The Way to Trade. John Piper
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trade the market on the basis of a precise algorithm, i.e. a precise formula such as used by stochastics, moving averages, etc., then you are dependent on exactly what the market throws at you. In this sense it is such a generator. If, however, you choose to look at something which has “meaning” then the market will not be solely such a generator. However, most of the chart patterns, etc. that are used are fairly meaningless. This is illustrated by two facts:
1 For something to have meaning it has to be right more than half the time. Strictly, the variance from the 50/50 criterion has to have statistical relevance.
2 Very often, no sooner do we see a “pattern” than it aborts. It was never really there in the first place. It just so happens that the market, in its function as a generator of random sequences, is going to throw out all types of “pattern” but that does not mean that they have any meaning.
I became interested in markets via the Elliott Wave Theory (EWT). This is a good example of what I consider fairly meaningless. The theory is general enough that there are going to be lots of random sequences meeting its criterion. Some of them work, some of them don’t. I doubt the ratio is much away from 50 per cent. But I find I am now indoctrinated in EWT, see Appendix 5, so I have learnt to live with it. I now ensure that I only take signals which have something meaningful attached to them – for example, Minus Development from Market Profile (see Chapter 18).
So what does have meaning? In my view the only fact that can be stated about markets is as follows:
Markets move from extreme to extreme across all time frames.
Markets are a manifestation of human psychology. They are driven by fear and greed. Peaks are driven by greed, troughs by fear. This is obvious in the very long-term extremes. Fear is often illustrated, literally, with blood in the street. Greed is so endemic nobody recognizes it for what it is. But stand aside and it becomes obvious. Not so obvious in the shorter term moves, but still there. At the extremes the key point is that price is stretched unrealistically. Why is this? Because traders and/or investors are paying too much, selling too cheaply, because it is an emotional decision. To win you must put yourself outside that emotion.
Extremes are detectable and I have built an array of tactics for spotting them – see Section 2.
Market Profile
There is something else we can use, and this is Market Profile developed by Peter Steidlmayer. The concept is simple and built around the bell curve. A bell curve takes chaos and substitutes order. Market Profile is another way of displaying market action. Other ways are:
1 A quote screen.
2 A bar chart.
3 A tick chart.
4 A Point and Figure chart.
5 Candlesticks.
6 All the various indicators.
All of the above (and others, as this is not meant to be exhaustive) display the same thing in a different way. In all cases you lose some information but other information is highlighted. To an extent this is your first decision point. What is the most useful way for you to look at market action? The answer to this critically important question depends on how you are going to trade and what you therefore need to see to do so. Don’t put the cart before the horse. Decide what you want and then go and get it. Do not get something because someone sells it to you and then adapt yourself to that, it is the wrong way round. Incidentally, modern software is such that you can often have a number of the above all on the same screen layout. My software will give me all of the above on one layout and it is not expensive. But I don’t use them all because I see no need to.
Market Profile has a number of key concepts. To my mind the most important is Minus Development (MD). MD is merely a technique which shows determined buying or selling. It is fairly obvious, as are most useful techniques. Indeed I would say that if it is not obvious why something should work, it probably doesn’t! MD comes in various shapes and sizes, but I consider the most important to be spike highs or lows. In fact most of my own trading is concerned with just these. The key concept is that MD shows where price is swiftly rejected. You want your stop to be beyond such a point, that way it is relatively secure. If you want total security, you had better get out of the market and call in Securicor. Gaps are also a form of MD but I do not like gaps so much because a market will try to close any gaps. There is a simple reason for this: the aim of any market is to maximize trade. You can prove this by looking at who runs the market and how they get paid. In the case of a futures market it is organized and run by the Exchange itself (LIFFE in the case of FTSE, CME in the case of the S&P), the brokers and the market makers. All of these make more money the more trading there is, so that is the aim of their market. In order to maximize trade a market must trade at all levels because there will be buyers and sellers at each of those levels. Or there may be, so the market has to check and see – if it is efficient. So gaps get closed, at least on markets that are actively traded, like the FTSE futures. Not so much on the FTSE cash, because this is just an index, it is not actually traded. In fact since the introduction of the appalling SETS system the FTSE cash no longer leaves gaps.
SUMMARY
The market can be seen as a generator of random sequences, if you follow a precise trading system, that is exactly what it is.
You have got to have commitment to succeed. The road to success has many pitfalls and those who lack commitment will be easily dissuaded.
Markets move from extreme to extreme across all time frames. This is the only absolute truth we have about markets.
Different ways of looking at market action all serve to highlight some information; whilst minimizing or eliminating other elements.
Market Profile and Minus Development are ways of looking at the market which have some meaning and may, therefore, prove more useful than other techniques.
The market is designed to generate trade and maximize it. This is a fundamental fact it is always well to remember.
Chapter 6: DISCIPLINE
The next level of the pyramid is discipline. It is said, and it is true, that without discipline you will be unable to make any progress. The reason is simple and comes in a number of guises. First, without discipline you will be unable to follow your own methodology, you will, in effect, have no methodology. Thus you will be doomed to trade emotionally, and that is not a winning approach. Second, you will not have the self discipline to overcome your own emotions and instincts. So in some ways these two factors overlap, but the second is far more pervasive than simply in operating your methodology.
The big question here is whether you can develop the discipline if you do not have it naturally. I believe that the answer is “yes, you can,” but you must have the necessary commitment to do so.
Clearly discipline can be developed, and you only need to look at an army training program for confirmation of this fact. But it is one thing to have a vast and experienced organization bearing down on you and prepared to do whatever it takes to make its point, quite another to do it yourself in the comfort of your own home, with all the distractions that normally involves. Clearly self discipline is going to be a requirement even to start the process.
However, the market itself is going to be helpful, although not as helpful as it might be. Ultimately undisciplined behavior is going to be punished by the market, either by direct losses or by the loss of profits which would otherwise have been available. So private traders who persevere do have external stimuli that help the process. But the market does not help as much as it might because of the principle of random reinforcement. I will mention this again. It is the market’s tendency to reward bad behavior from time to time. What works one day may not work the next and this applies to the “best” trading practice. Similarly bad habits