Let’s begin with the markets themselves, and with fear and greed. We have all heard the cliches about fear and greed. They rule the markets. In fact, that’s all the markets are—a reflection of these emotions. In order to make money trading, you must learn to control your fear and greed.
Overcoming Fear and Greed
We all have to deal with our runaway emotions at various times in life, and these emotions really begin to run away when we trade. Bill Williams1 used to say in his seminars that trading was the clearest window into your own personal psychology, clearer than any other endeavor. I think he was right.
UNDERSTANDING THE MARKETS
We give in to our fear when we don’t take the next trade because we’ve just been through a string of losers and fear losing again. We give in to our fear when we put our stop loss too close and get stopped out of a trade without giving the trade enough room to develop. We give in to our fear when we freeze as a trade starts to lose money, and we don’t take the exit signal because we’re afraid of losing money.
We give in to our greed when we take a profit early, before the regular signal, because we don’t want to give back any of the profits. We give in to our greed when we trade more contracts or shares than we normally would because we feel good about this trade.
So we start with the question, “How can we understand the markets?” If we understand how they work, we can get a better understanding of ourselves, and inturn be better traders.
Controlling greed takes discipline. As far as fear, Peter Steidlmayer2 explained in his work with Market Profile that markets exist for one purpose and one purpose only—they exist to facilitate trade. Facilitating trade means that the markets will do anything they can to get individuals to participate in the market. How they do this is through movement. Markets move up and down searching for buyers and sellers.
The crucial point here is that markets must move for their survival. Understanding this literally changed the way I thought about the markets. Think about it. Markets have to move! This concept is major for anyone who has had to sit through a trend-following strategy trading in a sideways market. The knowledge that the
market has to move eventually changes the way you look at trading. It gives you confidence that the string of losses can’t continue indefinitely. It eliminates the fear!
You see, Steidlmayer explained that if a market does not facilitate trade, it will die. If it does not continue to bring traders in, to lure the buyers and sellers, the market will cease to exist. And the prime directive of a market is survival. To keep traders interested, the market has to move. It cannot remain in a small trading
range or traders will lose money, become disinterested and leave. Eventually there will be less and less liquidity, traders will stop trading, and the market will die.
Knowing that a market must facilitate trade and move, or else die, has given me great confidence in trading. When I am forced to trade through quiet markets, I remember this principle. This principle has reduced my fear and increased my confidence immeasurably.
STRATEGY TRADING: MAKING GOOD BUSINESS SENSE
For me, strategy trading is the only answer to the problem of fear and greed, and it is the only logical way to take advantage of the concept of Market Facilitation.
First, trading a strategy provides the discipline necessary to begin overcoming fear and greed. Trading a strategy that has been back tested on historical, quantifiable data is a major way to inject discipline into your trading and to begin to control your fear and greed. If we think of a trading strategy as a small business, we can design our business to make money based on historical simulations. Then, our job becomes the implementation of the strategy rather than the interpretation of the market. If the strategy loses money and busts, we change the strategy. It’s a matter of good business sense.
Second, if we know that a market must facilitate trade to stay alive, we can devise strategies that guarantee that we will always be in for that inevitable big move. If we know that the big move will eventually come, and devise the strategy accordingly, our task becomes to minimize the drawdown (investment) while we wait. I have never been able to predict when the market was going to facilitate
trade and get in for the big move. Instead, I have devised strategies to ensure that I will be in for the big ride and my losses will be minimized while I wait. It’s just a matter of good business sense.
As a businessman, I have concluded that the only rational way to trade the markets is to trade a strategy. All of the hocus-pocus about predicting when this market will move, and how far, is just that—hocus-pocus. The people that make the big money are the ones who don’t try to predict tops and bottoms but who
consistently take a little out of the middle. The only logical way to do this consistently is through a well thought-out, well-designed strategy. It’s a matter of good business sense.HOME
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