‘The Psychology of Trading’ Book Review

The Psychology of Trading: Tools and Techniques for Minding the Markets

Author Brett Steenbarger has done a great job with this book. He covers what I personally believe is the most important element in trading: psychology.

New traders will probably not last through their first year in the markets without blowing up their accounts by taking losses too personally. Many times draw downs cause traders to start gambling when they become desperate to recover their losses. Many times increasing position size when they should be decreasing it is an ego-driven desperation to get back their losses. Other similar bad mental behaviors creep into our trading careers as dysfunctions in our personal lives cloud our minds from being able to make the right decisions in following our systems and established trading principles.

What this book shows is how to take the proper perspective and observe our greed and fear, enabling us to see them for what they are instead of getting caught up in these powerful emotions that lead to terrible consequences in our accounts and lives.

This book is a very good book on both psychology and trading. It is packed with lessons from the authors patients and his own experiences. What the book shows is that we are the most important element in our trading. We must have the right mind set in trading, and while developing as a trader we need to keep a log of the emotions we feel on our losses and wins to better understand ourselves and why we make emotional charged decisions that we shouldn’t while trading.

We must continually ask ourselves:

Why did I make that bad trade?
What exactly was I telling myself when I entered it?

This book is about being mindful of our thoughts and emotions while trading. About not being lead blindly by them away from our predetermined trading rules and plans.

Is our low self esteem getting in the way of our trading or is our ego causing us stress and losses? Out of the many trading books I have read I would put this in the top ten with no hesitation. The psychology of the trader is the most important element of trading and often the most neglected in other books. Without the right mind set you can not trade the markets successfully for any length of time. The pressures, stresses, and emotional highs and lows are to much for most traders to handle over the long term. This book is a must read if you are serious about being a profitable trader over the long term.

Discretionary Versus Systematic Trading

The difference between traders that rely on their instincts and chart reading abilities and those who are pure system traders.

Discretionary Traders…

  • …trade information flow.
  • …are trying to anticipate what the market will do.
  • …are subjective; they read their own opinions and past experiences into the current market action.
  • …trade what they want and have loose rules to govern their trading.
  • …are usually very emotional in their trading and taking their losses personally because their opinion was wrong and their ego is hurt.
  • …use many different indicators to trade at different times. Sometimes it may be macro economic indicators, chart patterns, or even macroeconomic news. They are very “flavor of the month” in that regards.
  • … generally have a very small watch list of stocks and markets to trade based mostly off the time on their expertise of the markets they trade.

Systematic Traders…

  • …trade price flow.
  • …are participating in what the market is doing.
  • …are objective. They have no opinion about the market and are following what the market is actually doing, i.e. following that trend.
  • …have few but very strict and defined rules to govern their entries and exits, risk management, and position size.
  • …are unemotional because when they lose it is simply that the market was not conducive to their system. They know that they will win over the long term.
  • …always use the exact same technical indicators for their entries and exits. They never change them.
  • …trade many markets and are trading their technical system based on prices and trends so they do not need to be an expert on the fundamentals.

While discretionary traders are busy trying to digest what fundamental news and information mean, systematic traders are taking the signals they are getting from actual price movement in the market. Systematic traders are not thinking and predicting what the market is going to do, they are reacting to what the majority is doing based on their predetermined system’s entry signals.

For the average trader being a 100% Mechanical System Trader usually maximizes the chance of success in the markets, especially if you are using a historically proven profitable system. If you are removing the emotions and ego out of your trading and are controlling your risk of ruin with proper trade size and stop losses, then you have probability on your side of joining the consistently profitable traders in the market.

Now what sort of trader do you want to be?

The Three Skills of Top Trading

top trading skillsThe Three Skills of Top Trading: Behavioral Systems Building, Pattern Recognition, and Mental State Management by Hank Pruden shows how traders must learn to combine three crucial skills in the markets to become a top trader.

Pattern Recognition and Discretionary Trading

The author uses the Wyckoff method to show chart representations of how hot stocks are accumulated in bases for long periods of time, eventually have pull backs, and then break out to new highs. You will learn to recognize the patterns of how they eventually have exhaustion tops that fail to rally and they begin to break down as sellers rush in to distribute their holdings.

The patterns in this book will be nothing new for traders who have studied William O’Neil and the Investor’s Business Daily methodology of trading winning stocks, but reinforcement is always a good thing. The author encourages traders to use discretionary trading to profit from the markets repeating patterns of accumulation and distribution, however chart reading experience is required to be able to identify market action through the past models.

Behavioral Finance and Systems Building.

You must be flexible in your trading – you must bend so you do not break your account. When you are wrong you must sell and not allow your mistakes to hurt your trading capital. You are merely a tiny ship on the ocean of market opinion. The book suggests that top traders have learned to follow the trend by trading with the prevailing sentiment during the middle of the the trend, they then go contrary to it at the extreme tops and bottoms.

Hope, fear, and greed are the most influential movers of the market and are capable of moving the markets in many ways. The price action of the stock market is nothing more than a manifestation of crowd psychology in action. Like bullets, prices never lie. The Pruden model shows a chart of how accumulation, mark-up, distribution, works in the market tied to price, volume, sentiment, and time. It attempts to explain how the market for growth stocks work.

The Ten Tasks of Top Traders: 

  1. Daily self analysis:   Successful trading is 40% risk control and 60% self-control.
  2. Daily mental rehearsal:   Practice being disciplined in your mind before you trade daily.
  3. Developing a low risk idea:   Trade with the odds on your side with a defined risk.
  4. Stalking:   Wait for the entry. Utilize patience and don’t pull the trigger to soon.
  5. Action:   Take the entry when the signal is hit. Do not freeze up. Be definitive.
  6. Monitoring:   Keep an eye on what is happening with your position.
  7. Abort:  Be ready to cut your losses, when you are wrong and hit your stop loss.
  8. Take profits:  Use trailing stop or profit target when one is hit. Allow the market to take you out.
  9. Daily briefing:   Think through your trading & what you did right/wrong based on your trading plan.
  10. Periodic review:   Is your trading working? Do adjustments need to be made?

Pruden’s book also explains the principle of the “Composite Man”, it is much like Benjamin Graham’s “Mr. Market”. It explains that you must think of the market as one big trader you are trading against. Your job is to understand how he is trading to adjust your trading accordingly to be profitable trading off his greed and fear.

Top Trading is a key book for all traders who truly want to be successful in the markets, dig into the psychology of trading, and is a great guide to taking someone from a trader to a Top Trader.

Losers Don’t Belong in Your Life

 

 Asher Isbrucker
Asher Isbrucker

I never understood why traders held losing trades for too long. Our goal is to make money, isn’t it? And yet, we’ve all held onto something negative for too long;  a losing trade for a few days, a bad marriage for a decade, smoking for a couple of decades, or any number of other things that make us consistently unhappy.

Cutting your losses is not just for traders. This philosophy can be applied to just about every area of your life. While I typically talk about this in a financial context, it also relates to relationships, health, jobs, nutrition, and habits.

If you stay in a losing ‘situation’ of any kind for too long, you limit your future probabilities. Every day that you stay mired, you decrease your chances of finding something that is right for you. So the question becomes, how do you know when it has been too long? Do you face the fear of letting go and make a change for the better?

If a specific behavior is not taking you in the direction of success then you are going toward failure. If you are not profiting from a situation today, then what makes you think you will profit from it tomorrow? Life is all about trends, and trends typically continue in the direction they are traveling. If our lifestyle today is making us unhappy, the odds are that we will be unhappy with it again tomorrow and the next day. We have to consciously stop doing what causes the loss of our happiness and move toward what brings us joy.

  • In relationships, the biggest mistake is that people hope that their partner will change, rather than evaluating the status of their relationship.
  • In health, our habits toward exercise and diet must improve in order for us to see better overall wellness. 
  • Professionally, staying in a bad job and not looking for the right opportunity, eats away at our happiness and wastes precious years.

One of the most powerful habits we can develop in our lives is the ability to cut our losses short. By eliminating a losing situation, we can put all our energy and time into a winning opportunity. Typically, when a person’s ‘pain of same’ exceeds their ‘pain of change’, they will do something positive for themselves and their future. If we can expedite the process and cut losses when we know that we are wrong, we conserve our time. Time is our most valuable resource, and it can’t be recovered once lost.

People fail to achieve their life goals because they allowed their path to success to be blocked by a log. Instead of removing the log from their path, they stayed on the wrong side of it, unwilling or afraid to change. They thought they loved the log. The log was good enough for them. What if they got rid of the log? Would the next log be any better? The log was more comfortable than traveling any further down an unknown road.

Our fear is that we may leave a bad situation, only to end up in a worse one. Our greatest fear should actually be that we waste or lives staying with losers, when the winners are on the other side of the log. We just have to move it out of the way.

10 Great Technical Trading Rules

 

 

“We learned just to go with the chart. Why work when Mr. Market can do it for you?” – Paul Tudor Jones

Only price pays. In trading, emotions and egos are expensive collaborators. Our goal as traders is to capture price moves inside our time frame, while limiting our drawdowns in capital. The longer I have traded, the more I have become an advocate of price action. Moving away from the perils of opinions and predictions has improved my mental well-being, and my bottom line.

In developing a trading system of your own, you must begin with the big picture. First, look at the price action and then work your way down into your own time frame. You need to create a systematic and specific approach to entering and exiting trades, executing your signals with the right trailing stops, setting realistic price targets and position sizing, and limiting your risk exposure. Relying on fact, rather than being tossed around by your own subjective feelings, will insure your long term profitability.

Here are 10 great technical trading rules that will help you build a systematic approach to trading:

  1. Start with the weekly price chart to establish the long term trend, and then work down through the daily and hourly charts to trade in the direction of that trend. The odds are better if you are trading in the direction of the long term trend.
  2. In Bull Markets, the best strategy is to buy the dips. In Bear Markets, the best strategy is to sell short into each rally. Always go with the path of least resistance.
  3. Support and resistance levels can hold for long periods of time; the first few breakout attempts usually fail.
  4. The more times a support or resistance level is tested, the greater the odds that it will be broken. Old resistance can become the new support, and the old support may become the new resistance.
  5. Trend lines are the easiest way to measure trends by connecting higher highs or lower lows, and they must always go from left to right.
  6. Chart patterns are visible representations of the price ranges that buyers and sellers are creating. Chart Patterns are connected trend lines that signal a possible breakout buy point if one line is broken.
  7. Moving averages quantify trends and create signals for entries, exits, and trailing stops.
  8. Moving averages are great tools for a trader to use, but they are best used along with an overbought/oversold oscillator like the RSI. This maximizes exit profitability on extensions from a moving average.
  9. 52 week highs are bullish, and 52 week lows are bearish.  All-time highs are more bullish, and all-time lows are more bearish.  Bull Markets have no long term resistance, and Bear Markets have no long term support.
  10. Above the 200 day is where bulls create uptrends. Bad things happen below the 200 day; downtrends, distribution, bear markets, crashes, and bankruptcies.

Originally posted on www.seeitmarket.com