Note: While the book is about trading, it is applicable to investing too.
Most traders lose money.
Two main reasons are:
- They did not manage their losses well.
- They take profits fast.
The net effect is that they can have a high win rate, but, on average, they profit less on eachg winning trade and they lose more on each losing trade. Hence, they end up with net losses.
Other shortcomings that worsen the situation are overtrading and trading for excitement.
The difference between the losers and winners is how we deal with losing and winning.
Here is what the author believes about how the 90% think:
- People are hopeful when they are losing money. They should have been fearful instead of losing positions.
- They are fearful when they are making money. They should have been hopeful about winning positions.
What does this mean?
- The majority don’t add to winners.
They don’t add to winning trades. To be profitable, add to winning trades, whether you add a little or you double up. Start slowly, add a little. - They don’t use a stop-loss.
They don’t like to use a stop-loss, because that would crystallise the pain of the loss. As long as the position is open, there is hope. So, to be profitable over time, use a stop-loss. Use a stop-loss on your first position and subsequent positions. - They add to losing trades.
While you may get lucky from time to time, this is one of the main traits of losing traders. Remember, we are focused on establishing the behaviour that will ensure we will be profitable over time. - They take half profits.
The problem the author has with this strategy is that it never gives you the home-run trades that you need to sustain yourself in this business. You will never be on board the big moves because you have always limited yourself.
He has two fundamental arguments against taking half profits:- The market agrees with you with your winning positions. Let it ride.
- Since he doesn’t believe in the risk-to-reward argument, because no human being can know in advance what their reward will be without limiting themselves, he doesn’t believe that taking half profits is the right way to trade.
The survey of 25,000 traders executing 43 million FX trades over a 15-month period illustrates this point perfectly. Overall, they had more winning trades than losing trades. Out of those 43 million trades, up to 61% of them were winners, depending on what currency pair they traded.
What does that tell you?
- It tells you that those 25,000 traders have a good grasp on the markets and where to place their trades. It tells you that if they were somehow able to operate with a 1:1 risk-to-reward ratio, they would win 61 out of 100 and lose 39 out of 100. That is a winning formula. That creates a net positive trade flow of 22. That is a business model that has an integral foundation.
- The problem is that the survey shows that when they win, they win on average 43 pips. When they lose, they lose on average 83 pips. In other words, they lose twice as much (almost) on their losing trade than they make on their winning trades.
- It tells you that they are good at picking winners, but when they are faced with a losing trade, they don’t have the mental discipline to cut the loss.
- It tells you that they need to work on their mental game so that they are better equipped to handle losses. Their minds are most likely wired to associate pain with taking a loss. The mind has at its core a mandate to protect you against pain — physical as well as mental pain, perceived pain and real pain.
The author believes in defining his risk but he doesn’t believe in defining his reward. There is only one variable we have meaningful control over: how much money/points/pips will we risk on this trade? How much we will make will depend on the market. It will not depend on us unless we put a limit on our profits. A very wise old trader once told the author that losers spend their time thinking how much they will make, while winners spend their time thinking about how much they will lose.
He does not belong to the brigade of traders who believe that “you can’t go broke taking a profit.” He does think you can go broke taking a profit, if it means you never have really big profit days because you are unable to let profits run.
How do we know where the top or the bottom is? He has seen a lot of trading systems, but none of them had an acceptable success ratio of predicting tops or bottoms. Hence, he believes it is important to establish some criteria for how much of your paper profits you are prepared to give away to capture the really big days.
The most frequently observed behaviour is the inability to take a loss. As long as a losing position is open, there is hope that the position will turn positive. The moment you close the position, the pain of the loss becomes real. They didn’t hold on to the position because they believed in the position. They held on to the position because they could not stand being wrong.
The moment they were relieved of the pain of the losing position, they got out — for nothing. They were so relieved to have avoided the pain of being wrong that they completely ignored the fact that the market was now actually agreeing with them.
They weren’t trading the financial market. They were trading their emotions, responding to how they felt. When they felt relief that the position had come good again, they now associated a tremendous amount of pain with the thought of having to relive this anxiety once more.
If you are taking your profits early under the excuse that ‘you can’t go broke taking a profit’, you are reacting to your mind warning you against future pain.
If you are on a winning streak, and you reduce your stake size, you are essentially anticipating the pain of losing some of your gains. You are now rationalising your way to avoid the pain, even though nothing painful has happened.
Are you increasing your trading size or decreasing your trading size when you are winning? The vast majority of traders will decrease their trading size when things are going well because they are afraid their winning streak will eventually run out. The true measure of your growth as a human being is not what you know, but rather what you do with the things you know.
Fear will always be part of our lives. We need to understand why we feel that fear and how to process it, so you can take the trade.
Good traders “think differently from everyone else”.
Mark Douglas
We need to learn to handle losses a lot better than the general population does because they handle them very poorly, and as a result, they are generally unable to make money from speculation.
The author’s motto: control your mind — control your future. Doing so requires constant vigilance. You have to own your life. If you don’t own it, you are not the boss. You have to take full responsibility for everything that you do. If you don’t take ownership of your life, you are not the boss. Your mind is a tool. If you let it delude you into thinking all is well, you will not get the success you want in trading or life. Losing and failing might be a knock to the ego, but it is rocket fuel for growth.
Your path to becoming a profitable trader lies not in better understanding the markets, but in better understanding your mind. Your mind and how you operate it will dictate the level of success you have as a trader.
The trader the author wanted to become was patient but aggressive when the time was right. He spends less time on technical analysis and more time on self-analysis.
The markets determine the outcome. We have no control over that. The author has faith and he believes that his process will carry him through the highs and the lows of trading. Only through a dedicated approach to practice, with specific attention to finding your mistakes, will you improve. Otherwise, you are just cementing your unprofitable behaviour.
A significant part of your success as a trader is correlated to your relationship with failing. If you see failure as the endgame, then you won’t make it as a trader. Kobe Bryant missed more shots than any other player in history. Bryant was willing to encounter failure in every game he played.
What you become in life is dependent on the decisions you make and how you react to decisions made on your behalf. Instead, it’s about losing. Your relationship with fear and adversity will to a very high degree define your life.
The author’s belief and approach to winning
The road to consistency, success, and enlightenment in trading begins in the last place you’d ever think to look — inside yourself.
The paradox of trading is this: by doing what the 90% cannot do, you will become successful. In other words, expect to be uncomfortable and expect trading to cause anxiety. Be prepared for it. He sums them up as follows:
- I assume I am wrong — until proven otherwise.
- I expect to be uncomfortable.
- I add when I am right.
- I never add when I am wrong.
He will assume that he will quickly have to get rid of a losing trade. His confidence in his actions is not centred around his ability to select the right setup. That is what the 90% will do. Instead, his confidence is centred around trusting he will get rid of a trade that is not performing. He trusts himself to know that if this trade does not work out, there will be another one coming shortly. He will assume he is wrong until the market proves me right. He already expected to lose anyway, so the market disagreeing with his trade will not be associated with pain or fear. He expected it. He has accepted his loss already. His mind knows he wants to be big when he is right, and he wants to be small when he is wrong.
In trading, unlike life, the best loser wins.
One exercise the author uses in the morning is closing his eyes and playing out a scenario. He imagines he loses a large amount of money. He will often use an amount that has some significance to him, such as the cost of his last car, the cost of his son’s college tuition, or the size of a memorable loss.
Say for the sake of the argument that he has opted to meditate on losing £78,000. He will see himself losing the amount. He will let it sit there — in his consciousness. He will let it take hold. He will imagine what he will not be able to buy because of the loss. He will make it as emotionally vivid as he can.
Now he will turn the table. He will now imagine that he is winning the same amount. He will imagine that he is winning the £78,000. What will happen is that his emotional response system will not allow him to feel a reciprocal sense of joy to the misery he felt earlier.
Neurobiology has shown we experience a financial loss 250% more intensely than an equivalent financial gain. After going through this exercise of feeling pain and then not feeling pleasure, he then swapped back to feeling the loss again.
The purpose of the exercise is to align his feelings of gain and loss. In truth, he doesn’t really want to feel anything — he has found that if he gets overly happy about a win, he tends to get overly sad about a loss. He doesn’t want that.
Win; move on.
Lose; move on.
The purpose of my warm-up is not to take away everything that is bad in our lives in one swift move. The purpose is not to guarantee I won’t mess up. The purpose is to focus on what I want to achieve or become, while being mindful of the things that will most certainly sabotage my goals.
Ideal trader mindset
There is an ideal mindset — one that is flexible to the extreme. It does not care about winning. It does not care about losing. It is a carefree state of mind, but it still acts in your best interest.
The ideal trading mindset has no fear. The ideal mindset may have no fear, but the ideal mindset is still acting in your best interest. The ideal mindset might be fearless, but it is not reckless.
Fear plays a significant role in explaining why people lose the game of trading. It can be the fear of not being in the market and missing a good move. It can be the fear of staying in the market for too long and seeing the open profits disappear.
When you arrive at this state of the ideal trader mindset, it means you can perceive information from the markets without feeling threatened or fearful. The ideal trading mindset is as at peace with losing trades, as it is with winning trades. Neither will impact your ability to unemotionally and dispassionately perceive market information in a non-threatening frame of mind. Your emotional state will stay in balance.
When we do not operate from a frame of mind of the ideal mindset, we are afraid of something. This fear is a manifestation of a lack of trust. We do not trust ourselves to do what we have to do without hesitation, without reservation or internal conflict or argument. Our mind is the problem. Our mind’s core objective is to keep us alive and avoid pain. We are automatically wired to think in a way that keeps us alive. This thought pattern is hard-coded into our DNA. It might keep us alive, but it makes trading difficult.
Information on its own has no power over us. It is our belief system and the energy we give to the information that decides its potency.
What we focus on is what we attract.
The fear we experience causes us to focus on the object of our fear so that we end up creating the very experience we’re trying to avoid. My point was not to state the obvious but to point out that this state of mind is not open to other possibilities. The more fear we experience, the less information the mind will focus on. It will narrow its focus. It will stop you from perceiving alternative options.
Focus on the process. Focus on what you can control.
Our beliefs determine how we react to information. We were born with a clean slate, and our beliefs are taught and adopted. We were taught what to think. We also had experiences that shaped our beliefs.
What it boils down to is creating a mindset that always acts in your own best interest. It is a mindset that allows you to see opportunities. It knows your weaknesses and what to be mindful of. It allows you to receive information without being threatened by the information.
The biggest belief the author had to overcome in trading was the associations I made when I was confronted with losses. He had to learn how to disassociate losses from feelings of failure or feelings of wanting to extract revenge on the market to create a state of mental equilibrium. Achieving that was a momentous leap for my trading performance.
Book of Truths
The author decided he needed to relive my trades to truly figure out what his problem was. So, he downloaded his trading results into an Excel spreadsheet and went to work. He meticulously went through the trades. He split my trades up into many different categories, with many of them appearing in more than one category. There were trades he held for days. There were trades he held for seconds. There were trades he executed in the mornings. There were trades he executed in the afternoons and evenings. He called his compilation of his trades, the Book of Truths. The courage to be honest with yourself is its own rewards. Here is the author’s truths:
- He had periods where his win rate exceeded 85%.
- His average profitable trade was less than his average losing trade.
- He was a winning trader but his big losses were seriously denting his overall P&L.
- He traded well in the first half of the day.
- He trader well in the first three to four days of the week.
- He often gave away much of his profit from the morning session when he tradedd in the afternoon.
- He often gave away much of the weekly profit on Fridays.
- He would do very well on rang-bound days.
- He would almost always miss trend days and he would often fight them.
- His biggest losses came from fighting trending moves.
The breakdown of his performance was incredibly cathartic. He took great pleasure in reviewing his own mistakes because it felt like he was actually meaningfully moving towards a better version of himself.
This process stood out as the single most beneficial practical exercise in enhancing his performance.
He knew more about himself and became much more trusting of the markets. He trusted that he would be given an opportunity to make money every day. As odd as it sounds, he began to trade less and he started to make more money. He wasn’t perfect and he is not perfect today either — one of his beliefs is don’t insist on perfection in trading. One truth he came face to face with was less is more.
Your prime objective is to follow the strategy you have developed. More importantly, your prime objective is to follow the process you have designed for yourself. If you follow the process, the outcome will take care of itself. I don’t set goals. I just focus on my process.
Charlie Di Francesca, the legendary bond trader in the pits in Chicago, said that good trading goes against normal human instinct. To succeed you have to get used to being uncomfortable. Trading is a battle of the self.
The Book of Truths is key to his transformation. It arouses a desire to do better than the old pattern of behaviour.
The Book of Truths will give you up-close, face-to-face time with your shortcomings. It made him realise what his faults were. He also started plotting his good trades. He felt it was necessary not just to remind himself of the behaviour he wanted to avoid. He should also remind himself of the behaviour he wants to strive towards.
Trust. His review of his trades revealed that he didn’t trust himself or the markets. Profitable trading requires trust. If you don’t believe it can happen, you should not even start. If you don’t trust, then you will not make money. Therefore, before you start trading again, you have to work on your beliefs about yourself and the markets.
Trust yourself. You have to trust that you already have all the tools you need to make a living from trading.
Trust markets. Now he wasn’t just studying for the sake of identifying patterns. He studied to prove that the technical analysis setups that served me well would repeat every day. He came to accept that he could produce a good living from trading, from waiting for those ideal setups.
Patience. There is an inherent trading flaw in our thinking which makes us want to go against the trend. Another reason this behaviour is commonplace is because of the prolific use of chart indicators that display what is technically known as overbought and oversold price levels. The use of overbought and oversold indicators has a terrible track record in trending markets.
Expanding my field of information The exercise of printing out the specific charts every day instils in his faith that every day the market will allow him to make good trades. The exercise is also an opportunity for him to discover new behaviours in the market and continuously train his mind and eyes to spot patterns. He happens to believe that you only see things you have trained your eyes to see.
Imagery and breathing; calm your mind. Through the use of breathing exercises, he has been able to increase my attention span significantly. The reality is that calming your mind through breathwork is used extensively by high-performance athletes.
The goal is simply to be, to be an unemotional observer of the market. The goal is to act without fear, without hope, without anything but an objective assessment of the price action.
Twenty trades
His friend Dr David Paul gave him an exercise which at its heart is designed to strengthen the process of your trading. The job is to execute 20 trades as the signals appear. One by one, you take your trade signal as it comes. The purpose of the exercise is not actually to make money. You will probably break even and that is fine. The purpose of the exercise is to smoke out your internal conflicts and unresolved emotions.
It has at its core the idea that if you can execute 20 trades without any kind of conflicts, you are trading from a crefree and fearless frame of mind. This means that you are trading from the perspective that:
- Anything can happen — and you are emotionally detached from the outcome.
- Every moment is unique — and you are no longer drawing associations between this moment and another moment. You are pain-free.
- There is a random distribution of wins and losses — you accept the outcome as if it were a coin-flip exercise.
- You don’t have to know what will happen next to make money — so you trust the process, and focus on controlling the only variable you truly can control, which is how much you want to risk on this trade.
The purpose of the exercise is to add energy to your beliefs. Until you can do that without conflict and unresolved thoughts and conflicting energy issues, the negative charge will not dissipate.
Money is a by-product of the ideal trading mindset. You are creating a process that will guarantee an optimal mindset for your trading life. The essence of good trading lies squarely in how we think and perceive information about the markets. It has everything to do with how we think and how we live our lives.
Do what you have to do so that you can do what you want to do. The idea of deciding what you want can undo a lifetime of negative energy surrounding your beliefs and your belief system. The power of making up your mind will remove all negative energy surrounding a belief system.
Everything the author does daily is the result of grit and determination.
I am not talented. I am hard-working. I am not gifted. I am determined. I am not lucky. I am persistent.
Work on what you think and how you respond and evaluate your responses will improve your trading in measures you would struggle to appreciate right now.
Be in the moment and focused. That is what he wants to bring to his trading every day.
My trust (in the markets and in myself) supports my patience. My patience (that a setup will materialise) feeds my confidence. My confidence (that I will win) dictates my inner dialogue. My inner dialogue (what I tell myself while I am trading) supports my process-oriented mindset. The process enables me to stay focused in this moment. I support this loop with my mental exercises. They feed, nourish and sustain the loop.
By being utterly focused on the process as opposed to being outcome oriented, I ensure that I am staying present. When you are present, you don’t connect past moments with this moment or future moments. You are right here, right now.
I have no monetary goals or pip/point goals. I will take what the market will give me. I never trade with targets.
Process and trusting the process are important.
The one who is best able to lose will win the game of trading.
