1. Correct knowledge and the ability to change behavior (behavior modification) are the most important parts of successful trading.
2. 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.
3. 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.)
4. They fear being wrong when they get out and that the market will show them they should have stayed with the position. If they don't take early losses, it becomes more difficult to take a loss as it gets larger. However, the market assumption you must make is that big losses will eventually take you out of trading. My Rule Number 1 is to address the swiftness needed in keeping your losses as small and quick as possible. It won't always prove to be correct, but you will stay in the game this way. The market assumption you must make is that big losses will eventually take you out of trading.
5. Keep in mind that traders are usually unaware that trading is a losers' game. He who loses best will win in the end!
6. So what is a trader to do in a losing game? You must trade in the long run! How can you trade in the long run? Only way I know is that you must keep your losses small and take more small losses than small winners to come out ahead. This often means washing a position for the sake of being able to keep in the game.
7. The traffic light example. It's the same in trading as in crossing an intersection. We need to make our best assumption of what is possible. We must plan for that assumption in trading as long as it is a possibility and not just when it is probable. This is a very important point in understanding Rule Number 1 correctly!
8. The car example. The cloth example.
9. Most traders plan only for the probability side and that, to them, is always what they consider the winning side. This is the biggest mistake you can make in trading. Instead, you must plan for the losing side.
10. When you are told not to do something in trading, it is not ever the same thing as saying you must do the opposite.
11. On your meaning when you say "assume," you are telling me there is a possibility or probability based on some fact of the situation that requires me to acknowledge and always have a plan for the possibility or surprise side in trading. Your meaning of the surprise side of trading is the side that presents the possibility but not the highest probability.
12. By making the market prove you correct in order to hold a position is acknowledging that trading is a losers' game and not a winners' game. If you only remove your position because the market proves you wrong, you are acknowledging that trading is a winners' game.
13. Behavior modification is knowing the limits. You must know what the limits are in trading! In trading most of you have a greater chance of being wrong than right! Trade accordingly . . . which means expect the limit (being wrong more likely) in your trading. So what is a trader to do in a losing game? You must trade in the long run! How can you trade in the long run? Only way I know is that you must keep your losses small and take more small losses than small winners to come out ahead. This often means washing a position for the sake of being able to keep in the game.
14. It is your job to know you are wrong and not the market's job.
15. Rule Number two: Press your winners correctly without exception.
16. Reviewing Rule 2, it states only that you must add to correct (proven) positions and that it must be done correctly. The rule does not tell you how to add, as this is your requirement in the trade plan you develop. The rule makes no exception on adding to correct positions. The intent of Rule 2 is twofold: Reinforce your correct position both mentally in your thinking and your execution and increasing the size of your position.
17. It is true that Rule 2 is what makes my money for me. It does it in the long run and not the short run.
18. Rule 2 does not mean just because you have a position in your favor that you must now add to that position. "Correctly" in Rule 2 means you must have a qualified plan of adding to your position once a trend has established itself. The proper criteria for adding positions depends on your time frame of expectations in your trade plan.
19. The other good reason is that you must be larger when correct on a position than when your position is wrong.
20. Correctly adding to a proven position must be done so that a pyramid isn't established that will hurt the trader in a minor reversal. Each add onto an original position should be done in smaller and smaller steps. As an example, if you put six contracts on as your initial position, you should use four contracts for your first add and two contracts for your next add. This gives you twice the original position when all three positions are in place. This is a 3:2:1 ratio in establishing three levels of positioning.
21. At all times during the trade it is important that Rule 1 be in your plan. This includes when you are adding to your positions to protect your trade from any major reversals, which often happen.
22. One correct way for a day-trader is to see that the position is proven correct and then add at a proper retracement. This will not be the case for a trend trader. A trend trader would most likely have at least one add at a breakout or breakaway gap. It all depends on your trade plan. Your method of adding must be validated by your trade plan.
23. Day-traders will have a problem with Rule 2 unless they position properly and understand that their adds must only be made correctly. 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. Believe me, this is the proper probability in a loser's game like trading.
24. The first problem with understanding Rule 2 is that any time a trader cannot or does not incorporate a plan to add to winners, they may be under-funded and unable to margin properly the additional positions in the add. Another aspect of being under-funded may only be that over-trading in the original position is actually a problem from the start.
25. Another reason for problems with Rule 2 is that traders are actually day-trading so they won't have undue risk in their positions. This will cut their odds of making the goals expected in any kind of move. It is more of a hit-and -run type trading.
26. I want the traders to ask themselves two questions:
"Do you put only part of your expected position on from the initial entry?
"Are you planning for adds prior to your initial trade?"
If the answer to either of these questions is no, then you must go back and rethink your trading program.
27. Good aspects to the Rule Number 2:
--The fact that reinforcing a correct position actually keeps you thinking correctly is one of the important reasons.
--Another aspect is that, of course, you will be with a larger position when you are correct.
-- It will actually keep you from over-trading from the entry through to the end of the position if used properly
-- You will be eliminating the desire to be proud when the market moves your way and want to take profits to show that you are right. Traders love to be right. This is your enemy . . . to love to be right. Your motivation must be to love to do the right thing in trading by either reinforcing correctly your position or removing it should it not prove to be correct. You see, when you think you are right in the market, this is just the beginning of your trade -- not the time to take your profits to say to the world, "See, I was right!" Let me ask you, "Who really cares if you were right?" So what? You will become the best trader you can be by being wrong small, not right small! Get that in your mind now.
28. The protection is Rule 1, but the biggest protection is Rule 2.
29. What I want them to understand about that point is that they will only get bigger when their criteria in their trading program tells them it is time to add. They will not add just because the initial position has been proven correct. When they have completed their adding of additional positions, then and only then should they have their entire expected position established. Traders are over-trading most of the time when they say they can't seem to justify adding to an existing position. Most of the time a trader does not think about the reason for adding because they have their initial position on from the start. This is their maximum risk from the start.
30. To want to have a correct position from the start is over-trading when you place an entire position. Traders don't add because they have their position. The big drawdown is that when that original initial position is wrong, their losses are as large as their gains seem to be if they were right. We don't want that.
31. BIG money is on the surprise side. BIG LOSERS are on the familiar side or the popular side of a trade. I call that the expected side.
32. In trading, rules are not meant to be broken for your own sake. The rules bring you to a no judgment type approach.
33. The excessive commissions issue: If the market continued to drop against me, and my loss would have been 30-40 times my commission, Now you can't tell me that it is better to stay in and wait for the market to come back than it is to get out and re-evaluate the situation. In the end I would have been right, but my mental standing after a simple Rule 1 trade is a lot better and allows me to have sanity about my next move.
34. The building plumb example. 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.
35. Most traders think it is bad for them to be wrong and, when they are, that's it for the day. Well, being wrong is the best chance to put a correct position on with your next trade as you certainly can trade again. If you keep a trade that never proves to be correct within your program of time element, you will never be able to correct a bad situation but only be able to remove that bad situation. Your mental well-being is worth a lot in trading. You can trade well when you are thinking well.
36. Trading is a loser's game. You must learn how to lose. The biggest loser who loses small will continue in the game. Trading is a losing game, and the best loser is the big winner!
37. Just because you put on a trade that lost money is no reason to feel bad. If you put a position on and lose big money, that is when you can feel very bad. Most of your trades that don't confirm within a logical time frame are usually going to look bad sooner or later. Why not take the sooner?
38. The logical step is to have the plan in place for the next step before you put on the trade. I would guess that 95% of the traders put the trade on and then wait for the market to prove they have a bad position.
39. Many trading plans have the trader in a position at all times, the thinking being that the market is either going to go up or go down. Well, this is just absolutely an idiot's plan. I have to put this in the category of thinking a statement that says not to do something actually says to do the opposite of that statement.
40. Rule 1 will NOT protect you from wrong entries! Rule 1 will get you out of a position that is not proven correct, but it won't fix a bad entry. Know your plan before the market opens!
41. If you trade by looking in the newspaper each night, your trading plan will be different and your positions must be smaller as you are going to need wider ranges to work with your criteria.
42. When you take a position, do you feel you have taken a good position? Never! Do you understand my NO? If a trader thinks at any time they have a very good trade, they are going to get removed from trading very quickly. I make the best trade on my trade probabilities program, but who is to say my guess is better than someone else's? Never do I know it is a good trade until it proves to be.
43. It is not only to make as much money as possible but, most important, to make it in the least amount of time.
44. There are no long-term trades! Only trades that turn into long-term held positions. Don't ever let anyone tell you they have a long-term position on at any time. How do they know? How does anyone know? Only the market can tell you that.
45. Well, don't take your profit. Add to your position. Then, if it doesn't prove correct, take your remaining profit and expect to re-enter at a different level. So what if you lose a few ticks because you put an added position on and it was wrong! You will get enough lead on adds that you won't ever think twice after you see the runaway markets! It isn't because I say so but because the market catches traders the wrong way. It is seldom that it's not the case.
46. You see, there are variables in all of our trading styles. It is just that my Rules 1 and 2 are designed to give you the longest answer when it comes to trading longevity (Rule 1) and the shortest time to get to your goal of return (Rule 2). You need them both.
47. It is the day-traders desire to be able to trade and not worry overnight about their positions, risk and exposure of positions beyond a short period of time while expecting the maximum possible gain in the quickest possible time. Firstly, you could use the day -traders to your advantage in trading by knowing that they would have to get out by the close. Second, I learned that day-traders actually do a better job of keeping ranges smaller than do scalpers whose purpose is to fade small moves for quick profits. Third, I learned that day-trading did afford traders a way of keeping risk smaller and allow them to work larger positions in the short run as opposed to large positions in the long run.
48. A scalper is quicker to take a loss but tends to let profits run a little less than a day-trader's ability to take losses. In other words, a day -trader tends to lose on a trade more than a scalper makes. This leaves a margin of loss in losing trades. Believe it or not, guess who picks up that extra loss that day-traders make? It is usually the position trader. So that, to me, is the edge. You must know when you have the edge and just what it is. It is not an exact thing, but I feel it is because day -traders are not as good or don't have the ability to execute as scalpers. A day-trader would do better if execution became a market order on exits -- especially on taking losers.
49. Day-trader's odds are lower because of their limitations on overnight carries. Another big drawback is delayed reactions on what the market prices have done. They must pick the entry/exit points almost exact. This is another drawback for them
50. Do not ever over-trading at any time.
51. Today the funds must use fades because they must go at the market to position.
52. I also learned to not stake it all on one price. A long-time friend taught me the range strategy.
53. TAKE YOUR LOSSES. Trading is called coming out on the small losers' side and being rewarded with knowing how good you have been wrong. You can stop the market's oscillation any time you wish. Simply stop (remove) your position.
54. The main advantage I see in charts is that you can plainly see what will be dictated to other traders for them to think at certain points.
55. My charting is based on knowing what the signals of each type indicate to other trades more so than to myself. I am always looking to find what is the edge to me. I don't care about what the charts indicate if they are not my tools, but because others do use them, I must be aware of those indicators. I need to know what other traders are thinking.
56. How about making a chart that starts one hour and fifteen minutes prior to the close of a market? I need a creative thinking.
57. We are going to concentrate on protecting what we have rather than what we expect to make first. This, above all else, is just as important in trading as any plan for entry and exit.
58. A trader must learn from research what the proper behavior modification is in all possible situations. This takes lots of inner soul searching and market data to understand what behavior takes them to the threshold of successful behavior in trading. "You have to think it before you can act it!"
59. "What if I miss the move?" So what? Is there no tomorrow? Okay, you put the position on anyway and you are wrong! So what? You expect to be wrong if you are thinking and trading correctly. It is a big problem only if you don't properly protect your trade as required.
60. The adult-child theory in trading: As a child, we often don't need a reason but just the rule. As an adult, to be effective in trading, it is important to know why and not just the rule.
61. Most trades are placed with good reason and backed with good research. That feeling of better-than-average probabilities is self-defeating because, with that feeling alone, it is possible to miss the big moves by being wrong first.
62. The most important point of a newly established position is to understand that the initial entry of a trade is only a small part of the expected process of trading your position. Look at it as if you are going to make a series of trades anytime you get a signal. You must have the latitude of knowing and doing what it takes to correctly end up with a position that reaches to your goal. Your goal is the important part and not the trade you have just entered.
63. Rather than taking a position and letting emotion enter the picture, you must understand that position does not justify any emotional modification of your thoughts. Stop that position before emotion even enters the trade by removing the position. You can re-enter the position correctly again and again until you have no emotional effect from that position. If your position brings emotion into the picture, it is usually wrong or the wrong way.
64. The best part of being wrong is that you are going to do the correct thing by removing that wrong position. Listen to your inner thoughts on being wrong, and when emotion becomes an element, remove the position. It really works. Emotion has no place in a trade. If emotion is in your trade, it is a wrong position.
65. There is another element that gives us the feeling that we seem to see the market go against us as soon as we enter. That element is timing. Timing will cheat us more than not. An inexperienced trader will fail to recognize the importance of persistence in our re-positioning after removal of a position. Just because we exited an unproven position in no way says we were wrong. It is our intention to keep the drawdown small and allow us a better entry when we are not proven correct.
66. You want to be swift when the market is working for you, and you want to have the least exposure you can have when it isn't working for you. I realize most markets spend lots more time going up than down, and your exposure will be longer in a bull market than a bear. But why diddle in the middle when the market is doing its chop-chop? You use the chop-chop to better position and to cheapen your position.
67. The most critical time of a position is immediately upon entering. That is when you must be prepared to be the quickest to protect your position. I always consider the most dangerous time of a position is at entry because you do not have a proven position at that time. Why is the most dangerous time of a position upon entry? My answer is that it is because this is your only opportunity to keep your drawdown small if you aren't proven correct with the position. Keep your loss small and quick; act early while you have the opportunity, otherwise you will allow bigger losses to affect your loss taking and thinking.
68. The day-and-a-half theory and three waves: The local traders, the pit, and the public.
69. But being alone is what trading is about. It is very lonely in the world of trading.
70. Holding a loser too long is the biggest cause of the big drawdown!
71. “A market is more than a day!" This alone tells you not to believe the markets are always correct! With good liquidity, I consider the market correct. With poor liquidity, I do not consider the market always correct but possibly distorted.
72. When the markets are thin, a trader's chance is greater of being stopped out of a good position. (bwc, athr)
73. Open interest and volume are very important.
74. If a market rises on low volume, the market is incorrect, and a short order would be the best way to enter a trade. If the market rises on large volume, the market is correct, and a long trade would be the best route. This pattern would be reversed on a market that goes down.
75. The market is always correct in the sense that If you lost, YOU lost. Not the market, the broker, etc.
76. The market itself is wrong most of the time. This is what gives opportunity to trade. If the market were to be right today, why should I trade it?
77. Taking profits must be considered differently than removing positions. We consider removing positions as keeping losses small, even though removing profits at times leaves us with a profit by the nature of the rules working for us.
78. In trading, you can never really know at each important point what the correct move is until you look backwards. Therefore, you must have a method that is systematic with what your goal is. In trading, you cannot make the exact moves each time you trade, but you can devise a system that prevents you from unnecessary steps. The unnecessary steps are usually costly losses in trading.
79. If I must either go straight ahead (continue status quo) or turn left (get out of my position) or turn right (add to my position), I have no room for turning around 180 degrees and taking profits outside of my Rules 1 and 2.
80. Taking profit could be at a point of adverse movement back to, say, the last point of adding to the existing position.???
81. The third rule: We shall go against the majority and assume the market is not always correct (those times being when liquidity is poor). At those times we shall question all signals and wait for future signals for positioning. We shall use the converse of poor liquidity and remove our existing positions when extreme liquidity takes place in two steps and within three days of extreme high volume. Half of our position shall be removed immediately the following day after an extreme high-volume day. The other half of our existing position shall be removed within two additional days. We shall wait for further signals in those cases for future positioning.
82. The true focal point of the third rule is to keep loss possibilities as small as possible and retain as much profit as we can. That implies taking profits at the correct time and properly outside of Rules 1 and 2.
83. Traders must never be complacent when the market is at extreme volume, whether high or low. These times are to be flagged, and I don't know a better way to flag them than to remove existing positions. "when in doubt, get out!" You don't ever lose when you are out.
84. Sometimes the most brilliant minds cannot trade correctly. Many times the correct answers for someone else do not mean they are the correct answers for us.
85. Intuition can come from known logical reasoning but with the emotional part removed. It is a feeling we have. Sometimes we can't explain the feeling with reasoning or a logical plan. The "second nature" is intuition. 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.
86. The answer to the logical or intuitive trader question is EXECUTION.
87. The best of a bad position theory: There are, of course, times when you should buy tops and sell bottoms. I do it all the time when I expect a market to reverse. My theory being a learned one that my best trades are usually after correcting a bad position and getting correct in a market.
88. Pick a range and not a price. The exact price cannot be done with consistency. A range is easier to pick and position when you have your signals.
89. I usually know within the last hour of the market what I am going to do. As an example, if there are 1000 day-traders in a market, you can almost be certain they have positioned by the last hour of the day. If the market is up, what do you think their position is most likely to be?
90. Two plans: One of your entry plans will always be a market order. The other order will be an intelligent order based on the nature of market you are trading. We know that each day there is a high and low and a range throughout the day. You seldom buy the low and sell the high so don't even consider it. Your second plan for entering positions will be based on the fact that better liquidity tends to migrate toward the middle of a day's range. Use intelligent order first, and use market order as a backup.
91. Keep in mind if you don't get positioned, you are acting like you only want positions when you are guaranteed wrong immediately. This is one time the market can give you an emotional letdown if you didn't get positioned. It will always be the time the market takes off without you. Stop! Stop yourself into your entry signal at last resort but absolutely do it if necessary.
92. What is important about a bad position -- one I consider not proven correct -- is that it gives you the greatest opportunity to get a correct position. Most of the time a good position, other than the bad position, is being out of that position. Other times the best position is to reverse the prior position. Your trade program should address this.
93. How do you know when to reverse? We watch effective ranges in bull markets. Effective range is nothing more than a broker's dream. The market will go to a level, reverse, go to a level, reverse and so on until you have a very large number of price swings within a small range. Buying gets met with selling and selling gets met with buying which swings the market back and forth many times in compact ranges. In bear markets your effective range may just go dead and not swing at all for lack of interest. A normal bear market will eventually have bottom-pickers cause upswings even though you are in a bear market. When all interest is lost in trading, you can look for a possible reverse of a bear market.
94. I find the positions that I reverse are usually the ones I have the intuition of not wanting to place in the first place. The most difficult positions to place are usually correct. That is true in most traders' situations.
95. Do not overtrade is more important than a good stop system.
96. The system used must be one I totally understand. The system should be simple. The system will be a tradeoff most of the time. I always want the system with the least drawdown and the maximum gain in the shortest period of time. You need price data and chart data. The system has liquidity filters.
97. There are times when the market hasn't given you enough altitude to be able to recover. At other times you have enough altitude on your position to make a good landing choice when the market goes wrong.
98. There would be many highs during a day but at the end of a day only one true high of the day. The thin part of markets is at highs and lows. You'll see this if you look back on volume at the end of the day. When the markets are thin, they can be pushed further until liquidity once again enters the markets. Even though markets are thin at the high and low of a day, during the day there will be many new highs or lows that are not the high or low showing at the end of the day. We can never know for sure which high or low during the day is the true high or low for that day.
99. Locals don't gun for stops; it is just how they trade. If you knew the market was thin at highs and lows and were positioned the wrong way, what would you do if you were a floor trader? It is the traders who are wrong who push the stops before the stops are hit. In other words, you don't want to have to buy many ticks higher if you are wrong and approaching the high of the day. That is what the public tends to do by putting their stops above the high for the day.
100. In every trading plan there must be an element that gives you the edge. It is that edge that can change the outcome of your trading career.
101. The three rules are not the plan, but the rules are a must to have a plan that will work. A good trading plan must have the third way a market can move included in the plan. On selection of a system to trade, it is best to have an additional trading plan along with the system. A system cannot know what the market is doing after entry. Your trade plan can. That is your edge.
102. A market that goes with the trend and then breaks support or resistance, which also flags traders to get out or cause them to get stopped out, will turn into your friend. The most powerful signals in a plan are the ones where the market has moved both ways in a trend and are showing reversal to the big buildup of trend-followers. Not throwing in the towel early is what is wrong. Big losses are the reward when you have convictions in a trend beyond support or resistance. The market trips and you must take it. You need not only to take the profit but also to head the other way. You need to make criteria for this situation in your trade program.
103. The public seldom reverses their position because they seldom get out at the right place in the first place. You must use this knowledge to your advantage and not be caught up in the same situation.
104. You don't want to stay around long after the first move through the line.
105. Some of your biggest trends and moves come from the breaking of support and resistance of a strong established trend.
106. This is the third way a market can move. The market must have moved in the direction of the trend and then broken support or resistance. It is not the same as the surprise side moves. The surprise side move is different in that it can be caused by a reversal of a market after going the way of a report and then failing. The surprise side also can be when opinion is one way and the market has no more traders to reinforce the opinion with positions so the market fades the other way.
107. When you select a system, look for a system that back-tests data currently. What I mean by this is that it must be current in the last six months or so. I like to see a system back-tested in two stages, one for lots of data and one for the last six months of data.
108. Too many indicators will cause you to enter too late many times. This also leads to staying in beyond the proper time.
