Weblog of Joe Ross, Trading Educator and Trader for over 5 Decades

There are times when our judgment is cloudy. Perhaps we want so much to win that we optimistically see trading opportunities that aren’t there. At other times we may be so stressed out, busy, and tired that we can’t concentrate, and end up making an impulsive decision or a trading error out of a sense of frustration. As much as we search for a rational, unemotional perspective on the markets, it is hard to come by. We are human, and our natural human tendencies can get in the way of trading calmly and rationally. How can you cultivate a more objective, rational approach to the markets? Here are some useful tips.

• Remember that self-control and discipline work like a muscle. You cannot over-tax your muscles. When you do, you feel tired and worn out. Your body needs to rest and rejuvenate before trying to exert more physical energy. Physical stamina isn’t built up over night. Similarly, your ability to maintain discipline for long hours, day after day, may also be limited at first. It’s necessary to build up this ability over time. And after a few hours of extreme self-control, you must let lose. Take a rest, leave the trading arena for a little while, and do something wild.

• Second, don’t underestimate the need for rest and relaxation. Not only does self-control take energy, but concentration takes energy as well. When you are hungry, tired, and frustrated, you’ll have difficulty concentrating. You’ll be easily distracted and thrown off course by even a minor setback.

• Third, don’t try to live up to standards that you can’t reach. If you try to over-leverage your knowledge, you’ll feel frustrated and crack under the added pressure. Set modest goals and trade with money that you can afford to lose. Don’t pressure yourself. When you put a lot of money on the line, money you can’t afford to lose, you will bias your perspective. You’ll hold on to losing trades too long, falsely hoping they will turn around, or you will see profitable setups that don’t exist. If you trade smaller positions and manage risk, you’ll feel more relaxed and you will minimize the need to perform miracles as a trader.

• Fourth, don’t personify the markets. Stay objective. If you take trading so personally that you act as if a trading setback is a personal affront against you, then you may become obsessed with perfection and feel down on yourself for making a mistake, or you may even become angry with the markets and seek revenge when things don’t go your way. Don’t think of the markets as a person. View the markets as nothing more that a nameless group of unknown market participants who don’t know who you are and don’t care about you. It’s not personal. It is just business.

It’s natural to want to seek out pleasure and avoid pain. But many times, you have to take a good hard look at the facts, no matter how much it bothers you and causes you to feel pain. Don’t be afraid to try to look at the markets as objectively as possible. It isn’t always easy, but if you feel stress-free, open, and creative, you’ll increase your chances of maintaining a crystal-clear view of the markets.

What are the latest headlines? Do they impact the markets? Well, it depends. On Monday, October 17, 2005, there were some headlines that may have impacted you. GM reached a tentative agreement with the union. What’s the impact? It seemed to satisfy long term investors. Company profits are bound to improve with lower labor costs, right? The Supreme Court refused to allow the government to pursue a $280 billion penalty against tobacco companies. That should help their profits. Are you ready to invest? What about oil prices? There was a tropical storm in the Gulf Coast region that threatens to raise the price of light crude oil once again. And the Federal Reserve Board? What will they do next? The economy has been a little uncertain with tropical storms, oil prices, and possibly lower than expected earnings of major companies. Are they going to tighten interest rates? No one knows for sure. If only we had a crystal ball.

In the movie “Broadcast News,” the news director tells a newbie anchor, you better prepare. His sarcastic reply, “How do you prepare for tomorrow’s news?” As a short-term trader, however, you may aspire to prepare for tomorrow’s news. Imagine if you had a magic newspaper, like on the television show, “Early Edition.” If you knew the headlines, think of what you could do. On second thought, what could you do? What you really need is the financial section of the magic newspaper. The notion that you could trade the markets more skillfully if you had tomorrow’s newspaper the day before is a fallacy. It is based on the erroneous, belief that market participants react to media news in predictable ways, but they don’t always do so. Conventional wisdom about how market participants will behave is only a guess. Conventional wisdom is only correct when it happens to be correct, and thus, history in the markets only repeats itself when it does, and that may not be all the time.

It is not useful to view the markets as following natural scientific laws. Market participants don’t behave like inanimate objects in the physical world. They are irrational. They allow their perceptions and emotions to guide them. Think about how you allowed today’s headlines to influence you. Did you read the headlines? If you didn’t read them, then how could they influence your trading decisions? Even if you did read them, what was your interpretation of them? An interpretation of the headlines is subjective. How you interpret a headline depends on your past experience with the markets or whether or not you want to admit that a piece of news actually may impact your trading plan. You may unconsciously decide to deny its existence, and if you did that, then it could not have impacted your trading decisions. In addition, consider the different stories about the markets reported on any given day. How do you weight the information?

Because the markets are made up of people, it’s virtually impossible to precisely anticipate what they will do. In the end, you’ll have to accept the fact that no information is perfect. But you aren’t helpless. The markets may be inherently chaotic and difficult to anticipate, but you can take precautions. First, admit that you don’t have perfect knowledge and that you can’t perfectly anticipate what the markets will do. All you can do is look at all the available information as completely as possible, and make an educated guess as to what the market will do. Many times, you can, in fact, accurately anticipate the future market action. It’s a matter of preparation and taking a risk. That said, the second thing you must do to survive is manage risk. Because the markets are inherently chaotic, you must assume that you will be wrong more times than you would like. There’s no point in risking more money than you can afford, losing it, and suffering dire consequences.

No one knows tomorrow’s news, but more important, no one knows how market participants will react to the news. Don’t make the mistake of thinking that you have special knowledge. Admit your limitations, study the markets thoroughly, make an educated guess, and manage risk so that you’ll be protected in the event that you guess wrong. You can’t make the market meet your expectations. You have to go where the markets take you.

Why do so many traders abandon their trading plan? Is it their personality, an inherent pitfall of the trading profession, or temporary insanity? A host of factors may contribute to a lack of discipline. Depending on your personality, background, training, and experience with the markets, you may have trouble reigning in your tendency to act on impulse.

For some people, being impulsive is in their nature. They have trouble focusing their attention. They are easily bored. Seeking out quick thrills relieves the tedium of life. For others, being impulsive is related to emotionality. Some people have so much trouble controlling their emotions that they react impulsively out of frustration. Minor setbacks are inevitable in the trading arena. When the extremely emotional trader encounters one of these setbacks, he or she becomes overly agitated, and may close a position early, or in a fit of confusion, make a major trading blunder that can only be remedied by closing the position.

That said, any trader can act impulsively at times. There are many situational factors that contribute to being impulsive. Research has shown, for example, that when people are tired, they have difficulty focusing their attention. As much as part of your conscious mind cares about sticking with your trading plan, your unconscious mind thinks, “Who cares? I want to take a break.” Psychological resources are limited. When you push yourself to the limits, you will have trouble focusing on your ongoing experience, concentrating on your trading plan, and sticking to it.

Other people may be impulsive because they lack experience with the markets. You can’t expect to stick with a trading plan when you are uncertain. If you lack experience with the markets, you’ll feel a lack of confidence and uneasiness. If you don’t trust your intuition and if you have wavering trading skills, you’ll have difficulty risking money and truly believing that your trading plan will produce a profit.

Trading plans must be clearly defined and easy to follow. When you have an incomplete trading plan in which important aspects are left unclear, you will have trouble following it. A trading plan should consist of clearly defined entrance and exit strategies. Signals that indicate how the trade is going are also important. Don’t underestimate the importance of clearly mapping out a trading plan. You can’t stick with a trading plan that you can’t follow.

The winning trader is the disciplined trader. Disciplined traders stick with trading plans. They don’t act on impulse. It is essential that you identify the reasons you are trading impulsivity. It could be your personality or it may just be situational, but whatever it is, you must gain awareness of these factors and work around them. If you can control the urge to act on impulse, you’ll trade more profitably.

When your money is on the line, it’s difficult to remain calm, rational, and in complete control. What happens if you lose? How will you recover? It’s natural to become consumed with self-doubt and abandon your trading plan, or act irrationally in the midst of the chaotic market action. But winning traders control their impulses. They execute a trading strategy effortlessly and flawlessly, even under the most adverse market conditions. The winning trader is disciplined. Although discipline is a key ingredient to success, not everyone is capable of maintaining a high level of self-discipline. It’s worth determining where you stand on this characteristic and, if you lack discipline and self-control, work to build it up.

Some people are highly disciplined and very self-controlled. They scrupulously follow rules and are careful to control their impulses. They pay off their credit cards every month, are never late for an appointment, and carefully plan every detail of their lives. Although these characteristics may seem ideal for trading, there’s a potential downside. Overly disciplined people often have trouble taking risks. They prefer a sure thing, and seek out consistency and safety. But trading outcomes are rarely sure things. It is often necessary to live a little on the wild side. The astute trader may not recklessly seek out risk, but he or she doesn’t mind it. In the final analysis, every trader has an issue with discipline to some extent, whether it is a lack of discipline or too much of it. That said, regardless of whether discipline comes naturally to you, or you have to work at, it is essential to trade with discipline.

How do you rate your discipline and self-control? Do you have trouble sticking to your trading plan? Do you long for more discipline and self-control when it comes to your trading?

How is your discipline in everyday life? Are you often late for appointments? Do you spend more money each month than your budget allows? Do you frequently find yourself breaking promises? It’s not necessarily the case that a disciplined trader is disciplined in all aspects of his or her life but it helps. I know there are several areas of my life where I lack discipline, but when I’m trading or making investment decisions I am very much in control.

The life strategies we use in everyday life may bleed over into our trading life. If you often overspend, overeat, or have an unrestrained need for pleasure, you may find maintaining self-control and discipline while trading a little more difficult than others. But don’t despair. Even the most undisciplined person can learn to trade with discipline. It merely takes time and practice.

The markets are chaotic and unpredictable, and thus, it is understandable to feel unsure and unsettled at times. After a trade is executed, what happens next is anyone’s guess, and this state of uncertainty can cause stress. However, once you have been filled, is the time when you need the greatest degree of self-control.

The best way to gain control is by organizing your perceptions and activities. If you trade with a detailed trading plan, for example, you will impose structure onto an unstructured reality. You can reduce some of the feelings of uncertainty by clearly defining a target profit objective, and entrance and exit strategies. The more structure you impose and follow, the less uncertain and unorganized you’ll feel. You will know what to do and when to do it. Your trading plan will be easy to follow, and you will be more in control.

It’s also important to view your ability to maintain discipline as similar to a muscle. Like an actual muscle, it’s necessary to build up stamina. Maintaining control takes mental energy, and humans have a limited amount of mental energy. When the limits are reached, maintaining discipline is a challenge. The best solution is to build up as much mental energy as possible, which will in turn allow you to maintain self-control. It is important to get plenty of rest and relaxation. When you’re tired, the available mental energy you can devote to trading is restricted. You will have great difficulty controlling emotions and impulses. By getting the proper amount of rest, you’ll have enough energy stored up to combat pessimism, stay focused, and maintain self-control.

Many traders have difficulty trading with discipline. It’s tempting to trade by the seat of your pants and live with the consequences. But the winning trader is the disciplined trader. By taking steps to build your self-control skills, you’ll increase your odds of success.

Traders have a tendency to forget the obvious. We often think that life is more complex than the issues right in front of us, and that obvious solutions offer little comfort when trying to find solutions to seemingly insurmountable problems.

The markets are complex at times, but the psychology of the market is not. And the psychology of winning isn’t all that complicated either. It is vital to accentuate the obvious. You may have heard it time and time again, but there are a few axioms of trading worth repeating: Trade with discipline, manage risk, and think of the big picture. Each of these seemingly obvious issues can powerfully influence your trading performance.

Trading with discipline means developing a detailed trading plan and following it. Obviously, if you don’t have a plan, you’ll trade by the seat of your pants and make errors. You’ll enter too late or exit too early. You’ll make impulsive moves that lose money. The disciplined trader is the winning trader. It’s obvious, but many traders forget this simple fact of trading profitably. Similarly, many traders refuse to admit that there is an element of probability involved in trading success. Sometimes the odds work in your favor and sometimes they don’t. If you manage risk, you’ll be able to account for those times when the odds just are not working in your favor. If you don’t manage risk, though, you won’t be able to ride out the bad times. Again, it’s obvious, but many traders wipe out their account balance because they risked too much on a few bad trades. Similarly, no single, isolated trade should be more important than any other trade. Don’t elevate a single trade psychologically.

Don’t under-emphasize the obvious. Accentuate it. Get a whiteboard and write down your favorite axioms of trading. Put the list in a prominent place to remind yourself throughout the day of what’s important. It will keep you focused and make you a winner. My favorite axiom is, “Trade what you see, not what you think.

Sometimes a market just seems to become untradable. You start having more losing trades than you would like to have. You find that what you have been doing just doesn’t seem to work any longer. You are bored and frustrated with that market. Although you wait patiently for things to get better, they don’t get any better: in fact, they may become even worse. Finally, in despair, you choose and learn how to trade elsewhere, until your newly chosen market forces you to once again make a choice for a better place to trade.

You decide to take another look at the market you previously left. How will you know when to start trading that market again after taking a so-called “‘vacation?”

The things I look for are:

• Normal tick size, in the event that what caused me to leave was abnormal tick size.
• More or even less volatility, in case previous volatility was not to my liking.
• Fewer fast market conditions, if fast market conditions were what were previously causing me problems.
• Greater liquidity, if lack of liquidity had become a problem.
• Decent fills with little or no slippage. In a normal market situation, positive slippage should come almost as often as negative slippage, with many fills at exactly my price.
• Less noise, if there was too much of it in the past.

Any of the above or a combination of any of the above will cause me to choose or to leave a market. I know that many traders “marry a market” and try to trade it through both good and bad times. But it has been my experience that looking elsewhere is often a lot better than suffering through the difficult times in any market you choose to trade.

I can recall a time back in August of 1997 when a friend of mine, who was trading the S&P500 at the time, called me up. He was almost in despair. “What’s going on with the ‘snp?’ he asked. There’s no order flow.” He was right. The CME was about to cut the contract size in half, and at the same time introduce the e-mini S&P 500. There was much confusion about what it all meant, and the order flow in the “snp” had dried up considerably.

In my own trading I had dropped the contract entirely and was busy trading the bonds and grains. But my friend was frustrated for quite awhile because he was “married” to the S&P 500.

Do you suffer a lot when you trade? Are you under constant stress from trading? What are your thoughts about stress, and is it a major factor in your trading?

Stress in trading is not always harmful, probably depending on the source of the stress. For some traders it is imperative that they run scared. For those traders it is the emotion of fear that can generate the concentration necessary to survive.

For all traders, it has been proven that trading is a stressful business. Tests have shown that even when traders appear calm, relaxed, and comfortable during trading, their heartbeat rises, blood pressure rises, and skin moisture increases.

In other fields we see constant demonstrations of performing under stress. It is the ability to thrive under stress that sets athletic superstars apart. It is the ability to go onstage when a person’s stomach is full of butterflies that can make a stage performer into a star.

An effective trader learns to handle stress. His natural instinct of self preservation is what makes him effective when challenged.

There are other forms of stress besides fear. Selfishness can cause a trader to fight greedily for what he thinks he must have. Such a trader will trade without any consideration for personal honesty. The attitude of this kind of trader is “get what you want. Win somehow.”

As a trader you must find out who you are and learn to accept yourself that way, or better yet, change; become a better person.

Regardless of the source of your stress, if you are going to trade effectively, you must face the cause of it and learn to deal with it.

Do you think trading is an addiction? Can a person actually become addicted to trading?

Wow! That seems like a loaded question. My answer is “yes.” Trading can be addictive, much as gambling can be addictive. One trader wrote a book about what he learned by losing $1 million. Recently I received a call from a trader who told me he had reached a milestone: he has now lost $1 million, and continues to lose even more. He trades like a wild man. He seemingly cannot stop, despite his huge losses.

Imagine your own existence without knowing a single market tick in any market for an entire trading day. Does it bother you to not know? Do you have to look at some market, any market, to know how things are going? Imagine a day where you don’t know – where your perception of the world is not through the markets. How long ago was this imaginary day your reality? Would you feel anxious if you couldn’t see the market for a couple of trading days? If so, you may be a borderline trading addict.

When you win, is it one of the greatest days of your life? Do you feel triumphant? Let’s compare a winning day with some other events to gain some perspective.

Can you remember your favorite sunset or sunrise? Who was with you? Where was it? To sleep under the stars and walk with nature for an entire day, perhaps without speaking a word to a human being, is a spiritual experience of highest caliber that makes trading seem a little less important, and life seem a little more meaningful. Have you ever spent hours watching eagles soar, or spent the entire day inside the Grand Canyon from sunrise to sunset? Eyes are just small windows to a magnificent and wonderful world meant to be experienced. If you are sitting and staring at a screen all day long, what happened to your life?

There is no doubt in my mind that trading can be addictive. At Trading Educators we have seen traders lose everything, come back, lose it all again, then come back for a third time once they have put together sufficient funds to try again. If that is not a sign of addiction, what is? Sometimes they come back after many years of being out of the markets. Doesn’t that remind you of an addict who goes through rehabilitation, stays clean for a number of years, and then returns to his/her addiction because he never really kicked the habit?

If trading is the most important thing in your life, then you haven’t lived.

Is there any time when there is a valid use for oscillators and/or divergence?

Yes, there is a time when such things may prove to be of value. The opposite of trend-following trading methods involves trading techniques that enter on the tops and bottoms of movements, or counter-trend trading. Oscillator divergences may help accomplish this highest risk type of trading. Having set predetermined time and price objectives that should form below a previous top more than 70% of the time greatly facilitates this kind of trading. Selling short term rallies until intermediate downside price objectives are achieved is the best way to execute this strategy. This is one trading area where oscillators and their divergences are valuable. When you have strong down-trending intermediate markets – look to sell when short term RSI values rebound to hit 50, weaker downtrends hit RSI’s of 70 or higher. No system creates more open equity, defines trends, and forecasts the time and price objectives better than the 1-2-3 trading pattern, which may be the first objective pattern recognition system ever created. When the 1-2-3 price objectives are 200%+ over extended, the market is technically due for a correction of the 100% downside minimum value.

After a breakout, look for a return (retracement). Successful returns can beget generous returns.

When a market does finally overcome resistance, penetrate a psychological barrier, or break out of a formation or consolidation, it tends to do so boldly at first. But after its initial thrust, it often needs reassurance. To reconfirm its freedom, it may even return to the very area from which it just broke its constraints.

When traders on the wrong side exit and new participants eagerly enter in the direction of the breakout, the return to retest succeeds in reenergizing, reinforcing, and resuming the new trend.

Futures traders must always expect the unexpected when least expected. Would you, for example, expect prices to be pressured by a surge in supply before a decline in consumption?

Let’s look at some relationships in the soybean market.

Brazil harvests soybeans from February through May, during which crushing facilities run at capacity. Flush with new supplies for sale (most soybean oil is consumed domestically), the world’s second largest exporter of soybean meal competes aggressively in the world market.

But soybean meal is a high-protein feed supplement for livestock. World consumption is greatest by far during the Northern Hemisphere’s cold winter weather, when high caloric intake is required for animals to maintain and gain weight. Conversely, world consumption is lowest during July and August, when grass is available and the weather is hot.

So you might expect soybean meal prices to be especially weak during June, just after Brazil’s harvest and just before the heat of the northern summer. But that is not so! Soybean meal has instead been the leader in the grains and soy complex.

Why is that the case? A seasonal transition appears to occur during June. As the surge in South American supplies begins to recede, the market turns back towards old-crop US supplies — perhaps stimulating some change in commercial ownership. U.S. soybean processors, who may have hedged soybean meal during Brazil’s harvest in order to protect product prices and profit margins, may now begin covering short positions. Conversely, with low July/August consumption already discounted, the market begins to anticipate a rise in Northern Hemisphere demand — perhaps generating commercial buying.

Although product value within the soy complex has generally begun to favor soybean meal over soybean oil from as early as March, this sudden surge in soybean meal has been especially reflected in spreads between the two right around the middle of June. You might want to mark that on your trading calendar; it has been a high percentage spread trade for many years.

This strength in old-crop soybean meal is also reflected in spreads against new-crop soybean meal. As world demand returns to U.S. supplies, a new crop of soybeans is emerging to offer potentially plentiful new supplies late in the year. So, usually, the old-crop outperforms new-crop, often throughout the rest of the marketing year.