The Finance Book Club

Chapter 12 - Q&A
This is a chapter consisting of theoretical questions with answers by Unger. Heavily edited for length.

Q:Can we use the strategies?
A: No, they’re too basic. Make something ‘more solid’. Whatever that means.

Q: Does ‘risk’ = capital invested?
A: No, risk is how much you could lose on the current trade.

Q: Is 5% aggressive?
A: Could be. Probably. Yes.

Q: “I heard that Ryan Jones, who invented the fixed ratio method, entered the Robbins contest and ended up with a 95% drawdown. Is this true?”
A: LOL! If he was using his options or MA crossover systems then probably yes. Unger answers this diplomatically by saying that anything can happen in a trading contest where actual trading behaviour is nothing like what should be done in real life. True.

Q: Was Larry Wiliams lucky when he won 10,000% using full Kelly bets?
A: Yes, yes he was. His DD was $1.3M after passing $2M. If he had encountered this DD at the start he wouldn’t have finished. Williams switched to FF after this.

Q: Why don’t pros use FR?
A: It’s too aggressive in the early periods. Most pros have enough capital so there’s no issues with using FF for them.

Q: How important is DD, really?
A: Important. Really important.

Q: If I miss trades in real life should I still consider the theoretical results of backtests?
A: Unger says yes, I say no.

Q: Why doesn’t Unger believe in trade dependency and the z-score?
A: Too ‘statistical’. “If you apply mathematics to trading too much, you run the risk of turning it into some sort of scientific monster that loses its foundations.” Or is it just that Math doesn’t take into account the predatory nature of all markets?
Keep it simple.

Q: Can I use the Monte Carlo simulation method with a heavily filtered strategy?
A: Yes, but don’t.

Q: In the work plan is it more important to plan profits or drawdown limits?
A: Limit DD. But also be suspicious of profits that are greater than 2 standard deviations above or below the mean.

Q: Should I use the same strategy for a portfolio of stocks and futures?
A: No, diversify.

Q: Should I limit global exposure?
A: Yes.

Q: Can trading give me a monthly income?
A: Lolz, no bud. Sorry. Prepare for months or even years of losses.

Appendices
Appendix 1 and 2 are ‘mad scientist’ chapters where Unger goes through the motions of developing a strategy and adjusting it based on findings. He perfectly summarizes why chapters (and whole books) like this are of limited use to the general public.

“In fact, it’s very hard to suggest a correct development path that’s valid for any approach, and only deep-rooted knowledge of money management dynamics will give you the right intuition for one particular strategy being developed.” What works for him will not work for me, or likely, you.

Appendix 3 is a chapter in praise of Forex, but FX futures, not retail forex, alas. I’m not really sure what is special about FX futures either. Might need to reread it.

Appendix 4 is a jumble of topics including a justification for the role of the trader in society, not a parasite, or a predator of the gullible, but an important contributor to liquidity in the markets, a piece of the puzzle. But also a predator.

He also takes the chance to sing the praises of the ‘Unger academy’. I wonder which activity makes up more of his income?

“Home-based traders can make 30% a year.” Probably true. But 30% of what?

“Risk takes the stage, disguised as an opportunity; but it’s a false opportunity because all it does is eliminate some unfortunate person who dabbled in trading blinded by a mirage called get-rich-quick. This person will never be a trader: first and foremost because they’ll lose everything, but also because at the end of the day, they’re not that interested anyway.” True.

“Personally, I wouldn’t say I’m great at discretionary trading. I would say, though, that if we compared the best systematic trader in the world with the best discretionary trader in the world, the second would come out on top. So why am I a systematic trader? Simply because I don’t think I’ll ever be the best discretionary trader in the world, or even come close, but I do know how to build trading systems.”
Same here. I would add though, that the era of the ‘discretionary’ trader is approaching its twilight.

Systematic vs. Discretionary

1. Systematic trading is repeatable and measurable
2. No need for psychology
3. No need to become a machine
4. Discretionary gurus often use psychological tricks to hook students and rarely prove their techniques are worth anything

Brokers
Watch out for brokers who make their own markets and unregulated brokers. Although Unger admits unregulated brokers aren’t necessarily more risky.

Platforms
Unger goes over MetaTrader, NinjaTrader, TradeStation, AmiBroker, but doesn’t really come out for any particular one.

Trading “should never be considered a way out of a difficult economic situation.”

“No one would dream of opening a dental studio without knowing the first thing about it, just because dentists earn a lot, but many new traders approach trading with this idea.” I’ve said this exact same thing on the Factory I believe, and used the dentist example as well. Great minds think alike I guess.

And that's another book, done and dusted, as they say on Blinkist. Next: Trading Against the Crowd by John Summa.

Trading Against the Crowd
Profiting from Fear and Greed in Stock, Futures and Options Markets

Preface
Begins with a quote by our friend Robert J. Shiller about the efficient markets theory.

“Price may appear to be too high or too low at times, but, according to the efficient markets theory, this appearance must be an illusion.”

In fine form, we can’t tell if Shiller is being sarcastic or not.

Summa also starts off by quoting our friend Humphrey B. Neill but not from the book we read! Did we read the wrong one?

“The task of the contrarian “consists in training [the] mind to ruminate in directions opposite to general public opinions.” Humphrey B. Neill - The Art of Contrary Thinking (1954).

At least we know we’ve read a lot of books once we start seeing the same quotes by the same authors. We’re reaching a saturation point, people!

“At extreme levels of market sentiment the market tends to be most predictable, the best precondition for taking a trade.”

Summa promises to explain how to understand investor sentiment data, build custom indicators with that data, and incorporate these sentiment indicators in trading systems that he has developed and tested. Quite a lot to deliver, actually.

“The premise of this book is that the speculative crowd tends to misread the market at the most extreme sentiment points.” But of course they do, otherwise they wouldn’t be extremes would they? I suppose I should have raised this objection while reading Neill as he made the same argument didn’t he?

“While markets ultimately may be regulated by fundamentals, the common errors and misjudgments that regularly appear in the crowd’s actions suggest another dimension to market price behavior is at work. It appears markets become victim of the crowd’s emotions for periods of time longer than random walk theorists (who believe that predicting future price movements is not possible) are willing to accept.”

Example:

1. Manias
2. Overreaction to news

Introduction
Summa discovered the power of investor sentiment indicators while tracking daily put/call option volume during the bull run of the 1990s.

Most followed and ‘most reliable’ is the CBOE equity-only put/call ratio. It began sending warning signals in late 1999 and 2000. Ah yes, the warning signals that last years at a time. Very useful.

Sentiment showed excessive bullishness. Then technical conditions worsened.

The crowd is a term to describe less sophisticated, emotional, investors.

Sentiment indicators can produce market timing signals.

“I incorporate put/call ratios, as well as other gauges of crowd psychology—option volatility, short sales, investor surveys, advisory opinion, and news flow—into trading systems that I have developed, such as Squeeze Play I and II and Tsunami Sentiment Wave, (for which I have presented MetaStock and TradeStation system code in Appendices A and B).” Ah, custom trading systems, eh? Cool brand names and everything. Those wouldn’t happen to be for sale would they?

“Trading systems fail mostly because traders fail to follow the rules, but they can also suffer from periodic drawdowns when the signal accuracy misfires. So even a good trader can suffer from periodic failure of even the best indicators and systems. The ability to manage drawdowns largely separates the successful trader from the rest of the pack.”

Contrary Opinion Vs. Contrary Investing
Summa ignores fundamentals and concentrates only on ‘sentiment technicals’

1. put/call ratios
2. Option volatility
3. Short sales
4. Advisory opinion
5. Investor surveys
6. Quantitative news flow (his own invention)

Using these we can identify price extremes and turning points.

Combines price triggers + sentiment gauges.

Sentiment is rarely enough for a system, but is an ‘excellent’ initial screen.
Sentiment indicators often give premature signals.
Sentiment technicians - technical analysts who put great weight on measures of crowd psychology.
Is Contrary Trading For You?
Going against the herd is tough, mentally. You’re contradicting experts. Requires solid belief in your trading plan. Offers profits for those with “fortitude”. Ah, the appeal to the Chosen Few. A great gimmick for cult leaders and trading gurus alike.

Chapter 1 - Reflections of a Contrarian on Investor Psych
The trend is your friend, but what about when it’s about to end?

Market sentiment is the most important force in market moves, not fundamentals. This derives from the ‘greater fool’ theory of price behaviour.

“Sentiment technicians try to take the temperature of both the average investor and the trading crowd in hopes of finding an advantageous entry point just before an old trend ends and a new one begins. Therefore, by trading against the crowd at times of extremely bullish or bearish market sentiment, contrarians aim to get in early on the start of a new trend, which follows a market reversal.”

Summa can’t resist taking repeated digs at believers in market efficiency.

The Theory of Contrary Opinion
If every bullish actor is already in the trade there’s no one left to keep prices going up. This will result in a decline eventually.

During times of excessive bullishness or bearishness it doesn’t matter if it’s fund managers or rank and file investors driving the bubble. Experience and capital become irrelevant. The ‘crowd’ is usually the unsophisticated public, but these days, it usually includes pro investors and traders who get tempted to go with the momentum for some reason.

Finding Inefficient Markets
Not just mega-bubbles.

Short-to-medium-term cycles also exist.

Summa goes back to the EMH. We get it. You hate it. What a chatty paddy he is! Sheesh.

What markets work best with contrarian approaches?
Any market heavily traded by the retail public.

Summary
LOL - because he’s said so little with so many words, a summary is surely as necessary as an extra appendix at this stage.

People are people so human fallibility ensures that while other indicators go stale or become worthless over time, sentiment is always worth trading against. Group behaviour is a powerful psychological factor.

Chapter 2 - Measuring ‘Joe Options Trader’ Sentiment
Summa takes aim at options traders as lacking market acumen.
They are so bad at trading, he says, that despite tech advances they will likely remain a good source of sentiment data.

Put/Call volume ratio
Invented by Marty Zweig in 1971.

“These traders make highly leveraged, poorly timed bets on what they think will be short- to medium-term market directions on which the options trade. Bullish options traders purchase call options to bet on an anticipated market rise; bearish options traders buy put options to speculate on a perceived decline in markets.”
Just to be safe Summa starts defining puts, and calls and explaining how options work. I’ll spare you.

Options markets attract the least capitalized and least experienced traders. (I think Forex has them beat though) The trouble with options is their value decays over time.
What does options trading volume tell us?
“When options volume increases it suggests more speculative fervor.”

QQQ (NASDAQ 100) options are seen to be the most active list on any trading day.
“By creating a ratio of daily put volume divided by daily call volume, we in effect have a bear/bull sentiment intensity ratio.”


Note that the S and L points could only be seen in retrospect. How many days of trend would you be able to capture once you observed the peak/trough formation and before it became the corresponding opposite signal? How many false signals are not marked on this chart? I see a lot.

“The best raw data time frame I have found is the daily put/call ratio.”

1. CBOE equity-only,
2. CBOE total,
3. OEX index options put/call ratio series (options that trade

on the S&P 100)

Summa continues to beat up on the dead horse which is the efficient market hypothesis, right to the end of the chapter. It’s in your head dude. Let go.

Chapter 3 - Will the real put/call ratio please stand up?
The put/call ratio has been modified with variable results in various forms.

1. CBOE weekly put/call ratio - 1985 to present
   1. ‘Most’ traders consider the daily number more effective
   2. Fixed levels like 40 - buy and 65 - sell are no longer useful due to ‘trendiness in the data over the long term (non-stationarity)
   3. ISE competition has not diminished the predictive power of the CBOE options, says Summa

2. ISE options volume is maybe better due to its higher liquidity and use by the ‘point and click’ crowd

“Many sentiment technicians prefer the equity-only put/call ratio, which is a derivative of the CBOE total ratio, to get a better read of the speculative crowd. Figure 3.2 shows the equity-only put/call ratio at .77 and the index put/call ratio at 1.42.”

“It appears…the best measure of the pure trader crowd is the equity-only option volume. Or, better yet, the equity-only put/call ratios of all exchanges combined.”

Attempted Improvements of the Standard Put/Call Ratio Formula
Traditional put/call ratio doesn’t distinguish between which volume is being measured. In the money or out of the money options get weighted equally and no matter how far in or out.

So one refinement is to dollar-weight the put/call ratio. This measures the put/call daily options value, instead of the volume. Summa’s research doesn’t find much benefit to using this approach, however. He figures that unsophisticated options traders prefer far out-of-the-money options. So the best approach might be comparing dollar-weighted out-of-the-money options.

Static levels are of no use, you have to compare relative values.

Summa talks about using a 52 week high/low of a moving average and detrending the difference between faster/slower moving average to give him a stable range to examine, but he shows nothing.

The Hines ratio - named for Ray Hines. Compares volume data to open interest. Looks at daily call volume in relation to open interest in calls, and vice versa for puts.

Summa says he hasn’t found open interest data to be easy to interpret.

So what is this chapter? A list of things he doesn’t use? I’m losing patience.

‘Traders’ also watch intraday put/call ratios.

“If you attempt to apply these indicators to markets, you should try to diversify as much as possible to improve overall performance, as some markets can outperform others and some not do well at all. That said, I limit my testing of custom indicators and trading systems in this book to a small group of randomly selected big-cap stocks, stock indices, and in futures markets to the long bond.”

Don’t do as I do; do as I say. Pfft.

Chapter 4 - The Options Trading Crowd at Extremes
“Equity-only put/call ratios have the most intuitive appeal for sentiment technicians looking to keep a finger on the pulse of the nonprofessional crowd, the most likely traders to make common misjudgments among options traders as a group.”

Summa determines that examining options trading crowd behaviour, and the penetration of ‘extreme bearishness thresholds’ predicted price changes in the S&P500 that ‘easily beat’ random price changes and probabilities. However, on penetration of sell threshold levels, the results were ‘mixed’ with shorter-term time frames beating randomness, and longer time frames showing inferior performance.

Yeah, because stocks only go up, all this data is trend-biased, so just buy and hold.

Chapter 5 - Does the entire group of options traders get it wrong?
Short answer: no. The equity-only put/call ratio is better because some index traders get it right.

Chapter 6 - OEX Options - Is this a Smart Money crowd?
Short answer: yes. They are relatively more correct than equity-only options traders. Traders should avoid using them as a contrarian signal.

Chapter 7 - From Statistical tests to sentiment trading system
“The CBOE equity-only option put/call ratio was used for a measure of options trading crowd sentiment in the system tests. An EMA5-21 oscillator was used as an entry screen. Performance of the tests using EMA5-21, as well as EMA21-50 and EMA50-250 oscillators, failed to produce viable results.” LOL. Summa will make some changes and see if he can get this to “an acceptable level for risking real money.”

Chapter 8 - Squeeze Play I: Pulling the Price Trigger

“I am a big believer in the KISS (Keep It Simple, Stupid) philosophy. This applies as much to my trading systems development and testing as it does in my money management techniques and my personal life.” But clearly not when it comes to writing trading books.

Ok, I basically skipped the previous chapter but now that Summa claims to have some positive results I have to fill you in.

Squeeze Play 1 is his trading system.
Entry happens when his oscillator (the EMA5-21) has been above zero (for longs) or below zero (for shorts) and then experiences a crossover. This captures the start of a sentiment reversal, in theory.

“The sentiment measured in the EMA5-21 oscillator just needs to have been above average levels of sentiment, then suddenly to have reversed to get us into the trade. As for exits, when the slower (EMA21-50) oscillator follows this path, it is time to get out.”

Summa admits this is a crude method. However now he’s going to add ‘price triggers’ and everything will be wonderful.

“The entry rule for long positions now includes a close above the high of the previous day by the cash index price.”

The very first thing I think about is - do we even need the sentiment indicator for this to work? If you trade a breakout system where you wait for a close above the high of the previous day, that’s already a pretty good system. Especially in a highly trend-biased environment like equities. However, Summa will (eventually) address this.

First he presents results for a long-only system without the sentiment filter.


Naturally it works great when long-only. Everything in equities will work great if it’s long only.


He claims it does even better when trading long/short but I only see an improved total net profit. The other metrics look worse to me. Of course the short-only doesn’t work.

But now it’s time for the pièce de résistance! The sentiment filter is added.

As Summa says, ‘it doesn’t get much better than this’.

So it’s all about the proprietary sentiment filter! What is it, how do we get it?




Summa isn't telling. He just keeps on bragging.

Chaper 9 - Sentiment Squeeze Play 2
Naturally, since Summa has us on the hook now, he’s not going to let us off easy. Instead he’s going to tantalize us further with his next system.

SP2 is all about trying to apply SP1 to individual stocks, not just the index.

Large cap stocks have listed options that are are an ‘excellent secondary data stream for gauging market sentiment.’

Daily options volume is too noisy. We want to look for ‘prolonged sentiment waves’ and sentiment extremes of the ‘dumb money’.

“Instead of an EMA5-21 oscillator, Squeeze Play II uses a EMA50-100 oscillator, which is created by differencing a 50-day exponential moving average with a 100-day exponential moving average (subtracting the 50-day from the 100-day creates the oscillator series).”

But Summa doesn’t stop there with the changes. He also changes entry and exit rules. This makes comparisons between 1 and 2 more difficult. Frustrated face.



System Logic
“When the EMA50-100 has been above zero by 5 percent or more, it means there has been above average bearishness, and when it has been below −5 percent there has been above average bullishness, which establishes a sufficient sentiment setup. These readings are always taken on a daily closing basis. In other words, if investor psychology is sufficiently one-sided based on these conditions, either too bearish or too bullish, a trade is entered on the next open.”





Summa then does in-sample/out-sample tests on various stocks.


It isn’t universally successful.

“Based on tests in this chapter using put/call ratios for individual stocks, there is clearly an inefficiency in these markets that allows astute traders to capitalize on the ebb and flow of excessive fear and greed. Here, too, it pays to watch the equity option buyers and trade against this crowd. However, testing Squeeze Play II, it was shown that performance underperformed the buy/hold approach as a group.”

So, a lot of extra work for not much extra payoff you say? Tell me more! On second thought, don’t.

Alas, Summa is not done. He is going to add LEAPS (long-term equity options) to see if he can avoid using stop losses and to get more leverage.

Chapter10 - Squeeze Play II and LEAPS Surrogates
Again Summa changes his exit rules making it nearly impossible to compare his systems. Is any potential improvement due to the rule change or due to the addition of LEAPs? The LEAPS are meant to replace stops, but he also adds a time-based stop.





Now Summa says we want to remove all short trades when using LEAPS?

“While you might make the case that this is cherry picking the best periods, previous tests substantiated that it is very difficult to make money on short trades using put/call ratios thus providing support for such an approach.” Yes I would make that case. Just buy and hold. Brutal.

So I’m ‘out’ as the kids say. This book ‘gives me the ick’.

This is another mad scientist book where you may or may not be able to follow the method that is not really clearly defined and where the results are all highly speculative.

I do think the idea of using a daily close-breaking system with some other filter is a compelling one. It’s a bit like my ‘band-saw’ notions (from my trading journal thread) but it uses sentiment instead of cycles. I don’t see any logical reason why this might not work, apart from my objections against the signal value of sentiment which I describe below. BUT first, what happened to John Summa?

He wrote this book in 2004. He lost his job at the University of Vermont in 2017 and then became a documentarist. He is not a trader. He did not parlay this great idea of his into a trading empire, just a website https://optionsnerd.com where the only links are to some other books of his. He is an author. He seems like a swell guy, but this falls into ‘those who can’t do, teach’ territory. To make matters worse, this book is a chore to read, written as it is, in academic-ese and again, being a mad scientist notebook it simply details a testing routine carried out over some period.

Where do I think this goes wrong? Well, sentiment is bullshit, basically. Prices lead sentiment. Dumb money gets optimistic when prices go up and they get discouraged or bearish when prices go down. However because both ‘dumb’ and ‘smart’ money can’t really go short as much as they can go long, due to broker and legal restrictions designed to keep markets from crashing, prices mainly go up and you should probably just follow them and not overthink it.

I suppose I should look at CBOE equity-only options ratios to see if there’s anything that can be useful, but I’ve been down that road before.

Another reason I dislike this book is that its title promised something useful indeed, but of course, in order to be useful it would have to be either private or ‘dark public’ data that isn’t widely known or disseminated. Hard to share in a book.

Next: Phantom of the Pits by Art Simpson. Maybe. I'm getting fairly tired of the same old thing.

The Phantom of the Pits by Art Simpson

This book was apparently never formally published, and released for free on several websites. I'm not sure the version I have is 'official'.
It's a bit of a Socratic dialogue between the author, Art Simpson, and the mysterious 'phantom' a master trader on the the Chicago floor.

Art abbreviates 'Phantom of the Pits' as POP and I'll do the same thing.

POP: Behavior modification, without doubt, is the key to trading success -- not only in how we think but also how we act in certain situations. We must adapt to changing situations over which we have no control. We must change the situations over which we do have control.

"It requires a balanced life to sustain the meanness of the markets. Traders never plan for the bad days, and there are bad days. Either change your behavior or go down in defeat."

"The truth is that the BEST LOSER is the long-term winner."

The book goes on to include tips on preparation. We have seen all of these already and most of them are from the 1970s.
I like the tip about exercising for 20 minutes before starting though. It keeps the mind sharper says POP.
Give thanks to your higher power and explain what you will do with the funds. Don't be selfish. This gets your unconscious on side.

Rule Number 1
"I have often said the BIG money is on the surprise side. I should perhaps have said the BIG LOSERS are on the familiar side or the popular side of a trade. I call that the expected side."

POP explains this by using the 'what would you do if you cross the street' analogy we've seen before. You look both ways, you use caution and experience to navigate your way. You don't use a complex tapestry of rules.

"The correct way to control positions is to only hold them once they prove to be correct. Let the market tell you your position is proven correct, but never let the market tell you that your position is wrong. You, as a good trader, must always be in command of knowing and telling yourself when your position is bad."
This is Livermore's advice.

"Rule Number one: In a losing game such as trading, we shall start against the majority and assume we are wrong until proven correct! (We do not assume we are correct until proven wrong.) Positions established must be reduced and removed until or unless the market proves the position correct! (We allow the market to verify correct positions.)"

Yourthinking should be: When your position is right, you have to do nothing instead of doing nothing when you are wrong!

Be in control at all times. Never let the market be in control of you.

'Let me give you an example of what I mean. I enter a short position in the Dow Jones Index at 29,061. I have a stop loss 75 points away. After 45 minutes the position is 15 points on the wrong side. I am not stopped out, but the position is not exactly flying in my favour either. 12 My interpretation of Rule 1 is that I should consider closing the trade. I had expected to be right sooner, but I am not. What makes closing the trade a mental challenge is that the stop loss has not been breached. I have another 60 points of leeway on the stop loss before I am closed out, so why not give the market a chance to prove me right? I believe that Phantom is arguing that the best positions are those which are proving to be right immediately. By having a small losing trade open, which is going nowhere, we are draining our attention and our margin on such a position. Rule no 1 tells me to address my relationship with “hope” and “fear”.'

The Real Path to Profits

1. We want to make money trading.
2. We know most people fail.
3. We know even really smart people fail.
4. We know trading success is not just about technical analysis and intelligence.
All truths by my reckoning.

What if we trained ourselves to always to the opposite of what the 95% are doing?
Copper the public's bets.

Do what's uncomfortable because most people will not do that. Most people are like amoebas. They just react to stimuli.

Don't be afraid to get out and have the market turn back in your favour once the trade is closed. Big losses become more difficult to take as they get larger. Big losses take you out of the game.

Learn to be wrong fast.
It's more important to notice when you're wrong than to prove you're right. Acclimatize yourself to taking losses.

Rule Number 2
"I worked as a broker for 10 years. I saw some 100,000 people execute more than 100,000,000 (one hundred million trades) over those 10 years. I saw thousands and thousands of people destroy their trading accounts by adding to their losing positions. I saw perhaps a handful of traders add to their winning positions. That is what rule 2 is all about – pressing your winners."

"Press your winners correctly without exception. Without Rule 2, you will find that trading still isn't even a 50/50 game."

Being right doesn't make the most profit. You shouldn't simply add on to a winning position. You need a qualified plan.

When adding-on, do so in increasingly smaller increments.

"Day-traders are in for the quick profit so it is hard to have a good add plan. Their best trade is to put all positions on at once -- original and adds -- and use Rule 1 to take them off unless or until proven correct."

These two rules give you the best possibility of continuing to trade and avoiding huge drawdowns, the leading cause of going out of business.

"I cannot help you with over-trading or being under-margined. You must correct that situation before you can ever expect to be on even ground with the big funds. You must at all times be able to put only a portion of your expected position on at entry and be able to at least double your size somewhere along the route of an expected move."

Rule #1 tells you two things
1. Be confident, but be humble enough to admit when you are wrong.
2. Put only part of the position on.

Scale in because if you're wrong then you can get out at a smaller loss. If you're right, you can lay on your whole position.
Protect first entry profits by moving your SL. This is much easier swing trading than day trading.

This rule not only makes you larger when you are right but keeps you smaller when you are wrong from the start of a position. It's also a way to not over-trade. It is up to you to make sure you are properly funded.

Simpson adds, a bit late, that logically, rule 2 follows from rule 1. That is rule 2 only comes into play if rule 1 has already 'approved' the trade.

Traders who put their whole trade on at the start are taking on max risk at the start. If you don't have room to addon to your position then you are overtrading, probably.

Simpson: "It is so obvious now! It is just like playing chess and seeing after the stalemate that you could have won so easily if you had just thought there could have been a stalemate." Um...

Attached Image (click to enlarge)

Most of your money from trading is going to come from trades that take off rather quickly from when you put them on. (breakouts?)

"You can never let your guard down in trading. You must always know what the next step is for you in any situation. You rehearse your criteria of a trade, and it becomes second nature -- just like driving a car becomes a subconscious effort for you when you are proficient at it."

Trading is a loser's game. You must learn how to lose. The biggest loser who loses small will continue in the game.

"What you can do is to eliminate your reactions to what the market does to you. You do this by not giving the market the power to control your position or emotions with adverse market moves. You start out expecting the adverse market moves and plan your action based on those outcomes."

"With Rule 1 you are freeing yourself from having to feel bad. You put the trade on based on the trade plan. The market either confirms and you now have a good position, or it doesn't confirm, and you are not okay with the position and you get out. Simple!"

"To feel you are making a good trade is signing your death warrant in trading".

Markets go to extremes and you must use that to your advantage(mean reversion)

Don't take profits after you get a lead on a trade. Add-on and if it proves to be incorrect, then take your remaining profits.

Day Trading
Most of what is advised is no longer relevant. Except it is still true that you must be swift to take a loss when the Fed is ready to speak.
Plan for surprises by never overtrading.

Cloud Hopping
Charts can deceive. Something that worked 9/10 times might not work on the tenth attempt.
Even if you take short-term trades you should have a long-term outlook.

Behaviour Modification
Successful trading requires modifying behaviour. If you take a loss on a trade and then never trade that signal again, that's not proper behaviour.
Rule 1 incorporates behaviour modification, POP claims.

We need our focus to be on taking a quick loss rather than trying to decide when to take gains. Instead of protecting ourselves by becoming braver, we need to remove losing positions in order to protect them. Think about this protection aspect rather than the money you are losing.

Rule 1 protects you from ever being in distress. When you are distressed you make the wrong decision most of the time.
Behaviour modding is your responsibility and no one else's.

Mentally preparing for having to change your position 3-4 times makes it easier to do when the time comes. The initial entry is just the start of the battle.

Being wrong on the entry is OK, and you can always counter this by being correct in your behaviour which is to remove the position.

POP says the same thing over and over again in different ways. Cut your losses fast.

"You never need to conform to anyone's view but your own in trading."

"Trading must be the most important thing in your life for it to be possible for you to become the trader you know you are capable of being."

"You will take the blame and try to take the claim. But listen to me! You must never be so lost in your trading to think that your success is because of you." (?)

Taking Profit

"POP: My trade programs allow me to take profits after three adds upon a third wave of movement. The third wave usually is the strongest, and that is where I get out of the elevator on the 14th floor rather than ride to the 18th floor if it seems to move rather fast.

I know it is going to stop eventually. The only question in traders' minds, I think, is do we get out at the 14th floor on the way up or the way down."

"Having all the answers is still an incomplete process in trading. Often in trading we know the logical answer but don't know the intuition answer. There are situations in trading when we don't want to take the logical answer but the intuition answer. To know which answer to take is the most difficult decision for most traders. I believe at least 90% of the traders lose money and that close to 80% of traders are logical in their trading and not intuitive. What do you now see about trading? Wouldn't you now look more at the intuition side of trading and do more research on intuition?"
Interesting.

"You don't want to chase the market, but you don't want to miss it either. So your two plans cover all the bases with your input of market characteristics. If each day the market tends to give you a range of, say, 15 points, then you surely must be cautious when the market is already up 15 ticks. But only be cautious for a short period of time. Don't miss the move and use your "at the market" plan after a period of time. Sort of like a stop and I must say the best use of stops I know".

Trading isn't an impossible road but a lonely one, because you can't assist people when you're changing your mind six times a day. No expert trader can convey confidence to their customers by being so changeable, but they need that flexibility. That's why it's a solo affair, mostly.

You must have the courage to do what is correct at all times. Giving advice, and trading are conflicting endeavours. Most new traders are better off without the conflict of advice. (!) uh-oh

We must always have the the latitude to change positions based on our systems.

Locals (pro traders) are good at taking the smallest possible losses and going with the flow. That is their advantage over public (retail) traders.

"To understand why markets act as a system that tends to prove the most people wrong in any one day is a good start in correcting bad entries when trading. Traders are correct in thinking that the stops will get them out, and then the market will just turn around and go the way they had thought prior to being stopped out. The fact that it happens is reason enough to devise your trading plan accordingly. This idea is especially useful upon planning entries. I never really liked stops but trading off-floor creates a problem for the public because they certainly need protection from being hurt from extreme moves."

Stops don't work in choppy markets.

"We proceed with a trading plan after we feel our behavior and reaction to market conditions is in our total control. As long as we are prepared for any outcome and adapt our behavior to all possibilities, we can start to follow a good system."