The Way to Trade. John Piper
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see sharp moves after a news item, often in the opposite direction to that suggested by the news item itself. This is because the big traders, who got that way by minimizing risk, wait for such risky items as news to be out of the way before taking positions. But what the news actually says is rarely of import – See Chapter 25 on Market Myths. Higher risk times include around news items, overnight and over the weekend, among others. Unexpected news items are something we can do nothing about except minimize risk at all times. We can never eliminate risk and we don’t really want to because without the risk there would be no reward. Traders have to be like tightrope walkers. Many people think that tightrope walkers learn to balance, but they don’t. Instead they learn to live with imbalance, in the same way a trader must learn to live with risk.
This takes us to the three simple rules, which I often call “trading secrets.” You see the best place to hide anything is out in the open where everyone can see it. You see such things all the time but do not realize their value. This is completely true of the three simple rules. You know these well:
1 Cut your losses.
2 Run your profits.
3 Trade selectivity.
These correspond with the three stages which traders go through, although these stages can be described in different ways. The Evolution of a Trader (see Chapter 2) describes these three stages as “greed-orientated,” “fear-orientated,” and “risk-orientated.” These three stages can be linked to the three simple rules. Another way of describing the trading experience can also be linked to three simple rules. This is Emotional to Mechanical to Intuitive, but we are getting a little ahead of ourselves.
In my view any methodology which does not follow the three simple rules is not going to be effective. Having said that, some purely mechanical approaches are reputed to do well, but they would perform much better if you get the trade selectivity right (see again Chapter 25). Only now do we get to talk about market analysis, as we must now look at system parameters. But all the key features are already in place, and once they are in place we will have no real difficulty with system parameters because we will better know ourselves, know how we want to trade, know what we need to trade that way (rather than merely buying the software package with the glossiest brochure or the best sales pitch), and be able to do so – and this final stage should not be minimized.
In my opinion the purpose of analysis is generally misunderstood. It is not for market analysis, it is for putting your system in place. You must decide how you want to trade; futures, options, hedging, long term, short term, are all factors which relate to this. You may decide that you want to trade with the trend and hold trades for between three days and three weeks depending on market conditions. You may decide that some form of trend indicator would be useful within your approach. Alternatively you may prefer to observe market action and draw appropriate conclusions from that, as I do. But whichever style you adopt you need to decide what triggers you into a trade and also how to get out. Personally I leave some of this to intuition, but I am far from perfect in this. But the point I am making is that there is some flexibility at this stage and the key thing is that the system/methodology follows the principles laid down in all the stages of the pyramid up to this point, that it is in accord with your trading personality and what you are trying to achieve.
Once this is the case you have your system and it merely comes down to operation. Now the real problems can start. There is a trader in the USA called Joe Ross. Among many other things, he has said “Trade what you see, not what you think.” This is the key phrase when it comes to operation. So many trades are taken because traders become convinced of what might happen, they imagine the riches which would flow from that big fall, or that big rally. Wisdom lies in sticking with what you can see.
Some traders develop blocks on their trading. I will deal with this in Chapter 13 on Operation. But to introduce this topic, some of these problems have to do with complex thought processes which need to be unravelled, some to do with confidence which can be built through practice, and some to do with past experiences which need to be properly dealt with. Sometimes a trading psychologist can be helpful and there is a chapter on this as well (see Chapter 16).
The top of the pyramid is the result: profits or losses. Sadly most make losses, but this is inevitable. It is one of the conundrums of trading that if everyone was perfect no one would make any money because it is a negative sum game (see Chapter 25). But this is not going to happen because people are emotional animals and many do not want to change that. They provide the fodder for the winners. This book is about how to join that select group, I hope you enjoy it.
SUMMARY
The rules we live by in every day life do not work in the market environment.
We need to construct a separate trading “personality” to succeed in the markets. This personality must learn much greater control over the emotions.
The Trading Pyramid provides the necessary framework for this personality. Each of us will seek a different trading personality, making the most of our strengths and minimizing our weaknesses.
The Trading Pyramid has the following levels:
YOU
Commitment
Discipline
Money management
Risk control
The three simple rules
System parameters
Your system/methodology
Operation
Profits/losses
The structure is organic and each level interrelates with each other level.
Trade what you see, not what you think. (Joe Ross)
Chapter 2: THE EVOLUTION OF A TRADER AND THE 55 STEPS
This chapter describes some other ways of looking at the path traders take to success.
For some years I have set out a simple process which all traders seem to encounter on the road to success. This is detailed below and thereafter I expand this in a way which I feel will be useful for those who want to tread this path.
STARTS OFF “Greed orientated.”
Loses because:
1. Market problems
(a) Not a zero sum game, a “very negative” sum game (see Chapter 25)
(b) Market psychology – doing the wrong thing at the wrong time
(c) The majority is always wrong
(d) Market exists on chaos and confusion.
2. Own problems
(a) Overtrading
(b) No knowledge
(c) No discipline
(d) No protection against market psychology
(e) Random action through uncertainty, broker’s advice for example
(f) Market views.
RESULT: the “greed orientated” trader gets a good kicking and becomes “fear orientated.”
Loses because:
1. Market problems as above
2. Scared money never wins
3. Own problems
(a) Still overtrading – derivatives
(b) Fear brings on what it fears
(c) Tries to cut losses too tight