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CHAPTER 11
THINKING LIKE A TRADER
If you asked me to distill trading down to its simplest form, I would say that it is a pattern recognition numbers game. We use market analysis to identify the patterns, define the risk, and determine when to take profits. The trade either works or it doesn`t. In any case, we go on to die next trade. It`s that simple, but it`s certainly not easy. In fact, trading is probably the hardest thing you`ll ever attempt to be successful at. That`s not because it requires intellect; quite the contrary! But because the more you think you know, the less successful you`ll be.
Trading is hard because you have to operate in a state of not having to know, even though your analysis may turn out at times to be "perfectly" correct. To operate in a state of not having to know, you have to properly manage your expectations. To properly manage your expectations, you must realign your mental environment so that you believe without a shadow of a doubt in the five fundamental truths. In this chapter, I am going to give you a trading exercise that will integrate these truths about the market at a functional level in your mental environment. In the process, I`ll take you through the three stages of development of a trader.
The first stage is the mechanical stage. In this stage, you:
1. Build the self-trust necessary to operate in an unlimited environment. 2. Learn to flawlessly execute a trading system.
3. Train your mind to think in probabilities (the five fundamental truths). 4. Create a strong, unshakeable belief in your consistency as a trader.
Once you have completed this first stage, you can then advance to the subjective stage of trading. In this stage, you use anything you have ever learned about the nature of market movement to do whatever it is you want to do. There`s a lot of freedom in this stage, so you will have to learn how to monitor your susceptibility to make the kind of trading errors that are the result of any unresolved self-valuation issues I referred to in the last chapter. The third stage is the intuitive stage. Trading intuitively is the most advanced stage of development. It is the trading equivalent of earning a black belt in the martial arts.
The difference is that you can`t try to be intuitive, because intuition is spontaneous. It doesn`t come from what we know at a rational level. The rational part of our mind seems to be inherently mistrustful of information received from a source that it doesn`t understand. Sensing that something is about to happen is a form of knowing that is very different from anything we know rationally. I`ve worked with many traders who frequently had a very strong intuitive sense of what was going to happen next, only
to be confronted with the rational part of themselves that consistently, argued for another course of action. Of course, if they had followed their intuition, they would have experienced a very satisfying outcome. Instead, what they ended up with was usually very unsatisfactory, especially when compared with what they otherwise perceived as possible. The only way I know of that you can try to be intuitive is to work at setting up a state of mind most conducive to receiving and acting on your intuitive impulses.
THE MECHANICAL STAGE
The mechanical stage of trading is specifically designed to build the kind of trading skills (trust, confidence, and thinking in probabilities) that will virtually compel you to create consistent results. I define consistent results as a steadily rising equity curve with only minor draw downs that are the natural consequence of edges that didn`t work. Other than finding a pattern that puts the odds of a winning trade in your favor, achieving a steadily rising equity curve is a function of systematically eliminating any susceptibility you may have to making the kind of fear, euphoric or self-valuation based trading errors I have described throughout this book. Eliminating the errors and expanding your sense of self-valuation will require the acquisition of skills that are all psychological in nature.
The skills are psychological because each one, in its purest form, is simply a belief. Remember that the beliefs we operate out of will determine our state of mind and shape our experiences in ways that constantly reinforce what we already believe to be true. How truthful a belief is (relative to the environmental conditions) can be determined by how well it serves us; that is, the degree to which it helps us satisfy our objectives.
If producing consistent results is your primary objective as a trader, then creating a belief (a conscious, energized concept that resists change and demands expression) that "I am a consistently successful trader" will act as a primaiy source of energy that will manage your perceptions, interpretations, expectations, and actions in ways that satisfy the belief and, consequently, the objective. Creating a dominant belief that "I am a consistently successful trader" requires adherence to several principles of consistent success. Some of these principles will undoubtedly be in direct conflict with some of the beliefs you`ve already acquired about trading. If this is the case, then what you have is a classic example of beliefs that are in direct conflict with desire.
The energy dynamic here is no different from what it was for the boy who wanted to be like the other children who were not afraid to play with dogs. He desired to express himself in a way that he found, at least initially, virtually impossible. To satisfy his desire, he had to step into an active process of transformation. His technique was simple: He tried as hard as he could to stay focused on what he was trying to accomplish and, little by little, he de-activated the conflicting belief and strengthened the belief that was consistent with his desire.
At some point, if that is your desire, then you will have to step into the process of transforming yourself
into a consistent winner. When it comes to personal transformation, the most important ingredients are your willingness to change, the clarity of your intent, and the strength of your desire. Ultimately, for this process to work, you must choose consistency over eveiy other reason or justification you have for trading. If all of these ingredients are sufficiently present, then regardless of the internal obstacles you find yourself up against, what you desire will eventually prevail.
Observe Yourself
The first step in the process of creating consistency is to start noticing what you`re thinking, saying, and doing. Why? Because everything we think, say, or do as a trader contributes to and, therefore, reinforces some belief in our mental system. Because the process of becoming consistent is psychological in nature, it shouldn`t come as a surprise that you`ll have to start paying attention to your various psychological processes. The idea is eventually to learn to become an objective observer of your own thoughts, words, and deeds. Your first line of defense against committing a trading error is to catch yourself thinking about it. Of course, the last line of defense is to catch yourself in the act. If you don`t commit yourself to becoming an observer to these processes, your realizations will always come after the experience, usually when you are in a state of deep regret and frustration.
Observing yourself objectively implies doing it without judging about yourself. This might not be so easy for some of you to do considering the harsh, judgmental treatment you may have received from other people throughout your life. As a result, one quickly learns to associate any mistake with emotional pain. No one likes to be in a state of emotional pain, so we typically avoid acknowledging what we have learned to define as a mistake for as long as possible.
Not confronting mistakes in our everyday lives usually doesn`t have the same disastrous consequences it can have if we avoid confronting our mistakes as traders. For example, when I am working with floor traders, the analogy I use to illustrate how precarious a situation they are in is to ask them to imagine themselves walking across a bridge over the Grand Canyon. The width of the bridge is directly related to the number of contracts they trade. So, for example, for a one-contract trader the bridge is very wide, say 20 feet. A bridge 20 feet wide allows you a great deal of tolerance for error, so you don`t have to be inordinately careful or focused on each step you take. Still, if you do happen to stumble and trip over the edge, the drop to the canyon floor is one mile.
I don`t know how many people would walk across a narrow bridge with no guardrails, where the ground is a mile down, but my guess is relatively few. Similarly, few people will take the kinds of risks associated with trading on the floor of the futures exchanges. Certainly a one-contract floor trader can do a great deal of damage to himself, not unlike falling off a mile-high bridge. But a one-contract trader also can give himself a wide tolerance for errors, miscalculations, or unusually violent market moves where he could find himself on the wrong side. On the other hand, one of the biggest floor traders I ever worked with trades for his own account with an average position of 500 Treasury bond futures at a
time. He often puts on a position of well over a thousand contracts.
A position of 1,000 T-bond contracts amounts to $31,500 per tic (the smallest incremental price change that a bond contract can make). Of course, T-bond futures can be very volatile and can trade several tics in either direction in a matter of seconds. As the size of a traders position increases, the width of our bridge over the Grand Canyon narrows. In the case of the large bond trader, the bridge has narrowed to the size of a thin wire. Obviously, he has to be extremely well-balanced and very focused on each step that he takes. The slightest misstep or gust of wind could cause him to fall off the wire. Next stop, one mile down. Now, when he`s in the trading pit, that tiny misstep or slight gust of wind is the equivalent to one distracting thought. That`s all, just a thought or anything else where he allows himself to lose his focus for even a second or two. In that moment of distraction, he could miss his last favorable opportunity to liquidate his position.
The next price level with enough volume to take him out of his trade could be several tics away, either creating a huge loss or forcing him to give a substantial winning trade back to the market. If producing consistent results is a function of eliminating errors, then it is an understatement to say that you will encounter great difficulty in achieving your objective if you can`t acknowledge a mistake. Obviously, this is something very few people can do, and it accounts for why there are so few consistent winners. In fact, the tendency not to acknowledge a mistake is so pervasive throughout mankind, it could lead one to assume that it`s an inherent characteristic of human nature. I do not believe this is the case, nor do I believe we are born with the capacity to ridicule or think less of ourselves for making a mistake, miscalculation, or error. Making mistakes is a natural function of living and will continue to be until we reach a point at which:
1. all our beliefs are in absolute harmony with our desires, and
2. all our beliefs are structured in such a way that they are completely consistent with what works from the environment`s perspective.
Obviously, if our beliefs are not consistent with what works from the environments perspective, the potential for making a mistake is high, if not inevitable. We won`t be able to perceive the appropriate set of steps to our objective. Worse, we won`t be able to perceive that what we want may not be available, or available in the quantity we desire or at the time when we want it.
On the other hand, mistakes that are the result of beliefs that are in conflict with our objectives aren`t always apparent or obvious. We know they will act as opposing forces, expressing their versions of the truth on our consciousness, and they can do that in many ways.
The most difficult to detect is a distracting thought that causes a momentary lapse in focus or concentration. On the surface this may not sound significant. But, as in the analogy of the bridge over the canyon, when there`s a lot at stake, even a slightly diminished capacity to stay focused can result in an error of disastrous proportions. This principle applies whether it`s trading, sporting events, or computer programming. When our intent is clear and undiminished by any opposing energy, then our
capacity to stay focused is greater, and the more likely it is that we will accomplish our objective. Earlier I defined a winning attitude as a positive expectation of our efforts, with an acceptance that whatever results we do get are a perfect reflection of our level of development and what we need to learn to do better. What separates the "consistently great" athletes and performers from everyone else is their distinct lack of fear of making a mistake. The reason they aren`t afraid is that they don`t have a reason to think less of themselves when they do make a mistake, meaning they don`t have a reservoir of negatively charged energy waiting to well up and pounce on their conscious thought process like a lion waiting for the right moment to pounce on its intended prey. What accounts for this uncommon capacity to quickly move beyond their errors without criticizing themselves?
One explanation may be that they grew up with extremely unusual parents, teachers, and coaches, who by their words and examples taught them to correct their miscalculations and errors with genuine love, affection, and acceptance. I say "extremely unusual" because many of us grew up with just the opposite experience. We were taught to correct our mistakes or miscalculations with anger, impatience, and a distinct lack of acceptance. Is it possible that, for the great athletes, their past positive experiences with respect to mistakes caused them to acquire a belief that mistakes simply point the way to where they need to focus their efforts to grow and improve themselves? With a belief like that, there`s no source of negatively charged energy and consequently no source for self-denigrating thoughts.
However, the rest of us, who did grow up experiencing a plethora of negative reactions to our actions, would naturally acquire beliefs about mistakes: "Mistakes must be avoided at all costs," "There must be something wrong with me if I make a mistake," "I must be a screw-up," or "I must be a bad person if I make a mistake." Remember that every thought, word, and deed reinforces some belief we have about ourselves. If, by repeated negative self-criticism, we acquire a belief that we`re "screw-ups," that belief will find a way to express itself in our thoughts, causing us to become distracted and to screw up; on our words, causing us to say things about ourselves or about others (if we notice the same characteristics in them) that reflect our belief; and on our actions, causing us to behave in ways that are overtly self-sabotaging. If you`re going to become a consistent winner, mistakes can`t exist in the kind of negatively charged context in which they are held by most people.
You have to be able to monitor yourself to some degree, and that will be difficult to do if you have the potential to experience emotional pain if and when you find yourself in the process of making an error. If this potential exists, you have two choices:
1. You can work on acquiring a new set of positively charged beliefs about what it means to make a mistake, along with de-activating any negatively charged beliefs that would argue otherwise or cause you to think less of yourself for making a mistake.
2. If you find this first choice undesirable, you can compensate for the potential to make errors by the way you set up your trading regime.
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