trade will succeed and a stop is a piece of reality that prevents traders from hanging on to empty hope when you are long you may keep your stops in place or raise them but never lower them when you are short you may keep your stops in place or lower them but never raise them cutting extra slack to a losing trade is a loser's game if a trade is not working out it shows that your analysis was flawed or the market has changed then it is time to run fast serious traders use stops the way sailors use ratchets to take out the slack in their sails losers who move stops away from the market vote in favor of fantasy and against reality learning to play stops is like learning to drive defensively most of us learn the same techniques and we adjust them to fit our personal styles the following are the basic rules for placing stops 1 stop-loss order place your stop the moment you enter a trade trading without a stop is like walking down Fifth Avenue in Manhattan without pants on it can be done I have seen people do it but it is not worth the trouble a stop will not protect you from a bad trading system the best it can do is slow down the damage a stop-loss order limits your risk even though it does not always work sometimes prices gap through a stop a stop is not a perfect tool but it is the best defensive tool we have when you go long place your stop below the latest miner support level when you go short place a stop above the latest miner resistance the parabolic system moves the stop in the direction of the trade depending on the passage of time and changes in prices if you use the triple screen trading system place your stop after entering a trade at the extreme of the past two days range avoid all trades were a logical stop would expose more than 2 percent of your equity this limit includes slippage and commissions to break even order the first few days in a trade are the hardest you have done your homework found a trade and placed an order it has been filled and you placed a stop-loss order there is not much else you can do you are like a pilot strapped into his seat for takeoff the engines are blasting at full power but the speed is low and there is no room to maneuver just sit back and trust your system as soon as prices start to move in your favour move your stop to a break-even level when the take-off is completed your flight is at a safer stage now you get to choose between keeping your money or gaining more instead of choosing between a loss and again as a rule prices have to move away from your entry point by more than the average daily range before you move your stop to a break-even level it takes judgment and experience to know when to do it when you move a stop to a break-even level you increase the risk of a whipsaw amateurs often kick themselves for leaving money on the table many amateurs allow themselves only one entry into a trade there's nothing wrong with re-entering a trade after getting stopped out professionals keep trying to get in until they get a good entry using tight money management 3 protect profit order as prices continue to move in your favour you have to protect your paper profits paper profit is real money treat it with the same respect as money in your wallet risk only a portion of it as the price of staying in the trade if you are a conservative trader apply the 2 percent rule to your paper profits this protect profit order is a money stop protecting your equity keep moving it in the direction of the trade so that no more than 2% of your growing equity is ever exposed more aggressive traders use the 50% rule if you follow it half the paper profit is and half belongs to the market you can mark the highest high reached in a long trade or the lowest low reached in a short trade and place your stop halfway between that point and your entry point for example if prices move 10 points in your favor place a stop to protect 5 points of profit if in doubt use the parabolic system to help you adjust your stops when you are not sure whether to stay in a trade or not take profits and reevaluate the situation from the sidelines there is nothing wrong with exiting and re-entering a trade people think much more clearly when they have no money at risk a trade does not end when you close out your position you must analyze it and learn from it many traders throw their confirmation slips into a folder and go looking for the next trade they miss an essential part of growing to become a professional trader review and self analysis have you identified a good trade which indicators were useful and which did not work how good was your entry was the initial stop too far or too close why and by how much did you move your stop to a break-even level too early or too late we're your protect profit stops too loose or too tight did you recognize the signals to exit a trade what should you have done differently what did you feel at the various stages of the trade this analysis is an antidote against emotional trading ask yourself these and other questions and learn from your experiences a cool intelligent analysis does you more good than gloating about profits or wallowing in regrets start keeping a before and after notebook whenever you enter a position print out the current charts paste them on the Left page of your notebook and jot down your main reasons for buying or shorting write down your plan for managing the trade when you exit print the charts again and paste them on the right page of your notebook write down your reasons for exiting and list what you did right or wrong you will have a pictorial record of your trades and thoughts this notebook will help you learn from the past and discover blind spots in your thinking learn from history and profit from your experiences this is Richard Davidson for Wiley Audio thank you for listening this audio book is a co-production of Penton overseas and audio scholar and is based upon the book entitled trading for a living by dr. Alexander elder it is copyrighted in 1993 in the name of dr. Alexander elder and is available in print form from the publisher John Wiley & Sons incorporated audible hopes you have enjoyed this program you

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Length: 180min 2sec (10802 seconds)

Published: Mon Mar 05 2018

Reddit Comments

[u/lilcartivert]

So yes it’s a little long at 3 hrs and the first chapter is a little out-dated but the info included is priceless. If you’re serious about trading highly recommend y’all give this a listen.

[u/rwoooshed]

Use an mp3 converter to rip the audio from the vid and just listen to it on your headset while asleep.

[u/kittensmittens125]

I've listened to this and it's by far the best of the "Learn Day Trading" books

[u/garry_armstrong]

I read this book last year, it’s really great.