The full title of this book is The Art of the Trade: Mastering the Analytic and Intuitive Elements of Successful Trading by R. E. McMaster, Jr (1999).
There are a lot of good trading advice in this book. Most of it is standard good advice for any style of trading, with a focus on the psychology aspects of trading (e.g. managing emotions, accepting the market for what it is, etc.) There is less focus on an actual trading methodology, though there is one chapter where the author walked through some of the things he looked at when he shorted the Dow two days from the top on Jul 22, 1998.
McMaster gave a good suggestion on stepping outside yourself, as though you are explaining your trade to your mentee, to check whether you are following your rules and that your trade makes sense. I also liked his emphasis on maintaining a strong work ethic in working hard every day, which is vitally important when we are trading on our own where it is so easier to find excuses to take a break.
All in all, this is a good read for the softer side of trading. McMaster also shared that the publisher originally titled the book Investing with Both Side of Your Brain.
Use Simple Trading Techniques
- The more sophisticated the techniques that people attempt to master in trading and money management, the less frequently they will use those techniques.
- If you have to put too much time, energy, money, or life into any particular thing and its payoff is not commensurate, you tend to reduce your commitment to it. Accordingly, it loses its marginal utility.
Plan Your Trades in Advance to Utilize Both Sides of Your Brain
- To preserve psychological capital, I prefer to do my homework (plan your trades) for the markets the night before so my left-brain activity is completed. Then I can sleep on the trades I’ve planned and let my subconscious and right brain contemplate what I’ve already worked out in my left brain.
- Planning ahead allows your right-brain intuition to identify signals or other important details that left-brain analysis may have missed.
- I find that the best long-term traders implement a plan in the markets that they prepared for days or weeks in advance and slept on the night before, with the markets moving consistently with their expectations.
Pyramid Equity, Not Contracts
- If you pyramid more shares or contracts when the market has already moved in your favor, the odds are greater that the market will then move against you — at the same time that you are betting on the market continuing its current trend. A small correction can wipe out your hard-earned profits when you pyramid.
- However when you pyramid your equity, you use actual profits from completed trades to increase dollars at risk in your next trade. That allows you to be more aggressive without violating your money management system increasing market risk.
Cut Losses Short to Focus on Opportunities Instead of Problems
- Letting losses ride will force you to focus on problems instead of opportunities.
Take Partial Profits to Let the Other Half Ride
- Experience has taught me that any time you get a per contract profit above $1,000 in futures trading, if you can take part of that profit down by selling a profitable contract, the odds are you’ll be better able to let the profits ride on the remaining contract. This approach helps you preserve psychological capital too.
Let Your Trade Play Out
- Let a market trade play itself out according to your original plan. Be reluctant to jump in and out of a trade before it has a chance to develop and mature.
Track Fundamental Factors to Catch Unexpected Market Moves
- Fundamental expectations will tell you that when a market doesn’t do what you expect it to do in light of the news, this is often a tremendous opportunity to profit from a trade in the opposite direction.
- The fundamentals often give you confidence to stick with the trend if you’re trading longer term.
Things McMaster Looked at for His Dow Trade
- Bullish Consensus’s and Consensus Magazine’s bullish sentiment indices
- Price action of sub-indices of Dow (Transports, Utilities, etc.)
- Russell 2000
- Bearish divergence on both slow stochastic and RSI
- Rounded top forming on the weekly chart.
- Moving averages flattening out and rolling over to the downside, with short-term crossover sell signal.
- Market struggling to move higher in the price channel.
- Dow futures made an outside day reversal down with a low close on July 21, 1998.
- Asian crisis would undermine U.S. stock market, with lower earnings for exporters.
- Stocks were overvalued. S&P P/E was 28.3 vs. 14 (norm), dividend yield was < 1.5% vs. 3% (norm), P/B was 6.04x.
- Lower interest rates would not support profits.
- U.S. T-bonds were yielding 5.5%, better than stocks.
- A bear market was taking place on the other indices.
- Leadership was scant, market breadth was poor.
- Mutual funds were holding the lowest amount of cash in history.
- Insiders were selling stock in 2Q 1998.
- Utilities and REITS were doing relatively better, indicating a shift in preference of earnings over capital appreciation.
- European rally was because of the Euro coming on, and it was artificially boosting the U.S. markets.
- Russian stock market has fallen 50% since May, and would influence rest of Europe.
- Bull market was featured on the cover of Time and Newsweek.
- There is uncertainty over the president due to the Clinton-Lewinsky scandal.
- Consumer confidence fell for 3 straight months.
Don’t Dwell on Mistakes, Focus on Opportunities
- Holding onto the baggage of the past, the mistakes of yesterday, is nonproductive. If robs you of your energy and mental and emotional focus on new opportunities. You must see what opportunities exist now and take advantage of them… Focus your time, energy, and money on making money — on new trading opportunities.
- Yes you need to learn from your mistakes, but don’t dwell on them. Use them as positive learning experiences; as a springboard to becoming a better trader.
Don’t Blame the Market or Others
- When pain surfaces, if you are honest and in touch with yourself, you will own the upset and seize the opportunity to release that internal reality — to forgive! Pain functions to inform us of our errors.
- False forgiveness is based on the belief that others are responsible for what we feel, and therefore it tends to reinforce that error. To forgive others, in this manner, for what happens in your mind leaves your pain intact and the opportunity to heal is lost.
- Making use of every opportunity to heal is an important decision you can make and that decision will immeasurably accelerate your process.
Accept Negative Emotions to Neutralize the Negative Charge
- Whenever we avoid processing a negative emotion, then attach an emotional charge to it, and shorten our breath and tighten our diaphragm, our blood pressure often shoots up so that we lock that memory of that emotional charge into our system.
- When you go to sleep, the current in you literally reverses and you lock your daily emotional charges into your organ systems, body processes, and memory. It’s a very negative thing to do.
- Processing the situation correctly short-circuits the negative cycle. So, before I go to sleep at night, I forgive others whom I think have wronged me and give thanks personally for all things. I want to stay free, healthy, and unencumbered.
- Remember, emotions are a choice. The realm of unconscious bad habits is where the demons live in all of us. We need to exorcise them.
You Make Money on Market Uncertainty
- Remember, you make money only when there is risk, unknowns, uncertainty in the market.
- Once the news is known and the risk is removed, there is little profit potential left.
You Need to Stand On Your Own Two-Thirds of the Time
- A bull market normally has three legs up: (1) when it is oversold and undervalued (1st up leg), (2) as it becomes fairly valued (2nd up leg), and (3) when it becomes overvalued (3rd up leg).
- As trend followers, they are usually correct only in the middle leg, which is the only time it’s okay to be part of the crowd. You trade comfortably with the masses (or the funds) only about one-third of the time.
- The rest of the time, you need to stand on your own two feet, buy on fear at the bottom (undervalued), when little positive is known, and sell on greed at the top (overvalued).
Step Outside Yourself to Check Your Objectivity
- Imagine that there are expert consultants standing behind you, looking over your shoulder as you are about to make a trade. What would they tell you to do? Would they feel you are thinking objectively and following your trading system and money management plan?
- You may find it helpful to imagine a respected mentor standing behind you; others find it effective to imagine someone they are mentoring. For example, if your children were there with you, what would you tell them to do in the trade in question.
Check Your Underlying Beliefs
- What we believe determines how we think, which determines how we feel, which molds our bodies. It is therefore important that we set up our theoretical models accurately, as we reprogram ourselves, because they will determine how we subjectively view the facts of reality.
- How we think in turn influences how we will emotionally respond and behave, which will ultimately shape or mold our human bodies.
Trade on Intuition, Not Impulse
- If you do your homework, you will develop a sense of intuition regarding the market. Intuition evolves from a foundation of long hours of study and work. It wells up from a long period of successful experience, thoughtful research, reflection, and wrestling with ideas, concepts, and markets.
- Traders who trade on impulse are usually ungrounded, very excitable, emotional, and often wrong about their trading decisions. Impulsive traders tend to get carried away by greed and fear.
Put Trading First, Be There Day In and Day Out
- Consistency is your willingness to put trading first in your life so you’re online day in and day out, trading your system to maximize the odds that it will work for you when the market is moving.
- When traders take a break for whatever reason — because they want to play, because they have experienced a series of losses, because of complications in their personal lives, or because the market is dead — they end up missing moves that could have resulted in hefty profits.
- That doesn’t mean you always have to trade, but you should always be there to follow the markets.
- It’s very easy once you’re self-employed and trading to excuse yourself for all kinds of reasons. This can prove to be a devastating mistake. You will find over time that those days you take off to play golf or go fishing or whatever will inevitably be the days when the two or three trades you’ve been waiting for are triggered. These trades would have made your month very profitable. Then you have to scramble for the rest of the month. When you trade this way, you tend to lose money. Inconsistency does not pay off.