The full title of this book is Essentials of Trading: It’s Not WHAT You Think It’s HOW You Think by Larry Pesavento with Leslie Jouflas.
This book is a compilation of 110 short articles written by Larry Pesavento and Leslie Jouflas, most of which are written by Larry. As each article is usually around 2-3 pages, it is a good book for those who are looking for short snippets of trading information. As these articles are probably written at different times for different channels, there tend to be a fair bit of repetition as the concepts don’t really change.
As the title of the book suggests, this book focuses on trading psychology rather than any specific method or money management strategy. I believe that psychology is a major component of successful trading, especially for short time frames. If one can erase the mistakes made due to poor psychology management, trading results can turn from being horrible to being spectacular. For those keeping trading journals, it is a good exercise to look at what your P&L might be, if you take away trades where you did not follow your trading plan because you were caught up by emotions at that point in time.
The book advocates focusing on the losers and letting winners take care of themselves. I think a balance needs to be achieved between focusing on the losers, and focusing on winning. Overfocusing on losers leads to fear of loss, which can in turn lead to cutting winners short, letting losers run, and not taking trade setups when they occur. I remember a quote from a famous trader that says that amateur traders lose by letting losers run, and professional traders lose by cutting winners short. The amateur trader did not focus enough on the losers, while the professional trader did not focus enough on the winners.
One of the points brought up in the book that I have found useful, is to not focus on the results. If you keep looking at your P&L at the end of each trade, you let the results of the past trades affect your future trades. It is better to not look or think about the running P/L and instead focus on taking each trade afresh as it comes. You can then “discover” your P/L at the end of the trading day when you are doing your review.
Another point is on how closely to watch the market. If you watch every tick or every second of the market, it is easy to fall into the trap of overtrading because you are compelled to react to every momentum change that occurs as the bulls and bears tussle with each other. In just a 5-min period, you can find that in 1-min the bulls are winning, next minute the bears are winning, and the control flips back-and-forth. So if you have a long position, you might be compelled to sell when you see the bears are winning, and the next moment when the bulls recovered, you might be blaming yourself for a stupid sell and decide to get back in, only to make the same mistake again when the bears come again. There are two ways I found to deal with this:
- Trade at a higher timeframe, e.g. daily. This might not work if you are an intraday trader or a scalper because your bread-and-butter is indeed to pay attention to the minor fluctuations.
- Focus on the market structure, e.g. support / resistance, swing highs / lows, key levels, and ignore the fluctuations in-between, essentially treating the fluctuations in-between levels as pure noise.
The book does have a few articles on methodology, e.g. trade in the direction of the open, cut losers after 3 days, etc. From the articles, Larry trades using pattern recognition of market geometry, with influence from astrocycles.
Work on the Only Thing You can Control — Risk
- The Holy Grail is that nine-inch cycle that extends from your left ear over the top of your head to your right ear.
- Once the trader recognizes that he has no control over which trades are profitable or how much he can make on any one trade with any certainty, he will come to realize that the only thing that the trader can control is the risk on any one trade.
- Take care of your losses and the profits take care of themselves.
Close Non-Profitable Positions After Three Days
- If your position is not profitable at the end of the third trading day, exit the position on the close of the third day.
- This rule has saved my bacon many times and never made me regret exiting the trade.
Focus on the Execution, not the Results
- Losers are results oriented and winners are execution oriented.
- Losers think how much can I make — winners think how much can I lose.
- The key to overcoming fear of failure is breaking one’s attachment to results. Whenever we convince ourselves that results are all that count, we fall into anxiety that paradoxically limits our ability to achieve results. [from R. E. McMaster, Jr. — Trader’s Notebook 1]
Get Your Confidence From Good Trade Management
- I believe many traders believe that if they just have a string of winners, that will give them the confidence they need to forge ahead. Can there be confidence on the losing side of trading?
- After many ups and downs with “confidence” I finally learned that my true confidence comes not with my winning trades but in my ability to control the losers and manage my trades.
- I noticed a consistent positive attitude that was associated and linked with how I was handling my losses! I started to feel good about how I would take a loss.
- There was an immediate down emotional feeling if I experienced a larger loss than necessary or exceeded a maximum daily loss. So that led me to change the behavior that led to that feeling that I didn’t like.
- I cannot control the markets, but I can sure control my trades, i.e. entries, exits, stops, how much I trade during the day, how many positions at one time, etc.
Learn from Past Trading Mistakes
- When you know that you are wrong you are in perfect position to do something about it.
- It took a devastating loss to bring me to my knees. The loss was so great that it formed me to stop trading for almost two years. It was those two years that allowed me to learn what I had done right and what the errors of past trading mistakes were.
- I’ve always loved the quote from legendary soybean trader Roy Longstreet, “Your first mistake teaches but the second mistake kills.”
Cherry Picking Trades Seldom Work
- The problem with this concept is that there are no very best trades. They are all the best trades. The problem is we don’t know which ones will work.
- You must learn to treat all patterns the same — as a probability not a certainty. Cherry pickers are defensive traders.
- Experience has taught me one great lesson and that is the very best trades I find are seldom the very best trade.
- The reason for this is if a perfectly symmetrical pattern fails it will offer another opportunity in the opposite direction. When the patterns fail they tend to move a long way in the opposite direction.
Embracing the Fear of Losing Money
- FEAR = False Evidence Appearing Real. Almost all fears never materialize.
- When facing these fears, and we must face them, it might be good to ask the question “what is the worst thing that could happen?” If the pain in the answer to this question is too much to bear then simply exit the trade.
- The main reason traders’ exit their losers is that the pain of losing one more dollar becomes almost unbearable. All of this pain could be eliminated by using a trading plan and learning to think in probabilities — nothing is certain.
- Ask yourself what is the worst possible thing that could go wrong with the trade and what would be the best possible outcome that could happen with the trade? Somewhere in between these two extremes is the logical outcome.
- Differentiate between rational and irrational fear. If it isn’t life threatening, it is probably irrational fear.
A Losing Streak is Normal
- Most losing streaks are the result of probability distribution.
- In 100 trades, a system should encounter a losing streak of up to eight trades in a row, and this is the time when the trader begins to question the validity of the system.
- It is also normally the worst time to stop trading as long as the trader has followed his methodology, because it’s been shown that winning streaks generally follow losing streaks.
Emotional State Reached by the Best Traders
- The best traders can put on a trade without the slightest bit of hesitation or conflict, and just as freely and without hesitation or conflict, and admit it isn’t working. They can get out of the trade — even with a loss — and doing so doesn’t resonate the slightest bit of emotional discomfort. [from Mark Douglas]
Nothing is More Important Than a Positive Mental Attitude to Trading
- You have to believe in your methodology! You must know you can win!
- Think of only positive thoughts that come into your mind. The use of 3×5 index cards with positive affirmations is an easy and extremely exercise to ingrain positive thoughts into your psyche. Your trading results will improve immensely if you keep your thoughts on the positive side of your psyche!
- Work on removing negative thoughts. Ask yourself where the negative thought originated. Cut it out at its roots and replace it with a seedling of positive thoughts. Your forest will grow strong with positive seedlings.
- Positive affirmations
- Altitude is determined by attitude.
- Success is measured not by the number of successes but by picking yourself up after each failure and starting again.
- You can only fail if you stop trying. There are no losers just those that quit trying.
- Read 4 or 5 pages of Mark Douglas’ Trading in the Zone before each trading day.
Take Pressure Off Yourself
- Quote from Linda Bradford Raschke: … it is just that this game, where like any performance oriented discipline, it is easy to be very critical of ourselves, for not playing the piece perfectly, for picking apart our game…
- You HAVE to take pressure off yourself and look at the small amount of progress you gradually make.
- The FIRST step in a trader’s education is simply learning to control emotions and be as objective as possible.
Discipline is Key
- Mental – Think through risks, know in advance how to get out of the trade and at what point. Alcohol takes up to 24 hours to leave the blood system, so don’t consume alcohol from Sunday through Thursday.
- Technical – Scan charts daily for opportunities.
- Physical – Do exercise to release tension in a positive way
- Control risks – cut losers
- Follow the trading plan
- Hold winners
- Ask yourself the following questions:
- Has the market changed since I placed the trade?
- Is the original pattern still valid?
- Has anything occurred that causes the original position to be suspect?
- Has the initial price objective been reached?
- Can I afford to take the risk on this trade?
- If yes, stay in the trade.
Watching Every Tick Leads to Overtrading
- One great mistake the man makes who watches the ticker all the time is that he trades too often. [William Gann]
- Why emotionalize over a trading situation that is out of your control? The worse thing that you can do is focus on all the upticks and downticks while staring at your monitor.
- What can a trader do to take the emotion out of the equation? First, place orders before the market opens and leave. Stops and contingency orders will be placed at this time.
Take a Break After Despairing Events
- There are three major causes of despair: death, divorce, and a debilitating loss in capital.
- Any one of these events puts the trader on a one-month trading sabbatical.
- After the one month sabbatical, the peer committee would meet each day to review trade status and evaluate the mental and physical state of the trader.
Continuously Improve, Move Forward and Not Keep Going Back to the Starting Point
- Quote from Charles Faulkner: I can say that after years of studying traders, the best predictor of success is simply whether the person is improving with time and experience.
- Many traders unconsciously acknowledge their lack of progress by continually jumping from one system or methodology to another, never gaining true proficiency in any.
- As a result, these people end up with one year of experience six times instead of six years of experience.
It is Emotionally Tough to Pick Tops and Bottoms
- The reporter said to Paul Tudor Jones that he must have been elated that he picked the exact low day to buy T-bonds before they exploded to the upside.
- Mr. Jones replied that the statement was only partially correct. He said a more accurate statement would be: “Paul Tudor Jones correctly forecast the recent low in Treasury Bonds — after failing to forecast the low on his last five attempts!”
Trade in the Direction of the Opening Price
- The opening price is usually near the high or low of the day approximately 80% of the time.
- Try to trade in the direction of the opening price (i.e, be a buyer when prices are above the opening price, be a seller when prices are below the opening price).
Successful Trading Takes Time
- Marty Schwartz, author of The Pit Bull, revealed that it was 10 years before he was able to become consistently profitable. There is hope for all traders.
- Men and women are not judged by how they handle success — they are measured by how they pick themselves up after a failure.
- Every day I track the 40 most active and volatile stocks (20 NYSE and 20 NASDAQ). My favorites are JPM, AXP, INTC, MSFT, CSCO, GE, etc.
- The S&P 500 futures, 10-year note and t-bond/dollar/yen charts are also followed. Within these 40 or so charts, several patterns will be tradable set-ups for the next few days or possibly a day trading opportunity.
- The S&P 500 is the only vehicle I trade everyday — it provides a speculator’s dream — volatility, liquidity, low commission and most importantly, good execution.
- At the end of each day’s trading, I review the 40 plus charts. First I check for the daily patterns, next I scale down to the 30-min patterns. Finally as a trade is setting up I go to the 4-min charts for entry. 4-min charts allow me to estimate sales volume and the bid and ask spreads.
- Next is to wait for the pattern to complete and enter the market.
Keep a Trading Diary
- Write short notes on what you did well and what could have been improved.
- When things go wrong, this will help spot inconsistencies in various parts of the trading plan.
- Examining their daily trading log will enable the trade to spot common trading mistakes such as lack of discipline, sloppiness in trade preparation, over trading, impulse trading, impatience and all of the other cousins and uncles of the mistake family.
- Profits in the Stock Market, by H.M. Gartley
- The Profit Magic of Stock Transaction Timing, by James Hurst
- The Torque Analysis of Stock Market Cycles, by William Garrett
- Stock Market Predictions, by Donald Bradley