Trading and Position Sizing™

By Van Tharp

 1. Whenever you enter into a position, always have a predetermined exit point at which you will concede you were wrong about the position.

This is your risk (R), and if you lose this amount, you have a 1R loss. Even if you are a buy-and-hold investor, you should have some point at which you will bail out of an investment because it is going against you (e.g. a drop of 25%). This rule essentially sets up all position sizing rules.

2. The golden rule of trading is to cut your losses short (1R or less) and let your profits run (more than 1R, i.e. a multiple of R).

Let’s say you buy a stock at $50 expecting the price to go up $10, a 20% gain. You decide in advance to exit if the price falls by $1. Now assume that you have four failed breakouts (i.e. 4 x 1R losses) before you have your $10 gain (in this case a 10R gain). You were right only 20% of the time, but your losses totaled minus 4R and your profits totaled plus 10R. Your total gain was thus 6R, six times your initial risk.

3. When the total sum of your R-multiples for all of your trades is positive, you have a ‘positive expectancy’ system. You must have a positive expectancy system to make money in the market.

Expectancy is the sum of your R-multiples divided by the total number of trades. Thus, if you have 50 trades which give you a total R-multiple of 20, then from your 50-trade sample, you would estimate your expectancy to be 0.4. In other words, over many trades, on average, you will make 0.4 times your initial risk on every trade.

4. A low risk idea is an idea with a positive expectancy that is traded at a low enough risk level to allow for the worst possible contingency in the short term so that you can survive to achieve the expectancy over the long term.

This basically means that ‘how much’ you risk on any trade is critical. ‘How much’ is what we call position sizing. In my opinion, aside from personal discipline, it is the most important factor in your trading.

5. Anti-Martingale position sizing strategies work.

Martingale strategies do not work. Martingale strategies are strategies that have you risking more after you lose, such as doubling your risk after a loss. Because people tend to have long streaks against them, they do not work. Eventually you will go broke. In contrast, anti-Martingale strategies, which cause you to increase your position as you win, tend to be very successful. In general, strategies which are based on increasing your bet size as your equity goes up are anti-martingale strategies and they work well.

6. A simple strategy that will work for everyone is to risk a small percentage of your equity on every trade, such as 1% or less.

If you have an account that is worth $100,000, then risking one percent would mean risking $1000. If your stop (i.e. 1R risk) is $5, then you would buy 200 shares (i.e. 1000 divided by 5 = 200 shares). Furthermore, if you applied a 1% risk to the example given in Rule 2, after 5 trades you would be up about 6% since you would be gaining 1% per each R-value. You would be up exactly 6%, since you would only be risking 1% of your remaining equity on each trade.

7. You need to know the R-multiple distribution of your trading system to determine your position sizing strategy.

We frequently play trading simulation games in our workshops in which the R-multiple distribution of the potential trades are known but the value of each individual trade is unknown because the trades are selected randomly from the sample (i.e. a bag of marbles) and replaced. People can become very good at determining their objectives and achieving them in this sort of game.

8. Strategies that are designed to achieve only the maximum return (such as optimal f; the Kelly criteria, etc) are foolish and usually result in huge drawdowns.

For example, if you trade a system that is 55% 1R winners, 5% 10R winners, 35% 1R losers, and 5% 5R losers, then the percentage risk that will achieve the highest average return is 19.9%. With this percentage, you could achieve a huge return if the right sample occurs (i.e. all 10R winners), and this would also give you a very high average return, but you would generally lose a large amount of money on most samples. In other words, you might get one sample in which you make a total of a billion dollars, and many samples in which you lose money. If this were the case, you would have a high average ending equity (because of the huge return in one sample) even though most samples lost money.

9. Position sizing is the part of your trading system that will help you achieve your objectives.

Most people don’t think about position sizing because they are too concerned over what stocks they should buy. However, as long as you have a positive expectancy system, position sizing is what will help you achieve your objectives.

10. Rather than place big bets, scale into positions that go in your favor.

Many long-term traders will only have one or two really successful trades each year that will account for most of their profits. You need to capitalize on those trades. And one way to do that is to add another position each time you can raise your initial stop to breakeven. For example, if you bought JDSU in Feb 99 and kept a 25% trailing stop, you would have made a 32R gain by the time you sold it on April 5th, 2000. If you had added another 1% position each time you raised your stock to breakeven, up to a maximum of 4 times, your exposure on JDSU would have been $5,700. In fact, the maximum exposure to your equity would have been about $1,430 on the 4th scale in. However, your total profit would have been $112,476.

Contrarian advice from Dr Doom

By Marc Faber

Rule 1: There is no investment rule that always works.

If there was one single rule, which always worked, everybody would in time follow it and, therefore, everybody would be rich. But the only constant in history is the shape of the wealth pyramid, with few rich people at the top and many poor at the bottom. Thus, even the best rules do change from time to time.

Myth 1: ‘Stocks always go up in the long term.’

This is a myth. Far more companies have failed than succeeded. Far more countries’ stock markets went to zero than markets which have survived. Just think of Russia in 1918, all the Eastern European stock markets after 1945, Shanghai after 1949, and Egypt in 1954.

Myth 2: ‘Real Estate always goes up in the long term.’

While it is true that real estate has a tendency to appreciate in the long run, partly because of population growth, there is a problem with ownership and property rights. Real estate was a good investment for Londoners over the last 1,000 years, but not for America’s Red Indians, Mexico’s Aztecs, Peru’s Incas and people living in countries which became communist in the 20th century. All these people lost their real estate and usually also their lives.

Problem rule 1: ‘Buy Low and Sell High.’

The problem with this rule is that we never know exactly what is low and what is high. Frequently what is low will go even lower and what is high will continue to rise.

Problem rule 2: ‘Buy a basket of high quality stocks and hold.’
Another highly dangerous rule! Today’s leaders may not be tomorrow’s leaders. Don’t forget that Xerox, Polaroid, Memorex, Digital Equipment, Burroughs, Control Data were the leaders in 1973. Where are they today? Either out of business or their stocks are far lower than in 1973!

Problem rule 3: ‘Buy when there is blood on the street.’

It is true that bad news often provides an interesting entry point, at least as a trading opportunity, into a market. However, a better long term strategy may be to buy on bad news which has been preceded by a long string of bad news. When the market no longer declines, there is a chance that the really worst has been fully discounted.

Rule 2: Don’t trust anyone!

Everybody is out to sell you something. Corporate executives either lie knowingly or because they don’t know the true state of their business and the entire investment community makes money on you buying or selling something.

Rule 3: The best investments are frequently the ones you did not make!

To make a really good investment, which will in time appreciate by 100 times or more, is like finding a needle in a haystack. Most ‘hot tips’ and ‘must buys’ or ‘great opportunities’ turn out to be disasters. Thus, only take very few investment decisions, which you have carefully analyzed and thought about in terms of risk and potential reward.

Rule 4: Invest where you have an edge!

If you live in a small town you may know the local real estate market, but little about Cisco, Yahoo and Oracle. Stick with your investments in assets about which you may have a knowledge edge.

Rule 5: Invest in Yourself!

Today’s society is obsessed with money. But the best investments for you may be in your own education, in the quality of the time you spend with the ones you love, on your own job, and on books, which will open new ideas to you and let you see things from many different perspectives.

Behavioural finance

By Gary Belsky

1. Every dollar spends the same.

People tend to treat money differently depending on where it’s come from. They spend money received as a gift, bonus or tax refund freely and easily, while spending other money – money they’ve earned – more carefully. Try not to compartmentalise your money in this way. Treat it all the same. One way to do this is to park ‘found’ money in a savings account before you decide what to do with it. The more time you have to think of money as savings – hard-earned or otherwise – the less likely you’ll be to spend it recklessly.

2. Control your fear of losses.

A bedrock principle of behavioral economics is that the pain people feel from losing $100 is much greater than the pleasure they get from winning $100. Be careful that this does not lead you to cling on to losing investments in the hope that they’ll return to profit, or to sell good investments during periods of market turmoil when holding them would be better in the long term.

3. Look at decisions from all points of view.

Too many choices make choosing harder. If you suffer from ‘decision paralysis’ try looking at the options from a different perspective. For instance, if you are trying to decide between different stocks or funds, imagine that you already own them all. Your decision then becomes one of rejection (“which one am I least comfortable owning?”) rather than of selection, and you may find this helps.

4. All numbers count, even if you don’t like to count them.

The tendency to dismiss or discount small numbers as insignificant – the ‘bigness bias’ – can lead you to pay more than you need to for brokerage commissions and fund charges. Over time, this can have a surprisingly deleterious effect on your investment returns. Avoid this ‘bigness bias’. Count all the numbers.

5. Acknowledge the role of chance.

A failure to fully grasp the role that chance plays in life leads many investors to be overly-impressed with short-term success and other random or unusual occurrences. Thus, many investors pour money into mutual funds that have performed well in recent years under the mistaken belief that the funds’ success is the result of something other than dumb luck.

6. Your confidence is often misplaced.

Nearly everyone falls prey, at some time or another, to an overestimation of their knowledge and abilities. Most dangerous for investors is the delusion that, with a little knowledge or homework, you can pick investments with better-than-average success. In reality, there is little reason for even the most sophisticated investor to believe that she can pick stocks – or mutual funds – better than the average man or woman on the street.

7. It’s hard to admit mistakes.

This sounds basic, but we’re not talking about pride so much as the subconscious inclination people have to confirm what they already know or want to believe. Because of this ‘confirmation bias’ it’s important to share your financial decisions with others – seeking not only specific advice, but also critiques of your decision-making process.

8. The trend may not be your friend.

In the long term, conventional wisdom is often on target – as it has been over the past 25 years in the trend away from fixed income investments towards stocks. In the short run, however, the vagaries of crowd behavior – particularly ‘information cascades’that result in dramatic shifts in tastes and actions – frequently lead to costly overreactions and missed opportunities. Treat trends and fads with skepticism and caution.

9. You can know too much.

Knowledge is power, but too much ‘illusory’ information can be destructive. Studies have shown that investors who tune out the majority of financial news fare better than those who subject themselves to an endless stream of information, much of it meaningless.

10. Don’t check your investments too regularly.

The less frequently you check on your investments, the less likely you’ll be to react emotionally to the natural ups and downs of the securities markets. For most investors, a yearly review of their portfolios is frequent enough.

Building a margin of safety

By Jim Slater (chairman of the legendary financial conglomerate, Slater Walker Securities)

1. Develop a method that suits you.

Carefully select a method of investment and then, based on personal experience and the performance of your portfolio, hone, temper and refine it until you are satisfied beyond doubt that it works for you. As you become more expert you can use several different methods at the same time according to market conditions.

2. Establish a margin of safety.

Any method, whether it be growth or value, should be based on establishing a margin of safety – a cushion between the amount you pay for a company’s shares and the amount you believe they are worth. The attraction of building a margin of safety is that it helps to protect against downside risk and at the same time provides the scope for an upwards re-rating.

3. Adjust the margin of safety to your approach.

For growth stocks, a typical method embracing a margin of safety would be to seek out shares with strong earnings growth records and a relatively low price-earnings ratio in relation to their future growth rates. Ideally the growth rate should be at least one third more than the price-earnings ratio. To increase the safety factor, it is also highly desirable for the company to have a record of strong cash flow in relation to earnings per share and a strong balance sheet.

For value stocks, the margin of safety can be established by a low price-to-sales ratio, low price-to-book value and strong cash flow. Also with many undervalued asset situations it pays to look for recent relative strength and recent directors’ buying which can be signals that a company is about to turn around.

4. Keep an eye on significant share dealings by directors.

Directors’ buying is frequently linked to a change in a company’s fortunes especially if the directors are buying a significant number of shares in a cluster of three or more. Equally, directors selling large tranches of shares is often a warning signal and should put you on red alert.

5. Judge management by their numbers, not by their manners.

The ability of management is very hard to quantify. If you go to see them or meet them at a presentation, they naturally put their best foot forward. Management can best be judged by several years of good results with brokers’ forecasts confirming that they are likely to continue. The financial results are the best judge of management, not the people going to see them.

6. Look for positive relative strength to corroborate your view of a share.

Shares that perform well in the market are often winners in the making. With growth stocks, relative strength in the previous twelve months should be positive and certainly greater than the one month figure. O’Shaugnessy found in What Works on Wall Street that relative strength was in most years the best single investment criterion.

7. Run profits and cut losses.

This is much easier said than done but it is far better practice to add to winners and pare down holdings that are not performing well. This way your losses will always be small and your gains can be gigantic. Remember that the power of compounding is the eighth wonder of the world.

8. Never stop learning.
There is always a faster gun, so keep reading books on investment by well-known and established experts, attend investment conferences and consider joining an investment club. Also make sure that you have a regular source of sound statistical stockmarket data. In the UK, Company REFS does, of course, come to mind!

9. Be tax efficient.

Use annual capital gains tax allowances, PEPs, ISAs and a personal pension scheme to the maximum possible extent.

10. Don’t kid yourself.

Do not be fooled by your own excuses. Measure your investment performance honestly and regularly and if, over a year or so, you find that you are not consistently beating the market, delegate to an expert manager or invest in a unit trust or tracker fund and use your surplus time and energy elsewhere.

Overvalued stocks and Ponzi schemes

By David Tice

 1. Study stock market history – recognize where you are in the long-term secular cycle.

Most investors remember and learn from what has occurred in the recent past. Investors must realize that they must learn from periods that might extend beyond their own memory. Market cycles can last a long time, and people have too much at stake to make all the mistakes themselves, so they must learn from market history.

Most of the money in the stock market over the last 104 years has been made in secular bull markets. However, being invested at the tail end of secular bear markets can result in very poor investment performance for a very long period of time. Recognize that the greatest contributor to stock market performance is the P/E multiple afforded to earnings, and that in bull markets, the P/E multiple expansion is what drives stock prices.

2. Uniform opinion among analysts about an individual stock is dangerous.

When many Wall Street analysts are unanimously positive on a company, the stock price tends to be too high and reflects very favorable expectations. The key to making money in stocks is selecting companies where your analysis of fundamentals shows better prospects than the current Wall Street expectations. However when all analysts have very high expectations for a company, then it becomes very difficult to beat lofty expectations.

3. There are elements of Ponzi schemes in many areas of investment.

Always keep your eyes open for investments that require a bigger fool to continue to pay a higher price to have the investment make sense. These investments are dangerous, as eventually you run out of buyers willing to continue to pay a higher price. Determine that there are underlying economic fundamentals that justify the investment based on future cash flows, not just that someone is willing to pay a higher price.

These ponzi-like situations can be found both in the investment markets as well as in the fundamentals of real businesses. For example, the recent telecom boom was founded not on the ability of companies to make money, but on their ability to sell the bandwidth they developed on to a bigger company. This was a classic Ponzi scheme. When it was realised that the bigger telecom companies couldn’t buy all the bandwidth that was being developed, stock prices crashed because the business models were not viable on their own merit without the benefit of a bigger fool buying them out.

4. Buy low, sell high – don’t buy high, sell higher.

This advice seems straight forward, but is always difficult to follow. Attractive sounding growth stories have the most intrinsic appeal, but are always the highest priced in the market. These companies have the highest expectations, and it normally requires a bigger fool to keep paying a higher price to keep the stock price rising. Also, there usually exists very little downside asset value support in those cases where the growth story does not come through.

5. Consider selling short to reduce exposure and to create outperformance.

There are always many stocks which reach outrageous price levels and can be sold short. One great attribute of selling short is that it reduces overall equity allocation which reduces portfolio risk and equity exposure. Short exposure of 15% offsets long exposure of 75%, thereby resulting in net long equity exposure of 60%. Reduced equity exposure means lower risk, thereby helping investors generate improved risk-adjusted returns if stock selection is done well.

6. Be a contrarian and independent thinker

Always attempt to challenge the conventional wisdom which is normally wrong. Following the crowd is not normally the way to get rich. Great riches are typically earned by people who identify an opportunity before anyone else and who exploit those opportunities successfully. You should invest in the same manner.

7. Have a long time horizon – it’s the key to riches.

Look for companies that are experiencing short term disappointment. Most investors attempt to chase short term performance which is very difficult to achieve. Earning a 50% performance return over three years, is equivalent to a 15% annual return. The chance of earning that 50% return is higher if all the other investors ignore a stock because they see the performance being too far in the future.

8. Look at micro-cap companies. The market is more inefficient, and the profits can be huge.

Companies with smaller market values are followed less by Wall Street and therefore generally carry lower expectations. If you can identify companies with great prospects before others do, your chances of generating outstanding returns are much greater.

9. Always think about risk vs. return.

Always seek the optimal trade-off between the two functions. Stocks that most people already know about generally possess lesser return potential. Companies that sell at significant multiples of revenue, possess the highest risk in case of disappointment or in a bear market. In a mania bull market, stocks with the highest risk can earn the highest returns for a while, but if market conditions change, they will decline the most.

10. Follow the smartest analysts who are indepedent thinkers.

Read and follow the advice of the most insightful analysts you can find. Sometimes those analysts with the best short term track record have been the ones taking the most risk. This should always be assessed. Look for analysts who make sense and who consider downside support as an important element of the investment strategy.

Trading and the importance of a plan

By Joe DiNapoli

 1. Loss of opportunity is preferable to loss of capital.

There was a time when I felt it was my duty to be personally involved in every wrinkle of the S&P. I’ve traded this market since it’s inception in 82. It took quite a while for me to realise that picking safe, readable, and high probability winning trades was the way to go.

2. Use Logical Profit Objectives for all positions.

The concept of using and executing LPOs is one of the most important I know of. It keeps your percentage of winning trades high and gets you back to the computer the next day. Everyone enjoys a pay day. With the correct concepts this is something you can do.

3. Place your Logical Profit Objectives in the market ahead of time. Markets are squirrelly animals. If you know how to calculate your profit objectives, get them in the market ahead of market action. If you wait for the alert to go off, hoping to capture more, it’s likely the market will move away from your exit before you have time to execute your order.

4. Enter markets on retracements.

Don’t buy new highs or sell new lows. Wait for the market to come to you. Precalculate your entries and be patient. If you miss the move another bus will come by shortly.

5. Above all, follow your trading plan.

Having a clearly defined trading plan is the single most important aspect of profitable speculation. Never trade without one and once you have it, following it is more important than any single profit or loss.

6. Trade quietly.

With the exception of a mentor, tell no one about your positions, profits, or losses. Especially those close to you, like your wife, husband, or friends. This self-gratification process or sharing process puts you under psychological pressure to win on every trade and can be a primary reason for failure to follow your plan.

7. Don’t carry a sizeable position while traveling.

It will catch you!! The laptop won’t work. The hotel internet connection will break. The cell phone battery will run out. The plane won’t land! I know you’ll try it anyway. It’s good for the markets, we need to spread the money around a bit.

8. ‘You are only one trade away from humility.’

For over 15 years this tattered hand-written sign, scrawled with bold black strokes with a magic marker, has hung over my trading table. A swelled head does not belong on a trader’s shoulders.

9. Add to your knowledge before attempting to add to your wallet.

This seems obvious but somehow many newbie traders think they can become pros with little more than a computer and hope. In this business hope is a four letter word. I hear the following a dozen times a month. “I only wish I came across you before I blew 50-500 grand.” I was here. Others like me were here. They thought it was easy and needed to find some humility. Now they’re ready to progress.

10. Develop your sense of humour.

You’ll definitely need it.

11. Help other traders whenever you can.

This is more practical than philosophical: giving keeps the ego in line and when you need help, and you will, you’ll find it!

Murphy’s laws of technical trading

By John Murphy

John Murphy’s ten laws of technical trading explain the main ideas to beginners and streamline the trading methodology for experienced practitioners. The precepts define the key tools of technical analysis and show how to use them to identify buying and selling opportunities.

1. Map the trends.

Study long-term charts. Begin a chart analysis with monthly and weekly charts spanning several years. A larger scale ‘map of the market’ provides more visibility and a better long-term perspective on a market. Once the long-term has been established, then consult daily and intra-day charts. A short-term view alone can often be deceptive. Even if you only trade the very short term, you will do better if you’re trading in the same direction as the intermediate and longer term trends.

2. Determine the trend and follow it.

Market trends come in many sizes – long-term, intermediate-term and short-term. First, determine which one you’re going to trade and use the appropriate chart. Make sure you trade in the direction of that trend. Buy dips if the trend is up. Sell rallies if the trend is down. If you’re trading the intermediate trend, use daily and weekly charts. If you’re day trading, use daily and intra-day charts. But in each case, let the longer range chart determine the trend, and then use the shorter term trend for timing.

3. Find the low and high of it.

The best place to buy a market is near support levels. That support is usually a previous reaction low. The best place to sell a market is near resistance levels. Resistance is usually a previous peak. After a resistance peak has been broken, it will usually provide support on subsequent pullbacks. In other words the old ‘high’ becomes the new ‘low’. In the same way, when a support level has been broken it will usually produce selling on subsequent rallies – the old ‘low’becomes the new ‘high’.

4. Know how far to backtrack.

Measure percentage retracements. Market corrections up or down usually retrace a significant portion of the previous trend. You can measure the corrections in an existing trend in simple percentages. A fifty percent retracement of a prior trend is most common. A minimum retracement is usually one-third of the prior trend. The maximum is usually two-thirds. Fibonacci retracements of 38% and 62% are also worth watching. During a pullback in an uptrend, therefore, initial buy points are in the 33-38% retracement area.

5. Draw the line.

Draw trend lines. Trend lines are one of the simplest and most effective charting tools. All you need is a straight edge and two points on the chart. Up trend lines are drawn along two successive lows. Down trend lines are drawn along two successive peaks. Prices will often pull back to trend lines before resuming their trend. The breaking of trend lines usually signals a change in trend. A valid trend line should be touched at least three times. The longer a trend line has been in effect, and the more times it has been tested, the more important it becomes.

6. Follow that average.

Follow moving averages. Moving averages provide objective buy and sell signals. They tell you if existing trend is still in motion and help confirm a trend change. Moving averages do not tell you in advance, however, that a trend change is imminent. A combination chart of two moving averages is the most popular way of finding trading signals. Some popular futures combinations are 4 and 9 day moving averages, 9 and 18 day, 5 and 20 day. Signals are given when the shorter average crosses the longer. Price crossings above and below a 40 day moving average also provide good trading signals. Since moving average chart lines are trend-following indicators, they work best in a trending market.

7. Learn the turns.

Track oscillators. Oscillators help identify overbought and oversold markets. While moving averages offer confirmation of a market trend change, oscillators often help warn us in advance that a market has rallied or fallen too far and will soon turn. Two of the most popular are the Relative Strength Index (RSI) and Stochastics. They both work on a scale of 0 to 100. With the RSI, readings over 70 are overbought while readings below 30 are oversold. The overbought and oversold values for stochastics are 80 and 20. Most traders use 14 days or weeks for stochastics and either 9 or 14 days or weeks for RSI. Oscillator divergences often warn of market turns. Those tools work best in a trading market range. Weekly signals can be used as filters on daily signals. Daily signals can be used for intra-day charts.

8. Know the warning signs.

Trace MACD. The Moving Average Convergence Divergence (MACD) indicator (developed by Gerald Appel) combines a moving average crossover system with the overbought/oversold elements of an oscillator. A buy signal occurs when the faster line crosses above the slower and both lines are below zero. A sell signal takes place when the faster line crosses below the slower from above the zero line. Weekly signals take precedence over daily signals. An MACD histogram plots the difference between the two lines and gives even earlier warnings of trend changes. It’s called a histogram because vertical bars are used to show the difference between the two lines on the chart.

9. Trend or not a trend?

Use ADX. The Average Directional Movement Index (ADX) line helps determine whether a market is in a trending or a trading phase. It measures the degree of trend or direction in the market. A rising ADX line suggests the presence of a strong trend. A falling ADX line suggests the presence of a trading market and the absence of a trend. A rising ADX line favors moving averages; a falling ADX line favors oscillators. By plotting the direction of the ADX line, one is able to determine which trading style and which set of indicators are most suitable for the current market environment.

10. Know the confirming signs.

Include volume and open interest. Volume and open interest are important confirming indicators in futures markets. Volume precedes price. It’s important to ensure that heavier volume is taking place in the direction of the prevailing trend. In an uptrend, heavier volume should be seen on up days. Rising open interest confirms that new money is supporting the prevailing trend. Declining open interest is often a warning that the trend is near completion. A solid price uptrend should be accompanied by rising volume and rising open interest.

Short term trading and Survival

By Larry Williams

1. It’s all about survival.

No platitudes here, speculating is very dangerous business. It is not about winning or losing, it is about surviving the lows and the highs. If you don’t survive, you can’t win.

The first requirement of survival is that you must have a premise to speculate upon. Rumors, tips, full moons and feelings are not a premise. A premise suggests there is an underlying truth to what you are taking action upon. A short-term trader’s premise may be different from a long-term player’s but they both need to have proven logic and tools. Most investors and traders spend more time figuring out which laptop to buy than they do before plunking down tens of thousands of dollars on a snap decision, or one based upon totally fallacious reasoning.

There is some rhyme and reason to how, why and when markets move – not enough – but it is there. The problem is that there are more techniques that don’t work, than there are techniques that do. I suggest you spend an immense and inordinate amount of time and effort learning these critical elements before entering the foray of financial frolics.

So, you have money management under control, have a valid system, approach or premise to act upon – you still need control of yourself.

2. Ultimately this is an emotional game – always has been, always will be.

Anytime money is involved – your money – blood boils, sweaty hands prevail, and mental processes are short circuited by illogical emotions. Just when most traders buy, they should have sold! Or, fear, a major emotion, scares them away from a great trade/investment. Or, their bet is way too big. The money management decision becomes an emotional one, not one of logic.

3. Greed prevails – proving you are more motivated by greed than fear and understanding the difference.

The mere fact you are a speculator means you have less fear than a ‘normal’ person does. You are more motivated by making money. Other people are more motivated by not losing.

Greed is the trader’s Achilles’ heel. Greed will keep hopes alive, encourage you to hold on to losing trades and nail down winners too soon. Hope is your worst enemy because it causes you to dream of great profits, to enter an unreal world. Trust me, the world of speculating is very real, people lose all they have, marriages are broken up, families tossed asunder by either enormous gains or losses.

My approach to this is to not take any of it very seriously; the winnings may be fleeting, always pursued by the taxman, lawyers and nefarious investment schemes.

How you handle greed is different than I do, so I cannot give an absolute maxim here, but I can tell you this, you must get it in control or you will not survive.

4. Fear inhibits risk taking – just when you should take risk.

Fear causes you to not do what you should do. You frighten yourself out of trades that are winners in deference to trades that lose or go nowhere. Succinctly stated, greed causes you to do what we should not do, fear causes us to not do what we should do.

Fear, psychologists say, causes you to freeze up. Speculators act like a deer caught in the headlights of a car. They can see the car – a losing trade, coming at them – at 120 miles per hour – but they fail to take the action they should.

Worse yet, they take a pass on the winning trades. Why, I do not know. But I do know this: the more frightened I am of taking a trade the greater the probabilities are it will be a winning trade. Most investors scare themselves out of greatness.

5. Money management is the creation of wealth.

Sure, you can make money as a trader or investor, have a good time, and get some great stories to tell. But, the extrapolation of profits will not come as much from your trading and investing skills as how you manage your money.

I’m probably best known for winning the Robbins World Cup Trading Championship, turning $10,000 into $1,100,000.00 in 12 months. That was real money, real trades, and real time performance. For years people have asked for my trades to figure out how I did it. I gladly oblige them, they will learn little there – what created the gargantuan gain was not great trading ability nearly as much as the very aggressive form of money management I used. The approach was to buy more contracts when I had more equity in my account, cut back when I had less. That’s what made the cool million smackers – not some great trading skill.

Ten years later my 16-year-old daughter won the same trading contest taking $10,000 to $110,000.00 (The second best performance in the 20-year history of the championship). Did she have any trading secret, any magical chart, line, and formula? No. She simply followed a decent system of trading, backed with a superior form of money management.

6. Big money does not make big bets.

You have probably read the stories of what I call the swashbuckler traders, like Jesse Livermore, John ‘bet a millions’ Gates, Niederhoffer, Frankie Joe and the like. They all ultimately made big bets and lost big time.

Smart money never bets big. Why should it? You can win big on small bets, see #5 above, but eventually if you bet big you will lose – and you will lose big.

It’s like Russian Roulette. You may well spin the chamber holding the bullet many times and never lose. But spin it often enough and there can be only one result: death. If you make big bets you are destined to be a big loser. Plunging is a loser’s game; it can only set you up for failure. I never bet big (I used to – been there and done that and trust me, it is no way to live). I bet a small percent of my account, bankroll if you will. That way I have controlled loss. There can be no survival without damage control.

7. God may delay but God does not deny.

I never know when during a year I will make my money. It may be on the first trade of the year, or the last (though I hope not). Victory is there to be grasped, but you must be prepared to do battle for a long period of time.

Additionally, while far from a religious person, I think the belief in a much higher power, God, is critical to success as a trader. It helps puts wins and losses into perspective, enables you to persevere through lots of pain and punishment when you know that ultimately all will be right or rewarded in some fashion.

God and the markets is not a fashionable concept – I would never abuse what little connection I have with God to pray for profits. Yet that connection is what keeps people going in times of strife, in fox holes and commodity pits.

8. I believe the trade I’m in right now will be a loser.

This is my most powerful belief and asset as a trader. Most would be wannabes are certain they will make a killing on their next trade. These folks have been to some ‘Pump ’em up, plastic coat their lives’ motivational meeting where they were told to think positive thoughts. They took lessons in affirming their future would be great. They believe their next trade will be a winner.

Not me! I believe at the bottom of my core it will be a loser. I ask you this question – who will have their stops in and take right action, me or the fellow pumped up on an irrational belief he’s figured out the market? Who will plunge, the positive affirmer or me?

If you have not figured that one out – I’ll tell you; I will succeed simply because I am under no delusion that I will win. Accordingly, my action will be that of an impeccable warrior. I will protect myself in all fashion, at all times – I will not become run away with hope and unreality.

9. Your fortune will come from your focus – focus on one market or one technique.

A jack of all trades will never become a winning tradee. Why? Because a trader must zero in on the markets, paying attention to the details of trading without allowing his emotions to intervene.

A moment of distraction is costly in this business. Lack of attention may mean you don’t take the trade you should, or neglect a trade that leads to great cost.

Focus, to me, means not only focusing on the task at hand but also narrowing your scope of trading to either one or two markets or to the specific approach of a trading technique.

Have you ever tried juggling? It’s pretty hard to learn to keep three balls in the area at one time. Most people can learn to watch those ‘details’ after about 3 hours or practice. Add one ball, one more detail to the mess, and few, very few, people can make it as a juggler. It’s precisely that difficult to keep your eyes on just one more ‘chunk’ of data.

Look at the great athletes – they focus on one sport. Artists work on one primary business, musicians don’t sing country & western and opera and become stars. The better your focus, in whatever you do, the greater your success will become.

10. When in doubt, or all else fails – go back to Rule One.

Time tested trading rules

By Linda Bradford Raschke

 1. Plan your trades. Trade your plan.

2. Keep records of your trading results.

3. Keep a positive attitude, no matter how much you lose.

4. Don’t take the market home.

5. Continually set higher trading goals.

6. Successful traders buy into bad news and sell into good news.

7. Successful traders are not afraid to buy high and sell low.

8. Successful traders have a well-scheduled planned time for studying the markets.

9. Successful traders isolate themselves from the opinions of others.

10. Continually strive for patience, perseverance, determination, and rational action.

11. Limit your losses – use stops!

12. Never cancel a stop loss order after you have placed it!

13. Place the stop at the time you make your trade.

14. Never get into the market because you are anxious because of waiting.

15. Avoid getting in or out of the market too often.

16. Losses make the trader studious – not profits. Take advantage of every loss to improve your knowledge of market action.

17. The most difficult task in speculation is not prediction but self-control. Successful trading is difficult and frustrating. You are the most important element in the equation for success.

18. Always discipline yourself by following a pre-determined set of rules.

19. Remember that a bear market will give back in one month what a bull market has taken three months to build.

20. Don’t ever allow a big winning trade to turn into a loser. Stop yourself out if the market moves against you 20% from your peak profit point.

21. You must have a program, you must know your program, and you must follow your program.

22. Expect and accept losses gracefully. Those who brood over losses always miss the next opportunity, which more than likely will be profitable.

23. Split your profits right down the middle and never risk more than 50% of them again in the market.

24. The key to successful trading is knowing yourself and your stress point.

25. The difference between winners and losers isn’t so much native ability as it is discipline exercised in avoiding mistakes. 26. In trading as in fencing there are the quick and the dead.

27. Speech may be silver but silence is golden. Traders with the golden touch do not talk about their success.

28. Dream big dreams and think tall. Very few people set goals too high. A man becomes what he thinks about all day long.

29. Accept failure as a step towards victory.

30. Have you taken a loss? Forget it quickly. Have you taken a profit? Forget it even quicker! Don’t let ego and greed inhibit clear thinking and hard work.

31. One cannot do anything about yesterday. When one door closes, another door opens. The greater opportunity always lies through the open door.

32. The deepest secret for the trader is to subordinate his will to the will of the market. The market is truth as it reflects all forces that bear upon it. As long as he recognizes this he is safe. When he ignores this, he is lost and doomed.

33. It’s much easier to put on a trade than to take it off.

34. If a market doesn’t do what you think it should do, get out.

35. Beware of large positions that can control your emotions. Don’t be overly aggressive with the market. Treat it gently by allowing your equity to grow steadily rather than in bursts.

36. Never add to a losing position.

37. Beware of trying to pick tops or bottoms.

38. You must believe in yourself and your judgement if you expect to make a living at this game.

39. In a narrow market there is no sense in trying to anticipate what the next big movement is going to be – up or down.

40. A loss never bothers me after I take it. I forget it overnight. But being wrong and not taking the loss – that is what does the damage to the pocket book and to the soul.

41. Never volunteer advice and never brag of your winnings.

42. Of all speculative blunders, there are few greater than selling what shows a profit and keeping what shows a loss.

43. Standing aside is a position.

44. It is better to be more interested in the market’s reaction to new information than in the piece of news itself.

45. If you don’t know who you are, the markets are an expensive place to find out.

46. In the world of money, which is a world shaped by human behavior, nobody has the foggiest notion of what will happen in the future. Mark that word – Nobody! Thus the successful trader does not base moves on what supposedly will happen but reacts instead to what does happen.

47. Except in unusual circumstances, get in the habit of taking your profit too soon. Don’t torment yourself if a trade continues winning without you. Chances are it won’t continue long. If it does, console yourself by thinking of all the times when liquidating early reserved gains that you would have otherwise lost.

48. When the ship starts to sink, don’t pray – jump!

49. Lose your opinion – not your money.

50. Assimilate into your very bones a set of trading rules that works for you.

Gann’s Trading Rules

Source: page 43 of the original edition of WD GANN’S “How to make Profits in commodities” Published by Lambert , 1942

1) Amount of capital to use: Divide your capital into 10 equal parts and never risk more than one-tenth of your capital on any one trade.

2) Use stop loss orders. Always protect a trade when you make it with a stop loss order.

3) Never overtrade. This would be violating your capital rules.

4) Never let a profit run into a loss. After you once have a profit (…), raise your stop loss so that you will have no loss of capital.

5) Do not buck the trend. Never buy or sell if you are not sure of the trend according to your charts and rules.

6) When in doubt, get out, and don’t get in when in doubt.

7) Trade only in active markets. Keep out of slow, dead ones.

8) Equal distribution of risk. Trade in 2 or 3 different commodities, if possible. Avoid tying up all your capital in any one commodity.

9) Never limit your orders or fix a buying or selling price. Trade at the market.

10) Don’t close your trades without a good reason. Follow up with a stop loss order to protect your profits.

11) Accumulate a surplus. After you have made a series of successful trades put some money into a surplus account to be used only in emergency or in time of panic.

12) Never buy or sell just to get a scalping profit.

13) Never average  a loss. This is one of the worst mistakes a trader can make.

14) Never get out of the market just because you have lost patience or get into the market because you are anxious from waiting

15) Avoid taking small profits and big losses.

16) Never cancel a stop loss order after you have placed it at the time you make a trade.

17) Avoid getting in and out of the market too often.

18) Be just as willing to sell short as you are to buy. Let your object be to keep with the trend and make money.

19) Never buy just because the price of a commodity is low or sell short because the price is high.

20) Be careful about pyramiding at the wrong time. Wait until the commodity is very active and has crossed resistance levels before buying more and until it has broken out the zone of distribution before selling more.

21) Select the commodities that show strong uptrend to pyramid on the buying side and the ones that shows definite downtrend to sell short.

22) Never hedge. If you are long of one commodity and it starts to go down, do not sell another commodity short to hedge it. Get out of the market; take your losses and wait for another opportunity.

23) Never change your position in the market without a good reason.  When you make a trade, let it be for some good reason or according to some definite rule; then do not get out without a definite indication of a change in trend.

24) Avoid increasing your trading after a long period of success or a period of profitable trades

25) Don’t guess when the market is top. Let the market prove it is top. Don’t guess when market is bottom. Let the market prove it is bottom. By following definite rules, you can do this.

26) Do not follow another man’s advice unless you know that he knows more than you do.

27) Reduce trading after the first loss; never increase.

28) Avoid getting in wrong and out wrong; getting in right and out wrong; this is making double mistakes.

When you decide to make a trade be sure that you are not violating any of these 28 rules which are vital and important to your success. When you close a trade with a loss, go over these rules and see which rule you have violated; then do not make the same mistake the second time. Experience and investigation will convince you of the value of these rules, and observation and study will lead you to a correct and practical theory for successful Trading in Commodities.