Bear Mountain Bull

If you’re new to the trading world - or even if you’re not - here’s some solid advice from Dave Landry. This is just the beginning - make sure you read the whole thing:

I don’t have any medical training whatsoever but I think tomorrow I’m going to be a surgeon. I’ll pick up some knives tonight and open an office in the morning.

Obviously, no one would ever attempt this (even if there weren’t laws in place to stop you). However, in trading, this happens all the time. The barrier to entry is very low. All you need is a computer and a trading account. That’s it! Now you’re a “trader!” Well, obviously, it’s a little more complicated than that. My point is, even though it’s easy to become a “trader”, it must be approached like any other profession. You’ll need education and more importantly, you’ll need experience.

Getting started:

You’ll need a methodology

Keep it simple

In spite of numerous claims, NO ONE knows exactly what a market will do next. It’s an odds game at best. Simple methods can and do work—but NO methods work ALL of the time.

I follow a fairly simple trend following methodology. It works very well when the market is trending and not so well when it’s not. This doesn’t mean its right for you. It’s just what works best for me after years of “chasing rainbows.” This brings us to our next point.

Study It

Study methods historically. Make sure you look at them in both good times and bad. I’m often approached by those who have discovered a “new methodology.” They’ll send me countless examples of how well it would have worked based on historical charts. However, when they go to implement it in the real world, they often lose money. Why? Assuming they are disciplined and using proper money management, it’s possible that they failed to observe all the times the methodology did not work. The historical big winners tended to “jump out” at them but the multiple small losing trades went un-noticed.

Make sure you can implement it

Once you do find something, make sure you can implement it. If you have a busy career, don’t attempt to day trade.

If you’re smart, I have some bad news

If you’re an Engineer, a Lawyer, a Doctor, or any other highly educated or skilled professional, I have some bad news: It’s going to take a little longer. Your profession was likely approached with a high degree of logic. Therefore, you’ll probably assume that markets are no different. However, often there is no logic. Markets trade off the emotions of the participants.

You’ll Need To Understand Psychology

Know yourself

The battle is often from within. Finding a methodology is (fairly) easy. Having the discipline to implement it is not. Once your money is “on the line” things become much more stressful. If a trade isn’t working out right away, you might be inclined to “pull the plug.” You then watch in agony as the market takes off without you. On the flip side, you might be inclined to stay with a losing position long after your methodology would have exited. You’ll then watch in agony as your losses grow and grow.

It’s beyond the scope of this article to cover all the psychological pitfalls you’ll face as a trader. Therefore, make sure you study trader’s psychology as hard as you study your charts.

Don’t forget to check out Dave’s daily “Market In A Minute” (produced every market morning) and weekly “The Week in Charts” video presentations, the links to which can be found on his website.

Becoming a good trader doesn’t happen overnight. Just as with any other skill or discipline, it requires time and practice to become proficient at it:

One of the biggest problems I see new traders struggle with is the mindset that somehow trading can be approached differently from other ventures or activities. This is something which either comes from too much focus on the prospects of profits and easy wealth building (greed, in short) or from just not considering that it is an activity which requires skill to do well.

In Enhancing Trader Performance, Brett Steenbarger talks about trading as a performance activity. He relates it closely to athletics, but you could very easily extend the metaphor to any other activity which takes time and effort to progress in skill. The point is that you cannot expect to just jump right in and be an expert. You must progress through stages of understanding, competence, and experience.

Trading is easy. I mean pointing and clicking to buy and sell is about at simple as it gets.

Playing guitar is easy too. Just pluck or strum. No one thinks they are going to pick up a guitar and become the next Jimi Hendrix, though. They know it takes hours and hours of practice to develop even a basic ability to play, nevermind getting to the point of having people pay to listen to you.

Why do people think that things are different in trading?

Good trading requires learning and practice - just like anything else you want to get good at. There are no quick solutions. Don’t expect them, and don’t let anyone lead you to believe that there are.

And after hitting a couple of buckets of balls, you’re still no Tiger Woods.

At Chart Swing Trader, Mac looks back over his first quarter of trading for the year, and has some valuable (in my opinion) thoughts to share on the challenges of trading:

As we end the first three months of the year, one thing I wanted to do for my own personal growth as a trader was to examine my trading so far this year and what I need to do to be better. Obviously this has been a very difficult environment to trade in, even for bears, since the middle of January. I have been bearish throughout the year, but that bearishness has not always paid off as well as I had hoped. I am still up overall for the year, but not nearly as much as I was after January 22. Some lessons hopefully learned so far include:

• Overtrading is a recipe for disaster - I have definitely been guilty of this so far this year. I had nice positions that I closed early because I couldn’t sit still, and I took bad positions because I couldn’t sit still. I go back to what I saw in a Dan Zanger interview when he said the market presents about three or four money-making opportunities per year that allow you to make tremendous returns, and the rest of the time is just choppy trading that cause most traders to lose a significant amount of money. January 1 to January 22 was one of those nice opportunities to make money if you were short, and I don’t think we’ve had one since. Perhaps this just takes time to learn and as I progress, I will be able to recognize these profitable times and also show the discipline to sit on my hands if there is no real edge to be found.
• Emotional trading is a recipe for disaster - Looking at my gains and losses for the year, I have noticed that many of my losses came from trades that were taken during the middle of the day or from trades in which I changed my original plan after the trade was taken. I am really focusing on making trades only at the end of the day and also not watching the intraday action too heavily, especially in a volatile environment like February. I also need to do a better of job of setting stops and sticking to them, rather than adjusting them after the trade has been made, which usually just led to bigger losses.
• Avoid trading right before or right after decisions by the Fed - for some reason, I thought it would be smart to make a lot of trades around January 30-31. I closed a total of nine trades those days, and only two were winners. Several were stocks I was stopped out of the same day. These days of course correspond with the first Fed decision about interest rates, which led to an extremely volatile trade that I would have been much better off staying completely away from. I plan on doing this from now - I will not be making any new trades during the few days after Fed decisions, at least not in the current environment.

Basically, I feel I am putting in the necessary work to be a successful trader, and I feel my chart-reading abilities are fairly strong, although I can still improve in both areas. I still need to tighten my overall system and trust some of the indicators I use more. For me, it is still some of the psychological difficulties that I am having, and I know those are issues for many traders. You can’t become a master trader until you’ve mastered trading psychology, trading discipline, and your own personal emotions. These are the hardest skills to develop and master, but I will keep working on them and hopefully improve as we enter this second quarter.

Well said Mac. Thanks for sharing those thoughts!

Gary Kaltbaum, on his radio show today:

“Take your time. There are moments in time where you walk into the market and you open up the chest, and there’s a ton of treasure in there. Then there are times you open up the chest, and you get skeletons. And then there are times you open up the chest and it looks good — and then the next day it doesn’t.

Do not ‘over take‘ what the market is giving — or it’s going to carve you up like there’s no tomorrow. And that’s what this market has been about.”

We’ve talked about this subject before here at BMB, and you know that our mantra is to “Never Lose Big”.

To avoid big losses in the market — and to protect profits — you need to learn to sell. Here’s Gary Kaltbaum on his radio show today:

You know, once you’re down 25-30 percent, you’re in that emotional ‘web’. That you think, “Man, it’s gotta come back”, and you know, “if it just comes back a little bit, I’ll sell”, and then it doesn’t and then you’re down 40 percent. And then it comes back to only down 30 percent, and you’re saying “ok, I’m going to sell it when it comes back to down only 20 percent”, and then it goes right back down.

And then once you’re past 50 and 60 percent, you know what you say to yourself — you know the words, you’ve had it happen to you before, right? “Aaah, screw it, I don’t care if goes to zero!” Right? Isn’t that what you say once you get into ‘the web’?

So don’t let that happen to you. There’s a simple word to protect yourself from big losses in the market. Easy word — “Sell.” “Sell.”

Another ‘trading truism’, seen in the Schwab ad at the top of the page on Minyanville:

“It’s not how much you make trading. It’s how much you hold onto.”

Indeed. Risk management and capital preservation skills are key, especially in difficult times like these.

Good stuff — Quint Tatro on how to recover from those rough times, when the trading gods have decided to knock you down:

Sometimes in trading you have to pick yourself up and dust yourself off. It is the simple truth and anyone who has been involved in the game for longer than a cup of coffee will tell you the same. There will be times when you are caught with a blow up, caught in a squeeze or simply caught leaning in the wrong direction but over the years what I have learned is it is always about getting back into the ring for another round.

—

It’s important to have a routine for handling those times when not only your financial capital gets bitten but your emotional capital sinks as well.

1) Reposition:  Whether you are caught in a downturn or short squeeze, removing the position is often the best way to remain objective. So often when people start to see a position run against them they freeze up and start to rely on hope rather than remaining in control of the trade. When I see stocks breaking down or acting poorly, they are sold immediately and I am able to start fresh.

2) Check the Charts and your Bias:  I have written many times before that price action is never wrong. If you are caught on the wrong side of price action it is a must to re-evaluate the charts you are viewing and check any bias you may have. It is imperative to embrace the prevailing direction and avoid seeing what is not there. Having raised cash and avoiding any further significant draw, take a fresh look at the action and once again analyze your position accordingly.

3) Embrace the New Day:  Trading is unique in that each and every day presents a new opportunity. This must be embraced as it is one of the features that makes trading so great. Rather than dwelling on the past, embrace the future. Each and every day presents new opportunities but not unless you are looking for them.

4) Move Slow and Small:  Most people make the mistake in believing that restoring financial capital will improve emotional capital when I would argue it is actually the opposite. One can only trade at peak performance when his emotional tank is filled and confidence is high. Regardless of how long you have been trading there will be times when this tank takes a dip and before moving on to make any new financial progress, it is imperative to restore the emotional side first. The best way to do this is to move very slow and small. Rather than taking full positions, take quarters or even tenths. Paper trade if you need to and analyze results. As time goes on your emotional capital will be restored and you will soon have the confidence to re-enter the game at full speed.

If you trade, one thing is for sure, you will have good times and you will have bad times. The best way to handle the bad times is to know they will come and have a plan in place to follow so that you may bounce back quickly and put them in the past.

Some interesting stuff on what makes an ‘expert’ trader, from Brett Steenbarger via The Big Picture:

What makes an expert? And how can traders develop their own expertise? Three elements:

1) “Measures of general basic capacities do not predict success in a domain”
Experts cannot be distinguished by superior intellects or other cognitive talents.

2) “The superior performance of experts is often very domain specific and transfer outside their narrow area of expertise is surprisingly limited”

Being an expert in one domain does not predict expertise in others; a person can be a highly accomplished trader, but not expert in other areas. Think “niche” — the successful trader has found a particular sphere of success that expresses his skills and interests.

3) “Systematic differences between experts and less proficient individuals nearly always reflect attributes acquired by the experts during their lengthy training”

The expert is one who has undergone a structured, deliberate process of training that builds competencies, offers extensive feedback, and draws upon intensive effort over time to internalize knowledge and skills.

So what might this mean? Here are the good doctor’s conclusions:

1) The majority of traders are looking for expertise in all the wrong places. Learning to trade does not involve finding magic indicators or systems.

2) The vast majority of offerings in trader education are not structured for expertise development. Seminars, books, Web articles and blogs, weekend courses–all can be useful in imparting information. But expertise development is not simply about the accumulation of information; it is about skill development under realistic, challenging conditions.

3) Most traders fail because they never enter a path of expertise development. What does a trader need to progress from being a novice toward becoming competent toward exhibiting expertise? A curriculum: a structured process, that begins with information and understanding and then progresses steadily through skill development.

Then there’s the way Dave Landry puts it:
- Trading is all about making decisions.
- Making good decisions comes with experience.
- Experience comes from making bad decisions.

In John Hussman’s column this week, he’s got some interesting commentary on bear market behavior — reminders of how bear markets work, what they look like, and what they feel like — just in case we’ve all forgotten, less than ten years removed from one of the worst in history:

…as I’ve frequently noted, most bear markets are not simply one-way movements. Bear markets typically comprise two, three or more separate 10-20% declines, punctuated by fast, furious rallies. It’s easy to forget that the 2000-2002 bear included three bear market advances of 20% from intra-day low to intra-day high, as well as numerous smaller advances, all of which were surrendered in subsequent plunges to new lows.

This is a good time to review what bear markets look like, because even though our own focus is always on the prevailing Market Climate, an understanding of how such market periods evolve can be helpful in riding one out. As I wrote in April 2000, bear market psychology typically evolves something like this:

“This is my retirement money. I can’t afford to be out of the market anymore!”

“I don’t care about the price, just get me in!!”

“It’s a healthy correction”

“See, it’s already coming back, better buy more before the new highs”

“Alright, a retest. Add to the position - buy the dip”

“What a great move! Am I a genius or what?”

“Uh oh, another selloff. Well, we’re probably close to a bottom”

“New low? What’s going on?!!”

“Alright, it’s too late to sell here, I’ll get out on the next rally”

“Hey!! It’s coming back. Glad that’s over!”

“Another new low. But how much lower can it go?”

“No, really, how much lower can it go?”

“Good Grief! How much lower can it go?!?”

“There’s no way I’ll ever make this back!”

“This is my retirement money. I can’t afford to be in the market anymore!”

“I don’t care about the price, just get me out!!”

—

The following are actual figures and headlines from the 1973-74 bear market. At the January 1973 market peak, earnings had hit a new high, and stock prices were selling at a P/E multiple of 20, which is extreme on the basis of record earnings. Over the next 2 years, corporate earnings grew by 56%, yet the market fell by half. The 73-74 bear market teaches that stock prices can decline from rich valuations even if earnings grow dramatically:

Suppose you own stock. You have decided to be a “long term investor.” Stock prices rise to a new all-time high. You feel vindicated. The economy looks great. Although market breadth has deteriorated, your commitment is firm. “I can’t afford to keep my life savings out of the stock market.” “Buy-and-hold” is your motto.

Then, after a modest rise in interest rates, the market sells off -12.3% in just over 2 months time. Ouch. A correction. Buy on the dip. These things happen from time to time. You’re a long term investor. Buy-and-hold is your motto.

Sure enough, prices recover. Somewhat. A 4.8% advance, but already, you think, you’re on your way to new highs again. Then, you lose it all in a -10.2% decline. Two months later, you’ve given back your advance, and you’re at a lower low. Alright, another correction. Maybe you buy on the dip. Bargain prices. Buy-and-hold is your motto.

And it’s already paying off. A month later, you’re up 7.8% from the low. But then a -9.1% selloff takes your portfolio even lower than the first two drops. The market is down -19% overall. You start to question the amount of risk you’re taking, but how much lower can it go?

Thank goodness. 15.8% advance over the next few months! Should have bought more on the last decline. Earnings are still growing strongly. You decide not to wait. You buy more on the advance, confident that you’ll be rewarded by new highs. Then the market plunges -20% over the following 4 weeks. You stare at your statement and feel sick. You’ve held on for a year and your reward is a new low in your portfolio. This really is a bear market.

Now some volatility. Up 12% over a few months. Then you lose it all a few months later in another decline. Then another 11% advance, followed by a -12% plunge to a new low. Seven times now, you’ve seen your portfolio collapse by more than -10%. With every recovery, a fresh disappointment. And the months march on. It’s a year and a half since the peak. You’ve lost nearly 30% of your wealth. Price/earnings ratios look low, but they looked low before the last decline, too. But maybe it’s the bottom. After all, the average bear market takes stocks down about 30%. Holding your calculator, you realize how that works. A -30% decline wipes out a 43% gain. Didn’t really consider that at the top.

Stocks rebound a little over the next month. Just 6%. You’re still clinging to the bottom. Then, the bottom drops out. Not just 10%, or 15%, but a real free-fall. Over the next 6 weeks your portfolio plunges by -27%. You’re another -23% down from the previous low! Almost 2 years of nothing but losses! Major ones. You’ve lost almost half your retirement, now. Half your life savings! And the economy has turned bad. Everybody knows that stocks were overpriced at the top! It was so obvious! Greed. Valuations were so high. Everyone was so optimistic. Why didn’t you see it at the time? You decide you can’t afford the risk. Sell half. See if things recover, then get back in.

Well, prices do recover. More than 15%. But then you lose it all in another selloff! Another new low! The market has lost half its value! Nine major plunges. Nearly every one to a lower low, and getting worse. This market has no support. Where are the buyers going to come from in an economy like this? People are unemployed. They don’t have the income to invest! And certainly not in the stock market. The financial headlines trumpet “The Real Recession is Yet to Come”, and “The Coming Dividend Crisis.” Some of the less diversified mutual funds are down as much as -80% from their highs! 80%! Every $100 has collapsed to $20. If it could happen to them, it could still happen to you. This is too risky. After all, you think, “I can’t afford to keep my life savings in the stock market.”

“Better safe than sorry” is your motto.

That’s what a bear market feels like, but we all have a tendency to forget. Though my impression is that the market is at less risk here than it was before the 1972-74 or 2000-2002 declines, it’s glib to believe that rich valuations on record profit margins can be fully corrected by a 15% market decline, after which stocks will again be off to the races. As always, we’ll take our evidence as it arrives. For now, we remain fully hedged.

More good trading advice from Quint Tatro today:

I am not so sure people would believe me nor give me much credibility if my common theme was “Making money in the market is easy.” The irony of it all is that I feel making money in the market is easy but keeping it is the hard part.

Whenever I meet a new trader my primary goal is to impart to them what I have learned over the years to help them grow, but my job as a teacher is much easier if a person can simply stick with trading long enough to experience a few market cycles. The bottom line is that when you are a trader there will be certain times when the moons align and stocks do exactly as you desire them to do.

Then, all of a sudden, out of the clear blue, things change. Reversals set in, stocks that went up every day now fall back to Earth and the general mood abruptly shifts from euphoria to disgust.

—

We have all met a person that tries their hand at trading during one of these euphoric cycles, putting some capital on the line only to see it grow rapidly. They increase their exposure, not understanding risk management, and sooner or later they are squashed like a little bug when the market turns on them. Unfortunately, when a person goes through this cycle they are often done with trading forever. They immediately feel as if the game is rigged against them and trading stocks is a sucker’s play.

Markets have and always will move in cycles. The key for every trader is to first realize, recognize and respect this choosing to trade with the trend or go with the wind at your back. If you favor the long side, as most do, then learning when to step aside and let the market run its course is extremely valuable.

Jessie Livermore, one of the greatest traders of all time, used to say that “you can beat a horse race, but you can’t beat the races.” He would often say this as he was preparing to embark on one of his many trading vacations when he simply didn’t have an edge on the market.

Dave Landry says that every trading methodology has its “sweet spot”. Knowing and understanding your methodology, knowing when it works best, and when it doesn’t work well is key to trading that methodology successfully, regardless of the method. If you’re a trend follower, for example, choppy markets will be very difficult for you. Being able to recognize those difficult market environments will help you, and allow you to back off and preserve your capital by trading smaller or not trading at all.

One of the hardest things for a trader to do is to stop trading. The general understanding is that successful traders are always in motion, seeking out trades long, short or a mix of both. While there are many who follow this path, the most successful traders I have ever come across know when to play and when to sit. They have no desire to risk hard earned gains or deplete unnecessary capital when the market does not favor their style.

The biggest challenge for participants is to actually recognize when these trends are changing. I have often found that probing individual stocks is the best method for learning of what the market is truly doing but it can also be an extremely dangerous thing to do as small losses can mount creating substantial damage.

Typically, whenever I start to see trades not act as I would desire them to, I immediately reduce my position sizing dramatically. I will continue to incur small nicks but I seek to limit them and chalk them up to research expenses.

From Guy Lerner, of The Technical Take, comes this excellent commentary:

11 Rules For Better Trading In 2008

Trading in the markets is a process, and there is always room for self improvement. So as we start the new year, here are my 11 rules that help me navigate the markets. By no means is this list exhaustive or exclusive.

Rule #1
Be data centric in your approach. Take the time and make the effort to understand what works and what doesn’t. Trading decisions should be objective and based upon the data.

Rule #2
Be disciplined. The data should guide you in your decisions. This is the only way to navigate a potentially hostile and fearful environment.

Rule #3
Be flexible. At first glance this would seem to contradict Rule #2; however, I recognize that markets change and that trading strategies cannot account for every conceivable factor. Giving yourself some wiggle room or discretion is ok, but I would not stray too far from the data or your strategies.

Rule #4
Always question the prevailing dogma. The markets love dogma. “Prices are above the 50 day moving average”, “prices are breaking out”, and “don’t fight the Fed” are some of the most often heard sayings. But what do they really mean for prices? Make your own observations and define your own rules. See Rule #1.

Rule #5
Understand your market edge. My edge is my ability to use my computer to define the price action. I level the playing field by trading markets and not companies.

Rule #6
Money management. Money management. Money management. It is so important that it is worth saying three times. There are so few factors you can control in the markets, but this is one of them. Learn to exploit it.

Rule #7
Time frame. Know the time frame you are operating on. Don’t let a trade turn into an investment and don’t trade yourself out of an investment.

Rule #8
Confidence and conviction. Believe in your strategies and bet wisely but with conviction. There is nothing more frustrating than having a good strategy work as you expect, yet at the end of the day, you have very little winnings to show for your efforts.

Rule #9
Persistence. It takes persistence to operate in the markets. Success doesn’t come easy, and if it does, then I would be careful. Even the best strategies come with losses, and they always seem to come when you get the nerve to make the big bet. Stay with your plan. If you have done your home work, the winning trades will follow.

Rule #10
Passion. In the end, trading has to be about your bottom line, but you have to love what you do and no amount of money is worth it if you aren’t passionate about the process. No matter how much success you enjoy, in the markets you can never stop learning.

Rule #11
Take care of yourself. No amount of money is worth it if your health is failing or you have managed to alienate yourself from family and friends in the process.

The pointer comes via The Big Picture. Thanks Barry. Great stuff.

From Barry Ritholtz, of The Big Picture fame, comes a list of thirteen “Lessons from 2007″.

Here are the bullet points - go check out the full column for Barry’s ‘elaboration’:

• Ignore market rumors
• Buy sector strength (Corollary: avoid weak sectors):
• Never blindly follow the “Big Money” (a/k/a Professionals make dumb mistakes also):
• Day-to-day stock action is noise
• P/E matters less than you think
• Ignore deteriorating fundamentals at your peril
• Nothing is more costly than chasing yield
• Know what you own
• Simple is better than complex
• Stick to what you do best
• Fess up!
• Risk management matters
• The Trend is still your friend

For all of you traders out there putting together your New Year’s resolutions, here are some thoughts on trading psychology from Joe Ross at TradingEducators.com:

Ask many experienced traders to describe their most profitable trade, and you’ll hear a fantastic story. It’s usually purely chance. I know it was that way for me on a number of occasions. For example, the trader may have been going long on a large position when suddenly a report came out that shocked the market. Prices shot up as the public heard the news, and the trader made a killing. These stories are thrilling. They inspire you to sharpen your trading skills and master the markets. Who doesn’t want to be at the right place at the right time? But if you want to be a profitable, consistent trader, you can’t sit around waiting for a fantastic trading opportunity to present itself. Most of the time, trading is about making trade after trade to the point that it seems boringly routine. Rather than seek out big, exciting trades, it’s important to remember that small trades matter a lot.

As thrilling as big trades seem to be, it’s the smaller trades that keep you in business. It’s not unusual for traders to feel they have reached a plateau when trading. They make trade after trade and little seems to happen. They don’t suddenly find the Holy Grail of trading and achieve the great wealth and status they’ve dreamed about. Whether they realize it or not, however, they are still making progress. Each new observation of the market, each trade they execute, no matter how small, adds to their wealth of knowledge. They intuitively learn what to do and what not to do. They may see a slight variation in chart pattern that creates an inefficiency in price and learn just how far the pattern can deviate from the norm and still forecast the most likely movement of prices. On another day, they may learn a new way to place a protective stop so that they protect their risk, yet don’t get stopped out prematurely. These small everyday, seemingly insignificant experiences matter a lot.

Trading is challenging. Few survive trading over many years. The traders who do survive, however, know how to stay focused and patient. They don’t go for quick thrills, and unrealistically huge profit objectives. They know that losing is easy and can happen in the blink of an eye, but rebuilding capital usually takes a lot of work over a long period of time.

Instead of going for risky, exciting trades, you must seek out high probability setups, take steps to protect your capital, and execute your trades decisively, according to your trading plan. You may not have an exciting tale to brag about, but you take home steady profits–you get paid to trade. And when you make trade after trade, the small profits add up, and you end up with big profits in the end.

So when you feel that your earnings have reached a plateau, don’t get discouraged. As long as you are making profits, and staying in business, you’re continuing to develop your trading skills. You’re adding to your knowledge base. You’re developing a more intuitive feel for how the markets operate. It may not seem like you’re making the profits of a trading wizard, but if you keep at it, you’ll be one of the rare few that join the ranks of winning traders.
__________________

Trade what you see, not what you think!

Quint Tatro says that, in trading, you need to have rules and stick to them - because your emotions can’t be trusted:

In my studies I have often found something that is rather interesting and maybe different than most would suspect. The most successful traders I have studied don’t rely on gut calls or feels, but rather adhere to a disciplined set of rules or guidelines and are humbled enough to admit that their emotional decisions aren’t consistent enough to hold up during the heat of the moment.

Ironically, most would think just the opposite that the more successful a trader is, the more ‘feel’ he or she has or the more ‘instinct.’ Sure, it looks macho to make calls or predictions and when proven correct a person is often praised and viewed as having some superior knowledge, but in reality these people are one step below those that have already moved through this stage and left it behind.

As an individual trader it is simply impossible to remain emotionless, making the proper trading decisions at all times, when the action is heated. Even when there is a lull, our emotions kick in and we feel a change is needed or something should be done, when in reality our rules may say to stay put or do nothing.

Gary Kaltbaum on his radio show today:

“We open up strong - we get destroyed into the close. That is the definition of bearish action in the stock market. You need to know this. I’ve told you this a hundred times in the past years, I’m going to say it again: In bullish markets, you get bad opens and great closes, in bearish markets, you get big opens and bearish closes. Today was the definition of that.”

“The fact that we can only go up for one day, and now just turn down badly and break those lows today, is the definition of a bear. And when you cannot bounce when you are oversold and extended to the downside, it tells you how weak things are. Let’s do the opposite: in bull markets, you’re up 500 points on the Dow and it won’t pull back 10 points. That tells you how strong things are, regardless that things are extended to the upside. So we’re getting the opposite here.”

Here’s the link to the mp3 file of today’s show if you’re interested in hearing it all.

The Big Picture passes along some great trading advice this weekend. Here’s Barry:

One of the first books I read in this business oh-so many years ago was Stock Market Wizards. It had a profound impact on my thinking about trading, psychology, risk, capital preservation, etc.

Sometime ago, I came across a good discussion of the lessons from the book at Simply Options Trading. What follows is my edited adaptation of those rules he derived from Stock Market Wizards:

1. All successful traders use methods that suit their personality; You are neither Waren Buffett nor George Soros nor Jesse Livermore; Don’t assume you can trade like them.
2. What the market does is beyond your control; Your reaction to the market, however, is not beyond your control. Indeed, its the ONLY thing you can control.
3. To be a winner, you have to be willing to take a loss; (The Stop-Loss Breakdown)
4. HOPE is not a word in the winning Trader’s vocabulary;
5. When you are on a losing streak — and you will eventually find yourself on one — reduce your position size;
6. Don’t underestimate the time it takes to succeed as a trader — it takes 10 years to become very good at anything; (There Are No Shortcuts)
7. Trading is a vocation — not a hobby
8. Have a business/trading plan; (Write This Down)
9. Identify your greatest weakness, Be honest — and DEAL with it
10. There are times when the best thing to do is nothing; Learn to recognize these times (Nothing Doing)
11. Being a great trader is a process. It’s a race with no finish line.
12. Other people’s opinions are meaningless to you; Make your own trading decisions (The Wrong Crowd)
13. Analyze your past trades. Study what happened to the stocks after you closed the position. Consider your P&L game tapes and go over them the way Vince Lombardi Bill Parcells reviewed past Superbowls
14. Excessive leverage can knock you out of the game permanently
15. The Best traders continue to learn — and adapt to changing conditions
16. Don’t just stand there and let the truck roll over you
17. Being wrong is acceptable — staying wrong is unforgivable (I liked this one! - BMB)
18. Contain your losses (Protect Your Backside)
19. Good traders manage the downside; They don’t worry about the upside
20. Wall street research reports are biased
21. Knowing when to get out of a position is as important as when to get in
22. To excel, you have to put in hard work
23. Discipline, Discipline, Discipline !

The links in parentheses are part of The Apprenticed Investor series I did for the Street.com.

Good stuff.

Sometimes the market allows you to be aggressive, and at other times, you might be better off sitting on your hands. Quint Tatro discusses how “Patience is part of the cycle”:

As a trader it is inevitable that we will go through challenging times. Regardless of what anyone says it is also these times which will lead to the next great opportunities, but we must successfully navigate the rough spots in order to enjoy and participate when the environment improves. There are times when less is more and this is one of those times.

Simple, but effective. From Jeff Macke:

The trick, of course, is never letting a bad trade become a long-term investment.

Have an exit strategy - never lose big.

More trading advice from Quint Tatro - what to do when you’re wrong:

Accepting the fact that you are wrong…is the first step, however, correcting it quickly is step two. Many people at this juncture become paralyzed or zombie-like, not knowing what to do or what action to take. They realize they are wrong, however they start to rationalize the action and hold the stock starting to cling onto hope. Some will even invest more money thinking they are doing the proper thing by averaging in. Luckily, I have been in this situation many times, and knew the proper course of action was to correct myself very quickly, which I did by selling shares and moving on. The stock went on to creep steadily higher and I may have been better off waiting a few days, however the psychological effect the stock would have had on me would have kept me out of other areas that I played, making up the loss very quickly.

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The simple fact is that should you trade in the market, you will be wrong on numerous occasions. The key however is to never let this damage you for more than is necessary. Once you recognize you are wrong, correct yourself quickly and move on. Accept the fact that you were wrong and let it go.

No matter how good you think you or your methods are, you will be wrong now and then. Probably more often than that - but hopefully not too much more.

Learn to recognize when you’re wrong, recognize it quickly, and rectify the situation. Use the Gary Kaltbaum method: Be wrong quick, and be wrong small. Never lose big.

When it comes to trading the markets and investing, there are a million-and-one different ways to make money. Unfortunately, none of those ways are as ‘easy’ as many people believe they are. And it’s up to you to decide which ‘way’ suits your comfort level and personality. Then you must learn how to effectively trade in that style, as Quint Tatro explains today:

I have often used a line from trading great Jessie Livermore when talking with others about speculating in the markets. The most recent conversation came during a doctor’s visit. As my doctor was doing his normal ‘breath deep’ routine he asked how he could make some good money in the markets. Unfortunately, his question was met by a rather awkward pause in the conversation and I simply responded by saying “I’ll make a deal with you. I’ll tell you how to make some good money in the market if you tell me how I can make some good money practicing medicine.” He didn’t laugh.

Trading is a very unique craft with incredibly low barriers to entry, however in my opinion opening an account in order to buy a few stocks is far from trading. Though, I will be the first one to stand and say that I firmly believe anyone willing to commit the time necessary and possess the work ethic to study and hone the skill can become an incredibly successful trader.

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You see, like medicine, accounting or sports, trading or investing is a general term that encompasses a multitude of styles. It is arrogant to think one style is superior to the next. Rather, there are always people at the top of their style who are consistently performing exceptionally well. One of the biggest issues I see facing many people who desire to venture down the trading path, is not correlating the style they desire to learn with their personality. In my opinion that is the first and foremost way in which one starts learning to trade. Even if you have already started down a particular trading road, it may be beneficial to ask yourself some questions.

Go read the rest, and see if you can find your own style.

Another entry in Quint Tatro’s “Becoming a Better Trader” series, this one on using stops:

One of the questions I receive often when we go through a poor market environment is how I was able to sidestep much of the carnage. My answer is quite simple. Markets don’t get terrible over night. They typically start to act poorly before the real selling kicks in.

By watching your underlying positions and adhering to a strict stop loss discipline, you will immediately be selling stock and raising cash when your individual stocks start to break down. When this happens, my stocks are cut and very quickly my cash level starts to grow. As the market continues to wane one by one my stocks are cut as they cross their lines of technical health and most of the time, I have raised cash taking only small losses while sidestepping the true carnage that is coming. You see, most people who suffer significant losses do not cut stocks quickly. Rather they adhere to the buy and hold mentality and ride the stock all the way down for a terrible loss. Finally, when the stock is done going down and becomes lifeless, the trader decides to cut the stock and is now faced with a very large loss to make up. These losses are very hard to recover from and often significantly damage not only the trader’s financial capital but emotional capital as well.

Rather than fall into this trap, adhere to a basic stop loss rule and save yourself the headache.

Go check it out.

Quint Tatro has published a couple more ‘chapters’ in his series on ‘Becoming a Better Trader’.

Here are the latest: “Let the Chart Be Your Guide”, and “Legging In”.

As Quint says: “There are countless trading styles and I have seen many that work incredibly well. Typically a person’s trading style and their rules will correlate with their personality.” So that doesn’t mean you have to adhere strictly to his rules and his rules only. However, it can’t hurt to take his ideas into consideration when developing your own set of rules and discipline.

More on trading rules from Quint Tatro. Today’s lesson is risk management.

Rule #1 - Position Sizing.

Bottom line? Don’t put all your eggs in one basket. Or even two baskets.

In today’s column, Quint Tatro doesn’t tell you what your trading rules should be - just that you need to have some. As he says, most people either 1) don’t have any rules at all, or 2) even if they have rules, don’t stick to them.

Rather than trying to unlock the mystery of trading through the vast array of noise that surrounds our chosen craft, ask yourself a few questions.

1. Do I possess a set of rules by which I follow to execute each and every trade?
2. Are these rules written down and do I review them frequently?
3. Do I constantly review my trades against my rules as my first area of investigation for a trade gone wrong?
4. Am I constantly looking to improve these rules over time?

Most people could improve their results dramatically simply adopting and adhering to a simple set of rules. Picking up any book on trading will give you these rules to follow. Over time, the true professional will slowly start to build his own set of rules that better correlate with his personality and tolerance for risk and ultimately, this foundation will be the building blocks for the true success that I believe is available to all.

It’s up to you to decide how you want to trade and/or invest. But as we often say here at BMB, you need to have some sort of plan, some rules, or some discipline as to how you’re going to go about doing it.

Some good tips from Quint Tatro on how to survive in today’s world of financial ‘noise’ - how to find your way through the noisy media storm, and a few tips on how best to find your own investment footing - and keep it amidst the distractions:

As my mini-vacation was nearing an end, I started to think about how an individual who is not involved in the financial markets on a daily basis is supposed to decipher all of this information and make an informed decision. I found it extremely ironic, that I for one was clueless and confused by the time I found myself back at the trading desk. I pondered this further and thought it demanded some attention.

The fact is society today is littered with information. Any person exposed to any form of media can soak in multiple opinions each and every day, but despite the good intentions those with the opinions are not the ones making the final decisions for your portfolio. It is the individual who is ultimately responsible for their financial future.

Despite the fact that I am one who trades stocks day in and day out, and methodical investment management is no longer my cup of tea, I felt moved to compile a few basic guidelines that may just help a methodical investor navigate through the noise and land on that island we are all seeking called financial freedom.

Here are my five “noiseless” rules that I hope you will find helpful.

1. Turn It Down: Headlines draw us in whether they are in print or floating through the airwaves. Eyeballs or ears are what drive revenue so it is the pundit’s primary job to grab your attention. Many wise people will tell you to gather as much information as possible, but I don’t believe those who stated this quite understood all the information available to us today. Adopt moderation in your financial intake. Simply cutting back on the clutter will help you to keep things in perspective and strike a healthy balance between the unbelievable numbers of opinions that abound.
2. Stick With One Source: If you are reading this, chances are you gravitate towards financial information or opinions that may come from independent sources such as the ‘Ville. There are many wise individuals out there that have navigated the toughest of seas. Find a friend or two and stick with them. They are in their position for a reason, but will not always get it right. Find one that you identify with, who writes or speaks for your demographic or life situation, and adhere to this person’s advice for the long haul.
   
   If you have all your investment money in a 401K, I wouldn’t be reading a day trader. On the flip side, if stock picking fits your fancy, stay clear of those preaching the macro-economic scene. In my opinion giving a financial friend a five-year cycle to prove themselves is a must. Many people bail after the first wrong call, and never fully benefit from the vast experience of the individual. Stop hopping and find a friend.
3. Index It: I will leave this debate to Jeremy Siegel and those much smarter than I, but I do know that most people who fall into the passive camp could improve their results dramatically by just sticking with a few index-only vehicles.
   
   An index is a basket of stocks that fall within a certain criteria. Most of the indexes are rebalanced each year, which means your portfolio will constantly be dropping the laggards and adopting the winners, a basic strategy people have the hardest time with. Furthermore, indexing today has been made so very simple through the use of ETF’s or exchange traded funds. No longer does one have to utilize mutual funds and buy or sell at day end. They have the ability to purchase an index vehicle like a stock.
4. Add Rules: Once a person adopts the above mentioned strategy for all or a portion of their portfolio, I do believe a set of basic money management rules can easily increase your downside risk. Despite the fact that indexing removes much of the emotion and decision making from investing, it does not however limit the risk.
   
   The market always undergoes cycles and regardless of who you are, you will not be immune to a nasty downward cycle that can last for months to years. Adding a simple set of money management rules, such as selling half of an index once it breaks its 50 day moving average, can help not only improve your longer term results but also preserve your emotional capital and allow you to sleep at night. This is not as cut and dried as an article on such rules is to follow, but adopting some set of money management rules, which a person religiously adheres to, will definitely help you to navigate the noise and improve your results.
5. Leg In, Leg Out: One of the most important rules I ever learned was to always buy in pieces and sell in pieces. The premise is that attempting to catch the precise bottom for a buy, or a top for a sell, is a fool’s game and a waste of time.
   
   While I never give out stock ideas to friends or family, this is a rule I always relay. Many people always struggle with how to invest and nail down the timing. Let me tell you a secret: you can’t do it, so don’t try. Sitting with heavy cash on the sidelines can be frustrating, especially when a market moves higher. At the same time, it can be torturous to see a portfolio drop each and every day and have no idea if now is the time to sell.
   
   In addition to a basic set of rules as mentioned above, I believe each person should adopt a methodical and unemotional strategy for entering or exiting the financial markets. I often suggest a 1/3, 1/3, 1/3 strategy over the course of six months for someone who desires to put capital to work. Vice versa, selling something, would be done in a similar manner. This of course, should correlate with the rules you set above and despite any siren call or new noise, one should not break or alter these rules.

Good advice. You can decide whether they’re the right things for you or not.