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

The most profitable trading strategies are innovative. You cannot merely follow the crowd or think conventionally if you plan to make profits in market after market. You have to sift through information on your own, and in the end, you must trust your instincts and go your own way. It takes courage, willingness to take risks, and is not for the faint of heart. It isn’t for everyone. Make sure it is right for you.

Market conditions are continually changing. You can’t expect to simply follow the masses and hope that it will always work. Instead of following the herd, buying when everyone else is buying and selling when everyone else is selling, you have to anticipate the crowd. You have to be a leader rather than a follower. That often means buying when everyone else is selling, and selling when everyone else is buying. In other words, buy on weakness, and sell on strength.

How does this work? Assume that prices move in cycles. For mere illustrative purposes, pretend that market cycles, or waves, go down at the open at the middle of the week, up at the close of the following day, and open down on the next day. If history was to repeat itself, and unfortunately it rarely does, you could buy low, wait for the price to go up, and sell for a sure profit. If the cycle followed a reliable, consistent pattern, you wouldn’t need to be a rugged individualist, or know how to use your intuition. You would know exactly what would happen and when, and trading would be simply a matter of waiting for the right moment and buying or selling, depending on the specific point during the cycle. But history only repeats itself when it does; the rest of the time it does not, and no one knows for certain when it will or will not repeat. That’s what makes trading a challenge. You simply don’t know exactly where or when the cycle will repeat. In the end, it’s just a matter of probabilities. You can’t wait for solid confirmation from the herd and merely follow them. The future is never certain, and so that’s where thinking independently, like a rugged individualist is relevant.

In the final analysis, you only have a cache of fallible trading strategies and your own intuition to rely on. It helps if you are a natural, rugged individualist, a person who isn’t used to looking toward others to see what to do next. A rugged individualist is familiar with taking chances, and using gut instincts to make decisions. And that’s all trading is — making a good guess, taking a chance, and having the courage to follow your convictions so that you manage the trade to a profitable outcome.

Having the flexibility to follow the crowd when it is advantageous and to go against the crowd is not difficult. You can be neither a conformist who feels safety in numbers, nor a deviant who likes to go against prevailing opinion. The winning trader truly thinks independently and trusts his or her own instincts. Cultivating these talents is necessary to achieve lasting profitability. How can it be done?

The first step is to assess your own personality. Are you a conformist, rule follower or a deviant, rule breaker? Neither extreme is very adaptive. It’s useful to know where you stand on the continuum and to realize that you must develop skills characteristic of the other end. Rule followers must learn to deal with uncertainty and risk, for example. Rule breakers, in contrast, must learn discipline and self-restraint. In other words, they must learn how to follow conventional wisdom (when it’s actually right). Second, you must gain a wealth of experience, and over time learn to trade in different market climates, and at different points during the ebb and flow of market prices. Many traders know how to trade the trend, and that’s a good start. But seasoned traders also know how to anticipate a turning point and capitalize on the masses’ herd mentality, which compels them to stay with the trend even when it is about to change.
Some people are natural individualists. Other people have to work at it. But regardless of your natural inclination, it is vital that you find the courage to follow your own convictions. The winning trader is a rugged individualist. If you can find the strength to go your own way, you can join the league of winning traders.

Skillful traders know how to use their intuition to make quick, conclusive decisions. There are times when going with your “gut” instinct can be shrewdly accurate. There are also times when your intuition can be dead wrong and nothing more than wishful thinking. An experienced, profitable trader knows the difference, and so should you.

The human mind is capable of making decisions without full conscious awareness. An experienced driver, for example, doesn’t need to pay close attention to every action. It’s quite easy to automatically shift gears, hit the brakes, and avoid hitting an obstacle quickly and decisively without thinking. However, it takes practice. When we first learned how to drive, or when we bought a new car, it took a little time to process a vast array of new information and act on it competently.

It’s the same with trading. When you first start trading, it’s wise to look carefully and consciously at a variety of indicators and sources of information before taking action.

I love the way Ed Seykota says it. “It is very, very easy to confuse intuition with into-wishing.” An intuitive idea is unconscious, and may arise from unconscious wishes. For example, novice traders are often uncertain of their decisions. In the back of their minds, they wonder if they can trade the markets profitably. To relieve the uncertainty, they may dream of making brilliant, winning trades. In the midst of monitoring a trade, it is quite tempting to be overconfident and want to believe that you’re about to make a huge win. If you aren’t careful, your intuitive mind confirms your expectations. It’s hard not to listen to it. You feel good. You feel in control, for a while at least. At some point, you are likely to find that your gut instinct wasn’t based on accurate information, and you end up losing. Your seemingly intuitive hunch was merely wishful thinking.

Decision-making requires that we look at both sides of an issue and arrive at a prudent decision. When we aren’t sure which side is obviously right, we feel uneasy. A sense of psychological tension creates a strong disparity within your mind. Your unconscious mind has difficulty handling such ambiguity. It seeks out a quick resolution. If you aren’t careful, an intuitive hunch creeps up that does nothing more than alleviate mental tension. It’s not based on a quick, decisive evaluation of facts, but on a psychological need for resolution between two opposing ideas.

At other times, our unconscious mind seeks thrills and excitement. An intuition may reflect an urge to alleviate boredom. You must always question the validity of a gut level hunch.

Experienced traders frequently report trading in the zone, a time when intuition allows the skilled trader to quickly seize rare market opportunities, act decisively, and make a financial killing. It is important to remember, however, that beginning traders have only rudimentary intuitive skills. These skills are not yet fully developed. It takes time, experience, and practice to develop them.

Intuitions may not reflect facts. Any intuitive thought should be grounded in facts. In other words, if a seasoned trader were to think backwards after making an intuitive decision, he or she should be able to map out the information and signals that went into making the decision. All intuitive thoughts and hunches should reflect the processing of specific pieces of information. If you’re an inexperienced trader, it’s unlikely that an intuitive decision is based on such information, so rather than act on intuition decisively, it is vital that you stop and think backward. Write down and map out the information on which your intuitive thought is based. If you can then determine that the hunch is based on valid information, act on it. If it’s unfounded, ignore it.

Although experienced traders know how to act on their hunches, inexperienced traders are better off if they stay close to the facts. Over time, and with experience and practice in many situations, you’ll be able to trade intuitively, decisively, and profitably.

Traders often hold an erroneous belief that good traders are naturally born, and thus by instinct they can handle anything the market throws at them. The belief goes something like this: “Natural born traders see good trade setups instinctively, and can close a trade like a virtuoso.”

Don’t you believe it, much of that kind of thinking is folklore. Traders are made, not born.

It’s necessary to sharpen your trading skills through practice and experience. You can’t expect yourself to know everything right away. When you’re caught off guard and you lose because of an unanticipated set of market conditions, don’t berate yourself by thinking, “I’m a dummy. I should have known that.” How could you know? Do you have infinite, infallible knowledge? Do you have a lifetime of trading experience? You can’t expect to trade like a seasoned trader without experience and practice.

Everyone has different talents. Some people can see patterns more quickly than others. They’re artistic and see structure in a seemingly random array. Other people are math wizards who can process numbers with lightening speed. Still others can stay cool under pressure, calmly surveying the landscape and making logical, astute decisions. Everyone has a different learning curve when it comes to trading, and it is necessary to remember that.

Sure, if a person grew up in and around the trading industry, he or she may know a little more than the average novice, but a person’s background doesn’t ensure success. Over the course of a career, it’s quite possible that a late bloomer can outperform an early rising star. If you berate yourself for not being skilled enough, or not having enough trading experience, you will sabotage your efforts. Comparisons to others are worthless. If you think you must perform up to some external standard before you’re ready, you’ll never achieve what you’re striving for. You will choke under the extreme pressure you are putting on yourself. Take your time. Give yourself an opportunity to gain the experience you need. You can’t expect to trade like a master over night.

When learning how to trade, it is vital to gain experience across a variety of market conditions. That takes time, considering that the knowledge base of many novice traders is essentially a blank slate. Most novice traders have relatively little real world trading knowledge. Over time, however, they will accumulate the requisite knowledge they need to trade like a master. Until then, it is necessary to ease up a little if you are new to the trading business. Give yourself time. Instead of beating yourself up for having limited knowledge, begin each trading day by thinking, “Of course I don’t know what’s going on. I have a lot to learn.” It’s better to go in with an upbeat, optimistic attitude. Don’t think, “How is the market going to show me up today?” Instead, it’s more inspiring to think, “I wonder what new knowledge I’m going to acquire today?” By easing up on yourself, you’ll be open to gaining valuable experience, and eventually, you’ll hone your skills and trade like a master trader.

Ray Venge lost a bundle in the last six weeks. He was riding high at the end of 2011, but when the New Year started, he couldn’t get his act together. He hasn’t been trading very long, but he has seen some success. But the past two weeks have been particularly devastating to his account balance and to his ego. It all seemed so simple a couple months ago. Recently though, he made a series of trades that have wiped out six months worth of profits. For the past week, he has been determined to get his revenge. Although seeking revenge is a natural response to losses, it rarely fixes things. As tempting as it is to work with an “I’ll show them” attitude, it doesn’t work well for trading the markets. It just puts you on edge, and there are not any real enemies to fight against when plotting revenge.

Ultimately, the only enemy is you. A vengeful spirit usually makes matters worse. It’s better to trade calmly and logically, rather than in spite and on impulse. It’s easier to lose money than it is to make it back. It’s just a matter of the mathematics of trading. Lost money is difficult to make back because of margin requirements and risk management. Recovery will require skill, time, and effort. Seeking your revenge isn’t going to help you accomplish the daunting task of recouping your losses.

We seek out revenge when we feel that we have been unnecessarily wronged. A need for revenge reflects a sense of overconfidence. Some overconfident traders are novices who made a bunch of wins, and then mistakenly believe that just because of a run of good luck they now know how to trade like an experienced professional. Because they believe they are now skilled traders, they expect to always make big wins. But they aren’t skilled traders, and when market conditions change they lose, and lose big. From their point of view, they are angry. The markets should have provided rewards, yet they are now beset with doubt and losses.

It’s easy to understand why traders working under the assumption that they “should” have made wins are angry upon realizing a loss. When we feel that something is owed to us, we become angry when we don’t get it. We feel we were entitled to win, and when we didn’t, we see it as an affront. It would be nice if we could win across a variety of market conditions, but not every trader has such fortune or skill. Losses are inevitable, and when you’re a novice trader, you should expect to go on losing until you develop enough skills to trade more profitably. Although it’s understandable, seeking revenge isn’t going to help. When we seek revenge, we are agitated. All our energy is focused on fighting. It works for a wild animal ready to bring down an opponent, but trading is largely an intellectual endeavor. You need your wits. You need to be calm, focused, and objective.

Rather than seeking revenge, it’s more useful to think in terms of making a strong commitment to success upon encountering a setback. Don’t think in terms of “beating an opponent.” Think in terms of building up your trading skills. Tell yourself that you are committed to mastering the markets, and that you will persist and overcome any obstacle. In the markets, it isn’t useful to think of obstacles as other people. You can’t dominate the market. Unless you are a market mover with enough money to actually manipulate the price action, you have to settle for going where the market takes you. You can’t impose your will onto the market, and that’s what you are trying to do when you try to seek out revenge. Sometimes market conditions are not conducive to your trading style and there is nothing you can do about it. When the right market conditions aren’t there, you have to stand aside and wait. If you go in there fighting, you’ll probably just make more bad trades and lose even more. It’s better to stand aside and use that pent up negative energy to study the markets or to learn new trading strategies, but whatever you do, calm down. If you can stay calm, even during a major setback, you can think creatively and figure out a way to trade profitably until you make back your losses. Plotting revenge only makes matters worse.

Many novice traders are frustrated when they start trading. It’s common to hear a beginning trader complain, “I don’t know what’s going wrong. I study the markets every chance I get. I put on trades under ideal market conditions, but I just can’t make a profit overall.”

You may wonder if enough time and effort is being devoted to trading. How much time is actually put in? How many trades are actually made? Answers to these questions are quite subjective.

For some novice traders, a couple of hours a day may be all they have available. In that time, they must monitor the markets, look for ideal markets to trade, and actually execute trades under optimal conditions.

Is this enough time? It depends. If you have a large enough account, and don’t need to make very much profit, it will be sufficient. But what if you have a small account, not much time to trade it, and want to make a huge profit? Well, in that case, you may be unrealistic. Successful traders work within a realistic frame of reference. They don’t try to do the impossible.

Trading requires time. Learning to trade requires a lot of time, and a lot of concentrated focus. Unless you want to use trading for entertainment, you need time to learn this business.

Can you imagine becoming a medical doctor using the approach that many traders use in learning the business of trading?

“I have a couple of extra hours every evening, so I can read medical books and then try out my skills. My operating plan is to start out using a simulator. I guess I can do that over at the morgue, until I feel ready to tackle the real thing. To make it more realistic, I’ll wear my green scrubs and a face mask. I don’t want to get any germs from the corpses I’ll be working on.”

“When I think I’m ready, I’ll go over to the hospital to see if anyone will let me operate on him.”

When you get an easy winner, do you feel guilty? Do you ask yourself, “Do I deserve to win?”

The world’s most successful traders believe in themselves and their ability to win. In fact, many of them feel that they “own” the market. They are not necessarily being arrogant, but they are sure of themselves and sure that they are able to take profits out of the market. Most important is that they believe they deserve to win. They have a mindset that is conducive to winning as a trader. It’s essential that you make sure that you too have such a mindset.

Do you find yourself acting as if you don’t deserve to win? Do you waiver between two opinions, declaring that you know how to take big gains out of the market one day, and doubting whether you can really do the same the next day?

Do you often make gains, and then give them back, plus a little more? How about a lot more?

Deep down inside, you may be suffering from the “work ethic.” You may not believe that making money easily is honest work. Is it possible that this belief interferes with your making easy money without guilt?

There is a powerful human need to hang onto tradition. Everyone in your family worked hard, so you must work hard. Have you considered that working smart might be a better way to go? When we stray from certain social mores and traditions, we feel confused and uneasy. Therefore, it’s essential that we learn who we really are, and identify which beliefs we hold that prevent us from working smart instead of hard. We need a mindset that is conducive to trading.

Think for a few minutes as to how you feel about the profits you make. Do you believe that you deserve wealth? Do you believe that you are justified in accumulating more capital than you currently have? Do you believe that by winning, you are taking money away from others? Such beliefs are not consistent with trading success, so if you hold such beliefs, you are going to have to get rid of them in order to be a successful trader.

Money is a means of exchange that provides us with circumstances and experiences we would not otherwise have. There is plenty for everyone. Let’s face it, the government can (and will) always print more. When we acquire wealth, we are able to support our loved ones, others, and ourselves more fully. We can be an asset to family and society.

If it is a religious belief that keeps you from making money, then read these words: “…I pray that you may prosper in all things and be in health, just as your soul prospers.” 3rd John, Chapter 1, Verse 2.

Read this one as well: “He who has a slack hand becomes poor, but the hand of the diligent makes him rich.” Proverbs Chapter 10, Verse 4.

I was asked a question about Bull and Bear spreads, and I was forced to do a bit of thinking about them. I anticipate that we will be in a commodity bull market at some time in the future. So maybe it’s a good idea to explain a bit about them.

What exactly are the functions of each of these situational trades? Bull and Bear spreads perform opposite economic functions.

Bull spreads ration demand, Bear spreads distribute supply.

In most demand-driven markets for a physical commodity, nearby contract months increase relative to deferred contract months. In the first stage, usually associated with plentiful supply and futures in contango (a price structure in which progressively deferred contracts are priced at progressively greater premiums), cash prices stabilize even as Commercials continue to buy their needs hand-to-mouth and forego forward pricing — steadying nearby futures while further eroding the deferred contracts. As demand begins to outstrip production, cash prices rise.

Experienced Commercials not only continue to buy their immediate needs, but also begin to slowly accumulate physical inventories.

The action of the Commercials affects futures much like a pebble’s impact creates concentric circles on a pond — the most intense circles are nearby, and have progressively less impact with distance.

In the latter stages, if demand exceeds supply, the price for nearby deliveries can exceed those for deferred deliveries as the market wants the physical commodity now — not later. If demand is sustained, futures can go into backwardation (inverted market) — a price structure in which progressively deferred contracts are priced at progressively greater discounts.

The eventual economic function of continued bull spreading is to restrict supply to the most productive (efficient) demand by making immediate consumption the most expensive.

When an inverted market occurs, it often, but not always, affords an excellent situation for spread trading — long the front (nearby, or delivery) month and short one or more back (deferred) months.

There are two sure ways to go broke trading a market — picking tops and bottoms based on valuations, and taking trades based solely on indicator readings.

When did the Japanese market become overvalued? When the Price divided by the Earnings ratio was 30, 40, 50, 60, 70, or 80 to 1? At 80 to 1, the Japanese market was so overvalued, that at the time I wrote, “Nikkei Dow futures will see 1,000 or below before it ever sees 3,200 again.” When did silver become over-valued? The previous high before 1978 was $6.40, yet it rose to over $50 per ounce in 1980.

When attempting to sell a top, focus on an intraday time interval suitable to the market traded. I use 1, 3, and 5 minute charts to trade the S&P mini with a pattern recognition reversal setup. Any trader can find an indicator to agree with an opinion or analysis, but it must be confirmed with valid price action. A market is never too high to buy, despite the overbought indicator, but may be too cheap to sell based on intrinsic valuation.

The trader who thinks he can pick tops and bottoms has a built-in self-defeating character flaw. That trader is selfish. He wants it all, from top to bottom, or bottom to top. Selfish is different from greed. Greed never has enough. The greedy trader stays in too long, hoping for more. The selfish trader wants it all for himself, not willing that anyone else should have their piece of the market.

When you look at the best and the brightest, it’s often necessary to merely admire them rather than to actually become them. Not everyone can be the best and the brightest, but it’s nice to know that ideals are possible, and that least one person made it. It’s tempting to elevate them to the status of an idol, hoping that if we emulate them, we can be like them. Trading is a field in which few reach the status of an elite trader.

The closest most traders ever get to such greatness is to read about great traders. Although we may never join the elite group of super traders, it’s inspiring to study them. It’s motivating to emulate them and believe that someday, if we work hard enough, we’ll achieve just some of their greatness.

However, it is important to carefully screen who the great traders were or are. In some cases, so-called great traders are not the ones we want to emulate. Take the example of Jesse Livermore, a true super trader, but a trader who died broke of suicide. Do you want to emulate him? Or how about W.D. Gann, who, by direct testimony from his own son, was not much of a trader at all? Gann also died broke.

There are many more I could name, but there is no profit in doing so. And, if you please, I do not consider myself to be a great trader, nor do I think I am a super trader. At the end of my career there will be time enough for such an evaluation. I do know that many of my students have exceeded my own results, and that is as it should be. The student should surpass his or her teacher.

It is motivating at times to forget about how you are doing right now as a trader, and dream about what you can be. Rather than limit your thoughts, you can dream about the perfect set of circumstances that will ensure success. What would you need in terms of equipment and resources? How much money would you need? What kind of time commitment is necessary? You might not meet the ideals, but it is useful to think about how close you can get.

Perhaps the single most important asset you can have as a trader is a pure passion to succeed. That doesn’t mean focusing on becoming the richest, most famous, or the best trader in the history of the profession. It means loving what you do, and not caring about the outcome, even if it means just making a living as a trader.

It is the passion for trading that gives the focus to concentrate on studying the markets, learning the nuances of the business, and working hour after hour to build up a repertoire of skills to the point where anything the market hands down can be handled.

The ideal trader is fearless, but knows how to control risk. He or she can put on a trade with unfailing objectivity. You may know of some traders who are fearless, yet give it all back because they don’t take proper risk controls. So although the ability to take risks is an ideal characteristic, it must be tempered with a healthy skepticism of the markets. The ideal trader finds the proper balance between risk seeking and risk aversion.

Besides psychological characteristics, the ideal trader has a wealth of experience with the markets. He has an arsenal of tried and true winning trading strategies, and virtually unlimited trading capital. If only we could be the ideal trader, we could conquer the world of trading. Some will make it, some won’t. But it’s fun to dream, and it is often useful to think about what you need to do to become a top-notch trader.

“It’s all a sham. There’s no way to make money in the markets. There are just too many roadblocks. The odds are against you all the way.”

You are fed up. Ready to quit, and searching for a way out. You want to escape from the markets. Rather than persist in the face of adversity, you’re ready to find a new way to make living.

You are forgetting that at such times resilience is vital. It’s not a time to brood, but a time to stand up and persist.

I agree, your complaints are somewhat legitimate. If someone tells you trading the markets is easy money, they are either kidding you or kidding themselves. If trading were easy, everyone would be making huge profits doing it. There is no Holy Grail, no quick-and-dirty way to make profits. If you want to reach the status of a trader, it’s going to take sacrifices, commitment, and just plain hard work.

There are seemingly endless setbacks, and unless you are a skillful, experienced trader, then the odds are against you.

For those who approach trading as an amateur hobbyist, it might as well all be a sham because taking such an approach isn’t going to make you a winning trader.

If you want to convince yourself that it just isn’t worth it, you can find many reasons to give up. At that point, you will try to find any excuse to avoid the hard times ahead and just walk away. You’ll sabotage yourself by taking unnecessary risks and impulsively trading poor setups. If you want to find a justification to give up, you will find it. It’s natural to fall prey to such a pessimistic attitude, but if you want to be a winning trader, you can’t give in to such pessimism. To make it, it is essential that you learn to stay optimistic, persistent, and ready to overcome any setback.

It is often difficult to stay upbeat. There are times when nothing seems to click. Your trading strategies don’t work, or you may have trouble getting an accurate read on the markets. It’s a common ailment.

Depending on your past experience, there are times when the market doesn’t seem to behave in the way you anticipate, especially if you trade your opinion instead of what you see.

Market conditions are fluid, and unless you have a wealth of experience, you may simply not be familiar with all the factors that are driving market action. It may just be a matter of standing aside until market conditions change.

To a trader who is tired, worn out, and looking for excuses to give up, less than optimal market conditions can be a deathblow. It’s just one of the many reasons to give up. But to reach the status of a trader, it is necessary to weather the storm.

Instead of reacting with stunned paralysis, the winning trader views unfavorable market conditions as a learning opportunity. It is a time to gain more market experience. The optimistic trader objectively studies the markets, trying to understand how the market moves and why. It isn’t a time to be stuck, but a time to think creatively and sharpen trading skills. It’s at times like these that it’s time to stand up and cultivate a fighting spirit.

When you’re down and out and ready to give up, it can be difficult to cultivate a fighting spirit. All looks bleak, as if it is impossible to get back on track. But it’s possible to overcome the malaise.

First, acknowledge that you feel beaten. There’s no point in pretending that you are not feeling down. If you don’t, you may not put your feelings in the right perspective. Rather than thinking, “I may be down, but I’m not out,” you may start to think, “It’s time to throw in the towel.” If you admit that you’re merely tired and worn out, you avoid making matters worse by making trading errors and digging yourself into a deeper emotional hole of despair.

Second, stand aside and rest. It’s alright to take a break. Even the most successful trader feels a little burned out at times. By resting, relaxing, and rejuvenating, you’ll find the strength to muster enough enthusiasm to tackle the markets again. And this time, you may find that the obstacles that once seemed insurmountable are now just minor bumps in the road to success.

After you have taken care of practical issues, like managing risk and building up enough trading capital, you can then address the psychological side of accepting losses.

First, put the money you spend for trading in a different “mental compartment” from the money you allot to your personal life.

Second, identify and refute assumptions about risk and loss. It may be useful to make a list of justifications that you can read after you have lost: “Losses are a business expense. It’s like a personal investment in your trading business. It’s like paying tuition in order to learn important trading lessons.” These sayings may not work at first. It’s hard to change your expectations — it takes practice. That’s why you should actually write down these sayings about losses, and read through the list when you feel guilty about a loss.

Trading the markets can be emotionally draining, and if you aren’t careful, you can feel beaten and ready to quit. But rather than search for a way out, it’s essential to remember the reasons to stay. If you persist, gain as much experience as possible and hone your trading skills, you’ll achieve enduring financial success.