How to Trade With Your Mind not Your Emotions.

What is the most important part of your trading? The chart? Managing the risk? Finding the Holy Grail of trading that can’t lose?

No, I am convinced how a trader emotionally reacts to the markets while trading will determine their success above any other consideration.

Mark Douglas is a trader and author of Trading in the Zone and The Disciplined Trader two great trading books for traders at all levels that deal mainly with developing the correct mindset of a successful trader.

My favorite Mark Douglas quotes.

Trader Psychology:

“There is a random distribution between wins and losses for any given set of variables that define an edge. In other words, based on the past performance of your edge, you may know that out of the next 20 trades, 12 will be winners and 8 will be losers. what you don’t know is the sequence of wins and losses or how much money the market is going to make available on the winning trades. This truth makes trading a probability or numbers game. when you really believe that trading is simply a probability game, concepts like ‘right’ and ‘wrong’ or ‘win’ and ‘lose’ no longer have the same significance. As a result, your expectations will be in harmony with the possibilities.”

“The less I cared about whether or not I was wrong, the clearer things became, making it much easier to move in and out of positions, cutting my losses short to make myself mentally available to take the next opportunity.”

“You need to ‘change your thinking’. The goal is to reach a ‘care-free state of mind’. When a pattern presents itself, don’t think. There’s nothing to think about. Take the trade because you have an edge. Then odds, probability and your risk control mechanisms will take care of everything. In the end, the key is to learn more about yourself. The most important lesson though is the importance of viewing every single trade as being part of a series of trades.”

Mark Douglas’ 5 fundamental truths:

• Anything can happen
• You can make money without knowing what is going to happen next
• There is a random distribution of wins and losses that define an edge
• An edge is just the greater probability of one thing happening over an other
• Every moment in the market is unique

Trading Emotionally With Intelligence

An excellent recent article outlines some of the qualities shared by people who demonstrate a high degree of emotional intelligence.  Emotional intelligence refers to our ability to understand our feelings and make use of them in constructive ways. As the graphic depicts, that requires a high degree of self-awareness (knowing what you feel) and the self-management capacity to channel feelings in constructive ways.  Emotional intelligence also includes social awareness of the feelings of others and the ability to make use of that information constructively in relationships.

I've consistently found that the best trades emerge from situations in which the head and gut are aligned.  That means that one is both analytical and intuitive:  you know something is right and you feel it lining up.  Many of my worst trades have occurred when I relied on an analysis to trade a market and have not had a strong feel for the trade.  I've also lost money going with feelings and flying in the face of patterns I've carefully researched.  When intelligence and emotional intelligence come together, an idea makes deep sense.  That is what provides traders with the confidence to hold positions through choppy conditions.  It's a great example of how performance hinges upon some of our softer strengths.

Cultivating emotional intelligence begins with work on awareness.  We can respond constructively to our experience if we're not mindful of that experience.  We are always in a relationship with markets--what are we feeling in that relationship?  How might that be related to what others are feeling?  How have those feelings helped or hurt my performance recently?  How do I feel when I'm trading at my best?  At my worst?  Structuring a journal to observe emotions and identify what we can learn from them is a great way to build self-awareness.

Emotional intelligence begins with the insight that our experience provides information.  It's another brain processing the world for us.  The emotionally intelligent trader learns from that information.  Many good trades come from watching the reactions of other traders.

The 8 Downfalls of Jesse Livermore

                                        

“A stock operator has to fight a lot of expensive enemies within himself.”
– Jesse Livermore

Jesse Livermore was a pioneer in the trading world. He was one of the very first trend traders, rule based discretionary traders, and traders of pure price action. He was a trail blazer. It was not his methodology that was his undoing, it was other short comings. After reading books about the life of this trading legend along with his own, here are my eight observations that I believe was his ultimate undoing.

1. Letting losers run: Many times he did not cut his losses. “I did precisely the wrong thing. The cotton showed me a loss and I kept it. The wheat showed me a profit and I sold it out. Of all the speculative blunders there are few greater than trying to average a losing game. Always sell what shows you a loss and keep what shows you a profit.” – Jesse Livermore
2. Over Trading: “What beat me was not having brains enough to stick to my own game – that is, to play the market only when I was satisfied that precedents favored my play.” – Jesse Livermore
3. Following tips: “Gradually, as I began to accept his facts and figures, I began to fear I had been basing my previous position on misinformation. Of course I could not feel that way and not cover. And once I had covered because Thomas made me think I was wrong, I simply had to go long. It is the way my mind works.” “It cost me millions to learn that another dangerous enemy to a trader is his susceptibility to the urgings of a magnetic personality when plausibly expressed by a brilliant mind.” – Jesse Livermore
4. Risk of ruin: From the quantity of his account blow ups and personal bankruptcies it appears that he did not understand the mathematical risk of ruin based on winning percentage and the loss of  capital per trade.
5. Position sizing: The sheer size of his astounding wins at key times shows that he did not really have a position sizing model to limit his exposure to risk, he was likely all in with leverage on his biggest wins. Which results in inevitable account blow ups.
6. Discipline: In his writings he seems to always hint that he had trouble following his own rules and advice and lost money when he didn't follow his own plan.
7. Lavish lifestyle: Livermore spent money lavishly on his lifestyle with mansions, vacations, and the best things money could buy. He had no number that allowed him to ever really retire and enjoy his wealth. He continued to trade with full size and aggressively through his career.
8. Mental risk of ruin: In the end, for whatever reason he ended his life. The stress and strain of trading, finances, and his personal life probably took its toll.
   
   

Iron Condor Option Strategy.

Iron Condor Option Strategy.


The iron condor is a limited risk, non-directional option trading strategy that is designed to have a large probability of earning a small limited profit when the underlying security is perceived to have low volatility. The iron condor strategy can also be visualized as a combination of a bull put spread and a bear call spread

Sell 1 OTM Put
Buy 1 OTM Put (Lower Strike)
Sell 1 OTM Call
Buy 1 OTM Call (Higher Strike)

Using options expiring on the same expiration month, the option trader creates an iron condor by selling a lower strike out-of-the-money put, buying an even lower strike out-of-the-money put, selling a higher strike out-of-the-money call and buying another even higher strike out-of-the-money call. This results in a net credit to put on the trade.

Maximum Profit is the Net Credit received while executing the Iron Condor. The Maximum loss under the strategy is also limited once the range is broken. Though the success rate of strategy is significantly higher, the only drawback is that the Maximum Loss under the strategy may be significantly higher than the Maximum Gain.

The Strategic Payoff of the Strategy would be like as follow

The following example of Iron Condor of Nifty would better clear the concept.

Underlying : Nifty

CMP : 8130 (Spot)

View : Range bound 7800-8400

So now our view on Nifty is that it won't go beyond 8400 and at the same time it won't fall below 7800 mark. So we can initiate Iron Condor as follow

Sell 8400 CE @ 43 so net premium received = Rs. 1075 (43*25)

Buy 8500 CE @ 25 so net premium outflow = Rs.625 (25*25)

Sell 7800 PE @ 36 so net premium received = Rs.900 (36*25)

Buy 7700 PE @ 22 so net premium outflow = Rs. 550 (22*25)

So Net credit is Rs.800 (1075-625 +900-550)  which is our Maximum Profit

Maximum Loss Above 8400 & Below 7800 is Rs.1700  (2500 - 800)



 

The Life Cycle of the Typical Trader

The exciting start

Do you remember how you got started in trading? Everything seemed possible, and you were ecstatic about the possibilities that trading offered, but what happened afterwards? This article will help you understand the different phases almost all traders will go through, why they are stuck in the same routine, and where they go wrong. It will help you avoid making the same mistakes, and save you some time along the way.

The indicator phase

When traders start out, most will start by using a variety of different indicators. After all, indicators look very sophisticated, they provide a very clear signal, and they transform what you see on your charts into easy to digest information.

New traders don’t really know what they are doing, and don’t understand what the indicators tell them; they just look for trade signals without having ‘to do too much work’.

The price action phase – less is more

When traders move on, they adopt the ‘get rid of the mess’ approach, and use phrases like ‘keep it simple’ or ‘only trade what you see’. Price action trading, and looking at blank price charts is where they will go, because price is ‘the purest form of information’, or at least this is what people tell you.

After leaving indicators behind, traders report that they feel free, and can finally see beyond the indicators. They understand what is really moving the markets. Needless to say, it does not really matter whether you are using price action or indicators – but this insight will come much later, if ever, in a trader’s life cycle.

Higher timeframes – less noise and more time to enjoy your freedom

Lower time frames are so noisy, and even though your trading strategy might be profitable, it is disproportionately harder on the lower time frames, isn’t it? A typical thought in this phase goes something like this:

‘When I finally trade profitably on the higher time frames, which is easier, I have more time to enjoy life; the reason I came to trading in the first place.’

Every time frame is unique, and the characteristics and skill-set you need to have for each time frame differ significantly. Traders who switch to higher time frames have to deal with completely different emotions. If you tend to make impulsive trading decisions and have difficulty executing trades with patience, trading time frames where you have to wait weeks for a signal to be validated, or stay in trades for days and weeks, and withstand drawdowns calmly, will often result in a whole new set of problems.

Fundamentals – understanding the context

Next, traders start reading news articles and learning about macroeconomic figures. They try to understand the overall market sentiment, since this is the actual factor which is moving the markets.

The fundamental phase is usually short, since traders notice relatively quickly how difficult it is to understand fundamental data. It isn’t as easy as trading absolute numbers of news releases.

Automation – removing the personal mistakes

EAs, trading robots and automated trading strategies seem like the perfect way out. They remove the personal factors that are responsible for trader failure. You get rid of emotions, avoid impulsive trading mistakes, and stop unnecessarily messing up your trades, by fully automating your trading approach.

Traders usually underestimate the factor that markets are never the same. The fact that financial markets are constantly changing, going from trending to ranging mode, having different phases of volatility and even the way markets respond to price behavior and other trading tools changes, is causing major problems for automated trading strategies. They require constant monitoring and adjusting the algorithms.

Back-testing – Finding what has worked before

After some frustrations, and without really seeing any improvements, traders usually start backtesting different trading ideas excessively. Before they are ready to invest more money, they want to make sure that their approach has worked before and, therefore, has a higher chance of working going forward; at least theoretically.

Back-testing, similar to automated trading, underestimates the changing nature of financial markets. Furthermore, backtesting avoids a variety of common issues that traders have to deal with during live trading which include: executing patience, feeling the pressure of having real money on the line and seeing the whole context of financial markets. Needless to say, backtesting results (almost) never translates into actual trading success.

Completing the cycle

Giving up

Most traders will go through this cycle once and then have enough and give up. Studies of retail trading data confirm that 40% of all traders quit after one month and a staggering 80% of all traders quit after 2 years.

The reason is that their dreams and hopes about fast and easy money have been destroyed, and they come to the conclusion (without losing lots of money, hopefully), that trading is not the easy task they were looking for.

Repeating the cycle

The ones who do not quit and keep on chasing their dream will repeat the cycle over and over again. However, traders will alternate between different phases of the cycle, leaving out some completely, and stick to others longer.

Adopting a professional and serious approach

At one point, some of the traders that are still left will come to the conclusion that they need to escape this cycle and try a different approach. Trading without the belief in the Holy Grail, and trading detached from the get rich quick mindset, often enables traders to tackle the whole situation in a completely different way.

Once traders stop system hopping, start implementing a trading plan and a trading journal and pay attention to detail, they have a chance of making it in this business. By understanding that the markets are not your greatest enemy, but that you yourself and your wrong beliefs are the factors that are causing you to make the wrong decisions, you can finally start focusing on the important aspects.

 Tips for a professional trading approach:

• Stick to one system only and stop system-hopping
• Stop focusing on entries only as the Holy Grail
• Adhere to risk and money management principles
• Do not personalize losses
• Start tracking your trades in a trading journal to find negative patterns and find out what is causing you to lose money
• Start using a trading plan to avoid impulsive trading decisions

The Surprising Reason For Many Trading Failures

Our cognitive, social, and personality strengths are gateways to our emotional well-being and life satisfaction.  When we exercise our strengths, we're most likely to find our work and relationships to be fulfilling.  Unfulfilling situations, very often, are those that frustrate our deepest values and competencies.

Many people pursue trading careers when, in fact, those careers are not well suited to their strengths.  They look for the right trading styles and setups and seek to make changes in their psyches when what they need is work that is aligned with the best of who they are.

If you're not succeeding at trading despite your best efforts, looking at alternatives is not an admission of failure.  It could be the first step toward your success.  If these are some of your strengths, trading may well not be your best career option:

*  People skills and interests
*  Spiritual values and interests
*  Creative skills and interests, especially of an aesthetic nature
*  Mechanical skills and interests
*  Helping skills and interests

Many people need a reasonable degree of career and financial security to function at their best.  Trading rarely offers these.  Many people also perform best in highly social, intellectual, or creative environments.  Many trading settings do not maximize these factors.

Sometimes, what looks like self-sabotaging behavior in trading is simply people acting on unfulfilled needs.  The trader who needs variety and creativity breaks trading rules.  It is his or her strengths--not their weaknesses--that cause them to lose discipline.

Your trading problems may be caused by the best of who you are, not the worst.

No one really talks about that.

Drawdown Diagnosis: Understanding Why You Are Losing Money

When you experience a drawdown in your profitability, the most important thing you can do is accurately diagnose what is going on.  There are three possibilities:

1)  Nothing is going on - The drawdown is normal and expectable for you and your trading approach.  Unless you have an insanely high Sharpe ratio historically (steady gains, modest losses), you can count on sequences of losing trades and losing days, weeks, and months.  You don't want to overreact to every losing period and continually change what you're doing; otherwise, you'd never build expertise in any particular trading modality.

2)  Market have changed - This is clearest when you identify shifts in market trends, volatility, and correlation over the period of your drawdown. If your drawdown correlates with such a period of market change, some adaptation is in order.  Not all trading problems are psychological in origin.

3)  You are trading poorly - A dominant theme  is the importance of knowing your best practices.  If you know what you do well when you are making money, you're most likely to be able to identify when you deviate from those strengths.  Poor trading can result from distraction, fatigue, frustration, and/or patterns of negative self-talk.  Until you address those factors, putting capital at risk undermines your trading business.

Markets continually challenge us, and that is what prods us to continually change.  Drawdowns are the market's way of telling us that we need to focus on our trading and not on screens.  Some of the greatest and most constructive changes in people's trading have been inspired by the most painful losses.