Trading To Win. The Psychology Of Mastering The Markets (Pdf)

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WILEY TRADING ADVANTAGE Trading without Fear / Richard W. Arms, Jr. Neural Network: Time Series Forecasting of financial Markets / E. Michael Azoff Option Market Making / Alan J. Baird Money Management Strategies for Futures Traders / Nauzer J. Balsara Genetic Algorithms and Investment Strategies / Richard J. Bauer Technical Market Indicators: Analysis and Performance / Richard J. Bauer and Julie R. Dahlquist Seasonality: Systems, Strategies & Signals / Jake Bernstein The Hedge fund Edge/ Mark Boucher Beyond Technical Analysis / Tushar Chande The New Technical Trader / Tushar Chande and Stanley S. Kroll Managed futures: An Investor's Guide / Beverly Chandler Trading on the Edge / Guido J. Deboeck Trading the Plan / Robert Decl The New Science of Technical Analysis / Thomas R DeMark Point and figure Charting / Thomas J. Dorsey Trading for a Living / Dr. Alexander Elder Study Guide for Trading for a Living / Dr. Alexander Elder The Day Trader's Manual / William F. Eng The Options Course: High Profit &Low Stress Trading Methods / George A. Fontanills The Options Course Workbook: Step-by-Step Exercises to Help Tou Master The Options Course / George A. Fontanills Trading 101 /Sunny J. Harris Trading 102 /Sunny J. Harris Analyzing and Forecasting futures Prices / Anthony F. Herbst Technical Analysis of the Options Markets / Richard Hexton Pattern, Price & Time: Using Gann Theory in Trading Systems / James A. Hyerczyk Profits from Natural Resources: How to Make Big Money Investing in Energy, Food & Metals / Roland A. Jansen Trading Systems & Methods, 3rd Edition /Perry Kaufman Trading to Win / Ari Kiev Understanding Options / Robert Kolb The Intuitive Trader / Robert Koppel McMittan on Options / Lawrence G. McMillan Trading on Expectations / Brendan Moynihan Intermarket Technical Analysis / John J. Murphy Forecasting financial Markets, 3rd Edition / Mark J. Powers and Mark G. Castelino Neural Networks in the Capital Markets / Paul Refenes Cybernetic Trading Strategies / Murray A. Ruggiero, Jr. The Option Advisor: Wealth-Building Techniques Using Equity and Index Options / Bernie G. Schaeffer Gaming the Market / Ronald B. Shelton Option Strategies, 2nd Edition / Courtney Smith Trader Vie IT. Principles of Professional Speculation / Victor Sperandeo Campaign Trading / John Sweeney The Trader's Tax Survival Guide, Revised / Ted Tesser The Mathematics of Money Management / Ralph Vince The New Money Management: A framework for Asset Allocation / Ralph Vince Portfolio Management Formulas / Ralph Vince Trading Applications of Japanese Candlestick Charting / Gary Wagner and Brad Matheny New Trading Dimensions: How to Profit from Chaos in Stocks, Bonds, and Commodities / Bill Williams Trading Chaos: Applying Expert Techniques to Maximize Tour Profits / Trading to Win THE PSYCHOLOGY OF MASTERING THE MARKETS Ari Kiev John Wiley & Sons, Inc. For my wife Phyllis, with love and admiration This book is printed on acid-free paper. © Copyright © 1998 by Ari Kiev. All rights reserved. Published by John Wiley & Sons, Inc. Published simultaneously in Canada. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 750-4744. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 605 Third Avenue, New York, NY 10158-0012, (212) 850-6011, fax (212) 850-6008, E-Mail: PERMREQ@WILEY.COM. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold with the understanding that the publisher is not engaged in rendering professional services. If professional advice or other expert assistance is required, the services of a competent professional person should be sought. Library of Congress Cataloging-in-Publication Data: Kiev, Ari. Trading to win : the psychology of mastering the markets / Ari Kiev. p. cm.—(Wiley trading advantage) Includes index. ISBN 0-471-24842-8 (cloth : alk. paper) 1. Investments. 2. Stock exchanges. 3. Investment analysis. I. Title. II. Series. HG4521.K455 1998 332. 024'01—dc21 Printed in the United States of America. 98-20497 Foreword If you want to learn how to be a super-trader, then closely examine the concepts in this book. It is based on a proactive trading program that has helped my firm, SAC Capital Management, LLC, grow from a $20million hedge fund to one handling over $500 million annually after only five years. I have been trading the stock market for twenty years. Originally, I made my trading decisions by watching the ebbs and flows of the ticker tape. I knew very little of the fundamentals of the companies I was trading and based my decisions on the tape action. Later, as I refined my art, I began to combine it with a deeper understanding of the fundamentals of the underlying companies, the industries, and the general market trends. I have worked with and met many traders in my life. Most combine some form of chart reading, tape analysis, and/or fundamental analysis to make their decisions. The super-traders, though, share certain common traits that supersede whatever discipline they might pursue. They are totally committed to their own particular style and demonstrate complete conviction when trading. Because of this conviction they are able to take large financial risks and have the confidence and belief that probability is on their side. They also have the ability to admit their mistakes and minimize their consequences—that is, losses—when they are wrong. They are independent and think for themselves; they are not easily influenced by others. Most traders, surprisingly, are not like that: They are indecisive, lack conviction, and are afraid of taking risks and making mistakes. They are unaware of the personal demons that are holding them back from true success. viii Foreword That is why I brought Ari Kiev in to help my group. He has had experience with Olympic athletes, helping them maximize performance by setting goals and then improving on those goals. I felt the same concepts could work equally well with the traders in my company. Most traders have only a vague idea of why they are underperforming and attribute this underperformance to the market or other trivialities that they feel they have no control over. They don't realize that their own personality flaws may be the primary reason why they haven't achieved maximum success. Ari and I hold weekly meetings where we attempt to help our traders identify and modify those limiting thoughts and bad habits. Proactively the traders learn to modify their trading behavior and incorporate successful changes into their strategies. Additionally, we monitor the results to ensure that each trader remains committed to these changes. The results speak for themselves. I have traders working for me whose profits have gone up 100 percent since implementing this program. The Trading to Win approach has helped us to expand our horizons and branch out from equity trading into various strategies such as foreign exchange, convertibles, options, junk bonds, risk arbitrage, and systems trading. The ideas and concepts that Ari presents in this book will help any trader increase profits. Combining good common sense with established psychological principles, the book will enable the reader to walk away with a greater understanding of the complexities of being a successful trader. Using these principles and concepts as a road map will benefit anybody who has chosen trading as a profession and livelihood. Happy trading. STEVE COHEN Acknowledgments Numerous people have helped in the preparation of this book. Most of all I am indebted to the various traders I have worked with in the past six years, in particular Steve Cohen and the staff at SAC Capital Management, LLC. I am also appreciative of the support given me by Peter Kellogg, Gary Goldring, and Chip Weinberg at Spear, Leeds and Kellogg, and Jay Goldman at J. Goldman, LLC. In addition, I want to express my thanks for editorial assistance given me by Tricia Brown in the early stages and Grace Lichtenstein in the later stages of the manuscript, and to thank my editor, Pamela van Giessen, for her guidance throughout the preparation of this book. Most of all, I am indebted to my wife Phyllis, who as always has continued to be a constant source of support and encouragement at every stage of this process. A. K Xll Contents PART THREE Mastering the Trading Game Chapter 10 Dealing with Stress 187 Chapter 11 Overcoming Common Mistakes 197 Chapter 12 The Power to Change 223 Index 249 Trading to Win Trading to Win Introduction ; '^ • trading to win" defines a goal-oriented approach designed to help JL traders maximize their performance in a unique way—by tapping personal resources they might never know they had, by developing a rational strategy for trading, by learning new psychological skills, and by letting go of unproductive, even maladaptive, behavior patterns. This approach puts a special emphasis on learning to get rid of past memories and erroneous notions around which people have organized their lives. This book shows you how to commit to a future goal by surrendering to it, and simultaneously relinquishing all thoughts of gain, achievement, or attachment. Sounds paradoxical, you say? It is. That's the point. This system encourages you to trust a higher power that assists you in realizing the power within yourself. Periodically it helps you refocus on your goal, realigning yourself with your objectives. Then, you use your objectives as a filter through which to make distinctions in the present moment. The world of trading is one of high stakes and high-risk activity. The goal is, ostensibly, financial gain. Give up that goal, and you gain the freedom to genuinely listen to the sounds of the marketplace and to be able to read the movement of stock prices in a way that enables you to increase your probability of success. TRADING TO WIN For master traders, the monetary result is secondary to the gratification that comes from being able to make the right market call. They get their primary satisfaction from having an idea about a stock and implementing this idea in a profitable trade. Master traders trust their information, sense the direction of the marketplace, and assess many other variables before finally executing a lucrative trade. This requires an enormous ability to abandon pride and to maintain equanimity in the face of loss or excessive profit. The master trader knows—and you can learn—that neither despair nor euphoria should cloud one's judgment. As you improve, the market becomes even more challenging, requiring you to commit to bigger numbers or more complex dimensions of the game. If you are willing, this can lead you to give up more of your old habits and to become more at one with the universe. I have watched this occur in real-life traders. For the past six years I have met weekly with a group of professional traders to explore the psychological and emotional dimensions of their trading and to find ways of maximizing their performance. The Trading to Win principles discussed in this book evolved from these seminars and have since been tested and developed in several other trading settings. I am deeply indebted to Steve Cohen for making this opportunity possible and for paving the way to a greater appreciation of these broader issues to the traders in his and other firms. (Because of the proprietary nature of many of the issues considered in this book, I have not identified any specific traders by name. All personality profiles represent composites of the various traders and, although there are female traders, the masculine persona has been used throughout for realism in this currently male-dominated field.) Reading the market's direction and the directions of specific stocks is essential to trading success. It is like the childhood game of musical chairs. In that game, you have to time your move so that you do not jump for a chair before the music has stopped; you also don't want to linger too long after the music stops so that there are no seats left. This is the trader's dilemma as well. The more skilled you are, the more patience you have, the longer you can stay in as the stock rises or falls before you act. You stay in longer, and therefore maximize your profits. However, you do not stay in so long that, by t-nnnir tr. i-rarlr the "rnns." vou end uo beine stuck on the downturn Introduction and caught holding declining stock in hope that it will turn around. The same goes for being able to minimize your losses. Rather than hoping and praying and rationalizing your hesitation by convincing yourself that the stock will eventually turn around, you cut your losses instead. The Trading to Win program spotlights a set of philosophical and behavioral principles that can help you to implement proactive trading strategies. This approach involves commitment, concentration, recovery, and preparation for the next day. It enables you to trust your true self. This approach is not for the fainthearted. It puts much emphasis on proactive trading strategies designed to produce exponential results. It encourages you to do counterintuitive things—such as admitting uncertainty, fear, and lack of knowledge and asking for help; sharing information; and facing vulnerability. All of this means letting go of ego and arrogance, which blurs your focus on the marketplace. It compels you to learn to communicate directly and clearly with others, whether they be staff, associates, or floor brokers. Trading to win obliges you to review each day's trades, so you can see how you may have veered from your commitment, what dropped out of your trading, and what commitment you must add to get the desired result. You might need to raise the number of shares traded so they are consistent with your level of commitment. You might have to abandon energy-draining behavior—impulsiveness, chest beating, whining, and scalping (selling too soon to book a quick profit and missing the larger upward movement of a stock). You'll need to understand how to get out fast when stocks are dropping. You'll have to shed counterproductive habits, such as taking personal calls during trading times or racing home after the bell instead of reviewing the day with other traders and coaches. In addition, you must learn the appropriate role of money. In trading, it's not so much to be rich or secure. It is a way of keeping score. It is a way of defining the framework of events so that you can determine what actions are needed in the present. Paradoxically, the greater the amount of money, the more you must renounce your focus on it. While this program has been developed for professional traders, its principles have value for the ordinary trader as well. Sound trading ap- 4 T R A D I N G TO WIN plies to everyone, including the advanced trader who must regularly return to basics. Since it concentrates on a goal, yet makes you detach your ego from it, it has relevance not only to investing, but to life as well. I define "winning" as maximizing your own potential, as seeing the world realistically, and as living life like the miracle it is. After all, trading is a metaphor for the perilous yet exhilarating nature of living on the edge. What's the Concept, Doc? The objective of this book is to try to get at the underlying thought process behind trades. What are you are really thinking? What's motivating you? Is it consistent With your style? Does it make sense for you? Or are you governed at a given moment by emotion, by panic, or by whatever is going on in the Street? The ultimate objective is to be much more capable of reading the tape and reading the changes in the market in terms of what is occurring based on what you understand about it. You'll hear colleagues discuss in these pages things that they don't normally like to talk about, such as weakness or getting away from one's game plan. 'Trading, like sports, involves a high degree of uncertainty and unpredictabilityj This means playing in unfamiliar territory. Many books explore basic trading and basic psychological concepts such as relaxation, but don't link psychology and trading behavior. My aim is to develop the thought processes essential for trading in the realm of uncertainty. Whether you are hammered by fear or animated by euphoria, both can throw you off your game. It is important to understand why you may lose after you win big, or why you may sometimes feel that you don't deserve to win, or feel guilty about it, or have an attitude about money that colors your trading. To be a super-trader, you must learn not to forget your discipline and not to forget to respect the market. How do you surrender and yet keep your consciousness and your alertness so you can move in and out? Trading is a very high-pressure game. It triggers a lot of defensiveness that on the surface looks very rational and reasonable. I hope that Introduction 5 this book raises your level of awareness of certain critical processes so that you can begin to use them in your work. What Do I Mean by a Strategy? Once you set a specific goal for the year, you must ask how you are going to meet it. How many trades at what size would you have to make in order to make your number? What should your team look like? What general rules must you establish in terms of holding on, doubling up, or getting out of positions? If you reply with a shrug, "Well, I want to do as well as I can," you are less likely to get there. To reach your target, you'll have to elevate your game to a level where you say, "Okay, this is what I'm going to do." Why have rules? Because some moves, which you can find in your own database, consistently work. Forget the standard litany of rationalizations. You can always blame Alan Greenspan, or the market, or the fact that it's February. But regardless of different styles, certain principles remain immutable. If a stock goes down and you own it, you're losing money. "I'm going to make it a long-term trade," you say? You still lost money today. "It's a six-month trade" or "a three-month trade"? Maybe. But today you were hoping and wishing; you read something in Barron's, but it doesn't happen. You may keep thinking that you can make up for the loss, but, in fact, you would make much more if your losses were less. Once you stop having too great a tolerance for a high level of loss, you can start raising your monthly profit and loss (P&L) significantly. Some traders, even substantial ones, stay in positions even if they're dropping, because they are "macho" and can "tolerate pain." The stock will eventually come back, they tell themselves. But you are not a wimp if you get out of a losing position. One trader I know had to learn to get out at three points. Next he learned to get out at one and a half, and he made more money. Now he has to take the next big step: learning that it's okay to run away from a losing stock. So if he's making four thousand dollars and he starts cutting his losses, he can make five or six thousand. T R A D I N G TO W I N Losses are always hidden in your P&L. It looks like you're making some money, even though if you look closely you lost a lot of money, and that costs slippage and opportunity as well. Start looking at how much people are not making because they're scalping on the way up. Let's say a trader scalps—sells for a quick profit—and makes $5 million. Maybe if he didn't scalp, he could make $10 million. The issue is tracking where the stocks go after you get out. What if you're ahead at the end of a day, and you say, "The hell with it, I did well. Why should I look?" Hindsight, you argue, is twenty-twenty. You're right. But I think you can learn from your past experiences. It's like athletes reviewing recent game films to see what they are doing, so as to improve the way they win. Granted, the best thing would be to be right there at the time. I'm merely trying to make you aware of your thoughts, in order to give you a chance to change your thinking. Go ahead: Resist this idea. Argue that when you're in the middle of a loss, you're thinking about how to limit it, or how to get some back. Argue that you're as good as your next trade, not that you're as good as your last trade. If your past behavior has been successful, you ought to repeat it. If it's not successful, you won't repeat it. This all sounds fine, but these rationales ignore a basic characteristic of human beings—we tend to remain at the same level and repeat the past. Only if we are aware of the sources of our behavior will we be in a position to change it. Keep on resisting. Argue that people usually progress to the next level of trading, and that either they're going to make it and continue to grow or they're not going to make it. Assert that they will grow from experience by taking some losses but being right a lot of the time, and that there are no hard-and-fast rules because if there were you probably could have retired a long time ago. Point to the hotshots at your firm who have had a tremendous run in the past fifteen years and have consistently done better on a year-to-year basis. I believe that most people are not inclined to look inward, but pre- fer to live in the land of denial and rationalization. And I take the position that learning the fundamentals of trading success requires much more self-examination. I believe that the more consciousness you bring to this process, the more successful you will be. Introduction 7 The Unique Value of This Book The special value of this book is that it can teach you to recognize the psychodynamic underpinnings of your work (your subconscious perceptions and how they influence your trading), how to change your perceptions, and, finally, what self-observation techniques you can use to redesign your responses. Stay with me for a bit, and you'll learn to observe yourself. You'll detect the moment you make the wrong decision. You'll discover how to stop yourself when you know you are gambling or relying on hope. You'll learn to rely on your own ability to read the tape and understand the significance of known market indicators and the knowledge about specific companies. You'll learn to perceive your stress and learn to trust your insight, intuition, and decisions, while relying less on others. You will learn to take stock, review the basics, clean up your positions, and reduce them so you concentrate on getting the right kind of information to make sound judgments. This book will teach you how to let go of losers and overcome your reluctance to admit that you have made a mistake. This applies to buying high and selling low. It applies to adding to positions that are not profitable or are losing money, averaging up on short sales that are rising, and averaging down on longs that are dropping. In doing this you will be able to control your efforts to retrieve what you have lost. You'll learn not to fight the trend of the market by buying a stock when it's down, tricking yourself into thinking it's a bargain. It also applies to cashing in winners too soon—scalping. You might think you want to avoid looking bad, and you don't trust your instincts. You might want to get a quick profit to look good. Instead you'll learn trust, patience, and your ability to get out later on. You'll learn to trade in terms of the amount of money you have, and in terms of the kinds of percentages of profits you want to produce. You'll discover how to balance your expanded objectives against your available assets. As a by-product, you'll ascertain careful money management, so you preserve capital for when you need it—winning opportunities. How could a professional trader run into the same stumbling blocks as the amateur weekend trader? Well, he (or she) may know more
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