Read The New Market Wizards: Conversations with America's Top Traders Online
Authors: Jack D. Schwager
“Good idea,” he enthusiastically replied.
There are various levels of hypnosis. After about half an hour, I had him at the level I wanted. I asked him, “What is happening to your brokerage statements?”
“Why, I hide them, of course,” he answered.
“Do you open them?” I asked.
“Nooooooo,” he said, slowly drawing out the word, “I don’t want to see my mistakes.”
“How then do you know when you’re losing money?” I asked.
“My broker phones me and tells me that I have to put up another few thousand pounds on margin.”
“And do you send the money in?” I queried.
“Oh yes,” he replied. “I have to. Otherwise, I would have to stop trading—wouldn’t I? My broker would just close the account.” I asked, “Would you like him to close the account?”
“Oh no, I love trading!” he trumpeted.
“Well, do you know that you’re losing money?” I asked.
“Certainly, I’m not a fool,” he said authoritatively.
“Where do you hide your statements?” I inquired.
“Oh, I can’t tell you that,” he whispered. “You’ll just tell my wife.”
“I promise that I won’t tell her,” I assured him. “But, tell me, what would happen if she found out?”
“She’d be very cross,” he said. “She’d throw me out of the house.”
“Why would she do that?” I asked.
“Because I’m losing money that I should be giving her to buy new dresses.”
I thought to myself, The best favor I can do for this chap is to stop him from trading. I brought him out of hypnosis and made an appointment to see him again the following week. Before he left, he turned to me and asked, “Do you think you can get my wife to tell us where she’s hiding the statements?”
I said, “We’ll talk about that next time.”
“Why don’t I bring her along with me,” he suggested.
“You know what,” I said, “that’s a good idea.”
The following week they both showed up at the appointed time. I asked him, “Are we going to solve this problem?”
He answered, “Certainly we’re going to solve this problem—as long as you can stop her from taking my mail.”
I put him under hypnosis, and I told his wife exactly what had happened.
She nonchalantly replied, “Oh, I know he’s hiding his statements. I even know where he’s hiding them, but I dare not say anything, because it will destroy him.”
She was obviously a very clever woman. Under hypnosis I told him, “Your wife has agreed to turn over to you
all
your back statements. Moreover, she has promised that she will never stop the mailman again, as long as you take responsibility for your own actions and stop playing the fool.”
“Are you sure?” he asked.
“I’m sure,” I replied. “In fact, I’m going to bring you out of hypnosis now, and your wife is going to put this agreement in writing.”
He thanked me energetically, and I brought him out of hypnosis. Three days later, his wife called to tell me he had closed his account.
What had been his motivation for trading?
Just thrills. He was leading a very boring life. He held a civil service position and this was just his way of seeking some excitement. [His job only required a minimal number of hours of attendance in a consulting capacity; hence he was able to trade during the day.]
What motivated him to stop trading?
When he was confronted with the piece of paper stating that his wife would turn over all his past statements, he knew that she knew where he had been hiding them because that was the only way that she could give him the mail that she had supposedly intercepted. At this point, his conscious mind realized what had been happening.
His wife told me that, the next day. he pulled out the hidden statements, put them on the dining room table, and said, “Aha! I see that you have finally decided to give me all the mail.”
She said, “Yes dear; here it is; take it.”
The next day, he phoned his broker and closed the account.
What is the most surprising thing you have discovered about human behavior or human nature since you started doing hypnosis?
How ready we are to fool ourselves. I learned that people’s perceptions of reality and true reality are not the same thing. It’s a person’s belief system, not reality, that really counts. The more I worked with hypnosis, the more I realized how often our lives are warped and misdirected by invalid beliefs that have their origins in childhood. These beliefs frequently cause people to live their lives with a distorted view of reality.
Can you give me an example?
A young boy of five watches his father fixing the family automobile in the garage. Wishing to help, he picks up one of his father’s tools. The father, afraid that the boy will get hurt, shouts at him to put the tool down. This type of experience only has to happen a couple of times before the subconscious mind files it into permanent memory.
Fast forward the scene to when the boy is twelve. Now the father thinks his son is ready to learn how to use tools, and he asks his son to help him fix the car. Without knowing why, as soon as he picks up one of the tools, the boy feels uncomfortable. Whatever he tries, he does poorly. Eventually his father tells him not to bother, saying he’s just clumsy with tools. That boy is now convinced for life that he’s useless with tools.
What has happened in this example? The first experience at the age of five is filed away in the subconscious mind as, “If I touch these tools, my father will shout at me. Therefore it’s bad.” Then, when the boy is twelve and the father asks for help, the subconscious mind is reinforced at the conscious level by the belief that he’s also clumsy. Unless a way is found to eradicate these false premises, they’ll remain with the boy the rest of his life.
Can you give me a trading analogy?
We discussed one earlier. Based on past experiences, a person may believe he’s a poor trader on a subconscious level, even after he has developed an effective trading methodology. The result may be fear based on beliefs that are no longer relevant.
Why do most traders lose?
Recently I conducted a two-day workshop with a group of thirty part-time traders. At one point, I presented them with a questionnaire. The key question asked the students to rank the following list in order of importance as to what they thought were their greatest weaknesses in the markets:
[Note to reader: You may wish to answer this question yourself, before continuing on.]
Amazingly, 90 percent of this group picked the exact same four items for the top of their list, although the order varied:
What single element is the root of the other three? What causes lack of confidence? What causes fear of loss? What causes poor execution? NO TRADING PLAN! This is the basic feature that separates losing traders from winning traders. Lack of confidence disappears in direct relation to the validity of a back-tested trading plan.
What are the key characteristics of a winning trader?
Persistence, patience, and a willingness to take risks.
How has hypnosis changed your life?
I learned through the use of creative visualization that I could set goals and achieve them—providing, of course, that the goals were realistic. Incidentally, traders who do not set goals or targets find it much more difficult to achieve high returns than traders who set such goals.
What do you mean by “creative visualization”?
Using trading as an example, in a deep-relaxation state you see yourself applying your methodology, and you then see this methodology succeeding. By mentally playing through these images, you can alter the negative beliefs in your subconscious and in the process enhance your chance of success. This is the same methodology employed by many top athletes.
As a hypnotist, you’ve certainly been exposed to the gamut of human emotions. I assume that those people who want to succeed as traders want to do so because they believe it will make them happy. Let’s deal with a more fundamental question: In your experience, what do you believe is the essential element in achieving happiness?
I believe the single most important factor is having control of your own life. Everything else is secondary.
According to Krausz, the major factors traders cite as the reasons for why they lose—lack of confidence, fear of loss, and poor execution—are all a consequence of not having a trading plan. Clearly, based on this premise, the absolutely essential first step for a trader is to develop a trading plan. Once such a plan has been constructed, the trader must adequately back-test the method to gain the necessary confidence in the validity of the approach.
Thus far, the advice is sound but hardly unconventional. Krausz offers a more unique view in his discussion of the role of the subconscious as an impediment to trading success. Krausz explains that subconscious beliefs will dictate a person’s actions. The point is that if the subconscious believes that a person is a losing trader based on prior experiences, it will continue to hold that view even after the trader has developed an effective methodology. These beliefs, predicated on past experiences, can cause a person to feel fears that may no longer he appropriate. These fears can lead to what Krausz’s mentor, Charles Drummond, called the “freeze.” Thus, Krausz believes that once an effective trading plan is developed, it is critical to convince the subconscious mind of the new reality. The greater the harmony between the conscious and subconscious minds, the better the chance for success. The techniques for achieving such harmony include hypnosis or deep relaxation and visualization.
Krausz’s unstated motto might be: We become what we believe. If you accept this premise, then it becomes quite clear why psychology plays such an important role in trading success or failure.
B
y now it should be clear that the methods employed by exceptional traders are extraordinarily diverse. Some are pure fundamentalists; others employ only technical analysis; and still others combine the two methodologies. Some traders consider two days to be long term, while others consider two months to be short term. Yet despite the wide gamut of styles, I have found that certain principles hold true for a broad spectrum of traders. After a score of years of analyzing and trading the markets and two books of interviews with great traders, I have come down to the following list of forty-two observations regarding success in trading:
1. FIRST THINGS FIRST
First, be sure that you really want to trade. As both Krausz and Faulkner confirmed, based on their experience in working with traders, it is common for people who think they want to trade to discover that they really don’t.
2. EXAMINE YOUR MOTIVES
Think about why you really want to trade. If you want to trade for the excitement, you might be better off riding a roller coaster or taking up hang gliding. In my own case, I found that the underlying motive for trading was serenity or peace of mind—hardly the emotional state typical of trading. Another personal motive for trading was that I loved puzzle solving—and the markets provided the ultimate puzzle. However, while I enjoyed the cerebral aspects of market analysis, I didn’t particularly like the visceral characteristics of trading itself. The contrast between nay motives and the activity resulted in very obvious conflicts. You need to examine your own motives very carefully for any such conflicts. The market is a stern master. You need to do almost everything right to win. If parts of you are pulling in opposite directions, the game is lost before you start.
How did I resolve my own conflict? I decided to focus completely on mechanical trading approaches in order to eliminate the emotionality in trading. Equally important, focusing on the design of mechanical systems directed my energies to the part of trading I did enjoy—the puzzle-solving aspects. Although I had devoted some energy to mechanical systems for these reasons for a number of years, I eventually came to the realization that I wanted to move in this direction exclusively. (This is not intended as an advocacy for mechanical systems over human-decision-oriented approaches. I am only providing a personal example. The appropriate answer for another trader could well be very different.)
3. MATCH THE TRADING METHOD TO YOUR PERSONALITY
It is critical to choose a method that is consistent with your own personality and comfort level. If you can’t stand to give back significant profits, then a long-term trend-following approach—even a very good one—will be a disaster, because you will never be able to follow it. If you don’t want to watch the quote screen all day (or can’t), don’t try a day-trading method. If you can’t stand the emotional strain of making trading decisions, then try to develop a mechanical system for trading the markets. The approach you use must be right for you; it must feel comfortable. The importance of this cannot be overemphasized. Remember Randy McKay’s assertion: “Virtually every successful trader I know ultimately ended up with a trading style suited to his personality.”
Incidentally, the mismatch of trading style and personality is one of the key reasons why purchased trading systems rarely make profits for those who buy them, even if the system is a good one. While the odds of getting a winning system are small—certainly less than 50/50—the odds of getting a system that fits your personality are smaller still. I’ll leave it to your imagination to decide on the odds of buying a profitable/moderate risk system and using it effectively.
4. IT IS ABSOLUTELY NECESSARY TO HAVE AN EDGE
You can’t win without an edge, even with the world’s greatest discipline and money management skills. If you could, then it would be possible to win at roulette (over the long run) using perfect discipline and risk control. Of course, that is an impossible task because of the laws of probability. If you don’t have an edge, all that money management and discipline will do for you is to guarantee that you will gradually bleed to death. Incidentally, if you don’t know what your edge is, you don’t have one.
5. DERIVE A METHOD
To have an edge, you must have a method. The type of method is irrelevant. Some of the supertraders are pure fundamentalists; some are pure technicians; and some are hybrids. Even within each group, there are tremendous variations. For example, within the group of technicians, there are tape readers (or their modern-day equivalent—screen watchers), chartists, mechanical system traders, Elliott Wave analysts, Gann analysts, and so on. The type of method is not important, but having one is critical—and, of course, the method must have an edge.
6. DEVELOPING A METHOD IS HARD WORK
Shortcuts rarely lead to trading success. Developing your own approach requires research, observation, and thought. Expect the process to take lots of time and hard work. Expect many dead ends and multiple failures before you find a successful trading approach that is right for you. Remember that you are playing against tens of thousands of professionals. Why should you he any better? If it were that easy, there would he a lot more millionaire traders.
7. SKILL VERSUS HARD WORK
Is trading success dependent on innate skills? Or is hard work sufficient? There is no question in my mind that many of the supertraders have a special talent for trading. Marathon running provides an appropriate analogy. Virtually anyone can run a marathon, given sufficient commitment and hard work. Yet, regardless of the effort and desire, only a small fraction of the population will ever be able to run a 2:12 marathon. Similarly, anyone can learn to play a musical instrument. But again, regardless of work and dedication, only a handful of individuals possess the natural talent to become concert soloists. The general rule is that exceptional performance requires both natural talent and hard work to realize its potential. If the innate skill is lacking, hard work may provide proficiency, but not excellence.
In my opinion, the same principles apply to trading. Virtually anyone can become a net profitable trader, but only a few have the inborn talent to become supertraders. For this reason, it may be possible to teach trading success, but only up to a point. Be realistic in your goals.
8. GOOD TRADING SHOULD BE EFFORTLESS
Wait a minute. Didn’t I just list hard work as an ingredient to successful trading? How can good trading require hard work and yet be effortless?
There is no contradiction. Hard work refers to the preparatory process—the research and observation necessary to become a good trader—not to the trading itself. In this respect, hard work is associated with such qualities as vision, creativity, persistence, drive, desire, and commitment. Hard work certainly does not mean that the process of trading itself should be filled with exertion. It certainly does not imply struggling with or fighting against the markets. On the contrary, the more effortless and natural the trading process, the better the chances for success. As the anonymous trader in
Zen and the Art of Trading
put it, “In trading, just as in archery, whenever there is effort, force, straining, struggling, or trying, it’s wrong. You’re out of sync; you’re out of harmony with the market. The perfect trade is one that requires no effort.”
Visualize a world-class distance runner, clicking off mile after mile at a five-minute pace. Now picture an out-of-shape, 250-pound couch potato trying to run a mile at a ten-minute pace. The professional runner glides along gracefully—almost effortlessly—despite the long distance and fast pace. The out-of-shape runner, however, is likely to struggle, huffing and puffing like a Yugo going up a 1 percent grade. Who is putting in more work and effort? Who is more successful? Of course, the world-class runner puts in his hard work during training, and this prior effort and commitment are essential to his success.
9. MONEY MANAGEMENT AND RISK CONTROL
Almost every person I interviewed felt that money management was even more important than the trading method. Many potentially successful systems or trading approaches have led to disaster because the trader applying the strategy lacked a method of controlling risk. You don’t have to be a mathematician or understand portfolio theory to manage risk. Risk control can be as easy as the following three-step approach:
1. Never risk more than 1 to 2 percent of your capital on any trade. (Depending on your approach, a modestly higher number might still be reasonable. However, I would strongly advise against anything over 5 percent.)
2. Predetermine your exit point
before
you get into a trade. Many of the traders I interviewed cited exactly this rule.
3. If you lose a certain predetermined amount of your starting capital (e.g., 10 percent to 20 percent), take a breather, analyze what went wrong, and wait until you feel confident and have a high-probability idea before you begin trading again. For traders with large accounts, trading very small is a reasonable alternative to a complete trading hiatus. The strategy of cutting trading size down sharply during losing streaks is one mentioned by many of the traders interviewed.
10. THE TRADING PLAN
Trying to win in the markets without a trading plan is like trying to build a house without blueprints—costly (and avoidable) mistakes are virtually inevitable. A trading plan simply requires combining a personal trading method with specific money management and trade entry rules. Krausz considers the absence of a trading plan the root of all the principal difficulties traders encounter in the markets. Driehaus stresses that a trading plan should reflect a personal core philosophy. He explains that without a core philosophy, you are not going to be able to hold on to your positions or stick with your trading plan during really difficult times.
11. DISCIPLINE
Discipline
was probably the most frequent word used by the exceptional traders that I interviewed. Often, it was mentioned in an almost apologetic tone: “I know you’ve heard this a million times before, but believe me, it’s really important.”
There are two basic reasons why discipline is critical. First, it is a prerequisite for maintaining effective risk control. Second, you need discipline to apply your method without second-guessing and choosing which trades to take. I guarantee that you will almost always pick the wrong ones. Why? Because you will tend to pick the comfortable trades, and as Eckhardt explained, “What feels good is often the wrong thing to do.”
As a final word on this subject, remember that you are never immune to bad trading habits—the best you can do is to keep them latent. As soon as you get lazy or sloppy, they will return.
12. UNDERSTAND THAT YOU ARE RESPONSIBLE
Whether you win or lose, you are responsible for your own results. Even if you lost on your broker’s tip, an advisory service recommendation, or a bad signal from the system you bought, you are responsible because you made the decision to listen and act. I have never met a successful trader who blamed others for his losses.
13. THE NEED FOR INDEPENDENCE
You need to do your own thinking. Don’t get caught up in mass hysteria. As Ed Seykota pointed out, by the time a story is making the cover of the national periodicals, the trend is probably near an end.
Independence also means making your own trading decisions. Never listen to other opinions. Even if it occasionally helps on a trade or two, listening to others invariably seems to end up costing you money—not to mention confusing your own market view. As Michael Marcus stated in
Market Wizards
, “You need to follow your own light. If you combine two traders, you will get the worst of each.”
A related personal anecdote concerns another trader I interviewed in
Market Wizards
. Although he could trade better than I if he were blindfolded and placed in a trunk at the bottom of a pool, he still was interested in my view of the markets. One day he called and asked, “What do you think of the yen?”
The yen was one of the few markets about which I had a strong opinion at the time. It had formed a particular chart pattern that made me very bearish. “I think the yen is going straight down, and I’m short,” I replied.
He preceded to give me fifty-one reasons why the yen was oversold and due for a rally. After he hung up, I thought: “I’m leaving on a business trip tomorrow. My trading has not been going very well during the last few weeks. The short yen trade is one of the only positions in my account. Do I really want to fade one of the world’s best traders given these considerations?” I decided to close out the trade.
By the time I returned from my trip several days later, the yen had fallen 150 points. As luck would have it, that afternoon the same trader called. When the conversation rolled around to the yen, I couldn’t resist asking, “By the way, are you still long the yen?”
“Oh no,” he replied, “I’m short.”
The point is not that this trader was trying to mislead me. On the contrary, he firmly believed each market opinion at the time he expressed it. However, his timing was good enough so that he probably made money on both sides of the trade. In contrast, I ended up with nothing, even though I had the original move pegged exactly right. The moral is that even advice from a much better trader can lead to detrimental results.
14. CONFIDENCE