The Finance Book Club

Martin Taylor

1. On his ‘incredibly naive’ early trading strategy: My thinking was something like, The market has been down six days in a row There was some bad economic news, but I think that should be in the price now. I'll buy some.
2. His boss Rory was inclined to take no action even on good trades, but this was an asset when it came to times of panic. During volatile periods, when it was all going wrong, he would counsel me, “Just calm down. This is what happens.” Working with him allowed me to learn about volatility without making crass errors like selling at the lows or buying at the highs.
3. He uncovers massive corruption in Russia where the company owners are skimming 90% of profits and selling most of their inventory off the books. (surprise surprise)
4. Although I was disgusted by Russia at the time, I had been willing to stay in it as long as it kept going up. I wasn’t going to argue with all the idiots who were buying Russia. If I had gotten out, and it kept going up, it could have been the end of my career. Remember, Russia was 40 percent of my benchmark.
5. The reason I was right to start selling that day [of the dead cat bounce] was that the spell created by the senseless bull market had been broken by the previous day’s price collapse. When markets are trending up strongly, and there is bad news, the bad news counts for nothing. But if there is a break that reminds people what it is like to lose money in equities, then suddenly the buying is not mindless anymore. People start looking at the fundamentals, and in this case I knew the fundamentals were very ugly indeed.
6. The Russians knew perfectly well what was going on, and they put all their money in Switzerland. You have to look where the smart money is. In an emerging market, the smart money is domestic, not international.
7. There are three things I like to see when I buy a stock:
   1. a favorable macro situation,
   2. a secular trend,
   3. and good company management.

   
   

8. When the market is so bad that you think it is obvious that you should be net short, that’s typically the time when it is all in the price and you should be buying.
9. I am wrong all the time. If I can be right 60 percent of the time, and when I am right I have some big winners, and when I am wrong, I staunch the losses quickly, I can make a lot of money.
10. RSI is only useful on the oversold side (but in a bull market only, surely)
11. You have to be an expert in what you invest in. You need to understand why you are invested.
12. I consider my pattern of taking quick profits in 2009 a dreadful error that I think came about because I had lost a degree of confidence due to experiencing my first down year in 2008, even though the loss was consistent with the expected loss given the magnitude of the market decline. I was constantly worried that markets were about to turn down again, particularly in regard to all the new investors who came into the fund in the second quarter of 2009.

Tom Claugus

1. Vary exposure based on opportunity.
2. Our defining moment of a survival threat is being down more than 7 percent in a month and not knowing why. If you look at the history of our fund, you will find that 90 percent of the monthly returns were between +7 percent and -7 percent. So as long as a monthly loss is less than 7 percent, we are still in a normal range. If a loss exceeds 7 percent, it indicates that something is wrong. If I can figure out what is wrong, then I might not change anything. If I can’t figure out what is wrong, then I have to reduce the exposure.
3. Just because you made money doesn’t mean you were right, and just because you lost money doesn’t mean you were wrong. It is all a matter of probabilities. If you take a bet that has an 80 percent probability of winning, and you lose, it doesn’t mean it was a wrong choice.

Joe Vidich (and Nick Davidge)

1. Don’t try to be 100% right (scale in and scale out)
2. One of the key characteristics of Joe’s trading is his willingness and ability to gradually take losses. Joe’s comments about the emotional benefits of taking losses incrementally can give you an insight into how he manages portfolio exposure.
3. There is no high for a concept stock. (internet stocks in the 1990s, biotech in the 2000s) When P/E multiples get to 50, 60, or 70, you are in the realm of concept stocks.
4. [In a bull market] Prices open up lower and then go up for the rest of the day. In a bear market, they open up higher and go down for the rest of the day. When you get to the end of a bull market, prices start opening up higher. Prices behave that way because in the first half hour it is only the fools that are trading [pause] or people who are very smart.
5. CNBC is my sentiment indicator. [He laughs loudly.] It’s the best sentiment indicator, and it’s free.
6. There are two types of sentiment - public sentiment and market sentiment. The market sentiment is what the market actually does.
7. Stop orders are for fools.
   
   Attached Image (click to enlarge)

   
   
8. One of the best patterns is when a stock goes sideways for a long time in a narrow range and then has a sudden, sharp upmove on large volume. That type of price action is a wake-up call that something is probably going on, and you need to look at it.
9. you have to be willing to take your hit. Even when you are wrong in taking your hit, it cleans the slate, and cleaning the slate can be very therapeutic.
10. the larger the position, the greater the danger that trading decisions will be driven by fear rather than by judgment and experience.
11. It you are going to control your losses, there will be times when you will get out just before the market turns around. Get used to it. This frustrating experience is an unavoidable consequence of effective risk management.

Kevin Daly

1. I have tried to do that type of investing throughout the fund’s life—looking for companies that are somewhat obscure, not covered by Wall Street, or have a niche business inside the company that no one is focusing on.
2. Screens using various overlays such as
   1. Enterprise value
   2. EBITDA
   3. Price to FCF
   4. EV/EBIT
   5. Price/tangible book value
   6. P/E ratio
   7. Tangible common equity/ Total Assets

3. He reads
   1. Wall Street Journal,
   2. Barron’s,
   3. Wall Street Transcript,
   4. Dick Davis Investment Digest,
   5. Grant’s Interest Rate Observer,
   6. Value Investor Insight,
   7. Santangel’s Review, and
   8. Form40racle, which provides data on insider sales and purchases.
   9. I also use two members’ only websites that share investment ideas:
      1. Value Investors Club and
      2. SumZero.

   10. Two other useful websites are
       1. Vickers Stock Research, which tracks institutional holdings of individual stocks, and
       2. Thompson Reuters, which both aggregates brokerage firm research and provides transcripts of company presentations at conferences and quarterly earnings calls. These transcripts can be particularly useful. I will often read through a transcript more than once looking for upbeat or downbeat comments, or signs of evasiveness.

   11. Finally, I review SEC Filings (10Ks, 10Qs, and Proxy Statements) and
   12. FDIC Bank Call Reports.

4. the wider you cast your net through reading, screening, and speaking with others, the greater the likelihood that you will succeed in finding good ideas.
5. On timing an entry after a bear market: No bells sound when things get better.
6. Lots of companies screen as being “cheap.” I think that it’s easy to avoid value traps. The trick is to stay away from companies that can’t grow their cash flow and increase intrinsic value. If I think the business is a “melting ice cube” like newspapers, yellow pages, and video rentals, to name a few bad businesses, then I won’t invest in it, no matter how cheap

Rules:

1. Stick to businesses you understand.
2. Find companies in those businesses that are undervalued vis-a-vis the pertinent metrics or similar competitors.
3. Take profits when prices move up to fair valuation levels.
4. Sail into a cash harbor when the market seas turn stormy.
5. Stick to the basic process, and never take flyers.
6. Treat investments as a business, not as a gamble.

Jimmy Balodimas

1. Without a doubt this is the craziest interview Schwager does in the whole series.
2. Balodimas is heavily short at what must have been the beginning of the great bull market of 2011.
3. Schwager points out that the market has only been making new highs:
   1. Something was happening last week that seemed different from the rally before then. The market had been grinding steadily higher, but the fact that it was so easy for the market to go up last week, let me know that something was up. Thursday, the market rallied sharply after being weak in the morning. Then Friday, the market got really strong again near the close. The market was moving up like there was no supply. Coming on top of the large gains we had in the past four months, I thought, Now the market is getting stronger? Now? [He says this emphasizing the repeated “now” in a tone of incredulity at the sheer preposterousness of this price action—a tone that communicates, “Give me a break,” without saying the words.] The move felt fluffy to me, and I honor all the senses I get. It just seemed like a logical place for me to get more short. I try to formulate my own ideas by listening to what the market is saying. Sentiment is one of my big clues as to what is happening. (Terrible. React, don’t anticipate.)
   2. Despite this, he is ahead for the year, even more than the other traders who have been right about the market. To this Jimmy credits a ‘knack’.
   3. Maybe it’s being comfortable in situations where everyone is nervous. I always take some money off the table when the market is in my favor. Regardless of whether it is a lot or a little bit. Even if the market is down only 1/2 percent or 1 percent and I think the market should be 10 percent lower, I’m still taking money off. That saves me a lot of money, because when the market rallies, I have a smaller position.

4. I have made money every year in my career. Even though my system is flawed—I’m not entirely disciplined and I give myself too much leeway—it has still worked for me.
5. It’s a sense I’ve developed, and I have learned to trust that sense. I think I have spent as much time in front of screens watching the nature of stocks as anyone else in the business. Because I have watched these same symbols for almost 15 years, they almost take on a life of their own.
6. I never buy or sell anything at the market because I’m wrong and have to get out. I have never done that in my career. I’ll begin to work out of the position, and if I see it turn around, I’ll get back in again, thinking that I was right all along.
7. I have a lot of positions that made me cry uncle, but I don’t capitulate. (that’s what crying uncle means though)
8. He went long during the flash crash immediately
9. I don’t let myself panic. Even if I don’t know what’s going on, I’m not going to sell. I might lose 5 percent more trying to find out what is going on, but I’m not going to make a decision because other people are choosing to make a decision out of emotion. I’m not going to be that guy.
10. I’m not trying to prove I’m right. I’m not trying to prove the market is stupid. I just like making money. There are so many guys I’ve seen in my career who do something just because someone else is doing it. That is a way of getting beat up.
11. Even though my track record would indicate otherwise, I still have some lack of trust in my process. I still want to be in the market early, just in case I don’t see it.
12. On becoming successful at the start: I was totally focused on trading. Nothing else mattered. Not my health; not my relationships.
13. Trades 520 orders on the day he’s interviewed
14. Doubles down on losers (basically this guy does everything wrong and still wins; proving that entry methodology is not highly correlated with success)
15. The ETF could easily have been up another $10 on the next day. That’s where the chutzpah comes in. When no one else wants to do it, sometimes there is great opportunity.
16. Sitting in front of screens is very limiting when there are so many other things that interest me. This was my first job. I want to let go of the shackles. I know there is so much more of life that I can experience and engage in, but the only way I can do that is by stepping away.
17. Schwager, naturally, just about has a coronary trying to interview Balodimas and make sense of his crazy style. He also has trouble summing it up but finds 3 things
    1. Adaptability - he noticed the hedge funds were making trends smoother with fewer pullbacks where he could get in, so it made it important for him to stop getting in so early
    2. Trading around a position - adjusting position size, being nimble, scaling back at resistance, etc.
    3. No euphoria - when everyone around him is losing their head, he keeps calm and enters
    4. Schwager also addresses one of my questions - is he just lucky? Well he makes hundreds of trades and has been doing it for 15 years! Basically throw out everything we think we know. But, as Schwager also points out, Balodimas is cheating himself because he misses out on long-term profits that would allow him to step away from the screen, which is how I feel about manual scalping in general. A lot of pointless work that a computer can do for you.

    
    
    

Joel Greenblatt

1. Author of ‘You can be a Stock Market Genius’, ‘The Little Book that Beats the Market’ and ‘The Big Secret for the Small Investor’.
2. Created an indicator he calls The Magic Formula that combines earnings yield with return on capital
3. Return on capital was measured by calculating the ratio of pretax operating earnings (EBIT) to tangible capital employed (networking capital + net fixed assets).
4. EBrT (earnings before interest and taxes) was used in place of reported earnings because companies operate with different levels of debt and different tax rates. Using operating earnings before interest and taxes, or EBrT, allowed us to view and compare the operating earnings of different companies without the distortions arising from differences in tax rates and debt levels. For each company, it was then possible to compare actual earnings from operations (EBIT) to the cost of the assets used to produce those earnings (tangible capital employed).
5. Net working capital + net fixed assets (or tangible capital employed) was used in place of total assets (used in an ROA calculation) or equity (used in an ROE calculation). The idea here was to figure out how much capital is actually needed to conduct the company’s business.
6. During 2000 to 2009, the formula still managed to deliver an average annualized return of 13.5 percent, even though the S&P 500 was down nearly 1 percent per year during the same period.
7. We also divided the formula rankings into deciles with 250 stocks in each decile. Then we held those stocks for a year and looked at how each of the deciles did. We repeated this process each month, stepping through time. Each month, we had a new set of rankings, and we assumed we held those portfolios (one for each decile) for one year. We did that for every month in the last 23 years, beginning with the first month of the Compustat Point-in-Time database. It turned out that Decile 1 beat Decile 2, 2 beat 3, 3 beat 4, and so on all the way down through Decile 10, which consisted of bad businesses that were nonetheless expensive. There was a huge spread between Decile 1 and Decile 10: Decile 1 averaged more than 15 percent a year, while Decile 10 lost an average of 0.2 percent per year.
   1. The idea naturally presents itself to buy decile 1 companies and short decile 10 companies, but the problem is, in the year 2000, the shorts would go up so much that you’d lose your shirt.

8. Value investing doesn’t always work (which is what allows it to work long-term). Systems stop working when too many people start using them but value investing doesn’t have this problem.
9. On the track records of fund managers: The problem, however, is that there is no correlation between those who did well in the past 3, 5, or 10 years and those who continue to do well in the future. (recall Taleb)
10. One reason for the lack of correlation between past and future performance is that if investors chase good performers, the managers with better recent performance will attract more capital, and it is harder to run more money.
11. To beat the market, you have to do something different from the market. And if you are going to do something different, sometimes you will underperform significantly.

Schwager again concludes this book with a list of general principles, that you have probably already absorbed if you’ve been paying attention.

Next: The final book in the series, Unknown Market Wizards.

Unknown Market Wizards

Because this book is somewhat recent (2020) and I don’t want to run afoul of copyright vigilantes, I’m not going to summarize whole chapters but just give a general appraisal. This style of book review is probably what I should be doing going forward as much of the material I’m reviewing is starting to rhyme if not be outright repetitive. (sorry!)

This book divides a group of eleven traders into futures traders and stock traders. The futures traders are:

 

1. Peter Brandt (Well, if you’re on FinTwit you definitely know Peter Brandt.)
2. Jason Shapiro
3. Richard Bargh
4. Amrit Sall
5. Daljit Dhaliwal
6. John Netto

And the stock traders are:

 

1. Jeffrey Neumann
2. Chris Camillo
3. Marsten Parker
4. Michael Kean
5. Pavel Krejci

The book also concludes like the others with 46 principles that underlie success for each of these traders. I would guess about 80% (or more) of these principles are the same ones that we’ve already read about - finding a trading style that suits your personality, etc.

However there are a few novel notions.

1. Under risk control, Schwager divides the section up into
   1. individual position risk controls (using stops, basically),
   2. portfolio controls (using uncorrelated instruments), and
   3. equity based management (cutting position sizes down if drawdowns exceed a preset limit). This is easily followed and understood, if not exactly glamorous.

2. Peter Brandt has a Friday close rule that closes any trade that has an open loss on Friday. This also falls under Bargh’s rule that you don’t have to wait for a stop to be hit - exit early if you think it’s prudent.
3. In the same line of thinking is Dhaliwal’s notion that exit targets and stops can be dynamic; you don’t have to slavishly follow the one that you used when you put the trade on.
4. You can tighten your stop, take partial profits, etc.
5. Popcorn trades - are what Brandt calls a trade that moves in your favour and then retraces all the way back to the entry. Avoid these infuriating trades by taking partial profits and tightening stops.
6. Don’t feel compelled to make money back in the same market (this is something Balodimas said as well)
7. Don’t get sloppy after winning streaks
8. Have flexible opinions
9. Consistency can be counterproductive. This is paradoxical as most of the previous lessons emphasized the benefits of consistent approaches. The problem is when you strive to be profitable in low-opportunity periods you may take marginal trades that end up being net losers. Although Bargh was urged by his bosses to strive for consistency, he resisted this advice, sensing it was incompatible with the way he traded. “I never really thought that is how trading worked,” he said. “It’s more like you make nothing for a while, then you have a spurt.” As a strikingly ironic observation, Sall noted that a common trait he observed among traders who failed is that they had a goal of making money every month.
10. Watch for new behavioral trends - (I suppose a good modern example would be Covid stocks like Zoom.)
11. Trading for a living is hard - Brandt says ‘the markets are not an annuity’. Profits have to continually increase by more than the sum of taxes and cumulative withdrawals for living expenses. Another complicating factor is that trading profitability is inherently sporadic, while living expenses are continual. In recognition of these real-life considerations, Parker advises those seeking to trade for a living to keep their day job as long as feasible. (and live modestly)
12. Patience - waiting for the right trade, and staying with a good trade
13. Stay calm and focused - have a good internal mindset (we did cover this somewhat, especially the destabilizing impact a big loss can have on this)

Dhaliwal used a gamelike analogy to describe trading: “To me, playing the markets is like a never-ending chess game. It’s the most exciting game you can play.” (same) If you want to trade, your odds for success will be significantly enhanced if you are motivated by a genuine love of the endeavor.

Epilogue
Clemmo’s thoughts

As my reward for summarizing a mountain of material, I will now tell you what I think about Schwager’s opus, whether you’re interested or not.

It’s simply the best repository of fundamental trading wisdom there is. However as you’ve likely noticed, it has diminishing returns after each book, and there are not many interviews with algo traders.

Each book has an emphasis on the things that traders need to do to be successful and what I continually remarked upon is how each of those things is something that a computer can simply do better than people (be consistent, be patient, avoid emotions, work hard, etc.)

After hearing what makes a great trader (calm demeanour, emotional control, some weird sixth sense about charts) I think it's clear that my most likely path is by having a stable of robots trading under my shingle.

It’s true that human discretion is hard to encode, so some level of manual oversight is probably always going to be needed, but we live in an age where computers can dream, make art, and do just about every non-creative activity better than humans - especially strategic activities like Chess and Go.

I think most modern fund managers see things the same way which is why algorithmic trading has taken over from mainly human traders, and flesh and blood traders are a bit of a rarity at big firms, humans coexisting with computer programs until they are put out to pasture.

The rest of the humans who trade manually, whether they realize it or not, are doing it sub-optimally, almost assuredly.

At the same time, in my opinion quantitative analysts have not even begun to plumb the creative depths which exist in the market, and so there is still a lot of opportunity for people who can use computers, but think ‘outside the box’.

This is one reason that going forward I’m going to try to steer towards books that venture off the beaten track a bit, and I'm going to skip over books more readily that seem to be rehashes of what has been done in the past.

complete notes and footnotes for the Wizards series

Thanks for reading! I’mma take a another break, and then move on with the next book:

Trading From Your Gut by Curtis Faith

Trading From Your Gut
“How to use Right Brain Instinct and Left Brain Smarts to Become A Master Trader”

By Curtis Faith

Faith is one of the disciples of Richard Dennis and Michael Eckhardt's Turtles program. This is his third book. He emphasized a rational and systematic approach in his other books but in this one he deviates from the program and advises harnessing a 'whole mind' program. The book is basically about how an intuition-based approach to trading can be superior to analysis and reasoning, or effortful intellectual work.

I was extremely skeptical about this book and it only got worse after reading the foreword by Van Tharp (a self-professed NLP modeller) and the first few chapters whose themes are basically a patchwork quilt of trendy scientific concepts (at least they were hot back in 2010) such as

1. neural nets
2. heuristics
3. cognitive biases
4. sensory memory, working memory, reference memory
5. recency bias
6. groupthink
7. terminal velocity

Just to name a few. If there was some popular scientific concept that Faith could somehow try to tie into trading intuition, then he uses it in the first three chapters. However none of these concepts is examined in any depth and Faith makes no attempt to prove that they are useful in trading.

The actual brain science that Faith draws on is confused at best. One problem is that the whole notion of 'right brain vs left brain' is stuck in the 1970s and has largely been discredited by modern neurological research. Still, even if we ignore the pedantic details and assume there is a difference between a coldly analytical approach and a seat-of-the-pants intuitive approach to trading, this book doesn't really tell you how to to 'trade from your gut'. It just writes out a laundry list of activities (besides trading) where not thinking (or not overthinking) is beneficial to the fast action demanded by professions such as
-firefighting
-skydiving
-martial arts, etc.

If we assume that trading is a similar type of profession then he might actually have a point. However the book is full of statements like this one,
"It can be easy to confuse the feelings that have an emotional basis with the feelings that have a thinking basis when the right hemisphere performs that thinking. The major reason for this is that the thinking of the left hemisphere is top down and linear, but the thinking of the right hemisphere is bottom up and parallel." which not only doesn't seem to mean anything but is also not backed up with a single citation or footnote.

So basically this whole book is one trader's idea of how the brain works based on other things he might have read or is simply making up as he goes along. Not exactly persuasive. The parts of the book that deal with trading are also mostly rehashes of concepts from other trading books, like the idea that rapid price moves can be modelled by dampened harmonic oscillations.

Later on though, the book does come up with some interesting ideas, and Faith outlines a system whose radical simplicity might actually be a benefit, even if it means the details will need to be worked out by the reader. Some of these interesting ideas:

1. The less time you give yourself to make a trading decision the more you'll be relying on intuition (and therefore less likely to overthink)
2. The 'left brain' wants explanations that the 'right brain' can't always supply. It therefore is less trusting of intuition even when intuition can come up with the correct answer faster than the left brain
3. Feelings you get while trading are often the result of the right brain trying to signal something to you
4. The easiest way to know what kind of market you're in is to look at six months of prices and see what direction they're going
5. master trading is about simplicity and speed
6. total automation is impractical for swing trading because the programming required is beyond the capabilities of most retail traders
7. the maximum favorable excursion (MFE) adjusted for volatility, divided by the maximum adverse excursion (MAE) ratio which he calls the edge ratio. Reminds me of my 'variance tables' idea, and a useful concept to know how much pain to withstand.
8. invest in pro tools (but Faith makes no actual specific recommendations)

Overall I guess this book is a good reminder that there is no substitute for experience, and if intuition is compressed experience, then ...he's right. Will this book help you? I wouldn't bet on it.

Here's the system:
The Rebound Swing System

1. The premise of the rebound swing method is that the market generally moves several days in one direction after a rebound off of clear support and resistance. Therefore, this particular swing trading method is particularly well suited to range-bound markets. It is also suited for trading in the direction of the major trend during major bull- or bear-market moves.

The important components of the method are the following:
1. The market should show a clear level of support and resistance,
defined by at least one visual anchor point on the chart
for both the support and resistance. Each anchor point
should be a point that is visually separated from the trading
days before and after it.

2. There should be a significant price difference between these
support and resistance levels.

3. The market should return to test the support level. This can
be either a breakout through the support on the downside or
a test of the support that comes close to the support levels.

4. The market should demonstrate a clear bounce off the support
Levels.

5. The trade should be taken anticipating the cycle turning
from a series of down days to a series of up days.

6. The trade should be taken respecting the overall market
cycle.


"This illustrates the requirement of a rally after the support point. The support point needs to be something that other traders will see. It must serve the psychological purpose of a price point that will bring buying pressure as the price approaches that price level again. A low followed by a significant rally when viewed visually on the chart will do that. Traders will expect a potential rally off of support if the price level that defines that support is visually significant on the daily chart. The point must stand out visually. This is the reason for a level of vertical (price) and horizontal (time) separation."

This seems perfectly cromulent so far (after all it's the basic component of about 50% of all trading systems in existence) but what does it have to do with my gut, like, at all? Maybe you can tell me, dear reader.

complete notes and footnotes

The last book in the second book poll list is Alexander Elder's
New Trading for a Living
Psychology | Discipline | Trading Tools and Systems | Risk Control | Trade Management

I've been a bit reluctant to go through it because

1. it's a beast of a book
2. it's heavy on psychology and technical analysis

But it's a classic and if I don't read it I'll always wonder what I'm missing. Elder is, after all, the man who practically invented the CMT as a profession.

The first two chapters are on psychology, oh goody! But one of the chapters is on mass psychology which might be interesting indeed.

Introduction -
Trading - the Last Frontier

1. You can be free. You can live and work anywhere in the world. You can be independent from routine and not answer to anybody. (the eternal promise)

Psychology is the Key

1. The majority of traders spend most of their time looking for good trades. Once they enter a trade, they don't manage it but either squirm from pain or grin from pleasure. They ride an emotional roller coaster and miss the essential element of winning—the management of their emotions. Their inability to manage themselves leads to poor risk management and losses.
2. A good trader watches his capital as carefully as a professional scuba diver watches his air supply.
3. To be a good trader, you need to trade with your eyes open, recognize real trends and turns, and not waste time or energy on fantasies, regrets, and wishful thinking.

The Odds Against You

1. Markets are actually set up so that most traders must lose money. The trading industry slowly kills traders with commissions and slippage.
2. Trading is a minus-sum game. Winners don’t win as much as losers lose, because the industry takes a cut.
3. Even a “small commission” can build up a major barrier to success! I've heard brokers chuckle as they gossiped about clients who beat their brains out just to stay even with the game.
4. Don't be shy about bargaining for lower rates. I've heard many brokers complain about a shortage of customers—but not many customers complain about the shortage of brokers. (I do!)
5. Design a trading system that will trade less often.
6. A beginning trader, making his first steps, should look for a penny-a-share broker. Then you can trade your 100 shares for a dollar. A futures trader can expect to pay just a couple of dollars for a roundtrip trade.
7. an average trader spends three times more on slippage than on commissions.
8. Use limit orders whenever possible, don’t overpay

Why Trade?

1. Success cannot be bought, only earned
2. The goal of a good trader, paradoxically, is not to make money. His goal is to trade well. If he trades right, money follows almost as an afterthought. Successful traders keep honing their skills as they try to reach their personal best.

Reality vs Fantasy

1. Losing traders suffer from delusions
   1. There is no secret knowledge to successful trading
   2. Trading is actually intellectually simple; good traders are shrewd but not scholars
   3. A bigger account is not the answer
   4. The real problem is overtrading and sloppy money management

   
   

2. Complex human activities do not lend themselves to automation. (wrong, and anyway didn’t he say trading wasn’t that complex?)
3. Computerized learning systems have not replaced teachers, (not all teachers, but some)
4. and programs for doing taxes haven't created unemployment among accountants. (false)
5. Markets are always changing and defeating automatic trading systems. (this I can believe)
   1. Humans can handle unforeseen events
   2. Traders with autopilot fantasies try to repeat what they felt as infants. Free milk! (ouch! also, yuck!)

   
   

6. 3 types of gurus
   1. Cycle gurus call important market turns.
   2. Method gurus promote new highways to riches.
   3. Still others have escaped criticism and invited cult following through the simple mechanism of departing this world.

   
   

7. Markets are forever grinding down each method's edge, and what worked yesterday is less likely to work today and highly unlikely a year from now.
8. Elder claims Gann’s son claimed his father couldn’t support his family from trading, and his estate on his death in the 50s was only slightly over $100,000. (sad!)
9. Winner Takes All by William R. Gallacher.
10. The field of trading is as huge and diverse as that of medicine, where one needs to choose one specialty and work hard to become good at it.

Self-destructiveness

1. You have to analyze your feelings as you trade to make sure that your decisions are sound. Your trades must be based on clearly defined rules. You have to structure your money management so that no string of losses can kick you out of the game.
2. The markets are unforgiving, and emotional trading always results in losses.
   1. Gambling - fixated on a high, not paying attention to game plan, not treating both impostors just the same
   2. [Elder is] convinced that most failures in life are due to self-sabotage
      1. An unconscious wish to fail!?
      2. We sabotage ourselves by acting like impulsive children rather than intelligent adults. We cling to our self-defeating patterns. They can be treated—failure is a curable disease.
      3. Keep a trading diary—write down your reasons for entering and exiting every trade. Look for repetitive patterns of success and failure.
      4. Trading does not have the same safety nets that other professions have
      5. Trading is the most dangerous human endeavor, short of war.

   
   

Trading Psychology

1. Psychological safety net is as important as survival gear for a mountain climber
   1. “It is hard enough to know what the market is going to do; if you don't know what you are going to do, the game is lost.

Trading lessons from AA
This chapter really starts to distinguish itself from the usual trading book chatter. Comparing a gambling/losing trader to an alcoholic is a very powerful idea, and it’s possible all forms of self-destructive behaviour may be neurologically related. Since the 12-step program seems to have some ability to prevent/cure this type of behaviour it’s worth thinking about actually trying some of these steps because they are free, relatively straightforward and have worked for others.

1. AA principles
   1. Elder realized that he could substitute the word ‘alcohol’ for loss and it described his trading. He realized the principles underlying AA could help him avoid wild equity swings
   2. Denial
      1. As [the losing trader] keeps changing his trading tactics, he acts like an alcoholic who tries to solve his problem by switching from hard liquor to beer. A loser denies that he's lost control over his trading life.

      
      
      

   3. Rock Bottom
      1. They must see that alcohol [losses] controls their life and not the other way around
      2. Profits give traders an emotional high and a feeling of power. They try to get high again, put on reckless trades, and give back their profits. Most traders cannot stand the pain of severe losses. They die as traders after hitting rock bottom and wash out of the markets. The few survivors realize that the main trouble is not with their methods—it is with their thinking.

      
      

   4. First Step
      1. Admit you are powerless (over randomness?)
      2. The goal of every AA member is to stay sober today and go to bed sober tonight. (a powerful way to approach life; I wonder what else I can apply it to?)
         1. Workout and run today - that’s your only goal
         2. Trade without making a mistake today - that’s your only goal
         3. Admit that you are powerless over carbs
         4. One of the best things that a trader can do is go to an AA meeting.
         5. A recovering alcoholic can never drink again.
         6. So a recovering loser can never take a [big] loss again?
         7. Successful traders treat drawdowns the way social drinkers treat alcohol. They have a little and stop.
         8. Losers cannot stop as they are addicted to the excitement of the game
         9. Most losers hide their losses from themselves and from everyone else. They keep no records and throw away brokerage statements.
         10. The discipline of a winner

Losers Anonymous

1. Admit: I am a loser; I am powerless over losses
2. Predefine the acceptable businessman’s risk
3. A trader who blames high commissions on a broker and slippage on a floor trader gives up control of his trading life. Try to reduce both, but take responsibility for them. If you lose even a dollar more than your businessman's risk, including commissions and slippage, you are a loser.
4. Poor record-keeping is a sure sign of a gambler. Good businessmen keep good records. Your trading records must show the date and price of every entry and exit, slippage, commissions, stops, all adjustments of stops, reasons for entering, objectives for exiting, maximum paper profit, maximum paper loss after a stop was hit, and any other data necessary to review and fully understand your trade later in the future.
5. If you think you have beaten losses you will start losing again, just as an alcoholic who thinks they are no longer an alcoholic will start drinking again.
6. “Good morning, my name is so-and-so, and I am a loser. I have it in me to do serious financial damage to my account.”
7. Strict money management
8. Diary - learn from mistakes and successes

Winners and Losers

1. The market doesn't know you exist. You can do nothing to influence it.
2. “If the market's behavior seems mysterious to you, it's because your own behavior is mysterious and unmanageable. You can't really determine what the market is likely to do next when you don't even know what you'll do next.”
3. Emotional trading is addictive
4. Wall St. does not throw you out for being a good trader.

1. Decide that you are in the market for the long haul—that is, you want to be a trader even 20 years from now.
2. Learn as much as you can. Read and listen to experts, but keep a degree of healthy skepticism about everything. Ask questions, and do not accept experts at their word.
3. Do not get greedy and rush to trade—take your time to learn. The markets will be there, offering more good opportunities in the months and years ahead.
4. Develop a method for analyzing the market—that is, “If A happens, then B is likely to happen.” Markets have many dimensions—use several analytic methods to confirm trades. Test everything on historical data and then in the markets, using real money. Markets keep changing—you need different tools for trading bull and bear markets and transitional periods as well as a method for telling the difference (see the sections on technical analysis). (?)
5. Develop a money management plan. Your first goal must be long-term survival; your second goal, a steady growth of capital; and your third goal, making high profits. Most traders put the third goal first and are unaware that goals 1 and 2 exist (see Section 9, “Risk Management”).
6. Be aware that a trader is the weakest link in any trading system. Go to a meeting of Alcoholics Anonymous to learn how to avoid losses or develop your own method for cutting out impulsive trades.
7. Winners think, feel, and act differently than losers. You must look within yourself, strip away your illusions, and change your old ways of being, thinking, and acting. Change is hard, but if you want to be a professional trader, you have to work on changing and developing your personality.

1. Success == Drive, knowledge and discipline
   
   Next: Mass Psychology

Mass Psychology
What is Price?

1. Traders are either buyers, sellers or undecided
2. The presence of undecided traders puts pressures on bulls and bears. Bulls and bears move fast because they know they could have their deal ‘snatched away’ by a crowd of undecided traders at any moment
3. Every tick == a deal between a buyer and a seller
4. Bulls expect markets to rise; Bears expect them to fall
5. Buying by bulls pushes markets up; selling by bears pushes them down; undecideds make things happen faster by ‘creating a sense of urgency’
6. Each price is a momentary consensus of value of all market participants, expressed in action.
7. Chart patterns reflect swings of mass psychology in the financial markets.

What is the market?

1. Amateurs treat the market like a mass participation sport
2. Scientific/engineering types treat it like a physical process
3. Pros know that the market is a mass of people (robots)
4. Each member of the crowd tries to take money from others by outsmarting them.
5. In trading, you compete against some of the brightest minds in the world, while fending off the piranhas of commissions and slippage.
6. Most people feel a strong urge to join the crowd and “act like everybody else.” This primitive urge clouds your judgment when you put on a trade. A successful trader must think independently.
7. This herding instinct creates trends
8. Crowds are powerful but primitive; respect them but don’t fear them
9. A retired chief executive of a publicly traded firm explained to me that a smart man does not trade on inside information but gives it to his golfing buddies at a country club. Later they give him inside information on their companies, and both profit without being detected.
10. Technical analysis can help you detect insider buying and selling. (nah, nope, I don’t think so.)

The Trading Scene

1. An average private futures trader in the United States is a 50-year-old, married, college-educated man, coming to the markets after a successful career in business or in a profession
2. Most people trade for partly rational and partly irrational reasons. Rational reasons include the desire to earn a large return on capital. Irrational reasons include gambling and a search for excitement. Most traders are not aware of their irrational motives.
3. “When you trade from your house, you are never the first to hear the news,”
4. The firms that deal in both futures and cash markets have two advantages. They have true inside information, and they are exempt from speculative position limits that exist in many futures markets.
5. get a job with a trading firm and learn on someone else's dime. Firms almost never hire traders past their mid-twenties.
6. The Achilles heel of most institutions is that they have to trade, while an individual trader is free to trade or stay out of the market when he wants.
7. Most private traders fritter away this fantastic advantage by overtrading.
8. Trading someone else’s money and having a risk manager are big advantages for institutional traders; many of them fail when these are removed.
9. Recommends stockcharts.com
10. Toolboxes, black boxes and gray boxes; toolboxes are useful, black boxes are mysterious black magic (scams), and gray boxes are touted by ‘prominent market personalities’ - “hey disclose the general logic of their system and allow you to adjust some of their parameters.”
11. Elder is not a fan of newsletters and advisory services
    1. The first principle of letter writing is: “If you have to make forecasts, make a lot of them.” Whenever a forecast turns out right, double the volume of promotional mail.

The Market Crowd and You

1. Crowds are temperamental manic depressives
2. Cites Mackay’s Extraordinary Popular Delusions and LeBon’s The Crowd (better add them to the list)
3. “Whoever be the individuals that compose it, however like or unlike be their mode of life, their occupations, their character, or their intelligence, the fact that they have been transformed into a crowd puts them in possession of a sort of collective mind which makes them feel, think, and act in a manner quite different from that in which each individual of them would feel, think, and act were he in a state of isolation.”
4. [Crowds] become more credulous and impulsive, anxiously search for a leader, and react to emotions instead of using their intellect. An individual who becomes involved in a group becomes less capable of thinking for himself.
5. You lose your independence when you start trusting gurus more than yourself and don't follow your own trading plan. When you notice this happening, try to come back to your senses. If you can't regain your composure, exit your trades and go flat.
6. Crowds are primitive, and your trading strategies should be simple. You don't have to be a rocket scientist to design a winning trading method. If the trade goes against you—cut your losses and run. Never argue with the crowd—simply use your judgment to decide when to join and when to leave.
7. Price is the leader of the market crowd.
8. The weakest part of any trading system is the trader himself.
9. You have to observe yourself and notice changes in your mental state as you trade. Write down your reasons for entering a trade and the rules for getting out of it, including money management rules. You may not change your plan while you have an open position. (who is in charge of you, your plan or your brain? This last bit of advice may serve you well as a beginner, but a master knows when to break the rules)
10. Surowiecki - Wisdom of Crowds - the smartest groups maintain their independent decision-making and avoid ‘groupthink’.
11. SpikeTrade - Elder runs a trading competition, with each round lasting one week. After the market closes on Friday, the stock picks section of the website becomes closed to viewing by members until 3 p.m. on Sunday. During that time, any group member may submit one favorite pick for the week ahead—without knowing what other group members are doing. The picks section of the website re-opens on Sunday afternoon, allowing all members to see all picks. The race begins on Monday and ends on Friday, with prizes to winners. (this could be fun) The key point is that all decisions about stock selection and direction must be made in solitude, without seeing what the leaders or other members are doing. The sharing begins after all votes are in.

Psych of Trends

1. a leaderless group can't exist (controversial in this age of DAOs)
2. A technical analyst is an applied social psychologist, usually armed with a computer.

Managing Vs. Forecasting

1. There is a trick to help you detect your bias. If you want to buy, turn your chart upside down and see whether it looks like a sell. If it still looks like a buy after you flip it, then you have to work on getting a bullish bias out of your system. If both charts look like a sell, then you have to work on purging a bearish bias.
2. You have to extract information from the market and find out whether bulls or bears are in control.
3. You need to measure the strength of the dominant market group and decide how likely the current trend is to continue.
4. You need to practice conservative money management aimed at long-term survival and profit accumulation.
5. You must observe how your mind works and avoid slipping into greed or fear. A trader who does all of this will succeed ahead of any forecaster.
6. “It always amuses me in SpikeTrade when two elite traders pick the same stock—one long and the other short. Often by the end of the week both are profitable, proving that how you manage your trade is more important than what stock and direction you pick.”

1. Fear is three times stronger than greed, says Elder about Kahneman’s research although I don’t recall him saying this in Thinking Fast and Slow.

I don’t feel like I really learned that much about how crowds behave though, do you?

Next: Classical Chart Analysis

Classical Chart Analysis

1. Today's traders have access to immense analytic power at a very low cost.
2. Elder dismisses most classical chart patterns
3. Elder outlines the development of TA from Dow, Hamilton, Rhea to Schabacker, Elliott, Wyckoff, Gann, Edwards and Magee
   1. They popularized such concepts as triangles, rectangles, head-and-shoulders, and other chart formations, as well as support, resistance, and trendlines.
   2. stock market tops were sharp and fast, while bottoms took a long time to develop. That was true in their deflationary era, but the opposite has been true since the 1950s.

4. Chart Opening prices are set by amateurs, whose orders accumulate overnight and hit the market in the morning. Closing prices are largely set by market professionals who trade throughout the day.
5. In bull markets, prices often make their low for the week on Monday or Tuesday, when amateurs take profits from the previous week, then rally to a new high on Thursday or Friday. (turnaround Tuesday?)
6. Professionals as a group usually trade against the amateurs. They tend to buy lower openings, sell short higher openings, and unwind their positions as the day goes on. Traders need to pay attention to the relationship between opening and closing prices. If prices closed higher than they opened, then market professionals were probably more bullish than amateurs. If prices closed lower than they opened, then market professionals were probably more bearish than amateurs. It pays to trade with the professionals and against the amateurs.
7. The distance between the high and the low of any bar reflects the intensity of conflict between bulls and bears. An average bar marks a relatively cool market. A bar that's only half as tall as average reveals a sleepy, disinterested market. A bar that's two times taller than average shows a boiling market where bulls and bears battle all over the field.
8. Slippage (see the Introduction) tends to be less in quiet markets. It pays to enter trades during short or normal bars. Tall bars are good for taking profits. Trying to enter a position when the market is running is like jumping onto a moving train. It would be safer to wait for the next one.
9. Elder (rightly) dismisses efficient market theorists, and ‘perfect order’ theoreticians, like Elliotticians, and astrologers

Support and Resistance

1. Amateurs tend to follow breakouts, while professionals tend to fade them
2. The strength of these barriers increases each time prices touch them and bounce away. (nope)
3. Support and resistance exist because people have memories (or because of pain and regret). (doubtful to me)
4. When a market hits the same level for the fourth time, it shows that it really wants to go that way (could check this in some markets, but I already know the answer is NOPE)
5. When an uptrend begins, bears who sold short feel a great deal of pain. At the same time bulls feel an intense regret that they didn't buy more. Both are determined to buy if the market declines to the breakout point and gives them a second chance to cover shorts or to get long. The pain of bears and regret of bulls makes them eager to buy, creating support during reactions in an uptrend. (then why do most breakouts fail?)
6. The longer prices stay in a congestion zone, the stronger the emotional commitment of bulls and bears to that area. The older an S&R zone, the more established it is.
7. The taller the support and resistance zone, the stronger it is. (maybe worth checking) A tall congestion zone is like a tall fence around a property. If a congestion zone's height equals one percent of current market value, it provides only minor support or resistance. If it's three percent tall, it provides intermediate support or resistance, and a congestion zone that's seven percent tall or higher can grind down a major trend.
8. Greater volume also adds strength to the zone

You can measure the strength of support and resistance in dollars if you multiply the number of days a stock spent in its congestion zone by its average daily volume and price. Of course, when making such comparisons, we should measure support and resistance zones for the same stock, don't compare apples and oranges..

Trading Rules

1. Whenever the trend you're riding approaches support or resistance, tighten your protective stop.
2. Support and resistance are more important on long-term charts than on short-term charts.
3. Support and resistance levels point to trading opportunities.

1. One of the best patterns in technical analysis is a false breakout. If prices dip below support and then rally back into the support zone, they show that bears have lost their chance. A price bar closing within a congestion zone after a false downside breakout marks a buying opportunity; set a protective stop in the vicinity of the bottom of the recent false downside breakout.
2. Similarly, a true upside breakout should not be followed by a pullback into the range, just as a rocket is not supposed to sink back to its launching pad. A false upside breakout gives a signal to sell short as a price bar returns into the congestion zone. When shorting, place a protective stop near the top of the false breakout

False breakouts
The green arrowhead marks a pullback buying opportunity

1. Experienced traders avoid placing stops at round numbers.
2. Professionals expect prices to fluctuate most of the time, without going anywhere far.
   1. They wait until an upside breakout stops reaching new highs or a downside breakout stops making new lows.
   2. Then they pounce—fade the breakout (trade against it) and place a protective stop near the latest extreme point. It's a tight stop, and their monetary risk is low, with a big profit potential from prices returning towards the middle of the congestion zone.
   3. The risk/reward ratio is so good that professionals can afford to be wrong half the time and still come out ahead of the game.

3. The best time to buy an upside breakout on a daily chart is when your analysis of the weekly chart suggests that a new uptrend is developing.
   1. True breakouts are confirmed by heavy volume, while false breakouts tend to have light volume.
   2. True breakouts are confirmed when technical indicators reach new extremes in the direction of the new trend,
   3. while false breakouts are often marked by divergences between prices and indicators

Trends and Trading Ranges

1. Even a quick look at most charts reveals that markets spend most of the time in trading ranges.
2. Professionals tend to give the benefit of the doubt to trading ranges.
3. The pattern of lower lows and lower highs identifies a downtrend, and the pattern of irregular highs and lows points to a trading range
4. Plot a 20- to 30-bar exponential moving average (see Chapter 22). The direction of its slope identifies the trend. If a moving average has not reached a new high or low in a month, then the market is probably in a trading range.
5. Oscillators like MACD or the The Directional System (explained ch. 24) can identify trends (or just use your eyes)
6. Bull trends make higher highs and higher lows, Bear trends make lower lows and lower highs
7. Having identified a trend you have two choices:
   1. Buy immediately
      1. In faster on a true trend
      2. Stops are likely farther

   2. Wait for a dip
      1. Risk will be smaller
      2. But you have 4 groups of competitors
         1. Longs who want to add on
         2. Shorts who want to get out at even
         3. Late entrants (like you)
         4. Early sellers who want to get back in

      3. Deep pullbacks might be reversals not dips

8. If the market is in a trading range and you're waiting for a breakout, you'll have to decide
   1. whether to buy in anticipation of a breakout,
   2. during a breakout,
   3. or on a pullback after a valid breakout.
   4. If you aren't sure, consider entering in several steps:
      1. buy a third of the planned position in anticipation,
      2. a third on a breakout,
      3. and a third on a pullback.

9. Whatever method you use, remember to apply the key risk management rule: the distance from your entry to the protective stop, multiplied by position size can never be more than 2 percent of your account equity (see Chapter 50). No matter how attractive a trade, pass it up if it would require putting more than 2% of your account at risk.
10. When trend trading, it pays to put on smaller positions with wider stops. You'll be less likely to get shaken out by any counter-trend moves, while still controlling risk.
11. You may put on bigger positions in trading ranges but with tighter stops.
12. Before examining a trend on your favorite chart, step back to explore the charts in a timeframe one order of magnitude greater than your favorite. This search for a greater perspective is one of the key principles of the Triple Screen trading system, explained later.
13. Taking a longer view works better —and is a lot less nerve-wracking.