Have you heard the one about the poor guy who ends up lost in a minefield? Having no clue what to do, he prays, covers his eyes and walks a straight line. Miraculously, he survives. Brimming with confidence, he is convinced that if it happens again, he will employ the same technique to survive. Well, you can figure out the rest of the story. Boom. Its just too obvious. That guy was simply on borrowed time.
This guy could be any number of traders, including you, who trade in the same style. Finding themselves in that proverbial minefield with huge intra day losses. In a fit of desperation, they put on crazy Hail Mary trades with double, triple, and quadruple the normal size just looking for that miracle. You also know the ending to this story.
The one word that injects fear into the heart of every trader is blowout. As in, Honey, I blew out the account again and (Honey, please put the gun down..).
Control is the essence of good trading. You cant control the markets, but you can control your actions. You either have the control or you hand it over. This is a multi-layered statement, which I will explain later. As a trader, handing over control is putting it lightly. Realistically, you get beaten into a bloody pulp and have no other options but to submit.
Are you on borrowed time? If you are doing any of the following actions, then you are trading on borrowed time:
1)You go ALL IN on any single stock aka a Hail Mary.
2)You go all in on a stock position into an earnings report or an FDA meeting
3)You are constantly praying for a position to go your way even though all your original premises and signals have broken down
4)You start justifying your trade position with a longer term out look and decide to invest or swing the trade.
5)You keep trading to make up the commissions
6)You keep trading to make up losses on the day, even through the setups are blurry
7)You go double, triple or more of your normal comfort level size on trades after each stop loss--- especially when its during consolidation periods
8)Your intraday losses are greater than 10% of your account
9)You cant leave the screens for fear of missing an opportunity, not even to go to the bathroom
10) You regularly pray for just one more miracle trade! (several times a day)
Theres a fine line between having control and plunging head first into the abyss. This line can be crossed merely by a string of emotional stop losses. These losses can turn into a domino effect that gradually snowballs into disaster. The trader loses all sense of objectivity and pushes silly trades with size just to get back to even. As the trader continues to throw Hail Mary trades with too much size, he gets more and more desperate. Eventually, this trader is going to regain some of his senses and call it quits for the day, proceed to blowout the account or get real lucky as a miracle trade plays out, digging him out of the abyss. Every trader faces the abyss and recovers at least once with a miracle trade. Rather than considering this as a gift, consider it more of a warning. Just like our guy from the minefield, if the trader doesnt change his ways, a blow out is eminent.
Miracle Whip-ped
After a miracle trade, a trader will come to one of two conclusions. This is where the fate of the trader is sealed.
The trader will realize how lucky he was, take a step back and reevaluate his methods objectively. He will take the necessary steps to get back in control and maintain control. Never for once will the trader mistake the miracle trade for some great feat of trading ability. He got lucky. He wont be so lucky the next time.
Or
In the absence of reason, the trader will chalk it up to skill and natural born talent. Lol. The miracle trade has now embedded a dangerous precedent in the mind of the trader. In the guise of a profitable trade, the market has placed a ticking time bomb into the mindset of the poor trader. The trader will go on as if nothing has happened. He will inevitably find himself in the minefield again. He may survive again, which makes it even worse. With each successive miracle trade, the trader gains more false confidence. Instead of avoiding the minefield, this foolish trader now actively seeks them out. Its like a scene from some B rated horror flick where the victim is completely unaware of the psycho killer behind him. It doesnt take a genius to figure out the inevitable conclusion to this story. Lets just say, dead man walking. The best way to not get blown up in a minefield is to not place yourself in a minefield
The Paradox of Trading
Profitable trading is an endeavor that goes against human nature, mainly because of these annoying flaws called emotions. Fear and greed compose the actions of the market. When a position is profitable, greed kicks in until the position turns bloody and then fear kicks in. Blow off tops are peaks with the most volume because thats when the crowds greed gets the best of them as they chase an entry to get in on the action, only to have it peak and tank. The same holds with capitulation when the pain is too great and the crowd finally exits a losing position, right before it bounces.
The notion of working harder for a greater reward may apply in the job force, but in the world of trading, working harder as in making more trades means losing more money. There is a capacity to the number of trades one can effectively make before the slippage from stop losses and commissions far out weigh the profits. In fact, there are times to pay very close attention to the markets (like the first hour of trading) and time where its absolutely detrimental to pay too close attention (like the deadzone midday period).
As for control, people think the more stringent, tight focused and attentive you are during the day, the more profitable you will be. This expectation of control paints an almost militaristic picture of keeping a tight clenched fist on the market all day long. It implies that you are carefully watching every tick and gyration of the market with complete uninterrupted attention. It means you carefully analyze and berate yourself on every trade because you could have made more or you should have stopped out earlier. It means you have high expectations every day with a positive mental attitude and absolutely require no less than excellence. It means you have to be hard on yourself because you can always strive for better. You are the bastion of ironclad fortitude and dedication. Blinking is not an option, sir!
All the above criteria is perfect recipe for success in the corporate and fast food world, but when it comes to trading the markets, its a death sentence. This type of rigidity will eventually force a person to breakdown from the stress. Basically, the trader has already placed such impossible goals that he not only shoots himself in the foot, but eventually will voluntarily turn the gun on himself to relieve the pressure.
In fact, deep inside, the trader subconsciously invites the possibility of a blow out just to finally relieve the pressure of having to make money every day. Its like trying to get yourself killed just so you can finally get a good nights sleep. To a rational person observing from the outside, its insanity. But to the trader locked in his own prison within the eye of the storm, this rationalization is the only way out. This self-induced pressure is completely foolish, detrimental and hazardous. In all reality, its a form of self abuse. The line that separates one from being a delusional humanoid and a masochist freak is about as wide as a Mack truck. Get real. Everyone has their own threshold levels for stress. The key here is to place yourself only in situations where that threshold never has to be tested.
Instead of expecting to make big profits going into the trading day, try expecting less to end up with more. If you make $500 in either case, which mindset leaves you with confidence?
The first mindset leaves you wanting more. You should have made more. Try harder tomorrow, junior. This builds pressure to do better which is carried into the next day.
The second mindset leaves you with a confident and controlled peaceful state of mind, humble yet confident. You done good, even better than expected. Dont expect as much tomorrow, just filter tight and let the trades play out. No expectations equates to no pressure going into the next market day.
The Cognitive Dissonance Theory by Dr. Leon Festinger shows very clearly why people blowout their accounts when they start off this rigid. When contradicting piece of knowledge known as cognitions collide, they create stress. Human nature is to relieve that stress either through changing his beliefs or behavior.
Thats because they want to take the pressure off. Traders inherently desire to fail to relieve the pressure.
Human nature is to reduce stress by changing ones belief or ones actions.
Since 1998, UndergroundTrader.com has had thousands of traders worldwide come through the doors. Many of these traders learned the methods, applied their own style to them and left as profitable self-sustaining traders. Unfortunately, many other traders were internally programmed to blow out their accounts no matter what they were taught or told, and proceeded to do just that. Its a tragic but real aspect of this game. Everyone cant win.
However, a lot has changed since the old days. Trading has taken on a complete paradigm shift. The industry has gone through its boom and bust filtering cycle. As with every trend, theres the parabolic pop (1998-2000), the bust (2001-2004) and then a slow reemergence (2004-present). The good news is there are plenty more resources and materials available that work to shorten the time and costs of the learning curve. From training materials to trade simulators and back testing software, its gotten more sophisticated and more accessible. Nasdaq level 2 has been bypassed for converging time frame charts. Volume trading has been bypassed for sniper trading. Scalpers have evolved into range players. Basket trading has been bypassed for pattern trading. Full time trading is now effective part time trading. Less is more. The markets require more attention to pacing over methods. This is all part of the evolution of the trading markets. Failure to adapt results in extinction.
The people entering this game tend to be more educated and aware of the risks involved. Now if they only get rid of the pattern day trading rule and move to .05 spread increments, wed be in heaven.
The bad news is that as long as its humanoids making trades, there will still be blowouts. Then again, this is the market, a supposed zero sum game. We cant saveem all, only the ones who can adapt. For most, its really a blessing in disguise as they move forward with their lives to pursue other endeavors. For some, its a calling.
Some of the most successful traders I know blew out their earlier accounts first. Its almost a rite of passage amongst the old school traders. The pain and agony they suffered is a constant reminder of what they did wrong. It forced them to reevaluate and re assemble their methods. It allowed them to identify when a bad situation is forming and they are wise enough now to avoid it. I remember reading an interview with a successful fund manager who claimed his success was based on making every mistake possible enough times to know not to make them again. Traders dont have to go this route any more.
As I said, the resources available on the internet alone should be enough to thoroughly reduce a traders learning curve, but, some things just cant be taught. They have to be felt. Pain is a thorough and thought inducing teacher, as long as you learn from it.
Todays trader not only has to possess the ability to objectively assess the market, but also assess his own actions and mental state. He needs to be acutely aware of when he is pushing the risk envelope a little too hard as quality of set ups decline. Most importantly, he has to have the ability to ease up on the pedal or downright hit the breaks before disaster hits.
In the second article, I will go over the steps to climb back out of the abyss and prevent yourself from falling back in again. Please dont overtrade tight markets and stay out of deadzone. Good trading!
Please send any feedback or questions to jay@undergroundtrader.com
Jea Yu is a co-founder of http://www.Undergroundtrader.com , an interactive active trader chatroom and training site that has served over 8,000 traders, fund managers and investors worldwide since 1998. His brainchild was voted Forbes Best of the Web for four consecutive years under the active trader category. Mr. Yu has published two best sellers through McGraw Hill "Undergroundtrader.com Guide to Electronic Trading" ,2001 and "Secrets of the Undergroundtrader",2003 as well as two popular trading videos titled "Level 2 Warfare" and "Beating the Bear" published through Traders Library. He has been a featured speaker all over the country at various expos and seminars who enjoys a standing-room-only reception in the largest convention halls. Jays energetic presentation style, along with his obvious mastery of the materials being covered makes him an audience favorite. He has been quoted in USA Today, WallStreet Journal, and the Financial Times. Mr. Yu is an active contributing writer for http://www.TradingMarkets.com