Trade Like a Casino House

Any quick drive through Goa Casino makes it pretty clear who is making in the money – the Casinos!

Why do gamblers keep going back despite losing most of the time?  Misplaced hope, fantasies about the big win, promising themselves they will walk away when they are up and still winning, and probably the inability to calculate probabilities. These symptoms may sound familiar to new traders who have lost money in the stock market, especially when we were new to trading and had delusions of grandeur about trading their way to prosperity quickly and easily.

In gambling there are really only two sides to choose to be on, either you are a gambler or you are the house. The gamblers have the long term odds stacked against them. The more they gamble, the more the odds are that they will inevitably lose. The casino has stacked the odds on their side over the long haul. The more the gambler keeps gambling, the more the odds shift in favor of the casino operator. The more they gamble the greater the chance the gambler will leave empty-handed.

Profitable traders operate like casinos, with the odds in their favor over the long term. They have learned to trade with historically, back-tested trading systems that put the odds on their side. Much like casino operators, they risk small amounts of equity per trade (around 1% – 2% of their accounts), so no one trade can hurt them financially and mentally for that matter.

Most unseasoned traders behave like gamblers, with no real advantage. They plunge large bets on stocks so haphazardly that they just have a 50-50 shot like a roulette wheel – red or black. Many times these traders hurt themselves even worse by buying into the market in a downtrend and shorting into a rally, believing that they can pick the bottom or top. Some new traders would love to have a 50/50 win ratio, many actually to all the wrong things and are nowhere near a 50% win rate.

New traders often have no concept of risk management and like gamblers they eventual give back all their winnings and then some. Richard Weismann’s book is about becoming the casino through trading using math and probabilities,  instead of emotions. We do this by not being emotionally invested in any one trading outcome. It shows traders the supreme importance of risk management and a positive expectancy model. Traders must control risk and manage odds in the same fashion that casinos do. Casinos set table limits so as not to expose themselves to the risk of ruin by allowing a gambler to hurt the casino’s bottom line on any one huge bet.

Traders must have the discipline to stick with positive expectancy models and risk management. Casinos do not get upset and change their rules trying to win back money from a gambler who goes on a lucky streak, as they know luck eventually runs out. Traders should never go off their trading plan to try to win back money quickly that they lost. Luck is what gamblers hope for while good traders are trading for a positive expectancy. Successful traders and casino operators consistently play the probabilities and manage risk so should you if you want to win.

Trade the market – not the money involved in your account. Each trade must be based on a proven trading system of entries and exits and not by how much we hope to make. Never let failed trades in the past force you to revenge trade and do not anticipate a signal. Let the market come to you and take it only when it is hit, utilizing rigid discipline.

Winning traders always stick with their historically proven trading system. Casinos do not close down if gamblers get on a winning streak because they have calculated the odds and play based on those odds. Trading like a Casino is truly a great book with a great analogy to explain how to win the trading game. The principles the book explains to use for winning in the markets are spot on and are easy to understand when associated with what many readers should be familiar with: casinos and how they take our money. If we can’t beat them, let’s join them; be the casino not the gambler.

Traders Mindset

No trader wins on every trade... The best traders in the world only have a 50%-80% success rate

Trying to get rich quick requires so much risk, that the probabilities of ending up poor is far greater than your chances of becoming rich

Consistent 15% – 20% annual returns are what world class traders and portfolio managers make

Some of the best traders’ best years were 50% – 100% annual returns, in specific market conditions, that were conducive to their strategy

Market conditions will have a huge impact on your returns each year, regardless of how you trade

The higher returns you aim for, the more risk will be required, and the larger draw down you will have getting those returns

If you risk 5% to 10% of your trading capital on every trade, your risk of ruin is 100% in the short to long term... If you think that the above percentages are just too small, then it is very likely that your trading account is too small to make those percentages meaningful

To trade for a living, you likely need a multiple six figure account and a minimum of one years worth of living expenses to avoid the unrealistic expectations of small returns and the accompanying stress

Trading is a profession like any other and requires the same level of discipline and dedication to be successful

All your profits comes from other trader’s losses. You must beat other traders to be profitable

Trading is the hardest easy money you will ever make

Trading Stress and Emotion

*Everyone has a stop-loss level: For some, it’s a price; for others, it’s a pain threshold.

* It’s not stress and emotion that get in the way of trading; it’s the stress and emotion that results when trading becomes personal: about you, rather than about supply and demand.

* The measure of a trader is how hard he or she works when markets are closed.

* Much bad trading is hormonal: too much testosterone, too little.

* When traders don’t track their results, it’s because they don’t want to know them.

* The best traders have a passion for markets; the worst have a passion for trading.

* When it comes to market history, there are only two choices: trading with awareness of it, trading in ignorance of it.

* Losing a job or not wanting a 9-to-5 one is not the right reason to pursue trading.

* Markets tend to move in the direction of the greatest number of stops.

* The best traders are not relaxed *and* they are not anxious. They are alert.

* Deep down, traders who don’t prepare don’t feel they deserve to win. We always gravitate toward our just desserts.

Trading Lessons

·        Most of the time, markets are very close to efficient (in the academic sense of the word.) This means that most of the time, price movement is random and we have no reason, from a technical perspective, to be involved in those markets.

·        There are, however, repeatable patterns in prices. This is the good news; it means we can make money using technical tools to trade.

·        The biases and statistical edges provided by these patterns are very, very small. This is the bad news; it means that it is exceedingly difficult to make money trading. We must be able to identify those points where markets are something a little “less than random” and where there might be a statistical edge present, and then put on trades in very competitive markets.

·        Technical trading is nothing more than a statistical game. The parallels to gambling and other games of chance are very, very close. A technical trader simply identifies the patterns where an edge might be present, takes the correct position at the correct time, and manages the risk in the trade. This is, of course, a very simplified summary of the trading process, but it is useful to see things from this perspective. This is the essence of trading: find the pattern, put on the trade, manage the risk, and take profits.

·        Because all we are doing is playing the small edges as they occur in the markets, it is important to be utterly consistent in every aspect of our trading. Many markets have gotten harder (i.e. more efficient, more of the time) over the past decade and things that once worked no longer work. Iron discipline is a key component of successful trading. If you are not disciplined every time, every moment of your interaction with the market, do not say you are disciplined.

·        It is possible to trade effectively as a purely systematic trader or as a discretionary trader, but the more discretion is involved the more the trader himself is a key part of the trading process. It can be very difficult to sort out performance issues that are caused by markets, by natural statistical fluctuations, by the trading system not working, or by the trader himself.

·        There is still a tremendous bias in many circles toward fundamental analysis and against technical analysis. The fundamentalists have a facile argument because it is easy to point to patterns on charts, say they are absurd, and point out that markets are actually driven by supply, demand and fundamental factors—the very elements that fundamental analysis deals with directly. However, many times the element of art involved in fundamental analysis is overlooked. How much does your valuation change if your discount rate is off by a percentage point? How dependent is your model on your assessment of some manager’s CapEx decisions in year 4? Do you really have a good sense of how the company’s competitive position will evolve with the industry over the next decade? Does everyone else? There’s a lot more “wiggle room” in fundamentals than most people realize.

·        One advantage of technical trading is that, done properly, it clearly identifies supply/demand imbalances from their effect on prices. This is a form of look-back analysis, but good technical tools force you to deal with the reality of what is happening right now. There is no equivocation, wishing, or emotional involvement in solid technical trading. The best risk management tools are technical, or are based on patterns in prices themselves.

·        Most people (and funds) who try to trade will not be successful, and I believe this is because most of them are simply trying to do things that do not work. Taking a good, hard look at your tools, methods, and approach can be scary, but there is no other way to find enduring success in the market.

Milestones You Must Pass to Become a Trader

Most people jump into the stock market expecting instant, grandiose results that are not realistic. Sorry to burst your bubble, but trading success is a marathon, not a sprint! For a lot of people that is hard to hear. They don’t want to train, they don’t want to get out of their comfort zone, and they don’t want to change their lifestyle in order to achieve success. They want money to be handed to them on a silver platter.

We are here to tell you the truth: There are no shortcuts. Successful trading is hard work, and any other line of thinking is a one-way ticket to failure.

Trading is a journey, and you need to treat it as such. Back to the marathon analogy for a moment. When you are training for an endurance race, you don’t immediately go out the first day and run 26.2 miles, or even 10 miles. The first thing you do is build a realistic step-by-step program to build up your endurance based on your starting point. If you try to run too far, or too fast, you could injure yourself or damage your psyche.

Trading is the exact same way.

Goal-setting is extremely important in life, and especially in trading. Yes, you should have a long-term goal of where you want to eventually get to, but you also need to have short-term goals that are specific, realistic, and measurable.

In this article, I lay out what I believe to be a four milestones, or checkpoints, that every trader should pass through before trying to take the next step. In my opinion, if you try to bypass one of these milestones, you will end up costing yourself a considerable amount of money in the long-term.

1. Trade 100 shares until you have become consistently profitable for a three-month period.

It might get frustrating to trade small size, but during that initial phase you are training your hands, eyes, and, most importantly, your mind. Learn how to punch the keys fast and efficiently, develop a routine for watching stocks, and build good habits. During this period, you should craft a specific style of trading and be able to define your “edge.” If it takes you longer than three months to get past this phase, that is OK and normal. Again, in our opinion, if you try to bypass this stage and trade bigger size before you are ready, it will cost you money.

2. Increase share size and manage multiple positions at once.

In the first stage, you want to focus on micro-managing one position at a time, learning the ins and outs of how stocks move. Once you have mastered that skill, it’s time to take a step up. Don’t increase your share size by 10 times immediately, take incremental steps higher. Trade 200 then 300, and when you have achieved consistently at those levels, then makes the jump to maybe 500, 600. Don’t ever trade more size than you are comfortable with.

In the same vein, don’t go from managing one position at a time to 10. Add more positions incrementally as you get more comfortable and you get more clarity on the market. Eventually, you hope to get to a level of someone like big traders who often holds 20-30 positions at any given time, but keep in mind that he has been on his trading journey for more than 15 years and has developed his skills over a period of time.

3. Add more indicators and another level of sophistication to your analysis.

In the first stage of the trader path, you should be able to define your edge, but that doesn’t mean you have a complete tool belt! The core of your strategy should not change; you should simply add a few indicators to sharpen that edge. A few price action strategy that you may consider.

Adding a couple of price action strategy to your trading arsenal can be a powerful step, but it is very important not to use too many indicators.  If you try to wait for trades where seven to eight strategy line up, then you may never place a single trade! Find a few go-to strategies in which you have supreme confidence, and incorporate them into your trading.

Psychology & Risk Management For Traders

1.     I keep Blue Channels turned off while trading.

2.     I do not care about others opinions I care only about price and chart action.

3.     I do not try to predict, instead I trade in accordance with the chart.

4.     I am not trying to prove I am right I am trying to make money.

5.     I am not trading for ego gratification I am trading for money.

6.     I am not trying to be the genius who calls a top I am the trend follower who follows a trend all the way up until it ends.

7.     I admit freely to my losing trades along with my winning trades.

8.     I do not get emotionally attached to each price movement throughout the day.

9.     I have faith in my rules, methodology and system.

10.  I understand it that it is the market conditions and not me that creates profits.

RISK MANAGEMENT

1.     I never add to a losing position.

2.     I carefully control position sizing to limit risk based on volatility.

3.     I attempt to never lose more than 1% of my capital on any one trade.

4.     I trade smaller when volatility is high.

5.     I have stale stops and sale positions that do not trend in four days after entry.

6.     I quickly sell losing trades when my stop is hit.

7.     I sell stocks when they close in the bottom of the day’s range.

8.     I never expose more than 6% of my capital to possible loss at any one time.

9.     Risk is priority #1, profits are #2.

Ingredients to a Profitable Trading

As people get into this great business of trading, many are exposed to a heck of a lot misinformation.  So, that being said, let me lay out what I truly believe are the 5 keys to a profitable trading methodology:

·         Reliability.  This basically means at what percentage of the time do you actually make money?  A lot of people (most in fact) emphasize this.  Many traders want to be right on every trade because they were taught that 70% or less is failing.  NOT in trading though, you can be right only 50% of the time and still make a lot of money…as long as you have the other four keys in place

·        Risk to Reward Ratio in other words, this is the relative size of your profits compared with you losses.  Ultimately you want to have a 2:1 (or better) risk to reward relationship when first putting on a trade.  However, this may be pretty difficult to find.  It would be more realistic to find (or create) a trading methodology that has a 1:1 risk to reward relationship; then once you factor in your ‘trade management’ to the trades it comes out to a 2:1+ risk to reward type of trade.  You’ve heard this many times before I’m sure, and it applies here too:  cut your losses short, and let you profits run.  It’s obviously one of the keys to successful trading, but is very hard for many traders to do.

·        The number of your trading opportunities.  This means how many trades does your trading methodology actually generate?  If your system only generates, let’s say only 25 trades a year (for swing or position trading), that’s fine, but you’re limited to how much you can make due to the low amount of trade set ups.  However, if you have a system (trading methodology) that trades five or ten times that amount (25)you will make a lot more money, assuming that the other 4 keys are in place that are outlined here.

·        The size of your trading capital.  Let’s face it, if your trading account is real small (i.e. 50000 to 100000) it’s harder to make really good returns.  But, when your account is larger (i.e. 500,000+) it becomes easier to make good returns.

·        Position sizing strategies.  Position sizing strategies tell you how much to risk throughout the course of a trade.  It’s an essential ingredient to the whole money management philosophy.  In fact it’s so very important that without implementing a position sizing strategy the chances of you succeeding are doubtful.  Position sizing is responsible for about 90% of your overall performance variability; that’s how important it is.

So, there you have it, the five keys to a profitable trading methodology once again are:

1.  Reliability,

2.  Risk to Reward Ratio,

3.  Number of Trading Opportunities,

4.  Size of Trading Capital, and

5.  Position Sizing Strategies

And regardless of the market or time frame you decide to trade, all five of these keys are important to a highly profitable trading methodology.  At the minimum, you need number one (Reliability), two (Risk to Reward Ratio) and number five (Position Sizing Strategies) to make a lot of money in the markets.  So, I urge you to honestly evaluate your current trading system/methodology to see how it stacks up against these five keys in a successful trading approach.

Trading vs Gambling – Is there a Difference?

Put a trader in a group of non-traders and the conversation will inevitably turn to gambling.   At a recent family gathering I was asked about my share trading by an interested (or polite) family member, to which I responded with my usual cheery, ‘Good thanks!”

I had just mentioned that we were planning on selling our house and using the money to trade with, when a bystander with good hearing said rather loudly ‘Put it on Black!

These situations come up rather a lot; in fact some of my closest friends have expressed their thought that in the stock market it’s all luck and pretty much a 50/50 bet.  And for them, it probably would be.  Meanwhile I quietly bit my knuckle (hard) to stop myself from climbing a-top my soap box.  Because it was a dinner party, after all.

It seems the general population (in particular men in their forties on grand final day) don’t seem to consider a few quite important points, including but not limited to the fact that –

1.      It is highly offensive to be considered a gambler, particularly when you’ve just said you’re selling your house for funds.

2.      As traders we might have a slightly better idea of how the markets work than they do.

3.      A ‘girl’ in her extremely early thirties could have any knowledge at all of things they themselves don’t understand.

So, what is the difference between Trading and Gambling?

The difference between trading and gambling is, for me, enormous.  But I must admit that for a lot of ‘traders’ (or ‘speculators’ which is probably more accurate) there really isn’t any difference at all.  Even though I didn’t realize at the time, I started out as a share market gambler.  Now, however, I am not. To me, these are the differences –

·        A gambler is in it for quick bucks.  A Trader knows that profits often take time.

·        A gambler is caught up in the excitement.  A Trader knows that the job is boring, repetitive and mundane.

·        A gambler has the odds against him.  A Trader has a back tested edge that, over time, will consistently win.

·        A gambler focuses on the potential for winning, with no concept of risk.  A Trader focuses on the risk before anything, knowing profit will come as an afterthought.

If you are involved in the stock market, does your trading style sound more like that of a gambler, or a trader?   You might be surprised!

Quotes from successful traders

·        The key to trading success is emotional discipline. Making money has nothing to do with intelligence.

·        The big money is made by the sitting and the waiting — not the thinking. Wait until all the factors are in your favor before making the trade. (Jesse Livermore)

·        It’s not the mathematical skill that’s critical to winning; it’s the discipline of being able to stick to the system.

·        When you really believe that trading is simply a probability game, concepts like right and wrong or win or lose no longer have the same significance

·        A successful trader is rational, analytical, able to control emotions, practical, and profit oriented. (Monroe Trout)

Amateur Traders Vs Professional Traders

“A trader is the weakest link of any trading system” (Alexander Elder)

During one of the trading Seminar a student asked the following

“After 4 years of winning and losing hundreds of trades and blowing out several accounts both demo and live, trying different systems, experimenting with many strategies, I am still unable to achieve my trading goals and become a consistent profitable trader. I wonder why I am taking two-step forward one step backward and one step forward two-step backward and pretty much in league of majority of traders who are struggling to make consistent profit day in day out.

 As this problem is faced by many traders I decided write an article on this to find out reasons for failure for aspiring traders so as to kick start their trading career with a bang.

The most important reason for failure lies in my trading approach. Most of traders still react on emotion, fear & greed  and they need to change the way they think and get rid of this herd mentality, otherwise traders won’t be able to become profitable trader, no matter how hard they try.

“If you want to have a better performance than the crowd, you must do things differently from the crowd” (Sir John Templeton)

Professional traders think different from rest of the crowd majority of the time and that is why they are consistently profitable over longer period. Lot of these traders have started with small capital and made big fortunes by trading consistently year after year. Although their trading style and system is different from each other, some are technical traders; some are fundamental traders and some mixture of both.

Patience & Discipline

Amateur Traders are not sufficiently selective when entering trades. When they see volatile price movements, they become impatient and enter trades in middle of nowhere based on emotion, fear & greed rather than waiting for their system to give a buy/sell signal according to their trade plan. They want to be part of market action, as soon as they open their charts and see volatile price movements. They don’t think in terms of probabilities rather they give too much emphasis to an individual trade. They fear that if they don’t place an order instantly they might lose a golden opportunity to make money and when they finally place a trade, majority of the time it’s too late and they fall on trap to professional traders and enter at a level where these professionals are exiting their positions and as a result the market retrace and take out amateur traders stop-loss.

Professional Traders understand importance of patience and discipline in this business. They stick to their trade plan and don’t panic when they see volatile price movements. They understand that there is no place for emotion, fear & greed in trading. They know their edge and understand that if they stick to their system and follow their trade plan they would be profitable in the long run. They know that price doesn’t move up or down in a straight line and that after every impulsive move there would be a corrective move to entice more buyers/sellers and they don’t need to jump in the middle of a fast moving train. Rather they are looking for an opportunity to buy/sell at a discounted price (wholesale price) to get a better risk to reward ratio on majority of their trades. They assess their success or failure based on series of trades rather than an individual trade. They think in terms of probabilities and fully understand that there is random distribution between winners and losers. As such they don’t get upset if the miss out on a trade or have couple of losses nor they get excited after few winners

Ideas for Traders

·         The typical trader who is struggling will look for outside information that completes the puzzle or “holy grail” of trading. Go and look at yourself in the mirror. This is the missing piece in the trading puzzle. 

·        Mental rehearsal (of both positive and negative scenarios), positive imagery, inducing a relaxed state of mind, and developing daily rituals can help put you in the flow state of mind for trading. 

·         The most important question a trader can ask: “Am I acting in my own best interest right now?” This question will help you define your risk and maximize your opportunities and trading results. 

·         The very largest traders are focused primarily on risk management. Accepting and managing risk is a big part of trading. Some traders have difficulty following rules in this area. We should spend time learning about the mental biases humans have against suffering losses and become aware of these showing up in our trading. Keep a trading journal 

·         “If I was forced to rank the importance of [various aspects] of trading, setups would be at the bottom of the list. Position sizing, risk management, and psychology are really what are going to keep you out of trouble and ahead of the game. The best traders understand this and have internalized it.” 

·         You need to learn to do more of what works and less of what doesn’t. While it sounds obvious, many traders have difficulty with this as their unman aged emotions are interfering with their perceptions and trading process.