The full title of this book is “The Inner Voice of Trading: Eliminate the Noise, and Profit from the Strategies That Are Right for You” by Michael Martin. Martin joined Ed Seykota’s Trading Tribe many years ago, which explains why the Foreword of the book is written by Ed Seykota. Martin also has a website at http://www.martinkronicle.com.
This book focuses on trading psychology. Readers will not find any ‘trading system’ or rules in this book. According to Martin, successful trading is 80% psychological, and only 20% intellectual. Anybody can learn the rules of a good system, but is there a good psychological fit with the trader? Does the trader have the emotional make-up to execute those rules correctly and consistently?
The book highlights the need to have strong self-awareness (through writing a trading journal), to listen to your inner voice, your emotional debates. Various methods suggested include meditation, yoga, early morning runs, etc. basically activities that would allow you to quieten your mind. That will allow you to self-reflect, and not be too affected by trading losses / mistakes, so that you can focus on the process instead of the results.
I fully agree that emotions significantly impact trading success. Even with fully automated trading systems, the trader has to fight against urges to turn off the system, or to override the system in various scenarios thinking that he knows better, or doubting that the system is not working or catering for the current situation. Hence this book is quite a rare kind of trading book which talks specifically about trading psychology, compared to the tons of other books focusing on magical trading systems.
On a side note, one interesting bit of information in the book is the research on 8,035 companies in the Russell 3000 from 1983 to 2007, conducted by Blackstar Funds (Longboard Asset Management). The results showed that:
- 39% of the stocks go bust
- 18% lost at least 75% of their value
- 64% underperformed the Russell 3000 during their lifetime
- 20% was a winner (> 300% over that time period)
I was surprised that 40% of stocks go bust, which seemed high to me. Nonetheless, it reinforces my view that stock selection (for intermediate to longer-term trades) is a filtering process, in order to catch that 20% winners.
Trading is 80% Psychological
- The intellectual aspect of trading rules are what most aspiring traders reach for while learning the craft because they’ve had that approach ingrained in them since kindergarten.
- Unfortunately, most aspiring traders find out far too late that the act of trading is 20% intellectual and 80% psychological.
- From Jack Schwager: Time and time again, those whom I interviewed for this book and its predecessor stressed the absolutely critical role of psychological elements in trading success. When asked to explain what was important to success, the market wizards never talked about indicators or techniques, but rather about such things as discipline, emotional control, patience, and mental attitude toward losing. The message is clear: the key to winning in the markets is internal, not external.
Trading Rules Need to be Compatible With the Trader
- When Seykota was being interviewed, he was not speaking about rules that the trader can understand intellectually or technically. He instead referred to rules with which the trader is compatible. Compatibility equals harmony.
- Incompatibility between trader and system is the single greatest reason most traders don’t succeed, regardless of trading style.
- In unfortunate cases, the trader is not self-aware but continues to seek the answers. Ironically, these answers to successful trading are found within the trader’s own mind.
- Only when you can merge your emotions with your trading rules and combine the trading results with your feelings will you have developed your inner voice, the only “person” you can count on consistently. You then will have aligned your emotional system with your trading system.
Listen to Your Inner Voice to Learn About Your Internal Debates
- Your inner voice needs to decide on the tradeoffs to be made on the trading system.
- Accessing your inner voice comes with quieting your mind.
- Meditation can be defined as a process of quieting your mind through breathing techniques.
- Your mind controls your overall attitude.
- Your attitude affects your behavior and your persistent behavior predicts where you end up in life.
Preset Your Course of Action
- New traders have too much to think about and too many decisions.
- The more you can preset the course of action, the more you can alleviate stress.
- Too many variables each occurring at the same time will give you too much stress.
Don’t Be Too Hung Up About Your Entry Price
- When you become too emotionally attached to the entry price, you are going to kill your opportunities and your equity, too. Let go of how exact you have to be with your entry.
Protect Your Profits, Cut Your Losses
- In my experience, when a new position goes against you, it usually keeps going down. Good trades start making you money right away.
- You can always get back in if you exit too soon.
- The takeaway is that you can never let a single losing trade wipe out any of your gains — they’re hard enough to get in the first place.
- If you don’t take the small loss today, you risk total loss of your capital or career tomorrow.
- Gains look like gains only to the extent that you keep your losses small.
- “Win it right back” is a death spiral. Keep your losses small, and you’ll never be in one.
- If you do not take action, you are choosing a more likely chance of feeling despondent when you lose a larger portion of your capital, compared to taking a guaranteed small loss. All the while you had the power to get out of a losing position, but you chose not to. You chose not to do the right thing because you were afraid to feel certain feelings.
Accept Market Movements
- Surrender and accept market movements, and feel a -10% move the same as you do a +25% one. By allowing yourself to feel frustration, you eliminate the feelings of despondency for the rest of your life. That’s a great trade.
- When you’ve fully developed your inner voice, you’ll be able to say to yourself, “To be in the trades that make it to +25%, I need to emotionally endure trades that depreciate 10%.”
Focus on the Process, Not the Results
- The day that you can tell me that your best trade was a losing one, but one by which you acted consistently in your methodology, is the day that you are on to something.
- The day that you tell me that your best trade lost money and that you are emotionally placated is the day that you start behaving like a professional trader.
Keep a Journal, Don’t Be Hasty, Get It Right
- You need to keep a journal because you need to be hypervigilant about your behavior. Self-knowledge and self-awareness are your most important assets as a trader, more than any technical ability.
- You can write in your journal, “What are my feelings when I have to be patient?” Get to know these feelings, because they are likely to resurface in other areas of your life.
Enjoy The Learning Journey
- If you’re just beginning your career, you’re just starting to log the first of the 10,000 hours that Gladwell says you’ll need to become an expert, so you’re in no hurry.
- Why not enjoy the process of becoming a professional trader? What’s the rush? The markets will always be there.
- Using Gladwell’s math as a guideline, if you worked 10 hours a day (quality hours), 5 days per week for 50 weeks, you’d reach the expert level in 8 years.
- You have a long way to go. Be present and enjoy the journey. You learn the most by being present.
- Linda Bradford Raschke mentioned in Market Wizards about marking the tape in 5-minute intervals, take inventory of all the things you did well compared to the ones that did not work. Focus on profitable outcomes and not so much on losses.
- Focus on the positive outcomes and on learning more about what to do differently for the negative.
- Keep track of all the success that you have enjoyed.
Identify the Best Time Frame For The Security
- Your job as a trader is to identify the best time frame for the security and merge that with your emotional constitution, energy level, capital commitment, leverage, and your need for liquidity.
Never Override The System
- Even when Bill Dunn hears his inner voice speaking to him, he reverts to his trading rules as he’s done for the last 45 years and relies on the scientist in himself. “Our system was the distillation of all the past data that I could analyze, and that system was the best thing I knew to do for today and tomorrow,” he says.
- “The temptation to make discretionary trades was not very strong because I knew I shouldn’t. I’m enough of a scientist that I overcame my emotions and I told myself to let the market activity play out.”
- “The best I can do each day is follow my rules,” he says. “So if it didn’t work out today, big deal. There was no guarantee that it would work anyway. We never override the system.”
People Allocate Money to You to Pull The Triggers Correctly
- People allocate money to you to trade because they don’t have the mental toughness to do it themselves.
- Think about it. Are you going to tell me that someone who has a college degree cannot understand the basic tenets of defining a trend or recognizing the positive slope of a trendline?
- They hire you to pull the trigger the way you do because you don’t freak out in managing risk — or do you?
Relative Value Trades Are Better on Your Emotions
- Every professional trader incorporates some form of spread trading in his or her arsenal. You don’t garner the emotional rush you get with a directional trade, but you don’t suffer the massive hits to your equity, either.
- Commodities contracts of the same commodity are highly correlated. Spread traders are looking to trade the relative value, the spread, between two contracts on the same commodity that expire in different months.
- Spread trades allow you to take advantage of seasonal tendencies in the production and consumption of the commodity over a year. E.g. gas will be in higher demand after cold season and before the summer driving season, because oil refineries switch from creating heating oil to begin refining for gasoline. The spread between March and April Natural Gas contracts collapses after mid-June.
Place Stops at Proper Locations
- From Ed Seykota: A good stop order is placed at the price where you’re willing to transfer the risk to someone.