FINANCIAL RISK TAKING An Introduction to the Psychology of Trading and Behavioural Finance - Mike El

Financial Risk Taking

WILEY TRADING SERIES

Financial Risk Taking: An Introduction to the Psychology of Trading andBehavioural FinanceMike Elvin

Single Stock Futures: A Trader’s GuidePatrick L. Young and Charles Sidey

Uncertainty and Expectation: Strategies for the Trading of RiskGerald Ashley

Bear Market Investing StrategiesHarry D. Schultz

The Psychology of Finance, revised editionLars Tvede

The Elliott Wave Principle: Key to Market BehaviorRobert R. Prechter

International Commodity TradingEphraim Clark, Jean-Baptiste Lesourd and Rene Thieblemont

Dynamic Technical AnalysisPhilippe Cahen

Encyclopedia of Chart PatternsThomas N. Bulkowski

Integrated Technical AnalysisIan Copsey

Financial Markets Tick by Tick: Insights in Financial Markets MicrostructurePierre Lequeux

Technical Market Indicators: Analysis and PerformanceRichard J. Bauer and Julie R. Dahlquist

Trading to Win: The Psychology of Mastering the MarketsAri Kiev

Pricing Convertible BondsKevin Connolly

At the Crest of the Tidal Wave: A Forecast for the Great Bear MarketRobert R. Prechter

FINANCIAL RISK TAKING

An Introduction to the Psychology of Tradingand Behavioural Finance

Mike Elvin

Copyright 2004 John Wiley & Sons Ltd, The Atrium, Southern Gate, Chichester,West Sussex PO19 8SQ, England

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Library of Congress Cataloging-in-Publication Data

Elvin, Mike.Financial risk taking : an introduction to the psychology of trading and

behavioural finance / Mike Elvin.p. cm.

Includes bibliographical references and index.ISBN 0-470-85026-4 (alk. paper)

1. Stocks – Psychological aspects. 2. Speculation – Psychological aspects.3. Investments – Psychological aspects. I. Title.

HG6041.E48 2004332.6′01′9 – dc22

2004002789

British Library Cataloguing in Publication Data

A catalogue record for this book is available from the British Library

ISBN 0-470-85026-4

Typeset in 10/12pt Times by Laserwords Private Limited, Chennai, IndiaPrinted and bound in Great Britain by MPG Limited, Bodmin, CornwallThis book is printed on acid-free paper responsibly manufactured from sustainable forestryin which at least two trees are planted for each one used for paper production.

http://www.wileyeurope.com

http://www.wiley.com

List of Figures

Figure 3.1 The Comprehensive MOT 46

Figure 3.2 Example of technical analysis 69

Figure 3.3 Trading and decision diary 73

Figure 3.4 Candle chart 74

Figure 3.5 Equity chart 75

Figure 4.1 The Yerkes-Dodson law of arousal 95

Figure 6.1 The brain and limbic system 156

Figure 7.1 General centring triangle 187

Figure 7.2 Trading centring triangle 188

To my parents, and my son Lewis, through whom my lifehas been greatly enriched.

To traders everywhere, who have had the courage,determination, and vision to walk upon a unique path.

Contents

List of Figures ix

Foreword xi

Contrarian Investment Strategies xiii

Acknowledgements xv

1 Introduction: Between Scylla and Charybdis 1

2 Understanding Trading Competence 13

3 A Comprehensive Model of Trading Competence 45Part A: The Tactical Model of Trading Competence 47Part B: The Strategic Model of Trading Competence 59

4 Taming Stress to Become a Better Trader 83

5 The Psychology of Perceptual Bias 123

6 Emotions, Emotional Intelligence, and the Trader 151

7 Martial Arts and Budo Zen – Controlling Fear and Self-Sabotage 179

8 Standards and Criteria for Trading Competence 219

Appendix 1 Reading List 235

Appendix 2 Websites of Interest 239

Appendix 3 Courses and Seminars 243

Bibliography 247

Index 257

Foreword

My trading career stumbled last Friday. I sabotaged myself in an old, familiarway: with too much risk, after too little sleep, layering risk upon risk after thatfirst, losing trade. For months my miniature hedge fund had been doing well.Then, 90 hours ago, I gave away weeks of painstaking profit in an afternoon ofexhausted madness.

I have my excuses, of course. I have been under strain. The trades will turnout to be correct. But I should have remembered what is in these pages.

This is an interesting book, an unusual and lateral response to the trader’scondition. You will not find much in here about how or when to trade, and yetyou will find everything. The way you view this book will determine whetheryou join the 10% of successful traders or the 90% who lose.

That is because the author, Dr Mike Elvin, is a trader and a psychologist. He hashad his own, terrible lessons at the home-trader’s keyboard, with the professionalbackground to analyse them. On page 75 you will find a chart revealing that heknows how to trade, doubling his account equity in three months. But first youwill discover his old moments of frozen terror, sweating and shaking as he directshis mouse to enter an order. The honesty of the book, in contrast to most guruliterature, is one of its strengths.

The main strength is the subject matter. You are the most important variablein the trading equation. Not you, the set of technical indicators, or you, thefundamentalist with an insight into economies and companies. I mean you, thethinking, feeling human being. A good trader can make any strategy work, anda poor one will lose money over time regardless of method. A good trader, likea good parent, employee or lover, needs self-knowledge above all.

One of life’s challenges is to live in the present, and this book will help youto live in the trading present. Absorb what Dr Elvin has to say and there is a

xii Foreword

chance, albeit a small one, that you will succeed. The risk that you will destroyyourself is still great because you are human, and human nature never changes.But the survival guide is in your hands.

Tim RaymentYorkshire, England

January 2004

Contrarian Investment Strategies

Psychology is the reason for both the consistently superior performance of themethods the financial academics cannot explain, as well as the consistently poorerresults of those approaches that fail. Yet, psychology is not only misunderstood,but ruled out at source (sic) by most of the current generation of financial scholars.

The study of investor behavior in markets is still in an embryonic stage.Although we can statistically trace pattern after pattern of investor behavior,we know little of the dynamics of the complex interactions of cognitive, group,and other psychological forces that underlie them.

Psychology offers the marketplace the opportunity to gain a much clearerunderstanding of what causes predictable behavior. The marketplace in turn offersthe various branches of psychology a major laboratory to pinpoint patterns ofbehavior unlikely to be as statistically documented in such depth anywhere else.

David Dreman, (2002, p. 397)

Acknowledgements

My heart felt thanks and gratitude to Tom Williams, Director of Genie Softwareand author of The Undeclared Secrets That Drive the Stock Market, who throughhis friendship, guidance, and mentorship, inspired and encouraged me to achievewhat I could. Also, for his practical support and introductions to traders duringthe years of research and writing of this book.

My gratitude to Dr Richard McCall, who tutored me in the way of tradingdiscipline and for allowing me to paraphrase the contents of his personal lecturesand writings.

To Professor Keith Oatley, Head of Psychology at Toronto University, for hisadvice regarding research in the complex field of emotions, for permission to usesome of the contents of his book Understanding Emotions, and for his friendshipover the years.

My thanks to Professor Jennifer Jenkins of Toronto University for allowing meto paraphrase some of her work which was jointly written with Professor Oatley.

I thank Professor Fenton O’Creevy, Head of the Business School at The OpenUniversity, who allowed me to interview him in depth and for kindly forwardinga number of recent research papers to me.

My thanks to Mark Douglas, author of The Disciplined Trader and Tradingin the Zone, for reading my draft manuscript and making excellent suggestions.Also, for sharing with me his personal thoughts regarding trading, life in general,and his generosity of spirit.

My thanks to Richard Smitten, author of Jesse Livermore: The World’s GreatestTrader for reading a draft copy of my book and allowing me to interview him onmore than one occasion regarding his personal understanding of Jesse Livermoreand the relationships in his life.

I am grateful to Michael Feeny, Senior Trader at Sumitomo Mitsui BankingCorporation, City of London, for reading a draft of my book, making helpfulcomments, and for assisting me to understand the trading culture in invest-ment banking.

My thanks to James Montier, Head of Strategy at Dresdner Kleinwort Wasser-stein, for sharing his insights with me on behavioural finance and giving me

xvi Acknowledgements

a number of research papers he wrote since his book Behavioural Financewas written.

My thanks to Daniel Goleman, author of Emotional Intelligence, for giving mepermission to paraphrase from his books.

To Peter Schaapveld, Consultant Forensic and Clinical Psychologist, for read-ing a draft of the book and offering helpful comments.

My sincere thanks to Paul Gould, Webmaster of Trade2Win, and to Alan Rich,Group Moderator and Market Trainer, for reading draft chapters of my book. Thecomments were used to good effect.

My thanks to Symon Price at Mental Health Concerns & Issues for sendingme many useful research documents and website links.

My gratitude to Helen Quenet, Webmaster of ThePitTrader, for reading draftchapters of my book, giving me charting data, and inviting me to take partin seminars.

My sincere thanks to E. Hirsch, J. Joachim, T. Greenwood, and E. Ford, forreading the draft manuscript and making helpful comments as fellow traders.Also to Roy Didlock of TraderGuide Systems for offering useful charts andcomments.

My sincere thanks to “Kappa” and 37 other home traders, who gave me valu-able data on trading styles and personality, but who wished to remain anonymous.

My sincere gratitude for the support given to me by Chris Swain and RachaelWilkie (editor) at John Wiley & Sons (publishers). It took longer than we thought!

My thanks to Dr Alex Elder for allowing me to paraphrase some of his work.My gratitude to Mr K of the FSA for permission to publish his comments

regarding training.My sincere thanks to Lewis Borsellino for allowing me to interview him

between the 9th and 18th holes, and helping me to understand the nature ofopen outcry trading at the Chicago Mercantile Exchange.

Also, my sincere thanks to Girma Mesfin, who has given me encouragementand support over the years of writing this book and who has shown me byexample that perseverance will eventually result in success.

My sincere thanks to Sonia Stevens and Sue Bradbury, both of whom typed asignificant amount of this book and who make a tremendous effort to ensure alldocuments were completed quickly.

And finally, to my friend and trading colleague, Tim Rayment, a very talentedtrader and award winning journalist, who gave me helpful comments on themanuscript and spent a considerable amount of time writing the Foreword to thisbook. I am indebted for this kindness.

Mike Elvin 2004

1Introduction: Between Scyllaand Charybdis

‘‘The winds and the waves are always on the side of the ablest navigators.’’

Edward Gibbons

This book is written for people of moderate income engaged in risking theirpersonal finances on a speculative venture. It is for the brave new world of stockand futures day trading, spread betting, options hedging, or any activity requiringcourage owing to financial and personal risk.

For the purposes of this book, “risk” is defined as the coexistence of dangerand opportunity; where there is uncertainty in relation to future outcome. Theseductive blend of danger and opportunity has a powerful allure and the challengeof day trading is fraught with dangers, not normally associated with traditionalemployment. If you have one, two or three degrees, diplomas, MBAs, whatever,you have no advantage over an astute corner shop newspaper vendor or a streetflower salesman. In fact, a hypothesis has been suggested to the contrary; thatpeople with professional qualifications need to “unlearn” their cognitive schemato engage the venture unencumbered by predispositions.

The substance of the book has been drawn from two sources: first, from my per-sonal experience of changing professions in my late thirties from a relatively safecareer of managing mental health services in London, England, to that of a stockindex futures trader; second, from the large volumes of academic research papersand related literature in the fields of experimental psychology, occupational andperformance psychology, economics, day trading, and business administration.I hold formal qualifications and training in these fields and have confidence tomake valid inferences from training, research and personal experience.

2 Financial Risk Taking

The purpose of this book is to present a synthesis of contributions to thepsychology of financial risk taking (I will use the term “trading” as synonymouswith “financial risk taking”) by numerous authors from the above fields. It willintroduce the neophyte trader or speculator to a world of personal growth andlearning which is as much of a requirement for competence as is a thoroughunderstanding of market technical analysis.

When I embarked upon my training as a derivatives trader, I read many booksby “experts” and I discovered that old concepts were being rebranded with osten-tatious new names. Many authors led me to believe that they had “invented” newanalytical systems or “discovered” scientific axioms, but I have now come tounderstand that many systems are combinations of moving averages of varyingdegrees of complexity. There will always be exceptions to this.

During my novice years of trading, I read Jack Schwager, Market Wizardsand The New Market Wizards, which I highly recommend. I met numerous other“experts” and “wizards” in England who did not quite have the pedigree ofSchwager’s “Wizards”, but nevertheless presented me with a model or paradigmfor learning. I did not understand the difference between going “long” or “short”in the market, which will give the reader an idea as to the amount and quality oftraining that I needed to achieve competence.

ALCHEMY AND WIZARDS

I met my first tutor through a highly complimentary article in a respected nationalnewspaper. The man seemed highly intelligent, had a few endearing idiosyn-crasies, and called himself “Chief Wizard”. I parted with ¤9000 for two weeks’tuition and software. Following this course, I discovered that the course contentwas seriously lacking and the software was archaic.

Whatever reason leads us to train to become traders, there is then the task offinding suitable courses taught by tutors with the personal attributes of integrity,quality and ability. In the USA there are numerous courses taught by recognisedtraders and there are numerous sources where candidates can access opinions andviews of previous attendees. In the UK, trading as a full-time endeavour has onlyrecently become a reality and many candidates have been hoodwinked by charis-matic tutors of questionable ability. Essential attributes such as qualifications,experience, and proven trading ability have largely been ignored by candidates,mainly as a result of lack of information and general knowledge.

I refer the reader to Box 1.1 where there is an outline of a course taught in theUK by a tutor calling himself Chief Wizard. I could be accused of inappropriatelyusing this book as a vehicle to “get even” since I was one of many people to beduped by this man. It is a known fact that post-course complaints often betraytheir underlying motives of subtle revenge towards the disappointing training andtutor. I have no such motives. My intentions are two-fold; first, to raise general

Introduction: Between Scylla and Charybdis 3

awareness of courses taught in the UK and second, to allow the reader to assessthe quality of this course on a continuum from unsatisfactory to satisfactory. Inother words, it is not my intention to bring Chief Wizard (CW) to his knees; itis my intention to bring the investing public to their senses! The course outlinedin Box 1.1 was not written by myself, but was written by a student of ChiefWizard who had the intention of sending the document to trading standards andlaw enforcement agencies. The document highlights many pertinent issues. Ihave preserved the document as much as possible in its original form, save forcorrecting grammatical errors and clarifying convoluted points.

Box 1.1 Derivative’s Trading Course of 1998 Sold and Taught by‘‘The Chief Wizard’’

Last spring I attended a two-week course in derivatives trading run by theChief Wizard (CW). The course fee was £5000 and one was also required topurchase software at a cost of £1865. It had since become clear to me thatthe software itself is out of date and significantly defective, and what littleinformation was gained during the course is almost of no value.

With the software, the buyer receives a book entitled “The UndeclaredSecrets of the Stock Market”, by the respected veteran trader and marketanalyst Tom Williams. Most of the relevant information presented by CW inhis course is in fact contained in this book. CW tells his students that thebook is fraught with deliberate errors in order to wrong foot those in theknow. After much build up, he eventually leads his students page by pagethrough the book in order to correct those errors. For the most part, thesecorrections involve replacing the words “selling” with “buying” and “buying”with “selling”. Clearly CW and Williams disagree on whether activities withinthe market should be referred to by the actions of the outside small time traderor the inside professional. In fact, the terminology is of little real consequenceso long as one is consistent. By changing some but not all of these terms, CWhas taken a book that has been written with internal consistency, and has madeit inconsistent. Other changes had little or no effect on the overall meaningpresented by Williams.

CW insisted that his instructions should be followed blindly without ques-tion. At the same time he gives us no hard and fast rules as to what to do (thisof course would be impossible). Half way through the second week someonepointed out that they still did not know what a futures contract was, and yetthey were expected to trade in these instruments. CW became irritated andeventually angry. He repeatedly insisted that it was his job to keep peoplefollowing the intended path, and those of us with awkward questions weretrying to stray from “the path”. It seems incredible that CW refused to explaina futures contract.


CW considers himself to be a great teacher, using radical methods to preparehis students for a deadly war or game. During CW’s course, students wererequired to memorize various lists of facts and market occurrences and tobe able to reproduce these on command. Amazingly, many people actuallybelieved that they were learning something of value by being put under press-ure like this. In my view, anyone spending £500 per day on such a courseshould be prepared to memorize a dozen or more such lists between the firstand second day or else stay at home and save their money. CW dragged thisrepetitive and puerile process out for two weeks.

Good teaching involves bringing the student to an understanding of thematerial being learned. CW deals only in indoctrination, by forcing people tomemorize lists of words when they have little or no idea of the underlyingmeaning of those words. In the end, students were left with the ability to fireoff lists at speed without really knowing how to recognize these concepts inthe real world of derivatives trading.

More than half of CW’s course time was taken up by CW talking abouthimself. He is a blatant racist with a deep-seated hatred of the German people.On one occasion, he stated to the class that he could not allow “Negroes” toattend because they were intellectually inferior and would hold up the restof the class. This was not so with Asian blacks, however, and one of thetwo Asians attending this course was made an example of by being tied upthen gagged by CW. The travesty was meant to be a joke and a salutaryexperience for all others who did not pay attention to CW. In addition tothese highly offensive actions and statements, he stated that any race capableof the Holocaust must necessarily be irredeemable and “rotten to the core”.He takes the silence from the group as tacit agreement. He does not seem torecognize that no one is willing to object, because they have spent severalthousand pounds and this more than any thing convinces them that CW musthold the key to substantial wealth.

At other times, he discusses his recent victories in the markets, his politics,how he enjoys spending his wealth, how he metaphorically owns a wheelbar-row to transport his money, the admiration he attracts, his personal strugglefor wealth, military training (this seems to hold a suspicious fascination forhim), memories of previous lives, the conspiracy behind the death of PrincessDiana, his own yachting experiences (including his focus and calm while sail-ing solo in the English channel during the 1987 hurricane), the shooting ofJohn Kennedy, the selling-out of British industries to foreign interests, and hispersonal abilities to auto-induce out-of-body experiences.

During one of the days, I kept a time line outlining the topics under discus-sion. Out of over seven hours of classroom time, just under two minutes weredevoted topics related to futures trading. Even this time was taken to answer, ina grudging and patronizing way, the queries raised by three different students


(one answer took four seconds). CW’s interests in the aforementioned topicstook up the rest of the time.

CW employed classic techniques to maintain credibility in the eyes of mostof his students. First and foremost, he offered them the hope of attaining greatwealth. This made him valuable in the minds of the listeners. Additionally hewould express great concern for the welfare of his students (no such concernhas been forthcoming since the end of the course). He would act in a graveand serious manner and then suddenly became friendly and easygoing. Hewould relate stories of his childhood, speaking of deep-rooted fears in anemotional manner. This would endear him to many of the listeners, creatingsympathy. He also allowed himself to be overcome with emotion on at leasttwo occasions – again with many students this had the effect of creating abond of trust. The tactics employed were (frighteningly) not unlike that of acult leader.

CW created the illusion that his students were learning information at anaccelerated rate. Often he would discuss a recent victory on the market, andthen take the group through a laborious calculation to determine the profit froma fractured fill. He ran through at least four such calculations. The mathematicswould not be beyond a reasonably able 13-year-old, but because of the tediousnature of the calculation and the amount of paper used people felt as if theyhad been working hard. Following such a calculation, he would remind us thatwe could not do this sort of trading anyway, but that we should understandthe “complex” calculations involved.

At no time during the course was a computer made available to observetechnical charts or actual market movement. In fact, technical charts were notused to teach any of the ideas presented. Occasionally CW would produce aphotocopied sheet showing a trade he himself had accomplished. Always thesetrades were carried out using “higher level methods” which we were not privyto. We could not see any evidence of the concepts we had learned in the charts.

There are several people who have benefited from the course. CW himselftook in almost 2 million pounds sterling in course fees alone. His personalfriends have made money by selling computers and data feeds to his prospec-tive students. CW’s broker, another personal friend, is clearly doing very wellfrom the commissions generated by fledgling traders, regardless of the successrate of such trades. There is little evidence to show that these traders are doinganything other than losing money, despite months of paper trading using ideaslearned from CW. The implications are obvious.

During the course, my group was presented with many blatant lies. Someof these are as follows:

1. As part of the course, CW sold a software package for £1865 called Vol-ume Spread Analysis (VSA Version 4.3.4) developed by Tom Williams,


a respected author and retired trader. A new version had simultaneouslybeen released by Tom Williams’ company called VSA Professional (Ver-sion 5). CW deliberately lied by saying VSA 5 was purposely sabotagedwith errors in order to wrong foot the professional trader. This wastold to us so that we would continue to believe that we possessed thebest available version of VSA, namely VSA 4.3.4 – an obsolete soft-ware package.

2. CW’s motive for lying becomes clear when you discover he bought thefull rights to VSA 4.3.4 from T. Williams. CW tells all students that hepaid a seven-figure sum for the rights (e.g. in excess of £ 1 000 000).T. Williams has publicly stated that this is a lie.

3. CW tells students that the book “The Undeclared Secrets of the StockMarket” also contain intentional errors designed to wrong foot anyonewho obtains the book but does not study with CW.

4. CW tells students that the software VSA 4.3.4 has a secret methodof initializing the moving averages – the formula needs to be enteredexactly as specified by CW. If the program does not recognize the user,it fails to function correctly.

5. CW’s personal friend, John Bollinger, specifically developed BollingerBands for VSA 4.3.4.

6. CW informs selected students that he has the ability to initiate out-of-body experiences at will. He can teleport his mind to any location atany time. Often he will travel to the home of a friend and describe tothat friend what is happening at his home.

7. The practice and study of derivatives trading involves the use of “sys-tematic vincivism” a neologism coined by CW. He defines this phraseas: “The practice of repeatedly examining an idea or pronouncementto constantly assess its validity.” Any student applying this self-styledconcept to the course itself will realize by the end of the second day thatthere is little to be gained from the course. The neologism “vincivism”is synonymous with “empiricism”, but is more sonorous and grandilo-quent, thus encouraging CW’s self-edification and a false belief in hisown myth.

8. The trading room at his home (called The Kremlin) is booby trappedwith CS gas canisters in case of intrusion. Only bona fide wizards areallowed into the “Inner Circle”.

In summary, I feel that CW has taken my money and failed to deliver on thefollowing points:

1. I paid for a course in derivatives trading and at least 85% of my timeon the course was taken up with CW’s personal opinions of unrelatedtopics, usually himself and his own achievements.


2. What little information was presented to me is almost useless in thecontext of real trading.

3. The venue for the course was held on a boat moored on the riverThames near Blackfriars Bridge. This was often uncomfortable, noisy,and the facilities were poor. Chairs were basic and no suitabletables were provided. Considering the amount CW took in fees frommy group alone (over £180 000), the use of such a cheap facilityis ridiculous.

4. No one that I am in contact with from the course is able to tradesuccessfully using CW’s teaching.

5. Two weeks of my time were taken up with a course that could easilyhave been taken in two days

6. CW refused to explain the nature of basic concepts such as volumeand the nature of an index futures contract, which are central to thestudy of derivatives trading.

7. The software provided is unreliable, incomplete, will not run in con-junction with other software, and often crashes despite running on itsown dedicated machine. No course time was devoted to the use ofVSA 4.3.4 and the material provided was inadequate.

8. I never received my own copy of the software for which I paid nearly£3000.

9. I have not received an invitation from CW since the course, despite hisinsistence that he would be inviting us down to his home to observereal time trading.

10. The course literature promises a receipt for course fees but nonewas given.

CW has now retired to a popular and exclusive seaside area in England andrarely offers training requiring public advertising. How is it possible for so manyintelligent people to be convinced by this man and his “helpers” to undertaketraining? In Chapter 5, entitled “The Psychology of Perceptual Bias”, I explainindividual and herd phenomena such as overconfidence, the halo effect, misplacedconsistency theory, the sunk cost error, and the risky shift, all of which influenceus to make inadequate decisions. These decisions create traps that impel us toremain consistent with an incorrect course of action.

In the writing of this book, I freely admit that I have borrowed extensivelyfrom research and literature as outlined above, and I have made every effort tocredit the originators of the research when appropriate. I have found numerousauthors who borrow from undergraduate psychology and business administra-tion courses and often the information is not relevant to trading. For example,


mastering statistical testing of a null hypothesis is a standard requirement forpsychology undergraduates. One author presented the two statistical tests of “chisquare” and “confidence limits” as an inference tool to ascertain trading compe-tence and consistency. I believe these peripheral skills can only help if you havelearned them prior to your trading career because non-relevant learning will bean additional and unwarranted stressor to a huge learning curve. Many excellenttraders have no mathematics background. In addition, I recently received a flyerfor a course on “How to make a business plan for traders”. The cost for thethree days was US$3500, which is more than one year’s MBA tuition fees at theUniversity of Kingston Business School where I had been seconded. The coursematerial was identical to the MBA course apart from the word “trader” liberallyapplied throughout.

Throughout the ages, people have tried to fulfil their dreams and ambitionsand even the smartest of us are gullible. In Amsterdam, Holland, during thesixteenth century, there was an accredited degree course in alchemy from anaccredited and respected centre of education. Our own historical ancestor, DrJohn Dee, mystic, astrologer, and adviser to Queen Elizabeth I, is reputed tohave researched alchemy there. No one had ever turned lead into gold and wenow know that turning lead into gold does not fit the facts of empirical quantummechanics and inorganic chemistry.

Regardless of the lack of evidence, it did not change the fact that peoplebelieved it could be done. This belief existed for almost a thousand years. Greathalls were filled with people, all discussing how to create gold from base metals.If you could convince somebody that you had done it once, people would listento you and pay large amounts to learn the secrets of alchemy.

If you are unable to show success at the time, there was always a good reasonwhy it did not work on this occasion. Others would take what the master knewand add to it, to “improve” it; others would try to refute the ideas with ideas oftheir own; still others would keep parts of the whole concept and discard otherparts not to their liking. Some would combine parts of the entire history withother parts into incomprehensible combinations that only they understood butclaimed worked. The same herd mentality is at work in these modern times andthere are many “experts” who would like to sell you this dream.

THE PSYCHOLOGY OF FINANCIAL RISK TAKING

The psychology of financial risk taking is a theoretical and practical disciplinethat can be used as a tool to preserve your capital. If you preserve your capital,winnings will take care of themselves. The psychology of trading offers an answerto the question: “Why do traders lose most or all of their money, even when usingsystems claiming 70% efficacy?”

Clearly, trading is about the person as well as market technical analysis. Theoveremphasis on mathematical charting was acknowledged by Jesse Livermore


in the early 1900s. On page 61 of the book Reminiscences of a Stock Operator(by E. Lefevre), it says:

I should say that a chart helps those who can read it, or rather who canassimilate what they read. The average chart reader, however, is apt tobecome obsessed with the notion that the dips and peaks and primary andsecondary movements are all there is to stock speculation. If he pusheshis confidence to its logical limit, he is bound to go broke. There is anextremely able man, a former partner of a well-known Stock ExchangeHouse, who is really a trained mathematician. He is a graduate of a famoustechnical school. He devised charts based on a very careful and minutestudy of the behaviour of prices in many markets – stocks, bonds, grain,cotton, money, and so on. He went back years and years and traced thecorrelations and seasonal movements – oh, everything. He used his chartsin his stock trading for years. What he really did was to take advantageof some highly intelligent averaging. They tell me he won regularly untilthe First World War knocked all precedents into a cocked hat. I heard thathe and his large following lost millions before they desisted. But not evena world war can keep the Stock Market from being a bull market whenconditions are bullish, or a bear market when conditions are bearish. Allthat a man needs to know to make money is to appraise conditions.

I am not belittling the importance of technical analysis; I am making explicit therequirement for traders to make a study of their own behaviour. I call this the“paramouncy principle”.

THE PARAMOUNCY PRINCIPLE

The “paramouncy principle” is this: that you are the most important variablein the trading equation. The psychology of trading addresses the “paramouncyprinciple” in a systematic manner. Implicit in this principle is my view thatanyone with average intelligence and the ability to continue learning for manyyears, will eventually become a successful trader. The ability to be persistent andflexible to new ideas is a personal trait of all the traders interviewed by JackSchwager in his seminal books.

Most traders lose money because they do not have an understanding of themarkets or themselves. They trade without method, strategy or discipline. Theyfall prey to powerful emotion, which leads to impulsivity and behaviours moreakin to gambling than to genuine understanding. They fall prey to perceptualbiases that lead to false conclusions and inappropriate actions.

Education is crucial in addressing the “paramouncy principle”, yet most tradersprefer courses on technical analysis. Tom Williams, originator of the WyckoffVSA model, has developed an outstanding technical system, yet he stresses the


necessity of method, the requirement of discipline, and the importance of moneymanagement. Even armed with this understanding, traders still have the dauntingtask of identifying the psychological factors that lead to self-defeating behaviours.

A primary factor contributing to a trader’s demise is stress. In trading, one’smoney is always on the line, often on a “tick-by-tick” basis, and it is exposedto potential loss. The uncertainty of all that could happen often makes the trader“believe” that certain things must happen. These “beliefs” often interfere withassessment and strategic/tactical planning.

In this mental state or schema1 traders make substantial errors in judgementand action. A major task for any trader is to preserve capital for more successfultrades. This rarely is done well enough. Traders often find that following exitinga trade at a loss, the market returns to the original entry point and then becomesa profit. This frustrating fact leads to self-defeating behaviour and “if only”recriminations. Traders are experts at punishing themselves, and the loss cycle(described in Chapter 3) leads to a self-fulfilling prophecy of failure.

ACTION, ANALYSIS, AND THE BELIEF PARADIGM

Uncertainty regarding future price action causes anxiety and many traders reducethis anxiety by attempting to “predict” and “forecast” the future. When a traderbelieves prices will rise or fall, the trader takes action. Action follows belief.

The word ‘paradigm’ comes from Greek para – beside, deiknynai – to show.This book employs the common usage of the word, which means a model, theory,perception, assumption or frame of reference. The personal belief paradigm ishow we perceive, understand and interpret the world. A paradigm is a theory,model, or explanation of something else.

Beliefs are very powerful and seductive. Most market technical analysis is biasedby a powerful impulse to confirm and strengthen belief. The belief paradigm seeksonly confirmation and does not seek contrary evidence. In addition to not seek-ing contrary evidence, the personal belief paradigm actively denies, discounts,ignores or distorts evidence. The personal belief paradigm has a powerful mech-anism of denial. This process of denial acts as a catalyst to elicit powerful emotions,such as fear. Emotions in general and fear in particular, can impair perception andarrest appropriate action based on contrary evidence. The implications for tradersare immense.

Research (Schwager, 1989) indicates that traders are poor at price prediction,showing only 35% to 50% accuracy. One only needs to read the Sunday Times

1 Bartlett (1932): during his famous research on memory, Bartlett coined the term “schema”. Regarding memory,Bartlett concluded that when we remember a verbal account, the words are never exact. What happens is whatwe perceive is assimilated into our own structure of meaning, that Bartlett called a “schema”, which includes agreat deal of general knowledge. Then when a recall is asked for, the subject takes a few significant remembereddetails and a general emotional attitude to the story, and from the “schema” constructs what the story must havebeen. The research on “schema” and perceptual biases has profound implication for traders and will be coveredin Chapter 5.


newspaper, or other quality broadsheets, to see that the experts have little or noexpertise in predicting prices.

Members of all professions sometimes perform poorly, but the poor perfor-mance of financial advisers is matched only by the poor judgement of theirclients. David Dreman (1979) has produced research in “Contrarian InvestmentStrategy”. Numerous studies show that advisers on equities consistently do worsethan the market they are in, even before making allowance for any fee. The sameapplies to the managers of pension funds, unit trusts, and of the portfolios ofinsurance companies. The main reason for their poor performance is that theyfollow the herd.

The continued employment of investment analysts, commodity trading advis-ers, etc., both by the general public and by large firms with money is an exampleof false belief paradigms in action, since these “professionals” are known to beworse than useless. Of this, Professor Stuart Sutherland, in his book Irrational-ity – The Enemy Within states: “It is as though a doctor were to be paid forprescribing drugs that were worse for the patient than ones selected at random.”

There is evidence presented in Chapter 3 of this book that suggests the proba-bility of success in day trading is increased by abandoning efforts at prediction,and focusing upon recognising the predicates for action. No one can predict withtotal accuracy what the price will be in the next minute, hour, day, or year,because the underlying catalysts of market actions are fluid and changing. Thetrader must always be aware of evidence that refutes the reasons for being in thetrade and when this evidence is confirmed, the trader must exit the trade withoutquestion, regardless of strength of belief of what will or should happen. Theprocess of analysis and refutation is counter to what happens in the psychologyof the personal belief paradigms and is something the trader must learn.

Chapter 2 introduces the concepts of trading competences and competencies.The competencies required to minimise risk, minimise dependence on predictionand minimise the influence of beliefs are examined. To understand the processand influence of these factors on trading behaviour is the first step to tradingcompetence and freedom from the cycle of loss.

The essence of successful trading is this: to know what to do when volumeand price spread patterns are recognised, to know with certainty that one will acton those parameters when they do occur, and to let go of belief and predictionin order to focus more clearly on what action is happening in the market, hereand now.

REFLECTIONS

I have suffered the hardship of trading losses and the indignity of being hood-winked by incompetent tutors charging extortionate fees for useless material.Surprising to some, it is an experience I am grateful for. The experience has


motivated me to provide affordable and efficacious education for traders. Duringthe writing of this book, I asked myself one question – “Would this book havehelped me in taking my first steps to trading competence?” – the answer is yes.

What follows is a navigational chart that will help to guide you safely throughthe treacherous waters between Scylla and Charybdis.

SUMMARY CHAPTER 1

• Risk is defined as the coexistence of danger and opportunity, where thereis uncertainty in relation to future outcome. People wishing to learn tradingskills have been hoodwinked by charismatic tutors, some of whom haveno formal qualifications, little trading experience, and no proven tradingability. A course taught in England is presented.

• The psychology of financial risk taking is a theoretical and practical dis-cipline that can be used as a tool to preserve your capital.

• The paramouncy principle is introduced. The principle embraces the notionthat you are the most important variable in the trading equation. JesseLivermore’s views on the overemphasis and dependence by traders oncharting are examined.

• Traders lose money because they do not have an understanding of the mar-kets or themselves, and they trade without method, strategy or discipline.They fall prey to powerful emotions and perceptual biases which lead togambling type behaviours.

• The concept of analysis and refutation is introduced. Market technicalanalysis is biased by a powerful impulse to confirm and strengthen belief.Traders often seek only confirmation; they do not seek contrary evidence.The process of analysis and refutation makes explicit the requirement toidentify all information that would militate against your position.

• Research by Dreman et al. demonstrates the poor performance of financialadvisers, portfolio managers, and pension funds. The public still investwith these professionals regardless of the considerable adverse evidence.

• Prediction of prices by traders is very poor, it is suggested that concen-trating on developing plans using calculated probabilities and then takingaction only when the preconditions are evident, is an essential skill to belearned by traders.

2Understanding TradingCompetence

‘‘There is nothing new on Wall Street or in stock speculation. What hashappened in the past will happen again and again and again. This isbecause human nature does not change.’’

Livermore/Lefevre

In the early 1900s Jesse “Laurie” Livermore had discovered for himself theparamouncy principle and worked hard at developing personal skills to becomea competent trader. In the twenty-first century we have new technology, newmarkets, but the rules and roads to success are the same now as they were inthe early 1900s. As a novice trader I had a huge appetite for modern authors,some of whom I will be recommending at the end of this book. When read-ing Reminiscences of a Stock Operator by Edwin Lefevre, I noted considerablesimilarities between Livermore’s emphases on money management, emotionalcontrol and intelligent battle plans and that of modern day educators. Below, Ihave chosen three contemporary authors, who educate the growing numbers ofhome traders and compare their general headings for skill development againstthose of Jesse Livermore:

JesseLivermore

AlexanderElder

VanTharpe

LewisBorsellino

Intelligent battleplans (timing)

Method System Ready

Emotional control Mind Psychology AimMoney management Money management Money management Fire


Contemporary authors advocate similar, if not identical, maxims, methods andattitudes. Each has different emphases; some specialise in pit trading, others inscreen trading; a few prefer trading futures or options, while most trade stocks.This kind of variety is of benefit to students and sometimes for no immediatelyapparent reason a particular author may “connect” with a student’s needs anda very beneficial relationship can develop between the student and the book.Jesse Livermore identified his own learning needs and the skills required tosucceed, and only published one book in 1940 entitled How to Trade in Stocks.The book may be short but is of tremendous value from both a historical andutilitarian perspective. Livermore was committed to the concept of speculationas a disciplined business venture. This discipline is reflected in his meticulousrecord keeping that enabled him to perceive price patterns. His persistence inthe continued maintenance of his records eventually led him to combine a timeelement to his price patterns and the Livermore formula was created. We knowmuch about Livermore’s ideas and methods through “Larry Livingston”, theprotagonist of Reminiscences of a Stock Operator, and more recently, in thebiography written by R. Smitten (2001) entitled Jesse Livermore: The World’sGreatest Stock Trader.

While Livermore’s original 1940 book is of tremendous importance (there arenumerous reinterpretations of this work), some might view it as crude or archaicby today’s standards. Contemporary authors have a wider remit and addressinformation technology, the new futures markets, globalisation, and personal psy-chology. By analysing the competencies required in the tasks of trading, thereare immediate advantages through honing personal skills, and more generally, bydeveloping a model for learning which can be shared.

Research (Kolb and Kolb, 2001) has shown that people learn best when theyuse methods and modes that suit them. David Kolb developed “The LearningStyle Inventory” when he was at the Massachusetts Institute of Technology andthis has been used for more than 30 years to understand learning in professionsranging from medicine, management, to law. Kolb found that people learn mostoften through one of the following modes:

• Concrete experience: Having an experience that allows them to see andfeel what it is like.

• Reflection: Thinking about their own and others’ experiences.• Model building: Coming up with a theory that makes sense of what

they observe.• Trial and error learning: Trying something out by actively experimenting

with a new approach.

Learning often happens best through a combination of two or three of thesemethods. Research indicates (Kolb et al., 2001) that some people rely on stylesor methods of learning that can actually hinder their learning, especially if used

Understanding Trading Competence 15

too early or too much. These learning methods can act as an impediment tomotivation and further learning because learning may feel boring or irrelevantand therefore drain their excitement.

It is useful here to recount some of the feedback that I have had from studentswho attended “The Chief’s” course, as referred to on page 3, Box 1.1. He hadrequested students to memorise particular patterns in the market in a nurseryrhyme fashion. This rote memorisation is relevant and helpful in the context ofrehearsing an action plan. However, the students never had an opportunity toapply the mnemonics to the trading screen. Instead of memorising patterns thatmany students did not understand, it would have been more appropriate to applythis to screen trading. After a few days, many students felt the course was irrel-evant and stopped paying attention. Trainers with an academic background oftenorganise courses to fit their own preferred learning style which for academics istypically abstract and reflective. However, a student, whose learning style may bemore active and concrete, needs to begin by learning some practical techniquesthat he can try immediately on the trading screen. Other courses, especially inAmerica, present a specific teaching style with a fixed learning agenda. This typeof learning may not suit everybody and it may assist the student to identify his orher learning styles to ensure that the cost of the course and the content will notbe wasted. It may help the student to look at the Kolb Adapted Style Inventoryand the reference with an Internet link (URL) is cited at the back of this book.

David Kolb did not undertake research specifically on pit or screen trading butthere are numerous authors who have contributed to this field. Before identifyingthe competencies required for the trading task, I will review some influential lit-erature of the twentieth and twenty-first centuries. Mark Douglas has written TheDisciplined Trader: Developing Winning Attitudes (1990) and has identified sevensteps to trading competence. Although Mark Douglas has not summarised therequired skills under three major headings as the authors above, he has been verythorough in identifying the major skills required for trading competence. In myopinion, Mark Douglas’ book represents a standard of excellence in authorshipin this field and I was surprised to find that he did not hold formal qualificationsin psychology, given the depth of his understanding.

THE SEVEN STEPS OF TRADING SUCCESS: MARK DOUGLAS

Step 1: Staying focused on what you need to learn

Douglas stresses the importance of understanding what it is one needs to learn toachieve their goal. He emphasises breaking down the goals into manageable partsand in trading stresses that there is a tremendous difference in focusing on moneyand focusing on using your trading as an exercise to identify what you need tolearn. In other words, learn to trade and profits will take care of themselves.


In addition, he draws the distinction that when focusing on money, the traderdoes not accept personal responsibility and often blames wins or losses on thevicissitudes of the market. When focusing clearly on what is required to attaintrading competence, one fully accepts responsibility for their own learning.

Douglas points out the importance of setting aside money as capital for tuitionand education. His view is that the amount of money set aside for education canbe interpreted as a commitment to continuing your professional development asa trader. He states that the stronger your commitment, the faster you will learn.

Step 2: Dealing with losses

Douglas outlines the importance of defining a loss before it is taken. He empha-sises the necessity for any trader to understand and completely accept the neces-sity for losses. If a trader fails to do this, he will generate fear and end upgenerating the very experience that he is trying to avoid. Douglas also empha-sises the necessity for traders to be flexible and open in defining what lossesmean. This definition should be incorporated into the trading strategy so that yourresponse to the loss will become automatic. Douglas further states, “When lossesare pre-defined and executed without hesitation, there is nothing to consider,weigh, or judge and consequently nothing to tempt you with.”

Step 3: Becoming an expert at just one market behaviour

Douglas emphasises that focusing on more than one market in the early stagesof your development will create confusion and overload that will inevitably leadto losses. Douglas recommends that one particular trading pattern is identified inone market and become an expert in that. To understand one system in depth,trading one market, is a difficult but possible task. He advises to let go of sometrading opportunities for educational purposes. After all, “what is the rush?” Ifyou are in a rush, it likely implies that you are focusing on money, not tradingskills. He recommends that you do not expand on more than one market untilyou understand thoroughly its characteristics.

Step 4: Learning how to execute a trading system flawlessly

Douglas defines a trading system as “what they do [trading system] is mathe-matically define, quantify and categorise past relationships in collective humanbehaviour to give you a statistically probable outcome of the future”.

Douglas makes a further distinction between gambling and executing a tradingsystem in that gambling has a purely random outcome based on statistical prob-abilities, therefore you do not have to take responsibility for the outcome. He


argues that because you have an element of responsibility in trading, your self-esteem is at stake and therefore it is much more difficult to participate. Douglasadds that two main concepts need to be integrated into your mental schema, firstin terms of probability and second, in correlating the numbers or the mechanicsof your system to the behaviour. He points out that traders rarely stay with asystem beyond two or three losses in a row, and it is a very common occur-rence. This is where discipline becomes important, as is developing confidencein your trading system to know that continued use with flawless executions willeventually provide profits.

Step 5: Learning to think in probabilities

Douglas argues that once you have mastered the mental skill of discipline, youneed to develop your thinking along the lines of probabilities. To do this Douglashas developed a series of questions that assist a trader in following the flow ofthe moment and to keep the trader focused on the here and now.

1. What is the market telling me at this moment?2. Who is paying up to get in or out?3. How much strength is there?4. Is momentum building?5. Can it be measured relative to something?6. What would have to happen to indicate momentum is changing?7. Is the trend weakening or is this a normal retracement?8. What would show that? If the market has displayed a fairly symmetri-

cal type of pattern and that pattern has been disturbed, then it is goodindication that the balance of forces has shifted.

9. Are there any places where one side would definitely gain dominanceover the other? If that point is reached, it still may take some time forthe other side to be convinced they are losers. How long are you willingto give them to stampede out of their positions?

10. If they do not stampede out of their positions, what will that tell you?11. What did traders have to believe to form the current pattern relative to

the past? Remember that people’s beliefs do not change easily, unlessthey are extremely disappointed. People are disappointed when theirexpectations are not fulfilled.

12. What will disappoint the predominant force?13. What is the likelihood of that happening?14. What is the risk of finding out in a trade?15. Is there enough potential for movement to make the trade worth the risk?

These questions assist the trader in remembering that anything can happen. Theyhelp you stay detached and keep in perspective that price movement is a function


of traders acting individually and collectively as a force, expressing their beliefsin future value. Douglas further argues that by asking yourself these questions,you are automatically keeping the focus of attention on the market and what thepossibilities are.

Step 6: Learn to be objective

Douglas argues that to be objective one needs to operate out of a set of beliefsthat will allow for anything to happen as opposed to beliefs that allow the marketto express itself in a limited fashion. Obviously a trader has to have some beliefor expectation about the future, or the trader would never put on a trade in thefirst place. Douglas suggests that you can assess your own level of objectivityby determining whether you have achieved the following states of behaviour.

• You feel no pressure to do anything.• You have no feeling of fear.• You feel no sense of rejection.• There is no right or wrong.• You recognise that this is what the market is telling you.• This is what I do.• You can observe the market from the perspective as if you were not in a

position, even when you are.• You are not focused on money but on the structure of the market.

Douglas argues that it is important to release yourself from the need to be rightand the more uncommitted your assessments are, the less potential there will beof distortion and experiencing a painful, forced awareness.

Step 7: Learning to monitor yourself

Douglas suggests that traders need to pay attention to what they are thinking andwhat market information is being focused upon. Earlier in his book, he states thata trader needs to identify personal dangers needed to function successfully in thetrading environment. Once recognising the need for change, the next step willbe to identify the techniques in changing. He suggests that some of the changesrequired are to neutralise commonly held beliefs about success. In addition, oneneeds to learn mental skills to adapt to the constant changes in the market. Also,he suggests a number of exercises to effect change, such as self-hypnosis, positiveaffirmations, writing and structuring one’s learning process.

Douglas has made a significant contribution to outlining the skills requirementsand of suggesting methods and techniques to achieve trading competence. He will


be one writer that will make a significant innovation in the thinking of the twenty-first century home-based screen trader. In the final chapter of this book, I outlinethe standards we hope to achieve as traders and the criteria by which we canassess our own level of competence on the continuum from novice to expert.In this structured manner, the trader can monitor his or her own developmentand will hopefully provide a simple yet apposite tool for continued learningand survival.

MIND, METHOD AND MONEY MANAGEMENT

I am grateful to Dr Alexander Elder for allowing me to reproduce some of hiswork here. Dr Elder has written two highly illuminating books called Tradingfor a Living and Come Into My Trading Room.

The three Ms of successful trading

Elder quite correctly points out that beginners focus on technical analysis. Iremember my first year of full-time trading when I sat from 7.30 a.m. until 8.00or 9.00 p.m. looking at a 21-inch screen searching for patterns on one-, five-, 10-and 60-minute charts. I was soon to learn that short time frame day trading isthe start of a slippery slide to bankruptcy. Novices gain the impression that theyare working extremely hard and must be progressing by virtue of the amountof effort they are investing in their newfound profession. Elder points out thatprofessionals operate in a three-dimensional space. By this he means that theyare aware of trading psychology, their own feelings and the mass psychology ofthe markets. Each trader needs to develop his own method for choosing specificstocks, options or futures as well as clear and concise rules for pulling the trigger.Money refers to how a trader manages his trading capital. In my first years oftrading I asked myself why I would want to enter trading as a second careerwhen all the evidence indicated that 90% of all traders end up losing a significantamount of money or losing everything they owned. While I was able to answerthis question to myself, Elder offered an interesting and additional point of view.Elder demonstrates that trading has great “Entertainment Value” for people whoare living “lives of a quiet desperation”.1 Elder depicts lives of people who aresleepwalking through life. We wake up in the same bed each morning, eat thesame breakfast and drive to work down the same road. We see the same dull facesin the office and shuffle papers on our desks. We drive home, watch the same TVshows, have a beer, go to sleep and repeat this routine day after day, month aftermonth, year after year. There is the occasional distraction with exotic holidays buteventually one returns to the same repetitive pattern of living. Discovering trading

1 Source: Henry David Theroux.


is like switching from a black and white TV to a colour TV with quadraphonicsound. Purchasing your first stocks and shares gives one a tremendous adrenalinerush and whether the stocks make or lose money, we have felt the excitementand kick of trading and its “Entertainment Value”. Elder states that trading is:“the most exciting activity that a person can do with their clothes on. Trouble is,you cannot feel excited and make money at the same time.” He further developshis thesis by saying that to become a successful trader, you have to:

• develop iron discipline (mind);• acquire an edge over the market (method);• control risks in your trading account (money management).

Mind

Elder argues that one of the most important aspects of becoming a successfultrader is to realise initially that you are a loser. He compares this insight to insightsgained by alcoholics who suddenly admit that they are powerless over alcohol.Elder does not develop his thesis further by inventing a 12-step programmefor losers, or “Losers Anonymous” as he puts it. He does, however, providedescriptions of typical losing behaviours.

Blame

Elder argues that losing traders do not accept responsibility for themselves. Theyblame the broker. He recalls the story of a professor with a PhD who blamedhis broker for wiping out his one million dollar account. He had shorted a stockthat his broker had recommended. “It could not go any higher.” The stock wentthrough the roof and the professor hung on for another year hoping for a retrace-ment. The stock continued to climb and his life savings were wiped out. Blamingthe guru is another excuse that traders will use when losing. Gurus are usuallyvery short lived, with a life span of approximately two years. Elder suggeststhat many of the gurus are failed traders who have “jumped on the band wagonwhich is to provide clarity to clients on future movements of the stock mar-ket”. These gurus also include psychologists who offer coaching and tuition fortraders. Rarely does one find a training guru who qualified both as a trader anda psychologist. Blaming unexpected news is another favourite of losing traders.How many traders have you heard comment about September 11, 2001 and itsdisastrous effect on their account?

Self-sabotage

Elder points out, as have many psychologists before him, that self-destructivenessis a pervasive human trait. We are trained to control aggression against others


but our aggression needs to go somewhere. We often turn our anger inwardand learn to sabotage ourselves in ways that we cannot even see ourselves. Wehave a number of safeguards for social self-sabotage, such as suicide. There arepsychiatric social workers to offer counselling and therapy to the potential self-saboteur, psychologists who measure risk of self-harm, and psychiatrists to giveanti-depressant/anti-psychotic medication. There are no such safeguards in thefinancial markets.

Addressing self-destructive behaviours

With regard to attitudes, Elder suggests that one must admit they are a loser. Thenext step will be to analyse why it is that one is a loser. A losing trader is indenial and his equity is shrinking but he continues to jump into trades withoutanalysing what is going wrong. He suggests that defining the difference betweena loss and a businessman’s loss is important. A businessman’s risk is a small dipin equity but a loss goes through that limit. As traders we are all in the business oftrading and must take normal business risks but we cannot afford losses. Moneymanagement techniques are essential to combat losses. Elder agrees with many ofthe authors before him who have described trading as a battle. Later in this bookI will outline the contribution of martial arts and Budo Zen to our understandingand application of discipline in trading.

Elder points out that most amateurs will not admit they are trading for enter-tainment and that financial trading is far more respectable than gambling onthe ponies. A losing trader will not have the discipline to plan strategically ortactically as a general would in combat.

With regard to discipline, Elder suggests that many new traders expect to sit infront of their screens and make easy money day trading. They skip high schooland head straight for neuro-surgery. Elder points out that good traders keep goodrecords. They keep them as tools of learning and discipline. If you do not havegood records you cannot measure your performance or identify your learningneeds. He suggests that records are kept of:

• trades;• balance of account;• trading diary;• tests and self-evaluation;• the gradual assumption of responsibility;• constant evaluations and ratings;• training until actions become automatic.

Method

Elder proposes that meticulous record keeping is a very accurate index to thequality of any trader and his skills. Regarding method, Elder focuses exclusively


on technical analysis. To assist the student in developing a mental model oftechnical and fundamental analysis, I have written a brief introduction to thesedisciplines on pages 65 to 70. Elder acknowledges the vast amount of informationavailable in the market and the purpose of technical analysis is to make thisinformation manageable. No trader can master all tools in technical analysis andit is therefore essential to understand what markets you wish to trade in andthe tools which will be most effective for those markets. In terms of skills,basic charting techniques are essential. Elder describes a number of techniquesthat he has developed personally but also acknowledges that there are basiccharting techniques which are essential and fundamental in developing tradingcompetence. Most textbooks on technical analysis will include the followingessentials:

The meaning of prices

• The open, the high, the low, the close.

Bar charts, candlestick charts, and point and figure

• The meaning of an uptrend, downtrend, how to draw trend lines.• The definition of support and resistance.• False breakouts.• Volume.• Open interest.• Moving averages.

– Simple moving averages.– Exponential moving averages.

• Trading signals.• Channels.• Entry and exit strategies.

Technical analysis is very much a personal choice and dependent on the type ofmarkets you are trading. Elder offers his personal view of trading methodology.I have known numerous traders to be highly successful in the market who havenever used the techniques outlined by Elder. My personal choice of methodologyis using volume in relation to price spread with a number of trend following andoscillating systems. Many successful traders have never used the technique I use.

Money management

Mature traders will tell you that your choice of indicators depends on personalpreferences. Most traders will accept that a mixture of trend following, stochastic,


volume, and other types of systems are most appropriate since the market is neverstatic, and there can never be only one indicator that is robust enough to accountfor all market activities. Elder proposes that it is easy to live through modernlife having very little understanding of basic arithmetic. Most of us rarely countand have ready access to calculators and digital screens on appliances. Moneymanagement is synonymous with risk management. While you could get awaywith few arithmetic skills in real life, you cannot have poor numeric skills andbecome a market trader.

Risk management

You do not need calculus, algebra or statistics but you must be on easy termswith adding, subtracting, multiplying and dividing. In addition, you need to becomfortable with calculating percentages and fractions and round numbers inorder to count fast. You need to be comfortable with the notion of probability.All competent traders are practical people who quickly calculate risks, resultsand odds. Elder offers a number of easily understandable money managementtechniques. He outlines the following rules:

• Limit your loss on any trade to 2% of equity in your trading account.• Never have more than 6% of your total trading account exposed to the

market at any one time. This means that you could have three trades risking6% of your total account at any one time, or six trades risking only 1%each of your total trading account, or multiples thereof.

• Whenever the value of your account dips 6% below its closing value atthe end of the month, stop trading for the rest of the month. In other wordsstop trading as soon as your equity dips 6% below where it stood on thelast day of the previous month. Close all positions and spend the rest ofthe month on the sidelines. Continue to monitor the markets and undertakea review of yourself and your trading systems.

Position sizing

Position sizing is the skill to determine how much to expose in the market at anyone time on a single trade, given the current market conditions. If we trade asize that is too large we will destroy our account, too small and we won’t makemoney, therefore determining an optimal level is essential.

Later in the book, we will discuss the process of defining the “expected value”of a trade. These useful concepts were introduced in 1980 by psychologistsTversky, Kahneman and Wagenarr. I will outline a couple of experiments thatdemonstrate our poor decision-making ability in assessing expectancy and there-fore our ability to position size.


INTERNET TRADING SCHOOLS

The past four years have seen an exponential growth in the number of schoolsfor day traders on the Internet. The vast majority are based in the US and quitenaturally some are of superior quality to others. Over a two and a half year period,I monitored four courses and the schools were headed by Linda Bradford-Raschke(of Market Wizards’ fame), Ed Downs, Lewis Borsellino, and R. Burchett/S.Prosniewski. It takes no imagination to see the effect of the Internet on markettrading. Some argue that it has levelled the playing field for all participants;others argue that it will become easier for market makers and large speculatorsto manipulate prices where transactions are executed in the semi-visible worldof IT; unlike open outcry, which is open to public scrutiny. Whatever view isheld, there is evidence emerging to demonstrate that the skills requirements forthe new age home trader are different to those of the open outcry pit trader.

Trading the PC from home

Very few open outcry pits are actively traded in London at the time of writingthis book. Clearly the future is from open outcry to the PC. Shortly followingthe closure of the LIFFE open outcry trading pit, I attended a course in theUnited States for traders. I met one trader who had been attempting to gainskills to trade from the PC and develop the discipline to trade profitability withtechnical analysis. By all accounts he had a successful career in the pit and Iwas very impressed by his story of the first time he had made ¤10 000 in oneday. He was a handsome man in his thirties, married with three children, andextroverted in a friendly and warm manner. It was clear his sports and physicalability was way above average. He confided honestly in me about the fact thathis school performance had not been brilliant academically and he had no needof a university education, given the opportunities in the LIFFE pit. In fact, I haveon good authority that many of the LIFFE futures traders had previously beenroofers and carpet-layers prior to their success in open outcry.

I liked this man very much and I kept in touch with him over the years tofind that he and 95% of all pit traders at LIFFE never returned to trading as aprofession. Clearly the PC requires different skills to that of open outcry. It is notthe focus of this book to compare and contrast the different skill requirementsfor trading the PC as opposed to open outcry. I will, however, show in a laterchapter that extroverts have been a prevalent personality type trading open outcry.In addition, I will quote incontrovertible scientific research that shows extrovertpersonality types are much slower to learn from mistakes in cognitive tasks thanare balanced or introvert personality types. This leads to the next section whichdiscusses one of many Internet trading courses in America, led by a successfulopen outcry S&P trader, that have sprung up as a response to the public’s need


to learn to screen trade from home. There are, however, a number of courses Ido not introduce in this book where the tutors have been screen traders most oftheir career. At the end of this book, I have placed a list of websites that thenovice and mature trader will find of great use and interest. I might add thatmany of the sites are of poor educational quality and are aimed at separating thestudent from his capital. It is up to you, the reader, to decide which is or is notappropriate to meet your needs.

I have chosen to give a brief synopsis of the work of Lewis Borsellino whohas been a local in the Chicago Mercantile Exchange, S&P open outcry pit since1981. I am grateful to him for allowing me to describe his theoretical approachin this chapter. He has written a number of excellent books and one I highlyrecommend was written with his colleague Patricia Commins entitled The DayTrader from the Pit to the PC. The book focuses mainly on Lewis Borsellino andhis career as a pit trader and is biographical in nature. It is a revealing book,giving a very personal feel to life in the pit. One gains the impression that anopen outcry pit is like a huge football stadium where aggression, intimidation,sharp minds and pugilism are all part of the skills repertoire of the pit trader. Onecan sense the tension, calm, and tintinnabulations of a raucous market rally ordecline. It is a world apart from the quiet, calm and reflective analysis undertakenby the home screen trader who is most likely to be seen sitting on his own in aroom ruminating over the charts on his screen.

Borsellino outlines three main areas where distinct skills are required. He termsthis Ready–Aim–Fire and Box 2.1 is a general outline of his teaching.

Box 2.1 Ready–Aim–FireReady:

• The mental game – preparing for the trading day.• Technical analysis – it starts with a chart.• Technical analysis – moving averages.• The economic calendar.

Aim:

• Intra-day dynamics.• Chart patterns.• Risk, reward and capitalisation.

Fire:

• Execution checks.• Analysing trades.


READY – THE MENTAL GAME

Borsellino states that “trading remains 90% psychological and 10% mental”. Heargues that traders should not be motivated by money because the statistics showthat 90% of all traders fail within three months of commencing their career. Theunderlying psychological dynamic motivating a trader to succeed is “competi-tion” and he argues that: “when you place that trade you are putting everythingon the line – not only the money involved in that trade but your research andanalysis, your decision-making process and your execution”. While there is truthin “competition” as a motivating factor, I believe the motives are more complexthan this and that each trader brings numerous personal reasons for why he orshe wishes to trade. I respect Borsellino in his admission that he was a clas-sic academic underachiever who had virtually no study skills, (Borsellino, 2002,page 61) and many novice traders will identify with this. Having interviewedBorsellino and spent a few hours with him, what is apparent is his natural intel-ligence paired with a determination to succeed. Also apparent is the reason forhis opinion regarding “competition” as a major motive for trading: it is relatedto his partial football scholarship to attend De Pauw University, a Division IIIschool. Lewis Borsellino’s success is not simply a consequence of innate abil-ity but is the result of hard work and commitment which supports the researchquoted earlier. I believe he will be an inspiration to many novice traders.

Borsellino states that the preparation to trade begins with a routine, such asworkout, meditation or listening to music. This will clear your mind of all dis-tractions and help you to get ready for the trading day. If there is a personal crisisor issue, it is better to sit on the sidelines and study the market than to trade withmental distractions. He makes clear that the primary objective for a trader is tomake well-executed trades, not to make good money, and that the best tradersare those who balance both personal psychology with technical analytic skills.A major skill for the trader to learn is when to trade and when to wait patientlyon the sidelines, monitoring the market. In order to achieve psychological andtechnical balance, he suggests that a trader follows the “Ten Commandments ofTrading”. The following rules are congruent with those of Jesse Livermore.

The Ten Commandments:

1. Trade for success not for money.2. Strive for discipline.3. Know yourself and how well you handle risk.4. Lose your ego.5. Forget all hoping, wishing or praying, when it comes to the market.6. Let your profits run and cut your losses quickly.5. Know your risk level and when you hit your stop loss point exit the trade.6. Know when to trade and when to wait.7. Love your losers like you love your winners.


8. Losing trades will be your best teachers.9. After three losing trades in a row, take a break.

10. Don’t break any of the above nine rules.

READY – TECHNICAL ANALYSIS

The Ready–Aim–Fire (RAF) formula is straightforward and robust, giving aclear indication of the kinds of skills required for successful trading.

• Definition of uptrend.• Definition of downtrend.• Definition of range.• Definition of support.• Definition of resistance.• Trend channels.• Moving averages.• Finding the “right moving average for your trading style and parameters”.• Applying moving averages.• Moving average envelopes.

The economic calendar

It is important to understand the key economic reports that have an effect on themarket and Borsellino suggests ways to trade during the following periods:

• Employment report.• Producer Price Index (PPI).• Consumer Price Index (CPI).• Gross Domestic Product (GDP).• Federal Open Market Committee (FOMC) or “FED” for short.

In addition to the above calendar, the trader needs to know which major stockshave an effect on the market and whether there are imminent report earnings orif a “conference call” has been scheduled. Microsoft is one of the most dominantstocks and one can monitor how earnings and conference calls have an impactboth on the NASDAQ 100 and the S&P 500.

AIM – INTRA-DAY DYNAMICS

The primary focus of “Aim” is to target the prices at which to initiate yourtrade. The “Aim” process follows the initial mental and technical preparation of


the previous “Ready” stage. The “Aim” process occurs immediately before themarket opens and the following assessment needs to take place:

• Determining neutral zone: The neutral zone is an area where the marketwould make up its mind about its future direction. (Note: Other authors callthis area “consolidation” or “congestion”.) It is essential to target pricesabove and below the neutral zone to indicate market direction. (Note:Many authors term this market movement as “a breakout”.)

• Gaps: The significance of gaps is discussed where Borsellino estimatesthat the gaps are closed within two days in 90% of all occasions. If theyare not closed it indicates that the market will continue strongly in thatdirection. (Note: Other authors call these two-gap phenomena “exhaustion”and “continuation” gaps respectively.)

• The hourly close: The hourly close is an important factor in assessingwhether the market is continuing higher, trading to the side or trad-ing downwards.

• Retracements: Borsellino outlines the common retracements of 25%, 33%,50%, 66% and 75%. He prefers these levels to that of the Fibonacci serieswhich is 38.2%, 50%, 61.8%, etc. Borsellino has a favourite retracementof 88% where his experience has indicated that this percentage often marksthe end of a significant move.

• Limits: Prior to the crash of 1987, stocks and stock index futures wereallowed to trade without limits. The regulated bodies concerned decidedthat any freefall could do massive damage to the economy and limits wereborne that can be accessed on the Chicago Mercantile Exchange websiteat www.cme.com. When the market sentiment is bearish and limits areborne, they act as targets for pit traders. Once the target is hit, the cashmarket can be used to determine the direction of the futures once the limitdowntime has been spent.

• Chart patterns: “V” formation on a chart. A sharp decline followed by abounce forms a “V” and indicates strong support at which the market canrally. A “U” formation on a chart shows a gentler bottom but neverthelessa point of support in the market. “W” is used both in intra-day and long-term charts and usually indicates a failed retest of the lows. To be a truefailed test, the second low cannot exceed the first to the downside. Thisusually confirms support and is an indication of a rally to come. “M”formation – this is an inverted “W” and is formed by a failed retest of thehighs, and is usually followed by a break or sell-off.

• Air balls and extensions: Borsellino describes this as being similar tobasketball, in that when a player shoots for the hoop but misses, thereis nothing but air between the player’s hand until it hits the floor. Somemarkets, including the DAX, can move 20 or 30 points very quickly forno immediate apparent reason. Borsellino states that an extension is sim-ply a percentage from various moving averages. Borsellino advocates the


200-day moving average for long-term moves and states that the all-timehigh for the NASDAQ composite was 54% above its 200-day movingaverage and the biggest reading on the downside was at 64% below its200-day moving average.

• The two-to-one rule – more commonly known as the risk reward ratio:Borsellino suggests that for every one dollar risk on the market, one shouldhave a target of a two dollar profit.

• Stops: Borsellino suggests that as you plot out your trades you must iden-tify at the same time three key points which are entry, exit and stop. Hesuggests that any exit point should reflect the two-to-one reward ratio,meaning that if you are in a position to make eight points on a trade,you would not wish to risk any more than four points; therefore your stopwould be at four points.

• Slippage: You may wish to get into the market at a particular price butyou cannot do so. Therefore slippage must be factored into your tradingplan so that the two-to-one reward to risk ratio is not violated.

• Money management: How large you trade depends upon how muchmoney you have in your account. How much risk is enough and how muchis too much is a matter of personal preference. Borsellino suggests thatas experience and proficiency in making trades increase you will increaseyour trading size. Borsellino suggests that you are the best judge of whenthe risk is too much.

• Gas tank rule: As a money management tool, Borsellino suggests thatif you place 20 or 30 dollars to fill the tank, you feel the pinch whenyou pay but after you drive away you do not think about the moneyany more. This is simply a cost necessary to drive the car and as suchcan be forgotten about as soon as you drive away from the gas station.This is also called “businessman’s risk” by other authors and in Chapter 5we will be discussing a perceptual bias that leads traders to the contra-dictory belief that a loss is not really a loss. Borsellino suggests that ifyou are thinking constantly about the 500 dollars, or 5000 dollars, or50 000 dollars that you risked during the trade, then you have risked toomuch. A trader who manages money well has little anxiety if the trade isunsuccessful.

FIRE

Fire is the final step where everything comes together. It is a synthesis of men-tal preparation, technical analysis, and observation of market behaviour. Youare determining your strategy while watching the market’s behaviour at keylevels. The following trade execution checklist is suggested as a foundationfor discipline:


• Are you mentally prepared to put on a trade?• Have you sufficiently cleared your mind of distractions?• Is your trade based upon support or resistance or other technical price

levels of the market?• Have you confirmed the importance of that price level by watching the

market’s behaviour?• Do you know what your profit level is?• Can you explain why you will exit your trade there?• Is it based on a support or resistance level?• Do you know where you will get out for a predetermined loss in accordance

with your risk/reward ratio?• Do you know how large a position you will take on this trade?

If you have successfully answered these questions, then you are ready to executeyour trade. Your goal should always be to make a well-executed trade, whichshould be automatic and robotic. If you are not prepared, you will be overcomewith fear and greed which is disastrous for a market trader.

“Fire” is that part of the RAF formula where one pulls the trigger and analysesthe trade. Borsellino states that while you must focus on each trade individually,you must be able to gain a better overall picture of your trading by makingan assessment on a daily, weekly and monthly basis. He recommends that youdevelop a trading log which should include:

• Time the trade was entered.• Price at which the trade was entered.• Position (short or long).• Size of the trade.• How the trade was entered (market order, price order, etc.).• Price at which stock was pledged.• Price at which the trade was exited.• Time the trade was exited.• Time/Duration of the trade (minutes, hours, days, etc.).• Profit? If so, how much?• Loss? If so, how much?

Borsellino suggests that you take an analysis of 20 trades to see whether thereare any patterns which come to mind. Do you hold on to losing trades or are youconsistently stopped out? Are you trading too large or too frequently for marketconditions? Borsellino suggests that you review the Ten Commandments at thesame time as undertaking your analysis of trades.

OVERVIEW OF THE THREE AUTHORS PRESENTED

The purpose of presenting these three authors has been to show that there aresimilar themes being presented by different authors. These themes can be loosely


summarised under three headings: Money Management, Psychology of Trading,and Technical Analysis. In each of these areas, there are numerous skills that needto be developed before attaining a level of competence in trading. In the field ofacademic teaching, each book written on a particular subject will credit and quoteresearch, anecdotes, and methods which have been developed by experts in thefield and accredited to them. Rarely in trading literature did I find an author whowill draw eclectically from a number of sources and then credit the proponentwith its development. In the next section we will look at a generic model oflearning and how this applies to market trading.

A GENERIC LEARNING MODEL

Research in learning theory supports the view that it is possible to improve skillsif you do three things:

1. Bring habits into awareness.2. Practise a more effective approach.3. Rehearse this approach until mastery is achieved.

Bringing habits into awareness

Bringing ineffective and counterproductive habits into awareness is difficult, timeconsuming, and against our general inclination to remain in a relaxed and un-harassed mental state. To identify a bad habit and overcome it necessarily involvespsychological discomfort. One particularly bad habit that I and many traders haveis to seek information that will support our view of the market. When I was longI looked at all evidence which supported that view. I saw strength in every uptick and an opportunity to add to my positions on down ticks. I gained insightand awareness instantaneously while revising for a Kingston University BusinessSchool examination, which required the testing of a null hypothesis in statistics.What I failed to do, like many traders, was to look at all the evidence which didnot support my view. If only I could open my mind to the possibility that I waswrong, I could then become sensitive to any market move against my position. Inessence this is the basis of analysis and refutation. I did not find it easy to changethis habit. As I developed my mental checklist, I had a continuing tendency tolook at everything which supported my position. I needed to experiment withpositive alternatives. The new way of thinking about the market and my actionfelt unnatural at first, like putting on a pair of shoes which were two sizes too big.Initially I was filled with self-doubt at this new approach and found it difficultto objectively assess whether or not I was achieving the analysis and refutationideal. When trading on your own at home, there is no external examiner or linemanager to guide you.


Great musicians spend a considerable amount of time practising and a smallamount of time performing live. Once a trader becomes experienced, there is afeeling that paper trading is irrelevant and unhelpful because it does not giveyou a “real experience of the market”. Some experienced traders find it difficultto overcome bad habits because of internal psychological pressure to trade live.It is as if hubris holds greater importance than developing new skills and pro-tecting your capital. These traders will mentally rehearse new behaviours onceor twice, then quickly apply the new behaviour to live trading before masteryis achieved. Many of you who have played an instrument or developed athleticskills will know that you can rehearse to a point of personal comfort. Under thestress of public recital or performance, you might forget parts of the piece orroutine. Professional musicians and athletes rehearse, rehearse, and then rehearsesome more. The skill is practised until the fingering, or physical movement, isautomatic. They practise until they can play or perform without thinking aboutit and can just feel it. This feeling is commonly known as “The Zone” in sports.

The process of “unlearning” old habits requires a special effort; being awareof the habit and holding back the tendency to react in the old way. A trader hasto override his natural inclination to the bad habit, and this adds to the burdenof learning and can make the trader lose focus.

The generic learning model suggests a learning strategy that first focuses onovercoming the poor trading habits you are trying to undo, before giving fullattention to the new habit with which you want to replace the old. By practisingself-control to the point of mastery, what was once an effort becomes automatic,taking the pressure off. Once you have taken this step, your mental energy andattention are freed up for practising new modes of trading.

INCIDENTAL LEARNING

Most initial learning occurs during training seminars and formal training eventssponsored by trading experts. A weekend or even a couple of weeks is hardly anadequate time frame to begin the process of learning.

Rather than going off to a training seminar and placing the learning in aformal context, it is exciting and challenging to apply some of your learning toeveryday life. How is it possible to apply to real life a seminar on “Volume SpreadAnalysis” (VSA), “Elliot Wave” or “Fibonacci sequences”? Before proceedingto the next paragraph, I suggest the reader writes down on a piece of paper howsome of these seminars might be applied in everyday life.

Provided you have a basic understanding of the VSA, Elliot Wave andFibonacci theories you would think of at least one application. VSA is basedon the Wyckoff method and analyses the market in terms of supply and demandas represented in the volume of buying and selling, or in the absence of buyingand selling. It is highly likely that a trader in the UK would also be a homeowner.


Over the past 30 years the UK has gone through a number of highs and lows in thehousing market. One could easily apply the VSA theory of supply and demand tothis market – in fact, any market. Elliot Wave is based on critical cycles and thesecycles can be applied generally to seasonality of crops or trends and fads in manyconsumer markets. The Fibonacci Sequences, and in particular what the Greekscalled “The Golden Mean”, defines the proportions of the Parthenon, the shapeof playing cards and credit cards, and the proportions of Westminster Abbey.The Golden Mean appears throughout nature, in flower patterns, the leaves of anartichoke, and the leaf stubs on a palm. The length of each successive bone in ourfinger, from tip to hand, also bears this ratio. I have purposely given more thanone example of Fibonacci and the Golden Mean to suggest that even the mostobtuse mathematical theorem can be applied to aspects of daily life, provided theperson applying has learned the concepts to mastery.

How can we apply other concepts in market trading to everyday life? I men-tioned earlier the concept of analysis and refutation, and the tendency for tradersonly to seek information that supports their current opinion. There are numer-ous opportunities in life to write down the negative consequences of any actionyou might take. People always tend to look at the pros rather than the consof any decision they are inclined to make. The business world has developedan easy and manageable method of determining the advantages and disadvan-tages of creating, continuing, or closing a business by analysing its strengths,weakness, opportunities and threats (SWOT). If you were to apply a SWOT an-alysis to setting up your own trading business at home, it might look somethinglike this:

SWOT analysis in creating a home trading business

Strengths Weaknesses

• Less overhead required thanmany small businesses.

• Can have large financial gains.

• Doesn’t have the liquidity tomanage successive drawdowns.

• Losses may lead to bankruptcy.

Opportunities Threats

• To become self-employed.• To learn new skills.

• To become isolated fromprofessional support.

• To lose confidence owing tofailures.

• To be vulnerable to thevicissitudes of market volatility.


One can apply the concepts of analysis and refutation to many situations, notjust that represented above. For every strength, there is a weakness, for everyopportunity, there is a threat. In Chapter 5, I have outlined a number of perceptualbiases that apply equally to market trading as they do to everyday life. I havedescribed a number of scientific experiments that demonstrate these perceptualbiases and I will be asking the reader to apply these concepts not only to markettrading but to facets of everyday life. In this way, I am hoping to make theresearch in cognitive and social psychology real and relevant to market tradingand everyday life.

The trick is to learn while doing other things – a strategy that can be called“incidental learning”, which can be useful for improving trading skills.

The relevance of mental rehearsal

The more time you put into practising a particular skill, the probability of achiev-ing mastery is greatly increased. This is particularly true of paper trading usinglive intra-day data, or end of day data for longer-term trading. Mental rehearsal isan effective practice tool and is highly compatible with the “hands-on” approachof paper trading. One of the first books I read regarding market trading was TheUndeclared Secrets That Drive the Stock Market by Tom Williams (no relation toBill or Larry Williams in the USA). Tom Williams has written a classic text onthe relation of price spread to volume and how supply and demand affect marketmovement. He developed his theory in conjunction with the original theories ofRichard D. Wyckoff, who wrote regarding the subject of volume reading in theearly 1930s. Tom Williams suggests a number of patterns that occur over andover and can be applied to stocks and stock index futures; in fact, his theoriescan be applied to anything that elicits supply and demand.

To aid my learning of technical analysis, I mentally rehearsed the followingsentences, which I paired with clear chart patterns.

Five patterns to recognise at the top of a bull market

1. Selling climax.2. Testing with the volume not low.3. An up day on high volume and next day

down on high volume.4. Narrow spread on high volume on an up day

into new high ground.5. An up thrust.

Can have combinations of the above except (4)which always occurs on its own.


Five patterns to recognise at the bottom of a bear market

1. Buying climax.2. Testing with low volume.3. A down day on high volume and next day up.4. Narrow spread on high volume on a down

day into new low ground.5. A down thrust.

Can have combinations of the above except (4)which always occurs on its own.

The reader may not have read the literature by Tom Williams but this is unim-portant for the example. Instead of sitting before a trading screen and practisingthe identification of technical patterns, I have written down five short and descrip-tive sentences which are mentally paired with images of the pattern I can identifywhen presented to me on the screen – five patterns for a bear market and fivepatterns for a bull market. As a novice I rehearsed these patterns and sentencesfive or six times a day for months. I have numerous other mnemonics, which Ihave memorised to improve my technical performance.

Mental rehearsal can also aid in the skills development required for tradingdiscipline. One of the first books I read regarding confidence and trading disci-pline was The Way of the Warrior-Trader by Richard D. McCall. The book ingeneral was motivating and inspiring, but in particular it served to help me with“freezing”; the inability to pull the trigger on a trade. Each trader encountersnumerous challenges during his journey to trading competence. This apparentlyinsurmountable problem occurred at the close of my second year of full-timeindex futures trading. When I saw an appropriate pattern on the screen, I brokeout in a sweat and I literally started shaking while my finger was on the mouse,with the cursor immediately over the “Bid” or “Ask” of the relevant trade. Theproblem was that I could not pull the trigger. When I did, I encountered suchfear, it was almost irrational. Richard McCall’s book outlined an acronym thathelped me tremendously as follows:

ACTION acronym

Accept all possible losses before entering the battle (trade).Centre yourself in body, mind and spirit.Trust your skills and intuition.Imagine success clearly within the mind’s eye.Only exist in the present moment to control fear.Never stop or look back once action has begun.


By committing this acronym to memory, and understanding the meaning appliedin my personal situation, made a tremendous difference to my performance andin my attitude to financial risk taking. I will be discussing this acronym in moredetail in the next section where I have incorporated this acronym into a compre-hensive model for trading competence.

I have found this action acronym to apply to almost all personal situationsin my life that require action based upon complex circumstances and decision-making processes.

SUMMARY OF COGNITIVE PSYCHOLOGICAL RESEARCH ONDEVELOPING EXPERTISE

I will now turn briefly to the scientific research that outlines the processesinvolved in developing skills from novice to expert. Problem-solving expertisedepends upon the acquisition of knowledge, structures, and strategies appropri-ate to specific circumstances surrounding a problem. Green and Gilhooly (1992)summarised the results of extensive research undertaken on learning and theyhave developed five maxims:

• Experts remember better.• Experts employ different problem-solving strategies to the same problem.• Experts have better and more elaborate problem representations.• Experts’ superiority is based on knowledge, not on some basic innate

capacity, such as intelligence or other personal advantage.• Experts become experts through extensive practice.

There is now a very large scientific census regarding the above maxims. In addi-tion, Anderson (1996) and Newall (1990) have developed an outline of numerouscomputational models, which are easily applicable to learning in everyday life.

LEARNING TO BE AN EXPERT

Theoretically we need an account of how people start as novice traders with littledomain knowledge, using weak methods to solve technical and personal problemsand end up as experts with elaborate, domain-specific knowledge structures andefficient problem-specific strategies. Research in cognitive science suggests thefollowing areas and models as relevant.

Practice makes perfect

Chase and Simon (1973a, b) have demonstrated clearly the relationship betweenpractice and performance in perceptual motor skills and in developing complex


cognitive skills, such as chess expertise. This clearly supports the view that papertrading and rehearsing of particular types of patterns and behaviours required fordecisive action is essential in the field of trading expertise. In addition, severalresearchers have suggested a number of mechanisms to explain these effects ofpractice and the acquisition of expertise: chunking, proceduralisation, and com-pressing (Anderson, 1993, 1996; Newall, 1990; Rosenbaum and Newall, 1986).

Practice and chunking make trading easier

Quite simply, cognitive science states that placing knowledge into specific chunksof information makes it easy to learn and assists in making procedural rules toapply that knowledge. The idea of a “chunk of knowledge” has become a standardin many cognitive architectures, e.g. Anderson (1996), Newall (1990) and, asdiscussed, proves to be a very useful concept in characterising trading expertise.

Learning from problem-solving attempts and instruction: proceduralisation

Anderson (1982, 1983) and Anderson et al. (1998) have proposed a theoreticalmodel called “The ACT Architecture” meaning Adaptive Control of Thought.This model proposes three areas integral to the learning of skills:

• A Declarative Memory, that is a semantic network of interconnected con-cepts.

• A Procedural Memory of production rules.• A Working Memory that contains currently active information.

Declarative knowledge is represented as chunks which are just schema-like struc-tures encoding small bundles of knowledge. Proceduralisation is the process thattransforms this declarative knowledge into production knowledge. The workingmemory contains the active information from both the declarative and procedu-ral memories. In its simplest form, Anderson’s view of learning is based on theacquisition and fine tuning of small units of knowledge; knowledge that com-bines to produce complex cognition, which is the essence of the trading function.The environment plays a critical role in the learning process in that it estab-lishes the configuration of simple objects that aid the learning of chunks and alsodrives the formation of production rules. This is why many authors, includingmyself, recommend that your trading environment encourages calm and attentionsimultaneously. In Chapter 3, I will be discussing the types of trading mentorsmost suited to traders’ learning needs. In addition, I will make emphasis ontrading in an environment that maximises both calm and attention. This is animportant step because it reemphasises the importance of analysing the nature


of the environment as an essential step to understanding the learning process, anemphasis that has been lost since the demise of behaviourism in the cognitiverevolution (Anderson, 1990).

LEARNING FROM YOUR MISTAKES

As traders we commonly hear of “the school of hard knocks”, or “love yourlosses, like your winners”, or “when we lose money, we learn the most”. Astraders, we intuitively know that we learn from our mistakes. Most scientifictheories of skill learning emphasise the importance of successful problem solv-ing to the learning process. Scientific theory also tells us that we learn fromepisodes in which we fail. Ohlsson (1996) has proposed a theory of skill learn-ing from performance errors. In this theory, errors occur because people usedknowledge that is too general. In other words, their coded knowledge or pri-mary chunks of knowledge do not capture a distinction or nuance that is inthe trading environment. In this way, novice traders may have so general aconception of threatening technical indicators that they miss opportunities toclose a position when they are under “attack”. Theory also stresses the subjec-tive nature of errors characterising them as conflicts between what the traderbelieves ought to be true and what is perceived to be the case. The learningthat occurs results in a specialisation of the knowledge structures being used sothat they come to be applied more under appropriate conditions in the future(e.g. adjusting personal beliefs). In a later section, I will discuss the effectsof position sizing and the effects of reward and punishment on learning andperformance.

I am hoping that this short section has not been too arduous or deemed irrel-evant by the reader. It is a professional imperative for an author to substantiateexpressed views with an accepted standard, such as making reference to research,or other rigorous method of enquiry. This standard is often lacking in literatureon trading. I believe that trading is an exacting combination of art and science,which demands academic rigour, in the same way as other professions.

INTUITION EXAMINED

Most people hold the belief that doctors are scientists who are able to arrive atconclusions through objective, careful and painstaking research. It is assumed thatthe conclusions are based upon calculated probabilities, based on scientific facts,discovered either clinically or in the laboratory. Psychologists Kahneman, Slovicand Tversky in Judgement under Uncertainty: Heuristics and Biases (1982) out-line some of the problems in reasoning in clinical medicine and D. M. Eddy onmistaken intuitive connections. The italics are those used by Eddy:


Chronic cystic disease is often confused with carcinoma of the breast.It usually occurs in parous women with small breasts. It is present mostcommonly in the upper, outer quadrant but may occur in other parts andeventually involve the entire breast. It is often painful, particularly inthe premenstrual period and accompanying menstrual disturbances arecommon. Nipple discharge, usually serious, occurs in approximately 15%of the cases but there are no changes in the nipple itself. The lesion isdiffused without sharp demarcation and without fixation to the overlyingskin. Multiple cysts are firm, round and fluctuant and may transilluminateif they contain clear fluid. A large cyst in an area of chronic cystic diseasefeels like a tumour, but it is usually smooth and well delineated. Theauxiliary lymph nodes are usually not enlarged. Chronic cystic diseaseinfrequently shows large bluish cysts, more often the cysts are multipleand small.

This passage illustrates the numerous symptoms that need to be taken into accountwhen making a diagnosis and the reliability is predicated upon “may”, through“usually”, and “most commonly” to “is” (complete certainty). It is unreasonableto assume that any physician examining a patient could keep all of the above 12symptoms listed in his working memory and then giving each its due weight andthen intuitively come to the diagnostic decision that is best given the evidence.Empirical research demonstrates that human intuition is remarkably poor. Whenthe same data used by people in making intuitive judgements is submitted toa formal mathematical analysis, the mathematical judgements are consistentlymuch better than those of “intuitive” people. Robyn Dawes is one of the lead-ing researchers in this field and has published a number of studies in his paperentitled, “The Robust Beauty of Improper Linear Models in Decision-making”(1982). In more than 100 studies comparing the accuracy of mathematical andintuitive prediction, in not one instance have people done better, although occa-sionally there has been no difference between the two methods. However, in thegreat majority of cases, the mathematical method has been more accurate by aconsiderable margin (statistically significant). Here are a few randomly selectedinstances in which mathematical analysis has been more successful than theintuition of experts.

It is worth a note that I searched for evidence to support the view that intuitionwas superior to mathematical calculation in predicting outcomes, or at least asgood as mathematical calculation. To be credible, the research needed to demon-strate reliability and validity in research design. I could find no reliable researchthat lived up to this basic criteria but found many studies where mathematicalcalculations based on probability and expectancy of outcome exceeded the intu-ition of experts. The subject matter and definition of expert were exceeded by adecent margin to intuition in the following:


Subject matter Type of expert

Prediction of ex-prisoners on parole who willshow good conduct or who will violateparole.

Psychologists and psychiatrists

Pilot performance after training predictedprior to the course.

US Air Force personnel officers

Adjustment by juveniles entering borstal orreformatory.

Psychiatrists

Job satisfaction in engineers predicted beforethey finished university training.

Counsellors

Recidivism in criminals. PhysiciansSuicide attempts in psychiatric patients. PsychiatristsAmelioration of mental illness in

schizophrenics.Physicians

Whether to diagnose and classify a mentalpatient as psychotic or neurotic.

Psychiatrists and psychologists

The growth of corporations as measured byvalue of stocks and shares.

Securities analysts

Horses’ performance at the races. Tipsters

It is known that traders are particularly poor predictors of future price, beyondthe most immediate short-term time frame. In the majority of the above examples,predictions have been made about people regarding behaviour, their attainments,their mental state or their capacities for future performance. Since the renaissancethere has been a general evolution of beliefs where collective belief paradigmshave shifted from theology and metaphysics to that of empirical science. Wecommonly believe that our understanding of the world can best be served byscientific methodology. It is this methodology which has allowed us to progressfrom the medical theories of blood letting and has led us from the Dark Ageswhere the general population believed the world was flat. If you use a personalcomputer as a tool for trading or investment and you experience “hanging”, or aprogram that for some reason does not work, you examine the power supply, thehardware and then the software, and so on, applying knowledge but not intuition.

Although prediction through mathematical methods is, in the great majorityof cases, much more successful than prediction by intuition, there are a numberof factors that limit the efficacy of employing these methods. First, the evidenceused in mathematical prediction must be relevant to the prediction and it is peoplewho in the first instance decide what is relevant. This has been light-heartedlyreferred to as the “GIGO effect”, meaning simply if you put garbage in youwill get garbage out. The information is that the data fed to the mathematicalmodel must be in numerical form. We know that during job interviews, most


interviewers simply carry away a global impression of the interviewee, highlycoloured by the halo effect (discussed in Chapter 5). During my staff interviewswith members of the health authority and social services department, ratings weregenerally on three scales:

1. Criteria met.2. Criteria was partially met.3. Criteria was not met.

In left-wing environments, employers tend to upgrade members of what are con-sidered “minority groups” in favour of others belonging to a social norm. Inthese circumstances, numerical ratings cannot counter personal biases, the onlyway to counter this bias would be to have an interview panel, say of six people,who hold different views of what employment criteria should be applied. Thebias would therefore be averaged and less pernicious. Finally the efficacy of themathematical model of prediction is influenced by the amount of past knowl-edge that we have that can be reliably used to make specific predictions aboutan event. For example, if we have 200 examples of the chairman of the FederalOpen Market Committee (aka “The Fed”) making an announcement and immedi-ately following the announcement stock market volatility is greatly increased, wecan assume safely that future announcements by the chairman will cause volatil-ity. Simply speaking, inexperienced traders should avoid trading until the dustsettles following a Fed announcement. Experienced traders, on the other hand,can thrive during these periods (Feeny, 2004, personal communication).

Herbert Simon’s research (see, for example, Simon & Caplan, 1989), con-tributes to our understanding of intuition through using Artificial Intelligence asa model. He has also made overlapping substantive contributions to the fieldsof economics, psychology, cognitive science, decision theory, and organizationtheory. Simon’s work was motivated by the belief that the human mind, humanthinking, decision making, or human creativity need not be mysterious. It wasafter he helped create “thinking” machines that Simon came to understand humanintuition as subconscious pattern recognition. In doing so he showed that intuitionneed not be associated with magic and mysticism, and that it is complementarywith analytical thinking. On this topic, Frantz (2003) and Eysenck (1997) havemade scientific contributions and the interested reader may wish to review thepapers cited in the bibliography.

I have witnessed with incredulity some startling exhibitions of intuition thatdefy empirical analysis. I therefore come to a definition being mindful of both prag-matic and metaphysical contributions (to be discussed in Chapter 7 on Budo Zen).

Intuition can be viewed as a manifestation and integration of skills mastery(unconscious competence) and life experience, which allows the trader to makean educated guess, when information cannot be mathematically calculated, forwhatever reason. Goleman et al. (2002) describes intuition as the capacity to sense


messages from our internal store of emotional memory, our personal reservoir ofwisdom and judgement. The ability to access this personal reservoir is the cor-nerstone of self-awareness and the associated competencies as shown in Box 4.2,page 93.

SUMMARY

• Synopses of the work of A. Elder, M. Douglas, and L. Borsellino wereoutlined and comparisons were drawn between their contribution and thoseof J. Livermore. Contemporary authors focus upon the nature and degreeof skills required to attain trading competence, and it is acknowledged thatLivermore had considered most of these skills almost one century earlier.

• Trading skills can be grouped under the three general headings of:

Psychology – Addressing emotional and perceptual biases.

Technical skills – Applying fundamental and technical forms of analysis.

Financial management – Applying consistent and efficacious rules of cap-ital conservation and exposure.

• A generic learning model was presented and methods of bringing habitsinto awareness were discussed. The importance of paper trading and mentalrehearsal was examined using mnemonics and acronyms as useful tools.

• The concept of incidental learning was demonstrated through the applica-tion to everyday life of seemingly unrelated concepts in market trading.

• Scientific research on how one becomes an expert was applied to markettrading. Expertise is not gained through innate ability but is developedthrough practice, mental rehearsal, organising and “chunking” informa-tion, developing specific and general procedures or rules, and learningfrom mistakes.

• Self-awareness and self-management as facets of Emotional Intelligence(Goleman et al., 2002) were discussed as essential skills for traders tobecome leaders of themselves.

• Intuition has been suggested as a skill possessed by competent traders.Empirical research shows that prediction through intuition by expertsis poor when compared to mathematical methods used to predict thesame outcomes. The implications are that discipline and consistent tradingmethodology are of greater importance to traders than intuition.

EXERCISES

1. Identify two bad habits you would like to change. Develop a strategy toovercome the habits. Review your efforts in three weeks.


2. Develop a SWOT analysis of your trading business.3. Apply three concepts learned from market trading tutorials and apply them

to everyday life.4. Write down any useful strategies used in any aspect of market trading

and memorise them. You may wish to memorise the ACTION acronymas many traders have found it very useful.

3A Comprehensive Modelof Trading Competence

There are very few occupations that require the determination, strength, courageand integrity of beliefs, as does the trading forum. You have only your knowledgeand courage – in essence you are on your own before the screen. There is noexternal examiner or line manager to help you navigate the waters between Scyllaand Charybdis. You have tools such as the computer, helping to analyse themarket, charts that may plot strengths and weaknesses or resistance and support.You may have a fast order entry system giving you depth of market, and MarketMaker (Level II) information. The final analysis is that you are on your own anddo not have the immediate or even the informal support of colleagues. In thesecircumstances, it is essential that traders have a comprehensive model of tradingcompetence to guide them.

Scientific studies show that trading experts are not born, they are made throughhard work, developing areas such as self-awareness, self-management, incidentallearning, and building schematic models and rules that facilitate the acquisition ofpersonal and technical skills. Gilhooley (1995) demonstrates that we learn to be anexpert and that experts have better and more elaborate problem representations.This chapter presents the competencies required to succeed as a trader withinthe context of a Comprehensive Model Of Trading Competence (ComprehensiveMOT; see Figure 3.1).

The data used to create the Comprehensive MOT has been drawn from a num-ber of sources. First, the field of academic psychology and I wish to acknowledgethe work of D. Gorman, K. Oatley, A. Damasio, H. Seyle, and M. Eysenck. Fromthe field of trading, I have borrowed from Tharpe, Schwager, Raschke, McCall,Douglas and Elder. Where possible, I have looked at literature and researchapplying to screen traders from home. There is a paucity of literature and data


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A Comprehensive Model of Trading Competence 47

regarding home traders and this may be as a result of (a) difficulty in gainingwilling subjects to be studied, and (b) the fact that many fail within the first sixmonths to a year. I had advertised in numerous traders’ Internet chat groups forpeople to come forward to be part of the study in identifying the skills require-ments for home traders. I was disappointed at the response but I was able toselect 32 home traders in the United Kingdom and five of those 32 traders Iwould consider expert.

The Comprehensive MOT (Figure 3.1) is divided into tactical and strategiccompetence. The Tactical MOT, as its name implies, is short term and addressesthe skills required to actively trade. The Strategic MOT is a long-term and ongo-ing process of skills development.

PART A: THE TACTICAL MODEL OF TRADING COMPETENCE

TACTICAL MODELOF

TRADING COMPETENCE

SELF AWARENESS

DEVELOPING TACTICS

MENTAL REHEARSAL

AMBUSH

ACTION

MONITORING

PROFIT TARGET

DAILY APPRAISAL

PERIODIC REVIEW

ABORT

Self-awareness

Competent traders have an emotional self-awareness and are attuned to their innerlife; recognising how powerful emotions can affect their personal perceptionsand their trading performance. There is a common theme in the interviews ofSchwager (1992) and Patel (1999) in that competent traders can see the big


picture in a complex situation and can be candid and authentic, having an abilityto discuss their values and guiding vision.

These competent traders make accurate self-assessments identifying their limi-tations and strengths. In addition, traders of this calibre have a sense of humourand can parody themselves. They welcome constructive criticism and feedbackfrom peers or trading mentors. In addition, these competent traders exhibit self-confidence, because understanding their abilities with accuracy allows them toimplement their strengths.

In Chapter 1 I referred to Jesse Livermore’s observations (through Larry Liv-ingston, page 61) that many traders overemphasised the value of technical analy-sis. Ninety years on from this observation, market traders still emphasise technicalanalysis and undervalue self-awareness and self-control, and do not give theseskills a high priority in determining risk. Traders need to reprioritise with regardsto the paramouncy principle, defined in Chapter 1.

Traders can immediately see the level of their performance through profits andlosses. Some traders become embroiled in the trap of continued losses and areoften locked in denial to themselves and to people close to them. Many lossesand poor performances in general are as a result of not being in an optimalstate of health. For example, an argument with your spouse or children couldresult in anger and a desire to take this out on the market. Suddenly you startlosing money because your focus and perception are tarnished by an upsettingevent. In addition, if you have a cold, headache or any physical discomfort, thisagain will detract from your trading performance. This does not mean to say thatdisabled people cannot trade. Disabled people have often come to terms withtheir disability and have achieved a form of compensatory balance in their lives.

If you can make a conscious effort to reflect upon your own general stateof well-being at the start of each trading day, you will find this a very helpfulexercise in improving your performance. Based on the Beck Depression Inventory(1988), research indicates that people who are aware of their own mental stateand who can accurately assess their position on continuum from feeling good tofeeling bad are able to control their feelings much more than a group of peoplewho exercise no insight tools.

It is helpful for traders to commence each trading day by checking out howthey are feeling and then rating it on a scale from 1 to 10 as follows:

Feeling distracted Feeling confidentand under par 1 2 3 4 5 6 7 8 9 10 and focused

This process should take no longer than two minutes and you may discoverafter a few weeks of employing this technique that there are recurring themesthat you had never previously recognised. I recommend this process for bringing


“bad habits” into awareness and we learned in Chapter 2 how useful this is inimproving performance. It also allows you to immediately identify the source ofthe problem and subsequently its rectification. If you are unable to understandthe source of your low score, it is best not to trade. If you practise this techniquefor a few weeks you will be amazed at how your trading will improve.

Developing tactics and assessing risk

Many traders analyse the market in order to predict prices, but we know thatpredicting prices does not lead to successful trading. Expert traders will analysea trade in relation to probabilities for success. Competent and successful tradersoften use different methods and techniques to analyse the market, so we canassume the type of analysis is unimportant so long as it allows the trader tominimise risk and assess probabilities of profit and loss.

My own style of developing tactics and assessing risk relies heavily on gath-ering data, determining the probability of success from the data, and waiting inambush for the right time to pull the trigger. The data most useful for my ownstyle of trading relies on real-time tick volume and activity volume in relation tothe price spread (the open, high, low close and net gain). I am able to identifya pattern which I recognise as a high probability trade based on both short-termand long-term time frames. If my indicator is congruent with a weekly chartshowing a bearish inclination, I will only look for those patterns that confirma high probability for a down move. This assists me to filter out contradictorysignals often shown in differing time frames.

Novice traders will gather some data and then immediately pull the triggerwhen a signal is received that supports their own position. Nothing will shakea trader’s view if he believes the market will turn bullish, even though all theindications are that a serious bear market is underway. This type of trader willcontinue to go long, believing he is being a “contrarian” and he will justify hisview when he makes a small profit on uptakes during a period of short covering.Within your tactical plan, you should include the process of analysis and refuta-tion, which is a highly effective risk management tool. It is important to avoidthe opinions of others as this can seriously bias your own analysis. Rememberthat your daily newspaper is full of the opinions of others and research indicatesthat newspaper commentaries are no more effective than chance in predictingmarket action. To understand the difference between newspapers’ “opinions” andimportant financial information (e.g. FOMC or “Fed meetings”) is an importantskill to develop.

Mental rehearsal

In the previous chapter I presented research that demonstrates the importanceof mental rehearsal and practice in becoming an expert. This applies to any


discipline, such as becoming an expert in music, athletics, or trading. Next timeyou are able to attend a sports convention or are able to watch the CommonwealthGames, Olympics or similar, watch some of the athletes warming up prior to theirroutine. You will notice some will be mumbling to themselves, and others mighteven be moving arms and hands as if to simulate their physical timing. Those ofyou familiar with martial arts will know that “KATA” is a fixed form of physicaland mental rehearsal of offensive and defensive moves.

Extreme concentration and focus upon the internal mental image of the processof the task is an ability shared by all experts. Not only do experts have the abilityto develop focused mental imagery for the required task, they also have imageryfor incidental tasks should an accident occur. Perhaps this is best representedby the Special Air Service (SAS) where great emphasis is laid upon alternativeplans should the primary plan go wrong. Not only do the SAS physically practisetheir tasks to unconscious mastery, they mentally rehearse actions over and overagain. These servicemen appreciate the need to mentally rehearse plans so that instressful combat situations, they do not need to think about what next to do. Theysimply do it. These servicemen will tell you that practice and mental rehearsalhad probably saved their lives in combat. What about your financial life? Doyou have a plan that you rehearse regularly should an alternative be necessary?As traders we have all experienced the contradictory signals of different timeframes. We know that this is not an exact science and that our main tool is tounderstand probabilities of outcome.

Mental rehearsal in trading requires us to keep the information as simple aspossible. G. A. Miller (1956) wrote an influential paper entitled “The MagicNumber Seven Plus or Minus Two”, demonstrating that our mind only has theconscious capacity of about seven chunks of information. A trader simply cannothold anything more than that in consciousness and if you attempt a highly com-plex analysis of the market, requiring greater capacity than we have naturally,you will fail. Indeed when we are under stress, the body releases glucocorticoidsinto the blood stream. Blood is diverted from the brain and redistributed to themajor muscles of the body. You suddenly have more energy (e.g. the fight/flightresponse) but reasoning and information processing capacity is diminished con-siderably. The potential for disaster during the highly stressful situation of tradingis limitless. The way to limit damage in this context is to mentally rehearse yourprimary and incidental plans.

Trading success can come from simple, yet effective, rehearsal of plans. Whatwill you do if you are open 10 contracts in the DAX and you receive a tele-phone call from your child’s school to say your child has fallen in the play-ground and is requiring an x-ray at the local hospital? (This actually happenedto me.)

It will be useful for you to rehearse the following:

1. What is my plan today? What criteria will I use to pull the trigger on atrade? How many contracts and what rules of position sizing will I use?


When will I capture profits? What rules will I use to abort a trade? Whatcould happen to cause me to abandon the plan?

2. Incidental plan: Employing analysis and refutation, what could go wrongwith this plan? What could go wrong in my everyday life? The incidentalplan could look as follows: if I see an adverse reaction to my position, Iwill close and capture profits if there is a 20% retracement, or if I havea recurrence of that toothache I briefly experienced the evening before Iwill close my position and go straight to the dentist.

3. Learning from previous mistakes: The following questions have assistedme to correct some mistakes I have made. Can I avoid overtrading thissession? Can I stick to my 20% retracement rule? Will I enter my tradeas soon as my signal is clear and criteria are met with conviction andconfidence regardless of outcome?

You will need to develop your own list of pertinent questions and if you canrehearse each of the above three areas in your mind, you will be able to actautomatically and effectively. Few traders use planning and mental rehearsaleffectively.

Ambush

Ambush is a form of risk control where the trader waits for the market to reveal theplanned scenario. Patience is integral to this process and you need to be in harmonywith the market and wait for the appropriate signs to tell you it is time for entry.

For many years I was an avid fly fisherman specialising in hunting some of thelarge brown trout resident in reservoirs, such as Rutland Waters and Bewl Bridge.I have had the great pleasure of fishing with Peter Cockwill, the British Still WaterChampion and I learned much from our frequent conversations, both on the bankand at his shop in Godalming, Surrey. Each season brings a different behaviourand change in feeding pattern for large still water trout. Sometimes they feed onthe surface, sometimes they feed very deep and sometimes they do not feed at all.Some of my best catches have been during periods where the trout are too deep tosee and stalk. You must wait in ambush for patrolling trout to pass a particular areathat you know will hold food or oxygenated water. You simply wait in ambush,casting and allowing your fly to trawl different depths. You allow the trout to cometo you in its own time and in its own habitat.

On one occasion I had the pleasure of watching a large pike lying in wait for itsprey to pass. A pike is shaped like a torpedo with huge and dangerous teeth, similarto a shark. When focusing upon its prey, this large, dark and silent predator lungesand attacks its prey with such speed and ferocity that the whole process of capturingits prey is within three seconds or less. A small pike (a jack), on the other hand, canbe seen chasing small fry mainly unsuccessfully. So what is the difference betweenthe mature pike laying in ambush and the small jack chasing its prey?


The mature pike waits quietly in ambush, saving its energy, and waits for aperiod when the odds are almost completely in its favour. In a similar fashion, thetrader can conserve his or her capital until the circumstances are overwhelminglyin the trader’s favour. Ambush is a skill requiring a plan, implemented withpatience, and with a clear understanding of the probabilities of outcome. Ambushis perhaps one of the most difficult skills for traders to learn, because we are ina mental state of readiness and the very nature of this arousal can lead us to takeaction when it is not appropriate.

Action

In many respects this is the moment of truth and it takes only a few seconds toinitiate. Taking action requires courage, focus and the confidence to execute yourmentally rehearsed plan.

Accept all possible losses before entering the trade

This is the first of six maxims taught to me by Dr Richard McCall at the BushinkaiDojo in Little Rock, Arkansas. Dr McCall is himself a successful market trader.

Dr McCall explained that the purpose of this maxim is accepting risk. Theperson who faces and accepts the intrinsic risk in a given situation has alsoaccepted all possible losses he might incur. Every major accomplishment has beenmade by people of vision and courage who have had what initially appeared tobe overwhelming odds against them. Given that 90% of traders will lose money,it is essential to develop a philosophy, which is compatible with your actions.Some traders have argued that to “accept all possible losses” is defeatism of theworst kind. However, “acceptance” can be viewed as optimistic or pessimisticsince how you perceive things is everything.

Optimistic acceptance is the type where you accept the risks and potentiallosses that stand between you and your objective, but your focus and visionare placed on successful accomplishment of your mission. Of course a traderwants and expects to win but has also mentally written a cheque to his brokerbecause he knows that in these situations his allocated money for the trade maynot survive. Because the trader accepts his losses prior to the trade, it allows himto engage in the trade with controlled anxiety, or none at all.

Pessimistic acceptance refers to a mental attitude accompanied by a senseof defeated resignation. This type of mental attitude leads toward the traderexpecting failure and often this type of mental attitude leads to self-sabotage andfailure in the markets.

On every trade I mentally write a cheque for the amount to my stop andpost it to my broker. As my skills improve, fewer cheques are cashed by thebroker.


Centre yourself in body, mind and spirit

To centre oneself in body, mind and spirit is a form of balancing or a generalfeeling of harmony at the time of committing yourself to the market. Dr McCalldescribes this as a state wherein body, mind and spirit become synergised into oneunified force, resulting in an overall effect greater than the sum of the individualparts. Centring will be described in greater detail in Chapter 7 on Budo Zen.

The unified force can be described simply as follows:

Body: Are you sitting comfortably in an upright position to enable deep breathingand to aid concentration? An upright posture, rather than slouching in your chair,is important to aid concentration and breathing.

Mind: Are you aware of any distracting factors currently in your life, and haveyou resolved them, at least during the period of taking the trade? Do you feelfocused and attentive?

Spirit: Do you feel that trading is your vocation, and that you are committed notonly to this trade but to many more following?

In its simplest form, centring in body, mind and spirit is bringing about abalance of the above three factors which will assist in your flawless execution ofyour trade.

Trust your skills and intuition

Every trader must possess technical skills and methods of market analysis thathave been well learned to the extent that they are committed to his unconsciousmind and can be accessed immediately it is required. In addition, the trader whohas mastered his trading system and methods of analysis will be in total harmonywith the nature of the market and through that harmony will come to possess agut level intuition within the area of his specialisation. For these learned skillsand intuition to be effective, the trader must also possess unconditional trust andfaith in their efficacy.

This trust can be viewed as a belief that has developed through testing yoursystem through paper trading and mental rehearsal so that you have a deepunderstanding of the probability of success of your trading system. Whenever aperson is deeply passionate about a person or activity, such as trading, he willexperience a kind of “connection” with it. It is an ineffable and noetic experience,similar to experiencing “The Zone”.

Imagine success clearly with the mind’s eye

At first glance this seems straightforward and easy to accomplish. We can simplyaim for our desired target and make a visual image of this. In fact our mental


image of our success will become much clearer when we implement planning,practice and mental rehearsal in the pursuit of our objectives.

Deepak Chopra is of the view that when we plan and rehearse the plan, there areactual physical changes at the quantum level that will bring about the fulfilmentof your goal. Whether you believe in the metaphysical aspects of visual imageryor not, the facts remain that visualising your goal, having a plan to achieve yourgoal, and rehearsing relevant skills and procedures, will assist you in fulfillingyour objectives.

Only exist in the present moment to control fear

It is only natural for people to be fearful when risking their hard earned money onthe stock market. Even the Samurai acknowledged and experienced fear, thoughit would appear they were courageous and fearless in their complete resignationto death if that were the outcome of a battle. The difference between the Samuraiand an average man was that they never let the fear stop them from takingaction. All fear is either anticipatory or reflective in nature. When fear is present,the experiencer is either thinking back to past events, giving credence to hispresent fear, or pre-qualifying his present fear by thinking ahead to the potentialoutcome of some future event. Either way, he is using his imagination to createhis problem.

Once you come to understand that the source of most fear is either antici-patory or reflective in nature, learning the skills to focus on the here and nowbecomes important.

Fear can suddenly enter your mind at the time it is necessary to pull the triggeron a trade. This could be because you anticipate a possible negative outcome,or because of a serious drawdown you experienced last month during similarmarket conditions. In order for you to clear your mind of this debilitating fear, itis necessary to refocus your attention to the present moment and remember thateach trade is totally independent of the previous trade. I shall be discussing thetendency for traders to form false associations in Chapter 5 on perceptual biasesand trading.

Never stop or look back once action has begun

This final maxim of the ACTION acronym implies that making a commitmentcan empower us. To commit oneself to taking a position in the market a numberof steps must be taken. First, you must know what you want to accomplish. Howmuch money can you reasonably expect to make? This should be related to yourstop loss and risk reward ratio. If you have a stop loss at 10 points, then youmight hope to achieve a 20- or 30-point profit. Second, you must possess a real


desire to accomplish it. If you are half-hearted about any venture, it will fail.Third, you must develop a workable plan with which to accomplish it. Effectiveplanning is essential to success. Fourth, you must set a reasonable time framewithin which to accomplish it. Have you been able to define for yourself whetheryou are a day trader, swing trader, or trend trader? Do circumstances dictate thetype of trader you are? Finally, you must never second-guess yourself if youfail. The Samurai understood that the present moment was the only one that hecould control and that the future was all he could ever hope to shape. The onlypositive purpose in looking back on past events is to assess future courses andbehavioural corrections. Self-recrimination is counterproductive.

Monitoring

It appears obvious that once a trader places a trade he should monitor this trade.Monitoring is a form of risk management and doing it well should allow yourwinners to run and assist you to cut your losers short; the trader’s “golden rule”.There is a downside to monitoring and I like the metaphor of the gardener whopulls out his plant to see how the roots are growing. A trader can watch his tradeunfold but market volatility can scare the trader into aborting a trade that mightotherwise have been quite successful. If only he had stuck to his stop loss rules.

The trader who observes the above steps of the Tactical MOT will be able totrade and monitor in an objective and relaxed manner. If the trader uses, as partof his rules, a trailing stop, then the market will dictate when and how the tradewill close. If, on the other hand, market volatility increases and an element ofunpredictability ensues, the trader could reduce his position to minimise lossesshould the market go against him, but maintain a position to continue in hisdesired trade.

In Chapter 5 on perceptual biases, I will be discussing traders’ inclination tointerpret, distort and rationalise data according to his preconceived expectations.The trader who does not have an objective and tested set of rules for monitoringwill not perform this task well. It will be of benefit for each trader reading thisto determine whether monitoring acts as a form of risk management or whether,like the gardener, he is pre-empting the market moves by preventing the tradeto unfold.

Abort

Most successful traders implement their plans in a consistent manner where theparameters of entering a trade are explicit. Developing methods to determinethe probability of market movement and defining a target is often neglected.Numerous authors of technical analysis refer to the golden rule of exit. The


golden rule is simple: If the market does not conform to your plan or your originalreasons for making the trade, then close your position. There are a number ofcircumstances where the golden rule of exit can be implemented. Traders willrecognise a range bound market that moves between a high and a low possibly forweeks. Traders use different names for this phenomenon, such as consolidation,congestion, or a neutral or narrow market. Following the identification of a range,the market will break to the upside or downside. Traders will enter a position uponidentifying this breakout and if the market retraces quickly to the consolidationarea, exit that trade.

Another example would be to identify an area of support or resistance andtake a position once this support or resistance is broken. If the market retraces tothe resistance and support levels over minutes or days depending on your timeframe, exit that trade.

It helps to remember that one of the greatest advantages the home traderhas over market makers, commercials, or large speculators, is that we have anadvantage in being able to stay out of the market for as long as necessary.

Aborting a trade requires mental agility, speed and focus, and requires thetrader to practise analysis and refutation during the monitoring stage. Good dis-cipline requires that traders put in a stop loss automatically with each trade. Thereare numerous techniques employed in defining the most appropriate area for yourstop. For example, if a trader takes a position on a breakout, the stop should beplaced immediately under the opposite high or low of the range.

It is important to define your own method of placing a stop loss. This willgreatly assist in controlling anxiety or despondency as a result of being in alosing trade.

Capture profits

General principles discussed in the previous section apply to capturing profits.The golden exit rule applies equally to profitable trades as it does to losing trades.Successful traders incorporate profit targets into their plan of action. The mostpopular methods are retracement, trend lines and consolidations.

Traders can define targets based on Fibonacci retracement levels of 38%, 50%and 62%. A friend of mine trading the DAX has a standard 90 point target onlow risk days that he identifies during daily and weekly chart analysis. He makesample profits on a simple rule to exit to any 20% retracement after his 90 pointtarget has been achieved.

Another popular technique is to use parallel trend line targets. When you havedefined a trend, for example, an up trend by connecting two major lows, you candraw a parallel trend from one of the major tops. The degrees of the angle areidentical and one can exit a long position as soon as it touches the upper trend.

There are numerous other techniques to determine profit targets, but the tradermust always be aware of the risk:reward ratio. Successful traders recommend that


you try to achieve a risk:reward ratio of 2:1 on any trade, therefore the targetshould always be two times the stop level.

Immediate performance review

Following the completion of a trade, be it 10 minutes, two hours, one day, twoweeks or more, mature traders will review their trading process while they stillhave the ability to remember small details that may have occurred at one ormore of the stages of the tactical MOT. It would be of benefit for the trader tophotocopy the tactical MOT directly from this book and use it as an aide-memoireduring the immediate performance review.

Once you have developed a set of trading rules that you can trust and thereforehave confidence in, your criteria for success should be whether or not you havefollowed those rules. It is important also to assess whether you have made moneyduring a period where you did not follow those rules. There will always beexceptions to your trusted rules and if you make money at these times, it willsimply reinforce bad habits.

My own method of immediate performance review goes along the follow-ing lines:

• I review my chart, trading diary and action plan that I printed while assess-ing risk and applying a strategy.

• If the trade was not successful because I did not follow my rules, whereexactly did I go wrong? Was the trading failure a result of a hostile mar-ket environment rather than something I could reasonably have predictedthrough technical analysis or other skills?

• I avoid self-recrimination.• If I identify a mistake, I attempt to think of one or two alternative decisions

or actions that would have been more appropriate in the circumstances. Iwill rehearse these alternatives in the hope that I will employ “the lesson”the next time the market presents a similar opportunity.

When I identify a fault in my trading process, I immediately write it down on thesame sheet that I keep my trading diary and action plan. I find this very usefulduring my periodic reviews in identifying patterns in my trading method.

Periodic review

During the 1990s, especially the latter part, we had a bull market that would notslow. Every time we heard experts comment that the market could go no higher,and a correction should soon be in store, we found the market would make a


new high. Some traders made large sums of money trading, for example, theNASDAQ index futures, by using a simple buy and hold technique. The moremoney they earned, the cleverer they thought they were. It was a rude shockfor these traders when the millennium ushered in a bear market. Many of thesetraders have given back all their profits.

We know that change is part of the dynamics of the market and of the humancondition. The purpose of periodic reviews is to determine whether the rulesyou employ are valid for the current market conditions and if they are com-patible with your current life situation. The old adage that “one cannot see thewood for the trees” is applicable to the periodic review because it is virtuallyimpossible to be objective if you are actively in an open position. Thereforea periodic review should be at a chosen time when you are not in a marketposition. A periodic review can take place at different times according to yourneed. A day trader, who places three or four trades a day would benefit froma monthly periodic review. A swing trader, perhaps trading three times a week,would benefit from a periodic review at three month intervals. A trend trader,holding trades for two or three week periods, would benefit from a six monthlyreview period. I review my own performance formally every three months in thefollowing manner:

• I look at the comments that I have written down during my immediateperformance review. Is there any pattern that I can identify?

• Through a periodic review I have been able to identify, acknowledge,and eradicate bad habits or trading behaviour. I have had problems withfreezing, overtrading, chasing the market, trading for entertainment andbreaking my rules regularly.

• Have there been any significant changes in the market? If there is anincrease in volatility: Do I need to reduce my positions and widen mystops? Do I need to pay attention to my oscillating signals rather thantrend or volume and spread signals? Do I need to trade fewer markets, ora different market completely?

• Are there changes to my personal life that require a different methodof trading?

• Does my trading diary reflect competent and appropriate market analysis?Are there patterns emerging in my style of market analysis? What needsto change?

• Review my business plan discussed. What needs to change and withinwhat time scale? Is the trading business plan still relevant or do I needamendments?

Periodic reviews will assist you in maintaining trading discipline and consistency.It will help you to identify not only trends in your trading style but will give


you an opportunity to identify your learning needs and to devise a plan on howto meet them.

PART B: THE STRATEGIC MODEL OF TRADING COMPETENCE

STRATEGIC MODELOF

TRADING COMPETENCE

SELF MANAGEMENT

DATA MANAGEMENT

CONTINUING EDUCATION

STRESS MANAGEMENT

FINANCIAL MANAGEMENT

Self-management and self-awareness

Given the solitary nature of trading, it is essential that traders gain the skill ofself-management and self-awareness. These skills rely on an element of emotionalintelligence, popularised by Dan Goleman (1996) in his seminal book entitledEmotional Intelligence. I wish here to express my gratitude to Dan Golemanfor allowing me to reproduce some of his ideas from his recent book, The NewLeaders that he wrote with R. Boyatzis and A. McKee (Box 3.1). Goleman et al.(2002) have developed a theory of personal competence – in other words, thosecapabilities that determine how we manage ourselves.

Self-awareness means having a deep understanding of one’s emotions as wellas one’s strengths and limitations and one’s values and motives. A self-awaretrader is realistic. He does not beat himself up regarding mistakes or continueto be self-critical when the incompetent trade has passed. The self-aware traderdoes not rely on hope but is honest with himself about this own performanceand the behaviour of the market. A well-balanced trader often laughs at hisown personal foibles as well as some of the silly and repetitive mistakes he


Box 3.1 Emotional Intelligence Domains and Associated Competencies

Self-Awareness:

• Emotional self-awareness: reading one’s own emotions and recognis-ing their impact; using “gut sense” to guide decisions.

• Accurate self-assessment: knowing one’s strengths and limits.• Self-confidence: a sound sense of one’s self-worth and capabilities.

Self-Management:

• Emotional self-control: keeping disruptive emotions and impulses un-der control.

• Transparency: displaying honesty and integrity; trustworthiness.• Adaptability: flexibility in adapting to changing situations or overcom-

ing obstacles.• Achievement: the drive to improve performance to meet inner standards

of excellence.• Initiative: readiness to act and seize opportunities.

may make. A self-aware trader knows where he is headed and why. He has adeep belief that trading is his vocation or at least part of it. Trading somehowintuitively feels right. Many authors have termed this “The Zone”. A self-awaretrader would turn down an offer of a job in a related field even though thesalary may be considerable and on the surface appears to have more security thantrading. Because self-aware traders make decisions which are compatible and notin conflict with their values, they find their work energising. This feeling of energyis not the same as entertainment value trading where one gets a “buzz” fromthe risks of loss and reward. One of the least visible aspects of self-awarenessin trading is the facility for self-reflection and thoughtfulness. Self-aware peoplefind time to reflect quietly by themselves. It allows them to think matters through,develop strategies and avoid knee-jerk reactions. Numerous methods of enhancingself-performance have become popular with traders, such as passive-meditation(Zazen – seated-meditation) or active-meditation (Misogi – walking-meditation).Some outstanding traders have brought to their work life – the thoughtful modeof self-reflection that they cultivate in their spiritual lives. It is no mystery whymany traders have made popular in their quest for self-knowledge the readingof authors such as Deepak Chopra, Neale Donald Walsch, Dan Millman and


Vernon Kitabu Turner (see Bibliography). All of these traits of self-aware tradersenable them to act with the commitment and life purpose that success in thisfield requires.

Neural anatomy and self-awareness

Davidson (2000) has made extensive studies of the left pre-frontal cortex and itsrole in motivation. Theoretically, our guiding values are represented in the brainas a continuum of emotional thoughts with what is “positive” and what we findlikeable at one end and what we loathe and dislike at the other. The valence anddirection of those emotions determine whether or not a goal appeals to us. If thethought of working with mentally disabled people appeals, or thrills us, it willbe highly motivating.

Davidson through extensive research, has shown that much of the processwhich motivates occurs in the brain’s pre-frontal areas – the seat of attention andhence of self-awareness – which monitors feelings about preferences. Circuits inthat part of the brain elicit our positive feelings bringing them to consciousnessas we struggle toward a goal. Positive thoughts in a sense operate as a sort ofpersonal audience cheering and exulting us to achieve over the long haul.

Davidson argues that, from a neurological standpoint, what keeps us movingtowards our goals in life comes down to the mind’s ability to remind us of howsatisfied we will feel when we accomplish those things; a capacity residing inthe circuitry between the Amygdala and left pre-frontal lobe (see Figure 6.1,page 156). This finding is much at odds with the description by Bill Williamsin his book Trading Chaos (1995) where he describes the left hemisphere as“the idiot” and the reader may wish to view Passage 1 on page 129 for thefull quotation.

Whatever it may be driving us to become competent traders, whether it beexcitement, competitiveness as postulated by Borsellino, money we might receive,or simply the joy of being socially recognised as Soros the Second, all motivatorsshare a common neural pathway. Not only do neural circuits in the left pre-frontalcortex elicit good feelings as we perform in trading, another set of circuits per-forms another function: they quiet the feelings of frustration or worry that maydiscourage us from continuing. It is often quoted that the successful trader is theone who does not accept failure and who does not recognise setbacks without acorollary solution. This neural anatomy allows us to see the hidden opportunitiesor as Deepak Chopra might state, “seeing the gems in the ashes”.1 It is this setof neural circuits that influences whether we become a pessimist who dwells onwhat is wrong and so loses hope or an optimist who keeps going and suggestsways to overcome particular problems.

1 D. Chopra – The Way of the Wizard, Lesson 14: “In the rubble of devastation and disaster are buried hiddentreasures.”


Intuition, self-awareness and market trading

Why should intuition have a place in market trading? After all, the world’s eco-nomy and decisions, which have implications on millions of pounds, should bebased on cold, emotionless logic and analysis of data – shouldn’t it? I have notbeen able to trace the exact origins of the following pejorative statement, but I canremember one of my psychology tutors stating that “Intuition is that strange abil-ity to think that you are right even when you are wrong.” Precisely because thereis a huge amount of data to consider in taking any complex decision involvingpersonal money or millions of pounds of other people’s money, there necessar-ily needs to be a combination of technical expertise, paired with life wisdom.I believe that the combination of this gives rise to what is popularly known as“intuition”. Regarding emotions and decision making, Antonio Damasio (1984)demonstrates neurological research, which indicates that our emotional memoryenables us to judge information efficiently. Emotions, science now indicates, arepart of rationality, not opposed to it. I will be discussing this in greater detail inChapter 6, “Emotions, Emotional Intelligence and the Trader”.

In some respects intuition can be seen as having a vision. Of this Dan Golemanet al. state, “Vision requires what looks to others like a leap of faith: the abilityto go beyond the data and to make a smart guess.”

An interesting account of the role of intuition and market trading is outlinedin anecdotal interviews conducted by R. Koppel (1996) in his book The IntuitiveTrader. Koppel interviews a number of traders who are convinced of the veracityand application of intuition in trading the markets. In harmony with the principleof analysis and refutation, I think it is important to provide an alternative andopposing view for the reader to consider as I have done on pages 38–39. I haveno doubt that intuition plays an important role in decision making, but tradersneed to be aware that overconfidence in their own judgements based on spuriousassumptions will result in financial disaster.

Data management

Data management is the ability to analyse information logically and to drawcorrect inferences from a set of facts and numbers. Our abilities and attitudesto compare numbers, and to apply elementary statistics, are crucial to protectingour money.

On any given day, the stock market can offer many courses of action, withseveral objectives, and a trader can suffer from information overload. He cannotassess all the possible actions and outcomes and decide which is best. In thesecircumstances, the trader attends only to those aspects of possible options thatoccur to him at the time and settles for a course of action that is only “goodenough”. The “good enough” course of action is usually far from optimal. Her-bert Simon, the Nobel Prize-winning economist, coined the term “satisficing”


in his book Models of Man: Social and Rational (1957). The person makingan important decision ceases his search through the possible options when hehas found one that is “good enough” but not necessarily optimal. Even peopleengaged on a very important decision do not begin to evaluate the full range ofoptions and their possible consequences. For example, cast your mind back towhen you first decided to enter a particular career. I suspect that a full range ofoptions and their possible consequences were not considered. In fact, you mayeventually have ended up in a career that was totally different to the career youinitially embarked upon and felt you had a vocation for. Did you compare theparameters of three or four jobs looking at pay, prospects, pension provision,number of hours of work, the friendliness of the people you work with, level ofresponsibility, travelling time, status, benefits to society, chance to be creativeand the stress involved? You may have been influenced by being impressed byone aspect of the job that outshone all the others, for example a company car.The few parameters a person does consider in forming a major decision may notbe the most important ones but they are more likely to be the ones that are mostavailable at the time. We will discuss the “availability error” in Chapter 5, ThePsychology of Perceptual Bias.

F. C. Keil (1978) developed a standard to describe the amount of informationcontained in a given event. The amount of information contained is equivalentto the number of “Yes–No” questions that one would have to ask to predict theoccurrence of an event. Each “Yes–No” question is called “one bit of informa-tion”. The greater the uncertainty of an event, the more “Yes–No” questions needto be asked.

As traders, we are constantly bombarded with millions of bits of informationand we can never be certain that the decisions we make based on the informationfiltered are correct. This is why we need strategies to minimise risk and disciplineto avoid irrelevant information. In a previous section entitled “Mental Rehearsal”,I refer to research by G. A. Miller (1956) who observed that people’s capacity forinformation was limited to 7 plus or minus 1 chunks of information. This limitedcapacity for dealing with information can be tested by yourself by reading thelist of letters below, closing your eyes and recalling as many of them as you can:

KB CN ZVTW CF LBBG NY OEVZ FC WT

Unless you have a developed strategy for organising and recalling the letters,it is unlikely that you remembered all of them. Twelve double lettered itemsexceed the capacity of most people. Alvin Toffler (1970), in his classic bookFuture Shock, predicted that human beings would struggle to cope with increasing


amounts of information. He predicted well-educated women and men could adaptto new technologies but it would take effort and flexibility; the less skilled wouldlag behind. Toffler suggested that the new age of vast information would makeunnatural demands on our biology which does not suit us for high speed, highaccuracy data analysis. At the time of writing his book, there were no Internet,faxes, pagers, mobile phones, or email. The stock market still operated in openoutcry where brokers and jobbers traded by scribbling on small bits of paper andby word of mouth.

Studies of cognition and memory show how, over short periods of time, infor-mation decays. We forget far more than we remember and we forget most ofwhat we perceive. Contrary to popular belief, there is no evidence that peoplecan remember scenes in perfect detail and with perfect accuracy as if they werestored in some internal video recording.

Toffler predicted that when people are confronted with information overload,they would adapt a number of strategies including ignoring new information, rely-ing on stereotypes, narrowing the field, and becoming emotional and attributingthis to stress.

There is some evidence to suggest that professional dealers also suffer stresswhen acquiring and using stock market information. Kahn and Cooper (1993)surveyed 600 dealers, of which 225 replied to their questionnaire. It is reportedthat the most significant sources of stress included fear of “misreading the mar-ket” (73.8% of survey sample), having too much work to do caused them stress(70% of survey sample), and having to learn new techniques of handling infor-mation (62% of survey sample). Market professionals have the advantage ofhaving sophisticated computers and computer programs to help filter a tremen-dous amount of market information.

Successful traders are often correct less than 50% of the time, yet they stillare able to make significant profits as a result of building a strategy around“letting your winners run and cutting your losses short”. At the core of tradingtasks are two important decisions: (1) initiating the trade, (2) closing the trade.Initiating the trade has a tremendous amount of subcategories of decisions, suchas should I trade options, futures, bonds, or stocks? Should the position be longor short? The important question is what to select from thousands of possiblealternatives and this is a highly complex question. Successful traders have clearcriteria by which to make this decision. Some will trade only one stock indexfuture and become totally proficient in that particular market. Some will tradeonly one group of stocks. Whatever decision the trader makes, the vast amountof information implies the necessity of method, the requirement of discipline andan overall strategy to limit risk.

The closing decision is as complex as the opening decision for similar reasons.While a position accumulates profit, the trader is always of the view that if itwere to be closed immediately it might become much more profitable as soonas it is closed. If the position is unprofitable, the trader might think that it could


turn at any minute and take it straight into a profit. As long as the trader ismonitoring the position, he will be making this decision continually. The trader’srules should define what strategy or method he will use to close the trade. Anumber of methods were suggested earlier in this chapter in the section “Abort”.For some time clinicians have been aware that lack of control over stressfulevents can cause depression and stress-related illnesses. This lack of controlcauses uncertainty which is integral to unpredictable markets. We can, however,control ourselves as traders. Provided we are disciplined we have a fair chanceof profiting from the market.

While it is acknowledged that trading information far exceeds an individualtrader’s capacity for making decisions, there are a few factors that are correlatedwith successful trading:

1. A healthy psychological profile.2. The ability to make accurate decisions.3. Discipline and money management.

One could view the Comprehensive MOT as a diagram outlining the basicskills required by traders for success.

MARKET ANALYSIS

Introduction to fundamental and technical analysis

An investor can use numerous methods to determine which stock offers thegreatest investment potential. Fundamental analysis uses economic and financialinformation to determine the long-term prospects of a company. Companies thatare highly profitable and have a sound balance sheet offer the greatest investmentpotential. Analysts calculate numerous ratios from profit and loss accounts todetermine asset viability. The four financial views address profitability, liquidity,efficiency, and risk. Later in this section, I outline an example of ratio calculationsfor the interested student. Technical analysis allows an investor to base decisionson price movements, volume, or the actions of other investors. Technical analystsbelieve that trends can be identified and charted and that these trends will persist.Volume spread analysis is a classic example of technical analysis. Each approachoffers advantages and shortcomings although most analysts fall into one of thetwo camps.

The above introduction should be sufficient for the newcomer to embrace andunderstand the differences between fundamental and technical analysis. I havewritten some further sections here for the student who would like an explanationin greater depth.


Trading styles

Defining the many investment styles and trading tactics is difficult because ofthe many dimensions that can be used to define an investor. The most basicapproach to defining management style forms two categories: active manage-ment and passive management. Passive managers seek to replicate the returns ofsome indexes like the S&P. Active managers seek to add value to a portfolioby selecting securities that will outperform the market or by adjusting the com-position of the portfolio based on their forecasts of the overall direction of themarket. In general, active managers are classified by the type of analysis they per-form. Fundamental analysis deals with the analysis of financial statements and/oreconomic fundamentals in order to value a security and its growth perspective.Technical analysis is the act of identifying patterns in security prices and volume.Technical analysts believe that trends can be identified and that these trends willpersist. A third investment approach typical to the active management style ofinvesting is arbitrage trading. Arbitrage can take several forms, from profitingfrom price differences between securities in different markets, to betting on thepotentiality that a merger will be completed.

Fundamental analysis

Analysts who use fundamental analysis might employ a number of approaches; atop-down investment approach begins with an analysis of the aggregate economy.This information is used to determine which industries will prosper given thegeneral economic outlook and which companies will become the top perform-ers. The best industries are determined by analysing the financial statements ofthese companies. With a bottom-up approach the analyst begins at the com-pany level and works up to the aggregate economy. Whether analysts use atop-down or bottom-up approach, they are usually placed in one of two camps,value investors or growth investors. Value investors seek out companies that theybelieve the market has incorrectly undervalued. Growth investors, by contrast,are less concerned about value and are more concerned with the growth rate ofearning. Growth investors are looking for companies only with accelerated earn-ings growth but whose growth exceeds expectations of other investors. A thirdtype of analyst is a hybrid that looks for growth at a reasonable price (GARP).

All three types of analysts care both about the price of a security and a rate atwhich earnings will grow. The difference lies in the emphasis they place on eachcomponent. Value investors place greater emphasis on the price paid relative tothe firm’s earnings, they are not looking for firms with superior growth prospectsbut rather firms that are inexpensive relative to their current levels of earnings.Growth investors on the other hand, place a great deal of emphasis on the earningsgrowth relative to the market price. That is growth investors are willing to pay


more for a company that they believe has superior growth prospects that arenot already reflected in the stock’s price. GARP investors tend to take a morebalanced view on the importance of earnings growth and price.

A fourth type of investment style is sector rotation. Analysts who followa sector rotation strategy rotate the portfolio into different industry sectors inorder to prosper from perceived mispricings. In addition to shifting the sectorsmanagers may shift between value and growth stocks or between small and largecaps stocks. Finally, there are analysts who attempt to act upon the market throughthe use of market timing – a strategy in which the manager adjusts the stock andbond mix or the risk of portfolio based on market forecasts. When the marketis expected to rise, the manager increases the portfolio’s percentage in stocks orshifts the portfolio into higher risk stocks, which are likely to rise faster than themarket. If the market is expected to fall, the manager will reduce the percentageor decrease the risk of portfolio. If the analysis is correct the portfolio will suffersmaller losses. Market timing is generally regarded as the most unreliable methodfor attempting to beat the market because of the difficulty in predicting the overallmovement in the market.

Valuation approaches for fundamental analysis

In deciding whether to recommend the purchase of a security, analysts needto determine the value of the asset. Several different methods can be used. Ihave chosen the following methods, which are taught on Master of BusinessAdministration courses throughout the UK.

Profitability

The extent to which the assets employed are generating returns over and abovethe current running costs. A profitable company would normally be achievingsatisfactory results and profit is a generally accepted performance method.

Example:

Return on capital employed = Profit before interest and tax

Long-term capital employed

Return on equity = Profit after interest and before tax

Equity

Liquidity

The extent to which the activities of the company are generating surplus fundsand its associated ability to meet debts as they fall due.


Example:

Working capital ratio = Current assets

Current liabilities

Acid test ratio = Current assets less stock

Current liabilities

Efficiency

The extent to which the company generates outputs in relation to inputs.

Example:

Net asset turnover = Sales

Net assets

Risk

The extent to which stakeholders in the company can foresee an acceptable returnon their investment through its future operations.

Example:

Debt to capital employed = Long- and short-term creditors

Long-term capital employed

Technical analysis

Technical analysis is based on the assumption that prices tend to move in trendsthat persist for certain periods and that these trends can be detected and charted.This approach is a dramatic departure from fundamental analysis. Many aca-demics equate technical analysis with mysticism. Technicians often criticise fun-damentalists and market efficiency theorists as divorced from the reality of themarkets. The fact is that some technical analysts are making a very comfortableliving (and vice versa).

Charting is at the heart of technical analysis. Chartists use support or resistanceto describe whether it is a trading or trending market, prices generally movewithin the support/resistance range (trading range). Traders buy at support andsell at resistance and moving above or below a support or resistance point isreferred to as a breakout. A breakout above a resistance point signals an upwardtrending market. Or a breakout below a support indicates that the markets aretrending downward. For the trader it’s an essential supporting factor. A newhigh on heavy volume is considered bullish while a new high on light trading


Do you have high volume up-bars inthe back ground and on that volumewas the market is refusing to go up?You would expect to see true'upthrusts' after signs of weakness.

Upthrust

Commentary - Tom Williams

Sometimes a market is so strongthat the prices have gaped up at theopening only to fall back and restgiving the appearance of a falseupthrust.

With the appearance of an upthrustyou would certainly be payingattention to your trade and yourstops.

On many upthrusts you will find thatthe market will 'test' almostimmediately. If the volume is low onany 'test' after a red arrow youwould take this as a strong signal ofstrength. The program may not beable to pick up all testing. But is,especially important immediatelyafter a red arrow.

Upthrusts are designed to catch stopsand to mislead as many traders aspossible and are normally seen afterthere has been weakness in thebackground. The market makersknow that the market is weak so the

SELL

SELL

SELL

Figure 3.2. Example of technical analysis. [This chart depicts RSI breaking the top linegiving three sell signals. We know the market is weak and this is confirmed in thecommentary by Tom Williams (Tom Williams is the creator of Volume Spread Analysisand the William’s rule sets with commentary were fully incorporated into TradeGuiderin 2004). We therefore give greater weight to RSI breaking the upper rather than lowerlines and vice versa for strong markets.]

volume may indicate a temporary move that is not likely to be sustained. Thereis no single magic formula for identifying trends and trading ranges. Techniciansgenerally combine several methods and when they confirm one another, the signalis considered valid. When they contradict each other, it is better to pass up a trade.

At the core of technical analysis are charts and a plethora of tools to interpretthose charts. Figure 3.2 is a candlestick chart utilising a tool called RelativeStrength Index. The tool predicts when a market is overbought, breaking the lineat the top, and when the market is oversold, breaking the line at the bottom. It mayact as a signal to buy at the bottom or to sell at the top, when the lines are broken.Most traders use two or more tools at any one time so that a confirmation andconsensus between tools will indicate a low risk, high probability opportunity.

Relative Strength Index

RSI analysis is based on the momentum concept. It measures the strength of aSecurity Index by monitoring changes in its closing price. RSI analysis is based


on the assumption that higher closes indicate stronger markets and lower closesindicate weaker markets. The RSI is defined by the following formula:

RSI = AU/AU + AD∗100

AU is the average of net up-closing changes for a selected number of days. Tradersfirst choose a time scale (14 days as recommended by inventor W. Wilder), thenfind all days when the security closed higher than the day before and add up theamounts of increases. The AU is equal to the sum divided by 14. AD is the averagenet down-closing changes for the same number of days. Traders find all days whenthe security closed lower than the day before and add up the amount of declines.AD is equal to the sum divided by 14. The RSI is obtained by inserting the valuesof AU and AD into the formula. As is clear from the formula, the RSI fluctuatesbetween 0 and 100. If the ratio is 50 the ups and downs are equally divided. Asthe ratio goes above 50 more closes are ups and downs, indicating an upwardtrend. Technicians would state that when the RSI passes 70 or 80, the market hasreached its top, conversely if the RSI falls below 20 or 30 the market is near itsbottom and a reversal is in sight.

Overview

Prior to studying basic accountancy methodology, I was intimidated by the sheeramount of numbers and related factors needing analysis. I did not have anyunderstanding of the process of valuation. Following calculating a number ofexamples and reading around the subject, I realised that accountants do not havethe impossibly difficult job I had once thought and I now have a more balancedview. In fact, most market analysis or company valuation can be undertaken byanyone who has basic arithmetic skills and the fortitude to learn from mistakes.If you have read this far I hope the section has served to demystify the role ofthe financial analyst.

FINANCIAL MANAGEMENT

Financial management is synonymous with risk management and this sectionsuggests areas of required competencies to preserve your capital. Even if youhave an exceptionally good quality trading system money can be lost throughincompetent money management. All trading systems have periods of drawdownsand if you do not have clear rules of engagement, you will not have the requireddiscipline to enhance your feelings of control and confidence and your behaviourwill become more like gambling than trading. Your confidence in your tradingability and the efficacy of your trading system will be undermined which maylead to substantial losses.


Defining how much money you are willing to risk on any trade and how tovary the size of your position in relation to market conditions and account equityis essential for your survival and success as a trader.

There are numerous books on risk management that will offer suggestions andmethods to manage your finance. Over the years I have developed a number ofprinciples and rules, which I apply consistently in the market. I will share theserules with you as follows:

• I trade objectively using the technical analytic skills I have learnt, with theprime goal of developing a low risk plan. I trade to increase the probabilityof winning, not to provide myself with excitement or entertainment.

• Hanging on to a losing trade is not a good strategy. Reluctance to take aloss is a sign of emotionality and lack of objectivity. I attempt to cut mylosses quickly through the appropriate use of stop losses.

• I always adjust my stop losses in the direction of the trade and once I lockin a profit, I use trailing stops. Having a second thought on a stop loss orwidening it after placing it is a sign of indecision and will result in losses.

• In managing my finances my primary goal is to preserve my capital. Mysecondary goal is to earn a steady rate of return.

• I am realistic in realising what returns I can expect from the market. Iknow that professional traders consider an annual return of 25% of theirtotal equity as excellent. As a small trader I would be wise to aim for a12.5% annual return. The more I succeed the higher goals I will set.

• I always factor in slippage and commission when assessing profit targets.• I never risk more than 2% of my total equity on a single trade. This

protects me when I have a string of losses.• The above 2% rule also assists me with determining the size of my expo-

sure. Professionals suggest that small traders should not trade more thanthree markets at any one time. It logically follows that if you have only2% exposure on three markets you will have a 6% exposure on a singlemarket, if you trade three lots of 2% of your equity. For example, if youhave a ¤30 000 account, 2% is ¤600 which will be exposed. You can tradeup to ¤1800 exposure for three lots of 2% if a trade is moving in a prof-itable direction. If you have a stop on one contract that allows say a ¤550loss, you could trade three contracts (total = ¤1650) leaving ¤150 forslippage and commission. You would automatically reduce your contractsif the market moved against you.

• At the start of my trading career, I viewed optimising my exposure as anessential skill to be learned. If one trades less than an optimal size, therisk diminishes, but then so does the profit potential. If one risks morethan optimum, one can go broke.

• Counting profits or losses in financial terms while in a trade is counter-productive. I have two order entry systems that automatically calculate


my profit and loss in the relevant currency being traded. Some traderswill argue that it is advantageous to know the exact position of a trade,however; my view is that it can cloud judgement. Only you can decidefor yourself whether it helps or hinders your judgement.

• When in a profitable trade and the market is approaching an area of con-gestion, support or resistance, I use trailing stops to counter a bounce fromthose areas. Profit targets and stop losses should be set at the “developingtactics” stage rather than while in the trade.

• Competent traders place stops at the commencement of the trade and adjustthem only in one direction. A stop is not a perfect tool as the marketcan gap through the price. This is where a clear “monitoring” strategy isessential especially in fast markets.

• Appraising your performance on a daily basis is an essential risk manage-ment tool as is a periodic review.

• If I lose more than 4% of my total equity in any one month I ceasetrading and review my trading diary to see if there are patterns emergingthat indicate the reason for my lack of success.

The trading diary can be viewed as a risk management tool and it is anessential requirement for the trader. In addition to keeping a trading diary I takea screenshot of each trade that I place using my personal trading methodologyand related technical analysis (Figure 3.4). Refer to Figure 3.3 where I illustrate asimplified version of my trading and decision diary. In the left column I place thebasic information about the trade. The categories are self-explanatory but I willgo through it here nevertheless. “Number” refers to how many trades have beenplaced during the current month and the date of the trade. I record informationon ticker symbol, direction (short or long), time, price fields, size (meaning howmany contracts), where I place my stop at the time of the trade, any slippagecosts, and fee (commission). I then give information on my exit date and thetarget price when I close. I give my total points earned and then a profit/lossminus the fee. That gives me the total profit and loss for that trade.

The section on the right records the decision diary. Technical indicators aredivided into three main groups. Trend-following indicators help identify trends.Oscillators help find turning points. Miscellaneous indicators, such as volumespread analysis, track supply and demand, which indicates strength or weaknessin the market. For this example I have chosen an exponential moving average, themoving average convergence/divergence histogram, and volume spread analysis.On each parameter I mark the weekly direction and whether indicators havebeen triggered. The smaller picture on the daily chart will indicate a likely short-term move. Other miscellaneous indicators such as commitment of traders, openinterest, fall of premium and a number of others can also be used in conjunctionwith the above indicators. Each trader needs to develop his or her own tradingstrategy and system. Once you have recorded your indicators you are able tomake a decision regarding action and this area defines your low risk plan.


TRADES

Number_______Date__________

Ticker_________Direction_______Time__________Price__________Size___________Stop___________Slippage________Fee____________

Exit date________ Price___________Total points______ P/L_____________P/L-Fee_________

Total___________

DECISION DIARY

WEEKLY

EMA:

MACD-H:

VSA:

DAILY

Intra-day:

EMA:

MACD-H

VSA:

OTHER: COT, OI, Forward Premium, etc.

ACTION PLAN

Date of Analysis: Date for Action:

COMMENTS:

Figure 3.3. Trading and decision diary


Figure 3.4. Candle chart

The action plan includes the date of analysis, since most plans of action aremade following the close of the market the day before the intended action. Finally,the comments section can be used to identify any patterns that you recogniseduring your trading day. The comments may include information regarding yourtrading style or about the markets in general. Following a number of weeksof trading you may collate these comments during your periodic review andidentify an important aspect of your behaviour, your trading system, or the marketin general.

I have drawn an equity bar chart using Excel (Figure 3.5). The breakeven linerepresents the initial capital deposited in the account. A move to either side ofthe breakeven line is a fairly accurate index as to the quality of my performance.

My trading diary is an A4 loose-leaf binder filled with clear plastic envelopes.I place the decision diary on one side of A4 and print the screenshot of marketentry on the other side. I then have a printed diary of my decision process anda pictorial representation at the time of making the trade. I also make numerousnotes on the chart that assist me during my periodic review to recollect mythought process and make any assessment of my performance with the benefitof hindsight.


0

20000

40000

60000

80000

100000

120000

140000

Month's P/L

Eq

uit

y EQUITY

EQUITY 62000 62451 61456 60333 59333 61899 62899 81228 102080 110956 105043 118567

January February March April May June July August Sept October Nov Dec

Breakeven

Figure 3.5. Equity chart

CONTINUING EDUCATION

Why should we learn to trade at all? Certainly the numerous professional eco-nomists and stockbrokers are able to provide excellent returns on our investments?In this section we will look at some of the research that questions the competenceof government economists and City brokers.

Economics is significantly involved in forecasting. Some have drawn a com-parison with meteorology where predictions are made for general public con-sumption. Newspapers such as The Times, the Observer, or the Guardian makepredictions regarding the numerous stock markets. The most influential globaleconomists are located in the United States and they are the Governors and Chair-men of the Federal Reserve, members of the President’s Council of EconomicAdvisers (CEA), and the Congressional Budget Office (CBO). All three organisa-tions are involved in running the United States economy from the highest echelonsof government and each publishes its own economic forecasts. These forecastsalso influence Europe and Asia. Economic forecasters also are employed at theinternational level, for example at the International Monetary Fund and the WorldBank. In the United States there are so many government economists that theyhave their own professional association, the Society of Government Economists.

There are also private sector economic forecasters who provide forecasts forclients. This includes the most major financial institutions such as Banker’s Trustand Chase Manhattan; major insurers, such as Prudential and Metropolitan; andWall Street firms, such as Merryll Lynch and Prudential Securities. In addition,


there are thousands of economic forecasters who make a living selling economicnewsletters, primarily to individual and institutional investors. In addition, thereare the media, which inundate us monthly, weekly, or daily with economic pre-dictions, sometimes as front-page news, which may also make it into televisionnews programmes. All major business magazines routinely publish their owneconomic forecasts.

William Sherden, in his book The Fortune Sellers (1998), has undertaken in-depth research and analysis on how well economic forecasters predict marketprices. His highly erudite study concludes the following points about economicforecasters:

• Economists cannot predict the turning points in the economy. Professionaleconomists forecasting skill on average is about as good as guessing– there are no economic forecasters who can distinctly lead the pack

in forecasting accuracy;– there are no economic ideologies whose adherences produce con-

sistently superior economic forecasts.• No economic forecaster has demonstrated a consistently higher forecasting

skill in predicting any particular economic statistic.• Increased sophistication provides no improvement in economic

forecast accuracy.• Forecasts are biased by forecasters’ personal views, which are often

extreme and not based in the facts of the economy.• Consensus forecasts offer little improvement.• There is no evidence that economic forecasting skill has improved over

the past three decades.

Sherden concludes that the practice of economic forecasting is a game of chance,not skill, with no one consistently beating the odds and excelling at makingeconomic predictions. Economists, sitting in their ivory towers at universitiesand government agencies, with access to sophisticated and expensive technicalresources, predict market direction very poorly. How then can the city brokeroffer a competent and effective service to clients like you and me? The researchsuggests that brokers are irrational in a consistently optimistic way, which maymake them more suited temperamentally to bull markets. Haugen (1996) suggeststhat brokers’ recommendations are influenced by the social situation they findthemselves in with their clients. They have to have something to talk about withthem so brokers “produce news to impress and as a result they are attractedto stocks which have interesting and exciting prospects upon which they canbuild captivating stories”. Extroverts, in particular, will behave in a way Haugendescribes because they like to please and to be the centre of attention.

The failure of analysts and brokers to predict well is summed up in researchby Beckers (1997) where it was discovered that only 5% of brokers and 11%of mutual funds did better than the Standard and Poor 500 Shares Index. British


studies suggest that only 18% of investment funds consistently outperform theFTSE 100 Index. The discovery that in the mid-quarter of 1999 Schroder’s Fundsbeat the FTSE 100 Index by just under 2% was seen as big news and meritedan editorial in The Sunday Times “Business News”, so poor is the reputationof brokers currently. The notion that brokers can spot a few shares with greatpotentials and pocket extraordinary profits is a total myth and all the evidenceindicates that the opposite is true. Regarding those brokers who showed success,Beckers suggests one should not underestimate the role of luck. He divided bro-kers into aggressive, skilful and lucky ones; and complacent, unskilled ones. Hereanalysed thousands of their recommendations. He found that 35% of aggress-ive and skilful brokers still ended up in the red after 36 months. The unskilledbrokers did even worse.

Stockbrokers are reluctant to discuss their own weaknesses and learning needsas implied in the study by Kahn and Cooper (1993) where only 225 replied to asurvey aimed at 600 dealers. Stockbrokers often talk about fear or greed drivingthe market but one wonders what drives them. Research on personality impliesthat extrovert brokers will admit less anxiety about pressure to perform; however,they find it harder to learn from their mistakes. Suggestible and extrovert brokersare likely to be least skilled at understanding risk and resisting the impulse toreact in a knee-jerk fashion. The weight of this research is worrying as it suggeststhat brokers and analysts are poor at telling their clients the nature of the relativerisks between differing shares and financial instruments.

The research indicates that both economists and stockbrokers are poor per-formers in terms of prediction and returns on investments. This is a good enoughreason for any intelligent person with adequate savings, including a pension fund,to learn investment and trading skills themselves.

Qualifications of dealers and brokers

There are no formal qualifications required, such as a degree, or even a certificateof secondary education, to train as a stockbroker or dealer and much training occursat their place of work. There is no relevant independent study regarding in-servicetraining to ascertain the consistency and quality of standards across UK brokeragesand financial institutions. Following “graduation”, many investors give completediscretion to a broker once a general plan of action has been agreed, and will acceptthe explanations of the broker when significant sums have been lost.

I spoke with Mr R. K., Client Relationship Manager at the Securities Institute,Centurion House, City of London. He informs me that the Certificate programmeis designed specifically to meet the requirements of individuals working in thesecurities and derivatives markets who need to obtain Financial Services Authority(FSA) Approved Person status. Achieving a Certificate qualifies candidates tooperate in the major areas of advising and dealing in securities and derivativesas well as managing investments. Some candidates have just started employment


when they register for the programme but the qualifications can be taken by thosenot yet in employment, and relevant experience is not a prerequisite for sittingthe exam.

I asked what the minimum requirement was for a person to become a broker (akaApproved Person). Only two papers need to be passed – (1) the Securities Instituteregulatory paper and (2) the certificate in securities (or derivatives or both). I askedwhat the minimum expected hours of study would be for a candidate. Provided acandidate had some experience, the regulatory paper would require 10–15 hours ofstudy and the certificate in securities would require 20–25 hours of study. A totalof 40 hours’ study is the estimated minimum to obtain broker status. In addition,the Institute runs a two and a half day “booster” course to prepare candidates forthe exam. It was stressed that these were minimum requirements for approvedstatus and that many brokers carry more substantial qualifications.

If a client sought the advice of a solicitor, doctor, social worker, or nurse,they would be stunned into disbelief if told the minimum requirement for theseprofessions to qualify was 40 hours’ study and the successful completion oftwo exams. However, many investors trust their life savings to brokers who mayonly have minimum qualifications. Perhaps this is another good reason to developinvestment and trading skills!

WHERE AND WITH WHOM CAN I CONTINUE OR COMMENCEMY TRADING EDUCATION?

I suspect that many readers would accept the view that the training offered by CW(Box 1.1) was unsatisfactory and are wondering why so many people attended. Isuggest that the strongest psychological dynamic at work is the halo effect, to bediscussed in more detail in the chapter on perceptual biases. Following the publi-cation of an article in a reputable Sunday newspaper, outlining the merits of CW(without making explicit recommendations), the article was mistakenly perceivedby the public as a tacit recommendation for this man’s ability, integrity, and qual-ity of tuition. The halo effect was further consolidated when the article includedCW’s home telephone number. Subsequent to numerous courses run by CW, manywritten complaints were sent to the editor of this newspaper and it is unlikely thata similar article will appear outlining the merits of any unknown person.

There have been a number of studies of irrational group behaviour. For example,the journalist Charles MacKay in his Extraordinary Popular Delusions and theMadness of Crowds looks at three episodes that took place before 1850; the Mis-sissippi Land Boom of 1718–20, the South Sea Bubble, and Tulip Mania thatswept Holland. More recently the economist John Galbraith wrote A Short Historyof Financial Euphoria and a study of the 1929 Wall Street crash; the financialhistorian Kindleberger also looked at speculative manias.

During CW’s first intake of students in spring 1998, one “student” came up witha particularly good idea on how to apply CW’s teachings. For the sake of clarity,


I will call this student by the pseudonym Robert Duncan (RD). RD could nottrade successfully using any of the techniques taught by CW so in order to earna decent income, he decided to train people in a similar manner to that of CW. Inan article dated Sunday 11 March 2001, in “The Financial Mail on Sunday”, RDstated that his qualifications and background could not be traced or confirmed byreputable sources. The newspaper reporter described RD as an investment guruwith a line that sold pie in the Skye. The reporter answered an advertisement byRD who was charging £5000 for a futures trading course of 10 days. When thereporter attempted to find out his educational background, work experience and,more importantly, his trading experience, he could not find out any informationabout him, even though RD had given references to him. The reporter found thatRD had used almost identical descriptions of his training procedures as those usedby CW two years earlier in another national Sunday newspaper. One of RD’s“graduates” stated: “the thing that convinced me when I first met him was thathe watched a screen while he talked – and successfully predicted the directionof the S&P Futures Index 13 times in succession”. Two other newspaper articlesdescribed RD as using unusual techniques to train potential traders. For example,one of the course attendees who had lost his money in a paper exercise wastied to a chair and blindfolded. RD explained: “being tied up was an allegoryfor his powerlessness, and he was blindfolded because he had no money left fordata feed and therefore couldn’t see the market”. The newspaper reporter furtherillustrates the nature of this confidence trick by showing that a quotation used byRD had been copied verbatim from the original article regarding CW and placedin the Scottish newspapers. The implication is that RD copied word for word thearticle written about CW and simply replaced CW’s name with his own.

When the reporter attempted to confirm RD’s credentials he reached an impasse.RD stated in an interview that he had been employed as a professional trader witha City bank. When asked the name of the bank he replied, “I prefer not to involvethem”. When asked how many people attended his courses he declined to give anumber. When asked how it was possible one of the articles was almost identicalto the original article regarding CW, RD stated that it was as a result of a lazypublicity agent. The reporter could not find one shred of evidence that RD had everworked with a City bank, had any qualifications, or could even trade the marketscompetently. The article concludes that people should look elsewhere for trainingas a trader.

I will now turn to the qualities we should be looking for in a tutor teaching theskills required for trading competence. My personal experience and those of mycolleagues support the view that a coaching style of tuition is far more valuableand applicable than a dry academic intellectual style popular with universities.Academic professors help train the mind whereas coaches have a far more per-sonal, proactive, hands-on responsibility for the trainee’s progress. When youhave all your life savings at stake you need to have implicit trust in any coach


or tutor who mentors you. Trading coaches should combine attributes of an aca-demic professor, a courageous warrior, counsellor, trainer, friend, mentor, rolemodel, and perhaps even spiritual guru! These tutors invest in your mind, spirit,and future family life. The results of their input are publicly demonstrated oneach trade and market entry that you make. They have a profound influence onthe formation of your attitudes regarding the market and also you and your fam-ily’s future welfare. These coaches teach the reality of trading the market andhelp to shape the trainee’s character and life.

No single coach can teach you all there is to know about the market but canbe your guide along the path to achievement. Some coaches may be familiarwith stocks and shares while others may be familiar with stock index futures oroptions. The best coaches know their own weaknesses and therefore have theability to have insight to yours. They can point to things of beauty on the wayto knowledge, which may not be directly related to market trading. For example,good coaches will recommend books and training on spiritual development, per-formance psychology, biographies, and activities that will develop relevant skillssuch as arithmetic and stockbroking in general.

One comment regarding CW was that he insisted that one stuck to “the path” heprescribed. If your guide insists that you travel exactly the same path he or she didthen it is clear that the guide’s knowledge is limited. Seek a coach or tutor who canassess your qualities and point the best way for you. A tutor with whom you have a“connection” will support and guide you even though they may not have the in-depthtechnical knowledge that you require to trade specific financial instruments.

When you are considering changing your career and risking your life savings,your tutor will have a profound influence on your self-concept and outlook on life.Deeply skilled tutors convey useful lessons of living whereas average teacherswill teach trading skills.

Pick a trading tutor for yourself in the same way that you would pick a dentistfor your child. You would use utmost care and sensitivity because you understandthat any trauma a child experiences could have far-reaching consequences in laterlife. You wouldn’t want a mediocre dentist even if he or she were really nice,had offices near where you lived, and perhaps was willing to take you underNHS sponsorship (costing much less). Regrettably this is how many potentialtraders pick tutors. Finding a superior tutor for yourself is worth research andmoney, because an inspired tutor can have an influence that you will rememberand appreciate for the rest of your life.

My father was a music teacher and he described teaching as “the art of com-munication”. If your trading tutor has an MA or PhD degree and yet seems onlyto communicate the most basic and elementary skills, he or she will have lesseffect on your development than a trading tutor who has only basic qualifications,a lot of experience, and the ability and motivation to make you succeed in markettrading. The important thing is not what these tutors know. It is what they canimpart to you and what you will eventually know.


In my opinion, the performance of a student is a very accurate index to thequality and ability of a trading coach/tutor.

Competent tutors communicate market skills so that the trainee understandsand is able to apply them. Excellent market tutors speak the language of themarket, by showing the actions of groups of people and how attitudes and beliefmove prices. They use prediction to anticipate the outcome of their actions. Greatmarket tutors inspire, motivate, and encourage the love of market trading. Theyuse insight to access wisdom and can enthuse the trainee.

I have very simple recommendations for those looking for appropriate training.First, ensure that you have contact with other traders who are at the same levelof development as yourself. This can be done through Internet chat groups andattending inexpensive seminars. I highly recommend attending one or two dayseminars as you can assess your compatibility with the tutor vis-a-vis tradingstyle and personality, and you are able to form informal relations with otherattendees. Second, read books on trading, and even a poorly written book, or onewith questionable knowledge can provide a baseline from which you can comparequality. Finally, make a training plan which can be similar to the contents of thefinal chapter of this book. If life does not seem to be going your way, alwayskeep a positive attitude and set yourself small learning goals. In this way, nomatter how insignificant the learning may seem during a challenging period, youwill remain in touch with the markets and your aspirations.

Remember that it is more important what you think about yourself than whata trading tutor thinks about you and your skills. I have found these words inspi-rational:

Others will underestimate us,For although we judge ourselves

By what we feel capable of doing,Others judge us only by

What we have already done.

Henry Wadsworth Longfellow

SUMMARY CHAPTER 3

• This chapter presents the Comprehensive Model Of Trading Competence(Comprehensive MOT).

• The Comprehensive MOT is subdivided into the Tactical Model Of Trad-ing Competence (the Tactical MOT) and the Strategic Model Of TradingCompetence (the Strategic MOT). The Tactical MOT, as its name implies,is short term and addresses the skills required to actively trade. The Strate-gic MOT is a long-term and ongoing process of skills development.


• The Tactical MOT and Comprehensive MOT are composed of compe-tences and competencies.

• The competences and related competencies of the Tactical MOT are:

Competences Competencies

Self-awareness Ability to reflect appropriately on internal state.

Developing tactics Identify and create an appropriate plan. Calculating theprobabilities of outcome.

Mental rehearsal Committing the plan to memory. Rehearse the appropriateactions and alternatives.

Ambush Ability to cope with high arousal patiently. Identify anopportunity.

Action Taking decisive action predicated on a sound personalphilosophy and predetermined action plan.

Monitoring Applying the theory of analysis and refutation.

Profit target Defining a profit target through calculating probabilities ofoutcome. Having a clear plan to let your winners run.

Abort Recognising an adverse move and having a clear plan of actionto cut losses short.

Daily appraisal Identifying problems/successes and making appropriateshort-term plans.

Periodic review Identifying patterns in trading – making appropriate long-termplans.

• The competences and related competencies of the Strategic MOT are:

Competences Competencies

Self-management andself-awareness

Emotional self-awareness, accurate self-assessment andself-confidence. Emotional control, adaptability and initiative.

Data management Logical analysis drawing correct inferences, comfort with basicarithmetic, and application of elementary statistics.

Market analysis Comprehension of fundamental and technical analysis. Use ofappropriate analysis congruent with prevailing marketconditions.

Financialmanagement

Ability to perceive, define and manage risk. Use of tradingdiary, decision diary, and equity charts.

Continuing education Having a general understanding of the standards employed byprofessional brokerage and trading institutions. Identifying andrecording short-, medium-, and long-term training needs.Identifying support systems, courses, and trading mentors.

4Taming Stress to Become a BetterTrader

‘‘Reality is the leading cause of stress amongst those in touch with it.’’

Jane Wagner

Traders know what stress is because we have all to a greater or lesser extentexperienced it. Defining stress is a challenge because when the term is applied tohumans, we need to assess both our psychological reactions to demanding eventsand our appraisal or perception of such a situation. If we wish to generate adefinition appropriate to all animals, then we can define stress as: “The demandmade on an organism to adapt, to cope or to adjust.” In human terms, stressis: “Our emotional and physiological reactions to situations in which we feel inconflict or threatened beyond our capacity to cope or endure.”

The twentieth century saw great advances in our understanding of stress andphysiologists have known for some time that stress causes illnesses, mental andphysical, often resulting in death. When you place an experimental rat on anelectric grid and administer shocks to it, you need not raise the shocks to a lethallevel to kill it, simply by giving very mild shocks at random intervals you canarouse the rat’s stress response. On each repetition of the shock, the body breaksdown a little more. Following a few days of such stress, the rat dies and anautopsy will display many signs of physical deterioration. Since the shocks weremild, the cause of death was not external stress, but the reaction by the rat tothe shocks.

Humans can stand extraordinary stresses from the environment and many of thesurvival stories emanating from the Second World War will testify to this. How-ever, if we are pushed too far, our stress response turns on our own bodies and


begins to create mental and physical breakdowns. During the Second World War,mental fatigue became a recognised syndrome with a clinical diagnosis (somesoldiers during World War One were categorised as malingerers or cowards).

Within the human brain are sets of behaviours programmed to cope with everystress in the same way as our distant ancestors. If you are in a situation where youmay be assaulted you instantly make a shift into a state of heightened arousal.This “fight-or-flight” response explodes throughout your body, preparing you foraction. A message of alarm from the brain releases adrenalin from the adrenal cor-tex, which races through the blood stream and supersedes the normal functioningof the body. Whatever course of action you decide in the “fight-or-flight” situ-ation, your body needs a large burst of energy to propel your muscles. To enablethis process, the usual style of metabolism that builds the body, called anabolicmetabolism, converts to its opposite, catabolic metabolism, which breaks downand destroys tissue. Adrenalin elicits a number of physical responses – bloodpressure rises, muscles tense, breathing becomes shallow and rapid, sexual desireand hunger are suppressed, digestion stops, blood coagulation increases, pupilsdilate, the brain becomes hyper-alert and the senses become uncannily clear. The“fight-or-flight” response is vital as a temporary measure but if it is not terminatedin time, the effects of catabolic metabolism are disastrous.

ENDOCRINE ACTIVITY DURING STRESS

The endocrine system is a network of glands that manufacture and secrete chem-ical messages called hormones into the blood stream. Although these hormonesgo all around the body in the blood, they only target specific hormone receptorsat specific locations. When we are under threat, the “fight-or-flight” response isinitiated by the hypothalamus, a tiny gland at the base of the brain which actstwo ways:

1. It excites the sympathetic nervous system (part of the autonomic nervoussystem) which stimulates the adrenal medulla (the central part of theadrenal gland) to release adrenalin and noradrenalin (known together ascatecholamines) into the blood stream.

2. It stimulates the pituitary gland (a tiny gland that lies beneath the hypo-thalamus in the brain) to secrete the hormone adrenocorticotrophic hormone(ACTH), which in turn stimulates the adrenal cortex (the outer part of theadrenal gland) to release corticosteroids (including cortisol). These causethe liver to release stored glucose, thus increasing energy and mobilisingthe chemicals that help inhibit tissue inflammation. They also stimulate theimmune system to attack any invading antigens (foreign bodies).

Endocrinologists classify stress hormones as glucocorticoids, which are hor-mones secreted by the endocrinal glands as part of the heightened arousal during

Taming Stress to Become a Better Trader 85

the “fight-or-flight” response. The function of glucocorticoids is to activate theshift from anabolic to catabolic metabolism. Specifically, glucocorticoids breakdown glucagon in the liver, a form of stored energy that the body can use asneeded. When the glucagon is used up, the same glucocorticoids go on to breakdown proteins. Under extreme conditions, such as times of famine, the body mustfend off starvation by starting to consume its own muscles in order to keep upblood sugar and again the chemicals responsible are glucocorticoids. (The bestknown of the glucocorticoids is cortisol.)

Since cortisol and adrenalin are secreted in response to stress, the amountof these substances in the body serves as an objective measure of stress. Forexample, psychologists frequently use the amount of cortisol in the saliva andthe amount of adrenalin in the urine as biological measures of stress.

Perception of stressor

Hypothalamus

Release of adrenalin and noradrenalin

Physiological reactions of “fight or flight’’

Stimulation of adrenal cortex

Release of glucocorticoids

Liver releases stored glucose

Stimulation of adrenal medullaPituitary gland secretes ACTH

TRADING STRESS

In everyday language, people often use the term “stress” to refer both to thecircumstances which cause stress and to our responses to these situations. Thisis confusing, so I will refer to the circumstances which cause stress as stressors.W. D. Gann (1976 reprint) in his book How to Make Money in Commoditiesmakes good health a prerequisite for successful trading. Gann recognised a fun-damental truth about trading stress. First, the basic demands of life can reach apoint at which they affect trading performance; that point may be reached whenwe are in poor health or even when we may feel slightly unfocused as a result of


life events. I will call this stress of living. I will call these basic life challenges lifestressors. Decision making during trading can, in itself, be stressful to the pointthat it can affect trading performance and produce losses. Everyone can identifywith some of the nerve-racking conditions of trading especially when tradinghighly geared instruments such as stock index futures. A large sudden loss ora missed opportunity is perceived as stressful. Numerous stressors exist in themarket, including for some traders, large profits. I will refer to these challengesof trading as trading stressors.

LIFE STRESSORS

Sources of stress are so numerous that there are many ways in which we couldclassify them. I will use the classification system suggested by Lazarus and Cohen(1977) who describe four general categories of life stressors:

• Cataclysmic events• Personal stressors• Background stressors• Workplace stressors

Cataclysmic events

Natural disasters, such as earthquakes or tornadoes, and events such as war andcar accidents, are all powerful threats that disrupt the lives of all touched by them.These stressors are often overwhelming and have several basic characteristics.They are usually sudden; there is little or no warning of their occurrence. Theyhave a powerful impact, such that dealing with them usually requires a great effortif it is to be effective. This category of stressor includes the King’s Cross fire inthe UK and the terrorist attack of September 11th, 2001 in the United States.

Personal stressors – life changers

Personal stressors include such life events as illness, loss of a loved one or redun-dancy – in fact any events powerful enough to challenge our ability to adapt.

Holmes and Rahe (1967) constructed the Social Readjustment Rating Scale(SRRS) to measure the degree of adjustment required by various life events,referred to as “normal life stresses”, such as moving house, having a holiday,being pregnant. Holmes and Rahe recognise events that are not negative, likegoing on holiday, nevertheless place demands on our resources. After consid-erable research into many people’s concept of the degree to which they needto adjust in order to cope with various stressful occurrences, Holmes and Raheassigned each a value of “life change units” according to the degree of adjustment


it took. They assigned an arbitrary value of 50 “life change units” to gettingmarried and then rated 43 events according to the amount and intensity of re-adjustment required relative to getting married.

The SRRS has been used in more than 1000 studies by researchers all over theworld. These studies indicate that people who score above a certain level on theSRRS often develop a physical illness within one year. For example, a personscoring between 200 to 300 life change units appeared to have a 50% chance ofdeveloping an illness. This increased to 80% for those scoring more than 300.

I have included the most recent revised SRRS in Box 4.1. Have a look at itand measure your own life change units for the last year.

Background stressors – hassles and ambient stressors

Background stressors are all the everyday, routine demands of life, such as moneyworries and getting the shopping done while the children are tired and fed up(and so are you). These types of stressors are less immediately powerful but oftenmore chronic than cataclysmic or personal stressors. Rotton (1990) suggests thatit is convenient to divide such stressors into two categories: daily hassles andambient stressors. Daily hassles (also referred to as micro stressors) are all theproblems encountered as part of the routine of life, such as getting to school ontime to collect the children, meeting a deadline at work, and mislaying the carkeys. Ambient stressors are the chronic and global conditions of the environment,such as noise, crowding and traffic congestion, which are unpleasant to experienceand with which we must try to cope.

Although any single background stressor is probably not particularly taxingand may not even be very noticeable, when a number of them are put togetherthey can exact a cost over time that is as serious as cataclysmic events or personalstressors. Long-term exposure to noise, the problems of commuting, or continuingarguments with the neighbours can be extremely exacting. Often it is difficultwith these types of stressors to envisage an end to them; indeed things can gofrom bad to worse.

Workplace stressors

The popular notion of job stress is that executives suffer more stress than doother workers. Several studies, however, have shown that this is not the case,e.g. Smith (2002). Karasek and Theorell (1990) suggest that the most stressfuljobs are those that involve low control and high demand. Most executives havejobs in which demands are high but so is the level of control; the same is the casewith physicians, but medical students, who typically experience this unfortunatecombination of high responsibility with low control, have been shown to suffer


Box 4.1 Sample items from a modified Social Readjustment Rating Scale(SRRS)

Below are some items from a modified form of the SRRS: In order to completethe scale, you need to indicate how many times you have experienced eachevent during the last 12 months, then multiply the frequency by the scale valuegiven in the right-hand column and add up all the points obtained.

1. Death of spouse, lover or child 942. Death of parent or sibling 883. Beginning formal higher education 844. Death of a close friend 835. Miscarriage or still birth of pregnancy of self, spouse, or lover 836. Jail sentence 837. Divorce or marital separation 828. Unwanted pregnancy of self, spouse or lover 829. Change in dating activity 79

10. Separation from someone you like very much 7711. Academic failure 7712. Change in marital status of parents 7313. Reconciliation of marital or love relationship 6814. Major personal injury or illness 6815. Marrying or living with lover with parents approval 6616. Major financial difficulties 6517. Change in general outlook on life 5718. Beginning or ceasing service in the armed forces 5719. Change in attitudes towards friends 5620. Change in frequency or nature of sexual experiences 5521. Change in relationship with siblings 5422. Academic success 5423. Change in responsibility at work 5024. Change in dependencies on parents 5025. Change in amount of leisure time 4926. Change in study habits 4627. Change in frequency of use or amounts of alcohol 4528. Change in religious affiliation 4429. Change in address or residence 4330. Change in weight or eating habits 3931. Change in driving pattern or conditions 3332. Change in number of family get-togethers 30


high levels of stress and considerably higher than average levels of anxiety.Air traffic controllers have four times as much hypertension (high blood pres-sure) as other airport employees doing different types of work due to their highresponsibility for other people.

Karasek defines job demands as the “psychological stressors involved in accom-plishing the workload”. He uses the expression “decision latitude” to describe thedegree of control in the workplace. Decision latitude is “the working individual’spotential control over his tasks and his conduct during the working day”.

Karasek has conducted several studies that support the idea that the most stress-ful combination of workload involves low control and high demand. For example,in a representative sample of male Swedish workers, the ones most likely to suf-fer depression, excessive fatigue, cardiovascular disease and even mortality werethose with high demands and low control (Karasek, 1981). Those workers leastlikely to suffer illness and death were employees who have moderate work-loads and high control over working conditions (Karasek, 1990). Johnson andHall (1988) studied 13 000 workers to see how the combination of job demands,control and social support from co-workers related to the prevalence of cardio-vascular disease. They found that jobs of high demands, no control and no socialsupport carried twice the risk for this disease when compared with jobs that hadlow demand, high control and high social support.

The above four general categories of stress cause stress-related illness andreflect general stress that has gone beyond people’s breaking point. It is stressthat has resulted in physical illness, but many people struggle with everydaystressors without becoming ill. These stressors still drain our mental energy andin doing so, affect our trading performance.

The twentieth century has seen great steps forward in developing technologybut also we have created numerous other hazards. Each development brings newadvances and, for many, new stressors. The automobile and the motorway allowpeople to work many miles from their residence, bringing “commuter stress”to many people. The jet aircraft permits overnight business trips bringing newpressures and jet lag. The computer age produces new jobs and new advancement,yet also displaces workers from their jobs and produces new stressors. In addition,television, supposedly a new means of relaxation, allows the average child towitness hundreds of homicides before he is old enough to attend school.

Not only is change occurring at a rapid pace, but also the reliability of theextended family, the traditional British support system, is breaking down. Twothirds of all new marriages are unlikely to last; 50% of children in the UK growup in single parent households; and one family in four moves each year. Whenfamily support decreases, the effects of stress become more apparent.

Life stressors can lead to significant physical and mental breakdowns. It isnot surprising that life stress is a major source of poor trading performance.In addition to coping with life stressors, the trader must also address trad-ing stressors.


Trading stressors

In the 1930s, Hans Selye pioneered research into stress and in 1936 presented aworking model called “The General Adaptation Syndrome” (GAS). The modelassumed that a pernicious outside stressor, such as sleep deprivation, starvation,physical pain and injury, would elicit the same stress response every time. Thisdid not prove true. Research indicates that when two groups of rhesus monkeysare deprived of food for a long period of time, their bodies release glucocorti-coids as we would expect. On the verge of death by starvation, the monkeys’bodies commence breaking down their muscles in order to survive. One groupof rhesus monkeys was given nutritional water while the other group of rhesusmonkeys was fed artificially sweetened water (placebo), which had absolutely nonutritional value. One would expect the levels of glucocorticoids to continue ris-ing in the placebo group until they finally died through starvation. However, thelevels of glucocorticoids do not rise despite the fact that it has received no realnourishment. The monkey perceives and interprets that its situation has improvedand that is enough to signal its body that the threat of starvation has passed. Itis clear that the monkey’s perception of satisfaction was accepted as food byits body. Any general theory of stress has to be modified to include cognitiveelements, such as interpretation, belief, and attitude.

For the trader, large losses are among the most poignant trading stressors. Kah-neman and Tversky (1996) demonstrate that people avoid closing out a position,even though large losses have already been realised, in the hopes of averting aloss. As a result, the loss continues to grow until it is forced upon the trader.The stressful impact of forcing a large loss upon a private trader who cannoteven accept a small loss can be devastating. I asked over 30 traders in the UKwho had over one year’s trading experience what they found most stressful. Theresults indicate that trading stress does not only result from losing. Some tradingstressors identified were:

• Doing nothing and staying out of the market can be stressful. The tradermay have closed a position only to find that the market has moved sig-nificantly in the direction of the trade. Simply knowing that one could bemaking money if the position were still in effect can be stressful.

• Some traders may simply sit on a losing trade, being unable to make adecision and simply watching their margin disappear. Doing nothing canbe a stressful experience.

• Money is a powerful incentive and incentives can be stressful. Manytraders become irrational when money is at stake and the act of simplybeing in the market can be stressful to some individuals.

• Trading success can also be stressful. Traders with a fear of success mayfind a profit of £2000 to be in the comfort zone while a profit of £1 millionis uncomfortable.


• Some traders find the simple fact of not being in control of market pricesas stressful and these traders often do not have a developed plan of action.

• Novice traders find the fact of being on their own highly stressful. Learningnew trading skills with little or no supervision from a mentor leads toself-doubt and stress.

• The solitary nature of trading from home leads to stress. Some traders findthe inability to discuss trading problems with colleagues highly stressful.Often these traders do not attend regular seminars or Internet chat groupsto form alliances with other traders.

Each trader perceives and therefore reacts differently to potentially stressfulevents as outlined above. These situations produce fear, anxiety, and worry inmany traders and the result is trading losses. These losses can have a devas-tating effect on the life of the trader, both in terms of his self-confidence andmore generally.

Each trader reacts differently to a potentially stressful event and not everytrader will be stressed by the examples outlined above. Traders who have pro-tected themselves against the devastating effects of stress are the traders whosucceed and consistently make money in the markets.

The purpose of this chapter is to assist you to understand how stress affectstrading performance and to introduce techniques that will reduce negative reac-tions to stress. We will discuss models of stress in the context of physiologyand psychology and demonstrate how life stress and trading stress can impairyour performance. Finally we will discuss stress prevention techniques, relax-ation procedures and techniques to optimise your chances of success despite alarge amount of stress.

STRESS MODELS

The autonomic nervous system

Before we discuss models of stress, it is important to understand the role of theautonomic nervous system. The autonomic nervous system has two divisions toit. The sympathetic nervous system is the portion responsible for the mobilisationof energy. “Sym”, the first portion of the word, means “together”, “pathetic”, thesecond portion of the word, means to “arouse the feelings”. The name sympatheticnervous system thus implies that the body is activated while feelings are aroused.The second division of the autonomic nervous system is the parasympatheticnervous system. The effect of this system is virtually the opposite of the effectof the sympathetic nervous system. It decreases blood pressure and respiration;it increases digestive system activities so that food is properly broken downand then stored. The prefix “para” means “beside” or “in a secondary capacity”.


Initially physiologists thought that the parasympathetic nervous system simplymodified the actions of the sympathetic nervous system; however, it is nowknown that the parasympathetic division is equally important for our well-being.It is the maintenance system of the body. The parasympathetic system assists withdigesting food, storing energy, maintaining normal blood pressure, and assistingwith sleep.

Put simply, the sympathetic system acts as an accelerator, mobilising you foraction, while the parasympathetic system acts as a decelerator, helping to calmyou down.

The General Adaptation Syndrome

A leading physiologist named Selye (1956), working with rats exposed toextremely adverse conditions, coined the term “General Adaptation Syndrome”(GAS) to describe the non-specific response made to any stressors regardless ofwhat they are.

GAS consists of three stages.

1. Alarm: When a organism first encounters a threat it responds with the“fight-or-flight” response. We recall that the “fight-or-flight” response pro-duces an increase in adrenalin, desperation, heart rate, blood pressure,muscle tension, digestion, dilation of pupils, and an increase in bloodcoagulability. This response has obvious advantages for coping with animmediately dangerous situation.

If stress is prolonged the organism passes to the next stage.2. Resistance: During this stage physiological changes gradually stabilise.

The adrenal glands return to normal size and begin to renew their supplyof steroids. This is a period of adjustment during which the organismattempts to restore its lost energy and repair any damage, which mayhave been sustained in the alarm stage. The arousal level is higher thanusual but eventually levels off.

If no more stress occurs then the organism gradually returns to normal,but in the meantime it remains much more vulnerable than it was before.If a second source of stress is introduced at this stage then the organism’sability to cope is sorely taxed. Humans are likely to become depressed,inactive and withdrawn. Trading performance is likely to suffer and shouldbe avoided.

If the physiological attempts to restore equilibrium fail, then the organ-ism enters the third stage.

3. Exhaustion: If the stress cannot be overcome, then the adrenal glandsbecome enlarged, the body’s resources become depleted, physiologicalarousal decreases and the organism will probably collapse from exhaus-tion. The rats studied by Selye died as a direct consequence of thephysiological changes undergone in their own defence.


Traders reaching or about to reach this stage are likely to suffer bothphysically and psychologically. They may become depressed, irritable andunable to concentrate. They may turn to alcohol or drugs in an effort tocope. Continuing in the exhaustion stage may lead to what Selye termed“diseases of adaptation”. Box 4.2 describes the circumstances of a traderwho has been trading from home for a period of 18 months and is wellon the way to the exhaustion stage.

Box 4.2 The stressed trader – conversation with John

In this new job of market trading everything has to be done quickly anddecisively or you can miss your opportunity. I nearly always work a 12-hourday, which is made up of monitoring the markets from early in the morninguntil approximately eight at night. Sometimes I will work later if I put on aposition in one of the US markets.

Last week I made £876 after commission and the other costs have beenremoved. This may sound acceptable but I had made approximately £4600 byWednesday on an excellent trade that I held from Monday. All the indicationswere that the market would continue in a bullish manner but my stops werehit. When the market commenced in the same direction, I put on new positionsand again my stops were taken out. This happened approximately 14 timesand I became exceptionally frustrated. What should have been a pleasure interms of having made money turned into unhappiness because of the largeramount I lost through overtrading. Well, Friday night after I closed out mypositions, I got well and truly drunk.

I get headaches and I also suffer from insomnia. I have never seen a doctorabout it but it has been helpful at least talking to you. I am only 36 and Iknow my wife is finding my moods extremely difficult and I often tell thechildren to keep the noise down when perhaps I wouldn’t do so if I were notworking from home. I have noticed recently that I have been taking more risksin the market and that my trading capital, even though at a profit, is slowlydiminishing. I have no inclination for sex and I know this must be a greatstress on my wife. I am not sure I can see myself doing this for another 30or so years.

Overview of the GAS

The GAS suggests that anything in the environment can be a stressor and that ageneral biological response occurs to any stressor. Selye also introduces the con-cept of positive stress (eustress) and negative (distress). Selye’s model supportsthe following assumptions:


• We all experience stressors that flow to us in a continual stream.• Stress effects on the body are cumulative.• Each person has a limit or breaking point beyond which the “fight-or-

flight” response is mobilised.• Stress is harmful to the body if it occurs in sufficient quantity or lasts

long enough. It breaks down the body and it interferes with the ability toresist illness.

There is an assumption in Selye’s model that people are mechanical andrespond in similar ways to external stressors. However, each person has theopportunity to control his or her own destiny through choice. In addition, every-body reacts to a given stress situation. Some traders would be overjoyed atearning ¤5000 in profit, yet others will find this difficult to accept.

Though Selye’s work is a major contribution to our understanding of stress,other theories have incorporated the notion that the mind plays a major role instress reduction.

The Yerkes-Dodson law: effects on trading performance

The Yerkes-Dodson law demonstrates that there is a relationship between ourlevels of arousal and our ability to function effectively as traders. This lawstates that:

• As arousal increases, performance on a task of moderate difficulty first risesbut eventually declines. This corresponds to our commonsense observationthat if you are too “laid back” about something, you don’t do it particularlywell. On the other hand, you are also liable to “go to pieces” if you arereally worked up. In other words, low arousal levels and high arousallevels are both associated with very poor performance. Best (optimum)performance is obtained when we are moderately aroused.

• But level of performance also depends on how difficult the task is. Highlevels of arousal allow us to perform better on simple behaviours, whereaslow levels of arousal facilitate performance on complex tasks, such astrading. This is expressed in Figure 4.1.

What this means is that we do better on simple tasks when highly arousedbut perform best on difficult tasks with low levels of arousal. This means thatstress has different effects dependent on the type of task. When we want to dosomething very basic, like running or riding a bicycle, stress helps us to performbetter but when we need to think carefully about a complex problem, such astrading, stress is extremely unhelpful.


Complextask

Simpletask

Optimumlevel

Optimumlevel

LEVEL OF AROUSAL

PE

RF

OR

MA

NC

E

Figure 4.1. The Yerkes-Dodson law of arousal

Muscle tension model

Jacobsen (1938) observed that muscle tension always seemed to accompany anx-iety or stress. He concluded that mental images of uncertainty caused muscletension. Muscle tension produced is equivalent to what we call “stress”. Sincemuscles are under voluntary control, Jacobsen assumed that one could train themto relax.

Jacobsen observed that when one thinks about an anxiety-related situation,subconscious images of the situation activate the muscles to become tense, tobrace for a personal attack on oneself. The problem was not some stressor in theenvironment but one’s thoughts about the stressor. The problem for an investorwould not be loss but the investor’s thoughts about the loss.

Jacobsen’s theory gives a psychological dimension to our understanding ofstress. It states that stress comes from our interpretation of an event rather thanfrom the event itself. Traders differ in their responses to a given situation becausethe situation is interpreted differently. One trader interprets a ¤10 000 loss as alearning experience, knowing that he will be less likely to make the same mistakein the future. Another trader would see the same ¤10 000 loss as a random eventto be expected in a normal month of trading. A third trader might see the ¤10 000loss as a significant personal failure. The third trader would experience stress from


the ¤10 000 loss while the first two traders may not experience any stress fromthe same loss.

From Jacobsen’s model came the understanding that physical relaxation caninfluence and decrease mental stress. The behavioural therapy of “desensitisation”was developed to assist people with significant phobias to overcome their fears.The person’s muscles are induced to relax completely and then the feared objectis presented to them with increasing frequency, on each subsequent relaxation.Clinical research shows that physical relaxation reciprocally inhibits the fearresponse and more appropriate behaviours can be learned.

Ideo-motor theory

William James is the founder of this model, which is one of the first theoriesof emotion in modern psychology. The model is supported also by Albert Ellisand Aaron Beck who argue that people’s emotional reactions are the result ofthe way they interpret reality. People’s interpretations are not only essential toemotion, they precede the physical arousal. A trader, according to this theory,becomes anxious over a loss because of the personal significance he attachesto it. For example, some traders may feel a complete failure because they hada loss and hence their self-esteem is low, possibly resulting in depression. InChapter 1 the concept of the personal belief paradigm was introduced and it ishighly compatible with this theory. The trader must label and interpret the lossas “negative” for it to cause stress, therefore the belief that one has about theloss, rather than the event itself, produces the stressful experience. Many tradersimagine losses long before they occur and experience fear as a result and thiscan become a self-fulfilling prophecy.

Many traders respond to even small losses in a very negative manner. Theyoften have recurring thoughts such as:

• “Luck does not seem to be with me.”• “I can’t afford these losses, what will I tell my spouse?”• “The law of averages states I should have a big win coming, but it never

seems to come.”• “I have worked so hard for so long, it’s about time I had some real wins.”

These interpretations of circumstances will result in traders continuing their lossesever increasingly.

However, Schwager (2002) interviewed some of the United States’ best traders,some of whom had the experience of losing millions of dollars in a few months.Their response to losses is significantly different to those above. They usuallymake statements such as:

• “Losses are simply part of trading.”• “I needed to review my trading system and isolate the problem with it.”


• “I needed to learn something.”• “I accept failure as a step to victory.”

These traders have not only made up their large losses but have increased theirmargins many fold. Part of the reason for their success is the way they interprettheir losses in a positive and proactive manner.

Large losses by themselves have no emotional content. Every day traders mon-itor and question their own performance and attempt not only to find the reasonfor a mistake but to categorise it in their schema of the world. The trader whodecides he lost money because he was “inadequate” or a “victim” of circum-stances will have a different perspective to the trader who views his experienceas a “need to learn”.

The trader who decides that he is inadequate will feel anxiety and pain, andthis can start a repetitive, negative cycle. The trader’s physiology will react ina typical stress response. The trader interprets this arousal as additional evi-dence of concerns and starts thinking very negative thoughts. Suddenly thetrader finds himself locked into a negative cycle, becoming more and morearoused. The proponents of ideo-motor theory believe that the best solution tothe negative cycle is to change (1) thoughts, (2) the body’s reaction, or (3) thesituation.

Two-component theory

Morris et al. (1970) studied human performance and the effects of stress. Thefindings suggest that the stress one experiences consists of two components:emotionality and worry.

Emotionality is the physiological component. It is similar to the “fight-or-flight” syndrome described earlier. Emotionality increases as a result of anythreat or potential assault.

The psychological component is called “worry”. Worry is a concern for one’sperformance and is integral to the negative cycle where one has a negative self-evaluation and an expectation of failure.

Research indicates that worry has a greater impact on human performance thanemotionality. Worry causes significant arousal and has a very negative effect asoutlined by the Yerkes-Dodson law. For example, people who worry about theirperformance on an important examination are likely to do poorly compared withthose who are not that concerned. Research indicates that for people who are“worriers” at least 25% of their conscious thought is worry about the outcomeof the examination. High emotionality just before an examination has little rela-tionship to performance on the examination. There is a lesson here for traders.Some traders overemphasise the role of “fear” but neglect the effects of “worry”,so the separation of the two components is useful in the trading context. Ask


yourself honestly if you continually worry once a trade is placed, or worry evenwhen out of the market.

There are individual differences in that some people worry much more thanothers and those who worry most tend to worry consistently. If you worry aboutyour investments, you probably do so often.

Emotionality is important to traders because if physical distress is poignantor perhaps moderate but extends over a long period of time this will result inphysical distress. The mind cannot make competent decisions in trading when itis labouring under physical duress.

Worry has a significant and direct effect upon investment performance. Thetrader who continually worries about the outcome of his positions is not likely todo well. He is likely to be like the gardener described in the section on monitoring(page 55), who digs up his plant to see how the roots are growing.

INDIVIDUAL DIFFERENCES IN MODIFYING THE EFFECTS OF STRESSORS

Types A, B and C personality

Numerous theories have been presented to help in our understanding of the com-position of personality. For example, there is Trait Theory (Cattell), Type Theory(Eysenck), and Psychoanalytic Theory (Freud), to mention only a few. We willnot be discussing the numerous theories that exist as stress researchers tend to usepersonality types A, B and C as a useful and appropriate model. The personalitytypes have the following characteristics:

• Type As are hostile, competitive, concerned with the acquisition of materialgoods and have an exaggerated sense of time urgency.

• Type Bs are more relaxed, less ambitious, less impatient and focus moreon the quality of life.

• Type Cs are hard working, conventional, sociable but tend to avoid con-flict rather than deal with it and suppress rather than express emotion.They also experience feelings of helplessness when faced with stressfulsituations.

Friedman, Straus and Rosenman (1966) have undertaken research on person-ality types and their inclination to developing illness. They found that type Asare at high risk of cancer and coronary heart disease whereas types B and C areless so. However, we must be very cautious of how we interpret the relation-ship of personality to illness since findings are by no means consistent. Somestudies suggest that there is a relationship between the suppression of anger andhealth problems. On the other hand, some studies suggest that it is the expres-sion of anger that is related to the development of health problems, both physicaland mental.


It is generally acknowledged that the majority of traders in open outcry areextrovert personality type As. In the frenetic environment of open outcry itis accepted that type A personalities would perform better than type B or C.Research indicates that type A extrovert personalities do not learn new skillsas easily as do types B and C. This has a significant implication for employersof traders.

Hardiness and optimism

Kobasa et al. (1982a) studied a number of high stress workers and examined thedifferences between those who suffered from high rates of stress-related illnessand those with low rates of such illness. They found that the low illness executiveshad a common trait, which they called “hardiness”. Hardiness has three maincomponents: commitment, challenge and control. People high in hardiness havea strong commitment to their work, family and to themselves. They see changeas a challenge rather than a threat and they feel they can have an influence overmost events and over other people.

Closely related to the trait of hardiness is that of “optimism”. Optimism is thatgeneral tendency to expect things to turn out well. Schier et al. (1986) found thatpeople with an optimistic outlook coped better with stress than did pessimists.They were more likely to meet a challenge head on and do their best to changethe situation, rather than surrender to it or deny it. They were also more willingto seek social support from others to help them cope with a stressful situation. Aswe may see in the section on managing stress, social support contributes greatlyto ameliorating the effects of stress.

Kobasa et al. (1985) argued that psychological hardiness helps individualsresist stress by providing buffers between themselves and stressful life events.Buffering allows people the opportunity to draw on social support and to usesuccessful coping mechanisms, such as controlling what they will be doing fromday to day.

Kobasa et al. (1982b) gained support for their view in a large-scale study ofhighly stressed managers. Those who scored most highly on optimism were theleast likely to suffer illness. Follow-up studies indicate that as well as hardiness,exercise and social support are also negatively related to illness, but hardiness isthe most important of the three factors (Kobasa et al., 1985).

In a criticism of this model, one might question the accuracy with which har-diness can be measured. A further limitation is that most of the research hasbeen carried out on white middle class males. We must also bear in mind thatthe studies of the relationship between hardiness and illness is correlational. Wecannot draw any firm conclusions about cause and effect. Nevertheless, sincemany studies demonstrate a consistent negative relationship between these per-sonality characteristics and stress, it has made an important contribution to ourunderstanding of factors affecting the impact of stress on health.


Stress management

There are no easy or simple answers to coping with, or managing, trading stress.Coping with stress involves the behavioural and cognitive efforts to manage theinternal or external demands made upon us. There are numerous attitudes to stressand how we cope with it. It is generally felt that traders who positively frametheir stressful experiences will perform better in the long run. However, there aresome attitudes that are highly offensive. Consider the statement, “There’s no suchthing as a problem, only a challenge.” When you see the desolation of peoplewho have lost a loved one, or have been diagnosed with a terminal illness, suchattitudes are unhelpful, inappropriate and insulting.

It is helpful to differentiate between effective and ineffective ways of coping. Ifyou are worried about a trade you can “cope” by not pulling the trigger; if you aremonitoring a trade that is moving against you, you can “cope” by having severalstiff drinks. These types of coping mechanisms result in greater stress while notsolving the problems involved. In this section we shall address effective copingstrategies: those techniques that help us deal with stress in a proactive mannermaking us feel better, both physically and psychologically and do not increasethe problems with which we have to deal.

There is no single coping strategy that can be applied at all times and in allcircumstances. The most appropriate way of managing depends on the stressor,the individual and the particular situation. The coping process is not a singleevent because coping involves ongoing management. There are many ways ofcoping and it is helpful to categorise them as follows:

• Physiological methods: Coping by controlling the physical effectsof stress.

• Behavioural methods: Coping by changing behaviour to better adaptto stresses.

• Cognitive methods: Coping by changing the appraisal of the stressor.

Budo Zen is a highly effective method of controlling stress and will be discussedin Chapter 7.

Physiological methods of managing stress

Since it is impossible to avoid all stresses, one way of coping with them is tominimise the physical effects that stressful situations have on our bodies.

Biofeedback

This is a technique in which an individual is connected to a machine that provideshim or her with information about the working of a particular activity in the body,


such as blood pressure or tension in the neck muscles, together with instructionsto try to control it. These instructions usually involve training and relaxation. Inthis way, the individual acquires voluntary control of a biological process throughoperant conditioning. If, for example, someone is trying to reduce neck muscletension and the device reports that the tension has just decreased, this informationreinforces whatever efforts they are making to improve their condition. Eventuallythese bodily processes can be controlled without feedback.

Despite some obvious successes, there are some disadvantages with this tech-nique. The need for specialised machinery makes it expensive and more difficultthan other methods to practise at home. As with some other methods, it doesrequire regular practice over several months. It is possible that biofeedback itselfhas no special benefits and that any progress made comes from the individ-ual’s commitment to improve their condition. Certainly biofeedback is no moreeffective than muscle relaxation techniques, as in the next section.

Progressive muscle relaxation

This technique is a means by which people learn to control their feelings of ten-sion. The technique involves the individual focusing attention of specific musclegroups while alternatively tightening and relaxing the muscles. Relaxation is aneffective means of reducing muscle tension but perhaps more surprisingly it alsoeffectively reduces heart rate and blood pressure.

Relaxation is a relatively inexpensive and straightforward means of stress con-trol, which has been very successful in assisting traders under stress to cope withtheir experience. This is also the basis of desensitisation therapy.

Meditation

This technique relieves stress in the same way as relaxation. We will be coveringZazen, which means seated meditation, in Chapter 7. The most commonly usedmethod of meditation involves focusing on a single, unchanging stimulus (likea visual dot or aural mantra) in order to narrow the focus of consciousness.Problem solving, worries and concerns all fade away as levels of arousal in thesympathetic nervous system are reduced.

Although there is disagreement about the exact level of consciousness inducedby meditation, there is no doubt that it produces a state of calm and does lead tomeasurable body changes. A number of clinics have successfully used meditationprogrammes to reduce anxiety, decrease blood pressure and diminish dependencyon drugs including tobacco and alcohol. It is worth noting that many traders havetestified to the efficacy of seated meditation as a tool to combat stress.


Regular physical exercise

This is an obvious technique for reducing stress, anxiety and depression. It alsotends to increase feelings of self-esteem and control. Research indicates thatvigorous exercise is particularly effective in reducing depression. Nevertheless,exercise alone cannot significantly reduce stress if you have to go from yourcycling, running, or walking, straight back into a stressful trading environment.Sometimes the only effective stress management technique is a direct attack onthe actual problem.

The benefits of progressive relaxation, meditation and regular exercise may beshort term if they are not incorporated into the lifestyle of the individual.

Cognitive methods of managing stress

Cognitive therapy acknowledges that stress arises from our interpretation ofevents. We all have varying levels of ability to cope with stress and some people,quite unconsciously, learn early in life to use strategies that manage stress, butothers acquire behaviours and irrational belief systems that may require assistancein order to develop effective coping strategies.

Problem-focused and emotion-focused coping strategies

Lazarus and Folkman (1966) differentiate between problem-focused and emotion-focused ways of coping with stressful situations. Problem-focused coping attacksthe problem itself. In essence it takes “the bull by the horns”. Emotion-focusedcoping concentrates on changing or managing the emotions that the problem hascaused. The primary step in problem-focused coping is to define the problemitself. There is an old saying: “If the kitchen is too hot, get out.”

You may be having large drawdowns and as a result you are becomingdepressed. You don’t know why or how things could have gone so far. A tradermust recognise where the heat is in his or her life and identify whether thesource is trading, financial, personal, or family stress. There may be combinationsof the above. Sometimes the definition of the problem is easy – for example,your spouse has left you, there is a family member with an illness requiringsignificant care. But in other circumstances it is not so straightforward andif the problem is defined incorrectly, then the wrong coping strategies maybe adopted. For example, a trader may commence trading early morning andundertake an assessment of his well-being as outlined in the Tactical MOTunder the section “Self-awareness” (pages 47–49). The trader may not feel 100%focused and will eventually give up the self-awareness stage, which may resultin an exacerbation of the problem with negative consequences on his trading


performance. It may take a family member or a trading colleague to notice thatthe trader has been drinking on a regular basis, not eating properly, and not takingproper exercise. Sometimes we are unable to see our own problems yet can seeother people’s problems clearly. If the problem can be correctly defined, suitablecoping strategies can then be adopted, perhaps with the help of professionalssuch as a trading mentor/counsellor, friends, and other sources of support.

In essence, problem-focused coping involves:

• Recognising the need for action – e.g. acknowledging the trading problemand its root.

• Appraising the situation and methods of dealing with it – e.g. how serioushas it affected trading? Develop objectives, and then methods of dealingwith it.

• Respond in a way that removes or diminishes the problem – e.g. under-take training to improve the planning process in trading, or maybe attendcounselling for dependency-related problems.

The problem-based strategy is useful to traders for managing controllable stres-sors and has considerable benefits. It tends to increase a trader’s self-esteem, setsup personal control, and general effectiveness (Perlin and Schooler, 1978).

Emotion-focused strategy is useful for managing the impact of more uncon-trollable stresses. If we cannot change the problem, we may be able to changeour feelings and thoughts about it such as we do not become overwhelmed bynegative emotions such as fear, worry, guilt, or anger.

Traders often repress or deny the reality of a situation where they are contin-ually losing money and to regulate one’s fear through repression or denial willbe totally ineffective and possibly even make the situation worse.

Similarly, a problem-based strategy such as taking out huge loans from thebank to pay off brokerage debts is only likely to have very short-term benefits.We need to recognise that problem-focused and emotion-focused approaches areumbrella terms for the types of strategies used by people in everyday life andinclude ineffective as well as effective means of coping.

Cognitive restructuring programmes

A variety of cognitive restructuring programmes exist, aimed at reappraising astressor or modifying our thoughts about how it can best be dealt with. Sometraders have irrational, non-adaptive beliefs concerning the extent of incidents ofa particular stressor. If a trader believes that two or three losses in a row willmake or break his or her whole career, then the stress experienced before takinga trade will be enormous. This is one of the many reasons and root causes of the“frozen trader” who finds it impossible to pull the trigger.


The focus of cognitive restructuring is to replace stress-provoking thoughtsor beliefs with more constructive or realistic ones that reduce the perception ofthreat or loss causing fear.

Rational emotive therapy

Albert Ellis pioneered rational emotive therapy. The aim of the therapy is tochange commonly held irrational or dysfunctional ways of thinking. Accordingto Ellis, some commonly held irrational beliefs include:

• I must be able to find quick solutions to all life’s problems.• I must always show perfect control.• I must be loved by everyone.• I must be good at everything.

Because these beliefs are unrealistic, anyone holding them will be overly con-cerned about the approval of others and will see even a minor setback as a causeof extreme anxiety.

The therapy programme aims to confront the faulty belief system and restruc-ture it in such a way that the problems are seen in a very different light and canbe dealt with more effectively.

Rational emotive therapy takes time and work but it is an effective pro-gramme, which not only deals with stress but also changes a person’s wholeview of life, increases self-esteem and, in certain cases, is an effective treatmentfor depression.

Stress inoculation

Meichenbaum (1983) has produced a three-step procedure for producing stressinoculation, designed to teach people skills for alleviating stress and achievingpersonal goals. The aims are to control irrational and catastrophising faults thatoften accompany stressful situations. The stages are as follows:

1. Conceptualisation: in which you learn about the stress and examine waysin which you respond to it. Through careful examination you considerways in which you can change the way you respond to stress in order todeal more effectively with it.

2. Skills acquisition and reversal: in which you learn behavioural and cog-nitive skills for effective coping. This will probably involve general copingskills such as relaxation but will also include specific skills appropriateto your situation such as time management of work, parenting skills, or


how to make presentations in front of others. You practice these skillswith the therapist to ensure they are effectively acquired.

3. Application and follow-through: the follow-up sessions ensure that anyimprovements are maintained.

In this way people who were previously insecure or depressed can gain a feelingof self-efficacy, the belief that they have the power to change things and arecapable of solving or managing their problems. Controlling irrational and catas-trophising thoughts lowers the arousal levels and thereby serves to reduce theimpact of a stressor. The methods used during the therapy are well thought outand include a number of well-established techniques such as relaxation. Researchon effectiveness is still in the early stages but results are encouraging.

The role of control in the perception of stress

Psychologists have found that human beings have a fundamental need for controland when they are put in situations where their control is reduced they try hardto gain it. Most cognitive therapies concentrate on the fact that stress can bebetter managed by increasing a person’s sense of control over their life. There isa common theme running through all the various cognitive therapies in that theyare concerned with increasing a person’s feelings of control and, at the sametime, increase self-esteem and general effectiveness.

Traders who exercise discipline and have clear and concise plans regardingtheir trading exercise control of themselves and competent traders recognise thatthey have no control over the market, only themselves.

Effective coping strategies provide several means of control, for example ifapplied to trading they provide:

• Information control: knowing what to expect when entering a trade.• Cognitive control: thinking about placing a trade in a different way and

feeling good about the likely outcome.• Decision control: being able to decide on alternative actions that have

been rehearsed to unconscious competence.• Behavioural control: taking action to reduce the unpleasantness if one has

a loss. For example, going for a walk to recover from a negative experience.

Learned helplessness is a model developed by Martin Seligman (1975) wherepeople learn to be inactive when confronted with noxious situations. For example,if you place a dog in a kennel that is divided in half by a pane of glass and delivershocks to the dog, the dog quite naturally will attempt to jump to the other sideof the kennel, but is prevented from doing so because of the pane of glass. Overtime, low voltage and random administration of the shocks eventually produce


a stress response similar to that observed by H. Selye in the General AdaptationSyndrome. However, what Seligman noted was that when you removed the glasspartition the dog did not attempt to avoid the shock and remained immobile,even though it could escape. In addition, attempts were made to ensure that thedog knew that the partition was removed and that by jumping to the other side,further shocks could be avoided. The “learned helplessness” was persistent inthe dog.

In his work with people, Seligman showed that people who believe they haveno control become apathetic in long-term stressful circumstances and when thesituation changes they fail to recognise that they may now be able to cope moreconstructively. They have, in fact, learned to be helpless. This is usually a resultof earlier experiences during which they did indeed have no control as children.If this model were applied appropriately to some traders who exhibit “learnedhelplessness”, the solution might involve a very long-term cognitive restructur-ing programme. Learned helplessness may also be one of the many possibleunderlying causes at the root of the loss cycle referred to by numerous authors.

One might assume from this research that high control is associated withreduced stress. However, this is not always the case. There are occasions whenperception of low control can alleviate stress. For example, if you’re a passengerin an aircraft it is less stressful to acknowledge that there is nothing you can doabout the possibility of crashing. There are times when it relieves stress simplyto lie back and let others get on with things. While this is appropriate whentravelling on an aircraft, it is less appropriate when considering the research wediscussed earlier on the performance of economists and City brokers in predictionof prices and market direction. In situations of high stress, such as investing yourlife savings, it is a natural response to give this responsibility to someone else,but it is not always the most appropriate choice of action.

The importance of social support

Regardless of what other means are used to alleviate stress, social support isof such value that it warrants special attention. Being cared about and valuedby other people, belonging to a social network, having people who can give usinformation on how to cope, all have positive effects on reducing stress. This isparticularly pertinent for traders. It helps to have a mentor with whom you candiscuss your trading, it helps to be part of a regular seminar group that meets,and it also helps to be part of an Internet chat group where people can giveinformation on how to cope with trading stress.

Social support with other traders helps in many ways: it offers information,social companionship, and instrumental help.

Stress can be greatly reduced, not only by receiving support but also by givingit. People who are involved with others, who can empathise and support others,


are better able to cope with life’s problems than those who are self-involved.People low in social involvement tended to respond to stressful events withanxiety, depression and hostility. The ability to look outside one’s self, to beconcerned for others and help them sort out their problems, is related to nearlyall effective coping mechanisms. It helps to see the world from others’ eyes, putsyour problems in perspective, and gains self-esteem and a feeling of control. Thisis highly pertinent for traders, especially those who trade in a solitary fashion fromtheir home. It is essential that traders develop support networks for themselvesand I have made a number of recommendations at the end of the book for Internetchat websites where information can be exchanged.

BEHAVIOURAL METHODS OF MANAGING STRESS

There are situations in which it is possible to reduce stress by structuring andchanging behaviour. Organising your life helps to reduce frustration, wasted timeand the potential for stress. Research by Lakein (1996) indicates that time man-agement programmes are highly effective in reducing stress in both work andeveryday living. There are three main elements of such a programme: set goals,make daily “to do” lists, and schedule the day.

Taking time management programmes a step further, there is considerable evi-dence to demonstrate that the stress experienced by market traders is significantlyreduced when they are supported by a comprehensive trading business plan.

The trading business plan

All business schools teaching MBA courses emphasise the necessity of planningand structure. Most businesses fail because they do not plan adequately. Tradingis no different to any other business. A business plan for traders is a way ofplacing your knowledge about the psychology of successful trading plus yourmethodology into a comprehensive business plan to make money in the markets.Having a business plan is not only a way to reduce stress but is the cornerstone ofthe paramouncy principle. With a business plan, every contingency can be con-sidered while you are away from the stressful situation of trading. You are able toconsider new methods of working and test alternatives to your current plan. As aresult, when you experience stress during live trading you have already developedthe discipline to apply preplanned behaviours in response to any novel situation.Having a trading business plan is a prerequisite to developing trading disciplinethat so many authors emphasise as a necessity for successful trading. The businessplan for traders should cover three major areas of skills competence as follows:

1. Decision making: SWOT analysis, SMART description of aims andobjectives, and identification of trading beliefs.


2. Technical systems, trading methods, and financial management:Your indicators, probabilities expected from your system, and moneymanagement.

3. Personal discipline: General rules and trading rules, daily work regime,reviewing progress.

Business plan area 1 – Decision making

Do you know yourself well enough to come to a conclusion about the typesof decisions you have difficulties with? Perhaps you are able to determine thelikely effect of any decision made on your life or those close to you. In thesecases perhaps you have a healthy attitude and balance towards making difficultdecisions. Are you a borderline gambler where trading decisions are easily madebecause you simply respond immediately to your signal without thinking of anyof the related parameters? Perhaps you overtrade? Perhaps you are a trader whomakes detailed and clear analysis to the extent that the opportunity has passedby the time your decision criteria is “activated”.

Not only does your business plan take into account your abilities to makedecisions, it should also account for the type of trader you are. Position tradersenter and exit positions within days or weeks. Day traders enter and exit tradeswithin a few hours if not minutes. You need to become a competent positiontrader before you can day trade.

Once you have decided what type of trader you are your business plan needsto reflect this. If you are a day trader what is your time frame for making profits?Do you use more than three time frames to confirm signals? Do you jump inand out of the market several times each day or are you like one trader I knowwho on one occasion made 57 round turns in a single day trading stock indexfutures? Perhaps you get in the market only a couple of times each week or eachmonth? Perhaps you are looking for those few excellent trades that come alongin each market once or twice a year?

Even if you are out of the market for most of the week as a position trader, youstill will need to monitor the market daily without any expectation of trading.If you lack the discipline to undertake a market analysis daily, you may missthat big trade when it occurs. The advantage of position trading over a long-termperiod is that your commissions will be that much less than a day trader; however,you also need to live with very large fluctuations in the market that could goagainst you significantly. You must have a clear understanding of when a marketreverses and when it is simply correcting to return to its original direction. Aposition trader is often tempted to take profits early and it is wise to draw uprules that will close only part of your position.

As a day trader the stress and pressure on you is constant and you need tounderstand the market so well that you do not need to make decisions while you


are trading. You have made these decisions already and you now simply act.Day trading requires a high level of exposure to the market and you are in andout for a significant amount. It is no wonder brokers like day traders; they makethe house and them so much money in commission. It is well known that shorttime frame trading allows greater exposure to mistakes. This is a significant truththat many home traders do not know, and if they do, will deny or ignore. Mostof the good traders make their money in the long time frame. In the US, andspecifically the open outcry pits, expert traders like Lewis Borsellino can makea decent income from arbitrage or scalping, but even they recognise that the bigmoney is made on those occasional longer time frame trades that happen onceor twice each year in most markets. It is a fact that most home traders with ashort time horizon do not make big profits unless it is on huge volume.

A number of home traders that I interviewed during the writing of this bookoften expressed ambivalence towards becoming a day trader and ceasing full-timeemployment. This particular area is rife with conflict. They may not be successfulas traders and give up the opportunities for advancement that they currently havein their employment. The wrong decision may damage family relationships orpeople close to them. If they commit themselves to day trading, they may notbe able to cope with the solitude and lack of social contact that home tradingengenders. Many expert position traders are of the view that these problems canbe solved simply by learning to become a position trader, while still having thebenefits of employment.

On page 33 I introduced the concept of the SWOT analysis, which assists thetrader to determine the advantages and disadvantages of creating, continuing, orclosing a business. This is a useful tool when giving a trader an overall view ofthe possibilities regarding a home trading venture, and it is an integral part ofthe business plan.

Students of business administration at UK universities are taught to valuethe process of planning prior to implementing an organisation’s objectives. It isfrequently suggested that the first step in this process involves specifying what isimportant to members of the organisation in terms of the behaviour, attitudes andbeliefs that are valued by staff (Johnson and Scholes, 2001; Walters, 1995). Thisgeneralised statement of priorities is often set out in a formal written documentand referred to as a statement of shared values or aspirations.

A statement for a home trader may look like this:

• I am committed to trading as a way of life.• I believe that I have an equal potential to anyone else to make money in

the market.• Trading excellence is a high priority for me.• Self-employment and the freedom that trading brings is something I wish

to attain.• Financial security is important to me and my family and trading will bring

me this security eventually.


• I value happiness and believe that trading will assist me in achieving thisstate of mind.

Having defined values and aspirations, the next stage involves the more detaileddefinition of the future aims of the organisation (or trader). The results of thisexercise are often written down and circulated to staff in the form of a missionstatement. In order to ensure that the message contained within the statement iseffectively conveyed to the staff concerned, management consultants frequentlyadvise that this statement should be short, ideally less than four sentences long,and written in a clear and comprehensible language. In the planning stagesof this book I sent a mission statement to the publishers of this book as fol-lows:

My mission (through this book) isTo empower investors to significantly increase

Their performance in order to achieveWorthwhile purposes through understanding,Education and the attainment of abundance.

If the reader has been able to use only one idea from this book to good effect,or is simply inspired and encouraged, I consider my mission fulfilled.

The next stage in the planning process is to detail the specification of medium-term objectives, i.e. goals which can be achieved within three months to twoyears. In many organisations this activity results in the production or revisionof an annual corporate plan specifying what has to be achieved, by which dateand who is responsible for this activity. For the solitary trader the plan shouldspecify what has to be achieved, by which date, and what resources includingpeople might be used for this activity. If these objectives are to be meaningfuland useful, it is important that they should be SMART. This acronym is used torefer to the following five features of effectively drafted objectives:

• Specific: Clearly and unambiguously stated so that the trader has no con-fusion on what is required to achieve these objectives. You may have agoal which is vague such as: “I wish to stop losing money in the market”or “I wish to stop hesitating when pulling the trigger”. It helps to rephrasethese goals as “I wish to attain trading excellence and become as good asI possibly can be”. The goals could be phrased even further by being posi-tive and specific: “in the next six months I will paper trade and rigorouslyfollow my written plan for becoming a competent trader”.

• Measurable: Capable of objective quantification so that you will knowwhen the target has been met.

Following writing the specific goal you now need to think about specificevidence that you can see and review. Using the tactical model of tradingcompetence, you can assess your level of ability at each stage. You can


mark your deviation from optimal performance and therefore improve it ata later date. By using these criteria you will be able to answer whether youfollowed your trading plan and whether it helped to resolve a particularproblem, such as “freezing”.

• Achievable: The goal can be accomplished by you.Is your trading plan simple enough for you to be able to enact and

evaluate outcome? Can the problem of “freezing” be addressed simply byfollowing a trading business plan or does it need further assistance via aprofessional?

• Realistic: The objectives take account of the circumstances and competingpriorities facing you and your life.

Learning to become a competent trader is a long, expensive and diffi-cult process similar to that of taking a degree. Do all the circumstancessurrounding your job, family, and personal finances allow you to achieveyour goals?

• Timely: The objective can be achieved within the specified time frame.If you have developed a plan that will allow your objectives to be

fulfilled between six and 12 months it is important that you continuallymonitor your progress towards those goals.

Once the process of defining objectives has been completed the next stage isto ensure that the appropriate course of action has been devised for these goalsto be realised. Formal statements setting out how these steps will be taken arereferred to as action plans. These documents provide details of how aspirationswill be turned into reality. They will normally specify the actions that need tobe taken, the resources that will be required, and the key milestones on the routeto achieving your objectives.

Finally, at the end of the specified periods for your goals you should evaluateyour success in achieving each goal and then compile the results in a periodicreview that may take place every few months or annually.

Business planning area 2 – Technical systems, methods, and financialmanagement

A trading business plan needs to address your trading system and methodsbecause they are the main tools of your profession, and require a financial andtime commitment. Given the insight you have regarding your own ability tomake decisions, you need to find an effective and workable system that you findcomfortable to use. You then apply the system consistently, being guided byyour business trading plan, which includes trading rules and general rules. It isimportant to understand the beliefs that you hold about the market so that yoursystem will reflect these beliefs. There are a number of beliefs that traders hold


depending on the school of trading they adhere to. I am an eclectic trader buthave based my theoretical understanding of the market on the Wyckoff method,as taught by Tom Williams in the UK. In my first six weeks of introduction totrading I drew a conceptual diagram of supply, demand, accumulation, and dis-tribution. In addition I identified particular patterns that would occur in relationto volume which have significant influences on the movement of the market. Itis upon this solid foundation and belief system that I have been able to developand grow as a trader and I would recommend any novice to study one system indetail before branching out.

Understanding your beliefs about the market is the first step to determiningthe appropriate trading method and system for yourself. Once you know yourbeliefs you can look for indicators that are congruent with those beliefs. Letus now define a belief and then see how this definition applies to trading. Abelief is defined as something you assume is true about reality and as longas you hold this belief, you will perceive something as likeable or distasteful,distressing or enjoyable, according to how it fits your expectations. Beliefs areassumptions at the very core of our being and are not necessarily true. If youspeak to a person who is agoraphobic there is nothing that you can do or sayto dispel their belief and fear that if they ventured forth from their front doora calamity would ensue. Agoraphobics believe without doubt that some ill willbefall them so to change the belief and behaviour, behavioural and cognitivetherapies are needed. I will repeat here a paragraph written in Chapter 1 regardingbeliefs:

Beliefs are very powerful and seductive. Most market technical analysis isbiased by a powerful impulse to confirm and strengthen belief. The beliefparadigm seeks only confirmation and does not seek contrary evidence.In addition to not seeking contrary evidence the personal belief paradigmactively denies, discounts, ignores or distorts evidence. The personal beliefparadigm has a powerful mechanism of denial. This process of denialacts as a catalyst to elicit powerful emotions such as fear. Emotions ingeneral and fear in particular, can impair perception and arrest appropri-ate action based on contrary evidence. The implications for traders areimmense.

Consider the implication of the above paragraph in relation to the beliefs tradershold regarding popular technical indicators. I will outline a number of indicatorsand beliefs traders hold about them.

Volume

Volume refers to the number of contracts, shares, and options, bought and soldduring a specific interval of time.


• Trader belief: Volume affects price spread and the relationship betweenthe two can give an indication of the likely market direction. High vol-ume indicates the interest of professional traders and market makers. Theabsence of volume indicates a lack of interest in the market.

Open interest

The Commitment of Traders report is published twice weekly by the CommodityFutures Trading Commission and publishes the total number of contracts held inopen positions by commercials, large speculators, and small speculators.

• Trader beliefs: Open interest gives important information about whetherinterest exists for a particular commodity. The continuation of a currentprice trend depends on the level of interest.

Volatility

The variation in price over a period of time.

• Trader beliefs: Traders are attracted to high volatility because fast movingprices mean profits. Some traders believe that highly volatile markets aredangerous because you can be right and still lose money.

Seasonality

Price patterns typically occur at certain time periods. A cycle is a regular riseand fall of prices.

• Trader beliefs: There are predictable patterns inherent in market prices atcertain times of years for certain commodities.

The herd sentiment

This refers to the consensus of emotion expressed by the media, other traders,and investment advisers.

• Trader beliefs: If most people around you are bullish about a particularstock or market, it is likely the market will fall in the near future. Theopposite applies if bearish.


Momentum

Momentum refers to the strength and rate of change of a price moving in aparticular direction. There are specific momentum indicators that can be used.

• Trader beliefs: Momentum changes before prices. Also, oscillators areadequate tools if the trader is looking to catch tops and bottoms andundertake envelope trading.

The trend

The trend is the current direction of market price moving within a particulartime frame. Trends can be measured from a couple of hours to years depend-ing on the time frame under consideration. Trends are typically measured bymoving averages.

• Trader beliefs: “The trend is your friend” – one should always trade inthe direction of the trend.

I hope the above will help you to identify the kinds of beliefs that you hold aboutthe market and encourage you to add to this small collection. At this point youshould have information about yourself regarding three important areas:

1. Your ability to make decisions.2. Your overall beliefs about the market.3. Whether you are a short-term (day trader) or long-term (position) trader.

There are a number of technical indicators that one can use and the vast arrayof methods and styles of trading is extremely daunting for the novice trader. Itis best to stick to one trading system that you can explore in depth, and refrainfrom changing indicators until you are confident with the ones you are using.There are a number of excellent books written on developing technical indica-tors and I recommend a number of them in Appendix 2. Schwager (2002) givessome excellent criteria for developing your own system and in trading auto-mated systems. Tharp (1998) identifies key elements to making money in themarket, and describes a way to develop trading systems that meet your person-ality and profit objectives. An excellent classic on this subject is by Colby andMeyers (1988) who describe a large range of indicators indicating strengths andweaknesses. The recommended reading will give you specific trading systems,methods, and information regarding many indicators and the appropriate uses invarious market conditions.


All authors recommend that you understand at least three outcome criteriato determine the quality and performance of the trading system you are eitheradopting or developing for yourself.

Criterion 1 – Identify a system that consistently makes profits: It is a factthat systems that are correct only 40% of the time are tremendously profitableif employed by a long-term position trader, using discipline, consistency, andclear trading rules. Short-term traders (day traders) need systems that have muchhigher rates of correct signals.

Criterion 2 – Clearly identify and define the maximum equity drawdown:Identify the largest overall losses to your capital over a period of time that it hasbeen tested. Some systems can show large equity drawdowns over a significantperiod of time but actually make excellent profits if employed consistently overa long period. These systems are more appropriately used by market makers andcommercial traders.

Criterion 3 – Identify and define the overall risk to reward ratio of thesystem: This is a simple ratio of taking the profitability of the system and dividingit by the maximum equity drawdown. This information will give you an indicationof the types of money management strategies you should be using. It is a greatadvantage for a trader to know the overall profitability and the overall risk ofany system.

If you do not have the above information in your business plan you will not havethe confidence to execute trades flawlessly and fearlessly. It will help you toask these three questions of each and every system vendor you encounter. If thevendors do not employ these performance criteria, it would be interesting to findout exactly what outcome criteria they use. Perhaps the purpose of the system isto analyse parameters of the market leaving the discrete rules of entry and exitto you. Any system will have a number of problems or biases and it is essentialthat you identify these problems. These biases have their roots in elementarystatistics and psychology. Some biases that affect trading system developmentare as follows:

• Validity bias (statistics): Does the signal, given by your system, actu-ally represent the market being “overbought” or “oversold”? We falselyassume that our favourite indicator is the market but in fact it is a symbolrepresenting a considerable amount of information, which may not fit theexact definitions we have originally applied.

• Reliability bias (statistics): Is the data upon which the system developerhas based his calculations reliable? It would only take a few errors interms of volume, open, high, low and close, to skew the efficiency of yourindicators. These errors will confound and bias your trading decisions.


• Illusory correlation bias (statistics): Making the wrong connectionbetween events is a widespread fault and is known as illusory correlation.It is well known that traders see patterns that in fact do not exist. Once atrader believes that he has found a pattern the inflexibility of his beliefspersists and contrary evidence is ignored.

• Sample size bias: Illusory correlation bias can occur as a result of devel-oping an indicator from a sample that is too small. Samples larger than 30incidents are recommended in statistics as an appropriate sampling size.You will need to read some of the books I recommend in Appendix 1where biases and solutions are discussed.

The above biases are well-known phenomena in the field of statistical analy-sis and most system developers of ability will ensure that the probability ofthese biases occurring is minimal. We will address perceptual biases in the nextchapter.

Developing a money management plan as outlined in the previous chapter inthe section entitled “Financial Management”, should be applied to the businessplan. For example, we discussed rules, which would ensure that on each tradeor contract we would not risk more than 2% of equity and over three trades wewould not use more than 6% of equity. If we did so we would stop trading forthe month. The financial management plan should include a disaster plan on whatyou should do if disaster of a personal or trading nature occurs. After identifyingthe possible disaster you should also suggest ways of solving the problem. Badthings can and do happen and it would be best that you thought about them fromthe start.

Business plan area 3 – Personal discipline

Developing two sets of rules is appropriate. One set of rules for technical andtrading methodology (technical trading rules) and a second set to facilitate optimalbehaviours, affirmative attitudes, and beliefs (general trading rules). I will sharemy general rules of market trading as follows:

General trading rules

1. I develop a written trading plan and I trade my plan.2. I keep records of my trading results.3. I keep a positive attitude, no matter how much I lose.4. Don’t inflict the market on my family and listen to comments they

may have.5. I continually set higher trading goals.


6. I know that successful traders buy into bad news and sell into goodnews.

7. I know that successful traders are not afraid to buy high and sell low.8. I study markets each AM and read something relevant every day.9. I isolate myself from the opinions of others.

10. I continually strive for patience, perseverance, determination, and rationalaction.

11. I control losses by using stops! Mental stops must be implemented.12. I never cancel a stop loss order after I have placed it!13. I place the stop at the time I make my trade, even if only mental.14. I never get into the market because I am anxious because of waiting.15. I avoid getting into or out of the market too often. ESPECIALLY IN

THE CHOP.16. Losses – not profits – make me studious. I assess every loss to improve

my knowledge of market action and my behaviour.17. The most difficult task in speculation is not prediction but self-control.

Successful trading is difficult and frustrating. I am the most importantelement in the equation for success.

18. I will always discipline myself by following a predetermined set of rules.19. I know that a bear market will give back in one month what a bull

market has taken three months to build.20. I will not allow a big winning trade to turn into a loser. I stop myself

out if the market moves against me by 20% from my peak profit point.21. I have a programme, I know my programme, and I follow my

programme.22. I expect and accept losses gracefully. If I brood over losses, I may miss

the next opportunity, which more than likely will be profitable.23. I divide my profits right down the middle and never risk more than 50%

of them again in the market.24. Knowing my stress point and myself is the key to success.25. The difference between winners and losers isn’t innate ability as it is

discipline exercised in avoiding mistakes.26. In trading there are the quick and the dead.27. I will discuss my successes with students; however, speech may be silver

but silence is golden. I know that traders with the golden touch do nottalk about their success.

28. I will dream big dreams and think tall. Very few people set goals toohigh. A man becomes what he thinks about all day long.

29. I accept failure as a step towards victory.30. Have I made a loss today? I forget it quickly. Have I taken a profit? I

forget it even quicker! I don’t let my ego and greed inhibit clear thinkingand hard work.


31. I cannot change yesterday. When one door closes, another door opens.The greater opportunity always lies through the open door.

32. I must subordinate my will to the will of the market. The market is truthas it reflects all forces that bear upon it. As long as I recognise this Iam safe.

33. It’s much easier to put on a trade than to take it off.34. If a market doesn’t do what I think it should do, I will get out.35. Beware of large positions that can control my emotions. I will not be

overly aggressive with the market. I treat it gently by allowing my equityto grow steadily rather than in bursts.

36. I never add to a losing position.37. Beware of trying to pick tops or bottoms.38. I believe in my judgement and myself. This enables me to make a living

in this way.39. In a narrow market I will not try to anticipate what the next big move

is going to be – up or down. I will remain flexible to all possibilities.40. A loss never bothers me after I take it. I forget it overnight. But being

wrong and not taking the loss – that is what does the damage to thepocket book and to the soul.

41. I never volunteer advice and never brag of my winnings.42. Of all speculative blunders, there are few greater than selling what shows

a profit and keeping what shows a loss.43. Standing aside is a position.44. It is better to be more interested in the market’s reaction to new infor-

mation than in the piece of news itself.45. If I don’t know who I am, the markets are an expensive place to find out.46. In the world of money, which is a world shaped by human behaviour,

nobody has the foggiest notion of what will happen in the future. Markthat word – Nobody! Thus the successful trader does not base moves onwhat supposedly will happen but reacts instead to what does happen.

47. Except in unusual circumstances, I will get in the habit of taking myprofit too soon. I will not torment myself if a trade continues winningwithout me. Chances are it won’t continue long. If it does, I consolemyself by thinking of all the times when liquidating early reserved gainsthat I would have otherwise lost.

48. When the ship starts to sink, I won’t pray – I’ll jump!49. I am learning to lose my opinion – not my money.50. I assimilate into my being this set of trading rules (and others as I

evolve) – and they work for me.

I also have a non-exhaustive list of specific technical rules reflected in mytrading diary and the Tactical MOT.


Technical rules

1. Self-awareness: Rules of preparation.2. Developing tactics: Rules of engagement. Specific plan to trigger

entry with calculated probability of success. Type of approachemployed – trend following, stochastic, other.

3. Mental rehearsal: Paper trading rules and commitment to memory oftactical plan.

4. Ambush: Entry rules. Awareness of tendency for boredom and percep-tual biases.

5. Action: Rules of correct discipline.6. Monitoring: Rules defining how you will monitor and what you are

looking for.7. Profit target: Rules of how to calculate a profit target.8. Abort: Rules of stop loss.9. Daily appraisal: Rules of what you will keep as written records.

10. Periodic review: Rules defining success and failure. Criteria employedto decide if the markets you are trading have changed significantly requir-ing a change of rules above. Criteria employed to determine significantlife changes and effect on trading.

SUMMARY CHAPTER 4

• This chapter discussed theories of stress and defined stress as “our emo-tional and physiological reactions to situations in which we feel in conflictor threatened beyond our capacity to cope or endure”.

• The “fight-or-flight” response was discussed in relation to endocrineactivity and the orientation of the sympathetic and parasympathetic nervoussystems.

• A distinction was drawn between life stressors and trading stressors.Lazarus (1977) described four general categories of life stressors: cata-clysmic events, personal stressors, background stressors, and workplacestressors. Common trading stressors identified were inappropriately hold-ing onto a losing position, doing nothing when an opportunity arises, beingin the market whether winning or losing, harbouring fears of success,having no control over the market, and being alone and isolated as asole trader.

• The following theories of stress were discussed:1. The General Adaptation Syndrome (Selye, 1956): this model

demonstrates the effects of positive (eustress) and negative(distress) stress.


2. The Yerkes-Dodson law: demonstrates trading performance as afunction of arousal or stress.

3. Muscle tension theory (Jacobsen, 1938): gives an account of howthe psychological perception of stresses can cause muscle tension.The therapeutic effects of muscle relaxation were discussed.

4. Ideo-motor theory (William James): demonstrates that emotionalresponses are triggered by the way we interpret reality. Theway traders psychologically frame the context of their losses isdiscussed.

5. The two-component theory (Morris et al., 1970): this theory statesthat stress consists of emotionality and worry. For traders, worry isa concern; research indicates that for people who are “worriers” atleast 25% of their conscious thought is worry about the outcomeof a specific action such as trading. Some traders overemphasisethe role of “fear” but neglect the effects of “worry”.

• Techniques to manage stress were presented. The biofeedback techniqueuses a biofeedback machine to monitor blood pressure and other physi-cal responses. Feedback from the system can assist the trader to acquirecontrol over some of the damaging physiological effects of stress. Theprogressive muscle relaxation technique involves the individual focusingattention to specific muscle groups while alternatively tightening and relax-ing the muscles. The seated meditation technique compared with focusedbreathing exercises can assist traders in combating stress significantly.Physical exercise and in particular aerobic exercises have been shown toreduce stress.

• Cognitive methods of managing stress: A variety of cognitive restructur-ing programmes exist, aimed at reappraising a stressor or modifying ourthoughts about how it can best be dealt with. Cognitive techniques canbe particularly effective in assisting the frozen trader syndrome. Rationalemotive therapy (Ellis) changes a person’s view of life which in turnreduces a perceived stressor. Stress inoculation (Meichenbaum, 1983) hasproduced a three-step procedure for producing stress inoculation, designedto teach people skills for alleviating stress and achieving personal goals.Psychologists have found that human beings have a fundamental need forcontrol and when they are put in situations where their control is reducedthey try hard to regain it. Learned helplessness (Seligman) proposes thatonce a trader fails time and time again he will begin to expect failureresulting in the trader’s cycle of loss.

• Behavioural methods of managing stress: In my opinion this is one ofthe most effective techniques in assisting traders to combat stress. Devel-oping a trading business plan is a major tool to combat stress and toencourage appropriate discipline and action. The trading business planaddresses three main areas. Decision making – it helps the trader greatly


to undertake daily to-do lists, and to develop a mission statement. It isessential to develop goals which are SMART. Goals should be specific,measurable, achievable, realistic, and timely. Area 2 of the business planshould include performance indicators of technical systems, methods, andfinancial management. Area 3 of the business plan addresses personal dis-cipline. Developing two sets of rules is appropriate. One set of rules fortechnical and trading methodology (technical trading rules) and a sec-ond set to facilitate optimal behaviours, affirmative attitudes, and beliefs(general trading rules).

5The Psychology of PerceptualBias

‘‘Get your facts first then you can distort them as much as you like.’’

Mark Twain

There is a belief among traders that emotions in general, and fear, greed, andanger in particular, cloud judgement and the ability to make optimal decisions intrading. Although this is a factor, it is not the most important. There are manyinherent defects in the way people and traders think and it is mainly these thatwill be examined here.

There are numerous reasons why traders and people make bad decisions.Traders under stress make bad decisions because they are unable to take accountof relevant factors. When we are stressed our attention narrows so that we focuson the urgent task at hand. We noted in the Yerkes-Dodson law that a high level ofarousal significantly distorts judgement in complex tasks such as trading. Traderslike to take shortcuts because making a complex decision could take such a longperiod of time and expend so much thinking effort that the opportunity could passbefore the trader makes his mind up. Saving the effort of thinking is shared in otherprofessions such as in business, medicine, and politics with dire consequences.

Poor decisions are made because we can only hold a small number of ideas inour minds at any one time and are therefore unable to combine all the relevantfactors (e.g. Miller, 1956). It is possible to remedy this by drawing up lengthylists regarding the pros and cons of an issue or drawing a complex decisiontree. However, few traders are inclined to go to this effort in making decisionswhen the very nature of the market is random and therefore has a number ofunknown factors.


Taking the best decision, whether in everyday life or in market trading, mayoften involve the use of concepts drawn from elementary statistics. Few peoplehave these tools at their disposal. Research indicates that many errors of judge-ment occur through neglect of elementary arithmetic and as a nation we are notparticularly numerate at the most rudimentary level.

People distort their thoughts about reality in order to make themselves feelmore comfortable or happier. One aspect of reality distortion is that of wishfulthinking, where a trader harbours a false belief that something he wants musthappen. The personal belief paradigm elicits the processes of denial, discounting,and distortion of the facts as they are, and does not seek contrary evidence. Thisthinking is universal. A common example of wishful thinking is when peopleexaggerate qualities about themselves, which are not true. One prime exampleof wishful thinking by traders is the use of black box systems, where tradersdo not have any understanding of how the system gives signals, apart from ageneral explanation given by the system developer. I refer to this as the SantaClaus syndrome, where traders nurture a false belief that “system BBB”1 willgive them untold riches and also has added value, because it allows the trader toabrogate responsibility for losses and learning.

Self-deception can also help to make people happy such as during war whenindividual commanders direct their troops to commit atrocities in the name ofreligion or some greater good when in fact the exercise of power and acquisitionof material goods are the primary purpose.

In this chapter we will be discussing decisions and judgements in trading andeveryday life that are either irrational or not optimal and are unequivocally animpediment to correct action. They do not arise from the negative effects of emo-tions; they arise from systematic and avoidable biases in thinking. These biasesare surprisingly common in the trading venue and in everyday life, and a numberof ingenious experiments have been designed by psychologists to illustrate theperceptual errors.

THE AVAILABILITY ERROR

The availability error permeates all reasoning and decision processes. The readermay recognise this phenomenon because a number of trading authors have describedit but perhaps did not realise it was a known and scientifically measured phe-nomenon. In essence, the availability error describes the behaviour of making atrading decision or an everyday judgement based on criteria that first come to mind.

Suppose you were thinking of buying or shorting a particular stock or future.Your broker outlines the outstanding performance of the company or financialinstrument. Being a “sensible” investor who likes to undertake thorough researchbefore buying a stock, you seek a second opinion through a friend who informs

1 Bolder Brighter Bullshit.

The Psychology of Perceptual Bias 125

you that he purchased this stock/future last month, and it has already increasedby 6% in value. Deeply impressed, you immediately pick up the phone and placea large order for the product, only to find a few days later it has reached the top,commences a retracement, and then succumbs to a full reversal in the followingweeks. The immediacy and salience (availability) of your friend’s descriptionand success have made you forget about objective technical analysis, discipline,and the need to stand apart from tipsters when making decisions. The availabilityerror permeates all reasoning and many other perceptual errors are in reality justfurther instances of it. Data feeds and trading software are resource intensiveand traders replace their hardware on a regular basis. Suppose you are thinkingof buying a new computer and you mention it to your friend. He gives you aglowing account of his own computer. Impressed by his description, you buy thesame model and specification from the same shop, only to find it is unreliableand it has a few annoying gremlins in the hardware. You did not feel the needto read the assessment in a consumer magazine that gave it a mediocre review.In this there is a second common error, which will be discussed in more detaillater: no matter how good your friend’s computer is, it may not be representativeof the model. No two computers of the same specification perform identicallyand he may simply have been lucky with his.

There are numerous experiments outlining the faulty reasoning caused bythe availability error. A classic experiment was conducted by Higgins et al.(1977), where two groups of subjects had to learn a list of words. The wordswere the same for both groups except that group 1 included four terms ofpraise – adventurous, self-confident, independent and persistent. For group 2,four derogatory words were included – reckless, conceited, aloof and stubborn.The subjects memorised the words and then read a short story about a youngman who had several dangerous hobbies, thought well of his abilities, had fewfriends, and rarely changed his mind once it was made up. They were then pre-sented with a questionnaire to evaluate him. It was made clear to both groupsthat the previously presented list of words had no connection whatsoever withthe man in the story, those who had learned the favourable adjectives gave himmuch higher ratings and thought much better of him than those who had learnedthe unfavourable words.

The subjects, having recently memorised these words, had them at the back oftheir mind. Therefore the words were available at the time they read the story,and hence had coloured their interpretation of it! This experiment has been repli-cated numerous times with identical results. If items such as the words learnedin this experiment can affect subjects’ interpretation of something completelyunconnected, how much more strongly are traders likely to be influenced byaspects of the media, or temporary market situations that are highly salient andare closely connected with decisions being made involving considerable amountsof money? It is unlikely that any financial institution would allow research thatmight undermine their credibility.


It is worth considering some examples of the availability error being put touse in trading and in everyday life. According to a popular book first publishedin the 1950s by Vance Packard, advertising firms had probed the psychology ofbuying so thoroughly that they now knew exactly what made consumers tick. InHidden Persuaders, Packard sounded the alarm of the rise of the “professionalpersuaders” – marketing personnel who applied psychology and social sciencesto sales. The “Depth Approach”, as it was called, was based on extensive “moti-vational research” (MR) financed by the marketing industry. Packard describedhow many advertisers, including some of the largest firms in the country, wereusing MR to concoct new ways of marketing goods and increasing buying habits,methods that pushed the margins of acceptable persuasion.

Among the new MR specialists, Packard profiled, was the enterprising JamesVickery, a man whose sale schemes would kick off decades of subliminal scaresin the US. Vickery had conducted MR on various groups of shoppers, andattracted some attention for his studies of the eye-blink rate of female customersin various store settings. In 1957, Vickery announced that he had designed asubliminal projection machine, capable of flashing unnoticeable messages withinbig screen movies. Vickery said that subliminal messages such as “eat pop-corn” and “drink coke” blipped on the screen every five seconds throughout thefeature films appearing so briefly that they were not consciously perceived bythe viewers. Vickery said that the subliminals increased sales of cola by 18%and popcorn by 58%. Fortunately, leaders of the broadcasting industry recog-nised the fact that whatever gains might be made with subliminal advertisingwould be cancelled out by the rapidly developing stigma associated with thissneaky technique.

However, vendors of numerous products, including trading software, manip-ulate the availability error to their advantage. For example, the organisers oflotteries give maximum publicity to past winners, and of course say nothingabout the great majority who have won no prizes. By publicising winners, theymake winning foremost in the minds of potential buyers of tickets and hencemake them believe that they are more likely to win than they really are. Fruitmachines in pubs make a horrendous noise of coins cascading into a tray whensomebody wins the jackpot, which is intended to call people’s attention to thepossibility of winning money.

People’s tendency to base their judgements on what is available is manipulatedby shopkeepers everywhere. Would you buy a book on technical analysis for US$50 or US $49.95? Experiments show that people seize on the number of dollarsrather than cents and it is therefore more available, disregarding the fact that inthe case quoted here, there is only a difference in price of 5 cents.

Courses run by “trading gurus” give reports from clients who have made“fabulous” amounts of money using this particular trading software. Tradingsoftware vendors rely on the fact that you do not understand curve fitting nor do


you understand the three most important aspects of determining the efficacy ofa trading system, which are:

1. a system that consistently makes profits;2. a statement of the maximum equity drawn down; and3. the overall risk to reward ratio of the system.

Software vendors run live data feeds during demonstrations and if they arelucky they will get an excellent signal. If they are not lucky, there will be agood reason why the system did not give a clear signal on this occasion and thevendors will remind you that standing on the side is in fact a position.

What is it that makes something “available”? From the previous experiments itis clear that recently presented material is “available”, but it has also been foundthat anything that produces strong emotions, that is dramatic, that leads to theformation of images, and is concrete rather than abstract is also readily available.For example, a murder committed by a black Muslim, who is also diagnosed asa paranoid schizophrenic, will receive far more coverage in the newspapers thanone committed by Joe Blogs: it is more dramatic, less of an everyday occurrenceand hence more available. Moreover, people are likely to have stronger emotionalfeelings about black paranoid schizophrenic Muslims than about Joe Blogs.

The implications of the availability error can be far-reaching and pernicious.A study by Hallam (2002) examined media influences on the government in theirdevelopment of mental health policy. The study focused on two cases involvingmen with a diagnosis of schizophrenia. Christopher Clunis, who killed a strangerin a London tube station, and Ben Silcock who climbed into the lion’s den atLondon Zoo. Silcock was partially eaten alive, but survived having sustainedserious injuries. The research demonstrates that emotive, headline-catching lan-guage was used to describe the predicaments of Ben Silcock and ChristopherClunis, but not solely by journalists whose knowledge of mental health issuesmight be limited. Both cases were associated with well-informed campaignerswho wished to ensure that people suffering from mental illness received bettercare and attention. By highlighting the risks individuals with schizophrenia maypose to themselves and in particular to others, however, such publicity has con-tributed to an unbalanced policy debate. The research is a clear demonstration ofthe relationship between the availability error and an introduction of additionalconstraints on people with mental health problems as a response to unwarrantedpublic concerns about risk and dangerousness. Mental health professionals andservice users have uncovered clear evidence of the media dramatically distort-ing facts. Policy at the highest level resulting in the reduction of civil libertieshas been influenced by the availability error: the media have dramatically dis-torted numerous incidents, engendered fear in the public, evoked images of bigblack paranoid schizophrenic men with weapons, all of which was immediatelyavailable at the time of the drafting of a new Mental Health Act.


A study by Slovic et al. (1984) found that people believe they are twice aslikely to die of an accident as from a stroke. In fact 40 times as many peopledie of strokes as from accidents. The reason for this false belief again has itsorigins in the availability error. Although most people die non-violent deaths intheir beds, air crashes and violence are constantly reported in the media and arehighly dramatic – they are therefore “available”. Not only do people hold falsebeliefs about the frequency of violence, but also they are driven by their beliefs.In 1986, there were a number of much publicised plane hijackings and there wasa significant drop in the amount of American citizens visiting Europe. It is astatistical fact that American citizens living in cities put themselves at greaterrisk of meeting a violent death by staying at home owing to the prevalence ofviolent crimes. An identical pattern and refusal to fly occurred during the GulfWar and following September 11th, 2001.

Elstein et al. (1978) undertook a scientific analysis of clinical reasoning inmedicine. A significant level of doctors who had recently seen a number of casesof a particular disease become more prone to diagnose that illness in patientswho have not got it.

The availability error affects traders and stockbrokers alike. Brokers, on seeingthe market going up, recommend their clients to buy, and to sell when it goesdown. Statistically there is little connection between rises and falls one day andthe next day but the mere fact that the index has risen prompts people to buy them.In trading this phenomenon is called “chasing the market”. The correct strategyis the opposite of that commonly used by brokers, namely to buy at bottoms andsell at peaks though this is very difficult to implement. Home traders are equallyguilty of being adversely affected by the availability error even though they mayhave written rules which state that they will not be influenced by others’ opinionsor by the news. We are likely to be influenced by a conversation we had at lunchor by a stray item read in the newspaper rather than using the full informationat our disposal or seeking new information when it is needed.

Much of the data we have at our disposal are abstract, pallid, and often veryboring. It is for this reason that traders and people in general will pay attentionto and recollect anecdotes, which are economical with the truth yet colourfuland interesting by comparison to truthful statistics. Mark Twain and BenjaminDisraeli have both been credited with coining the phrase “there are lies, damnlies, and statistics”. Rather than using mental effort to assess the facts as they areor to seek new evidence, it is much easier to dismiss them as “lies, damn lies,and statistics”.

Consider the following three descriptions of the functions of the left and righthemispheres of our brain in the processing of information. The first descrip-tion is written by a trader, the second by a psychologist, and the final by aneurophysiologist.2

2 Passage 1 – Bill Williams; Passage 2 – Daniel Goleman; Passage 3 – W. F. Ganong.


Passage 1

The left hemisphere is the “idiot” of the trio we are studying. It is digitaland sequential in design and can handle only about 16 bits of informa-tion per second . . . The left hemisphere is your Tasmanian Dragon, yourdespot, your gremlin, your no-good, sneaking, conniving saboteur thatmesses up your trading. Evolution wise, this is the youngest member ofyour brain group. It is sometimes described as your “thinking mind” eventhough it is the idiot of your three boarders.

Now consider the following:

Passage 2

Essentially, the left hemisphere is the more logical/verbal one and theright hemisphere the more intuitive, creative one. The left deals withwords, the right with pictures; the left with parts and specifics, the rightwith wholes and the relationship between the parts. The left deals withanalysis, which means to break apart; the right with synthesis, whichmeans to put together. The left deals with sequential thinking; the rightwith simultaneous and holistic thinking. The left is time bound; the rightis time free.

Now consider the following:

Passage 3

The persistence of the idea that the right hemisphere is usually dominantfor speech in left-handers is a classical example of how scientists canneglect data that do not conform to current theory or to common sense.The results of accidental or surgical interference with brain functioningalso indicate that part of the brain is specialised for language ability. Inmost people, dysphasia follows damage to the lateral surface of the lefthemisphere, especially in the region of the third frontal convolution andthe posterior temporoparietal area. Frontal lesions tend to produce express-ive dysphasia, and posterior lesions tend to produce receptive dysphasia,but the distinction is far from clear cut.

If you give an equal amount of time and effort to digest and understand theabove three passages it is highly probable that you will recollect the generalcontent of the first passage written by a trader, than the final passage, written bya neurophysiologist. The middle passage written by a psychologist is somewhere


in between trying to balance facts with non-technical language but you will find thatrecall in three months will be far less than that of passage 1. Your ability to recollectpassage 1 over the other passages is, in part, a function of the availability error.However, there is another variant of the error at work here called the halo effect,which will be discussed later in this chapter. Because this trader is known andrespected, people falsely assume he must also have expertise in brain physiology.In Chapter 6 on emotions I will show incontrovertible evidence that the left brain isfar from “idiot” and in particular, the left frontal lobe is of paramount importancein sustaining the motivation and effort required to succeed in the trading forum.

THE PRIMACY ERROR AND RECENCY EFFECT

In the previous section, we examined the availability error in everyday life andits influence on traders in general and the trading task. The availability error sug-gests that what happens last would be prevalent in the mind and therefore mostinfluential on our perception. It is also said that first impressions are most impor-tant for forming our beliefs about people, actions, perceptions, and interpretationsin general. There is a prima facie case for assuming that this contradiction cannotbe resolved, yet it will assist us to examine the empirical evidence for what istermed the “primacy error”.

In 1946, Solomon Asch undertook a series of experiments under the title“Forming Impressions of Personality”. He asked subjects to evaluate a personsimply on the basis of a list of six adjectives. They might be told that theperson was “intelligent, industrious, impulsive, critical, stubborn and envious”.Other subjects were given exactly the same six words but in the opposite order,“envious, stubborn, critical, impulsive, industrious and intelligent”. All subjectswere then asked to fill in a rating sheet in order to evaluate the person. Forexample, they had to indicate how happy they thought he was, how sociable hewas and so on. The subjects who had the first list, which began with favourableadjectives, evaluated the person considerably more highly than did those giventhe list beginning with the derogatory words. This effect, being more heavilyinfluenced by earlier than by late items, is called “the primacy error”.

These experiments and many others suggest that beliefs are formed by firstimpressions and later that evidence is interpreted in the light of these beliefs.There is no conflict between the primacy error and the effect of recency onavailability. The primacy error occurs because when related or connected material(such as financial information in a newspaper or a trading seminar) is presented,the interpretation of the later material is coloured by the earlier. The “recencyeffect”, on the other hand, occurs when material is unrelated or not connected;under these circumstances we tend to be influenced by what we have seen orheard most recently.

The primacy error can be regarded as one form of the availability error: theearly items are immediately available in our minds when we encounter the rest.


In making a judgement it is not the actual items that matter so much as themeaning we attach to them and that meaning can be altered by the first materialwe encounter, particularly if it is relevant to the remainder. This error is itselfrelated to another bias in thinking that will be discussed in a later chapter, whichwill show that for a variety of reasons traders cling tenaciously to their existingbeliefs and make every effort to avoid discovering that they might be wrong.This applies not only to decisions made in taking positions in the market butalso in terms of beliefs about methods of trading and their understanding of theabilities of trading coaches.

The primacy error has important effects in everyday life. If you first encountera person when he or she happens to be in a foul mood, you are likely to beprejudiced against this person, even if subsequently the behaviour is more pleas-ant. R. M. Dawes (1988) demonstrated in research that interviewers form animpression of the candidate within the first minute or so and spend the rest ofthe interview trying to confirm that impression. If you are writing examinationpapers, be sure to produce a very good first paragraph. If you are a doctor diag-nosing a patient, make every effort to take as much account of the symptoms youdiscover last as of those you discover first. As a trader the availability error, pri-macy error and recency effect all have profound implications. These experimentsdemonstrate that perceptual errors are common and can bias traders’ decisionsand judgements. These errors can be viewed as hidden persuaders that can causetrading losses as surely as can extreme emotional reactions.

THE HALO EFFECT

Related to the availability error is the halo effect. If a person has one salient(available) good quality, his other characteristics are likely to be judged by othersas better than they really are. Handsome men and women tend to be rated highlyon intelligence, athletic prowess, sense of humour and so on. In fact, physicalappearance has little to do with such characteristics. There is a small correlationbetween being handsome and being intelligent (Sutherland, 1992), but it is notenough to account for the mistakes people make in their judgements. There isthe opposite effect, which is known as the “devil effect”. The presence in anindividual of one salient bad trait like selfishness can lower people’s opinion ofall his other characteristics: he tends to be seen as a more dishonest and lessintelligent than he really is.

Although psychologists have known the halo effect for more than 70 years itis remarkable how little notice is taken of it. For example, only recently haveuniversity examination papers been submitted by number rather than by name, adevice that university administrators render worthless since they usually numberthe papers in alphabetical order, presumably under the misapprehension that theexaminers can’t count. One of the most damaging ways which the halo effectis ignored is the almost universal prevalence of the interview as a means of


selection. There are numerous reasons why current means of selection are uselessand may indeed lower the chances of selecting the right candidate. Part of thereason is the halo effect: the interviewers are too influenced by the comparativelytrivial but salient aspects of the interviewee, which affect their judgement of hisor her other characteristics.

Traders are also prone to be influenced by the halo effect and it is one of themajor influences affecting a trader’s decision in purchasing trading software, acourse, and developing a trading style. This is especially true in the UK wherethe general public are not aware of day trading or active investment, as are ourcolleagues in the US. Box 5.1 outlines the characteristics of a communicationlikely to persuade or induce attitude change.

Box 5.1 outlines many of the reasons why we are persuaded when perhapsit would be best to look at the facts objectively and clearly. The reasons aboveare why so many people undertook training with CW and RD. People marketingtrading courses appear to have a good level of expertise, good physical looksand extensive interpersonal and verbal skills. Furthermore, they are people withwhom we are familiar, or to whom we feel close, and to whom we are attracted.Such people are able to exert more influence on us than others. The source ofcredibility to promote a trading course or software is important and used bymarketing agencies extensively. For example, the newspaper report regardingCW was presented in a leading and reputable Sunday newspaper. The samestory was copied word by word by RD and published by a reputable Scottishnewspaper. In addition, RD was able to have one of his “students” interviewedby a popular UK radio talk show presented by Jimmy Young of the BritishBroadcasting Corporation (BBC). RD ensured that the student gave the name ofhis website for potential candidates to be convinced even further.

The effects of repetition are also important in persuasion. In the advertisingindustry, it is a maxim that the message needs to be repeated often in order tobe understood and to be recalled. In addition, fear-arousing messages enhancepersuasion. So to continually repeat that trading is “highly dangerous” and a“deadly game of war” is not only persuasive but is exciting and arouses people.Candidates for training courses are also persuaded if the message is perceived as“not deliberately intended to persuade or manipulate”. For example, the articleon CW appeared quite objective and yet his home telephone number was left atthe bottom of the newspaper article. Having a “student” to give a review is ahighly effective persuader and often the “student” is coached by the trainer priorto any media interview.

People with low self-esteem are persuaded more easily than people with highself-esteem. One tutor offering trading courses was noted to repeatedly state thathe would not accept medical doctors on his course because his methodologywas so successful, that the doctor would stop practising and therefore indirectlyhe would be robbing society of a valued member. In fact, the reason was that


Box 5.1 Characteristics of a communication likely to persuade or induceattitude change

• Popular and attractive communicators are more effective that unpopularand unattractive ones (Kiesler and Kiesler, 1969).

• People who speak rapidly are more persuasive than people who speakslowly (Miller et al., 1976). One reason is that rapid speech conveysthe impression the speaker knows what he or she is talking about.

• People are more easily persuaded if we think the message is not deliber-ately intended to persuade or manipulate us (Walster and Festinger, 1962).

• People perceived as experts are more persuasive than those perceivedas non-experts. (Hovland and Weiss, 1952). The same argument carriesmore weight when delivered by someone who presumably knows allthe facts.

• Persuasion can be enhanced by messages that arouse fear in the audi-ence (Leventhal et al., 1965). To persuade people to stop smoking forinstance it may be useful to create a fear of dying from lung cancerby showing a cancerous lung to smokers. Founders of trading softwareor courses will often demonstrate that the risk of ruin is far greater ifusing another competitor’s software or trading methodology.

• People with low self-esteem are persuaded more easily than people withhigh self-esteem (Yanis, 1954).

• People are sometimes more susceptible to persuasion when they aredistracted than when they pay full attention, at least when the messageis simple (Allyn and Festinger, 1961).

• When persuasion is tough – that is, when the audience is hostile – it ismore effective to present both sides of the issue than just one (Hovlandet al., 1949).

While the above represents the research finding of twentieth century scientificenquiry, Aristotle who lived from 384 to 322 BCE (before the common era),discussed three principles of persuasion in his book on rhetoric. First, a heareris more likely to believe a good person than a bad one. Second, people arepersuaded when what is said stirs their emotions. Third, people are persuadedby arguments that approach a truth, or an apparent truth, about the matterat hand.

medical doctors are generally of high self-esteem and are expert at making quickdecisions or judgements, regardless of whether they are right or wrong.

It would be reasonable to assume that the halo effect would be less likelyto occur in a scientific field. The following experiments are both humorous and


relevant to the publication of trading books by reputed publishers. When scientistssubmit a paper to a journal, a decision has to be taken on whether to accept it.Normally, the paper is sent off to two or three referees (as they are for books ontrading) who are experts in the usually rather narrow field covered by the paper.The editor decides whether to publish it on the basis of their reports. In 1982, twopsychologists published an account of a revealing trick. They selected from eachof the 12 well-known journals of psychology one published article that had beenwritten by members of one of the 10 most prestigious psychology departments inthe US, such as Harvard or Princeton. The authors of these scientific reports wereeminent psychologists. The researchers changed the names to fictitious ones andtheir affiliations to those of some imaginary university such as the York Centre forBehavioural Finance. They then went through the articles carefully and wheneverthey found a passage that might provide a key to the real authors they altered itslightly while leaving the basic content unchanged. Each article was sent typedand submitted under the imaginary names and affiliations to the very same journalthat had originally published it.

Of the same 12 journals, only three spotted that they had already publishedthe article. This was a grave lapse of memory on the part of the editors and theirreferees. There is a further humorous and worrying finding in this experiment.Of the 16 referees and eight editors who looked at these eight papers, everyone stated that the paper they examined did not merit publication. In decidingwhether an article should be published, referees and editors paid more attentionto the authors’ names and to the standing of the institution to which they belongthan they did to the scientific work reported.

D. Peters and S. Ceci (1982), the authors of the above research, examinedthe referees’ reports that had recommended the research not to be published. Agenuine reason for rejection would be that the research reported might alreadyhave been published by other workers in the two years since the original paperscame out. Scrutiny of the referees’ report revealed that this was not the reason;none of them rejected the papers because the findings were not new. Also, itcould be argued that workers from a good institution would be more carefulin selecting their data and less prone to fraud than those from an unknowninstitution. However, the referees made detailed criticisms of various points inthe papers, many of which appear to have been valid. They criticised the statisticsused and made remarks like “the theoretical organisation . . . seems loose andfilled with . . . undocumented conclusions” or “it is all very confusing”.

It is therefore likely that any publication, in trading or science, is subject tothe biases of a combination of the availability error, combined with the primacyand halo effects. The first words a referee or an editor sees on reading an articleare the authors’ names and the name of their institution. If these are prestigioushe will be biased towards interpreting the paper in the best light possible; if theyare not, he is probably going to look for flaws and to be more sensitive to whatis wrong than to what is right.


Many traders have used the halo effect to support their theories and views,whether the theories are accurate or not. For example, some traders who haveno formal training in psychology have invented anecdotes to demonstrate thepsychological dynamics of fear and greed at work in the individual and how thisinfluences their trading. Some have even become experts in neurophysiology bymaking unsubstantiated claims about the functioning of the brain and its relevanceto trading. In addition, I have seen traders in seminars use psychometric tests withlittle understanding of how to interpret the scores, but who can easily convince theaudience that they know what they are doing, and label their actions as methods ofbehavioural finance. The halo effect in these circumstances is potent and has beenused equally effectively by stage “hypnotists”. Many of you will have completed“psychological” tests in trading books. Have you ever stopped to think “on whatdata is this test based to ensure a reliable and valid outcome score?” Traderswould certainly ask this question of any trading system or methodology that theywould invest time and money in. There are also traders who have become expertsin understanding the “herd mentality” and group processes. In fact, CW on oneoccasion (see page 3, Box 1.1) attempted to replicate an experiment by Asch infront of a class of 12 students. You may recall that one learning technique heemployed was to tie up students who did not pay attention or who answeredincorrectly, and one student of Asian origin was used in this manner. He sentthis Asian student out of the room and asked the rest of the group to colludewith him on the length of a number of cigarettes. He took approximately fiveunfiltered cigarettes and placed them in a row on his desk. He asked the groupmembers to be “stooges” and all come up to the desk at a later time to examinethe cigarettes and state that one was almost imperceptibly longer than the others.At a later time, when the class had reconvened following a break, he placed thecigarettes on the table and had each student come up to state that one cigarette wasminutely longer than the others. The Asian student was then asked to come upand he hesitated but clearly stated that he could not see any difference regardlessof what the rest of the group had perceived. The purpose of the experiment wasto demonstrate that a fabricated group opinion could influence an individual tomake an incorrect judgement (or at least pretend to for the sake of conformity)but this failed. CW did not state that the experiment was based on Asch’s originalexperiments in the 1940s, which again tended to support his self-image of havinga “great mind and ability to understand group phenomena”.

Be aware of traders who pretend to be Nobel Prize winning psychologists (infact there is only one in psychology of finance, Kahneman, awarded in 2002) andbe aware of how the halo effect biases your own perception. Many traders haverecognised that their credibility has been questioned as a result of not holdingpsychology qualifications and a new branch of trading psychology has developedmore recently in the US called “behavioural finance”. There are many validreasons why the new title of behavioural finance is becoming popular. However,


it is generally more acceptable for a trader to be an “expert” in behavioural financethan in psychology, especially if he has no formal qualifications whatsoever.

Box 5.2 What is behavioural finance?

Much of economic and financial theory is based on the notion that individualsact rationally and consider all available information in the decision-makingprocess. However, the research presented in this chapter shows a surpris-ingly large amount of evidence that this is frequently not the case. Dozensof examples of irrational behaviour and repeated errors in judgement havebeen documented in academic studies. Peter L. Bernstein in Against the Gods(1998) states that the evidence “reveals repeated patterns of irrationality, incon-sistency, and incompetence in the ways human beings arrive at decisions andchoices when faced with uncertainty”.

A field known as “behavioural finance” has evolved that attempts to betterunderstand and explain how emotions and cognitive errors influence investorsand the decision-making process. Many researchers believe that the study ofpsychology and other social sciences can shed considerable light on the effi-ciency of financial markets as well as explain many stock market anomalies,market bubbles, and crashes. As an example, some believe that the outperfor-mance of value investing results from investor’s irrational overconfidence inexciting growth companies and from the fact that investors generate pleasureand pride from owning growth stocks. Many researchers (not all) believe thatthese humans’ flaws are consistent, predictable, and can be exploited for profit.

Some professors recognised as experts in the field include Daniel Kahne-man (Princeton), Meir Statman (Santa Clara), Richard Thaler (University ofChicago), Robert J. Shiller (Yale), and Amos Tversky. Tversky passed awayin 1996 and is frequently cited as the forefather of the field. There are alsofund managers who employ behavioural techniques in their market analy-sis. In the US, LSV Asset Management, Fuller & Thaler Asset Management,David Dreman and Ken Fisher are some money managers that invest basedon behavioural theories.

Common examples of irrational behaviour (many interrelated) thatresearchers have documented include all the biases that I have described in thischapter. This brings into question whether one can view behavioural financeas a pukka discipline that can stand apart from cognitive psychology. It isof interest that the psychologists (Asch, Milgram, Festinger, and Eysenckto mention only a few of many) who initially identified and measuredthe psychological and perceptual biases currently used as paradigms by“behavioural financiers”, are rarely if ever credited as major contributorsto the field of behavioural finance. For example, one can read literatureon economic and financial theory that either renames known psychological


effects, or places them in a new context, with the implication that there hasbeen a new “discovery” by economists. Some popular examples of renamingor reframing can be found in the use of concepts such as overconfidence,accounting, status quo, anchoring, sunk cost effect, herding instinct, hedonisticstates, false consensus, and illusion and locus of control; all have been wellresearched in cognitive and social psychology.

This is not to say that behavioural finance is a procrustean bed for pla-giarised concepts taken from psychology. Rather, it is at risk of becoming ahaphazard synthesis of half understood principles rooted in the discipline ofpsychology and applied to economics. We shall see. Research currently under-taken, which has significant psychological and financial components, wouldcertainly be subsumed under the title of behavioural finance, at least in theUSA. I interviewed Professor Fenton-O’Creevy, head of the UK Open Univer-sity Business School, on how he views his research on “Illusion of Control”,undertaken at City of London financial centres, using senior dealers and tradersas subjects. He states:

It would be fair to say that I do not consider myself to be a mem-ber of the school of behavioural finance though I do believe my workis relevant to that field. I would consider myself to be a scholar ofOrganisational Behaviour, a discipline which draws on underlying dis-ciplines of Psychology, Sociology and Economics. By and large thosewriting under the label of behavioural finance tend to have a financialeconomics background and to draw on the behaviour decision makingliterature which is a mix of economics and cognitive psychology. Prob-ably the best description of my work on the illusion of control wouldbe that it is an example of the application of cognitive psychology tohuman behaviour in organisations and [stock and futures] markets. Thewider project of which it is part is very multidisciplinary drawing onthe sociology of markets, economics, financial economics, cognitive andsocial psychology.

The demise of behaviourism during the cognitive revolution in psychologyof the 1970s, brings about the question of whether “behavioural finance” isa misnomer or possibly an archaic phrase? James Montier, the UK author ofBehavioural Finance (2002), explains:

I think psychology is fundamental to behavioural finance. I thinkpeople may have problems with the term behavioural finance because“behaviourism” has a specific meaning to psychologists. They look at“behavioural” as it relates to “behaviourism” and Skinner’s work butlooking at the phrase “behavioural finance” from a financial perspective,it is much more about relaxing the very strict rationality assumptions that


economists tend to impose upon people. Because we are rebelling againstthe “rational” approach it has been labelled “behavioural” because it ishow people “behave” as opposed to the connotations of “behaviourism”within the cognitive psychological literature. Behavioural Finance isreally an application of modern cognitive psychology to finance.

A cynic might argue that “behavioural finance” is a trendy and stylishphrase implying that proponents of this method have some deep-seated andscientific understanding of the underlying behavioural mechanisms of peoplewho drive the markets. Since these proponents have a rigorous and empiricalinsight to investors’ behaviour, it might also be assumed that they have an“edge” and are a conduit to wealth and prosperity. Recently, I received anemail flyer advertising a course in Technical Analysis and Behavioural Financecosting £800 for two days. Following my numerous enquiries, I discoveredthat the person “teaching” the behavioural finance element of the course hasno formal qualifications in psychology, economics, or finance in general. Hehas no evidence of successful trading yet he clearly believes he has the skillsto teach behavioural finance at £400 per person per 5 hour day! Followingconsultation with one of my lawyer colleagues, the view expressed was thatif the trainer had advertised psychology of trading seminars, there might beredress in law to reclaim fees owing to the fact that he had no accreditedqualifications. Not so with behavioural finance since it is not a recognisedprofession in the UK.

The fact is that there will always be the few who cast a shadow on the skilledand expert research of scientists like Tversky, Kahneman et al. There is alsothe difficulty of assessing whether behavioural fund managers actually practisereliable and valid behavioural techniques in executing trades or investments.Regardless of whether one calls it behavioural finance or the psychology oftrading, I am enthused and encouraged by the research to date from thesedisciplines.

THE RISKY SHIFT AND HERD BEHAVIOUR

Traders are generally aware that a person’s behaviour tends to conform to thatof any group of which he is a member. Belonging to a group, however, hasother implications and the interaction between members has significant effectson attitudes and their behaviour towards other groups. As individuals it wouldbe reasonable for us to assume that our attitudes would drift towards the midposition (regression to the mean) held by the rest of the group. However, Koganand Wallach (1964) have demonstrated that if there is a prevailing attitude in thegroup, it becomes accentuated in its members. For example, a group of traders


who have an affiliation with, say, Elliot Wave theory will see their techniquesand methods as far superior to those employing other methodologies.

An experiment was designed to demonstrate this phenomenon in a group ofpeople who were making a decision on purchasing stocks and shares of a riskycompany that could end in disaster for the group. They were told to imaginethat they were thinking of investing all their spare money in a company thatis fighting for a government contract. If it succeeds, they would multiply theirmoney by a factor of 1000; if it fails it would go bankrupt and they would loseeverything. If the chances were a million to one in favour of success, probablymost people would invest. In order to measure how much risk each was preparedto take, subjects were asked individually what odds they would need to makethe investment. The odds that the person would accept was used as an index ofthe degree of risk and 12 different kinds of risk were put to each individual, notonly stock market investing. After each had independently given the acceptableodds, they discussed the risks as a group in order to reach joint agreement aboutthe acceptable odds. The group as a whole opted for much lower odds than theindividuals. In other words the group was prepared to take a greater risk than itsmembers acting separately. This phenomenon has been termed the risky shift. Therisky shift effect has been replicated many times and in some experiments the riskwas somewhat more realistic than imagining ruin through stock market trading.For example, the possibility of receiving a strong electric shock balanced againstthe possibility of a monetary reward. The demonstration that group attitudes aremore extreme than those of individuals has been replicated many times and indifferent circumstances. The phenomenon occurs for a number of reasons. First,the group members want to be valued by the group. They may suppress argumentsthat are opposed to the attitude and beliefs of the group and they may be preparedto be more extreme in the group because we know that membership of the groupreduces individual responsibility.

Janis and Mann (1977) demonstrate that group members develop an illusion ofinvulnerability coupled with extreme optimism; they ignore inconvenient facts;their belief in their own morality may even commit immoral actions as a meansto an end; they hold stereotyped views of rival or enemy groups whom theyregard as weak; individual members attempt to silence dissent from others in thegroup; and each member suppresses his own doubts in order to conform; thereis an illusion of holding a unanimous view; and they protect other members byconcealing information not in line with the group’s views. In fact, group leaderstend to pick those candidates whose ideas and attitudes most suit their ownwhen a decision needs to be made regarding group membership. It is thereforelikely that the group, through selecting these members, will become even moreextreme in their views. I have been to numerous trading seminars where thisphenomenon can be observed easily. Simply apply to a couple of seminars inthe States supporting Elliot Wave and then go to the UK or Europe and attend


a seminar given by the proponents of Wyckoff – the implications for traders aresignificant.

It is difficult if not impossible to think of one’s own group and trading method-ology as special without thinking that other groups or trading methodologies areinferior. Such prejudice against other groups is usually accompanied by the for-mation of stereotypes. For example, Jews are seen as greedy, Blacks as lazyand so on. These racist stereotypes have no foundation in fact. Some reasonsexplaining the inflexibility and failure of some traders to adapt and learn newmethodologies in response to changing market conditions are rooted in the samedynamic that forms stereotypes. One reason for stereotypes is that they are con-venient; we do not have to assess the individual case. A second reason is we tendto notice anything that supports our own opinions but don’t pay much attentionto those that might not support our view. Third, we notice actions of anothergroup as more readily available than those of the larger group. They are conspic-uous because they are rare. Forth, stereotypes can be self-fulfilling. If Blacks arethought to be lazy, they find it hard to get jobs. In consequence, they are seenidling around the street thus confirming the belief that they are lazy. Finally,when discussing the halo effect in relation to individuals it is shown that theperson who has one salient quality may be seen as having other related qualitiesthat he does not possess. This also applies to groups because some ethnic groupslook different from Whites, the latter are likely to believe they differ radicallyin other ways. For these reasons and others, prejudicial stereotypes are commonand powerful and very hard to eradicate, and their basis in truth is unfounded.

It is comforting to belong to a cohesive group of traders showing a commonphilosophy, discipline, and method of trading. It is difficult to think of yourcolleagues and tutor as special without at the same time making others appear“inferior”. These prejudices against other traders holding different beliefs aboutmarket trading are not based on facts. In a sense, we pre-judge people, actions,and market action, based on our false belief paradigm.

MISPLACED CONSISTENCY THEORY, THE SUNK COST ERROR,AND PROSPECT THEORY

Traders and people in general make efforts to maintain or develop consistencyin their beliefs regardless of the veracity of those beliefs. The halo effect is agood example of our attempts to maintain consistency in beliefs. For example,if a trader has some salient (available) trait that is good it biases the way inwhich all other characteristics are seen. For example, in the cases of CW andRD, candidates who entered their trading courses chose to perceive them as“experts” even though they did not have the full facts about their backgroundand experience. People are unwilling to accept that we all have a mixture of goodand bad traits and will tend to view people as one or the other.


The halo effect influences us even when we have no vested interest in seeinganother person or object as wholly good but the theory of misplaced consistencyshows that the drive for consistency becomes even stronger when somebodyhas made a large investment in anything. If a novice trader is looking for atrading system they will examine several of the type that they want and thatthey can afford. They will find things that they like such as very clear buyand sell signals, and things that they dislike, such as very few alternative toolsto use simultaneously with the primary indicators. They will be influenced intheir appraisal of one part of the trading system by their attitudes to other parts(the halo effect) and will almost certainly be unduly influenced by their firstimpressions. Following much thought, looking at alternatives, and reading up onvarious systems, they will settle for a particular system and purchase it. Tradersinvest a great deal of time and money in either developing their own system orin purchasing one. If they are not to injure their self-esteem they justify the timeand financial commitments that they have made by altering their beliefs about thesystem. They exaggerate what they formerly saw as its good points and minimiseits bad points. The clear buy and sell signals become tantamount to the “HolyGrail” and the lack of alternative tools becomes minimised (because after all thesystem is so good it doesn’t need alternative tools!). Most traders believe thatthey make sensible decisions especially when they have put a lot of thought intoit. There is a motivational dynamic at work here: if a large amount of time andmoney had been spent on an inadequate system, it would be upsetting, to say theleast, and the purchasers unconsciously make their beliefs consistent with theiractions to reassure themselves that they have done the right thing. There is amuch better known phenomenon where studies have demonstrated that peopletend to lower their opinion of anything they don’t or can’t get. We all know thiseffect by the name of “sour grapes”.

In 1957, Leon Festinger developed the theory of cognitive dissonance. Cogni-tive dissonance can be defined as a state of psychological tension, produced byholding two simultaneous and opposing cognitions, that motivates the individ-ual to reduce the tension, often by changing or rejecting one of the cognitions.As stated in the misplaced consistency theory, we seek harmony in our attitudes,beliefs and behaviours, and try to reduce tension from inconsistency among theseelements. In other words we deny, distort, or actively seek information to supportour beliefs to reduce the uncomfortable state of dissonance that is experiencedthe moment we choose between two alternatives.

Festinger’s theory may help us to understand investor behaviour during thespeculative manias referred to on page 78. It also helps us to understand whytraders make poor decisions. During the bull market of the late 1990s tradersbelieved the two following dissonant propositions:

1. The price of technology shares is already very high and significantlyovervalued.


2. If I do not go long in this market I will miss out on the profits (supportedby the belief that many traders are positioned in the market and the trendis up).

During this period, traders reduced the dissonance between those propositions byignoring information that illustrated the overvaluation of equities. Traders alsowould seek out information that supported the second proposition – “I will missout if I don’t go long now”. There is also the underlying feeling that if they didn’tbuy, and the market rose, it was as if they had actually lost money. There is asubtle dynamic at work here: when we apply Festinger’s ideas to taking positionsin the market, it becomes apparent that traders become emotionally attached tothe positions they take. Investment in the market is not simply financial, it is alsopsychological. When the market turns these psychological beliefs are at workand it makes it very difficult for the undisciplined trader to take action. In thesesituations, to sell your position at a loss means to reject not only their financialinvestments but also their psychological/emotional investment and face the greatdiscomfort and anxiety caused by cognitive dissonance. A disciplined trader, whoalso understands the cycles of the market, whether that be through the Wyckofftheory of accumulation and distribution or Elliot Wave, or other, notices thatlosses have been growing to an unacceptable level and that the position wouldneed to be closed because the stops had been hit. Those traders who cannot copewith cognitive dissonance become overconcerned with justifying their behaviourin going long in the first place and do not cope well with what is happening inthe here and now. They cling on until it’s too late. They seek out news, technicalevidence and fundamental evidence to support the view that they are correct. Itwould be wrong to assume that cognitive dissonance can explain the reasons forgroup manias and poor performance in traders, but it does at least give us someinsight, and through insight we are able to build a more realistic model of thebehaviour of the market and, more importantly, our own.

There is a common understanding among us that if something is hard to get,it becomes more attractive. Experimental research by Arkes and Blumer (1985)shows this to be true, but only if someone voluntarily chooses to undergo therigours and stresses of achieving it. Related to this is an extreme form of themisplaced consistency theory and is called the sunk cost error. Traders, andpeople in general who have made a sacrifice in money, time and effort in orderto do something new or what they believe to be valuable in their life, tend togo on doing it even when they stand to lose more than they gained by contin-uing. We have all had experience of this either in trading or in our everydaylife. How many times have we told ourselves that we are determined to get our“money’s worth” even if we do not particularly enjoy the process? For example,if you spend ¤5000 on a trading course only to find that it is significantly sub-standard you will continue to try to get your money’s worth even though youwill suffer a double blow. You have foolishly spent money on a useless course


and then spent two weeks of wasted time and effort (when perhaps you couldhave been earning at work). The sensible thing to do would have been to cutyour losses short. That is to simply lose your money, and forget about attendingthe course.

Prospect theory was put forth by Tversky and Kahneman (1979), which cangive us insights into why traders do not cut their losses short. According toprospect theory, people value a certain gain more than a probable gain withan equal or greater expected value, the opposite is true for losses. Gains andlosses are evaluated from a subjective reference point. The function relating tothe subjective value and the corresponding losses is steeper than that for gains.As a result the displeasure associated with the loss is greater than the pleasureassociated with the same amount of gains. Therefore, people respond differently,depending on whether the choices are framed in terms of gains or in terms oflosses. The most famous and robust example of framing effects was illustratedby Tversky and Kahneman’s Asian Disease Problem.

Problem 1

Imagine that the UK is preparing for the outbreak of an unusual strain of Asianflu, which is expected to kill 600 people. Two alternative programmes to combatthe disease have been proposed. Assume that the exact scientific estimates arethe consequences of the programmes as follows:

Programme A: If Programme A is adopted, 200 people will be saved (72%).

Programme B: If Programme B is adopted, there is a one third probability that600 people will be saved, and a two thirds probability that no people will besaved (28%).

Which of the two programmes would you favour?

Tversky and Kahneman (1979) found that the majority faced with this problemwas risk aversive: the prospect of saving 200 lives with certainty was morepromising than the probability of a one in three chance of saving 600 lives. Thisrisky Prospect B was of equal expected value as the first Prospect A.

A second group of respondents were given the same story of the Asian fluproblem but were provided with different programme options.

Problem 2

Programme C: If Programme C is adopted 400 people will die (22%).


Programme D: If Programme D is adopted there is a one third probability thatnobody will die, and a two thirds probability that 600 people will die (78%).

Which of the two programmes would you favour?

The majority of respondents in the second problem chose risk taking: the certaindeath of 400 people is less acceptable than the two in three chance that 600 peoplewill die. Prospect theory predicts how people would behave within each frame.

Let us now apply prospect theory to subjective decision weights. The followingdecisions represent a psychological study of risk and will illustrate the biases oftraders and investors. Before looking at the answer to these decisions write downyour preferences to the following choices:

Decision 1

Which would you prefer?

A. A sure profit of ¤900; orB. A 95% chance of a ¤1000 profit and a 5% chance of no profit?Write down your preference

Decision 2

Which would you prefer?

A. A sure loss of ¤900; orB. A 95% chance of a ¤1000 loss and a 5% chance of no loss.Write down your preference

Decision preference analysis

Research by Tversky et al. indicates that 75% of people are risk aversive in therealm of profits and risk seeking in the realm of losses.

Risk aversion in the realm of profits means that they would prefer the suregain of ¤900 to a wise gamble.

Risk seeking in the realm of losses means that people would prefer a gambleto a sure loss.

The research suggests that most people would pick A for Decision 1 and Bfor Decision 2. In Decision 1 we prefer the sure gain to the wise gamble thatmathematically has a higher expected outcome. In Decision 2 the sure loss, even


though it is the smaller loss, seems worse to us than an unwise gamble, whichwill probably result in a bigger loss.

What are the implications of these findings for traders?

First, each preference violates a fundamental law of trading: “TO CUT LOSSESSHORT AND LET PROFITS RUN”.

If you pick the sure profit over a wise gamble, you are not letting your profitsrun. If you pick the unwise gamble over the sure loss you are not cutting yourlosses short.

Second, our natural inclinations go against the mathematical probabilities ofeach situation. Imagine you were faced with these two decisions 100 times each,you always pick the sure gain and always gamble against the sure loss:

1. You make ¤900 × ¤100 = ¤90 000 profit.2. You also lose ¤1000 × 95 = ¤95 000 loss.

By following your natural inclination to take sure profits and gamble againstlosses you will have a net loss of ¤5000. We have already discussed the sunkcost error, which is the refusal to abandon a useless project in which a sumof money has been invested. The sunk cost error arises because people fail torealise that all that matters is their future gains and losses. The past is irrelevantand if I will lose finances by continuing an activity in the here and now, Ishould discontinue it no matter how much I have already invested. The errorsdescribed here are made in decisions regarding trading and everyday life and canbe regarded as arising out of misplaced consistency.

Another form of misplaced consistency was demonstrated by Festinger andCarlsmith (1959). People who are persuaded to do something distasteful orimmoral have to justify themselves by inventing a reason for having done it.If they are given a large reward for their action that may be reason enoughbecause they only have to justify themselves if the reward is not large enough tocompensate for the distasteful act.

COMMON BIASES AFFECTING TRADERS

We have already discussed perceptual biases and how they influence traders’behaviour in relation to the market and to everyday life. There are a few com-mon biases that I see occurring on a regular basis, which I believe deservespecial attention.

The self-deception bias

We discussed self-deception earlier where traders distort their thoughts aboutreality in order to make themselves feel more comfortable or happier. We typically


feel that we are special and an exception to the case. For example, we all knowthat 90% of all traders fail and yet all traders consider themselves part of the10% who would be winners. In everyday life, seriously ill patients who are givena very low probability, say a 20% chance of surviving a further five years, willbelieve that they are an exception to this statistic.

The halo effect

We discussed the halo effect in detail earlier but there is a common mistake thatnovice traders make which I will share with you here. I was invited to give apresentation on the psychology of trading at a seminar organised by Tom Williamsand his staff at Genie Software. At the end of the technical presentation by TomWilliams, a member of the audience asked: “are you a millionaire yet fromtrading your system and, if not, why not?” Having read this chapter, the readerwill probably see the bias at work here. First, we should focus on developingdiscipline and making low risk and high probability trades. Second, I know anumber of millionaires who have come to trading as a second profession or as ahobby. These people have made their millions elsewhere and tend to lose largesums regularly to the market. However, the seminar attendee who asked theabove question would immediately assume the man driving the Rolls-Royce isa successful trader (the halo effect). I personally know at least five traders whoare highly successful, trade within their small means, and have regular profitablereturns. One of these successful traders drives a seven-year-old Fiat!

The stereotypical or representativeness bias

Earlier in this chapter we discussed the formation of stereotypes and how theyare used as a shortcut (also known as a heuristic) to forming our beliefs andmaking a decision about the person. We tend to imagine that what we see orexpect to see is typical of what should and will occur. We are often unaware ofthe possibility of unusual events occurring.

This stereotypical or representativeness bias is influential when it comes toassessing the performance of various trading systems or trading signals. Whatcriteria do you use to evaluate the efficacy of your trading system or signals?Did you consider the validity of the data or information upon which you devel-oped your system to be valid? Have you assessed the percentage of signals thatare correct by virtue of achieving your predicted outcome? Your criteria for tak-ing a long or short position in the market is your way of representing tradingopportunities; it is not the opportunity per se. In addition the indicators that youuse – be it an oscillator, trend-following indicator, or a testing of the market onlow volume – merely represents a potential trading opportunity for you. It is notthe opportunity itself.


Sampling bias or law of small numbers

Traders often observe small samples and assume that these samples represent thepopulation as a whole. How many trading decisions have you made based onseven or eight observations of the market that you now assume to be true? It islikely that those trading decisions based on that sample will work in the shortterm but certainly will not with any consistency.

How much back testing does a trader need to decide that the chosen methodof making trading decisions is worth following? The standard in statistics is tohave a minimum of 30 samples; however, it is probably most appropriate thatyou should use enough data to adequately know the true probability rate of yoursystem under the market conditions in which you will be trading. You will onlyhave adequate findings when you scrutinise the performance of your system underbullish, bearish, and neutral conditions.

The availability error

We discussed this earlier in the chapter and we now understand that traders makepredictions based upon how available the information is to us instead of the trueprobability rate in the population. Coinciding with the millennium most of themajor market indices reversed from a bull trend in a very speedy manner, andlocked many traders into long positions and significant losses. The fact that themarket reversed and plunged is immediately available in our minds and manytraders simply took their losses and left trading permanently.

Information bias

We discussed earlier that traders and people in general would pay attention toinformation that is colourful and interesting by comparison to truthful yet insipidstatistics. Also there is a limit (seven + or − two bits of information) on ourcapacity for processing. Upon what information have you based a decision toinvest in a particular stock or speculate on an index? It is likely that you will beinclined to invest or take positions in a market that you think about most. Youmay be thinking about a particular index because of some information that youhave received in the environment. It is likely that you will think of current marketconditions for the stock or instrument you are trading as possibly recurring whenyou are trying to predict the future activity of that market.

The framing of losses

Frames of reference are a form of belief that influence the way you perceive theworld. Framing can be accurate or self-deceptive and we will look at a coupleof examples of self-deception.


Prospect theory demonstrated how we are inclined to let our losers run. Byfollowing our natural inclination in the earlier example, we suffered a ¤5000 loss,and had this been a real case we would have justified it to ourselves by saying thatthe loss was not really a loss. How do you interpret paying for insurance? Is thissimply a business expense? What about the cost of trading courses, commissionsto brokers? It is my view that any expense, no matter what for, should go on theliability side of your yearly profit and loss account.

With regards to costs of items, framing is also important to our perceptionof value. Many traders will accept a ¤500 loss on a ¤10 000 position but willfind a ¤500 loss on a ¤2000 position hard to bear. The two losses are the sameamount but the percentage of the second loss (25%) is much higher and thereforeis perceived as much more. The same perceptual bias is at work during Januarysales. Many people would drive 15 miles or so to save ¤10 on a ¤40 pair of jeans.They would not do so, however, to save ¤10 on the cost of a ¤1000 television.The saving is exactly the same at ¤10 as would be the cost of petrol to drive.People are biased to perceive the percentage of a saving as more.

SUMMARY CHAPTER 5

• Many traders hold a belief that intense emotions are the major cause ofclouding judgement and impeding appropriate action. Although this is afactor, it only provides a cursory explanation. The major cause of poorjudgement and inappropriate action is because traders are unable to takeinto account all the relevant factors during analysis and are influencedby perceptual biases. These biases have been identified through empiricalresearch in the discipline of cognitive psychology and are being appliedby economists, investment banks, and related disciplines.

• Errors of judgement occur for many reasons. Markets are complex andtraders have limited information and processing capacity. Many neglectelementary concepts in statistics and basic arithmetic.

• Traders distort thoughts about reality to make themselves feel better ormore comfortable. Wishful thinking is one aspect of reality distortion. TheSanta Claus syndrome is introduced to describe the unrealistic thoughtprocesses of traders using black box systems with no specific technicalunderstanding of the rationale behind buying or selling signals.

• False beliefs are consolidated by the processes of denial, discounting, dis-tortion of the facts, and avoidance of applying the principle of analysisand refutation.

• Systematic and avoidable biases in thinking had been identified and studiedby cognitive psychologists. This chapter discussed the findings in relationto market trading and investment. The biases discussed are the availabilityerror, primacy error, recency effect, halo effect, devil effect, misplacedconsistency theory, the sunk cost error, and prospect theory.


• Related biases identified by experimental and social psychologists werediscussed in relation to group and individual processes. The chapter dis-cussed the risky shift and herd behaviour, psychological facets of per-suasion, cognitive dissonance, information bias, framing of losses, andsampling biases.

6Emotions, Emotional Intelligence,and the Trader

‘‘Why do you want to shut out of your life any uneasiness, any misery,any depression, since after all you don’t know what these conditions aredoing inside you?’’

Rainer Maria Rilke(Letters to a young poet)

When asking traders to define emotions many identify the emotions they experi-ence most while actively trading the market, such as fear, greed, anger, happiness,and a general state of excitement. Almost all traders are of the view that emo-tion kills successful trading. Some traders hold the extreme belief that emotionsmust be denied and suppressed, not merely controlled. I suspect that many of mytrader colleagues were nurtured as children on the first few series of Star Trekand perhaps had the ambition to grow pointed ears. Even Data in the more recentseries has his emotional reflections. So I am hoping that this chapter on emotionswill provide us with a better understanding of the role and function of emotionsin trading and in everyday life. The notion that “emotion kills successful trading”is a well-quoted phrase which needs to be challenged. This chapter demonstratesthe mechanism, role and function of emotions in the trading context and recentresearch asserts the value and goal directed nature of emotions.

I am grateful to Professor Keith Oatley, Head of Psychology at Toronto Uni-versity, and Professor Jennifer Jenkins, Senior Lecturer at the same universityfor their permission to use their book entitled Understanding Emotions (2000).Oatley and Jenkins are two of the world’s foremost educators and researchers inthe field of psychology and emotions, and part of this chapter is based on their


work. I am also grateful to Dan Goleman, author of the best selling book entitledEmotional Intelligence and more recently The New Leaders upon which the finalpart of this chapter is based.

Clearly there is ambivalence towards our belief about emotions and their value.On the one hand, emotions are what make us human such as love – of parents,of lovers, of children, of friends; and we readily accept that some emotions arethe foundations for compassion and heroic acts. On the other hand, we distrustemotions. We wonder about anger, contempt, and fear as destructive forces. Theseelements destroy our trading, our peace of mind, devastate families, and elicitwar between communities and between nations. There is greed, which drivestraders to make irrational actions and which makes for endless misery amongpowerless minorities. There is shame and humiliation, which drive people torage and desperate acts. Jenkins et al. (1998) comment that thinkers, writers, andresearchers on emotions have believed down the ages that there is something bothprofound and non-obvious about emotions, about how they arise, about how tounderstand them, and about how to deal with them.

Ancient Greek philosophers laid the foundations for modern European andAmerican psychology of emotions. Plato (427 to 347 BCE) wrote popular andinfluential philosophic writings consisting of a series of dialogues in which thediscussions between Socrates and others are presented with erudition and charm.Plato had thought that emotions are like drugs, that they pervert and distortreason. This assumption permeates the beliefs and attitudes of traders today andhas influenced the thinking of Victorian scientists. For example, the works ofDarwin and James imply that emotions are merely biological events like a coughor a sneeze with no meaning, and that they are the opposite of thinking. Aristotle(384 to 322 BCE) is the best known of Plato’s students and his contribution tothe understanding of emotions is significantly different to that of Plato and ismore in line with the findings of recent research into emotions. Aristotle’s mostfundamental insight was that emotions are connected with action, and that theyderive from what we believe. Aristotle’s book The Nicomachean Ethics is aphilosophical enquiry into virtue, character, and the “good life”. Our passions,when they are exercised, have wisdom, they guide our thinking, our values, oursurvival. But they can easily go awry, and do so often. Aristotle’s view was thatthe problem is not with emotionality, but with the appropriateness of emotionand its expression. Aristotle’s challenge is to manage our emotional life withintelligence.

If you wish to offend a trader or to dismiss what another person says, you cansay that the person is just being “emotional”, meaning in this context “irrational”.Emotions are often considered as impediments to correct action in trading andas destructive by comparison with the constructive products of thoughtful con-sideration. Darwin (1872) implied that in human adults, expressions of emotionsare obsolete, vestiges of our evolution from the beasts and of our developmentfrom infancy. However, there is a contradiction in our culture in that emotions

Emotions, Emotional Intelligence, and the Trader 153

are also seen as the very guarantee of authenticity and act as a window to thesoul and guide us to our true selves. Both distrust of emotions and affirmationof their value are constructs of western culture.

Oatley and Jenkins (2000) argue that in the realm of emotional life it is inap-propriate to ask to what extent emotions are a product of cultural or innatecharacteristics and they comment that these sorts of questions were popular inthe days of behaviourism when the view was the environment can programmebehaviours into a person who is a tabula rasa (blank sheet) waiting to be filled.They argue that humans are genetically provided with a start-up programme ofinnate patterns, distinctive abilities, and biases. In trying to understand emotionsthey believe that there are innate bases and the appropriate question to be asked ishow they are built upon and differentiated by cultures. Just as there are universalanatomical traits of humanity such as a skeleton that supports upright walking, sothere are universal psychological traits such as attachment between mothers andoffspring, the ability to learn language, and the sharing of food (Brown, 1991).

Scientists were previously of the view that lower animals’ actions were based oninstinct, while human actions were based on intelligence and learning. Researchover the last six years has shown this to be quite wrong. Not only do non-humanmammals learn exceptionally well but human behaviour is strongly influenced bygenetic patterns in the same way as other “lower animals”. If we feel unhappi-ness and possibly despair from the loss of a parent or lover, our feelings, pos-tures and actions are based on genetically based tendencies called “attachment”.Lorenz (1937) demonstrated the genetic basis of instincts in Greylag geese and thatbehaviour had a genetic basis, like anatomical features, which are characteristic ofa species. In the twenty-first century, the language has changed and most biologistsnow speak of “species-characteristic” or “species-typical” behaviour patterns. Theterms “instinctive behaviour” or “instinctual behaviour” are rarely used, if at all.

There has recently been a revolution in the way psychologists view emotions.They have traditionally been regarded as extras in psychology and not seriousmental functions like perception, language, thinking, and learning. Psychologistsnow view emotions as the very centre of human mental life. Campos et al. (1994)described emotions as being those processes which “establish, maintain, change,or terminate the relation between the person and the environment on matters ofsignificance to the person” (page 285). In other words, emotions link what isimportant for us to the role of people, things and events (trading the market).

Let us discuss some research in neuropsychology and one of the earliest andmost famous historical studies comes from the remarkable case of Phineas Gage,a 25-year-old construction foreman employed by the Rutland & Burlington Rail-road in Vermont, USA. In 1848, while he was preparing a hole for blastingpowder, an accidental explosion drove an iron-tamping rod (weighing 13 1

4 lb,3 1

2 ft long, and 1 14′′

in diameter) through Gage’s left cheek and out the front sideof his skull. Gage fell to the ground, but to the astonishment of his fellow work-ers who assumed he was near death, he sat up and asked for his tamping rod.


He was taken to a local hotel in an ox cart and was attended by a physician, DrHarlow, who later described the events immediately surrounding the accident andthe long-term changes in Gage’s behaviour. The rod was smeared with pieces ofbrain and Dr Harlow found that he could pass the entire length of his index fingerthrough the 3 1

2′′

opening in the frontal bone “in the direction of the wound in thecheek, which received the other finger in like manner”. To everyone’s amaze-ment, Gage recovered. Before the incident, Gage had been softly spoken, wellliked by the workers, and one of the railroad’s most reliable foremen. Harlowdescribed his patient after he recovered from his physical disabilities:

general appearances good; stands quite erect; with his head inclined slightlytowards the right side; his gait in walking is steady; his movements rapid,and easily executed . . . his physical health is good, and I am inclined tosay that he has recovered. He has no pain in his head, but says it has aqueer feeling, which he is not able to describe. He is undecided whetherto return to work or to travel. His contractors, who regarded him as themost efficient and capable foreman in their employ previous to his injury,considered the change in his mind so marked that they could not give himhis place again. The equilibrium or balance, so to speak, between his intel-lectual faculties and animal propensities, seems to have been destroyed.He is fitful, irreverent, indulging at times in the grossest profanity (whichwas not previously his custom), manifesting but little deference for his fel-lows, impatient of restraint or advice when it conflicts with his desires, attime pertinaciously obstinate, yet capricious and vacillating, devising manyplans of future operation, which are no sooner arranged that they are aban-doned in turn for others appearing more feasible. A child in his intellectualcapacity and manifestations, he has the animal passions of a strong man.Previous to his injury, though untrained in the schools, he possessed a well-balanced mind, and was looked upon by those who knew him as a shrewd,smart businessman, very energetic and persistent in executing all his plansof operation. In this regard his mind was radically changed, so decidedly sothat his friends and acquaintances said he was “no longer Gage”.

Gage flitted from one task to another and wandered to different places includingChile in South America for the purpose of establishing a line of coaches in thevicinity of Valparaiso and Santiago. He eventually returned to the US and died inSan Francisco in 1861 after a brief succession of what appeared to be epilepticseizures. Hanna Damasio and colleagues (1994), using computer methods withGage’s skull, determined that the region of his brain that was destroyed was thelower middle part of the frontal lobes. Dr A. Damasio (1994) and his colleagueshave now studied many patients with this kind of damage to their frontal lobesand have noticed that, like Phineas Gage, their emotions seem blunted. Alongwith the emotional deficit, frontally damaged patients have great difficulties inplanning ordinary life: they make disastrous social decisions – such as associating


with the wrong kinds of people – while dithering endlessly over issues that areinconsequential.

BRAIN PHYSIOLOGY AND EMOTIONAL DEVELOPMENT

Over many years of evolution the brain has grown from the bottom up, with itshigher centres developing as elaborations of lower, more ancient parts. The mostprimitive part of the brain shared with all species that have more than a minimalnervous system is the brain stem surrounding the top of the spinal cord. Thisbase brain regulates basic life functions like breathing and the metabolism of thebody’s other organs as well as controlling stereotyped reactions and movements.This part of the brain cannot be said to think or learn. It is a set of pre-programmedspecies-specific regulators that keep the body running as it should.

From this primitive route, the brain stem, emerge the emotional centres. Overmillions of years of evolution, these emotional areas evolved the thinking brainor “neocortex”, which is the great bulk of convoluted tissues that make up thetop layers of the brain. The fact that the thinking brain grew from the emotionalcentres reveals much about the relationship of thought to feeling; there was anemotional brain long before a rational one (see Figure 6.1).

The most ancient route of our emotional brain is in the sense of smell or, moreprecisely, in the olfactory lobe, the cells that take in and analyse smell. From theolfactory lobe the ancient centres for emotion began to evolve eventually growinglarge enough to encircle the top of the brain stem. With the evolution of the firstmammals came new key layers of the emotional brain. Because this part of thebrain rings and borders the brain stem, it was called the “limbic system” from“limbus,” the Latin word for “ring”. This new neural territory added emotions tothe brain’s repertoire (see Figure 6.1).

As the limbic system evolved it refined two powerful tools: learning and mem-ory. These revolutionary advances allowed an animal to be smarter in its choicesfor survival and to adapt to change in demands rather than having species-specificautomatic reactions. If, for example, food led to sickness, it could be avoided nexttime. Decisions like knowing what to eat and what to spurn are still determinedlargely through smell; the connections between the olfactory lobe and the limbicsystem now took on the task of making distinctions among smells and recognis-ing them, comparing a present smell with past ones and so discriminating goodfrom bad.

The idea that the limbic system is the brain’s emotional centre was introducedby neurologist Paul McLean more than 40 years ago. Joseph LeDoux (1993)refined the limbic system theory showing that some of its central structures likethe hippocampus are less directly involved in emotions while circuits linkingother parts of the brain – particularly the pre-frontal lobes – to the amygdalaare more central. There is a growing recognition among scientists that each


LEFTFRONTALLOBE

AMYGDALA

THE LIMBICSYSTEM

HIPPOCAMPUS

SPINAL CORD

THEBASALGANGLIA

HYPOTHALAMUS

THALAMUS

SENSORY CORTEXMOTOR CORTEX

FRONTAL LOBE

TEMORAL LOBE

PARIETAL LOBE

OCCIPITAL LOBE

Figure 6.1. The brain and limbic system

emotion may call on distinct brain areas. The most current thinking is that thereis not a neatly defined single “emotional brain”, but rather several systems ofa circuit that dispose the regulation of a given emotion to the far flung, butco-ordinated parts of the brain. Neuropsychologists predict that once mapping isat an advanced stage, it is highly likely that each major emotion will have itsown topography; in essence, a distinct map of neuronal pathways determining itsunique qualities though many or most of these circuits are likely to be interlinkedat key junctures in the limbic system, like the amygdala and pre-frontal cortex.


The pre-frontal lobes of the left and right hemispheres of the brain have anequal, important, and central role in the management of emotions. We knowtraders who are naturally easy-going and light-hearted while others are dour andmelancholic. These continuums of temperament such as ebullience at one endand melancholy at the other, appear to be linked to the relative activity of theright and left pre-frontal areas, the upper layers of the emotional brain. Thisinsight has emerged from the work of Richard Davidson at the University ofWisconsin, who discovered that people who have a greater activity in the leftfrontal lobe compared to the right are by temperament cheerful, typically takedelight in people, in what life presents them with and bounce back from bothemotional and cognitive tasks that may be frustrated. Those with relatively greateractivity on the right are given to negativity and sullenness and are easily phasedby life’s difficulties; and in a sense they seem to suffer because they cannot turnoff their worries and depressions. Davidson studied people who have a historyof clinical depression, and found that they had lower levels of brain activity inthe left frontal lobe, and more on the right than did people who had never beendepressed. This statistically significant finding was replicated also in patients withnewly diagnosed depressive illness which may be acute (temporary). Davidsonspeculates that people who overcome depression spontaneously increase the levelof activity in their left pre-frontal lobe.

Emotions can be seen as the guiding structures of our lives. The term “mood”refers to an emotional state that usually lasts for hours, days, or weeks. Exactlywhen moods commence or cease can be unclear. However, episodes of emotiontypically have an object (they are intentional); moods are often objectless, free-floating experiences. Frijda (1993a,b) has suggested that this distinction may bethe best way of differentiating emotions and moods. Both involve readiness:an emotion episode tends to change the state of readiness for action; moodsmaintain such states and resist change. When you’re in a sad mood, for instance,an invitation to go out and enjoy one’s self is resisted. We do not always tryto create an effective state that is most pleasant. Emotional disorders such asdepression and anxiety states last for months or years; personality traits alsohave an emotional quality, and can last a lifetime. One of the unresolved issuesin emotional research is what emotions are made up of.

LEARNING AND EMOTIONS

Experiments by LeDoux et al. (1990) use Pavlovian conditioning which is con-sidered to be the basic mechanism of learning about the significance of events thatsignal something pleasant or unpleasant. It is thought of as learning the temporalstructure of what causes important events relating to goals. The standard arrange-ment involves two stimuli – one is called the condition stimulus; it is the onewhose significance will be learned, perhaps a flashing light or an auditory tone.


For the experiment it has no significance other than being noticeable. Then thereis the unconditioned stimulus that has the biological significance – somethingrewarding like delivery of meat powder to the mouth of a hungry dog as inPavlov’s original experiments (Pavlov, 1927), or something nasty like an elec-tric shock.

What is learned in Pavlovian conditioning is not a response as such, and notthe association of two stimuli. It is an emotion about what signals the importantevent: readiness for something pleasant (happy anticipation), or for somethingunpleasant (fear or anxiety).

Such emotional effects are expressed as species typical actions, for example adog jumping, wagging its tail, and salivating when it sees its meal being prepared,or the same dog freezing, slinking, cringing, and struggling to escape whenthreatened. In market trading, traders are exposed on a daily basis to loss, whichin itself can be a negative experience. Emotional conditioning for negative stimuliis quick to be learned and slow to extinguish – one of the reasons why anxietycan be such a severe and long-lasting disorder in traders who have not developedthe discipline to cope with the stresses of market trading.

THE ROLE AND FUNCTION OF EMOTIONS IN TRADINGAND EVERYDAY LIFE

Having a general understanding of the role and function of emotions is a valid areaof study for traders because scientific studies have acknowledged that emotionsare indispensable to the process of making rational decisions during trading andin everyday life. Emotions have other related, yet equally important functionssuch as their role during individual development and in the co-ordination of ouractions with others. In this section we will examine the role of emotions withinthe context of decision making and cognition in general.

The nineteenth century founders of research in the field of emotions did notthink emotions would be useful. Charles Darwin viewed emotional expressionsas patterns of behaviour that had some function in our evolutionary past that nolonger served a purpose. William James, considered by some to be the founderof modern psychology, thought that emotions were perceptions of inner states,but with no immediate effect on action because they occurred following theproduction of context appropriate behaviour. We now know that emotions areimportant, not only in terms of evolutionary significance, but also during indi-vidual and social development. For traders the significance of emotions lies inthe two main cognitive properties of emotions: (1) the management of action and(2) the structuring of the cognitive system into distinct modes of organisation.The effects of this structuring are to modify perception, to direct attention, to givepreferential access to certain memories and to bias thinking. Box 6.1 outlines therole and function of emotions during the process of trading.


Box 6.1 The role and function of emotions in trading

• To assist in the management of action.• To structure the cognitive system into distinct modes of organisation:

– to modify perception– to direct attention– to give preferential access to certain memories– to bias thinking.

Definition of emotions

The definition of emotions has been a challenge to the discipline of psychol-ogy, and any current definition of emotions is likely to change with contributionsfrom ongoing research. Mandler (1984) complained that “too many psychologistsstill fail to accept today, that there is no commonly, even superficially, accept-able definition of what a psychology of emotion is about”. Oatley and Jenkins(2000) point out that definitions in science are really working definitions andthat we need not worry about people having different views since these viewsusually provide an orientation rather than a definition. However, the most widelyaccepted working definition asserts that emotions are at the very centre of humanmental life.

A generally agreed working definition of emotions is as follows:

1. An emotion is usually caused by a person consciously or unconsciouslyevaluating an event as relevant to a goal that is important; the emotion isfelt as positive when a concern is advanced and negative when a concernis impeded.

2. The core of an emotion is readiness to act and the prompting of plans;an emotion gives priority for one or a few kinds of actions to which itgives a sense of urgency – so it can interrupt, or compete with, alternativemental processes or actions. Different types of readiness create differentoutline relationships with others.

3. An emotion is usually experienced as a distinctive type of mental state,sometimes accompanied or followed by bodily changes, expressions,actions.

Let us now look at a situation during our trading where this definition mightapply. Imagine that you are showing a friend your trading system and duringthat demonstration you decide to place an order for three contracts long in stockindex futures. You have described the process that occurred prior to taking this


action. You describe the Tactical MOT, you take ACTION appropriately and thetrade progresses in the direction of your calculated probabilities and low riskplan. Feeling confident about this trade, you take your friend to the next room tomake copy and have a general discussion of your trading strategy and unrelatedmatters of mutual interest. You return to your trading desk 15 minutes later tofind that a major reversal has occurred and that you forgot to place stops in yourorder entry system. You immediately disengage from your conversation, you findyour heart pounding, and you are thinking that you could have severely damagedyour account. You resolve to be more careful and not to get so deeply involvedin a pleasant yet distracting conversation during trading hours.

The event is evaluated as important; priorities are changed, interrupting yourprevious actions. You are shaken bodily and you make plans about future actions.

Emotions in the management of action

Traders report that the emotions of anger and fear are the most pernicious anddifficult of emotions to deal with. Many believe that these emotions are dysfunc-tional and only serve to sabotage appropriate behaviour. This is not always soand if we examine the role of pain in the management of action, it functions toprotect the body from further injury, the intense unpleasantness and exclusion ofother issues means the matter is important.

Anger

Anger is the emotion of asserting ourselves in dominance. It is the emotion offrustration when it seems we cannot put in a correct trade or when people in ourlives who show a lack of consideration or who are perceived to be sabotagingour trading or any goal in general. If a goal that is obstructed looks as if itcould be reinstated, anger makes us try harder. For example, we can perceive amistake in our trading, become angry, mainly with ourselves, and learn from themistake provided the anger does not turn into self-denigration. Berkowitz (1993)has shown in many experiments that anger can be induced by subjecting peopleto restraints or to pain, and it prompts aggression either towards the person whois being frustrating, or to someone else who happens to be a convenient target.We are well aware of this bias and commonly call it “scapegoating”. The formalpsychological term for this and related phenomena is “misattribution”.

On the positive side, we can all identify when some angry arguments haveled to a renegotiation with friends, relations, or associates, when we have beendisappointed for some reason. On the negative side, we trade impulsively whenangry and sabotage our account.


Fear

Fear is the emotion of anticipated danger. We will remember the “fight-or-flight”response discussed in Chapter 4 on stress. This response occurs when a threat isperceived in the environment, or when there is a lack of resources to address anincident or to respond effectively. Fear promotes vigilance for the feared event,and it monopolises attention. Kalin (1993) identified a number of emotionalresponses in lower primates and one response is for mammals to freeze whenthere is a perceived danger. This is identical to the experiences of traders whofreeze when having suffered unnerving incidents in their trading.

Over the recent years, it has been discovered that a peptide called “chole-cystokinin” (CCK4) can induce fear, panic attacks, and free-floating anxiety inhumans and other mammals, without any perceived threat in the environment.The role of this peptide is currently being investigated in relation to patho-logical and enduring panic attacks and fear. Numerous traders have reportedexperiencing panic attacks, which include cognitive symptoms such as intenseapprehension, and bodily symptoms such as shortness of breath, dizziness, or theheart beating rapidly.

Effects of moods and emotions on cognitive functioning and trading

Moods and emotions can be seen as having two kinds of effect on the individual.The first effect is immediate: the core of an emotion is a change in readiness,making available a repertoire of actions that have previously been useful in thatcircumstance. Emotions usually last for a while and often extend into prolongedmoods. A second effect of emotions is to prompt us to search for possible plans:by changing cognitive organisation to help guide this search.

Emotions and perceptual effects

Psychologists have asked whether we are more tuned to receiving things that areconversant with our moods. Intuitively we think that this is true; however, sucheffects have been difficult to demonstrate scientifically. However, Niedenthal andSetterlund (1994) undertook a large series of experiments and found an effect ofselective perception of specific emotions of happiness and sadness. They played“happy” and “sad” music which did indeed put people into happy or sad moods.Following exposure to happy music, subjects were quicker at identifying happythan sad words when reading material of general interest. Conversely when sad,they were quicker at identifying sad than happy words. In Chapter 5 we revieweda number of perceptual biases and though there is very little scientific data toclaim that mood would increase the power of, say, the halo effect, it seems logical


that people in a good mood would look for good characteristics in whatever actionthey are undertaking and vice versa if they had a negative mood. It would make aninteresting experiment to see if traders took greater risks during “happy” or “sad”moods or if there were particular investor behaviours correlated with a range ofmoods. We know that the period of self-awareness (Tactical MOT) at the startof the trading day has been helpful to traders in assessing their comfort level.

Attentional qualities of emotions

We know that emotions have an affect on attention and this is particularly relevantto traders. You will recollect the two-component theory of Morris et al. (1970),when they demonstrated that stress consists of two components: emotionalityand worry. The effects of emotions on attention can be, for example, largelyunconscious processes of filtering incoming information because of consciouspreoccupation of the kind that we have when we worry.

The most fully researched effects of emotions on attention concern anxiety:it is clear that anxiety narrows attention. When traders are fearful or anxiousthey focus mainly on what they are afraid of, or on safety from this perceivedthreat, and they disregard almost everything else. For example, imagine you arehaving a day out with friends and you are sitting in the back seat of your friend’sspacious coupe with your partner. As the day progresses you decide to take aside route to visit a nearby lake. As you cross the wooden bridge it suddenlygives way and the car plunges 10 feet into ice cold water and the seating cabinis rapidly filling with water. It is likely that you would panic and start kicking atthe window beside you to attempt to break out, especially if it were an electricwindow which would by now be short-circuited from the water. You continuestruggling and kicking and would have no other thought on your mind except forescape from the vehicle. In less stressful circumstances you may have noticedthat your friend had opened the door and escaped to the surface. All you neededto do at this point was to push the release lever at the bottom of the seat, push theseat forward and make your own escape through the door. In these circumstances,it is likely that your attention had been so narrowly focused on the task at handthat even a simple task such as releasing the seat would not come immediatelyto your mind.

You will be able to think of many examples as a trader when circumstanceswent against you rapidly causing a fear response and you had no thoughts exceptto get out of the market quickly unless of course you “froze” with fear and wereunable to undertake any action. This is why discipline, mental rehearsal, anddeveloping and then practising your low risk plan is a very important aspect ofgaining confidence as a trader.

The “fight-or-flight” mode of mental processing is one in which attention isnarrowed, and directed to queues in the environment about threat and safety.


It is even more specifically tuned for queues related to particular objects of aperson’s anxiety. Easterling and Leventhal (1989) have demonstrated that peoplewho believe themselves vulnerable to cancer are induced to worry whenever theyexperience anything, including very un-cancer like body symptoms, that remindsthem of their vulnerability.

In the normal course of events the mechanisms of fear and anxiety have beeninvaluable to our survival but in an earlier chapter we discussed that stress andanxiety can occupy a trader’s cognitive resources, making the world a frighteningplace, undermining confidence, and preventing the trader from concentrating onmuch else.

Emotions and memory

The question for traders is whether intense emotions increase or decrease theaccuracy of what is remembered to act as a tool for learning more appropriateresponses to the market. Loftus and Loftus (1980) conducted a series of experi-ments where they gave people the following two statements and asked them tosay which better described their belief about how memory worked:

(a) Everything we learn is permanently stored in the mind, although some-times particular details are not accessible. With hypnosis or other specialtechniques these inaccessible details could eventually be recovered.

(b) Some details that we learn may be permanently lost from memory. Suchdetails would never be able to be recovered by hypnosis or any otherspecial technique because these details are simply no longer there.

This experiment found that 69% of the general public believe Statement (a). Itis a belief which has come under scrutiny with numerous cases portrayed in themedia about adults reporting sex abuse when they were children and with thehelp of a therapist they could now remember such incidents. From this arosethe controversial “false memory syndrome” and the issue is still being debated.There is no evidence that people can remember scenes in perfect detail, and withperfect accuracy, as if they were stored in some internal video recording. Thoughmemory is often good, even people with the most accurate memories make somemistakes. Moreover, there is evidence that features introduced after the event,for instance mentioned by other people or suggested by leading questions, areincorporated into memories, so that as far as the subject is concerned thesebecome indistinguishable from the real memory.

This has significant implication for traders because the ways of particulartrades, which are not contemporaneously recorded, will deteriorate over time andwill no longer act as appropriate tools for learning. These facts of memory arean excellent reason why traders should keep records of each and every trade.


A series of studies by Linton (1982) and later by Wagenaar (1986) showed thatany event that has emotional significance will be recorded far more accuratelyand in detail than events with little or no emotional content. This is a far cryfrom the school of traders who believe that emotions ruin trading. Researchindicates that events that have emotional significance are remembered as wellas discreet episodes. The common features which give emotional impact – theirimportance to a goal, their unusualness, their unpredictability, the absence ofpre-existing skills to deal with them – all make the event distinctive in memory.In addition, research indicates that pleasant events were recalled more accuratelythan unpleasant events. This implies that traders will remember their good tradesfar more readily and accurately than their bad trades.

The effects of moods on judgement

Psychologists have been able to demonstrate that moods bias thinking and affectjudgement. The psychologist G. Clore (1992) undertook a study on the affectsof moods on judgement and in his conclusion he stated: “The most reliablephenomenon in the cognition-emotion domain is the affect on mood on evaluativejudgment” (Clore, 1992, page 134). He was referring to evidence that when youare asked to judge something that’s good or bad to approve or disapprove ofsomeone, to accept or reject some course of action, to vote in this direction orthat, you do not solely weigh the facts. Life in general and the stock markets inparticular can be ambiguous and unpredictable. The research indicates that wemake judgements by combining what we know with how we feel.

What is worrying in this research is that moods can be manipulated quiteindependently of anything else. People assume that being offered employmentwould not be positively or negatively affected by the mood of the interview-ers. Traders think that they should not be influenced by their own mood whentrading or viewing demonstrations of particular trading systems. In fact softwarevendors attempt to enhance a positive mood by offering additional “freebies”to enhance the perceived value. If you can induce a happy mood and not givepeople too much time to think, you can incline a person favourably towardsyour product, independently of its merit or usefulness. The inclusion of moodsinto important judgements is explained by psychologists as “misattributions”: amood derived from one context has spilled into another to which it does notbelong. Many traders may have heard of the classic study by Schachter andSinger (1962) who found that subjects injected with adrenalin, which has anarousing effect, felt and acted happily if they did not know the physiologicaleffects of the injection, when they were put in a social context where they wereencouraged to feel happy. They felt and acted angrily when put in an insultingand frustrating situation. Emotion, or arousal, acquired in one situation can affectbehaviour and intensity of emotions in other situations, particularly if the people


concerned do not know the source of their mood. Clore (1992) has shown thatsome effects of mood on persuasion also work in this way: if subjects’ attentionis drawn to the source of an induced mood their judgements are less likely tobe affected.

An emotion is a response to a problem. It gives priority to one or a few goalsrelated to the problem and concentrates attention on it. Because of such effects,Dyer (1987, page 337) has called emotions “locally rational judgements” oftenmade quickly, without considering all implications. They have a certain feelingof involuntariness, of single mindedness, which we experience as authentic.

Previous ideas about emotions stressed their disruptive nature but modern sci-ence now asserts that, for the most part, they are functional. It is widely acceptedthat emotions are indispensable for rational thought, including the complex natureof developing and executing plans while trading the market.

EMOTIONAL INTELLIGENCE

I am grateful to Dan Goleman for allowing me to reproduce some of his ideas herein application to market trading. His two books, Emotional Intelligence (1995)and The New Leaders (2002), are wide-ranging accounts of the importance ofemotions in people’s personal, social, and working lives. The title “EmotionalIntelligence” was taken from an article published by Peter Salovey and JohnMayer in 1990 which showed the relationship between emotions and rationalthought. If we remember in the previous section the discussion of Phineas Gagewho, despite being fully intelligent, had made disastrous choices in his busi-ness and personal life, and even obsessed endlessly over decisions so simplesuch as going to the shop or making an appointment. The relationship betweenbluntness or lack of emotions and inability to make rational decisions has nowbeen well documented in many cases. Dr A. Damasio, a brain neurophysiolo-gist, has now published numerous research papers demonstrating that feelingsare typically indispensable for rational decisions; because they point us in theproper direction, where drawing logic can then be of best use. While the worldof trading confronts us with an unyielding array of choices and decisions thatneed to be made (do I go long or short? should I trade futures or stocks? shouldI abort my position?), the emotional learning that our experience has given us(such as memory of a disastrous trade or having made an excellent decisionbased on a market set-up) sends signals that streamline the decision by elim-inating some options and highlighting others at the outset. In this way, DrDamasio argues that the emotional brain is as involved in reasoning as is thethinking brain.

If you cast your mind back to your school days you will recollect that therewere a number of students who always seemed to get As and Bs and prob-ably just as many who got poor grades or maybe even failed. Some of those


“failures” may have gone on to excel in the business world such as developingtheir own gardening venture, perhaps becoming an expert builder, or a policeofficer. You may find that these so-called less intelligent students now have avery successful business or have obtained some high rank in the forces. Theymay have more affluence in its widest sense and in terms of personal happinessthan those so-called more “intelligent” students. The reason for these anomalies isbecause academics, teachers, and research psychologists have ignored the value ofemotional intelligence. These qualities of emotional intelligence are summarisedas follows:

• The ability to control impulses.• The ability to delay gratification.• The ability to motivate one’s self.• The ability to persist in the face of frustration.• The ability to regulate moods.• The ability to keep worry and fear from thwarting the decision process at

times of duress.• To empathise with others.• Not to lose hope and communicate hope to others.

These are the types of qualities which enable a trader to succeed where simplymore intelligence will not be of singular value.

Let us now explore two facets of emotional intelligence – “self-awareness”and “self-management” – which are key areas of required competence for trad-ing. The tactical model of trading competence has self-awareness as one of theprimary stages of preparation for trading. Self-awareness is much more than sim-ply preparing for the trading day and I refer the reader to page 60 where I haveoutlined emotional intelligence domains and associated competencies. Regardingthe section on self-awareness there are three main areas which are of relevanceto traders.

Self-awareness

Emotional self-awareness

Reading one’s own emotions and recognising their impact; using gut sense toguide decisions. Self-awareness to the trader means understanding one’s strengthsand limitations and one’s beliefs and motives. People with strong self-awarenessare realistic. Neither overly self-critical nor over-confident. They are honest withthemselves about themselves and they are honest with others to the point of beingable to laugh at their own foibles.

The brain constantly registers decision rules about what works and what doesn’tin trading. With the eagerness of a novice trader, the brain soaks up lessons to


better prepare him for the next time he faces a similar challenge and set ofcircumstances in the market. Goleman argues that this kind of learning goes onin a deep zone of the brain outside the reach of words, in the basal ganglia, aprimitive part of the brain atop the spinal cord (see Figure 4.1). Traders need tolearn to trust their intuitive side to access their life wisdom. The circuitry involvedin puzzling decisions, in fact, includes not just the basal ganglia, but also theamygdala, where the brain stores the emotions associated with memories. Whenit comes to drawing on a lifetime of silent learning as we face decision pointsin the market again and again, it’s not the verbal part of the brain that deliversthe best course of action. It’s the part that wields our feelings as demonstratedin the previous section. What Pavlov’s dogs learned was not an association oftwo events, it was the feeling or anticipation of a pleasurable event. Every daythat a trader gains more experience and takes positions in the market his brainautomatically extracts the decision roles that underline one turn of events oranother. Or the operating cause and effect sequences. As the brain continuallylearns in this classic mode, a trader accumulates the wisdom from a life’s on-the-job experience. This wisdom increases throughout a trader’s career even asthe abilities to pick up new technical skills may wane. We are all aware that ourability to learn technical information reduces as we grow older.

Accurate self-assessment

Knowing one’s strengths and limits. It is here that the self-aware trader will beable to utilise his trading diary and all related records to improving his perfor-mance in the market. For example, the self-aware trader may realise that he doesnot trade stock index futures particularly well. He may not have the ability totrade short time frames but realises this. He therefore develops a style of trad-ing more aligned to his own skills which would possibly be position trading ortrading stocks and shares.

Self-confidence

Self-confidence means a sound sense of one’s self-worth and capabilities. Thisform of self-awareness is having the confidence to know that you are able toundertake and succeed in achieving a long-term goal provided the resources andother necessary prerequisites are there to be used. Sometimes traders can focustoo much on what’s wrong and not what’s right. A trader with low self-confidencewill look more closely at gaps in ability, they assume they are less capable thanthey actually are, and therefore tend to distrust or dismiss positive feedback. Atthe other extreme we have overconfidence which causes perceptual biases and isdiscussed in Chapter 5.


Self-management

Goleman described self-management as an ongoing inner conversation which isa component of emotional intelligence that frees us from being a prisoner of ourfeelings. It allows the mental clarity and concentrated energy required in tradingand stops the disruptive emotions from throwing us off track with the subsequentloss of money.

The left side of the pre-frontal area, researchers believe, is part of a key circuitthat inhibits neurons in the amygdala, and so keep the person from being capturedby distress. This circuitry is essential in keeping a trader from taking inappropriateaction as a result of fear or anger and it calms emotions to maintain a confidentand enthusiastic approach to trading. Davidson (2000) – in this circuitry of theleft hemisphere is the essence of emotional self-control and of taming fear, thetrader’s Achilles’ heel.

Transparency

Transparency is displaying honesty, integrity, and trustworthiness. Traders whoare transparent live their values and beliefs. They have an authentic openness toothers about one’s feelings, beliefs and actions. These traders are able to openlyadmit mistakes or faults, and confront unethical behaviour in others rather thanturn a blind eye. Transparency is the ability to hold a deep belief that trading ispart of life’s purpose and is not dissonant with any other belief or value.

Adaptability

Adaptability is the ability to be flexible in adapting to changing situations orovercoming obstacles. A trader’s ability to be adaptable is related to the trader’smotivation and how he feels about learning. People learn what they want tolearn. If learning is forced on us, even if we master it temporarily just to sit atest, knowledge is soon forgotten. Some courses require traders to go through aone-size-fits-all trading development programme but a trader will only adapt tonew ideas if he truly wants to learn. There is no one path to trading success andthe trader will adapt to the changing personality of the market and learn newskills to apply in those circumstances.

Achievement

Achievement is the drive to improve performance and to meet inner standards ofexcellence. It is important for a trader to understand what he hopes to achieve and


through defining objectives he will arrive at standards of excellence. Chapter 8in this book suggests the standards of excellence required for successful trading.

Initiative

Initiative means readiness to act and seize opportunities. Successful traders areproactive, not only do they seize opportunities but they create them rather thansimply waiting for them. Traders with initiative have what it takes to controltheir own destiny. Such a trader does not hesitate to cut losses short and mayeven bend the rules a bit when necessary to create better possibilities for thefuture. This does not mean engaging in illegal acts. It means bending your owntrading rules when a set of special circumstances suddenly presents itself. Atrader with initiative recognises the difference between bending his trading rulesas a result of lack of discipline and bending them to meet an opportunity, whichmay be rare.

NEGATIVE EMOTIONAL STATES AND TRADING DECISIONS

We all create our own reality and our mental states through the beliefs weadopt as a result of our experiences. From the earlier sections in this chapteryou have gained an understanding of how we can be unconsciously influencedby our experience. Feelings are important in the organisation of our experi-ence and our memories are strongly linked to emotions and feelings. Tradershave problems coping with certain negative emotional and mental states. Whennegative states such as anger, fear, impatience, or frustration arise, traders findthemselves losing money or becoming ineffective and “stuck” in the market.Negative mental and emotional states have been the subject of much researchin psychiatry and psychology and Aaron Beck suggested two effective waysof coping with these states. The first is to stand back from yourself and listento your thoughts. Psychologists use the term metacognition to describe a per-son’s awareness of their thought processes, and metamood to describe awarenessof one’s emotions. This form of separating yourself from the negative thoughtand objectively viewing it gives you the opportunity to arrest a thought andreframe it in a more positive manner to avoid excessive worry, anxiety, orother negative states. The reframing of the negative state is an effective wayof moving yourself to a more productive state of mind, which is optimal fortrading.

In this section we will review some common emotional and mental negativestates that can act as an impediment to correct action. In addition we will lookat how to minimise the effect of those mental states and also look at how tooptimise positive mental states for trading the market.


Fear and anxiety

I am going to describe my personal experience of fear and anxiety because itwas a major problem that confronted me when commencing live trading for thefirst time. I seemed to be paper trading very well; making regular profits andfollowing six months of trading a particular system, method, and market I wentlive. I was one of the first traders in England to work with a direct order entrysystem and was trading the DAX regularly. The cost of an Internet connectionat that time was extortionate since in the 1990s very few people had static IPaddresses and I needed to find a company who would provide me with this facilityat a reasonable price. I then found out that the exchange that was leasing me thesystem did not have any training for home traders because there were only sevenof us at the time and they were more or less at an experimental stage.

This order entry system had two states of operation, the first was “live” in themarket and the second was in “training mode” off-line. There were approximatelyeight windows as part of the default setting and the way that you could tell thedifference between being live and being in training was to colour out a button andthen confirm on one of the eight screens your profit and loss balance. I intendedto trade the training mode for the first few days and placed my first trade – longtwo contracts of the DAX. The market at the time I took my long position wasundertaking a retracement on significantly low volume so I was unconcernedand went to make a coffee. When I returned the market was continuing itsretracement, which I had expected. My profit and loss account read approximatelyminus £850. I had foreseen the retracement though it was now approaching the60% retracement area on the 10-minute chart. I begin reading the training manual,which I had thought I had already digested yet found one error in my recollection.The profit and loss calculation only functions when you are live in the market. Ihad in fact been live from the start without realising it. Clearly I was at a loss andI went back to the original window that should tell me the exact price I enteredlong at and what my average for two contracts was. I could not find the screen.At this point I panicked because I had never lost so much money in such a smallspace of time in my life and I still was not able to master the trading discipline,which teaches you to accept losses as a step to success. I phoned up the salesrepresentative who sold me the system but he was unfamiliar with this “particularproblem” and could not tell me which screen would inform me of my position.He said the best bet would be to phone the live trading desk and they wouldhelp. I phoned up the desk and a very helpful dealer took me through a numberof windows to arrive at the stated position I had taken. To my horror we bothdiscovered that there was some corruption in the programme and that system wasnot working for me. At that point I was in such a state of fear and anxiety I evenforgot whether I had gone long or short in the market! Also, because I thought Iwas in training mode I had not bothered to write down the position, thinking ithad been logged by the system. By the time the dealer and I had gone through a


few alternatives my profit and loss calculator showed that I was in a profit nowof £480. I decided that I must have gone long on these two contracts and soldtwo to flatten the position. I was in a state of anxiety until the close of marketwhen I could get a statement of whether I had been long or short. The anxietyand fear of that one incident caused me to be fearful of all future trades and Imanifested the “frozen trader” syndrome. At one point I could not even executea trade let alone see it through to conclusion.

During the time of my trade I had a number of irrational thoughts and anxietiesrunning through my mind and I realised at that point my need for discipline andfurther training. Those irrational thoughts, which not only had to do with themarket but with all the circumstances surrounding my life, gave me a negativemental state which was carried forward in the first year of my trading. Pleasenote that the process of controlling negative mental states is similar for all typesso there will be some repetition.

Conquering fear and anxiety

I undertook training that taught me elements of meditation both passive andactive. If I feel anxiety during trading I breathe deeply into my abdomen, sitcomfortably but aligned in my chair and become mindful of everything in mysurrounding. The colours of the room, the flashing of the screen, the hum of thecomputers, the smell of cooking and I focus on each sense in rotation. Follow-ing two minutes or so I will let go of all thought and clear myself of mentaldebris. This is the essence of STILL meditation. I also adopted the ACTIONset of attitudes towards trading and it helped me tremendously. Whether a traderchooses to use ACTION, STILL, or any technique the most important thing is tobreathe deeply in a regular pattern, counting during breaths. I then went througha checklist and asked myself whether I was properly prepared, and what hadhappened to make me feel anxious. I adopted the disciplined attitude of seeingany negative action as a step to success.

The process to overcome symptoms of anxiety and fear while trading is to:

1. sit comfortably but erect in your chair;2. take deep breaths into your abdomen;3. be mindful of all that is in the room;4. let all the images and thoughts disappear for a few seconds; and5. once you are feeling more relaxed step outside your experience and look

objectively at the anxiety and fear and identify where it has come from andin that way you will be able to tackle the root rather than just the symptom;

6. plan how you might change the behaviour leading to the anxiety if asimilar situation occurs.


Regret

All traders in our initial stage of learning the trade will feel regret at missing anopportunity which with hindsight seemed absolutely obvious. It is as if we havelost the winnings for a trade that goes on without us because we failed to takeaction when we knew we should have.

Conquering regret

The process for resolving regret is:

1. step outside yourself and look at how regret is affecting your emo-tional state;

2. remember a trade that you put in that was successful and that you areproud of;

3. express gratitude that you are able to learn from this mistake;4. think on two alternative courses of action you could have taken to ensure

success;5. mentally rehearse the new behaviour and identify whether you have a

pattern that causes the negative state of regret.

Impatience

Some traders feel that they are always missing out if they take time off tradingand I felt this myself during the initial stages of my training. Some traders, evenwhen they have been experienced for 18 months or so, feel that a market shouldmove immediately in their direction as soon as they put a trade on. These tradersdo not follow their rules of monitoring or a stop loss and will often close out theirtrade thinking that they will save money because the market is in fact reversingrather than simply retracing. Having closed their position two hours later themarket sales through their abort point straight into the profit territory. The tradertakes another position. He sees the market reaching an area of resistance andcloses his position at a very small profit which is in fact less than his loss onthe previous trade. The market then breaks through this point of resistance andheads to the trader’s original target point. The trader has done four market moves(in-out, in-out), and is now feeling a bit angry at his inability to follow his rules.

Conquering impatience

1. Step out of your body and look at your feelings of impatience and theconsequences of your action.

2. Realise that impatience can be a product of boredom or a drive to completetasks as soon as possible.


3. Identify how you might have employed your trading rules better.4. Recall times that this has happened in the past and then recall times where

you have made a successful trade. What is the difference?

Impatience is what plants the seeds of compulsive trading, which we will discussin Chapter 7. Compulsive trading is a very serious problem for those who tradein this manner and for those who love or are friends of the compulsive trader.

Frustration

We have all had the experience of making money then losing it, making moremoney, then losing more money and so on. For some traders it seems that assoon as they correct a mistake in one area of their trading a different set ofproblems seems to reappear. The trader has tried everything, a written tradingdiary, screenshots of each and every trade, excellent use of the comprehensivemodel of trading, and yet still there is something going wrong.

Conquering frustration

The process to rid yourself of frustration is to:

1. step out of your body and look at yourself experiencing frustration. Whatis the root cause?

2. realise that negative feelings are often a signal for you to do somethingabout yourself or your environment;

3. identify alternative behaviours to the one that is causing your frustration.If you find that difficult to do you may wish to see a trading coach orexperienced trader.

Anger

We all experience anger at times when we lose amounts of money and we knowwe should have done better. I experienced anger and frustration regularly duringmy first year of trading and now that I look back I can see that it was my lackof discipline and generally my lack of experience as well. I hold a CFD accountwith a market maker in addition to the one described earlier. On one occasion Imade an excellent trade, closed out my position and felt very self-satisfied andthought that I could certainly become a full-time professional trader if this recentperformance was anything to go by. Following this trade the market plummetedand I felt even more self-satisfied that I took excellent and decisive action inclosing my position. When I finally returned to my trading desk and looked at


my order entry system I realised that I had left a stop in overnight which wastriggered by the retracement. Not only had I lost all my profits but I had givenmore to the market makers. I was very angry for making such a silly mistake andin fact it happened more than once. I have now developed a method of reviewingall resting orders.

Conquering anger

The way to rid yourself of anger is to:

1. step out of your body and look at yourself being angry;2. adjust your posture if you are sitting and breathe deeply into your

abdomen;3. ask yourself whether recurrent anger serves any purpose apart from upset-

ting you? You will most likely answer “no”;4. identify your trading rule that you violated that led to this loss;5. identify a new set of behaviours to ensure that this loss does not occur

again;6. mentally rehearse the new form of behaviour;7. go for a walk if you are still feeling angry.

In the previous section we looked at emotional intelligence and specifically atself-awareness and self-management. Emotionally intelligent behaviour is sup-portive of mental states that improve not only your trading but your life ingeneral. Following identifying a negative state you may wish to try to replace itwith a more supportive state. Many psychotherapists suggest the following stepsto ameliorate negative feelings and introduce new and more appropriate feelings:

1. Actively reframe your negative emotion by seeing what lesson can belearned from your circumstances. You may be able to learn somethingabout the market, about the way you make decisions, or even identify apattern of self-sabotaging behaviour.

2. Remember a time when you had felt very good about something andthe kinds of behaviours you showed at that time. It can be any positiveexperience – bring it clearly to consciousness.

3. If there is somebody you respect and who seems also to do the rightthing in the market or even in everyday life, imagine this person and howthey might react to the situation that caused you to become angry. Thisis modelling your behaviour on a person you respect.

4. Imagine yourself to have that enabling type of mental state and howit might feel. This is acting “as if” you were really happy, successful,winning as a trader.


5. Breath deeply and sit comfortably but straight to aid the breathing andimagine yourself having a positive mental state. Then act out the positivemental state.

The components of self-awareness and self-management can all be viewed assupportive mental states and I choose to discuss perhaps the three most importantfor traders. Optimism, initiative, and self-control.

Initiative

Traders with initiative are proactive. Go through the following steps to movetowards a supportive state:

• Remember a time when you used your initiative and brought about some-thing in your life of which you are proud.

• Think of somebody else you know who is very effective and whom yourespect. How does that person undertake that task? How does that personsit or stand? How does that person come across? Happy, understanding,and generally a warm person? Try to emulate this behaviour.

• Imagine life as a series of opportunities where you can use your initiativeand treat the journey with excitement. Remember a time in your life whenthings were a challenge, yet you managed to get through it and have cometo a much better place. Try to think about how knowledge gained from anew challenge will improve you for the better.

Optimism

This is a trader who can roll with the punches and who sees opportunity ratherthan a threat in a set-back. In a sense optimism is synonymous with motivationbecause you are more likely to fulfil a task or achieve a goal when optimistic.

To facilitate optimism undertake the following:

• Identify some of your life goals and acknowledge the ones that youhave achieved.

• Are you more optimistic when you are sharing a task or when you arecompleting a task on your own. Do deadlines help you to focus and achieveyour goals?

• Remember a previous time in your life when you were optimistic. Did itseem like everything was going your way in that the challenges experi-enced were minor set-backs that you saw as being part of life? Rememberthat time.


• What does somebody look like if they are feeling optimistic? Do you havea person who is close to you who is always optimistic? Put yourself inthe same mental state as that person.

Self-control

Traders with emotional self-control find ways to manage their disturbing emotionsand impulses and even to channel the negative impulses in useful ways. Methodsfor facilitating self-control are as follows:

• Remember a time in your past when you controlled your emotions. Imaginea negative trading scenario where you had become angry or fearful yetyou managed to control your feelings to good effect. Imagine times inyour life when you wanted to do something but for better reasons decidednot to. Have you been tempted to drink more than you should and yetmanaged to control it? Have you quit smoking?

• What does a person look like when they are in control of their emotions?How does this person breathe, carry him or herself, and what is theirgeneral demeanour? Do they stand straight, do they slouch?

• Some people control themselves by having a conversation with themselvessuch as “I know I’m a bit frightened by this trade I am about to make butI know that by breathing deeply, by sitting erect in my chair and focusingon what I really want in life I can achieve a great deal”. By talking toyourself and acknowledging the emotion you will control it and dispel it.

There are many courses that assist the trader to reframe the context or mean-ing of experiences so that the markets and world in general are perceived as aworld of possibilities not limitations. There are circumstances in life where theseapproaches are inappropriate and I suspect that a self-aware trader would havethe capacity to know when this is the case.

SUMMARY CHAPTER 6

• This chapter addressed the role and function of emotions in trading andeveryday life. Emotional Intelligence (EI) is discussed as a separate anddistinct subject matter. A number of facets of EI are proposed as relevantcompetencies for traders to develop.

• Traders’ beliefs about emotions are ambivalent. On the one hand they actas the foundation for heroic and compassionate deeds, and on the otherthey act as destructive forces causing self-sabotage, faulty reasoning, warand destruction.


• Plato thought of emotions as drugs; they pervert and distort reason. CharlesDarwin and William James thought of emotions as merely biologicalevents, such as a cough or sneeze.

• Emotions are now viewed by the scientific community as functional andindispensable to rational thought. Emotions are viewed as those processeswhich establish, maintain, change, or terminate the relation between aperson and the environment on matters of significance to the person.

• The limbic system and frontal lobes have been identified as the emo-tional centre of the brain. Neurophysiological studies are presented witha case study of Phineas Gage, where a significant and permanent changein behaviour occurred following destruction of part of the brain’s frontallobes and related circuitry.

• The affects of moods on judgements are significant and traders make judge-ments by combining what they know with how they feel.

• Emotions and moods have been shown to have substantial effects on othermental processes. They can affect perception, and they usually constrainattention to events relevant to the emotion.

• Emotions, particularly positive ones, tend to enhance the memorabilityof events in our lives. They also affect judgement and can be usedin persuasion.

• Emotional intelligence has recently been recognised as a set of skills ofequal importance to traditional IQ and is relevant to the trader.

• The qualities of EI are: to control impulses, to delay gratification, to moti-vate one’s self, to persist in the face of frustration, to regulate moods,to regulate worry and fear and prevent them from thwarting the decisionprocess at times of duress, to empathise with others, and not to lose hopeand communicate hope to others.

• Two facets of emotional intelligence have been suggested as a key areaof required competence for traders. They are self-awareness and self-management.

• Self-awareness is defined as having emotional self-awareness, accurateself-assessment, and self-confidence.

• Self-management is defined as transparency, adaptability, achievement,drive, and initiative.

• Negative emotional states and trading decisions – negative emotions affect-ing trading are fear, anxiety, regret, impatience, frustration, anger.

• Exercises have been suggested to combat the negative effects of theseemotions. In addition self-awareness and self-management can be viewedas supportive mental states and three elements identified were optimism,initiative, and self-control. Exercises were suggested to encourage thesepositive mental states.

7Martial Arts and BudoZen – Controlling Fearand Self-Sabotage

‘‘When the strike of a hawk breaks the body of its prey, it is becauseof timing.’’

Sun Tzu

When discussing martial arts and Budo Zen I am reminded of the comment of asuccessful trader who stated: “I am not sure there is a need to understand MartialArts or Zen in market trading, I have made a considerable amount of moneytrading and I have never studied Zen or Martial Arts.” This successful trader isquite correct; there is no need for an understanding of martial arts or Budo Zento become a successful trader. Nor is it necessary to learn the complexities ofthe Black-Scholes model, random walk hypothesis, or efficient markets theory;nor is it essential to use Bollinger bands, or 500 or so indicators that traderscan plug into Tradestation or other platforms. However, Budo Zen applied totrading has helped many traders to succeed where other methods failed and it issimply a matter of belief in what will work with you and for you; it makes foran interesting and rewarding journey.

Zen comes from the Japanese word Zazen, meaning seated meditation. Thepractice of this introspective deeply philosophical art was the major healing andcentring activity of the Japanese samurai. It was the foundation upon which theycould build their warrior ethic and the inspiration for their lives of duty andservice unto death. As a trader with limited funds, I needed to embrace a methodand philosophy that would assist me in becoming focused with courage. I was


fortunate to read Dr Richard McCall’s book entitled The Way of the Warrior-Trader and undertook training with him at the Bushinkai Dojo in Little Rock,Arkansas, USA. I am grateful to Dr McCall for allowing me to reproduce someof his book and practical teaching I learned during my period of training overthree years. This chapter focuses on how Budo Zen assisted me in becoming afocused and better trader through practising a number of techniques originallydeveloped by the samurai in ancient Japan.

I am hoping this chapter will introduce you to some of the values and benefitsof Zen in trading and in every day life. Zen can be many things. It is a philosophyof awareness. It is a psychology of truth and honest introspection. It is a meansfor controlling your emotions; a way of controlling the body and some of theharmful side effects of stress that may occur as a result of day-to-day living andtrading. It is important to understand that Zen is not a religion. It is a spiritualdiscipline which is appropriate for any religious persuasion. Zen recognises thatman is composed of mind, body and spirit, and that mind, body and spirit areinseparable. It is one of the universal truths that we all live under whether wechoose to recognise it or not.

The Budo of Japan are defined as the “martial arts” of Japan. In addition tomeaning “martial arts”, Budo offers an emphasis on the spiritual and meditativeaspects of a martial art, as the “Do” comes from the Chinese character for theTaoist “Way” (“Tao” or in Japanese – “Do”). To practise a martial “Way” is toemphasise the spiritual aspect of the art as an end point to mental and physicaltraining in martial (Bu) training methods.

Now that we have had a general introduction into the meaning of Budo ZenI will share with you its application to trading. I identified four objectives that Ihoped to achieve to improve my trading performance. First, to become aware ofthe primordial reflexes intended for self-protection. Second, to learn to eliminatethe potentially destructive “fight-or-flight” reflex. Third, to recognise that there isno place for emotional “reactiveness” in trading – only for efficient, intelligent,focused responsiveness. Finally, to fully understand that it is an accumulation ofanger and fear that is responsible for nearly all emotional maladies, including theabsence or deterioration of personal motivation.

In the words of Abraham Maslow: “He that is good with a hammer tendsto think everything is a nail.” In other words we see reality depending on ourpredispositions and beliefs. According to Maslow, there seems to be a hierar-chy into which human needs arrange themselves and it can be argued that thebehaviour of an individual at a particular moment is usually determined by hisor her strongest need. The hierarchy of need started with physiological throughsafety, social, esteem, and finally actualisation. Self-actualisation is the need tomaximise one’s potential, whatever it may be. A musician must play music, apoet must write, a professor must teach, a trader must trade.

Martial Arts and Budo Zen 181

As Maslow expressed it, “what a man can be, he must be”. Thus, self-actualisation is a desire to become what one is capable of becoming. Individualssatisfy this need in different ways. In one person it may be expressed in thedesire to be an ideal mother, in another it may be expressed in managing anorganisation, in another it may be expressed athletically, in still another by beingas good a trader as he or she possibly can be.

PERSONAL BELIEF PARADIGM

Psychologists know that human thinking is organised into logical levels and thatat the very base of these levels lie our spiritual beliefs. The structure of our beliefsdefines who we are, what we believe in, and what we hope to achieve. Any changeat the deepest level of belief would permanently change beliefs and attitudes at amore superficial level. Robert Dilts (1990) in his book Changing Belief Systemswith NLP identifies six areas of belief: environment, behaviour, capability, value,identity, and spiritual levels of belief. The spiritual level determines one’s overallphilosophy in life and is the base and most influential of all the beliefs. Thephilosophy of Budo Zen is a system of beliefs about the nature of the universeand lies at this spiritual level. Whatever philosophy you pick tends to determineyour overall outlook on life and it also determines who you think you are. Everyreligion imparts spiritual beliefs but Budo Zen is not a religion per se. Yourparticular beliefs tend to support and comfort you. However, some beliefs supportand promote trading skills, while others do not. For example, the view thatwe have no control and that our lives are predetermined are unsupportive oftrading. Whereas believing the world and universe have harmony and that allactions are meaningful are supportive beliefs. People have complex beliefs atthe environmental level and Chapters on perceptual biases illustrates this point.However, at the spiritual level one may have only a dozen or so beliefs whichare semi-permanent and very difficult to alter.

A person who has experienced significant trauma through loss, war, or crueltymight perceive the world as an evil place and that the universe is simply a placewhere we are continually challenged. People can have the same experiences yetbelieve totally different things. For example, an alternative belief, predicated onthe same traumatic experience, could be that the universe has perfect harmonywith both good and evil coexisting. This belief makes life purposeful and itpromotes a self-image that is useful and positive with regards to trading.

Budo Zen supports and promotes deep level beliefs that are useful in everydaylife and particularly in trading the market.

There are four beliefs at the core of Budo Zen that motivates the practitioner.Dr McCall refers to this as the four pillars of warrior motivation. First, is mortality


awareness – that we must utilise each moment of our lives to the fullest. Mortalityawareness is not a negative belief such as “when you die, that’s it – you’re dead”.Mortality awareness empowers one to take any necessary risk at any costs toachieve the mission and fulfil one’s destiny. The second is of life purpose – torecognise that trading is an important part of fulfilling one’s true life purpose.The third is soul passion – where the practitioner experiences feelings of joy,exhilaration, fulfilment, satisfaction, and inner completeness. It represents lovefor an activity and it is inseparable from life purpose. The final is that of highergoals and objectives – the practitioner cultivates an inner drive to be the best thathe or she can be. It transcends goal setting.

THE 10 LAWS AND BELIEFS OF THE WARRIOR TRADER KYOKUSHIN

The samurai’s Kyokushin means “the way of universal laws and truths”. Tradersoften take uncertain steps that could bring about disastrous results in their lives,yet more often than not, they have avoided disaster and succeeded in what-ever challenging activity they had been engaged in. The samurai believed thatthe law of duality, cycles, evolution, choices, responsibility, inertia, momen-tum, synchronicity, manifestation, process and action gave purpose and meaningto life.

I will describe these 10 laws and their application to trading as follows.

Law 1 – The law of duality

Nothing can exist without its antithetical counterpart, e.g. night/day, good/evil. Intraders terms, short positions cannot exist without long positions, profits withoutloss, or success without failure. The market rises and then it falls. A positive wayto frame your experience the next time you suffer losses is to think how luckyyou are that the market still exists.

Law 2 – The law of cycles

We are guaranteed that following bad luck we are due good luck; following amarket drop there will be a rise; following fear there will be courage; followingdepression there will be optimism and hope. A non-warrior trader is unpreparedand will only take quick opportunistic stabs at the market. The warrior traderknows that the money (and all desirable things) will be coming back withinreach eventually. All he has to do is carefully conserve his energy and resourcesin preparation for the eventual return of his financial gathering opportunity. Withregard to the loss of responsibility, synchronicity, and manifestation, the more


ready and vigilant he is, the faster the merry-go-round turns and the quicker themoney basket comes back.

Law 3 – The law of evolution

The oscillatory nature of all things, situations and events demands that all creationis in a constantly evolving state of change. One can progress or regress. To thewarrior trader, the law of evolution imports an important message. It is essentialthat while holding firmly to your trading knowledge, you should always be opento the possibility of new ideas and new methods. While always assuming thatthere is room for improvement, in yourself and your methods, you will morelikely progress towards success than regress towards failure as a trader.

Law 4 – The law of choices

Regardless of your situation there are always choices available to be made. Sometraders have lost repeatedly money in a particular market or trading system. Whenit is suggested to change the market or system a non-warrior trader would makeexcuses and continue with the old method. For better or worse, all traders willhave to live with the consequences of their choices. Take full advantage of eachday and opportunity by choice.

Law 5 – The law of responsibility

As a warrior trader you must always be willing to pay the price for your decisionsand actions. It is a common observation that many traders are unable to acceptresponsibility for their own actions and will constantly blame “the market”, “badadvice”, “lack of funds”, etc. Denial can only be counterproductive and ultimatelydestructive to your trading.

Law 6 – The law of inertia

An object at rest tends to stay at rest. Recovering from a large loss is one ofaction and assertion against the situational and emotional inertia it tends to cause.By becoming action oriented and asserting your behaviour you begin to recoverfrom a defeat. With reference to the law of physics, it requires much greaterenergy to commence movement than to simply continue moving owing to thelaw of momentum.


Law 7 – The law of momentum

A trader in progress tends to make more progress. Emotional and situationalmomentum is the positive consequence for having dedicated the short-term burstof focused energy towards overcoming the dampening effect of inertia (losses).During the period of loss, the law of momentum offers you assurance that thingswill look, feel, and be better once you get started on the right path again. Thiseffort, which gets you back moving in harmony with the rest of the universe, isset forth in the law of synchronicity.

Law 8 – The law of synchronicity

This law implies that the trader should view himself as an integral, inseparable,and mindful part of the machinery we call reality and this belief enables you toreclaim the natural and indisputable role as the “centre” of everything going onaround the trader. To recognise the law of synchronicity is to see the unity andharmony between all things, events and situations. The trader may not understandhow all events became interconnected but there is an understanding that the forcesat work create reality experienced and that you helped to bring about this realityby the way of the law of manifestation.

Law 9 – The law of manifestation

The samurai recognised that his thoughts and imagination possessed a power andpotential that was every bit as tangible as his sword. The metaphysical levelsof his imaginative power were an integral part of the creative forces of theuniverse. He was careful to have visually directed his thoughts in the directionhe wanted his destiny to go, rather than inadvertently use his manifestory powersto bring about bad luck and possibly his own demise. By using the potentialimplied by the law of manifestation, it is possible for traders to intentionally(but effortlessly), attract or create the various things, events, circumstances, andopportunities needed to make life rich and fulfilling – especially if the traderdoes so in an orderly and proactive manner as prescribed in the law of processand action.

Law 10 – The warriors’ law of process and action

This law stresses the importance of actually doing something with your potential.Process refers to taking a large task and breaking it down into manageable parts.You cannot expect to become a good trader immediately. Such an undertaking


requires introspective study, careful planning, diligent practice, and a reasonableamount of time to see your goal come to fruition (SMART objectives). The worth-while endeavour of following the way of the warrior trader should be used as ajourney. This law encourages you to recognise that every journey is made up of aseries of steps and through the action of each sequential step you will inevitablyarrive at your intended destination – a place we call mastery and success.

The above 10 laws facilitate and promote a system of beliefs that will carrya trader through to success; however, there will always be times when we lackconfidence, perhaps as a result of poor planning. We will now turn to howthe Samurai prepared for battle and how he recovered from failure, if he wasstill alive.

STRATEGIES OF THE WARRIOR TRADER

In the tactical model of trading competence (Figure 3.1). I gave a short descrip-tion of the ACTION phase of trading. This is an exceptionally useful tool andmany traders have incorporated it into their trading strategy with great success.The ACTION plan, in combination with a strong attitudinal stance and a pos-itive spiritual philosophy, can transform your trading and financial risk takingendeavours to a higher and new level.

Maxim 1 – Accept all possible losses before entering battle

The degree of opportunities that exist in any situation is usually directionallyproportional to the degree of risk. Every novice warrior trader must begin tomove like the wind in combat, taking advantage of every strategic opening,while accepting that at any moment you may be struck down by your opponent.

Optimistic acceptance

This is the type of acceptance wherein you truly accept the risks and potentiallosses that stand between you and potential reward, but your emotional focusand vision are clearly placed on the successful accomplishment of your trading.This is the type of acceptance practised by most successful risk takers before andduring the necessary action. This is the appropriate model for the warrior trader.

Pessimistic acceptance

This is the type of acceptance wherein risks and potential losses are accepted,but with a sense of defeated resignation. This type of acceptance leads towards


expecting or even manifesting negative results (self-fulfilling prophecy). Anytrader can reframe this negative type of acceptance to the more optimistic one.

Indifferent acceptance

This is the type of acceptance that accompanies situations where there is noperceived risk involved in the action taken, the operative word being perceived.The perception of risk is influenced by the amount of resources one has todispose of.

An important lesson for the trader is to develop your ability to accept risksand losses which is dependent on your personal perception and appraisal of riskversus reward, and no one else’s.

Maxim 2 – Centre yourself in body, mind, and spirit

This is the most physically important part of the ACTION plan and true way ofthe warrior trader. There comes a point in the development of warrior centringwhere there are things to do rather than think in order to get the results you seek.Figure 7.1 is the general centring triangle that demonstrates Haragei – the impor-tance of body posturing and movement; Kokyu-Kihara, which emphasises correctbreathing into the energy centre; and Budo-Zazen, which is seated Zen medita-tion. This diagram introduces the STILL acronym which outlines the correctprocedure for commencing seated meditation.

The trading centring triangle in Figure 7.2 gives a practical example of centringduring the ACTION stage of the Strategic MOT.

Maxim 3 – Trust your warrior skill and intuition

Every warrior trader must possess trading skills and methods that have beencommitted to the level of unconscious competence. After mastering your tradingsystem and becoming harmonised and in tune with the nature of the market, youwill naturally come to possess a gut level intuition within your own realm ofexpertise. For skill and intuition to be useful the warrior trader must also possessunconditional trust, or faith in your method and system. If you do not possessthis faith or unconditional trust it may indicate that your system or method needsfurther adjustment, study, or paper trading rather than live trading.

As your intellectual trust in your system and skills develop, so also will yourlevel of trust evolve to a higher level of belief or condition of faith.


HARAGEI: Body posturing around and movement from the one point

Rule 1: Keep your body aligned Rule 2: Maintain and move from your one point Rule 3: Keep your weight underside

KOKYUKIHARA:

Breathing into the energy centre

Push out with abdominal muscles while inhaling. Abdominal balloon fills first followed bychest balloon until you are fully inflated. By intentionally breathing deeper, you are alsoable to generate alpha and theta brain waves at will. The simple act of breathing serves asthe warrior's primary tool to instantaneously putting himself into the triangular zone of centredness.

BUDOZAZEN:

Warrior Zen meditation

Sit straight with your body balanced and centred then Take breaths slowly and deeply into the one point then Introspect on a positive affirmation or goal you wish to achieve then Let in all sensations available to your mind then Let go of all thoughts and awareness indefinitely

Centre

One Point

BODY

TAI

MIND

SHIN

SPIRIT

KI

Figure 7.1. General centring triangle


Spirit

Body Mind

As you watch the price activity in the DAX or S&P, you recognise that at any moment suki (a short livedopportunity to strike at an opponent's defensive opening) will present itself.

Body or Tai − you sit balanced and centred in your chair, recognising and appreciating the simple physicsof your body and PC technology that puts you in touch with the markets. Breathing smoothly and deeplyinto your hara (the centre one-point of your physical body located just below the navel), you also relax your hand in anticipation of its impending trip to the phone. (The body circle moves to the centre of the triangle.)

Mind or Shin − your superphysical mind, which is free from any emotional leftovers from the loss you haveincurred yesterday, calmly evaluates today's market conditions, including the upward trend that has suddenly taken place. Knowing that a buy signal is inevitably coming, and trusting your system's statistical track record and the universal law of averages, you are fully prepared to command immediate interactionbetween your hand, your phone, your voice, and your broker. (The mind or shin circle also moves in towardsthe centre of the circle.)

Spirit or Ki − at the deepest soul level, you believe in what you are about to do, and the metaphysics of a"higher" life force will reinforce your action. (The spirit circle moves in towards completion of theconvergence.) You are in the triangular zone. In 30 minutes you capture your profits.

Life is what I make of it and trading is my way of making it better every day!

EXAMPLE OF CENTRE ONE-POINT DURING TRADING

Figure 7.2. Trading centring triangle

Evolved faith

This faith evolves through trial and error and eventually proving itself to bevalid at the spiritual level of belief discussed earlier. Evolved faith will neverdesert the trader and will always back up actions, no matter how intensive orthreatening a situation might be. Faith that has not passed through the test ortempering fires of the trusting process and spiritual level beliefs will easily endor break under pressure.


Presumed faith

Novice traders who buy their trading system from smooth talking salesmen some-times discover too late that he or she was misled or misinformed. Formulate trustand faith for yourself by learning and testing your skills or trading system beforebelieving in them. The true warrior trader knows that he must practise his meth-ods and techniques to a point of near perfection (mental rehearsal and papertrading) before ever trying to trust them to serve them live in the market (or asa samurai in battle).

Intuition

Intuition is engendered by passion and skill and warrior trader philosophy ishighly congruent with the definition I proposed on page 41. The warrior tradermodel proposes that both passion and skill make the basis for informed intuition.

Passions contribution to intuition

When a person is passionate about a person, an object, or activity such as trading,he or she will nearly always experience some kind of connection with it. It is whatsupports athletes called being in “The Zone”. When you embark upon a warrior’spassionate mission of justice, your warrior intuition will help you fulfil it.

Skills contribution to intuition

It is the efforts of study and practice towards becoming as good as one can bethat engender intuition. As skill grows so does intuition.

To be able to trust your warrior skill and intuition, you must first come tounderstand the nature of trusting and through understanding, allow your trustingbeliefs to naturally evolve into faith. To have beliefs formed within your psyche,which you can trust and have faith in, you must also patiently practise yourtrading system until it is firmly committed to your subconscious mind where itwill be transformed into unconscious competency.

Maxim 4 – Imagine success clearly with the mind’s eye

1. Physical imagination: This can be described as the normal everydaythoughts and images in our minds. This level of imagination is respons-ible for how you feel – in other words, your mood and demeanour. Some


traders are inclined to thinking negative thoughts while other traders thinkpositive and optimistic thoughts. Begin practising simple, physical imag-ination now and before long it will become a habit, and the creation ofoptimistic moods and positive expectations will become second nature toyou. This process is similar to that employed in cognitive therapy withthe purpose of enabling more positive attitudes.

2. Superphysical imagination: This can be described as thoughts and imagesthat set direct creative forces in action and motion. You employ superphys-ical imagination when you visualise something that you want to bring toreality directly through your hands or body. One way of achieving this isto imagine yourself attentively and intuitively watching the markets beforeyour screens and then imagine yourself swiftly and confidently to eitherpick up the phone to place a buy and sell order or immediately trigger yourdirect entry order system. This imaginative imagery can be done brieflyat the start of your trading day when you are assessing yourself using theTactical MOT self-awareness stage which determines your mental state.

3. Metaphysical imagination: is simply recognising your own responsibilityfor the events in your life, and through recognition taking intentional wil-ful control of the human potential in yourself to shape your own destiny.In addition, by becoming aware of the interconnectiveness between yourthoughts, comments, or needs and the synchronistic events that follow,your confidence and spiritual belief level will increase and solidify havinga positive effect on all other beliefs in your life. What you ultimately wishto do is to intentionally cause the synchronistic events to occur.

Each and every action you take when you engage the markets should be initiatedwith a clear vision of what you wish to accomplish without exception. In thisway, you will definitely enhance your win-to-loss ratio, and at the same timeyou will be helping to eliminate the action stopping fear experienced by so manynon-warrior traders.

Maxim 5 – Only exist in the present moment to control fear

The samurai experienced fear but this did not stop them from taking action. Threebasic fears exist in warrior trader philosophy: fear of loss, fear of pain, and fearof the unknown.

Anticipatory fear

The experiencer is imagining his present fear by thinking ahead to the potentialoutcome of some future event.


Reflective fear

This is where the experiencer is thinking of past events, giving credence to hispresent fear.

Chronic fear

This is commonly known as worry and we have seen how damaging levels ofanxiety can be. Worry about jobs, family, money, incentives to render repeatedand unwarranted attention to issues outside our control is a waste of life’s energy.One should relay the focus to the here and now. A simple exercise to stopthis problem will only take a few minutes. When you feel emotionally out ofsorts, simply dedicate a few moments to honest introspection about the root ofthe feeling. You will discover that the feelings involved something in the pastor future so redirect your emotional energies and attention back to the presentmoment and the immediate issues you are handling.

Acute fear

This is one of the most common and destructive forces that a trader must face.It is intensive and short term and is a block to action. As a trader, you may needto quickly close your position or even open a position to offensively gauge themarket. In order to clear your mind of the debilitating fear it would be necessaryto refocus your attention to the present moment in order to initiate the tacticalaction required.

Exercise in fear control

There are two physical methods of fear control that can be practised while sittingin front of your screens trading. The first is Haragei – one-point centring – thesecond is Kokyu-Kihara – breathing into the energy centre. To employ thesetechniques to control fear in any situation, you simply need to:

1. keep your body aligned;2. maintain your one point by breathing deeply into your abdomen; and3. keep your weight underside.

It really is that easy and effective! You bring consciousness back to a centredplace in the present moment.


Maxim 6 – Never stop or look back once action has begun

Commitment combined with acceptance, centring, trusting, imagery, and livingin the controlled present can enable a warrior to move mountains. If mountainsare a bit difficult to move, it will certainly help you to consistently reap profits.The components of Maxim 6 are:

1. You must know what you want to accomplish: Reasonable and precisegoal setting is important for all successful people. Identify how muchmoney you will make in one day – no more no less – this theoreticalfigure being in practical reach. Use your SMART objectives.

2. You must possess a real desire to accomplish it: You can be formidableif you resolve to follow the plan of action and that you believe inthe outcome.

3. You must develop a workable plan with which to accomplish it: Plan-ning helps to eliminate doubt, fear, confusion, and surprise.

4. You must set a reasonable time frame from which to accomplish it:Realistic time frames avoid dragging out the mission.

5. You must never second guess yourself if you fail: Always learn frommistakes but never beat yourself up over missed opportunities. Transformmistakes into learning opportunities.

COPING WITH THE FIVE PHASES OF LOSS

Becoming resilient to losses is important. Taking risks automatically involvesthe inevitability of failure and defeat at some point or other. One major problemobserved among many traders is their tendency to transform what could havebeen (and should have been) short-term grief into a much more intensive anddebilitating long-term grief. Many traders tend to dwell on their losses, evenmasochistically embrace them, until the inevitable grief that results becomes areal problem for them.

When coping with the five phases of loss the first axiom is to acknowledge lossand grief and give it some recognition. Once grief is acknowledged, it usuallyevolves through five distinct phases:

Phase 1: Denial of loss – Some traders have acted as if they have not lost asignificant tranche of their trading account. Losses must be properly accountedfor or reality will manifest in your mind as anger.

Phase 2: Anger over loss – Anger is almost always misguided. If, for example,you lose money as a consequence of not following your system, it is possible toblame the markets or more distant targets. Anger is a way of directing yourselfaway from the truth – but you are responsible for what happened.


Phase 3: Guilt of loss – Self-criticism, what you could have or should havedone, all of which are fallacious. Traders can find themselves doubting theirpotential altogether and may even stop trading to avoid feeling like that.

Phase 4: Depression or despondency of loss – It’s hard on you and even harderon those around you. Symptoms of irritability, sleeplessness, fatigue, and relatedhealth problems are but a few. Following the passing of time and some support,you reach the acceptance phase.

Phase 5: Acceptance of the loss – The goal is to accept losses in life, but don’tfeel badly if at first it takes longer than you hoped to accomplish this.

Grief can get out of control but it is not the way of the warrior trader to do so.The samurai had a specific method called Misogi – which means to cleanse andpurify the psyche. This is a simple and easy way to refocus yourself. Prior tobattle or trading, centring is intended to prepare your psyche to trade (or fight).After trading (or battle), Misogi recentring is intended to cleanse and rebalancethe psyche and restore you to original form.

Step 1: Exercises for the body – Take a simple walk and concentrate on bodyalignment. Allow your feet to blend smoothly with the ground in harmony withyour breathing. With each step propel yourself with gentle pulses of energy fromyour one point, keeping actions smooth and level, rather than up and down asyou breathe. Do so deeply into the spiritual centre thus renewing your spirit.

Step 2: Exercises for the mind – Be attentive to breathing and the vital role thisplays in overall centring. After a brief period of this mindfulness, introspect on theuniversal laws that apply to the situation resulting in the loss, and remind yourselfof the truth they hold. Look for apparent lessons to be found in your defeat,and resolve to make any necessary behavioural corrections that may improveperformance and chances for victory in the future. Following contemplation,allow your observations to be committed to your memory, for future unconsciousreference. Continue with your Misogi walk, begin to quieten the internal dialogue,then cease altogether, and enter a state of mindlessness.

Step 3: Exercises for the spirit – For the spirit, continue to walk peacefully butsteadily, your mind still feels specific thought or intent, and allow the “intuitivemind” to fill your consciousness and psyche. This often renders messages andlessons of a much higher order, and you will experience a mindless enjoymentof a feeling of faith that all things, including loss and fear, occur for the highergood. By this time, no more than 15–30 minutes, you can be back at the startof your Misogi walk and back to your old self. You will feel refreshed, re-centred, and reasonably ready to re-engage the market when the opportunityagain presents itself.


For conditioning and practice, keep in mind that the exact same procedures canbe employed for any form of risk taking. This means that every day, whetheryou win or lose, you should be practising some variant of these centring, orrecentring, principles to maximise your warrior trader performance.

I have briefly tried to summarise a complex and important area of spiritualphilosophy, with the intention of introducing the reader to effective methods ofpreparation for trading, and resilience from potential losses. I am hoping thereader will see the benefit of this method and read Dr McCall’s book as thereis no substitute for reading the original text. I will be arranging practical andclassroom training in the UK with Dr McCall and invite you to join us in anadventurous and enlightening two-day course.

SELF-SABOTAGE

For the purposes of this section, I will define self-sabotage as a set of behavioursthat prevents a trader from achieving what he or she wants where the ability toachieve the goal is evident. There may be no immediate reason for self-sabotagebehaviour so we must assume the behaviour to be irrational. It is not a lack ofskills, knowledge, or motivation that holds the trader back. There is somethingwithin that is stronger than desire or motivation and it sabotages your efforts to dothe things you want to do or have. We all sabotage ourselves from time to time andfor many people these behaviours prevent us from having the happy, successful,fulfilling lives we wish to live. These behaviours create internal conflict and candestroy your motivation to fulfil your aspirations by creating an internal tug-of-war. Self-sabotage behaviour can leave you feeling frustrated, discouraged, andfor traders, trapped in a cycle of loss that he or she desperately wishes to change.

Self-sabotage includes perceptual biases and extreme emotional reactions,which in turn prevent us from achieving our goals. Self-sabotage behaviour affectspeople of all ages, professions, financial and social status. It is a frustratingfact of life and has varying levels of severity. Some forms of self-sabotageare obvious and others less so. We carry as adults much “baggage” from ourchildhood, which gets in the way of trading and other goals in life. I am not aqualified psychoanalyst so I will avoid writing “psychobabble” and concentratemainly on those areas that can be observed and changed in relation to trading.Self-sabotage behaviour occurs when you have conflicting internal beliefs aboutthe accomplishment of your goal, such as trading. One part of you wants toaccomplish the goal and another part does not. Self-sabotage manifests itselffrom the part that does not want you to accomplish your goals and is strongerthan the part that does.

Let us explore self-sabotaging behaviour which is common among traders.

Boredom: We know that one of the most difficult tasks for traders to master is thatof simply doing nothing in the market. We are constantly interpreting information


and we know that in a monotonous task (sitting watching the screens for signals)traders and people in general miss significant or important information. We alsoknow that some people become traders simply because their lives are boring andsuddenly they are invigorated by the challenge and stimulation of market trading.I have no doubt that boredom has been at the root of British football violenceand is responsible for some random murders in the USA and in Hungerford.

When trading and feeling bored, I always recollect a story that I had read ina book by N. Hawkes and colleagues (1986) entitled The Worst Accident in theWorld. This accident happened many years ago and therefore is no longer readilyavailable in recent memory to remind traders of some of the dangers of boredom.In 1973 a DC10 was flying on auto-pilot over New Mexico. The captain, hissecond, and the engineer had nothing to do. The black box flight recorder revealedthe following circumstances. The flight engineer wondered out loud to the captainwhether the auto-throttle would respond if he pulled the No. 1 manual throttle.The captain did not know but he warned the engineer that the engines were on fullpower and likely to do anything. Nevertheless they decided to go ahead with theexperiment with disastrous results. The starboard engine increased speed to sucha point that it broke up, smashing a window, and the resulting decompressionsucked the passenger sitting next to it out of the plane to fall 39 000 feet.

Bringing this incident to mind always helps me to find a safe form of relievingany boredom that I might have had such as cycling, jogging, or even playingcomputer chess or other computer games.

Procrastination: You purposely avoid a challenging task such as making a trad-ing diary or reading literature on how to make a business plan. There is alwaysa good reason why it should be done tomorrow and not today. Sometimes pro-crastination can be an indication that the task or goal is very important for yourown development and is an area you have neglected and have some fear of.

Persistence: You may start a project but don’t finish it. For example, you decideto back-test your system on 10 years of data with the intention of developingfairly accurate performance indicators, possibly in the form of a risk:reward ratio.You purchased one of the recommended books in Appendix 1 only to find thatit wasn’t really necessary to go to all that effort. You found instead a conflictingpriority that gave you permission not to complete this project.

Worry: Worry and fear take a tremendous amount of mental energy and effort.We are worried that we may put in a disastrous trade like we did six monthsago and we also have fears that we will end up broke and in a bankruptcy court.Remember, we attract what we fear most. Through worrying and fear, you mayhave missed a fabulous opportunity in the market or you may have decided


to abort a position, which at the time went nowhere near your predeterminedtarget. Later you find that not only did the market hit your target but went muchfurther. You then begin to worry about your poor performance and a cycle ofloss commences.

Anger: A trader may experience a series of losses that seem never ending andit appears to the trader that nothing he does is effectively stopping this slide. Anoccasional display of hostility or anger is not dangerous to health. Behaviour,which is marked by repeated feelings of mistrust, cynicism, and the propensity tosnide comments and put-downs of self and others, as well as the obvious boutsof temper and rage, predisposes one to heart attacks and mental depression.

Depression: You may feel discouraged and depressed at the way things areworking out for you. You feel that you have little control over the events inthe market and also yourself. A trader might develop a style of trading thatsimply confirms he is a “victim”, which has been an underlying theme sincechildhood.

Impulse control: You make a considerable amount of money on a trade only togive it back and more to the market. Having had such an excellent trade you feelthat it is time to take larger positions, and as a result of overconfidence have losta significant tranche of your margin.

Blaming others: Some traders fail to take responsibility for their behaviour.There is always a reason to blame somebody or something. “My broker gaveme bad advice”, “my wife doesn’t support me”, “slippage and commissions arekilling me”, “the war in Timbuktu eroded my profits”, etc. It never occurs to sometraders that by looking at patterns of success and failure through the keeping ofaccurate records, this might improve their performance considerably.

Relationships: Trading can bring much pressure on the family owing to losses,irregular hours, and never having time to have fun. The worse family relationsbecome, the worse your trading becomes, the cycle of loss continues.

Recreational use of drugs: While trading, you may smoke 40 cigarettes a dayand drink alcohol heavily in the evening. You know you should cut down yoursmoking and drinking and take more exercise, but for some reason you neverquite get around to it. You may take an amphetamine in the morning with yourcoffee to ensure that your concentration is at “peak performance”. This form ofself-deception is very common among people with substance misuse problems.

Mood: Some traders are always feeling low, depressed, and may even haveanxiety or panic attacks. Traders know that there are many agencies where they


can seek help in the form of counselling or psychotherapy, but somehow this doesnot fit their view of themselves, and they allow the problem to become larger.

Self-doubt: Some traders after experiencing a series of losses have a mind setcharacterised by self-doubt. They believe they might be successful as a trader;however, there seems to be some evidence that they will not be successful. Thesetraders lack commitment to learning and are unable to frame their mistakes andsignificant losses as a step closer to success.

Lack of stability: You may do things which place yourself and family at financialrisk. For example, some traders will borrow money to trade when their originalrisk capital has been lost.

Disabling feelings: Traders can feel resentment and shame when they have notachieved their goals of affluence. They may perceive people as having a lack ofunderstanding of why they do what they do, and each comment about tradingmay be misconstrued as a criticism. You know you have potential to do morewith your life but you’re not sure how to go about it.

Disillusionment: The trader begins to lose hope of ever being able to live thelife they had always dreamed of.

Gambling: The trader, through repeated losses, negative mental attitudes, and anundisciplined approach, commences gambling in the market under the impressionthat he is speculating.

It is important that the trader has an understanding of the fine line betweengambling and speculating. Some traders use these words synonymously and whilethey say that there is a difference between speculation and gambling, they don’treally understand the difference. Once a trader understands the subtle differencesbetween gambling and speculation, it will help the trader to avoid pure gamblesand develop a discipline which employs intelligent speculation.

So what is the difference? Gambling involves games of chance where prob-abilities remain constant. For example, if you played pontoon (also known asblackjack and twenty-one), say 20 years ago, your probability of drawing a givenhand out of the deck of 52 cards is identical across all time periods. The prob-abilities will remain the same whether you played 20 years ago, today, or 20years from now. In pure gambling the gambler has no control over the odds ofhis game and this means that the decision of when to make the bet is largelyirrelevant. Odds are fixed, probabilities are known in advance, and nothing willchange them.

Speculation is quite different because the probabilities of winning are con-stantly shifting. It makes no difference when you play pontoon because the


probabilities are determined by a fixed 52 card deck which remain constant,but when you take a decision in a speculative venture, the probabilities can shiftat any time. There are periods of history in the market where a particular type ofspeculation may have at least a 95% chance of winning while at other times theexact same speculation may only have 10% winning odds. The art of speculationinvolves constant study of the market and becoming familiar with the numer-ous peculiar ways and idiosyncrasies. The object of studying the markets as aspeculator is to finally understand in real time when probabilities swing vastlyin favour of a particular speculation. Unlike gambling, a speculation cannot suc-cessfully be employed at any time. The speculator patiently waits until the oddsare considerably on his side that a certain market move is “inevitable”.

The single most important difference between gambling and speculation liesin the timing. Gamblers can gamble any time because their odds are fixed andthey know what they face. Speculators can only speculate at certain opportunemoments as their odds swing wildly based on market conditions and they neverknow until something happens, when a wonderful high odds and low risk tradingopportunity presents itself. There are inevitable advances and declines in themarkets and numerous tools help to identify these periods. The fact that successfultraders, using very different tools to trade identical markets, have the same successis the strongest evidence in support of the paramouncy principle, discussed inChapter 1.

THE BOHICA EFFECT

My good friend Jim had been a Globex trader for about 18 months before Imet him. He lives in the US and had been employed as a senior ranking officerin the US Marines for many years. He gave active service during a couple ofinternationally famous wars and had been right in the middle of heavy fightingand loss of life. He had personally seen the worst of war and had come throughsome very difficult missions unscathed and emotionally and mentally intact, giventhe circumstances.

Jim had been married for eight years, had three boys and lived with his familyin a comfortable area of the US. For whatever reason, his wife started seeingsomeone else and Jim was quite understandably devastated by the circumstances.Being a generous and kindly person he attempted to work through the divorceas amiably as possible giving his children the type of stability that he knew theydeserved. On the proceeds from the divorce he opened up a small factory andsupervised a number of staff. Though Jim was excellent at managing the soldiersunder his command (I gained the impression that he was popular with them), hehad difficulties in the business environment. It was clear to me that he did not likemanaging staff and that there were problems though he did not reveal the natureof the difficulties. He decided to sell the business and did so at a small profit tothe original purchase. He used the capital to commence his trading business.


Jim was committed to learning to trade and attended numerous courses, whichis where we met. His wry comments and sense of humour endeared him toeveryone and, moreover, he was good company. Under the humorous, compas-sionate, and intelligent facade was a lonely and unhappy person. He had beenprescribed antidepressants (Prozac) for about 10 months and it became obviousthat the divorce had taken its toll. His loss of self-esteem regarding his wifeand another man and pain of separation from his children had not dampened hisperspicacious humour. He described the BOHICA effect to me. Whenever seniorofficers in the Marines gave an unpleasant order or had made a decision thatwould place Jim and his men under some duress or potential risk, they had theirsecret code. They simply said “BOHICA” to each other which meant “bend overhere it comes again”.

Jim described BOHICA to me within the context of stock index futures tradingand kept on saying that he could not understand how it was that traders couldmake money at this “game”. He had a couple of friends who were competenttraders and he was on the phone to them regularly, but for some reason he couldnot replicate their success. He lived in a comfortable house, in a pleasant area,but he was on his own and I could tell that the solitude of trading was at oddswith his previous experience of managing staff and commanding soldiers. Oneyear I flew over to spend a week with him trading to see if we could share andexchange any mutual ideas. At that time he was more experienced than me and hewas always willing to give good advice on technical analysis. Jim found it verydifficult to accept losses as part of successful trading and I found this somewhatsurprising given the action he had seen in a recent war. He was risk aversive inthe realm of profits, exhibiting hesitancy in entry, early profit taking, and placingstops which in my opinion were too tight. With other aspects of his life beingless than optimal, it appeared to me that his continuous losses had to do with fearof loss, so to prevent loss he closed losing and winning positions prematurely,which had the effect of increasing his loss. The loss cycle was complete – hehad attracted into his life what he feared most.

We discussed Martin Seligman and the model of learned helplessness and Jimidentified strongly with some of the cases I described to him. Having returnedto England I kept in touch by email and telephone and was glad to hear thatJim had made a decision about his trading. He had decided that futures daytrading was not for him and that a full-time job where he could be involved withpeople on a regular basis was more appropriate. Jim is currently studying andwill take exams to become a commodity trading adviser (CTA). Following twoyears of day trading he tells me he has not seen concrete evidence of anybodymaking money day trading and admitted that he had lost many thousands whichhe probably would never recover. In his usual ebullient and inimitable style hetold me that he was going to recommend to each of his clients that they steerclear of day trading. As a CTA he intended to advise them to take $50 000 in$1 notes up to the roof of a tall building and start throwing handfuls out to the


public below. He stated that the activity would be much more fun than tradingand “hell, who knows, you might even make a few friends!” I admire Jim greatlybecause he tried to do something different with his life and was not prepared tolive a life of quiet desperation.

It is clear to me that the reason for Jim’s lack of success in trading was directlyas a result of self-sabotage. He did not have a written trading plan, or a tradingdiary to enable him to spot patterns of behaviour that recurred. In addition, hisunderstanding of risk made him overcautious thereby cutting both his winnersand losers short.

I am convinced that structure and planning in the way that I have outlined inChapter 8 would have helped Jim tremendously though of course nothing canguarantee success in trading.

ADDRESSING SELF-SABOTAGE BEHAVIOURS

It is not possible to eradicate all self-sabotaging behaviours but it is possibleto minimise their effects through bringing them into consciousness, identifyinga method of overcoming them, making a plan of action, rehearsing the plan ofaction and then implementing it. You will remember that these are the proceduresoutlined in the generic learning model discussed in Chapter 2. With reference toJim’s particular set of circumstances, it should be noted that he very clearlyweighed up the pros and cons of trading and came to a conscious decision totrain in something that was related to trading, but not trading itself. ThereforeJim’s understanding of his circumstances must be considered a success becausehe extricated himself from the cycle of loss. However, Jim could equally havedecided to address the problem of continued losses. If he had done so the mostappropriate method of addressing his style of self-sabotage was as follows.

Bring self-sabotaging behaviour to consciousness: Through discussion withme, his trader colleagues, and his trading mentor, he would have come to therealisation that his perception of risk and losses was the main area of sabotage.

Set SMART objectives: Once identifying the problem, Jim could structure andplan a method or methods of overcoming this problem. He may have used theComprehensive MOT (Figure 3.1) to act as a base for his internal representationof market trading, and then he could have been more specific by adopting someof the standards and criteria outlined in Chapter 8.

Mentally rehearse the plan: Having a written and structured plan, Jim wouldnow mentally rehearse the plan to ensure that the steps to success were firmlyunderstood and available while moving towards his objective.


Plan implementation: Jim would now implement his plan, possibly with thehelp of a trading mentor, colleagues, or other professional.

There are numerous useful techniques to combat self-sabotage and once he pri-oritised his objectives he may wish also to include:

Mental attitude: Refuse to stop trying. Believe in yourself. He could repeatsomething like “I can, I will, and I’m going to be the best trader I can be”.During his repetition of these positive attitudes he will understand that they arenot empty phrases because he has a plan of action on how he can, how he will,and how he’s going to be the best trader he can be. Remember that much of thecontent of previous chapters in this book will actively address and minimise theeffects of self-sabotage behaviour.

Vacations: Take regular small breaks and go somewhere or do something thatyou find fun. Successful traders take a break every six months or so for a coupleof weeks and try not to bring the market with them. It depends on your financesof course and it has been my personal experience that short breaks away fromhome incurring minimum costs are as much fun as more expensive interna-tional sojourns.

Recreation: Take time throughout the day to do something you enjoy. You mayenjoy the occasional game of chess with a family member or you may enjoy achallenging computer game. Your recreational choice may be to prepare a meal,or listen to music. You may play an instrument and setting aside 15 minutes aday to practise will be enjoyable.

Nutrition: Ensure that you eat healthy and more balanced food on a regularbasis. You may wish to read a nutritional guide and there are many popular onesin self-help sections of libraries and bookshops.

Recreational use of drugs: Overindulgence in any drug, be it legal or illegal,will impair your performance. The nature and degree of your use will determinethe severity of its effect on your performance. If you find that it is not easyto miss a few days without a particular substance you may have a dependencyproblem and it would be worth discussing your use with a qualified counsellor.You may have only one meeting or telephone discussion just to satisfy yourselfwhere you are situated along the continuum from dependent to recreational use.

Exercise: I cannot stress enough the importance of exercise in maintaining per-formance in market trading. If you are sitting in front of a screen for most ofthe day you are missing out on the normal types of exercise that people havegoing to work and being at work. Exercise does not need to be Olympic style


jogging, swimming, or cycle riding. You need to identify a particular time in theday which is set aside as “stress reduction time” and go for a walk perhaps in thesame way as described in the section on Misogi. It is a fact that most successfultraders have a specific period during the day or week when they take regular aer-obic exercise. Do not underestimate the value of having a clearly defined methodof reducing stress.

Relaxation: Identifying a period to “cool off” and relax is as important asexercise. Seated meditation such as Zazen is highly beneficial and studies haveshown that meditation increases one’s ability to perform on cognitive tasks.

When is enough enough?

Compulsive gambling is defined in the psychiatric annals as:

a progressive disorder characterised by a continuous or periodic loss ofcontrol over gambling, a pre-occupation with gambling, and obtainingmoney with which to gamble, irrational thinking, and a continuation ofthe behaviour despite adverse consequences. (Source: Dr Rosenthal (Psy-chiatric Annals) February 1992)

While I have acknowledged that there is a distinction between gamblingand speculation, there is little difference between compulsive gambling andcompulsive trading. Compulsive trading is perhaps the most pernicious of allself-sabotaging behaviours and traders have a tendency to use the euphemism“overtrading” when in fact it is much more serious.

Theoreticians identify four phases of compulsive gambling/trading. It will helpyou to watch the biographical video or read the book entitled Rogue Trader, thestory of Nick Leeson and how he destroyed Barings Bank through employinga gambling style of trading in the SIMEX futures pit. How many of the self-sabotaging behaviours discussed below can you spot? Do the following fourphases apply to Nick Leeson?

The winning phase

During the winning phase (frequently six months to two years) these traders wonmore often than they lost, probably had a “big win”, an amount equal to at leastthree months’ normal salary and sometimes as much as a year’s normal salary ormore. This winning phase, and specifically a major early win, justified to thesetraders their opinion of being smarter than others and of course superior traders.These traders frequently believe that they are capable of becoming Livermorestyle “professional” market speculators. As these traders progress through the


winning phase, they begin to spend more time trading, and begin to trade moreoften and for larger amounts of money. Eventually they begin to lose.

The losing phase

In the losing phase the trader begins taking large positions and leveraging hiscontracts far greater than that dictated by his trading plan (assuming he has one).He starts to believe that he is simply on a losing streak and starts to double upon contracts and begins averaging down. He places large contracts on high risktrades which he knows don’t have much of a chance but have huge rewards. Hestarts losing much more than he wins. These trading losses cause him to tradeeven more in order to win back his losses. This is termed “chasing his losses”in the literature. He then borrows money with which to trade and he must lie inorder to cover his tracks. He must lie in order to convince people around himthat he is still a “successful trader” and an all round good guy. He begins to lieabout everything often when truth would better serve him. He continues to boastabout his skills of trading often talking about his wins but rarely about his losses.

At some point he has his first major “setback”. Deep in financial trouble, hemay convince his family or employer of some phoney major catastrophic disasterwhich requires a loan.

He is probably able to obtain this first “bailout” and probably has asked formore than he needed to settle up his trading losses and therefore providing extra“trading cash”. He considers this “bailout” as a victory. These bailouts may occurnumerous times; eventually, it is almost impossible to persuade others to againprovide a loan. His life has become unmanageable and his family life is rapidlydeteriorating.

The desperation phase

The desperation phase can last for a short time or for many years. During thedesperation phase, the majority of the trader’s time is spent thinking about trading,planning trading, or actively trading. He no longer has control over his trading.In order to relieve the inner pain he must trade; he knows he will lose, but it doesnot matter. His lying is completely out of control. When others don’t believe hislies, he becomes angry with them, blaming others for his problems.

He must obtain the money with which to trade at all costs. His family is inshambles. They have possibly already left or are on the verge of leaving. Illegalactivity may be occurring; the gambler may be embezzling money or stealing itin other ways. He will consider these as loans which will be paid back soon fromthe big win he believes he will have. He is still often able to present an outwardappearance of being in control.


His wife and children are suffering in many ways, the rent or house mortgageis behind, the utilities may have been turned off, few of their relatives even speakto them any more, they are now on a cash-only basis everywhere. Credit cardsare axed, the wife doesn’t know what is wrong. She knows he is trading. Sheknows he is continually lying. She has heard him say a thousand times that hewill stop and everything will be all right. He has to be in action. He is livingin a dream world, knowing he can’t win. Punishing himself, he wants it to end.He thinks often about self-destruction, and probably more often than most wouldlike to believe, does commit suicide. He has to trade because it is the only wayhe can relieve the pain.

The hopeless phase

Until the 1990s only three phases of pathological gambling/trading were noted inthe clinical literature. Many clinicians and experts who treat pathological tradersnow say a fourth phase exists.

Once the trader has been through the desperation phase it would seem thateverything bad had occurred; however, in the hopeless phase, pathological tradershave “given up”. They believe nothing can help; they don’t care if they live ordie. In fact for many the latter is the preference. They will all consider suicideduring this phase. Most will commit actions which could place them in jail orprison. Clinical depression is a given. In their minds no one cares, no hopeis available.

I have outlined above clinical thinking with regard to compulsive trading.Because you identify with some of the phases above does not mean that you area compulsive trader. You may wish to answer the questions that follow which willhelp you to determine where you are on the continuum of “compulsive trading”.

1. Do you lose time from work, education, or other essential activitiesto trading?

2. Is trading making your home life unhappy?3. Is trading affecting your reputation?4. Have you ever felt remorse or guilt after trading?5. Do you ever trade to get money with which to pay debts or to otherwise

thwart financial difficulties?6. Does trading cause a decrease in your ambition or efficiency?7. After losing do you feel you must return as soon as possible to the

market and win back your losses?8. After a win do you have a strong urge to return and win more?9. Do you often trade until your last Euro is gone?

10. Do you ever borrow to finance your trading?11. Have you ever sold anything to finance trading?


12. Are you reluctant to use trading money for normal expenditure eventhough it’s needed?

13. Does trading make you careless of the welfare of your family?14. Do you trade longer than you planned?15. Do you ever trade to escape worry or trouble?16. Have you ever committed, or considered committing, an illegal act to

finance trading?17. Does trading cause you to have difficulty in saving?18. Do arguments, disappointments, or frustrations create an urge within you

to trade?19. Do you have an urge to celebrate any good fortune by a few hours’

trading?20. Have you ever considered self-destruction (suicide) as a result of your

trading?

If you answered yes to more than six of the above questions you may be enteringthe realm of the compulsive trader and this will spell nothing but disaster foryour future. Stop trading now! If you cannot stop, reduce positions until you areclear about your own motives for trading.

In Appendix 2 I have placed the URL, address, and telephone number ofGamblers Anonymous. It will help you to speak to somebody on their helplineand it may be an idea even to attend one of their open meetings and speak tosome members to see if there is some behaviour that you can identify with. Youlose nothing by attending a meeting but stand to lose much if you deny and avoidthis issue.

We will now discuss two common areas of self-sabotage related to phases 1and 2 of the compulsive trading model.

Overconfidence

Overconfidence is a common form of self-sabotage significantly influencing atrader’s decisions. One element of overconfidence that skews our trading judge-ment is that of hindsight. Fischoff (1975) demonstrates two forms of hindsight.The first is believing that an event that has already happened was inevitableand could have been predicted, given the circumstances; the other is to believethat if you had taken a decision that was in fact made by someone else, youwould have taken a better one. As traders I am sure that we can all identify withthese phenomena. I know a number of market analysts who with hindsight woulddemonstrate on their charts exactly where a wave ended, where a selling climaxoccurred, or when a Fibonacci resistance zone had been hit. When looking atanother trader’s diary or discussing a bad trade, how many times have we feltthat in retrospect we could have done much better?


Fischoff’s experiments have been replicated many times with the same results.The experiments demonstrate that people’s misplaced confidence in their ownpowers of judgement not only make them believe that they are able to predictthe future from the past far better than they in fact can, it also makes them distortpast events and their recollections of their previous opinions. How many timeshave we seen a warning written into the literature sold with trading softwarestating: “Past performance is not a predictor of future performance”? The realityis that most software vendors base the credibility of the trading system solely onpast performance yet at the same time has a “get out” sentence as above, just incase any customer wishes to take them to court for financial losses incurred as aresult of exaggerating the efficacy of their trading system. As Fischoff puts it:

when we attempt to understand past events, we implicitly test the hypoth-esis or rules we use to both interpret and anticipate the world aroundus. If, in hindsight, we systematically underestimate the surprises whichthe past held and holds for us, we are subjecting those hypotheses toinordinately weak tests and, presumably, finding little reason to changesomething. Thus, the very outcome knowledge which gives us the feel-ing that we understand what the past was all about may prevent us fromlearning anything from it.

Traders are continually making important decisions and given the inadequacyand fallibility of human judgement, it is important that traders become self-awareof how overconfident they are and how that will affect their interpretation of thecurrent circumstances.

There is another peculiar effect little known by traders that sabotages ourtrading. Numerous experiments (Fischoff et al., 1977) have shown without doubtthat when people are given more information, whether pertinent or not, theywill falsely assume that their answer or assessment of circumstances is far moreaccurate than it actually is. This has clear implications for traders when managingrisk. Traders’ performance does not improve with the receiving of successivebatches of information. In contrast, traders’ confidence that they are right willrise steadily as traders receive more information. Traders clearly believe that theextra information will help them, even though it may not. We all know the adage“a little knowledge is a dangerous thing” and perhaps we should have a caveatthat “a lot of knowledge is a more dangerous thing” with the possible effects ofdecreasing accuracy of judgement, increasing false confidence, and diminishingone’s trading account.

There are some very scary and sobering examples in real life where pro-fessionals, such as doctors, financial advisers, and engineers, have unwarrantedconfidence in their judgements. Patients have died from having an operation theydid not need, yet the doctor was confident it would succeed. Many people areaware that mistakes in medicine are hard to spot because “doctors bury theirmistakes”. Lusted (1968) shows numerous examples in Introduction to Medical


Decision-Making. Also, financial advisers, brokers, and economists do consid-erably worse than the market in which they are investing: if you buy securitiesby sticking a pin in the stock market listing you will on average do better thaninvesting in unit trusts run by securities advisers because it is likely you willsave on their extortionate commissions for their non-existent expertise (Dreman,2002). If you speak to any broker, economist, financial adviser, or professionaltrader, he will be aware of these findings but will claim that he is an exception(perhaps because he uses the BBB – see the footnote on page 124 – method ofanalysis that has irrefutably given 70% annual returns).

It has been repeatedly shown that people are overconfident about their abilityto control events and have little understanding of the mental processes involvedin making judgements. This is particularly true of traders and has been termed“illusion of control”.

Illusion of control

I undertook a telephone interview with Professor Fenton O’Creevy (2003) atThe Open University who studied real dealers trading live in real markets. Theresearch team argued that a key factor in assessing perception of risk is thequestion of locus of control, and they acknowledge that traders and dealers arealways under pressure to produce good results; as a result, they develop anillusory understanding that they have some control over the stock market.

Professor O’Creevy and his team promised not to reveal the names of the Lon-don City firms who gave them access to traders, dealers and performance criteria.The research team studied 488 traders and managers. They used three methods:interview, computer game experiments and personality data. The research teampostulated that there were three elements in understanding how traders perceiveand manage risks:

1. Personality – some personality types of traders are more likely to havebiases in their perceptions of control.

2. Learning – overconfident traders may refuse to change tactics because hisoverconfident belief is that his method will come right in the long term.

3. The context – there are different forms of market “noise”. There is literalnoise where traders and dealers work, especially in the days of pit trading.There is also non-literal noise where markets are affected by politics – thechairman of the Fed gives an announcement which means markets willbuy, or a war is about to break out in the Middle East which will havea result on oil. With so much “market noise” it is hard to determinewhether the performance of the trader or the stock or instrument itselfwas the cause of the poor performance. Many traders are used to makingexcuses such as “my strategy would have worked if it hadn’t have beenfor the war in Timbuktu”.


Professor O’Creevy and his team found that traders with a high illusion ofcontrol may not be sensitive to feedback and therefore are less likely to learn thelessons when they make losses. These traders are also likely to deceive themselveswhen it comes to judging how well their managers thought they handled risk. Themore control dealers imagined they had, the less good was their real performance.They also overestimated how much they contributed to the overall profits of thetrading firm. From this research has come an understanding of three major factorsin understanding traders’ attitudes to risk.

1. Extroverts are more likely to take financial risks but decisions are notnecessarily made using an objective method of calculating probabilities.

2. Traders with a high illusion of control are more likely to take financialrisks. As a result of the illusion of control bias, they will underestimate thesize of the risks they are taking. The result is that they perform less well.

3. There is evidence that extroverts respond better to praise (but don’t learnnew tasks well) and that introvert personalities learn from their mistakesif they are punished.

The evidence so far is only suggestive and further research might give an indi-cation as to the most appropriate type of personality, given the change from pittrading to PC trading.

There is no doubt that home traders and professional dealers are under consid-erable stress. The advantage of the home trader is that he or she does not needto place a trade whereas the professional trader needs to constantly show prof-its. Given this pressure and the need to work with an unpredictable instrumentsuch as the stock market, professional dealers overestimate how much controlthey have.

It is a credit to those institutions that allowed Professor O’Creevy and histeam into the inner sanctum to undertake research. The implication of inadequateperformance has severe consequences to the future of their company and tradingoperations. I am of the opinion that the new age of computer-based tradingrequires a different personality type and age group to the old style open outcrypit. My opinion is that it is a mistake to continue to recruit young, inexperienced,extrovert personalities, which is known in the industry to be the predominant typeof man and woman who is recruited. My opinion is that an older trader, say latetwenties right through the forties, who has proven analytic skills will be farmore likely to succeed in the new age of screen-based trading. I mentioned myobservations to Mark Douglas (author of The Disciplined Trader and Trading inthe Zone) during an interview and he agreed with me on this point. He has runnumerous courses at the Chicago Board of Trade and at the Chicago MercantileExchange to assist open outcry traders to make the transition from the pit tothe computer screen. He jokingly added that employers of traders are recruiting“the type of guy, who if he wasn’t a trader, he’d be one of these extreme snow


boarders going down a 90% face, getting a huge adrenaline rush, and facing lifeand death. How can you expect the same guy to sit in front of a computer screenmaking decisions?”

It is no wonder that financial institutions treat psychological and related researchwith suspicion, especially if it shows that they continue to perform poorly, don’tlearn from research, continue to recruit inappropriate candidates, and have min-imum and unreliable training standards to qualify as a trader or approved per-son (broker).

So why is overconfidence so prevalent in trading? The first reason is thattraders fail to use the concept of analysis and refutation introduced in Chapter 1.There are dynamics at work influencing traders to support false beliefs, wherelooking for contrary evidence to reduce blind faith in their own judgement wouldundermine their concept of self. Second, we know that traders distort their mem-ories, and any new evidence is received in such a way to fit their current beliefsand judgements.

Although not recognised by the majority of traders, it is possible that overcon-fidence is responsible for more trading disasters than the commonly held beliefthat “emotion kills successful trading”.

A hole in my soul

As a mental health professional (and derivatives trader) I have worked with andcounselled people who have been seriously depressed as a result of unbearablelife events, some of whom made the decision to end their life. I have seen thepain of loneliness, the desperation of self-harm and the dark places that somepeople visit. One client described her experience to me as a hole in her soul,which is the title I have used for this section.

I have seen the pain and suffering of some traders who lost everything; partlyas a result of inadequate training (example in Box 1.1) and partly as a result ofother areas of their life falling apart, like the domino effect. Depression has beentermed the common cold of psychopathology, we all have it at some time in ourlife and it can be severely disabling for periods of time that seem to stretch onfor ever, seemingly without end. When the severities of symptoms from a coldor flu abate, we may still have a stuffy nose for months or a cough that just willnot remit. Many will recognise this to be true also of depression.

Some of you who are reading these pages may be contemplating the prospectof ending your life. Let me tell you that you do not have to be crazy, bad,mad, or mentally ill to have these thoughts. If you have never been to a play byShakespeare or read any of his sonnets, poems, or plays I can guarantee that youwill know the soliloquy: “To be or not to be, that is the question.” An Englishspeaking person with no education will know this quotation, its meaning, andwhere it comes from. It resonates with our collective unconscious a universal


understanding of our unique position in the animal kingdom: that of being theonly species that has a true conscious understanding of death and who can imagineself-destruction.

The truth is that most people who kill themselves are not mentally ill, at leastin the formal sense. These people are like you and me. For various reasons,they have decided that life is just not worth living any more. Some traders,when having an average time of the market, not necessarily having success orfailure, would think that suicide would never enter their head. But loss of moneyis important and does cause depression. Money in our society equals personalpower and personal power equals control over our own lives. When we lose alot of money, or maybe all we have, we lose the power to control what happensto us. And when we lose control over what can happen to us the loss can beunbearable and lead to depression.

How is it that a great man like Jesse Livermore can commit suicide? Whatare the precursors to this event? I had the great pleasure of interviewing RichardSmitten, author of Jesse Livermore: The World’s Greatest Trader, who gave mesome perspicacious insights to Jesse’s character, and it was clear that RichardSmitten held him in the highest regard. Jesse Livermore was a man prone to boutsof depression. There were numerous occasions where friends knew his mentalstate was exceptionally low and he would literally hide himself away in hotelsfor periods of weeks or months while these black ruminations took shape andthen dispersed spontaneously, as if they had not existed. Was Jesse Livermoreseriously mentally ill, in need of treatment and medication? Formal diagnosis inpsychiatry is not scientific and is subject to much clinical opinion depending onthe level of expertise of the clinician. Research in psychiatry informs us that apsychiatrist can diagnose two patients with completely different symptoms yetgive them the same diagnostic label (Clare, 1985). If psychiatric diagnoses areunreliable in the twenty-first century it was even less so during Jesse Livermore’slifespan. He was declared bankrupt on more than one occasion yet did not takehis life at those times. At the time of his suicide many people were thinkingthat he should be enjoying the benefits of his hard work, celebrity status, andcontribution to market analysis. I have taken the following excerpt from The DayTraders: The Untold Story of the Extreme Investors and How they Changed WallStreet Forever by Gregory Millman (1999).

On Nov. 28, 1940, he came to the Sherry Netherland Hotel for lunch. Hehad lived at the hotel for five years. Though he was now living on ParkAvenue, his office was only three blocks away, so he often came by forlunch. He arrived about 12:30, ate lightly, had one drink, and spent twohours scribbling furiously in a small notebook attached to his wallet. Heseemed nervous and excitable, but there was nothing unusual about that,lately. He left the hotel bar around 2:30, but returned at 4:30, lookingupset. He didn’t speak with anyone in the bar, but had two more drinksbefore going to the washroom at 5:25. On the way, he passed the hotel


manager, Eugene Volt, who said, “He looked normal and cheerful enoughto me.” At 5:35, hotel attendant Patrick Murray saw him slumped in achair in the men’s room and called the assistant manager, Vincent Murphy,who came and recognized Mr. Livermore immediately. Mr. Livermorestill looked normal, except for the blood trickling from his head and the.32-caliber Colt automatic revolver at his feet. On a scratch pad attachedto his wallet, the police found an eight-page note addressed “Dear Nina,”a pet name for his wife. “Tired of fighting,” it said, and “my life hasbeen a failure” and “couldn’t carry on any longer” and “everything is in abad way.” It mentioned “trouble” several times, but said many endearingthings about Mrs. Livermore and expressed contrition for what he wasplanning to do, according to The New York Times. It was signed “Laurie,”short for “Lauriston,” Jesse Livermore’s middle name. Inspector PatrickJ. Kenny notified Mrs. Livermore, who became hysterical and could notgo to the scene. Mr. Livermore’s son Jesse, who much resembled hisfather in the distant Boy Plunger days, arrived very shaken to make theformal identification. The medical examiner dispensed with an autopsyand accepted the police verdict of suicide.

The interesting part of this description is that Mr Volt, the hotel manager, saidthat he looked normal and cheerful enough. So how is it that somebody likeLivermore can destroy what is considered by others to be a gifted life?

There are many obvious reasons for people to arrive at the dark place ofdepression and suicide. Stress, anger, fear, and worst of all hopelessness. Thereis another less acknowledged symptom of our society which, in my opinion, hasdamaged the lives and self-confidence of many people. There is a tacit acceptancein our society that we must continually be moving up and up the ladder – theladders of success, employment, power, prestige, and feel free to add to this listthe upness of society’s values.

Wherever we are now we must be moving in a direction to somewhere new,perhaps to a more successful, higher place. If we are a C student we shouldbecome a B student. If we pass A-levels or GCSEs we should be thinking abouta degree and not just a 2:2 honours degree, at least a 2:1 or a first! If you are anexcellent mental health nurse, social worker, or psychologist, you should be inmanagement and forget about practice. Many women like being a mother and ahousewife but the pressure is to return to university, obtain a degree or a diploma,and get a full-time job to stay viable in the workplace.

Success depression – a paradox of belief

Everywhere I look there is pressure to do better and get more of everything.Recently, I have worked with traders in the UK who have been a success byany standard yet many are still unhappy. Many have two cars, computers, colour


TVs, microwaves, a house which is paid for (or almost) and a pension. Thenotion of the “American Dream” comes to mind but I am British. But all thesefactors are as close to the American Dream as one can get in the UK. Whateverit is that people wish for they often have, but now that they have moved up,and have reached the highest part of their life, where else is there for them togo? I undertook a general search of the literature and research through Internetand psychological search engines and typed in “success depression”. I mainlyaccessed articles on success of treatments with particular types of depression. Inmy discussions with clinical psychologists the concept is known but not formallypart of the International Classification of Diseases, 10th edition. I am offeringan opinion based on years of practice, delivering seminars and seeing tradersindividually and I believe that the phenomenon of “success depression” has aspecial place in the literature. With regard to self-sabotage and market trading,how much weight should be attributed to the unconscious wish to destroy one’sfinancial security in the hope that the person will be able to “start again”? Thereis no doubt that the process of achieving success in any field is an enjoyable,challenging, and fulfilling path to take. When you have achieved more than youever dreamed, where should you go?

Hopelessness

To be devoid of hope is to be without a future, without a cure, without a promiseof things to come, and without any belief. From this frame of reference there is asense of utter discouragement and it is here that thoughts of suicide grow strongand robust and I must tell you I am worried for you if you are there. One does nothave to be depressed to feel hopeless. Think of the people during wars who havefaced certain death, realising their circumstances were hopeless, but acceptingit with grace. These heroes and heroines of spirit have at least a conviction fortheir beliefs and this perhaps makes it less hopeless. However, there are thosewho have no real convictions or beliefs either religious or in life’s purpose andover the next few paragraphs we shall explore the roots of this hopelessness.

Many if not all depressed people experience hopelessness and this feeling ofdepression and belief in having no future is a common thread that runs through allthe research on suicides. If you remember the model we discussed earlier called“learned helplessness”, which contributes to our understanding of the processand roots of depression and hopelessness, it states that by people experiencingrepeated failures when they tried to change their circumstances for themselves,they eventually learn that no matter what they do, they are helpless to controlthe events in their lives or even themselves. Once they are helpless to controltheir own futures, they quickly fall into a state of depression and the associatedbeliefs and cognitions of hopelessness. In laymen’s terms this is exactly whatlearned helplessness is and there is no point in quoting clinical research because


the research can never express the depths of despair experienced by a personin this dark place. This is why the description “a hole in my soul” sums it upbeautifully.

There are depressions that have a significant biological basis yet even in thesebouts of serious depression, there is an environmental element which gives feed-back to the person saying he or she is “inadequate”, “sick”, in effect an invalidor someone who is in-valid, meaning not a valid human being. Excluding thosewith a significant biological basis the majority of us who become depressed do soin response to the loss of a loved one, failure to succeed in work or at college, orfailure in the trading forum with its subsequent financial setbacks, and we learnthat no matter how hard we try our trying doesn’t matter. Even successful peoplecan come to believe that it isn’t how hard you try, but the lucky breaks youget, also called opportunities, which are the real things that make a difference towhether a person is happy or not.

As traders we know that we cannot control the market and that the only thingthat we can control is ourselves. The theory of learned helplessness predicts thatonce you have been clobbered time and time again by the market, you may cometo believe that bad things just happen; not only to your trading but to your life ingeneral. There is nothing you can do to prevent them from happening and onceyou have arrived at this dark place, where your efforts to change or control yourlife don’t matter, it is a short step to that of hopelessness.

If you remember Jim and the description of the BOHICA effect, his patternof behaviour fitted the learned helplessness model perfectly. He had been tryinghard to stop the cycle of losses in his trading but nothing was working. Afterseveral months of trying Jim came to the conclusion that no matter what he didhe was going to fail. Then to try to minimise his sense of failure and contain thelosses to his self-esteem he began to predict that he would fail even before hedid so. Jim was well and truly locked into the loss cycle.

Jim was right, after experiencing a long string of failures it becomes easierand easier to predict your own future. The safest prediction, given your history,is to predict that you will fail again. Once you begin to predict your own failureyou won’t be disappointed because although you may not be aware of it, youwill begin to self-sabotage and ensure that you do things to ensure those failures.This is a loss trap that many traders fall into and many are happy to be trappedthere for years as long as their trading capital does not run out; many of thesetraders have private incomes or such significant capital that their cycle of lossand losers mentality can be seen as relative. Jim did not have an inexhaustiblesupply of money nor had he come from a wealthy family. Therefore his onlyoption was to break that cycle so that he didn’t enter the hopelessness phase. Jimquite successfully broke out of his phase, gave up trading, went into full-timework and addressed important issues in his life which did not have to do withtrading. By any standards Jim made an adequate and successful intervention tothe loss cycle.


Are there any advantages of being a loser? I suppose losers don’t have to try,don’t have to get up in the morning, they don’t have to expect anything fromthemselves, or other people for that matter. There is a self-fulfilling prophecythat we have all heard: “once a loser, always a loser”. What is it that qualifies aperson to be a born loser? Perhaps we should look at some of the most successfulmen in history and what happened to them and it may be that we need to changeour whole understanding of what it means to be a success and what it means tobe a born loser.

‘‘Successful’’ men of history

In his book Success, Glenn Bland (1972) examines the meaning of success andgives examples from the lives of some of the financial giants of the twentieth cen-tury. He tells of a meeting in 1923 of the world’s most successful and influentialfinanciers, at Chicago’s Edgewater Beach Hotel. These financial giants literallyruled the world of money:

Charles Schwab, president of the largest steel company in the worldSamuel Insull, president of the largest utility companyHoward Hopson, president of the largest petrol companyArthur Cutten, the great wheat speculatorRichard Whitney, president of the New York Stock ExchangeAlbert Fall, secretary of the interior in the United States CabinetJesse Livermore, the great Wall Street investorIvan Krueger, head of the world’s greatest monopolistic companyLeon Fraser, president of the Bank of International Settlements

These men were the “movers and shakers”, the kind many people envy and wantto be like. Yet something went terribly wrong. Twenty-five years later:

Charles Schwab went bankruptSamuel Insull died in a foreign land, penniless and a fugitive from justiceHoward Hopson went insaneArthur Cutten was insolventRichard Whitney went to prisonAlbert Fall had just been pardoned from prison, and died at home, brokeJesse Livermore committed suicideIvan Krueger committed suicideLeon Fraser committed suicide

I think that the above has surprised many readers since we all believe that havingthe four Ps of power, position, prosperity, and prestige will give us everythingwe need.


There is no point in kidding anyone. For some people suicide does work.There is a very good argument for people who have no quality of life and whoare experiencing intractable pain and their situation is truly hopeless. Nobodyknows what happens after death but you can be sure that you won’t be feelingthe same, and you couldn’t possibly care what happens in this physical world.One of the surprising things about suicide is that once you start thinking aboutit you immediately feel better. This is because you have found a solution to thepain. As a trader, you are not alone in feeling the pain of losses. In my initial daysof trading stock index futures I made the lethal mistake of gambling instead ofintelligent speculating and I compounded that error by throwing the vast majorityof my capital behind a single trade which was foolish. I went from being blessedwith having plenty of speculative capital to having virtually none at the time.But losing it all in one’s early years of speculating is par for the course; JesseLivermore wisely points out that there is no better way to learn how to makemoney than by losing “all you have in the world while teaching you what not todo”. Most of the wealthy self-made private speculators went through this verypainful learning process, losing most of their initial capital, and this taught themthe hard and painful lessons that helped to bless them with much success. Ifyou find yourself in this dark place, of losing it all while learning to speculate,please realise you are not alone and that countless others have been through thisexact same predicament before you. Pick yourself up, dust yourself off, learnyour hard lessons and start working hard in your usual profession to save upspeculative capital once again. Once you scrape up another capital bank roll getback in the saddle and this time listen, learn and take action with caution. Youmay be so far down the road that you cannot consider the above suggestions.Well, maybe you deserve to be depressed. By that I mean that maybe anybodyin your position would be depressed. It could very well be a normal reaction tothe losses you’ve suffered and maybe you are not as different as you think youare. One in four people will suffer a severe depression at some time in their lifebecause everybody loses something of great importance sometime; depression isgoing around like a bad Internet virus. Anyone who isn’t depressed today canprobably remember a time when they were or imagine that they could becomedepressed some time in the future. As human beings we simply cannot avoidfacing depression unless of course you have figured out how to live a life totallywithout risk, without challenge, and without fear of ever being hurt. Then youwill have lost what it is to be human.

If you have suffered terrible losses in the market, which is compounded withother losses in your life, it is true that I cannot personally know how well youwill cope with it nor how much it hurts you, but you are in fact no different fromthe rest of us. You will be surprised at how sympathetic some people will be.You may find this difficult to believe but the great majority of depressions getbetter without any intervention whatsoever. The old saying that time is a healer


is actually true. That as you progress down the road you will come to terms withall your losses, of this I have no doubt.

In addition, there are agencies that can provide counselling and there ismedicine, which can take the severity of depression away in the short term.There are a number of responses that can be made and personally I think thatsuicide is an extremely strong and permanent solution to what is after all similarto a passing cold.

What can you do?

The research indicates that people who are successful in committing suicide haveoften done so as a result of the opportunity presenting itself. In other words, itis done at the spur of the moment as a result of the intense feelings somebodyis experiencing at the time. It might be a good idea to remove any firearmsand shotguns from your immediate access. There are thousands of easy waysto commit suicide of course but it is interesting that people tend not to use themost painful or messy forms. This is a time for you to reassert new behaviourand try and discover new meaning in your life. You will also be inclined to takedrugs, drink alcohol heavily, and possibly even then make a fatal mistake. Manypeople who intend to commit suicide have ambivalence about it and yet throughdrinking too much to kill the pain of depression may end up dying from alcoholpoisoning, inhaling their vomit, or simply having a road traffic accident or otherfatal mishap.

This may be the time for you to ask spiritual questions. This does not meanthat you have to have a belief in God. It simply means exploring some of theprofound miracles that surround us on a daily basis which we tend to ignore.Perhaps once we confront and look death straight in the face, we are also ableto open and see things that previously we were blind to. Alcoholics Anonymousand Gamblers Anonymous have adopted the prayer written by the theologianReinhold Niebuhr (1892–1971), which is about accepting your circumstancesand yet also having the courage to change yourself:

God grant me the serenity to accept the things I cannot change, courageto change the things I can, and the wisdom to know the difference.

It is probably best to stop trading and concentrate on refocusing and recentringyour life. It is helpful to set small tasks such as getting up at a particular time inthe morning, undertaking housework, going for a walk, or washing your car. Tryto undertake something simple every day and remember that you will recoverand that life will take on meaning at some time in the future. You may also wishto seek counselling or contact a place of worship.

If you are in that dark place, now that you have read this section, I hope youwill make that telephone call, to talk to someone you know and love, to seek


out a counsellor, to find your way to God as you understand Him, or whateverit is that you need to do to end your pain, loneliness, and hopelessness. If youcan manage this, and do something very small every day, I know you will getthrough your period of loss, and I will feel tremendously grateful for havingshared some of your experience with you through this book.

SUMMARY CHAPTER 7

• Zen comes from the Japanese word Zazen, meaning seated meditation. Zenis not a religion; it is a spiritual discipline which is appropriate for anyreligious persuasion. Many traders have found the practice of Budo Zenvery useful because it cultivates mental focus, courage, and confidence.

• According to A. Maslow (1970) there is a hierarchy into which humanneeds arrange themselves and it can be argued that the behaviour of anindividual at a particular moment is usually determined by his or herstrongest need. Beliefs tend to support and comfort you but some beliefssupport and promote trading skills, while others do not. The beliefs inher-ent in Budo Zen are highly compatible with the lifestyle of traders. Thereare four beliefs at the core of Budo Zen: (1) mortality awareness, (2) lifepurpose, (3) soul passion, and (4) higher goals and objectives.

• There are 10 laws and beliefs of the samurai. The samurai believe that thelaw of duality, cycles, evolution, choices, responsibility, inertia, momen-tum, synchronicity, manifestation, process and action gave purpose andmeaning to life.

• The ACTION acronym refers to a philosophy of mind and action, andSTILL refers to a passive and sometimes seated meditation to prepare forthe market or to recover following action.

• Self-sabotage refers to a set of behaviours that prevents the trader fromachieving what he or she wants and where the ability to achieve the goal isevident. Self-sabotage behaviour occurs when you have conflicting internalbeliefs about the accomplishment of your goal, such as trading. One partwishes to accomplish the goal but another part does not. Self-sabotageincludes perceptual biases and extreme emotional actions which in turnprevent us from achieving our goals. Self-sabotaging behaviours which iscommon among traders, are: boredom, procrastination, lack of persistence,worry, anger, fear, depression, lack of impulse control, blaming others,negative relationships, recreational use of alcohol and drugs, moods, self-doubt, lack of stability, disabling feelings, disillusionment, and gambling.

• The distinction between gambling and speculation is explained. There islittle distinction between compulsive gambling and compulsive trading.

• The BOHICA effect is introduced and contributes to our understanding ofthe cycle of trading loss. A case study is presented portraying the BOHICAeffect and subsequent ramifications.


• It may not be impossible to eradicate all self-sabotaging behaviours but itis possible to improve and lessen the pernicious effects of these behavioursin four stages: (1) bring self-sabotaging behaviour to consciousness, (2) setSMART objectives, (3) mentally rehearse the plan, and (4) implementthe plan.

• Traders can develop positive habits to combat self-sabotaging behaviour,such as developing a positive mental attitude, having enough recreationand vacations, having adequate nutrition, and taking regular exerciseand relaxation.

• Compulsive trading is described as the most pernicious self-sabotagingbehaviour and professionals have identified four stages of development:the winning phase, the losing phase, the desperation phase, and the hope-lessness phase.

• Perceptual and emotional biases can also be interpreted as self-sabotagingbehaviour. We examine the negative effects of overconfidence and illusionof control, and discuss the significance of their impact on behaviour.

• Some compulsive traders do not stop until they have lost everything andthe feeling of desperation and hopelessness has been described as “a holein my soul”. I introduce the concept of success depression and relate thisto Jesse Livermore and his suicide. We examine the meaning of “success”and discuss some of the research undertaken by Glenn Bland. I discusssome of the causes of hopelessness and what the “ruined” trader can doabout his or her circumstances.

8Standards and Criteria forTrading Competence

‘‘The dream begins, most of the time, with a teacher who believes in you,who tugs and pushes and leads you on to the next plateau, sometimespoking you with a sharp stick called truth.’’

Dan Rather

Trading the financial markets requires a set of skills that enables a person tothink clearly under stressful conditions, make intelligent decisions devoid ofemotional and perceptual biases, and keep control of money in their account.These are difficult skills that can be learned by most people of average ability.The paramouncy principle makes explicit the requirement of self-awareness andself-management, which we can loosely term as discipline, and these skills canbe learned by anyone with a desire to succeed in this field.

A colleague of mine who is a financial analyst rather than a trader, uponhearing that I was writing a book to outline a model of trading competence,suggested that I write in a jocular and anecdotal style, similar to Schwager’s“Market Wizards”, to hold the interest of the readership. I replied that I hopedto achieve a balance between technical and general interest but also asked himto consider books of a biographical or anecdotal style that he had read. Wouldhe learn the professional skills of a doctor by reading a biography of WilliamSergeant, even though there were some excellent descriptions of psychosurgery?I apply the same criterion to market trading and while admiring and valuingnumerous anecdotal and biographical books, they do not intend to systematicallyeducate or provide a tool for traders to use on a daily basis.


For those people who wish to trade for entertainment I suggest that you buy ablack box system and write to Santa Claus for a set of trading rules to be placedin your Xmas stocking, that is, if you still own one this time next year. Thisbook is definitely not written for you. The following eight standards of tradingcompetence will challenge any novice to intermediate trader and I hope it willprovide a valuable structure to guide you through your initial stages of learning.I have purposely not recommended a method such as Wyckoff, Gann, or Elliotbecause these masters all have something to offer and I refuse to limit myselfwithin this fascinating field of study. I also hold no shares in any of the largesoftware firms nor act as an introducing broker.

There are a number of criteria in these eight standards that I have not referredto in the main text. A decision needed to be made regarding how wide a remit thisbook should embrace and I decided to focus on those topics that could be usedimmediately, and that qualified as an introduction to the discipline. There is hardlyany reference to the competencies required to achieve competence of Standard 1,Technical Analysis, yet I know this to be of paramount importance. The criteriadeveloped for Standard 1 was based on discussions with members of the Societyof Technical Analysts UK, websites of international technical associations, andextensive personal experience of using a wide variety of methods and tools. Thereading lists in Appendix 1 will guide the interested reader to literature thatcovers all the standards and criteria.

Some of the criteria are relevant to more than one standard. For example,the writing of a trading business plan represents excellence in discipline andplanning and is a standard in itself, yet it also is a major behavioural method ofreducing stress in the trading context. Financial management and risk assessmentis integral to any business plan but it is also a standard in itself.

I will briefly explain how to use this chapter. There are eight standards dividedinto five sections requiring the student to consider the following:

CRITERIA – This section describes either a concept that needs to be learned oran action that needs to be completed.

COMPETENT, NEED MORE, NOVICE – The three grades upon which youjudge yourself.

ACTION PLAN – Should include when you intend to complete the learning ortask, and how you will go about it.

DATE OF COMPLETION – The date you completed the task or learning. Howdoes it compare with your intended completion date?

PERFORMANCE – Are you happy with your performance on this criterion?

Standards and Criteria for Trading Competence 221

REVIEW – Set a date to review this criterion along with others.

NEW DATE – Having reviewed it, set a new date with action plan.

PRIORITY – Is this a high/medium/low priority for you. You may wish to groupall the high priority criteria on a separate sheet and plan accordingly.

I hope this book has been of some help to you. I have written it over a periodof five years and have found every day to bring me new challenges and new joysin market trading. Paradoxically, trading the financial markets has helped me tobecome more spiritually alive than ever before when working solely with clients,supervising mental health professionals, and managing budgets. I currently actas an expert witness for mental health review tribunals and write numerous riskassessments to assist them in their difficult decisions to release detained patients,some of whom have committed serious offences. I currently have an excellentbalance of freedom to trade, to teach trading on an individual and group basis,convene seminars, and yet continue with my career. I am blessed and I amgrateful. I wish you every joy in your journey to trading competence and success.


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10C

orre

ctio

ns:

whe

nan

dho

wfa

r.

C1.

11Su

ppor

tan

dre

sist

ance

.T

heva

riou

sch

art

poin

tsan

dfa

cets

that

can

act

assu

ch.

C1.

12B

asic

elem

ents

ofG

ann

theo

ryan

dE

lliot

Wav

eth

eory

.

C1.

13B

asic

elem

ents

ofW

ycko

ffth

eory

.

C1.

14Fi

bona

cci

seri

es,

fan

lines

,ar

csan

dtim

ezo

nes.


STA

ND

AR

D1

–M

AR

KET

AN

ALY

SIS

(CO

NT.

)

Cri

teri

a

Com

pete

ntN

eed

Mor

eN

ovic

eA

ctio

nPl

anD

ate

ofC

ompl

etio

n

Perf

orm

ance

Rev

iew

/N

ewD

ate/

Prio

rity

C1.

15C

ycle

s:am

plitu

de,

leng

th,

phas

e,ha

rmon

icity

,sy

nchr

onic

ity,

left

and

righ

ttr

ansl

atio

n,de

tren

ding

.

C1.

16R

elat

ive

perf

orm

ance

and

how

toin

terp

ret

rela

tive

stre

ngth

char

ts.

C1.

17M

omen

tum

indi

cato

rsan

dos

cilla

tors

incl

udin

g:R

ate

ofch

ange

,W

elle

sW

ilder

’sR

SI,

Stoc

hast

ics

(%K

&D

),M

ovin

gA

vera

geC

onve

rgen

ceD

iver

genc

e(M

AC

D),

MA

CD

His

togr

am,

Dir

ectio

nal

Mov

emen

tIn

dica

tor,

Para

bolic

s,C

omm

odity

Cha

nnel

Inde

x(%

V).

C1.

18V

olum

esi

gnal

san

din

dica

tors

,in

clud

ing

on-b

alan

ce-v

olum

e,vo

lum

eac

cum

ulat

oret

c.

C1.

19B

read

thin

dica

tors

.T

hepr

inci

ple

ofco

nver

genc

ean

ddi

verg

ence

invo

lvin

gtr

end

char

acte

rist

ic,

osci

llato

rs,

rela

tive

stre

ngth

,br

eadt

hin

dica

tors

and

volu

me

indi

cato

rs.

C1.

20Se

ntim

ent

indi

cato

rsan

dco

ntra

ryop

inio

n.


AN

DA

RD

2–

STR

ESS

MA

NA

GEM

ENT

Cri

teri

a

Com

pete

ntN

eed

Mor

eN

ovic

eA

ctio

nPl

anD

ate

ofC

ompl

etio

n

Perf

orm

ance

Rev

iew

/N

ewD

ate/

Prio

rity

C2.

1“F

ight

-or-

fligh

t”sy

ndro

me,

anab

olic

met

abol

ism

,ca

tabo

licm

etab

olis

m,

auto

nom

icne

rvou

ssy

stem

–sy

mpa

thet

icvs

para

sym

path

etic

.

C2.

2E

ndoc

rine

syst

em,

gluc

ocor

ticoi

ds,

cort

isol

,ad

rena

line.

C2.

3St

ress

ors

–ph

ysio

logi

cal

vsps

ycho

logi

cal

stre

ssor

s.

C2.

4L

ife

stre

ssor

s–

cata

clys

mic

,pe

rson

al,

back

grou

nd,

wor

kpla

ce.

C2.

5T

radi

ngst

ress

ors

–lo

sses

,in

actio

n,in

cent

ives

,su

cces

s,lo

cus

ofco

ntro

l,so

litud

e,se

lf-d

oubt

.

C2.

6Ps

ycho

logi

cal

effe

cts

ofw

orry

.

C2.

7St

ress

mod

els

–G

ener

alA

dapt

atio

nSy

ndro

me,

Yer

kes-

Dod

son

law

ofar

ousa

l,m

uscl

ete

nsio

nm

odel

,id

eo-m

otor

theo

ry,

two-

com

pone

ntth

eory

.

C2.

8Ph

ysio

logi

cal

effe

cts

ofw

orry

.

226 Financial Risk TakingST

AN

DA

RD

2–

STR

ESS

MA

NA

GEM

ENT

(CO

NT.

)

Cri

teri

a

Com

pete

ntN

eed

Mor

eN

ovic

eA

ctio

nPl

anD

ate

ofC

ompl

etio

n

Perf

orm

ance

Rev

iew

/N

ewD

ate/

Prio

rity

C2.

9St

ress

man

agem

ent

–ef

fect

ive

and

inef

fect

ive

copi

ngst

rate

gies

.

C2.

10St

ress

man

agem

ent

thro

ugh

the

use

ofM

ISO

GI,

STIL

Lan

dA

CT

ION

.

C2.

11St

ress

man

agem

ent

usin

gph

ysio

logi

cal

met

hods

–bi

ofee

dbac

k,pr

ogre

ssiv

em

uscl

ere

laxa

tion,

seat

edm

edita

tion

(pas

sive

),w

alki

ngm

edita

tion

(act

ive)

,re

gula

rae

robi

cex

erci

se.

C2.

12St

ress

man

agem

ent

usin

gco

gniti

vem

etho

ds–

prob

lem

focu

sed

and

emot

ion

focu

sed

copi

ngst

rate

gies

,co

gniti

vere

stru

ctur

ing,

ratio

nal

emot

ive

ther

apy,

stre

ssin

ocul

atio

n,le

arne

dhe

lple

ssne

ssth

eory

,be

havi

oura

lco

ntro

lof

info

rmat

ion,

cogn

ition

,an

dde

cisi

on-m

akin

gpr

oces

ses.

C2.

13St

ress

man

agem

ent

usin

gbe

havi

oura

lm

etho

ds–

daily

“to-

do”

lists

and

pers

onal

sche

dule

s.

C2.

14St

ress

man

agem

ent

–th

etr

adin

gbu

sine

sspl

anas

abe

havi

oura

lm

etho

dof

redu

cing

stre

ss.

See

Stan

dard

3.


STA

ND

AR

D3

–TH

ETR

AD

ING

BU

SIN

ESS

PLA

N

Cri

teri

a

Com

pete

ntN

eed

Mor

eN

ovic

eA

ctio

nPl

anD

ate

ofC

ompl

etio

n

Perf

orm

ance

Rev

iew

/N

ewD

ate/

Prio

rity

C3.

1T

heT

radi

ngB

usin

ess

Plan

Are

a1

–D

ecis

ion-

mak

ing,

SWO

Tan

alys

is.

C3.

2A

rea

1co

nt.

SMA

RT

desc

ript

ion

ofai

ms

and

obje

ctiv

es.

C3.

3A

rea

1co

nt.

Iden

tifica

tion

oftr

adin

gbe

liefs

.

C3.

4A

rea

1co

nt.

Stat

emen

tof

aspi

ratio

nsan

dva

lues

,m

issi

onst

atem

ent,

actio

npl

ans

and

eval

uatio

n.

C3.

5T

heT

radi

ngB

usin

ess

Plan

Are

a2

–Te

chni

cal

syst

ems,

met

hod,

and

finan

cial

man

agem

ent.

Stud

ying

one

syst

emor

met

hodo

logy

inde

pth.

C3.

6A

rea

2co

nt.

Use

ofin

dica

tors

,id

entif

ytr

adin

gbe

liefs

,de

fine

pers

onal

trad

ing

styl

e.

C3.

7A

rea

2co

nt.

Dev

elop

ing

perf

orm

ance

crite

ria

for

test

ing

trad

ing

syst

ems,

bias

esne

gativ

ely

affe

ctin

gtr

adin

gsy

stem

s,fin

anci

alan

dri

skm

anag

emen

t–

see

Stan

dard

7.


STA

ND

AR

D3

–TH

ETR

AD

ING

BU

SIN

ESS

PLA

N(C

ON

T.)

Cri

teri

a

Com

pete

ntN

eed

Mor

eN

ovic

eA

ctio

nPl

anD

ate

ofC

ompl

etio

n

Perf

orm

ance

Rev

iew

/N

ewD

ate/

Prio

rity

C3.

8A

rea

2co

nt.

Fina

ncia

lan

dri

skm

anag

emen

t–

see

Stan

dard

6.

C3.

9T

heT

radi

ngB

usin

ess

Plan

Are

a3

–Pe

rson

aldi

scip

line,

gene

ral

trad

ing

rule

s,sp

ecifi

cte

chni

cal

trad

ing

rule

s.

C3.

10A

rea

3co

nt.

Des

ign

trad

ing

diar

y,de

cisi

ondi

ary,

and

equi

tych

art.

C3.

11Pe

rson

alst

atem

ent.

Defi

neth

em

axim

umam

ount

ofca

pita

lyo

uar

epr

epar

edto

risk

,w

here

you

will

trad

e,w

hat

time

fram

esyo

uin

tend

totr

ade,

how

muc

htim

eyo

usp

end

daily

ontr

adin

g.

C3.

12Pe

rson

alst

atem

ent

cont

.W

hich

inst

rum

ents

you

inte

ndto

trad

e(f

utur

es,

optio

ns,

shar

es,

etc.

),w

hich

mar

kets

doyo

uin

tend

totr

ade

(FO

RE

X,

LIF

FE,

the

S&P

500,

the

NA

SDA

Q),

your

med

ium

term

obje

ctiv

es,

your

defin

ition

ofsu

cces

s.


STA

ND

AR

D4

–PE

RC

EPTU

AL

BIA

SES

Cri

teri

a

Com

pete

ntN

eed

Mor

eN

ovic

eA

ctio

nPl

anD

ate

ofC

ompl

etio

n

Perf

orm

ance

Rev

iew

/N

ewD

ate/

Prio

rity

C4.

1T

heav

aila

bilit

yer

ror,

prim

acy

erro

r,an

dre

cenc

yef

fect

s.

C4.

2T

heha

loef

fect

,co

mm

unic

atio

nan

dpe

rsua

sion

,ri

sky

shif

tef

fect

,gr

oup

phen

omen

aor

“her

dbe

havi

our”

.

C4.

3M

ispl

aced

cons

iste

ncy

erro

r,th

esu

nkco

ster

ror,

pros

pect

theo

ry,

cogn

itive

diss

onan

ce.

C4.

4R

isk

aver

sion

inth

ere

alm

ofpr

ofits

,an

dri

skse

ekin

gin

the

real

mof

loss

es.

C4.

5Se

lf-d

ecep

tion

bias

,ou

tlier

bias

,la

wof

larg

enu

mbe

rsbi

as,

info

rmat

ion

bias

,fr

amin

gof

loss

esbi

as,

perc

enta

gebi

as.

C4.

6Pe

rson

albe

lief

para

digm

s,an

alys

isan

dre

futa

tion,

BO

HIC

Aan

dle

arne

dhe

lple

ssne

ss,

the

loss

cycl

e.


STA

ND

AR

D5

–EM

OTI

ON

AL

BIA

SES

Cri

teri

a

Com

pete

ntN

eed

Mor

eN

ovic

eA

ctio

nPl

anD

ate

ofC

ompl

etio

n

Perf

orm

ance

Rev

iew

/N

ewD

ate/

Prio

rity

C5.

1R

ole

and

func

tion

ofem

otio

ns,

elem

enta

rybr

ain

phys

iolo

gyan

dem

otio

nal

path

way

s.

C5.

2U

nder

stan

ding

emot

iona

lst

ates

and

moo

ds.

Con

trol

ling

emot

iona

lst

ates

and

moo

ds.

C5.

3E

mot

iona

lin

telli

genc

e–

self

-aw

aren

ess

–em

otio

nal

self

-aw

aren

ess,

accu

rate

self

-ass

essm

ent,

self

-con

fiden

ce,

and

intu

ition

.

C5.

4E

mot

iona

lin

telli

genc

e–

self

-m

anag

emen

t–

emot

iona

lse

lf-c

ontr

ol,

tran

spar

ency

,ad

apta

bilit

y,ac

hiev

emen

t,an

din

itiat

ive.


STA

ND

AR

D6

–FI

NA

NC

IAL

AN

DR

ISK

MA

NA

GEM

ENT

Cri

teri

a

Com

pete

ntN

eed

Mor

eN

ovic

eA

ctio

nPl

anD

ate

ofC

ompl

etio

n

Perf

orm

ance

Rev

iew

/N

ewD

ate/

Prio

rity

C6.

1D

evel

opin

ga

low

risk

plan

with

high

prob

abili

tyof

succ

ess.

C6.

2C

alcu

latin

gex

pect

edou

tcom

eof

atr

ade.

C6.

3C

alcu

latin

gri

skof

ruin

.

C6.

4U

seof

stop

loss

es–

trai

ling

stop

,m

arke

tif

touc

hed

(MIT

),or

der

canc

els

orde

rak

aon

eca

ncel

sth

eot

her

orde

r(O

CO

),lim

itor

der,

calc

ulat

ions

ofm

argi

n,co

mm

issi

on,

and

slip

page

.

C6.

5Po

sitio

nsi

zing

,ru

les

ofca

pita

lex

posu

re(e

.g.

2%ru

le).

C6.

6D

evel

opin

gan

nual

profi

tan

dlo

ssac

coun

ts,

acu

rren

tba

lanc

esh

eet,

aca

shflo

wst

atem

ent.

C6.

7Py

ram

idin

g,ri

skto

rew

ard

ratio

,bu

sine

sslo

sses

vstr

adin

glo

sses

and

the

perc

enta

gebi

as.


STA

ND

AR

D7

–D

ATA

MA

NA

GEM

ENT

Cri

teri

a

Com

pete

ntN

eed

Mor

eN

ovic

eA

ctio

nPl

anD

ate

ofC

ompl

etio

n

Perf

orm

ance

Rev

iew

/N

ewD

ate/

Prio

rity

C7.

1U

nder

stan

ding

com

pute

rha

rdw

are

–ce

ntra

lpr

oces

sing

unit,

rand

omac

cess

mem

ory,

mot

herb

oard

,ha

rddr

ive,

AG

Psl

ot,

PCI

slot

,PC

MC

IA,

netw

orks

,lo

cal

area

netw

orks

(LA

Ns)

,w

ide

area

netw

orks

(WA

Ns)

.

C7.

2Ps

ycho

logy

ofhu

man

info

rmat

ion

proc

essi

ng,

max

imum

capa

city

,fa

llibi

lity

ofhu

man

mem

ory.

C7.

3H

uman

info

rmat

ion

over

load

–id

entif

ype

rson

alst

reng

ths

and

wea

knes

ses

inm

anag

ing

diff

eren

tty

pes

ofin

form

atio

n,de

velo

ping

pers

onal

stra

tegi

esto

man

age

info

rmat

ion.

C7.

4Sa

telli

tean

dIn

tern

etda

tafe

eds

–un

ders

tand

ing

the

stre

ngth

san

dw

eakn

esse

sof

your

data

colle

ctio

nsy

stem

,co

mpa

rean

dco

ntra

stcu

rren

ttr

adin

gsy

stem

with

two

othe

rty

pes

oftr

adin

gsy

stem

(e.g

.T

rade

stat

ion

and

Adv

ance

dG

et),

man

age

info

rmat

ion

data

base

(of

mar

ket

pric

ean

dtim

e).

C7.

5U

nder

stan

ding

the

soft

war

eyo

uar

eus

ing.

C7.

6U

seof

Com

preh

ensi

veM

odel

Of

Tra

ding

Com

pete

nce.


AN

DA

RD

8–

CO

NTI

NU

ING

EDU

CA

TIO

N

Cri

teri

a

Com

pete

ntN

eed

Mor

eN

ovic

eA

ctio

nPl

anD

ate

ofC

ompl

etio

n

Perf

orm

ance

Rev

iew

/N

ewD

ate/

Prio

rity

C8.

1K

now

ledg

eof

impo

rtan

tm

arke

ts–

Lon

don

Stoc

kE

xcha

nge,

New

Yor

kSt

ock

Exc

hang

e,N

ASD

AQ

,FO

RE

X,

LIF

FE,

and

DA

X.

C8.

2R

oles

ofth

epl

ayer

s–

mar

ket

mak

ers

(lar

gefin

anci

alin

stitu

tions

),jo

bber

s,st

ockb

roke

rs,

stro

ngho

lder

san

dw

eakh

olde

rs,

and

bulls

and

bear

s.

C8.

3B

onds

,co

ntra

cts,

futu

res,

optio

ns(p

uts

and

calls

),se

curi

ties,

ash

are,

ast

ock,

deri

vativ

es,

debe

ntur

es,

and

gilts

.

C8.

4K

now

ledg

eof

rele

vant

new

sas

sepa

rate

from

mis

lead

ing

new

s.T

heU

Sec

onom

icca

lend

ar–

empl

oym

ent

repo

rt,

prod

ucer

pric

ein

dex

(PPI

),co

nsum

erpr

ice

inde

x(C

PI),

gros

sdo

mes

ticpr

oduc

t(G

DP)

,Fe

dera

lO

pen

Mar

ket

Com

mitt

ee(F

OM

C),

stoc

kea

rnin

gsre

port

s,an

dco

nfer

ence

calls

.

C8.

5D

evel

opa

long

-ter

mtr

aini

ngpl

anus

ing

info

rmat

ion

abou

tst

reng

ths

and

wea

knes

ses

lear

ned

thro

ugh

usin

gth

ese

eigh

tst

anda

rds

and

crite

ria.

C8.

6T

hepa

ram

ounc

ypr

inci

ple.

Appendix 1Reading List

ESSENTIAL READING FOR METHOD, MONEY MANAGEMENT,PSYCHOLOGY OF TRADING, AND GENERAL INTEREST

Borsellino, J. L. (2002) The Day Trader – From the Pit to the PC. John Wiley &Sons.

Connors, L. and Raschke, L. B. (1995) Street Smarts: High Probability Short-Term Trading Strategies. M. Gordon Publishing Group.

Douglas, M. (1990) The Disciplined Trader, Developing Winning Attitudes. NewYork Institute of Finance.

Douglas, M. (2001) Trading in the Zone: Master the Market with Confidence,Discipline and a Winning Attitude. Prentice Hall.

Elder, A. (2001) Trading for a Living – Psychology, Trading Practice, MoneyManagement . John Wiley & Sons.

Fischer, R. (1993) Fibonacci: Applications and Strategies for Traders. John Wiley& Sons.

Fridson, M. (ed.) (1995) Extraordinary Popular Delusions and the Madness ofCrowds and Confusion de Confusiones. Authors C. MacKay (1841) and J. DeLa Vega (1688). Chichester: John Wiley & Sons.

Lefevre, E. (1923) Reminiscences of a Stock Operator. John Wiley & Sons.Millard, B. J. (1999) Channels and Cycles: A Tribute to J M Hurst. Traders Press.Murphy, J. (1999) Technical Analysis of the Financial Markets. New York Insti-

tute of Finance, Prentice Hall.Plumber, T. (1998) Forecasting Financial Markets. Kogan Page.Prechter, R. (1994) R N Elliot’s Master Works, The Definitive Collection. New

Classic Library, a Division of Elliot Wave International, Gainesville, USA.


Schwager, J. (1989) Market Wizards: Interviews with Top Traders. Harper Busi-ness.

Schwager, J. (1992) The New Market Wizards: Conversations with America’s TopTraders . John Wiley & Sons.

Schwed, F. (1940) Where are the Customers’ Yachts or a Good Hard Look atWall Street. John Wiley & Sons.

Williams, B. (1999) Trading Chaos – Applying Expert Techniques to Maximiseyour Profits . John Wiley & Sons.

Williams, T. (2003) The Undeclared Secrets that Drive the Stock Market. Inde-pendent Publication.

ESSENTIAL READING FOR DEVELOPING TRADING SYSTEMS ANDINDICATORS

Barnes, R. (1996) Trading System Analysis. McGraw-Hill Publishing Company.Barnes presents a comprehensive discussion of all the most important factorsin developing and analysing a trading system.

Demark, T. (1994) The New Science of Technical Analysis. New York, Wiley.Shows how trading systems are important as shortcuts for the frailties of humandecision making.

Irwin (1988) The Encyclopaedia of Technical Market Indicators. Dow-Jones. Aclassic text on technical market indicators showing uses and strengths andweaknesses of some of the most popular market tools.

Patel, C. (1996) Technical Trading Systems for Commodities and Stocks. TradersPress, Inc. An excellent book for the novice system developer as it is a collec-tion of 82 systems already developed, with precise entry and exit rules alreadyestablished. It gives a detailed summary for each system leaving no ambiguity.

Schwager, J. Winning with Alternated Trading Systems. Traders Library. This isan 86 minute VHS video in four parts. It gives an overview of trading systemsin general and specifically the benefits of a mechanical trading system. Aninformative and excellent introduction for any novice trader.

Tharp, V. (1998) Trade Your Way to Financial Freedom. McGraw-Hill PublishingCompany. Tharp shows how the interplay of an investor’s style, goals,and personality – in combination with a carefully designed and testedsystem – ultimately determines true success.

GENERAL READING LIST

Abell, H. (1996) The Day Trader’s Advantage: How to Move from one WinningPosition to the Next. John Wiley & Sons.

Abraham, A. (1977) The Individual Investment System.

Reading List 237

Ainsworth, R. (1980) Profitable Grain Trading. Traders Press.Anuff, J. and Woolf, G. (2000) Dumb Money. Random House.Appel, G. (1980) Stock Market Trading Systems: A Guide to Investment Strategy

for the 1980’s.Appel, G. (1991) Winning Market Systems: 83 Ways to Beat the Market.Argenti, J. Corporate Collapse.Arnold, C. (1986) Timing the Market: How to Profit in Bull and Bear Markets

with Technical Analysis.Badger, R. (1969) Investment Principles and Practices.Bernstein, J. (1986) Seasonal Concepts in Futures Trading.Bernstein, J. (1989) The New Prosperity: Investment Opportunities in Long-Way

Economic Cycles.Cahen, P. (2001) Dynamic Technical Analysis.Cattel, H. (1968) A Checklist of Stock Market Techniques.Craig, M. (1987) Successful Investment Strategy.Dines, J. (1972) How the Average Investor can use Technical Analysis for Stock

Profits.Dobson, E. (1979) The Trading Rule that can make you Rich.Dreman, D. (1982) The New Contrarian Investment Strategy.Eng, W. (1988) Exchange Rate Forecasting. Edited by Guines and Feeny.Eng, W. (1993) The Day Trader’s Manual.Fisher, K. (1984) Superstocks.Frost, A. (1990) Elliot Wave Principle.Frost and Prechter (1990) Elliot Wave Principle – Expanded Edition.Gann, W. (1976) How to Make Profits Trading in Commodities.Gann, W. (1976) Truth of the Stock Trader.Hamilton, W. P. (1993) The Stock Market Barometer.Harper, H. (1966) The Psychology of Speculation: The Human Element in Stock

Market Transactions.Kahn, M. (1999) Technical Analysis Plain and Simple.Kaufman, P. (1987) The New Commodity Trading Systems and Methods.Koppel, R. (1996) The Intuitive Trader.Koppel, R. and Abell, H. (1994) The Inner Gain of Trading Modelling the Psy-

chology of the Top Performing Traders.Le Beau, C. and Lucsa, D. W. (1992) Technical Trader’s Guide to Computer

Analysis of the Futures Market.Lewis, C. (2001) The Day Trader.Livermore, J. (1966) How to Trade in Stocks.Livermore, J. (1989) Volume 1: Jesse Livermore and his Solutions to the Problems

of Successful Stock Market Trading.Livermore, J. (1989) Volume 2: Jesse Livermore and his Solutions to the Problems

of Successful Stock Market Trading.Malkiel, B. (1990) A Random Walk down Wall Street.


McCabe, W. (2001) Short Term Price Effects of Popular Share Recommendations.Meyer, T. A. (1989) Technical Analysis Course.Murphy, J. (1986) Technical Analysis of the Futures Markets: A Comprehensive

Guide to Trading Methods and Applications.Murphy, J. (1991) Intermarket Technical Analysis.Murphy, J. (1999) John Murphy on Chart Analysis (including CD). Marketplace

Books/Traders Library; Book and CD-ROM edition (15 May 1999)Pring, M. (1989) Quantitative Methods for Market Orientated Economic Analysis

over Space and Time.Pring, M. (1993) Investment Psychology Explained–Classic Strategies to Beat

the Markets.Pring, M. (1993) Martin Pring on Market Momentum.Rhea, R. (1993) The Dow Theory.Soros, G. (1988) The Alchemy of Finance.Steidlmayer, J. (1984) Steidlmayer on Markets: A New Approach to Trading.Tharp, V. (1989) Peak Performance Course, Volume 1 to Volume 5.Toppel, E. A. (1992) Zen in the Markets: Confessions of a Samurai Trader.Wilder, J. (1979) Delta Phenomenon: Or the Hidden Order in all Markets.Williams, L. (1988) The Definitive Guide to Futures Trading, Volumes 1 and 2.Wyckoff, R. D. (1983) How I Trade and Invest in Stocks and Bonds.

Appendix 2Websites of Interest

The following websites should not be viewed as a recommendation of any kind.They are here simply as a reference point for novice or intermediate traders whomay be interested in expanding their knowledge of resources on the Internet.

www.tradersradio.com – Electronic trading systems and broker assisted trading.

www.esignal.com/advancedget – Esignal’s description of Elliot Wave theorythrough the application of Advancedget products.

www.bullishreview.com – A historical database on the commitment of tradersand an analysis by Steve Briese.

www.hometownproperty.com/cotham.htm – An analysis of commitment of tra-ders using charts.

www.elder.com – Dr Alexandra Elder’s web page for training and seminars.

www.borsellino.com – Louis Borsellino’s website including trading recommen-dations and training for home traders.

www.trade2win-Paul.com – The website of Tom Williams, developer of VolumeSpread Analysis.

www.gannalyst.com – Gannalyst software, weekly summaries and market an-alysis from an Elliot and Gann perspective.

www.tradetowin.com – A UK-based information and traders forum (definitelyworth a visit).


www.mrci.com – The More Research Centre Incompany, the website of LindaRaschke.

www.localknowledge.com – A live trading service offering momentum indica-tors and professional trading education.

www.marketvane.net – A brief consensus measuring the futures market senti-ment each day by following the trading recommendations of leading commoditytrading advisers.

www.wealth-lab.com – Commentaries by fellow traders regarding their currentpositions.

www.tradestation.com – The web page for Trade Station 7.

www.ontheclose.com – The Dell Mar trading system.

www.tradestationworld.com – Trade Station discussion groups and trainingcourses.

www.iitm.com – Website of the International Institute of Trading Mastery hostedby Van Tharp.

www.tradershelpingtraders.com – Chatroom for traders.

www.traderspressbookstore.com – Comprehensive web-based bookshop.

www.tradeguider.com – Website of Tom Williams.

GOOGLE INVESTMENT AND TRADING GROUPS

Google misc.invest.misc

Google alt.invest.technical-analysis

Google misc.invest.financial-plan

Google misc.invest.futures

Google misc.invest.mutual-funds

Google misc.invest.options

Websites of Interest 241

Google misc.invest.stocks

Google misc.invest.technical

Google misc.invest.marketplace

Google yahoo groups.behavioral-finance

GAMBLERS ANONYMOUS

Gamblers Anonymous (UK)PO Box 88,London SW10 0EU

UK: www.gamblersanonymous.co.uk

National 08700 50 88 80London 020 7384 3040Sheffield 0114 262 0026Manchester 0161 976 5000Birmingham 0121 233 1335Glasgow 0141 630 1033Belfast 028 7135 1329

INTERNATIONAL WEB ADDRESSES

Australia: www.gamblersanonymous.org.au

USA: www.gamblersanonymous.org

Canada: www.edmontonga.com

Appendix 3Courses and Seminars

SCHOOL FOR TRADING FUTURES AT RICHMOND COLLEGE – ENGLAND

The School for Trading Futures will be presenting affordable seminars and courseson a regular basis in the UK. Please visit www.schoolfortradingfutures.com wherefurther information will be available.

COURSES AND SEMINARS

The Mystery of Volume (2 days) – Tutors: Mr T. Williams, Mike Elvin, andguests. The course is an introduction to Volume Spread Analysis, created byTom Williams. The seminar reveals robust trading tools and methods of analysisto give traders a powerful edge.

The Psychology of Trading (2 days) – Tutors: Mark Douglas and Mike Elvin.The highly respected author of The Disciplined Trader and Trading in the Zonewill reveal the essence of disciplined trading and the requirements for becominga success in this difficult field. Mark Douglas has trained professional traders atmany of the International Exchanges and has assisted them in the transition frompit to screen trading.

The Way of the Warrior Trader – Futures Trading (2 days – followed by long-term personal coaching) – Tutors: Richard McCall and Mike Elvin. The highlyrespected author of The Way of the Warrior Trader introduces short-term futurestrading methods that have proved highly profitable. On completing the course, thetrainee joins an international group of master traders offering invaluable supportand guidance while trading live.


One-Day Introduction to Stock Market Trading – Tutors: Mike Elvin and guests.How do you know that you are able to make a major change in your career? Istrading for you? How do you know your tutor has genuine skills to teach you?

These and many questions can be answered by attending a one-day observationcourse. You will be able to observe a trader at his or her home and you can assessfor yourself the level of skills shown. The demonstrator may be a graduate ofthe course who has started on minimum funds and whose general background issimilar to your own. You are advised that each course participant undertakes thiscourse prior to paying full course fees thus enabling the student to make a lowrisk investment in training.

You will observe the trading process being applied by the trader as outlinedin the Comprehensive Model Of Trading Competence. There will be classroomteaching as well as discussions of personal needs.

Ten-Day Course on Stock Market Trading – Tutors: Mike Elvin and TomWilliams – Guests who are experts in the stock market industry will alsobe invited.

Week 1

Introduction to Stock and Futures MarketsThe Market ParticipantsMarket Division of Stock – Categories of LiquidityRotation of Stock and Market TestingFundamental and Technical Analysis ExplainedA Technical Analysis of the Processes Driving a Bull and Bear MarketHow to Interpret Market Dynamics to your AdvantageVolume Spread Analysis – Relation of Price to Spread; Implications of Climactic

Volume; Trading Rules of Thumb; Generic Trading RulesTypes of Brokerage Orders – When and How to Place ThemUse of Internet Trading PlatformsIntroduction to Database Management – The Essentials for TradersDeveloping Adequate Records – Double Entry Systems

Week 2

Review of Empirical Research on Personality Factors Producing Successful Tra-ders’ Objective Definition of Market Risk and Mathematical Models of Infer-ence (requires only basic arithmetic)

Spread Betting and Contracts for Difference

Courses and Seminars 245

The Loss Trap and How to Avoid ItNegative Stress – Biological and Psychological Perspectives Applied to TradingBudo Zen and the Application of Fear Control to TradingDefining Discipline and Writing a Business PlanEfficacy in Relation to Mechanical and Intuitive Trading SystemsPsychometrics as a Tool for Self-knowledge – Spotting Training NeedsBeliefs and Filters – The Influence of Beliefs on Decision-making ProcessesDeveloping Positive AttitudesBeliefs, Mental Strategies, and Mental States

The Comprehensive Model Of Trading Competence

Introduction to Generic Trading Systems – Elliot Wave, Gann, Omega TradeStation Review of Technical Analysis and the Commencement of Paper Trading

Following completion of the course, all participants will be able to read themarket and commence paper trading successfully. The school can provide a totalpackage of datafeed, PC, brokerage discounts, and training. See further detailsat www.schoolfortradingfutures.com. The above syllabus may vary to meet theneeds of the student group and to address any special circumstances in marketbehaviour.

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Index

aborting decisions, Tactical MOT 55–6,65

accept-losses concepts, ACTION acronym35–6, 52–54, 185–6, 192–3

accident fatalities 128, 195accounting concepts 137, 207–8, 231achievable objectives, SMART 111, 192,

200achievement needs, self-management

59–60, 80, 168, 230acid test ratio, definition 68ACT Architecture (Adaptive Control of

Thought), concepts 37–8ACTH see adrenocorticotrophic hormoneACTION acronym, concepts 35–6, 54,

171, 185–93action plans, concepts 74, 111, 220–33actions

beliefs 10–12, 96–8, 181–2concepts 10–12, 20–3, 35–6, 52,

72–7, 96–111, 119, 158–79,192–218

active management styles, concepts 66active meditation 60, 171, 193–4, 202,

226activity volumes 49, 112–13acute fears 191adaptability needs, self-management

59–60, 168, 230adrenal cortex 92–5adrenalin 84–5, 92, 164adrenocorticotrophic hormone (ACTH)

84Against the Gods (Bernstein) 136

aggressive behaviour 20–1agoraphobics 112aim skills, concepts 25–30air balls, concepts 28–9alarm stage, General Adaptation

Syndrome 92alchemy 8alcohol misuse, self-sabotage behaviour

20, 93, 103, 176, 196, 201, 216Alcoholics Anonymous 216alpha brain waves 187ambient stressors

concepts 85–7see also stress

ambush skills, Tactical MOT 51, 119American Dream 212amphetamines 196amygdala 61, 85, 155–7, 167–8anabolic metabolism 84analytical processes, concepts 11–12,

31, 33–4, 49, 71, 209, 229anchoring 137Andersen, J.R. 36–7anger 103, 151, 160–77, 180, 192–3,

196coping techniques 160–74, 192–3see also emotions

anticipatory fears 54, 190antidepressants 199anxieties 10–11, 16, 52, 91, 158–63,

169–71, 186–7, 191, 193–4Approved Persons, FSA 77arbitrage trading, concepts 66Aristotle 133, 152

258 Index

Arkes, H.R. 142arousal levels 84, 94–5, 98, 123, 164Artificial Intelligence, intuition 41arts, sciences 38Asch, Solomon 130, 135–6attachment tendencies 153attention 37–8, 158–62attitudes

concepts 21, 26–7, 29, 91, 143–5,199–209

risk 26–7, 29, 52, 143–5, 199–209autonomous nervous system, concepts 91availability errors

concepts 63, 124–34, 147, 229definition 124–5examples 130–31, 147

awareness 31–2, 42, 45, 48, 59–62,102, 119, 162–9, 181–2, 190

see also self-awareness

background stressorsconcepts 86see also stress

bad habits, awareness 31–2, 49, 58–9bailouts, compulsive trading 203Banker’s Trust 75bar charts, concepts 22, 74, 222–4Barings Bank 202Bartlett, F.C. 10basal ganglia 85, 167battle analogies 21BBC see British Broadcasting Corporationbear markets 9, 35, 49, 58, 113, 117, 233Beck, A.T. 48, 96, 169Beck Depression Inventory 48Beckers, S. 76–7behavioural coping techniques, stress

management 102, 107–19,220, 225–6

behavioural finance xiii, 9–10, 134–8behaviourism 38, 137–8, 153beliefs

actions 10–12, 97–8, 181–2availability errors 124–31Budo Zen 181–218concepts 10–12, 17–18, 90, 96–8,

105, 111–16, 124–31, 181–2

definition 112irrational beliefs 104, 130–1perceptual biases 7, 9–10, 12, 29, 34,

53–4, 123–36, 161, 194, 219,229

personal belief paradigm 10–12,96–8, 112, 124, 181–2, 229

rational emotive therapy 105reality 112, 184self-sabotage behaviour 194–218spiritual beliefs 181–2, 216, 221warrior trader Kyokushin 182–5

Berkowitz, L. 160Bernstein, Peter L. 136biases 7–12, 29, 31, 34, 41, 54–5, 78,

115–16, 123–49, 158–61, 194,205–7, 219, 227–30

concepts 7, 9–10, 115–16, 123–49,158–9, 205–7, 227–30

emotions 158–9, 230moods 161–4see also individual biases

types 205–7, 227–30biofeedback techniques, stress

management 100–1, 226black box systems 124, 220Black-Scholes model 179blame 20–1, 196Bland, Glenn 214Blumer, C. 142body

centring concepts 35–6, 53, 60,186–8, 193–4, 216–17

stress 10, 50, 63–5, 78, 83, 123–4,158–62, 180–218, 225–6

BOHICA effect 198–200, 213, 229‘bolder brighter bullshit’ (BBB) 207Bollinger bands 179, 222bonds 233boredom, self-sabotage behaviour 194–5Borsellino, Lewis 13, 24–30, 61bottom-up investment approaches,

concepts 66bottoms 118, 128Boyatzis, R. 59Bradford-Raschke, Linda 24

Index 259

braincorrect decisions 165–7emotions 153–7, 165–7, 230evolutionary developments 155–8functions 130, 155–60, 165–70motivation 61Phineas Gage case study 153–4,

165physiology 61, 85, 130, 155, 165–7,

225, 230stem 155stress 84–122, 225–6structure 61, 85, 130, 155–9, 165–7,

230breakouts 22, 28, 56, 68

see also market directionsbreathing techniques 171, 174, 186–7,

191, 193–4British Broadcasting Corporation (BBC)

132Budo Zen 21, 53, 100, 179–218

see also warrior tradersBudo-Zazen 60, 101, 179–80, 186–7bull markets 9, 34–5, 57, 68, 76, 113,

117, 141–2, 233Burchett, R. 24Bushinkai Dojo, Little Rock, Arkansas

180business losses, concepts 21business plans

action plans 111, 226–8biases 115–16, 227–8concepts 107–119, 159–61, 192, 200,

220, 226–8discipline 107, 116–19, 158–182,

226–8financial management 108, 111–16,

231methods 108, 111–16, 226–8SMART objectives 110–11, 192, 200,

227stress 107–19, 226technical systems 108, 111–16trading-competence standards 200,

226–8business risk, concepts 21, 29

calm 37–8Campos, J. 153cancers 98, 163candlestick charts, concepts 22, 69,

222–4capital, financial management 70–4, 115capitalisation 25cardiovascular disease 89, 99catabolic metabolism 84–5cataclysmic events, stressors 86–7Cattell, R.P. 98CBO see Congressional Budget OfficeCCK see cholecystokininCEA see Council of Economic AdvisersCeci, S. 134centring concepts 35–6, 53, 186–8,

193–4, 216–17challenges, stress 99–100, 175change 18–19, 58, 86–9, 92–3, 99,

107–12Changing Belief Systems with NLP (Dilts)

181channels 22charts 8–9, 22, 25, 28, 45, 65, 69,

222–4concepts 8–9, 22, 28, 45, 65, 69,

222–4method 22, 67–70, 112–16, 222–4patterns 25, 28, 34–5, 72–4, 222–4ready–aim–fire skills 25–30see also technical analysis

Chase Manhattan 75Chase, W.G. 36‘chasing the market’ 128chess players 37chi square 8Chicago Mercantile Exchange 25, 28Chief Wizard, training issues 2–8, 15,

77–81, 132, 135choices law, warrior trader Kyokushin

183cholecystokinin (CCK) 161Chopra, Deepak 54, 60–1chronic fears 191

see also worrychunking concepts 37–8, 50, 63City brokers 75–6, 135, 207, 208–9

260 Index

Clore, G. 164closing-the-trade decision 64Clunis, Christopher 127coaching styles, tutors 79–81Cockwill, Peter 51cognitive coping techniques, stress

management 101, 163, 225–6cognitive dissonance, concepts 141–2,

229cognitive effects, emotions 161–63cognitive psychological research, learning

issues 36–8, 168cognitive restructuring programmes, stress

management 103–4, 226cognitive schema, unlearning hypothesis

1, 32Cohen, F. 86Colby, R. 114Come into my Trading Room (Elder) 19commission considerations 71–2, 231commitment issues, ACTION acronym

54, 72Commitment of Traders report,

Commodity Futures Commission113

Commodity Futures Commission,Commitment of Traders report113

commodity trading advisers (CTAs)199–200

communicationhalo effect 130–3tutors 80–1

commuter stressors 89, 90competent/need-more/novice sections,

trading-competence standards220–33

complexity issues 2Comprehensive Model of Trading

Competence (ComprehensiveMOT) 45–82, 200, 232

see also Strategic. . .; Tactical. . .compulsive trading 173, 202–9computers, tools 45, 69–72, 89, 114,

126–7, 208, 232concrete-experience modes, effective

learning 14–15

confidence 7, 8, 48, 60–2, 136, 167,196, 205–7, 230

confirmation biases 10, 12, 31congestion 72Congressional Budget Office (CBO) 75consistency theory 7, 140–1consolidations, concepts 56Consumer Price Index (CPI) 27, 233contingencies 107–119, 200–1continuing education, Strategic MOT

75–81, 233contrarian investment strategies xiii, 11,

49controls

illusions 136–7, 139, 207–9learned helplessness 105–6, 199,

212–13, 226, 229locus of control 136, 207–9self-controls 48, 60, 102–3, 117, 168,

176, 230stress links 87–89, 105–7, 210

Cooper, C. 64, 77coping techniques

depression 215–17emotions 170–7, 179–218, 230losses 192–4role models 174self-sabotage behaviour 200–17stress 95–6, 99–108, 169–6,

179–218, 220, 225–6suicidal thoughts 215–17

corrections 108corticosteroids 84cortisol 84–5Council of Economic Advisers (CEA) 75counsellors, predictions 40courses and seminars 32–3, 78–79,

243–5see also training. . .

CPI see Consumer Price Indexcrashes, 1987 28criteria sections, trading-competence

standards 220–33CTAs see commodity trading advisersculture, emotions 152–3‘cut your losses’ rule 55, 64, 71, 143,

145, 148

Index 261

Cutten, Arthur 214CW see Chief Wizardcycles law, warrior trader Kyokushin

182–3

daily appraisals see immediateperformance reviews

daily hasslesconcepts 86–7see also stress

Damasio, A. 45, 61, 154, 165Damasio, Hanna 154danger, opportunity 1–2, 18Darwin, Charles 152–3, 158data management, concepts 232data-gathering exercises 49, 232date-of-completion sections,

trading-competence standards220–33

Davidson, R. 61, 157, 168Dawes, R. 39, 131DAX 28, 50, 56, 170, 188, 233Day Traders: The Untold Story of the

Extreme Investors. . ., The(Millman) 210–11

day tradersconcepts 108–9, 114–15profits 114–15

Day Traders from the Pit to the PC, The(Borsellino) 25

DC10 1973, accident fatalities 195dealers, qualifications 77, 135–8, 208–9debt to capital employed, definition 68debts, self-sabotage behaviour 197decision diaries 72–4decision latitude, concepts 89decision making

aborting decisions 55–6, 65ACTION acronym 35–6availability errors 62–3, 124–31, 147,

229business plans 107–11, 226–8closing-the-trade decision 64cognitive dissonance 141–2, 229emotions 62, 118, 153–4, 155–77,

219, 230expected values 23

information overload 22, 62–4, 232initiating-the-trade decision 62–4moods 161–4, 166–76, 196–7, 230negative mental states 169perceptual biases 7, 9–10, 12, 29, 34,

54, 123–49, 130–1, 158–63,194, 219, 229

satisficing concepts 62–3stress 95–6, 97–8, 123, 158–3warrior trader Kyokushin 183–5

declarative memory, ACT Architecture37–8

Dee, Dr John 8denial processes 10–11, 112, 124,

145–6, 192–3depression 48, 64, 89, 92–3, 102–8,

157, 193, 196, 204, 209–17causes 211–16concepts 209–17coping techniques 215–17diagnosis 210–11see also stress

derivatives 1–8, 11–12, 14, 15, 77–78,233

see also futures; optionsdesensitisation therapy 101desperation issues 19, 203–4development methods, tactics 49, 72,

119, 159devil effect, concepts 131Diana, Princess 4Dilts, Robert 181disabled people 48disabling feelings, self-sabotage behaviour

197discipline, concepts 9–10, 17–19, 21,

29–30, 35–6, 42, 56, 58–68,107, 116–19, 162, 219, 226–8

Disciplined Trader: Developing WinningAttitudes, The (Douglas)15–19, 208

diseases of adaptation 92–3disillusionment, self-sabotage behaviour

197Disraeli, Benjamin 128distortions, reality 10–11, 112, 124,

145–6, 147–8

262 Index

distractions 26, 30doctors 38–9, 128, 132–4, 206–7, 210,

219domestic considerations 50, 60, 196–9,

203–4Douglas, Mark 15–19, 45, 208Dow theory 222Downs, Ed 24downtrends 22, 27, 68dreams 8Dreman, David xiii, 11–12drug misuse 93, 196, 201, 216

see also alcohol. . .duality law, warrior trader Kyokushin

182Duncan, Robert (RD) 79, 133Dyer, M.G. 165

earningsfundamental analysis 66–7see also profits

Easterling, D.V. 163economic calendar

concepts 25, 27key reports 27

economic information, fundamentalanalysis 66–6

economistsfailings 75–7, 207predictions 75–7, 207

Eddy, D.M. 38–9efficiency, fundamental analysis 65–8EI see emotional intelligenceElder, Alexander 13, 19–23, 45Elliot Wave 32–3, 139, 142, 220, 223Ellis, Albert 96, 104Elstein, A.S. 128emotion-focused coping techniques, stress

management 102–3, 225–6emotional intelligence (EI) 42, 45,

59–62, 165–8, 230Emotional Intelligence (Goleman) 59,

152, 165emotional memory 41–2, 62emotions 9–16, 41–2, 47–8, 54–62,

91–8, 102–4, 118, 151–77,194–219, 230

attentional qualities 158–9, 162biases 158–9, 230brain 153–7, 165–7, 230Budo Zen 21, 52, 100, 179–218cognitive effects 161–4concepts 13–14, 59–62, 96–8,

102–3, 118, 151–77, 194–219,230

controls 13–14, 60, 118coping techniques 169–77, 179–218,

230culture 152–3decision making 62, 118, 153–4,

155–77, 219, 230definition 159depression 48, 64, 89, 92–3, 102–8,

157, 193, 196, 204, 209–17focus 162, 180functions 155–70historical literature 157–8ideo-motor theory 96–7, 225–6learning issues 157–60memories 158–63, 166moods 157, 161–4, 168–76, 196–7,

230negative states 169–76neuropsychology research 153–4,

165only-exist-in-the-present-moment

concepts 35–6, 54, 190–2perceptions 159, 161–77, 186Phineas Gage case study 153–4, 165psychologists 152–4rational thoughts 104, 152–3, 155–8,

165, 171reframing techniques 177role 155–67self-awareness 47–8, 59–62, 102–3,

162–9, 173–6, 190, 230self-sabotage behaviour 194–218successful traders 151–75thinking brain 152–3, 155thoughts 152–3, 155–9, 171trading 13–14, 47–8, 58–62, 97–8,

103, 118, 157–77, 209, 230trading-competence standards 230

Index 263

worry 97, 103, 159–2, 191, 195–6,225–6

see also fearsEmployment reports 27endocrine activity, stress 84, 225energising work 60entertainment value, trading 19–20, 21,

60, 71, 220entry strategies 22, 29equity bar charts, examples 74equity drawdown, system selections 115,

127errors of judgement 10, 124evolution law, warrior trader Kyokushin

183evolved faith, concepts 188–9execution checks, concepts 25, 29–30exhaustion stage, General Adaptation

Syndrome 92–5exit strategies 22, 29–30, 55–6expected values, concepts 23experience 6, 14–15, 61, 168–941experts 8, 16, 36–40, 45, 49–50, 62,

135–6, 140–1, 146‘experts’ 8, 132–8halo effect 131–5, 140–1, 146intuition 39–40, 62

exposure rules 71, 117, 231extensions, concepts 28–9Extraordinary Popular Delusions and the

Madness of Crowds (MacKay)78

extroverts 24–5, 76, 99–100, 208–9Eysenck, M. 41, 45, 98, 136

failed retests, chart patterns 28failures, predictions 105–6, 199, 212–13faith, concepts 188–9Fall, Albert 214false breakouts 22false consensus effect 136‘false memory’ syndrome 163fast order entry systems 45fears 10–11, 16, 54, 90–1, 95–6,

103–4, 132–3, 151, 158–77,179–218

breathing techniques 171, 186–7,191, 193–4

Budo Zen 21, 53, 100, 179–218concepts 10–11, 16, 53, 90–1, 95–6,

132–3, 151, 159–77, 190–1,195–6

coping techniques 169–71, 179–218definition 159only-exist-in-the-present-moment

concepts 35–6, 54, 190–2persuasion techniques 132–3Samurai 54, 179–218self-sabotage behaviour 195–6types 52–4, 190–1see also emotions

Federal Open Market Committee (FOMC)27, 41, 49, 233

Federal Reserve 75feelings see emotionsFestinger, L. 133–6, 141–2, 145Fibonacci series 28, 32–3, 56, 205, 223fight-or-flight responses 84–5, 92–5,

96–7, 161–2, 180, 225–6financial advisers

poor performance 10–11, 206–7, 209prediction statistics 10–12, 75–8

financial management 70, 108, 111–16,220, 231

see also risk. . .

financial risk taking, concepts 1–2Financial Services Authority (FSA) 77financial statements, fundamental analysis

66–8fire skills, concepts 25–30first impressions 130Fischoff, B. 205–6Fisher, Ken 136fishing analogies, ambush considerations

51five phases, losses 192–4flawless executions, concepts 16–17flexibility needs see adaptability. . .

focusconcepts 15–18, 37–8, 48, 101, 159,

162, 180, 216mental images 50, 53, 101self-awareness 102–3

264 Index

Folkman, S. 102FOMC see Federal Open Market

Committeefootball violence, boredom 195forecasts see predictionsFOREX 233Fortune Sellers, The (Sherden) 76four pillars of warrior motivation, Budo

Zen 181–2frames of reference, concepts 147–8,

212framing effects 143, 169–76Frantz 41Fraser, Leon 214freezing considerations 35–6, 58,

110–111Freud, S. 98Friedman, M. 98Frijda, N. 157‘frozen trader’ syndrome 171frustrations 169, 173

see also emotionsFSA see Financial Services AuthorityFTSE 100, 76–7fund managers 11, 207fundamental analysis, concepts 65–6,

222–4, 233Future Shock (Toffler) 63futures 1, 2–8, 14, 15, 58, 233

Gage, Phineas 153–4, 165Galbraith, John 78Gamblers Anonymous 205, 216, 241gambling, concepts 16–17, 21, 70, 108,

197–8, 202–9, 215Gann, W.D. 85, 220, 223gaps, concepts 28, 222–4gardening metaphor, monitoring needs

55, 98GARP investors (growth at a reasonable

price) 66–7GAS see General Adaptation Syndromegas tank rule, concepts 29GDP see Gross Domestic ProductGeneral Adaptation Syndrome (GAS),

concepts 90–2, 93–5, 106,225–6

general centring triangle 186–7general trading rules, concepts 116–18generic learning, concepts 31–6, 200Genie Software 146Gibbons, Edward 1GIGO effect 40–1Gilhooly, K.J. 36, 45glucocorticoids 50, 84–5, 90, 225–6glucose, stress 84–6God 216–17golden exit rules 55–6Golden Mean, The 33Goleman, D. 41, 59–62, 152, 165–8‘good enough’ courses of action 62Google 240–1Gorman, D. 45government economists, failings 75greed 151

see also emotionsGreen, A.J.K. 36grief 192–4Gross Domestic Product (GDP) 27, 233group behaviour, concepts 78, 138–40,

229growth investors, concepts 66–7Guardian 75guesses 41–2, 76guilt feelings 103, 193‘gurus’ 20, 126–7

habits, awareness 31–2, 49, 58Hall, E.M. 89Hallam, A. 127halo effect

concepts 7, 41, 78, 131–5, 140–1,146, 161, 229

definition 130–4persuasion techniques 131–4

handsomeness, halo effect 131hara 188Haragei 186–7, 191hardiness concepts 99Harlow, Dr 154Haugen, R. 76Hawkes, N. 195hedging 1hedonistic stakes 136

Index 265

herd phenomena, concepts 7–8, 11, 113,135–40, 229

Hidden Persuaders, The (Packard) 126Higgins, E. 125high blood pressures 89higher goals and objectives, Budo Zen

182hindsight bias, concepts 205–7hippocampus 85, 155‘hole in my soul’ 209, 213Holmes, T.H. 86home trading 24–5, 33–4, 56, 91–2,

93–4, 109, 170, 208advantages 56, 109–10, 208availability errors 128day traders 109disadvantages 91–2, 93–4, 107, 109statements of shared values and

aspirations 109–10stressors 91–2, 93–4, 107, 208SWOT analysis 33–4, 109

hopelessness 204–5, 212–17Hopson, Howard 214hormones, stress 50, 84–6hourly close, concepts 28How to Make Money in Commodities

(Gann) 85How to Trade in Stocks (Livermore) 14human needs, Maslow’s hierarchy

180–1hypnosis 163hypothalamus 84

ideo-motor theory, concepts 96–7,225–6

illusion of control 137, 139, 207–9illusory correlation bias, concepts 116imagine-success concepts, ACTION

acronym 35–6, 53–54,189–90

IMF see International Monetary Fundimmediate performance reviews, Tactical

MOT 57–8, 119impatience

concepts 169, 172–3see also emotions

impulse controls, self-sabotage behaviour196

incentives, stressors 90incidental learning, concepts 34–6, 45,

59indifferent acceptance, losses 186individual differences, stressors 98inertia law, warrior trader Kyokushin 183information 10–11, 22, 49, 62–6, 72–4,

125, 206, 232–3dangers 206, 232–3decaying tendencies 64filtering methods 63–4overload problems 22, 62–4, 232stress 63–5see also data. . .; knowledge

information bias, concepts 147initiating-the-trade decision 64initiative 60, 64, 169, 230instincts 153–4Insull, Samuel 214insurance companies 11intelligence 36, 131, 152–3, 165–8

see also emotional intelligenceintelligent battle plans 13–14International Monetary Fund (IMF) 75Internet

background 24–5, 78–81, 91, 106–7,170, 232

chat groups 81, 91, 106–7trading schools 24–5websites list 25, 107, 205, 220,

239–41intra-day dynamics 25Introduction to Medical Decision-Making

(Lusted) 206–7introverts 24–5, 208intuition

concepts 38–42, 53, 62, 186–9, 230definitions 41–2, 62predictions 39–41self-awareness 42, 59, 62, 162–4, 230

Intuitive Trader, The (Koppel) 62investment funds, performance statistics

77irrational beliefs 104, 124–49, 152–3irrational group behaviour 78

266 Index

Jacobsen, C.F. 95–6James, William 96, 158Janis, I.L. 139Japan, Samurai 54, 179–218Jenkins, J. 151–3, 159Jesse Livermore: The World’s Greatest

Stock Trader (Smitten) 14,210

Jim’s story, self-sabotage behaviour198–200, 213

job interviews 40–1Johnson, J.V. 89judgement effects

moods 158–65, 168–9, 196–7, 230see also decision making

Judgement Under Uncertainty: Heuristicsand Biases (Kahneman et al )38–9

Kahn, H. 64, 77Kahneman, D. 23, 38–9, 90, 135–8, 143Kalin, N.H. 161Karasak, R. 89Karlsmith, J.M. 145‘KATA’ rehearsals, martial arts 50Keil, F.C. 63Kennedy, John 4Kindleberger, C.P. 78knowledge 36–8, 63, 206

see also informationKobasa, S.C. 99Kogan, N. 138–9Kokyu-Kihara 186–8, 191Kolb, A. 14–15Kolb, D.A. 14–15Koppel, R. 62Krueger, Ivan 214Kyokushin 182–5

lack of stability, self-sabotage behaviour197

Lakein, A. 107law of small numbers see sample-size biaslaws, warrior trader Kyokushin 182–5Lazarus, R.S. 86, 102

learned helplessness, concepts 105–6,199, 212–13, 226, 229

learning issues 1–8, 14–43, 57, 77–81,97–8, 111, 157–69, 200, 207–8

ACT Architecture (Adaptive Control ofThought) 37–8

alchemy courses 8brain evolution 155–7Chief Wizard 2–8, 15, 135cognitive psychological research

36–8, 165concepts 14–19, 31–6, 80, 97–8,

111, 157–60, 162–3, 165–9,200, 207–8

continuing-education needs 76, 233courses and seminars 32–3, 75,

243–5effective modes 14–15emotions 157–60, 162–3, 165–9environmental factors 37–8experts 36–8, 45failings 2–8, 11–12, 14–15generic learning 31–6, 200incidental learning 34–6, 45, 59Internet 24–5lessons learned 57, 97–8, 172, 192,

207–8locus of control 136, 207–9mistakes 38, 97–8, 117, 168, 172,

192qualifications 77–8, 135–8, 208–9Strategic MOT 81, 233trading-competence steps 15–19,

36–8, 79–81, 111, 220–33unlearning hypothesis 1, 32see also training. . .

Lebriere 37LeDoux, Joseph 155, 157Leeson, Nick 202Lefevre, E. 9, 13left pre-frontal cortex 61, 85, 157, 168lessons learned 57, 97–8, 120, 172, 192,

207–8‘letting your winners run and cutting your

losses short’ 55, 64, 143, 145,148

Leventhal, H. 162

Index 267

lies 128, 202–9life purpose, Budo Zen 182life stressors

concepts 86–91, 225–6see also stress

LIFFE 24, 228, 233limbic system 85, 155–7limits, concepts 28, 231Linton, M. 164liquidity, fundamental analysis 65–7liver, stress 84–5Livermore, Jesse 8–9, 12, 13–14, 26,

48, 202–3, 210–11, 214locus of control 136, 207–9Loftus, E.F. 163Loftus, G.R. 163logs see record-keeping. . .

London Stock Exchange 135, 207,208–9, 233

long-term traders see position tradersLongfellow, Henry Wadsworth 81Lorenz, K. 153losing behaviours, concepts 20–1,

214–16losing phase, compulsive trading 203loss cycles 10, 198–200, 213losses 9–10, 16–27, 30, 52–55, 64,

67–72, 90–2, 96–106, 117–19,192–200, 213

accept-losses concepts 35–6, 52,185–6, 192–3

anger 192–3, 196blame 20–1, 196coping techniques 192–4five phases 192–4grief 192–4‘letting your winners run and cutting

your losses short’ 55, 67–72,143, 145, 148

money management 21profits 26–7, 30, 48–51, 64, 71–2,

117–19risk attitudes 26–7, 29, 52, 143–5,

199–209stressors 91–2, 96–105Tactical MOT 55–7

trading-competence steps 16, 20–1,117–19, 231–3

types 21luck 77Lusted, L.B. 206–7

‘M’ formation, chart patterns 28, 222–4McCall, Richard D. 35–6, 45, 52–53,

180–2, 194MacKay, Charles 78McKee, A. 59McLean, Paul 155‘Magic Number Seven Plus or Minus

Two, The’ (Miller) 50stress 100–13, 170–6, 179–218, 220,

225–6Mandler, G. 159manifestation law, warrior trader

Kyokushin 184Mann, I. 139market analysis

concepts 58–65, 220, 222–4see also fundamental. . .; technical. . .

market directions 28, 55–6Market Maker (Level II) information 45Market Wizards (Schwager) 2market-timing investment approaches,

concepts 67markets 5–9, 16, 32–5, 49, 57, 68–76,

113, 117–18, 141–2, 224, 233bear/bull markets 9, 34–5, 49, 57, 68,

76, 113, 117, 141–2, 233Relative Strength Index 69, 224trading-competence steps 16Volume Spread Analysis 5–7, 9,

32–5, 65–72martial arts 21, 50, 179–218

see also warrior tradersMaslow, Abraham 180–1, 217Massachusetts Institute of Technology 14Master of Business Administration courses

(MBAs) 8, 67, 107mastery and success destination 185mathematics 5, 8–9, 23, 39–41, 62Mayer, John 165MBAs see Master of Business

Administration courses

268 Index

measurable objectives, SMART 110–11,192, 200

media 10–11, 76, 125, 127meditation techniques, concepts 59, 101,

170, 186–7, 193–4, 202, 226memories 10, 36, 155–7, 158–9, 162–3,

166, 232see also schema

mental accounting 136mental fatigue 84mental health policies, availability errors

127mental images 35–6, 50, 53, 95–8, 102,

189–90, 225–6mental rehearsals, concepts 32, 34–8,

49–50, 119, 162, 200–1mental state see schemaMerryll Lynch 75metacognition concepts 169metamood concepts 169metaphysical imagination, imagine-success

concepts 190metaphysics 54, 184, 188, 190method, concepts 9–10, 13–14, 19,

21–3, 42, 55–6, 108, 111–16,219–33

Meyers, T. 114micro stressors see daily hasslesMeichenbaum, D. 104Milgram, S. 136Miller, G.A. 50, 63Millman, Dan 59Millman, G. 210–11mind

centring concepts 35–6, 53, 61,186–8, 193–4, 216–17

concepts 19–23, 26–30, 79–80, 179,194–218, 221

see also brain; psychologymisattribution concepts 160, 164Misogi (walking meditation) 60, 193–4,

202, 226misplaced consistency theory 7, 140–5,

229mission statements, concepts 110, 227Mississippi Land Boom 78

mistakes, learning issues 38, 97–117,118, 168, 172, 192

mnemonics, learning processes 35models

effective learning 14–15stress 91–9

Models of Man: Social and Rational(Simon) 62–3

momentum, concepts 69, 184–5money, power 210money management

concepts 15–16, 19, 21, 22–3, 29,31, 65, 69–80, 113–16

losses 21, 69–72trading competences 19, 21, 22–3,

29, 31, 59–65, 69, 113–16see also risk. . .

monitoring needsconcepts 18–19, 55–6, 69–72, 98,

119see also self-monitoring. . .

monkeys, stress 89–90Montier, James 137moods

concepts 158–64, 168–77, 196–7,230

see also emotionsMorris, L. 97, 162mortality awareness, Budo Zen 181–2motivation

Budo Zen 181–2concepts 61, 130, 155–6, 168, 175–6see also optimism

motivational research (MR) 126moving averages 2, 6, 22, 25, 27–9, 72,

114, 222–4see also trends

MR see motivational researchmuscle-tension model, stress 95–8, 101,

225–6music, self-sabotage minimisation 201musicians, rehearsals 32mutual funds, performance statistics 76

NASDAQ 27, 29, 58, 228, 233needs, Maslow’s hierarchy 180–1negative emotional states 174

Index 269

negative stress, concepts 93–5net asset turnover, definition 68neural anatomy, self-awareness 61neuropsychology research 156, 165neutral zones, concepts 28never-stop-or-look-back concepts,

ACTION acronym 35–6, 54,192

New Leaders, The (Goleman) 59, 152,165

new-date sections, trading-competencestandards 221–33

Newall, A. 36–7newspapers 10–11, 49, 75, 79–81, 125,

127Nicomachean Ethics, The (Aristotle) 152Niebuhr, Reinhold 216Niedenthal, P.M. 161NLP 181noise 87, 207–8noradrenalin 84null hypotheses 8, 31nutrition benefits, self-sabotage

minimisation 201NYSE 233

Oatley, K. 45, 151–3, 159objectiveness needs, trading-competence

steps 18, 26, 31–2, 71, 141–2,169–76

objectivesbusiness plans 107–119, 226–8processes 184–5self-sabotage behaviour 20–1, 23,

179, 194–218SMART objectives 110–11, 192, 200,

227Observer 75O’Creevy, Professor Fenton 137, 207–8Ohlsson, S. 38olfactory lobe 155only-exist-in-the-present-moment

concepts, ACTION acronym35–6, 54, 190–2

open interest, beliefs 22, 72, 113open outcry 24, 99–100, 109, 208opinions, others 49

opportunities 1–2, 18, 33–4, 60–1,109–10, 146, 169, 175

optimal sizes, exposure rules 71, 116optimism 52, 61, 99, 139, 175–6,

185–6, 190see also motivation

options 1, 14, 233oscillators 72, 146out-of-body experiences 6overconfidence issues 7, 62, 136, 167,

196, 205–7overtrading problems 58, 108, 202

see also compulsive tradingoverview 1–2, 220–1

Packard, Vance 126panic attacks 161, 170–1

see also fearspaper trading, benefits 32, 34, 37paradigms, concepts 10–11parallel trend lines, concepts 56paramouncy principle, concepts 9–10,

12, 13, 198, 219, 233parasympathetic nervous system, concepts

91–2passive management styles 66passive meditation 60, 102, 171,

179–80, 186–7, 202, 226‘past performance’, predictions 206Patel, A. 47Pavlov, I.P. 157–8PCs, home trading 24–5pension funds 11, 77perceptions, emotions 158–9, 161–77,

186perceptual biases 7, 9–10, 12, 29, 34,

54–5, 123–49, 161–3, 194, 219,229

see also self-sabotage behaviourperformance reviews 57–8, 72–4, 108,

119, 220–33performance sections, trading-competence

standards 220–33periodic performance reviews, Tactical

MOT 57–8, 119persistence failings, self-sabotage

behaviour 195

270 Index

personal belief paradigm, concepts10–12, 96–8, 112, 124, 181–2,229

personal competence, theories 59personal stressors


personality types 24–5, 98–100, 157,207–9

persuasion techniques, concepts 132–4,165

pessimism 52, 61, 99, 185–6, 190Peters, D. 134physical effects, stress 84–122physical exercises, benefits 102, 201–2,

226physical imagination, imagine-success

concepts 189–90physiological coping techniques, stress

management 100–3, 225–6physiology, brain 61, 85, 130, 155,

166–7, 225–6, 230pike analogies, Tactical MOT 51pit traders 24–5, 99–100, 109, 208pituitary gland 84–6plans 50, 54, 74, 107–19

action plans 74, 111, 220–33business plans 107–119, 159–61,

220, 226–8contingencies 107–119training issues 81, 233

Plato 152point and figure, concepts 22poor predictions, traders 39–40, 72,

206–7, 209position sizing 23, 29–30, 38, 71, 231position traders, concepts 108–9,

114–15, 167positive affirmations 18positive stress, concepts 93–5power, money 210PPI see Producer Price Indexpractice, concepts 32, 34–8, 49–50, 189predictions

accuracy statistics 10–12, 76, 125,207

biases 75–8, 125

economists 75–7, 207failures 106, 199, 212–13intuition 39–41, 62mathematics 39–41newspapers 10–11, 49, 75–79, 125‘past performance’ 206poor predictions 39–40, 77, 206–7,

209preferences 61presumed faith, concepts 189price spread 1, 22, 49, 113prices

predictions 10–12, 49, 76, 125, 207technical analysis 22, 27–30, 66–9,

primacy errorsconcepts 130–1, 229see also availability. . .

priority sections, trading-competencestandards 221–33

probabilitiesconcepts 11–12, 16–19, 22–3,

49–50, 197–8gambling/speculation contrasts

197–8, 202–9, 215see also risk

problem-focused coping techniques, stressmanagement 102–3, 225–6

problem-solving techniques, experts36–8, 45

proceduralisation concepts, ACTArchitecture 37–8

process and action law, warrior traderKyokushin 184–5

procrastination, self-sabotage behaviour195

Producer Price Index (PPI) 27, 233profits 26–7, 30, 48, 56, 64, 71–2,

114–19, 143–5fundamental analysis 66–8‘letting your winners run and cutting

your losses short’ 55, 64,114–19, 143, 145, 148

see also returnsProsniewski, S. 24prospect theory, concepts 143–4, 148,

229Prudential Securities 75

Index 271

Psychoanalytic Theory 98psychologists

emotions 152–4predictions 40

psychologyconcepts xiii, 1–2, 7–9, 13–14,

19–23, 26–31of financial risk taking 8–9of trading 31see also mind

punishments, learning issues 38

qualifications, dealers and brokers 77,135–8, 208–9

racism 4, 140RAF see ready–aim–fire. . .Rahe, R.H. 86random walks 179range concepts 27, 56Raschke 45rational emotive therapy, stress

management 104, 226rational thoughts, emotions 104, 152–3,

155–7, 165, 171rats, stress 83, 92–5RD see Duncan, Robertreadiness effects, emotions 157–75reading lists 114, 195, 220, 235–8ready–aim–fire (RAF) skills, concepts

25–30real-time tick volumes 49realistic objectives, SMART 111, 192,

200reality 10–11, 83, 96–8, 112, 124,

145–6, 147–8, 184reason, emotions 152recency effect

concepts 130–1, 229see also availability errors

recommended readings 114, 195, 220,235–8

record-keeping needs 21, 30, 116, 119,163

recreation benefits, self-sabotageminimisation 201

reflection, concepts 14–15, 54, 60, 191

reframing techniques, emotions 169–76refutation processes, concepts 11–12,

31, 33–4, 49, 56, 62, 209, 229regrets 172

see also emotionsrehearsals, concepts 32, 34–8, 50, 119,

162, 200–1relationships 50, 58, 112–13, 196–9,

203–4Relative Strength Index (RSI) 69, 224relaxation benefits 96, 102, 171, 202reliability bias, concepts 115religions 181, 216–17Reminiscences of a Stock Operator

(Lefevre) 9, 13–14repetition 19–20, 132representativeness bias, concepts 125,

146resistance concepts 22, 27, 30, 56,

68–72, 92–5, 223resistance stage, General Adaptation

Syndrome 92–5responsibilities

trading 16–17, 183, 192–3warrior trader Kyokushin 183

retracements, concepts 28, 56, 170,173–4

returns 66–75on capital employed 67on equity 67see also profits

reversals 108, 222–4review sections, trading-competence

standards 221–33rewards

learning issues 38risk/reward ratio 29–30, 54, 56, 115,

127, 231right pre-frontal cortex 157Rilke, Rainer Maria 151risk 1–2, 17–21, 26–9, 35–6, 49–52,

63–71, 133–8, 185–6, 192–3,199–200, 207–9

acceptance 35–6, 52, 185–6, 192–3assessments 49attitudes 26–7, 29, 52, 143–5,

199–209

272 Index

risk (continued )business risk 21, 29concepts 1–2, 17–18, 26–7, 29, 52,

69, 137, 199–200, 207–9definition 1management 23, 29, 71–2, 111–16,

220, 231risk/reward ratio 29–30, 54, 115, 127,

231see also probabilities

risk-aversive attitudes, concepts 143–5,199–201, 229

risk-seeking attitudes, concepts 143–5,199–209

risky shift 7, 138–40, 229role models 174Rosenman, R.H. 98Rosenthal, Dr 202Rotton, J. 87RSI see Relative Strength Index

S&P see Standard and PoorsSalovey, Peter 165sample-size bias, concepts 116, 147, 229Samurai 54, 179–218

see also warrior tradersSanta Claus syndrome 124, 220SAS see Special Air Servicesatisficing concepts 62–3scapegoats 161Schachter, S. 164schema, concepts 1, 10, 17, 45schizophrenia 127Schjer, P. 99Schroder’s Funds 77Schwab, Charles 214Schwager, Jack 2, 10–11, 45, 47, 96–8,

114, 219sciences 5, 8–9, 23, 38, 39–41, 62,

134–5seasonality concepts 113seated meditation (Zazen) 60, 101, 170,

179–80, 186–7, 202, 226Second World War 83–4sector-rotation investment approaches,

concepts 67securities analysts, predictions 40

Securities Institute 77self-actualisation, concepts 180–1self-assessments, concepts 48, 60, 167,

230self-awareness

components 59–60, 162–4, 175, 230concepts 42, 45, 47–8, 102–3,

165–7, 173–6, 181–2, 190, 219,230

emotions 47–8, 59–62, 162–4,174–6, 190, 230

intuition 42, 62, 162–7, 230neural anatomy 61–62skills 47–8, 102–3, 190, 219, 230see also awareness

self-concept, tutors 80self-confidence

concepts 60, 62, 167, 230see also confidence

self-controls 48, 60, 102–3, 117, 169,175–6, 230

self-deception bias, concepts 124,145–6, 147–8, 229

self-defeating behaviour 9–10self-destructive behaviours 20–1self-doubts, self-sabotage behaviour 197self-efficacy 105self-esteem 17, 96–8, 102–7, 132–4,

199, 213self-fulfilling prophecies 186self-hypnosis 18self-management, concepts 45, 59–62,

169, 174–6, 219, 230self-monitoring needs, trading-competence

steps 18–19self-recriminations 55, 57self-sabotage behaviour 20–1, 23, 179,

194–218alcohol misuse 20, 93, 103, 175, 196,

201, 216beliefs 194–218Budo Zen 179, 194–218compulsive trading 173, 202–9concepts 20–1, 23, 179, 194–218coping techniques 200–17definition 194drug misuse 196, 201, 216

Index 273

emotions 194–218Jim’s story 198–200, 213learned helplessness 105–6, 199,

212–13, 226, 229locus of control 136, 207–9mind 20–1, 179, 194–218minimisation techniques 200–17overconfidence issues 202–3, 205–7suicides 21, 204, 209–10, 212–17see also perceptual biases

Seligman, Martin 105–6, 199Selye, Hans 45, 90–2, 93–5, 106seminars 32–3, 81, 243–5September 11th, 2001 terrorist attacks

20, 86, 128Sergeant, William 219Setterlund, M.B. 161Shakespeare, William 209Sherden, William 76Shiller, Robert J. 136Short History of Financial Euphoria, A

(Galbraith) 78short-term traders see day tradersSilcock, Ben 127SIMEX 202Simon, H.A. 36, 41, 62Singer, J. 164skills

ACT Architecture (Adaptive Control ofThought) 37–8

cognitive psychological research36–8, 168

experts 36–8, 45, 132–8improvement methods 31–8, 45,

219–33rehearsals 32, 34–8, 49–50, 200–1self-awareness 47–8, 102–3, 190,

219, 230stress inoculation 104–5, 226trading 11–12, 13–43, 45–82,

186–9, 219–33trust concepts 35–6, 53, 186–9warrior traders 179–218

slippage concepts 29, 71–2, 231Slovic, P. 38–9, 128SMART objectives (specific, measurable,

achievable, realistic, timely),

concepts 110–11, 185, 192,200, 227

smell senses 155Smith, J. 87Smitten, R. 14, 210Social Readjustment Rating Scale (SRRS)

86–8social support, stress 89–90, 99, 106–7Society of Technical Analysts UK 220Socrates 152Soros, George 61soul passion, Budo Zen 182South Sea Bubble 78Special Air Service (SAS) 50specific objectives, SMART 110, 192,

200speculators 2, 9, 14, 78, 117–18, 197–8,

202–9, 215spinal cord 155, 166spirit 35–6, 53, 60, 79–80, 180–218,

221sports 32, 50spread betting 1SRRS see Social Readjustment Rating

ScaleStandard and Poors (S&P) 24–5, 27, 76,

188, 228standards 19, 38, 168, 219–33statements of shared values and

aspirations, concepts 109–10statistics

biases 147concepts 8, 116, 124, 134, 147‘lies, damn lies, and statistics’ 128sample-size bias 116, 147

Statman, Meir 136stereotypes 140, 146STILL acronym, concepts 170, 186–7stock index futures 1–2, 7, 58stockbrokers 75–7, 207, 208–9, 233stop points, concepts 29, 56–8, 71–2,

160, 231Strategic Model of Trading Competence

(Strategic MOT) 47, 59–82,186, 188

see also Comprehensive Model. . .

274 Index

strategiesconcepts 9–10, 47, 185–92warrior traders 185–92

strengths 33–4, 60, 233stress 10, 50, 63–5, 77, 83–122, 123–4,

161–2, 179–218, 225–6biological measures 85brain 84–122breathing techniques 171, 174,

186–7, 191, 193–4Budo Zen 21, 53, 100, 179–218business plans 107–19, 226concepts 10, 50, 63–5, 77, 83–122,

123–4, 161–2, 179–218,225–6

control links 89–90, 105–7, 210coping techniques 95–6, 99–13,

170–6, 179–218, 220, 225–6decision making 98, 123, 158–2definition 83depression 48, 64, 89, 93, 102–7,

157, 193, 196, 204, 209–17fight-or-flight responses 84–5, 93–5,

97, 161–2, 180, 225–6General Adaptation Syndrome 90–2,

93–5, 106, 225–6hardiness concepts 99home trading 91–2, 93–4, 107, 109,

208hormones 50, 84–6ideo-motor theory 96–7, 225–6individual differences 99inoculation techniques 104–5, 226learned helplessness 105–6, 199,

212–13, 226, 229meditation techniques 60, 101, 170,

186–7, 193–4, 202, 226mental images 95–8models 91–9, 225–6muscle-tension model 95–8, 101,

225–6negative/positive stress 93–5optimism 99, 174–5personality types 98–99physical effects 84, 226physical exercises 102, 201–2, 226rational emotive therapy 104, 226

rats 83, 92–5reality 83, 96–8relaxation techniques 95–6, 101–2,

171, 202Social Readjustment Rating Scale

86–8social support 89–90, 99, 106–7sources 86–92survey 64, 77, 97–8time-management programmes

104–5, 107–12trading-competence standards 225–6two-component theory 97–8, 162,

225–6worry 97–9, 103, 159–2, 191,

195–6, 225–6Yerkes-Dodson law 94–5, 98, 123,

225–6stress of living, concepts 85–91stressors, concepts 85, 225–6subliminal advertising 126Success (Bland) 214success depression, concepts 211–12‘successful’ men 214–16suicides 21, 204, 209–10, 212–17

see also depressionSun Tzu 179Sunday Times, The 10–11, 77sunk cost theory, concepts 7, 142–3,

229superphysical imagination,

imagine-success concepts 190support concepts 22, 27, 30, 56, 68–72,

223surveys 64, 77, 97–8, 207–8Sutherland, Stuart 11SWOT analysis (strengths, weaknesses,

opportunities and threats),concepts 33–4, 109–10, 233

sympathetic nervous system, concepts91

synchronicity law, warrior traderKyokushin 184, 190

‘systematic vincivism’ 6systems 13–17, 22–3, 71, 108, 111–16,

127, 169–70, 232

Index 275

Tactical Model of Trading Competence(Tactical MOT) 47–58, 102,118–19, 160–2, 190

see also Comprehensive Model. . .tactics, concepts 49–58, 72, 118–19,

159, 160–2Taoism 180teaching issues

Chief Wizard 2–8, 15, 78, 132, 135failings 2–8, 11–12, 15, 78–81see also learning. . .

technical analysis 2, 5, 8–12, 22–31, 48,66–71, 107, 111–16, 220,222–4

concepts 2, 5, 8–10, 12, 22, 25–31,65–6, 69, 112–14, 220, 222–4

essentials 22, 25–30, 68–71purposes 22, 68Relative Strength Index 69, 224see also charts; Volume Spread

Analysistechnical indicators, concepts 114technical skills, learning 167–8technical systems, concepts 13–17,

22–3, 108, 111–16, 127, 141,146, 169–171, 232

technical trading rules, concepts 118–19‘Ten Commandments of Trading’ 26–7Thaler, Richard 136Tharp, Van 13, 45, 114Theroux, Henry David 19theta brain waves 187thoughts

emotions 152–3, 155–9, 165, 168–71warrior trader Kyokushin 184

threats, SWOT analysis 33–4, 109three Ms of successful trading, trading

competences 19–23time-management programmes, stress

management 104–5, 107–12timeliness issues, SMART 111, 192Times, The 75tipsters 40, 125Toffler, Alvin 63–4top-down investment approaches, concepts

66tops 118, 128

traders/trading 9–23, 26–30, 47–82, 91,107–19

biases 7–12, 29, 31, 34, 41, 49, 78,115–16, 123–49, 158–9,205–7, 227–9

Budo Zen 21, 53, 100, 179–218business plans 107–19, 200, 220,

226–8cognitive dissonance 141–2, 229compulsive trading 173, 202–9concepts 1–2, 8–43diaries 58, 72–4, 118–19, 167, 200emotions 13–14, 47–8, 59–62, 97–8,

102, 118, 151–77, 209, 230entertainment value 19–20, 21, 58,

60, 71, 220gambling contrasts 16–17, 21, 70,

197–8, 202–9, 215general trading rules 116–18halo effect 131–6, 146, 229imagine-success concepts 35–6, 53,

189–90‘letting your winners run and cutting

your losses short’ 55, 64, 71,143, 145, 148

losses 9–10, 16, 20–1, 26–7, 52, 55,64–7, 90–1, 96–106, 185–6

personality types 24–5, 98–9, 157,207–9

poor predictions 39–40, 77, 125,206–7, 209

record-keeping needs 21, 30, 116,119, 163

responsibilities 16–17, 183, 192–3returns expectations 66–75simple rehearsals 50, 200–1skills 11–12, 13–43, 45–82, 186–9,

219–33standards 19, 38, 168, 219–33stress 10, 50, 63–5, 78, 86, 225–6styles 58–66, 74successful traders 9–23, 26–30,

45–82technical trading rules 116–118tools 45, 72, 114, 126–7, 208, 232

276 Index

traders/trading (continued )trading competences 9–23, 26–30,

45–82, 107–19types 24–5, 32–3, 55, 98–100,

108–10, 159, 208–9warrior traders 179–218see also financial risk taking

trading centring triangle 186, 188Trading Chaos (Williams) 61trading competences 8, 12, 13–43,

45–82, 107–19, 180–233biases standards 227–30business plans 107–116, 159–61,

192, 200, 220, 226–8Comprehensive MOT 45–82, 200concepts 8, 12, 13, 180–233continuing-education standards 233criteria 219–33data-management standards 232discipline 9–10, 17–19, 21, 29–30,

35–6, 42, 56, 58–65, 108,116–19, 162, 219

emotional-biases standards 230experts 16, 36–8, 45, 49–50financial-and-risk-management

standards 231learning issues 15–19, 36–8, 77–81,

111, 220–33market-analysis standards 220,

222–4method concepts 9–10, 13–14, 19,

21–3, 42, 108, 111–16,219–33

mind concepts 20–3, 26–30, 221money management 13–14, 19, 21,

22–3, 29, 31, 65, 70objectiveness needs 18, 26, 31–2, 71,

141–2, 169–76perceptual-biases standards 229record-keeping needs 21, 30, 116,

119, 163rehearsals 32, 34–8, 49–50, 119, 162,

200–1standards 19, 38, 168, 219–33steps 15–19stress-management standards 225–6

technical-analysis standards 220,222–4

three Ms of successful trading 19–23Trading for a Living (Elder) 19trading schools, Internet 24–5trading systems see technical systemstrailing stops, concepts 55, 71–2, 231training issues 1–8, 11–12, 25–6, 31–8,

77–8alchemy courses 8Chief Wizard 2–8, 15, 132, 135continuing-education needs 75–81,

233costs 16courses and seminars 32–3, 79–81,

243–5failings 2–8, 11–12, 14–15international comparisons 2–3Internet 24–5plans 81, 233qualifications 77, 135–8, 208–9Strategic MOT 81, 233trading-competence standards 233tutors 2–8, 11–12, 15, 80–1, 133,

135, 243–5UK 2–8, 67, 75, 243–5USA 2–3, 15, 24–5see also learning. . .

Trait Theory 98transparency needs, self-management

59–60, 169, 230trends 22–3, 27, 56, 65–72, 114, 146,

222–4see also moving averages

trial-and-error modes, effective learning14–15

trust concepts, ACTION acronym 35–6,54, 186–9

Turner, Vernon Kitabu 61tutors 2–8, 11–12, 15, 80–1, 133, 135,

243–5Chief Wizard 2–8, 15, 133, 135failings 2–8, 11–12, 15, 78–81, 135see also training

Tversky, A. 23, 38–9, 90, 136–138,143–4

Twain, Mark 123, 128

Index 277

two-component theory, concepts 97–9,162, 225–6

two-to-one rule, concepts 29–30, 56type A/B/Cs, personality characteristics

98–99Type Theory 98

‘U’ formation, chart patterns 28, 222–4UK

homeowning traders 32–3London Stock Exchange 77, 135, 207,

208–9, 233training issues 2–8, 67, 75–81,

243–5uncertainty, beliefs 10Undeclared Secrets Drive the Stock

Market, The (Williams) 3, 6,34–5

Understanding Emotions (Oatley andJenkins) 151

unit trusts 11, 207unlearning issues, concepts 1, 32uptrends 22, 27, 68USA

behavioural finance 135–8economists 77September 11th, 2001 terrorist attacks

20, 86training issues 2–3, 15, 24–5

‘V’ formation, chart patterns 28, 222–4vacation benefits, self-sabotage

minimisation 201validity bias, concepts 115valuation approaches, fundamental

analysis 67value investors, concepts 66Vickery, James 126vision 48, 52, 62, 185, 190volatility concepts 113volume concepts 5–7, 9, 22–3, 32–5,

49, 65–72, 112–13Volume Spread Analysis (VSA) 5–7, 9,

32–5, 65–72see also technical analysis

‘W’ formation, chart patterns 28, 222–4Wagenaar, W.A. 23, 164walking benefits 60, 193–4, 202, 226Wall Street Crash 78Wallach, M.A. 138–9Walsch, Neale Donald 60warrior traders, Budo Zen 35–6,

179–218Way of the Warrior-Trader, The (McCall)

35–6, 180, 194weaknesses 33–4, 114, 233websites see InternetWhitney, Richard 214Wilder, W. 70Williams, Bill 61Williams, Tom 3, 5–6, 9–10, 34–5, 69,

112, 146winning phase, compulsive trading

202–3, 205–9wisdom 41–2, 62, 166–7wishful thinking, concepts 124working capital ratio, definition 68working memory, ACT Architecture

37–8workplace stressors


World Bank 75worry 95–9, 103, 159–62, 191, 195–6,

225–6Worst Accident in the World, The

(Hawkes) 195Wyckoff method 32–4, 112, 140, 142,

220, 223Wyckoff, Richard D. 32–4, 112, 140,

142, 220, 223Wycoff VSA model 9

Yerkes-Dodson law, arousal levels 94–5,97, 123, 225–6

‘Yes–No’ questions, events 63

Zazen (seated meditation) 60, 101, 170,179–80, 186–7, 202, 226

Zen 21, 53, 101, 179–218‘The Zone’ 32, 53, 60, 189

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FINANCIAL RISK TAKING An Introduction to the Psychology of Trading and Behavioural Finance - Mike El