GARTMAN’S RULES OF TRADING – Part 1: Trading Psychology

22 Trading Rules by Dennis Gartman, Editor/Publisher of The Gartman Letter:
(I was just trying to group the rules based on their topics)

TRADING PSYCHOLOGY

1. Capital comes in two varieties: Mental and that which is in your pocket or account.
Of the two types of capital, the mental is the more important and expensive of the two. Holding to losing positions costs measurable sums of actual capital, but it costs immeasurable sums of mental capital.

2. "Markets can remain illogical longer than you or I can remain solvent", according to our good friend, Dr. A. Gary Shilling.
Illogic often reigns and markets are enormously inefficient despite what the academics believe.

3. An understanding of mass psychology is often more important than an understanding of economics.
Markets are driven by human beings making human errors and also making super-human insights.

4. The market is the sum total of the wisdom ... and the ignorance...of all of those who deal in it; and we dare not argue with the market's wisdom.
If we learn nothing more than this we've learned much indeed.

5. The hard trade is the right trade: If it is easy to sell, don't; and if it is easy to buy, don't.
Do the trade that is hard to do and that which the crowd finds objectionable.
Peter Steidelmeyer taught us this twenty five years ago and it holds truer now than then.

6. There is never one cockroach: Bad news begets bad news, which begets even worse news.

Continue to Part 2: Trading System & Money Management

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Some Trading Wise Words

I found quite a number of good trading quotes from Trading & Motivational Quotes blog.
I think this blog tries to compile the words of wisdom or trading principles from many sources or books.
You can check it out on you own for the whole collections.

Here are some of the quotes from that site that I really like and I hope it can be useful for my readers:

Turtle Trading Principle
Trade with an edge, manage risk, be consistent, and keep it simple.
The entire Turtle training, and indeed the basis of all successful trading, can be summed up in these four core principles.

Curtis Faith, Way Of Turtle

Why Chart Patterns Repeat Themselves
All through time, people have basically acted and re-acted the same way in the market as a result of: greed, fear, ignorance, and hope.
That is why the numerical formations and patterns recur on a constant basis.

Jesse Livermore, How To Trade In Stocks

Stick To Your Trading Rules
Successful trading is about finding the rules that work and then sticking to those rules.

William J. O’neil

Perfect Speculator
Perfect speculator must know when to get in;
More important he must know when to stay out;
And most important he must know when to get out once he’s in.

Source: Trend Following: How Great Traders Make Millions in Up or Down Markets

Emotional Makeup Is More Important
I haven't seen much correlation between good trading and intelligence. Some outstanding traders are quite intelligent, but a few aren't. Many outstanding intelligent people are horrible traders. Average intelligence is enough. Beyond that, emotional makeup is more important.

William Eckhardt

Emotional Discipline: The Key To Trading Success
The key to trading success is emotional discipline. If intelligence were the key, there would be a lot more people making money trading.

Victor Sperandeo

Human Emotion In Trading
Human emotion is both the source of opportunity in trading and the greatest challenge.
Master it and you will succeed.
Ignore it at your peril.

Curtis Faith, Way Of Turtle

What We Can Learn For Trading From A Fable
A monkey was carrying two handfuls of peas. One little pea dropped out. He tried to pick it up and spilt twenty. He tried to pick up the twenty and spilt them all. Then he lost his temper, scattered the peas in all directions and ran away.

Fables, Leo Tolstoy

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Follow Your Trading System

Previously, we have discussed the important components of a trading system.

When you have built or found a trading system that suits you, it is recommended that you test the trading system through paper / virtual trading before you trade it using real money.

Once you’ve had a proven & tested, profitable trading system, you yourself & your discipline will be the key determinant whether the system will be a success and a failure. Successful traders are those who are psychologically prepared and have the discipline to stick with their system through good times and bad times. You can never reach your goal as a trader if you can’t maintain the self-discipline to trust and stick to the rules you’ve chosen.
Follow the rules of your system, no matter what your emotions are telling you.

Mark Douglas, the author of The Disciplined Trader: Developing Winning Attitudes suggested:

As a trader it is more important to know that you will always follow your rules than it is to make money, because whatever money you make, you will inevitably lose back to the markets if you can't follow your rules.

Dr. Alexander Elder in his book, Come Into My Trading Room: A Complete Guide to Trading, also suggested likewise, as discussed in this post.

However, there is a caveat to this concept. You need to have a proven & tested trading system with a positive expectancy (average gains higher than average losses) which will produce a positive expected return over the long term.
If your system has a negative expectancy (not profitable over the long term), then sticking to your system would only lead you to your ruin. That’s why it’s also important to always monitor your trading performance over time. That’s where trading journal plays an essential role.
Sticking to your system doesn’t mean you cannot refine it.
As what Trader X suggested:

Don’t jump from strategy to strategy, timeframe to timeframe - pick something and stick with it! That does not mean you cannot refine it - you SHOULD constantly refine and improve what you do. But that is different from changing things completely.

Related Posts:
* Why Trading Psychology Is Very Important
* Why Being Right In Your Trading Does Not Necessarily Mean Making Money
* The Psychological Need To Be Right vs. Making Money
* The Fear Of Losing Money

You might also be interested in the following topics:
* Learning Candlestick Charts
* Learning Charts Patterns
* Options Trading Basic – Part 1
* Options Trading Basic – Part 2
* Understanding Implied Volatility (IV)
* Option Greeks

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Book Review: Come Into My Trading Room by Dr. Alexander Elder

One of the books that I read when I began learning trading is: Come Into My Trading Room: A Complete Guide to Trading, authored by Dr. Alexander Elder.

In my opinion, this is one of the best books for beginners, as it provides a comprehensive introduction to trading essentials as a solid foundation to build upon.

In this book, Dr. Elder shares three important pillars of trading: Mind, Method, and Money (3M).

The first M, Mind, refers to your trading psychology. Here he stresses the importance of discipline in trading,
In order not to let emotions (fear and greed) to lead you astray, you must instill discipline to stick to your own trading system and follow your trading plan prepared beforehand. Dr. Elder explains how to develop discipline in trading and avoid the traps caused by emotional trading, and also the importance of trading diary.

Discipline means designing, testing, and following your trading system.

It means learning to enter and exit in response to predefined signals rather than jumping in and out on a whim.

It means doing the right thing, not the easy thing.

And the first challenge down the road to disciplined trading involves setting up a record-keeping system.

The second M, Method, discusses how you about finding the trades and making entry and exit decisions. Basically, in order to achieve long term success, you have to develop a good system that gives you an edge over the market, and you must trade consistently based on your system.
In this section, Dr Elder covers technical analysis and trading indicators, and how to use and combine them to develop your own trading system.
He also shows using various examples on how to identify good trades and determine entries and exits (i.e. stops & targets).

The third M, Money, refers to how you manage your trading capital for long-term survival and success (i.e. money management).
Here Dr. Elder explains the importance of money management. Basically, a successful trader always manages his risks properly.
He then lays down the rules / formula of a good money management and provides the detail steps of proper money management.


Good quotes from the book with regards to how important the 3M is for trading success:

Every winner needs three essential components of trading: a sound individual psychology, a logical trading system and a good money management.

These essentials are three legs of a stool – remove one and the stool will fall together with the person who sits on it.

Losers try to build a stool with only one leg, or two at the most. They usually focus exclusively on trading systems.

Your trade must be based on clearly defined rules.
You have to analyze your feelings as you trade, to make sure that your decisions are intellectually sound.
You have to structure your money management so that no string of losses can kick you out of the game.

In addition, Dr Alexander Elder also provides some ideas on how to how to set up a good trading diary. Trading diary is very important from a trader. Because by having a good trading diary, you can learn from your own trades & experiences, both good & bad.

At the end of his book, Dr Elder discloses his own trading diary, which shows the details of some of his real trades (charts & indicators, trading signals, entry, stop, target, exits, etc.).

The bottom line is that, I HIGHLY recommend all beginners to read this book.
As I said earlier, this book can equip you with a complete introduction to trading essentials, which would serve as a solid foundation to build upon.

In case you’re interested, for your info, another popular & excellent book from Dr Alexander Elder is Trading for a Living: Psychology, Trading Tactics, Money Management

Related Post:
* Why Trading Psychology Is Very Important
* Book Review: When The Market Moves, Will You Be Ready?

You might be interested in the following topics:
* Learning Candlestick Charts
* Learning Charts Patterns
* Options Trading Basic – Part 1
* Options Trading Basic – Part 2
* Understanding Implied Volatility (IV)
* Option Greeks

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Reverse Psychology For Success

I came across a great motivational article that is related to trading on the importance of Goal Setting (Part 1 & Part 2) by Dr. John Eliot in the Weekly Newsletter of Dr. Van Tharp’s International Institute of Trading Mastery.

I truly recommend you to read the full articles.
In this post, please allow me to quote only a part of the article that I personally find very inspirational. It’s about the “Reverse Psychology For Success”.

Here they are:

REVERSE PSYCHOLOGY FOR SUCCESS

In the five areas below the opposite of what we normally think may work in our favor.

Having Confidence
The best in every business are likely to strike most people as irrationally confident, but that's how they got to the top.

Richard Branson, Bill Gates, Michael Dell — they first believed in themselves, utterly, and let their belief be their guide. Sure they experienced numerous obstacles and setbacks and failures. Confidence allowed them to keep getting up and looking for ways to move forward.

Legends Never Say They're Sorry
Having a long or frequent memory for mistakes and a short or infrequent memory for successes is a guaranteed way to develop fear of failure. High achievers dwell on what they do well.

Learn from your mistakes? Of course. The road to success is full of adversity from which we can gain significant insight. The key, however, is to set aside specific, deliberate times for evaluation. Process setbacks, errors, and your performance at times when you have planned to.

The alternative is to get caught up in second-guessing, doubt, and worry whenever things look a bit gray. You excel during the tough moments by having a positive blueprint to look at — and to have a positive blueprint, you have to spend a lot of time looking at the image of success.

Where Stress Works
The so-called detriment of stress is the psychological interpretation you place on critical situations, not the stress itself. If you want to perform at your best, change the lens through which you view stress.

Put All Your Eggs in One Basket
Unlikely accomplishments are born out of single-minded purposefulness. Future superstars don't get there by keeping part of their heart in reserve.

Multitasking is merely doing a bunch of things half-heartedly all at once. Isn't the idea to perform at your utmost? If you truly want to find out what your potential is, you've got to pour everything you've got into one thing at a time and be committed to it. If you hold back, you'll never know.

And if you put all your eggs in one basket and drop the basket? Guess what: They'll make more eggs, and there are plenty of baskets to choose from.

Risks
For exceptional people, risk equals reward. The challenge of uncertainty is the fun of doing the job in the first place — and where overachievement lies.

High achievers do not look for the safest, most comfortable, or sure solution. That would not push them or their companies to grow. Growth is the key — something stockholders certainly understand. But growing requires going to new places and thinking new things — not succeeding at the new, but learning from the process regardless of outcome.

Michael Jordan, perhaps the most legendary basketball player of all time, based his entire performance philosophy on the notion: "I am a success because I have failed more times than anyone in history."

Perhaps you can find some of Michael in you!?

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The Psychological Need To Be Right vs. Making Money

In my previous post, I picked one simple example from the book Trade Your Way to Financial Freedom by Dr. Van K. Tharp to illustrate that being right does not necessarily mean making money.

Yes, in trading, you can be right most of the time, yet still lose money in the end. On the other hand, you can be wrong most of the time, but still making money over the long run. It depends on “how much” you gain when you’re right & how much you lose when you’re wrong, more than on the “how often” you’re right or wrong.

Basically, “being right” is represented by frequent / majority small gains but with occasional large losses, which results in a losing money overall in the long run.
In contrast, “making money” corresponds to frequent / majority small losses but with occasional large gains, that causes the trader to make money overall in the long run.

Dr. Brett Steenbarger showed that many people prefer “to be right” in the short run to “making money” over the long run. The psychological need “to be right” (frequent wins) inhibits traders to let the profits run or to accept losses.
As he suggested, “the desire for frequent wins causes traders to take profits quickly; the aversion to losing leads to holding losers in hopes of converting them to winners.”

Yes, it’s not easy to overcome the psychological need to be right. Even if one does know that he has a trading system with positive expectancy, which will make money in the long run if he’s consistent, it may not be easy to accept when consecutive, frequent small losses happen in the row. His pride & self-esteem may be hurt. He may also lose his confidence of himself or the system. All this could negatively affect his subsequent trading performance.

This is another good example why trading psychology is important. Professionals even say it’s the most critical aspect of trading success. It’s not the trading system / strategy, market indicators, fundamental / technical analysis, or your outstanding market knowledge that will bring you success in trading. It’s you yourself that matters the most for your trading success.

Related Posts:
* The Real Purpose Of Trading
* The Fear Of Losing Money

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The Real Purpose Of Trading

I found the following thought-provoking post from Van K. Tharp’s blog, the author of "Trade Your Way to Financial Freedom" book:

The real purpose of trading is not to make money. If that's your goal you probably struggle with it a lot. But all of the following tend to work.
If you goal is to be a great trader, then you probably will do well.
If you goal is to use trading as a way to measure your self-development, then you will probably do well.
If you just love trading and that's why you do it, then as long as you are willing to work on yourself you will probably do well.
Those, in my experience, are the key motivations that bring success in trading.

Are you wondering what he meant by that? Most of us are trading with the intention to make money, aren’t we?

If we think further what he says here, actually it does make sense. This has something to do with how we handle our psychology & emotions.

When we’re trading with the goal in mind of making money, we’re always struggling a lot as our mind is burdened with more stress and our emotions, fear & greed, are getting more attached to trading. As a result, we become more tensed in our decision making. The more tensed we are, the more mistakes we make. The more mistakes we make, the more we cannot make money.

When you love trading, your focus is not on making money. You’ll just work hard and are determined to improve your trading not for the sake of money, but it’s more because you just love it. You’ll focus more on how to manage your risk / losses in order to protect your trading capital (good money management), so that you can still trade as long as possible. And you will just keep on working & working on yourself (psychology & discipline) as well as your trading, learn from it, tweak it, improve it, etc.

Why is it extremely important to work hard on yourself? Because, as mentioned before, the trader itself is the most crucial part of trading. People can learn the same trading system, but the results can be different. What causes different results from the same trading system is the trader itself as a part of the system. Trading psychology is what differentiates winners from losers, even from exactly the same system.

When you do just that, perhaps without your realizing it, your capital will not keep decreasing, but instead it’s growing. Why? Because when you know how to trade well and have had what it takes to trade well, the money would follow you.

Related Posts:
* Why Being Right In Your Trading Does Not Necessarily Mean Making Money
* The Psychological Need To Be Right vs. Making Money
* The Fear Of Losing Money
* Trading System: What Is It and Is It Important?

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Link: The Fear Of Losing Money

Chris Perruna recently wrote a good article on “The Fear of Losing Money”.
I believe all traders, both successful and unsuccessful traders, will have this kind of fear. I think this fear is normal, particularly for those who trade using their own hard-earned money. However, what differentiate between successful and unsuccessful traders are the way they handle it.
Like what Chris said in that article:

“Many investors fail in this world due to their fear of losing money.
Brilliant people continue to fail at trading the markets because of their
emotions, not their intelligence or their work ethic. It’s their psychological
make-up…….

Successful investors develop systems with expectancies that allow them to negate emotional fear by knowing what can happen if the investment fails. Successful investors are emotionally prepared to handle the side effects of losing money. Unsuccessful investors think about losing the initial investment and more often than not, pass up on a potential golden opportunity.”

Traders have fear of losing money because they don’t want to lose money. But they can lose even more money, or fail to make big money because of the fear of losing money. A few examples:

• Because of the fear of losing money, traders may pass up on many potential golden opportunities.
• Because of the fear of losing money, traders are not willing to accept losses. They have stop loss targets in place, yet do not honor the stops, but instead they are hoping that the trade will make a turn. And this hope may never come into reality. As a result, they would realize bigger losses, and in turn, make them even more fearful of losing money.
• Because of the fear of losing money, traders will take the profits quickly and not letting the profits run.
• Because of the fear of losing money, traders may become irrational or undisciplined, not following the rules and not confident on their own rules / system.

Personally, I admit I’ve made all those mistakes. It’s really not easy to handle this fear, because the fear was growing, especially after experiencing consecutive losing trades. However, I realized that to be successful in trading, I have to overcome this fear, and learn to accept losses because they are a part of this business. If we cannot accept losses, then we shouldn’t trade.

How to overcome this fear? I agree with Chris. When we make sure that we have positive expectancy system, proper risk management and money management (position sizing), we’ll eventually win the battle over time. Knowing this did help a lot to overcome my fear.
Go check out the full article.

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Why Trading Psychology Is Very Important

When ones start learning about trading, normally they will focus more on learning trading set-ups, entry and exit strategies, and spend less time on studying the psychological aspect of trading.
Until they started real trading, they will realize that trading psychology is in fact one of the most important aspects for trading success, because it concerns the most crucial part of trading – the trader itself.

People can learn the same, best trading system. However, the results can be different. What makes the results different from the same trading system is the trader as a part of the system. Trading psychology is what differentiates winners from losers, even from exactly the same system.

I remember a quote I read from Jake Bernstein’s book "Momentum Stock Selection: Using The Momentum Method For Maximum Profits":

The best trading system in the hands of an undisciplined trader is a losing system.

I personally think that discipline in trading is much more difficult than discipline in normal daily life. Ones could be very discipline in daily life, but they may fail to instill discipline in trading because there are 2 monsters inside them that can greatly affect their normal self: FEAR and GREED.

I also think even extremely logical and discipline persons in a normal daily life may turn to be illogical and undisciplined, when they are facing these two monsters inside them. Yes, dealing with one’s emotion in terms of fear and greed in trading is really not an easy thing to master at all. Why? Because you’re risking something that is precious to you: your hard-earned money.

It will be a different story if you’re not trading with your own hard-earned money at risk. As discussed in the previous post, this is also one reason why some people argue that paper trading is not the right way to learn trading.
One can be very profitable in paper trading, but may lose money in real trading. Why? Because one disadvantage of paper trading is that it does not involve the emotion, fear and greed, etc., which actually plays major parts in trading success.
Therefore, Dr. Alexander Elder in his book "Come Into My Trading Room: A Complete Guide to Trading" also suggested to learn trading by putting on very small real trades. Because real trades, although it’s very small, it still engages emotions.

The essence of this article:
Never underestimate the importance of Trading Psychology. Trading is the biggest battle against your most difficult enemy: your own emotions. If you want to win the battle, you have to conquer this biggest enemy of yours.

I’d like to end this post with the following quotes:

The real reason so few succeed in trading is because the traits required for success are almost exclusively psychological.
(Gary Smith)

I haven't seen much correlation between good trading and intelligence. Some outstanding traders are quite intelligent, but a few aren't. Many outstanding intelligent people are horrible traders. Average intelligence is enough. Beyond that, emotional makeup is more important.
(William Eckhardt)

Related Posts:
* Why Being Right In Your Trading Does Not Necessarily Mean Making Money
* The Psychological Need To Be Right vs. Making Money
* The Fear Of Losing Money
* Trading System: What Is It and Is It Important?

You might be interested in the following topics:
* Learning Candlestick Charts
* Learning Charts Patterns
* Options Trading Basic – Part 1
* Options Trading Basic – Part 2
* Understanding Implied Volatility (IV)
* Option Greeks

Read More