Key To Trading Success: Ignore Nature’s Laws?
The following is excerpted from Robert Prechter’s Independent Investor eBook. The 75-page eBook is a compilation of some of the New York Times best selling author’s writings that challenge conventional financial market assumptions. Visit Elliott Wave International to download the eBook, free.
By Robert Prechter
…The natural tendency of people to apply physics to finance explains why successful traders are so rare and why they are so immensely rewarded for their skills. There is no such thing as a “born trader” because people are born — or learn very early — to respect the laws of physics. This respect is so strong that they apply these laws even in inappropriate situations. Most people who follow the market closely act as if the market is a physical force aimed at their heads. Buying during rallies and selling during declines is akin to ducking when a rock is hurtling toward you.
Successful traders learn to do something that almost no one else can do. They sell near the emotional extreme of a rally and buy near the emotional extreme of a decline. The mental discipline that a successful trader shows in buying low and selling high is akin to that of a person who sees a rock thrown at his head and refuses to duck. He thinks, I’m betting that the rock will veer away at the last moment, of its own accord. In this endeavor, he must ignore the laws of physics to which his mind naturally defaults. In the physical world, this would be insane behavior; in finance, it makes him rich.
Unfortunately, sometimes the rock does not veer. It hits the trader in the head. All he has to rely upon is percentages. He knows from long study that most of the time, the rock coming at him will veer away, but he also must take the consequences when it doesn’t. The emotional fortitude required to stand in the way of a hurtling stone when you might get hurt is immense, and few people possess it. It is, of course, a great paradox that people who can’t perform this feat get hurt over and over in financial markets and endure a serious stoning, sometimes to death. Many great truths about life are paradoxical, and so is this one.
Robert Prechter’s Five Tips for How To Trade Successfully
September 15, 2009
Take it from the person who won the United States Trading Championship with profits of more than 440% in 1984 – there are five things that every successful trader needs to know how to do:
- Have a method to trade.
- Have the discipline to follow your method.
- Get real trading experience, instead of only trading on paper.
- Have the mental fortitude to accept the fact that losses are part of the game.
- Have the mental fortitude to accept huge gains.
- Bonus tip: Find a mentor.
That trader who won the championship in a record-breaking fashion is Robert Prechter, the founder and president of Elliott Wave International. Once you think you’ve mastered his 5 tips for how to trade successfully, then the best thing to do is to find a mentor. In this excerpt from the book, Prechter’s Perspective, Bob Prechter discusses how sitting at the elbow of a professional trader can make all the difference in learning the trade of trading.
Free 47-page eBook: How to Spot Trading Opportunities
Elliott Wave International has released part one of their hugely popular How to Spot Trading Opportunities eBook for free. The eBook sells as a two-part set for $129. You can now download part 1 for free. Learn more here.
(The following Q&A is excerpted from Prechter’s Perspective, revised 2004.)
Question: Has any specific trading experience decreased your trading success?
Bob Prechter: Yes. My first trade in 1973 was wildly successful, and I was hardly wrong in my first six years at it. Then I had a big trading loss in 1979, and that taught me more than the wins. The best way to develop an optimal state of mind for trading is to fail a few times first and understand why it happened. When you start, you’re better off speculating with small amounts of real money. Using larger amounts of money will bankrupt you early, which, while an excellent lesson, is rather painful. If you want to be a trader, it is good to start young. Then when you lose your first two bundles, you can gain some wisdom and rebound.
Q.: It sounds painful. Is there any way at least to reduce the hard knocks?
Bob Prechter: There is one shortcut to obtaining experience, and that is to find a mentor.
Q.: Did you have a mentor?
Bob Prechter: In 1979, I sat with a professional trader for about a year. The most important thing he taught me was to keep trades small relative to your capital. It reduces the emotional factor.
Q.: How would one select a mentor?
Bob Prechter: The best way to select one is to find a person who is doing exactly what you would like to do for a living, then get to know him well enough to ask if he will tutor you or at least let you watch while he works. Locate someone who has proved himself over the years to be a successful trader or investor, and go visit him. Listen to him. Sit down with him, if possible, for six months. Watch what he does. More important, watch what he doesn’t do. Finding a guy who knows what he is doing is the best lesson you could ever have. You will undoubtedly find that he is very friendly as well, since his runaway ego of yesteryear, which undoubtedly got him involved in the markets in the first place, has long since been humbled, matured by the experience of trading. He will usually welcome the opportunity to tell you what he knows.
Free 47-page eBook: How to Spot Trading Opportunities
Elliott Wave International has released part one of their hugely popular How to Spot Trading Opportunities eBook for free. The eBook sells as a two-part set for $129. You can now download part 1 for free.
Are These 4 Emotional Pitfalls Sabotaging Your Trading?
August 13, 2009
By Jeffrey Kennedy
The following is an excerpt from Jeffrey Kennedy’s Trader’s Classroom Collection. Now through August 17, Elliott Wave International is offering a special45-page Best Of Traders Classroom eBook, free.
To be a consistently successful trader, the most important trait to learn is emotional discipline. I discovered this the hard way trading full-time a few years ago. I remember one day in particular. My analysis told me the NASDAQ was going to start a sizable third wave rally between 10:00-10:30 the next day… and it did. When I reviewed my trade log later, I saw that several of my positions were profitable, yet I exited each of them at a loss. My analysis was perfect. It was like having tomorrow’s newspaper today. Unfortunately, I wanted to hit a home run, so I ignored singles and doubles.
I now call this emotional pitfall the “Lottery Syndrome.” People buy lottery tickets to win a jackpot, not five or ten dollars. It is easy to pass up a small profit in hopes of scoring a larger one. Problem is, home runs are rare. My goal now is to hit a single or double, so I don’t let my profits slip away.
Since then, I’ve identified other emotional pitfalls that I would like to share. See if any of these sound familiar.
Have you ever held on to a losing position because you “felt” that the market was going to come back in your favor? This is the “Inability to Admit Failure.” No one likes being wrong and for traders, being wrong usually costs money. What I find interesting is that many of us would rather lose money than admit failure. I know now that being wrong is much less expensive than being hopeful.
Another emotional pitfall that was especially tough to overcome is what I call the “Fear of Missing the Party.” This one is responsible for more losing trades than any other. Besides overtrading, this pitfall also causes you to get in too early. How many of us have gone short after a five-wave rally just to watch wave five extend? The solution is to use a time filter, which is a fancy way of saying wait a few bars before you start to dance. If a trade is worth taking, waiting for prices to confirm your analysis will not affect your profit that much. Anyway, I would much rather miss an opportunity then suffer a loss, because their will always be another opportunity.
This emotional pitfall has yet another symptom that tons of people fall victim to chasing one seemingly hot market after another. For instance, metals have been moving the past few years so everyone wants to buy Gold and Silver. Of course, when everyone is talking about it is usually the worst time to get into a market. To avoid buying tops and selling bottoms, I have found that it’s best to look for a potential trade where (and when) no one else is paying attention.
My biggest, worst emotional monster was being the “Systems Junkie.” Early in my career I believed that I could make my millions if I had just the right system. I bought every newsletter, book and tape series that I could find. None of them worked. I even went as far as becoming a professional analyst guaranteed success, or so I thought. Well, it didn’t guarantee anything really. Analysis and trading are two separate skills; one is a skill of observation, while the other, of emotional control. Being an expert auto mechanic does not mean you can drive like an expert, much less win the Daytona 500.
I am not a psychologist or an expert in the psychology of trading. These are just a few lessons I’ve learned along the way… at quite a cost most times. But if you are serious about trading, I strongly recommend that you spend as much time examining your emotions while you are in a trade as you do your charts before you place one. What you discover may surprise you.
For more trading lessons from Jeffrey Kennedy, visit Elliott Wave International to download the Best of Traders Classroom eBook. Normally priced at $59, it’s free until August 17.
Jeffrey Kennedy is the Chief Commodity Analyst at Elliott Wave International (EWI). With more than 15 years of experience as a technical analyst, he writes and edits Futures Junctures, EWI’s premier commodity forecasting service.
The Three Phases of a Trader’s Education:
Psychology, Money Management, Method
July 23, 2009
By Jeffrey Kennedy
The following is an excerpt from Jeffrey Kennedy’s Trader’s Classroom Collection. Now through August 10, Elliott Wave International is offering a special45-page Best Of Traders Classroom eBook, free.
Aspiring traders typically go through three phases in this order:
Methodology. The first phase is that all-too-familiar quest for the Holy Grail – a trading system that never fails. After spending thousands of dollars on books, seminars and trading systems, the aspiring trader eventually realizes that no such system exists.
Money Management. So, after getting frustrated with wasting time and money, the up-and-coming trader begins to understand the need for money management, risking only a small percentage of a portfolio on a given trade versus too large a bet.
Psychology. The third phase is realizing how important psychology is – not only personal psychology but also the psychology of crowds.
But it would be better to go through these phases in the opposite direction. I actually read of this idea in a magazine a few months ago but, for the life of me, can’t find the article. Even so, with a measly 15 years of experience under my belt and an expensive Ph.D. from S.H.K. University (i.e., School of Hard Knocks), I wholeheartedly agree. Aspiring traders should begin their journey at phase three and work backward.
I believe the first step in becoming a consistently successful trader is to understand how psychology plays out in your own make-up and in the way the crowd reacts to changes in the markets. The reason for this is that a trader must realize that once he or she makes a trade, logic no longer applies. This is because the emotions of fear and greed take precedence – fear of losing money and greed for more money.
Once the aspiring trader understands this psychology, it’s easier to understand why it’s important to have a defined investment methodology and, more importantly, the discipline to follow it. New traders must realize that once they join a crowd, they lose their individuality. Worse yet, crowd psychology impairs their judgment, because crowds are wrong more often than not, typically selling at market bottoms and buying at market tops.
Moving onto phase two, after the aspiring trader understands a bit of psychology, he or she can focus on money management. Money management is an important subject and deserves much more than just a few sentences. Even so, there are two issues that I believe are critical to grasp: (1) risk in terms of individual trades and (2) risk as a percentage of account size.
When sizing up a trading opportunity, the rule-of-thumb I go by is 3:1. That is, if my risk on a given trading opportunity is $500, then the profit objective for that trade should equal $1,500, or more. With regard to risk as a percentage of account size, I’m more than comfortable utilizing the same guidelines that many professional money managers use – 1%-3% of the account per position. If your trading account is $100,000, then you should risk no more than $3,000 on a single position. Following this guideline not only helps to contain losses if one’s trade decision is incorrect, but it also insures longevity. It’s one thing to have a winning quarter; the real trick is to have a winning quarter next year and the year after.
When aspiring traders grasp the importance of psychology and money management, they should then move to phase three – determining their methodology, a defined and unwavering way of examining price action. I principally use the Wave Principle as my methodology. However, wave analysis certainly isn’t the only way to view price action. One can choose candlestick charts, Dow Theory, cycles, etc. My best advice in this realm is that whatever you choose to use, it should be simple. In fact, it should be simple enough to put on the back of a business card, because, like an appliance, the fewer parts it has, the less likely it is to break down.
For more trading lessons from Jeffrey Kennedy, visit Elliott Wave International to download the Best of Traders Classroom eBook. It’s free until August 10.
Spot a Pattern You Recognize: One Simple Tip for Becoming a Better Trader
July 15, 2009
By Gary Grimes
The following article is adapted from market analysis by Elliott Wave International Chief Commodity Analyst Jeffrey Kennedy. Now through July 22, Jeffrey Kennedy’s daily, intermediate, and long-term forecasts for up to 18 markets are free via EWI’s FreeWeek. Learn more here.
Wave patterns are like beautiful women, classic cars and great art – you know them when you see them.
EWI analyst Jeffrey Kennedy drives this point home during his live Elliott wave trading tutorial. It’s my favorite of his tips for trading with Elliott waves.
“Trade the pattern not the count,” Jeffrey says.
If you don’t recognize a pattern at a glance, don’t trade it – plain and simple. After all, your wave count can be wrong; the pattern cannot.
Does that mean you must know the exact wave count at a glance, as well? No. Simply spotting a pattern you recognize is where you should start.
Jeffrey scans hundreds of charts, clicking through them one by one, spending mere seconds with each. If he doesn’t spot a pattern he recognizes, a click of his mouse takes him to another potential opportunity.
Does price action look extended or choppy? Is it trading in a channel? Is it forming a wedge or triangle shape? These are some of the signals Jeffrey’s looking for. Each could help him identify – at the quickest of glances – whether price action is impulsive or corrective. This is the first critical step, Jeffrey says, to spotting high-confidence, Elliott wave trade setups.
That brings us to the following chart. Do you see a pattern you recognize? I do.
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Look at the downward price action; the moves look decisive, almost in straight lines like impulse waves. Now look at the upward moves; they look indecisive and choppy like corrections. There’s also one down move that is clearly longer than the others – that’s almost certainly a third wave of some degree.
At just a glance, here are a few things we can determine:
- This is a bearish market pattern, because downward impulses are interrupted by upward corrections.
- The price action from September to November seems to be a pretty clear wave 3 down, followed by waves 4 up then 5 down, completing what appears to be a larger degree wave 1 in early March.
- Wave 2 follows wave 1, so the upward move starting in early March is most likely a larger degree wave 2.
- Wave 3 follows wave 2, so that’s what we can expect next.
- Wave 3 is never the shortest and often the longest of all five waves, so we can expect the next impulse move to take prices to new lows.
You see, with just a quick glance, we’ve put a finger on the pulse of the market. Negative psychology pulls prices down, and brief reversals of mood result in upward corrections – this appears to be a long-term bear market.
If you can gain this much insight simply by glancing at a chart, just think of what else you can glean by spending more time with it. Look at this pattern within a longer time frame, and you can determine the degree of trend (this one appears to be primary). Formulate Fibonacci price and time targets, and you can be confident about when and where prices will most likely turn.
There are literally hundreds of things you can do with a good chart, but none of them mean much unless you can first identify a pattern you recognize.
Gary Grimes focuses on mass psychology, U.S. stocks and the U.S. economy. Gary has a bachelor’s degree in journalism from Auburn University in Auburn, AL, where he was first turned onto the Austrian School of economics by way of the world-famous Mises Institute. His study of classical liberalism eventually led him to discover the Elliott Wave Principle and Robert Prechter’s theory of socionomics.