Your Personality &

Successful Trading

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DESTRUCTIVE a compulsion that this is the place to go
now. By the sky knows the reasons and
EMOTIONS & THE patterns behind the movements, and you’ll
know too if you lift yourself high enough
MARKETS to see beyond the horizon.”
Richard Bach - Illusions
“Money alone sets all the world in
motion.” Take any price of any commodity and
Pubilius Syrus Maxims you will notice trends over a sustained
1st century BC period of time, where the price moves in a
specic direction for a sustained period of
Most people dream of being totally time. Many analysts believe that prices are
independent and self-sufcient nancially. random and that trying to predict future
These people spend millions of pounds on price movement is futile and doomed to
lottery tickets, hoping to be the lucky one failure. However, behind the seemingly
to scoop the jackpot. There is another way chaotic price movements there is order.
to make a million, the highly leveraged
futures markets. Everyone has heard In the following pages I will give you an
stories of investors turning small stakes insight into how and why price movements
into vast fortunes, and it is this chance that occur and how, over a period of time, you
attracts traders to open futures accounts can capitalise on these moves and how
and dream, just like the lottery ticket you can trade with the odds of success
buyers, of receiving the big payout. The being rmly in your favour.
reality of futures trading is different; the
prots always seem to be elusive so each SELF CONTROL & DISCIPLINE
time the trader trades he suffers consistent
losses rather than consistent prots. “To the destructive element submit
yourself.”
Trading looks deceptively simple, yet few J. Conrad
succeed. If you read interviews with
the great traders, you will perhaps be Successful trading is 80% psychological
quite surprised to learn that very few are and 20% methodical. As I have already
intellectuals, many have never been to said, self-knowledge is the key to market
college, and a considerable number even success. A trading method by itself, no
dropped out of school. Additionally, most matter how well thought out, cannot be
will claim they have simple trading systems successful if it is not applied in the correct
that almost anyone can understand. manner. It is in the application of a
trading method that many traders end up
So what separates winners from losers? losing. Consider the analogy of a high
The answer is not just knowledge of performance-racing car. No matter how
the trading environment, but also an aerodynamic or technically advanced, it
understanding of our personality make-up needs to be driven. An advanced piece
and how it needs to interact with the of engineering such as racing car needs
market in order for the trader to emerge to be driven by a person who can drive it
with consistent prots. In the following with care. Just as a disciplined driver is
pages you will learn why an understanding needed to race a car, a disciplined trader
of our own personality is the key to is needed to apply a trading method. All
successful trading, and how the emotions traders have heard the word “discipline”,
of greed, fear, pride and hope are fatal to but few really understand what it is and
trading success. why it is so important to develop it.

“A cloud does not know why it moves in

such a direction at such speed, it just feels
EMOTIONS AT WORK prices low in historical terms, now is the
time to buy. You ring your broker to place
“When dealing with people, let us the trade; however, the overwhelming
remember that we are not dealing with condence of paper trading has now
creatures of logic. We are dealing with deserted you. Perhaps you had better
creatures of emotion, creatures bursting double-check the formation. After much
with prejudices and motivated by price deliberation you decide to phone the broker
and vanity.” and the trade enters the market. For
Dale Carnegie the next two days prices rise dramatically,
your prots grow; you feel great, what an
Intelligence, knowledge and talent have to easy way to make a living. The next day
be applied. Any person who is successful prices drop and your prots are cut in half.
knows that application requires discipline, You feel uncertain; perhaps you should
self-control and condence in one’s take the prot now before it gets away.
abilities. Bjorn Borg was a great tennis You decide to wait. The next day prices fall
player, he had talent. However, what further and close below your mental stop
always gave him the edge when playing loss. Your system is telling you that you
was his mental control, which earned him should be cut. However, you only have a
the nickname “Iceman”. He combined small loss and it should turn around and
talent and discipline to achieve his success you will soon be back in prot. The next
and you must do the same. day, to your horror, prices have collapsed
and the majority of your equity is now lost.
We are all put in situations where, after Your reaction is now one of anger, why
they have occurred, we look back and didn’t you bank the prot when you had it!
feel that if only our emotional control The market’s move is totally illogical, you
had been better. You are going for a feel anger, pain and frustration, you are
job interview and role-play Th a friend now totally disillusioned and fed up, and
beforehand. You come over as assertive all you want to do is exit the trade.
and condent. In the interview itself,
however, the condence goes. You practise Welcome to the real world of trading!
a best man’s speech, it ows well and
sounds great; however, on the day, delivery “Seeing is believing, but feeling is the
suffers as you feel nervous and shy. truth.”
Thomas Fuller
All the above we can associate with.
The fact of the matter is, when the The above is a hypothetical yet common
pressure is on, our actions are inuenced example of how traders who have made
by our emotions. The more important the money on paper suddenly crumble under
scenarios, the greater the inuence will the strain of real trading. Many people
be. deride paper trading and say it is of little
use. However, providing you know the
Trading is no different. As soon as money pitfalls in advance, it is a great way to
is committed, logic can go out of the mentally prepare yourself for the day you
window and basic emotions take over. have to trade real money.
Consider the difference between paper
trading and trading real time. Whilst paper “The mainstay of training her is condence.
trading, you earn very good prots, you That’s why we show them how to let a tank
are condent and optimistic. You see a run over them - it gets their condence
very lucrative business opportunity, so you up.”
now decide to open an account and trade Ofcer in Charge
for real. US Special Operations Command
On studying your charts you see an
opportunity, a perfect double bottom and Of course nothing will take the place of the
real trading arena; however, practicing the Man is brought up in a society that is
basics on paper is a very useful exercise. held together by rules and laws that are
To ridicule paper trading is similar to saying imposed by an external authority.
soldiers should not go on manoeuvres
because the bullets are not for real! In Society is structured, and it is its denitive
conclusion, paper trading is useful if we structure that makes people feel
adopt the right attitude to it, (i.e. we make comfortable. Laws and rules are perceived
it as realistic as possible and we don’t as protection when our security and well
cheat). being are threatened. We can, for instance,
go to the police or Courts to look into and
Going back to our hypothetical example, act on our grievances.
it is clear that the trader was making
investment decisions based upon his In contrast, the trading environment has
emotions rather than logic. No matter no clearly dened rules and no structure.
how good the trading system was that he It would be, in society terms, total anarchy.
used, he would still fail due to his lack of The market moves where it wants,
discipline and self-control. This is not to whenever it wants. The society of trading
imply that you can trade any system with has no governing body that makes or
discipline and be successful; however, a enforces rules; there is no judicial body to
disciplined trader with a mediocre trading appeal to should the investor feel prices
system has the edge on the best trading are not moving in the right direction. This
system in the world if its operator lacks anarchy can be extremely unsettling for
discipline. investors if they think prices should go
up and they actually decline. There is
To develop discipline you need to acquire absolutely nothing we can do about it. The
total condence in your abilities, i.e. market does not care whether investors
acquire self-control. You can do this by make or lose money, it has no conscience,
acquiring knowledge, practicing on paper and it is a natural phenomenon and never
and real time trading experience. Nothing has to justify its actions.
replaces real time trading, but preparation
in terms of understanding the markets and A harsh and hostile environment. Every
how you should relate to them will give trader tries to take money from everyone
you a distinct edge in the quest for the big else. Everyone is trying to make money at
prots. everyone else’s expense. It is a uniquely
harsh environment, everyone is against
you and you are against everyone else.
CHARACTERISTICS OF THE
One analyst compares it to a medieval
MARKETS battle - a man used to go to the battleeld
and hill his adversary while his opponent
The unique world of trading futures is tried to do the same to him. The winner
one that encourages traders to reject took the loser’s weapons, his chattels and
objectivity and logic in favour of the basic sold his wife and children into slavery.
human emotions of greed, fear, hope and Today traders to battle on the Exchanges
pride, with disastrous consequences. Let’s instead of on the eld. When you take
take a closer look at the markets and the money away from a trader, it is not that
psychological problems they create. different from drawing blood, he may
los his home, his chattels, and his wife
Operating in an unstructured environment. and children may also suffer. Is this
Trading requires you to operate in an description a bit exaggerated? Perhaps;
environment with few rules and little however, there is no denying how hostile
structure. Most people need order and the trading environment feels when you
rules for guidance, it is the way their trade in it, to stand alone can be, and is,
lives have been structured since childhood. uncomfortable.
Confronting your inner self. Standing loss. His subconscious mind constantly
alone is uncomfortable because it makes equates time and effort with reward, and
people do one thing that most feel uneasy this affects his objective judgment.
about, which is taking responsibility for
one’s actions. Most people like to delegate There is unlimited prot and loss potential.
responsibility, blame others and make This is the one characteristic that brings out
excuses when they don’t succeed. Most the worst emotions in traders and causes
people simply cannot face the simple truth them to lose. They simply cannot cope
that they are responsible totally for the with the unlimitedness of the markets’
consequences of their actions. A person movements. This “unlimitedness” and
can go for a job interview and convince the massive leverage available causes
himself that he did not get the job due traders to create risk by their emotional
to a personality clash with the interviewer. desire to avoid it. This may sound
A lawyer can drink too much before an illogical until we examine how an investor’s
important case and convince himself he lost emotions interact with his perception of
because the Jury was biased, a salesman risk reward.
can convince himself that it was his product
that was not up to scratch and not his Consider the following: If making money
presentation. is important to you, as it is to most people,
you will have difculty taking a small loss.
The trader, however, has nowhere to hide If you bear in mind a trader’s self esteem
when interacting with the market. He is and the fact that money is on the line, you
really competing against himself, and the will appreciate the psychological turmoil
market will judge every day how well he this can cause. Prots, on the other hand,
is doing. This confrontation with our own are just as difcult to cope with. When
personality, our strengths and weaknesses a large prot occurs, he gets excited, and
graphically exposes, is something most the bigger the prot becomes the harder it
people would rather avoid. is to resist the temptation to take it now.
However, prots need to be run to cover
The work ethic does not apply. The normal inevitable losses. In their efforts to avoid
work ethic of time, effort and reward that risk, investors actually end up creating it.
is common in most job situations does Consider the following psychological test:
not apply in the markets. For example,
a factory worker putting in overtime and A group of people are given the following
working extra hours is rewarded with more choice over a number of trades:
money. As a general rule, the greater the
effort we put in, the greater the reward A 75% chance to win $1,000 with a 25%
we expect. However, no such work ethic chance of getting nothing, or a sure $700.
exists with the markets. A trader can Four out of ve subjects take the second
spend years creating a trading system, choice, even after it is explained to them
only to see his equity wiped out in a matter that the rst choice leads to a $750 gain
of days. A trader, however, may quickly over time.
develop a simple system and reap huge
prots. Whether we acknowledge it or Another test gives people the following
not, we normally believe that we deserve option; a sure loss of $700 or a 75%
money under certain conditions where chance of losing 1,000 and a 25% chance
we have to expend a certain amount of of losing nothing. Three out of four took
effort to get our reward. For example, the second choice, condemning them to
an investor sitting on a big prot feels he lose 50 more than they have to. So, in
does not deserve it, and therefore tries to trying to avoid risk, investors create it.
snatch it. When a trader loses, he feels
that his input in terms of effort means Emotion causes most traders to act in a
he deserves a reward and he holds his way that will lead to their ultimate demise.
They prefer a sure gain, however small, time. They want big prots and they
to a logically based speculation to seek want them now. The desire to make
a large prot. On the other hand, they money, however, is in many instances
actually seek risk in the realms of losses. unrealistic. If, for example, I gave you a
They let losses run to avoid taking a small vegetable patch and told you to feed
small loss and, by doing so, they create your family from it, you would probably
greater risk for themselves. They expose think about it logically and deduce that you
themselves to bigger losses when they had insufcient resources at your disposal
could have had a certain small loss. to achieve the aim. Contrast this with the
amount of people I speak to who want
to invest $5,000 in a commodity account,
THE PARTICIPANTS
and earn a living from it and retire from
their job. The chance of achieving their
Wall Street, the famous nancial area of desire is almost nil, but over condence
New York, is named after a wall built in and desire overcome logic and objective
Manhattan in the early settlement days, thinking.
to stop animals wandering. Today the
farming connection lives on in the language Fear All people fear losing money,
of the brokers; namely bulls, bears, hogs worrisome news in relation to their
and sheep. investments and savings stimulates more
fear. Fear then spreads; a fearful man’s
Bulls are buyers: a bull ghts by striking psychology is contagious. If people around
upwards with his horns. A bear, on the us are fearful, so are we. If we have
other hand, ghts by striking with his suffered fear in the past, we retain all
paws. Bulls look up, bears look down, our past experiences in our subconscious
and the price is a constant ght between mind. Finally we have the fear of losing.
the two. So, who are the hogs and Also, if we see other people making money,
sheep? These are the majority of investors we want to be in on the action as well.
trampled underfoot. A hog is greedy and
takes positions that are too large and is Hope This is dened as the expectation of
wiped out by small, adverse moves, or something desired. However, investment
holds prots for too long in the hope that decision making should not be based purely
prices will go on for ever. Sheep are on desire, but on a rational assessment of
passive and fearful followers of the media, the facts. When a trader loses he hopes
gurus, brokers and friends. They bleat that things will get better when he really
at everyone when they lose, and cannot should be being objective.
accept they were responsible.
If you read the great traders, you will
The farming analogy is very close to what constantly see them refer to Hope and
happens in reality. Only strong bulls and Fear and their destructive power.
bears make money. The crowd-following “Hope and fear: I have written about this
characteristics of the sheep, combined with often in my books, and I feel I cannot
the greed of the hog, characterises most repeat it too often. The average man or
losing traders in the market. woman buys commodities because they
hope they will go up or because somebody
DESTRUCTIVE EMOTIONS advises them they will go up. This is
the most dangerous thing to do, never
There are four that are really important in trade on hope. Hope wrecks more people
investing, greed, fear, hope and pride. than anything else. Face the facts and
when you trade, trade on facts, eliminating
Greed Greedy investors tend to be over- hope.”
condent and want to make as much
money as they can in a short period of “Fear causes many losses. People sell out
because they fear commodities are going welfare, it is not, as many losing traders
lower, but they often wait until the decline think, out to punish you.
has run its course and sell near the bottom
… never make a trade on fear.” Consider an analogy with the sea. A sailor
W.D. Gann cannot control the sea but he can control
himself, and in doing so he can earn a
“The successful trader has to ght … two reward. A skilled mariner knows that the
deep-seated instincts, instead of hoping ocean needs to be respected, but he does
he must fear, instead of fearing he must not fear it. He develops skills and discipline
hope. He must fear that his loss may to help him benet from it. By using
develop into a much bigger loss, and hope his acquired skills, no matter what the
that his prot may become a big prot. weather, the sailor is condent of getting
It is absolutely wrong to gamble in stocks into port without harm, and earning his
the way the average man does.” living. An ocean is like the markets, it can
make a man money or he can drown in it,
“The speculator’s chief enemies are always the choice is there for each individual.
boring from within. It is inseparable from
human nature to hope and to fear.” Just as mariners follow rules to navigate
Jesse Livermore from A to B, so must a trader follow rules
to keep him from being sidetracked. The
After greed the average speculator, to rules that I will outline are not new and they
achieve his desire, falls victim to both hope are not original. They will, however, help
and fear and ultimately loses his money you reach your goal of consistent prots.
If you do not have rules and guideline
you will fall victim to outside inuences
PRIDE
and be inuenced by your emotions, your
objectivity will be lost and so too will your
“Price of opinion has been responsible for
the downfall of more men on Wall Street money.
than any other factor.”
Charles Dow THE SECRET OF THE GAMBONI

Pride of opinion is a characteristic of losing The secret of the Gamboni is the secret
traders that have not been able to see of how to survive in the nancial markets.
their inner selves; they do not know their Understand it … really understand it … and
own strengths and weaknesses. They you are on your way to success as a trader,
do not understand themselves and their speculator, or investor. So, here it is.
emotions. Pride is simply stubbornness Joe was a card player, a good one. He was
and the inability to admit a mistake. Any so good, in fact, that he had to move from
trader who insists on holding a viewpoint city to city and nd games where he wasn’t
in total contradiction to what is actually known in order to play for high stakes.
going on around him for no other reason One afternoon, in a bar in the suburbs of
that he cannot admit he is wrong, will meet Chicago, he’s shooting the breeze with the
the nancial disaster. Price can be a direct bartender and asks, “Say, where can I nd
reection of the preceding emotions. a good card game around here?”
“What kind of stakes are you talking
The market is all-powerful, it moves about?”
regardless of any man. You can do nothing
to inuence where it is going and you “Big,” Joe says, “the biggest game you
cannot control its behaviour. When you know about.”
compete in the market only you can be
wrong, and it can never be the other way “Well now, I hear there’s a game out in
around. Although the market is a harsh the farm country. It’s a bit of a drive,
environment and does not care about your but these particular farmers play for big
money. Let me make a call and see if it’s CONSTITUTE A GAMBONI, THE TOP
OK.” WINNING HAND IN THIS
ESTABLISHMENT.
So the bartender makes the call, and then
gives Joe directions to the game. Joe is really angry, but after all, rules are
rules, so he continues to play with what is
That evening, after a long drive, Joe left of his holdings. About an hour later,
pulls up to this barn in the middle of he draws three clubs and two diamonds …
nowhere. Tentatively, he walks inside, a Gamboni! He bets everything, and on
tiptoeing around the fetid piles on the the nal round of betting with the same
oor. At the back of the barn, he spots a leather-faced farmer, he has to throw in
partially open door, with light and smoke his solid gold Rolex to make the call. The
pouring through the opening. The familiar farmer turns over his cards, a queen-high
rush of anticipation and energy sweeps spade ush. Joe turns over his Gamboni
through him as he enters the room and and starts to rake in the pot.
introduces himself.
“Hold it there, fella,” says the farmer, his
Farmers in overalls sit around the table, grin cutting deep lines in his cheeks.
chewing cigars and pufng their pipes. In
a quick glance, Joe estimates the current “But I got a Gamboni!” cries an exasperated
pot to be about $40,000 - perfect. So Joe.
he sits down. “Ante up,” says the farmer
holding the deck of cards. And Joe begins “Sure ‘enough, but look at the sign over
to play. there,” and he points over Joe’s left
shoulder.
About an hour later, Joe is holding is own. Joe looks:
He is about even when he draws three
aces and two queens - a full house. With ONLY ONE GAMBONI WILL BE PERMITTED
a large pot already on the table, he raises PER NIGHT IN THIS ESTABLISHMENT.
$15,000. The next two guys fold, but the
leather-faced farmer across the table calls Joe, broke but thankful for the invention
him and raises another $15,000, without of credit cards, leaves the barn with dung
so much as batting an eye. Joe, certain on his shoes, and the leather-faced farmer
that the guy us blufng, calls the bet and drives his tractor home feeling the weight
lays down his aces-high full house. The of a solid gold Rolex on his wrist.
farmer lays down junk: three clubs and
two diamonds of mixed numbered cards. So the secret of the Gamboni is this: if you
Joe, suppressing a smile, starts to rake in want to win, you’ve got to know the rules;
the pot. and also, you can’t win if you’re not at the
table.”
“Wait just a darn minute,” says the farmer,
a stern and reprimanding tone in his Reprinted by permission of J. Wiley &
voice. Sons. Excerpts from Trader Vic - Methods
of a Wall Street Master.
2Whattaya mean, wait a minute,” says See enclosed reading list.
Joe, “you got nothin.”
Any gambler will tell you that to make
“Take a look at the sign over your right money you need to keep the odds in your
shoulder,” smiles the farmer. favour, and the same is true in trading,
there are no certainties, only probabilities.
Joe looks: To win, you need to speculate when the
odds are in your favour, so succeed you
THREE CLUBS AND TWO DIAMONDS need to accurately predict and play the
odds. You need to know how to place your so too can we use probabilities to predict
bets to maximise your prots and keep market direction. When you trade you
your losses small. To do this you need need to trade with the probabilities and
a disciplined trading plan. The following odds in your favour.
rules, if followed, will help you keep the
odds in your favour, know and follow the In recent years many academics have
rules and you will succeed. If you break scoffed at the idea that markets can be
any of the rules you will end up losing predicted and they point to the theory of
money. Random Walk. The theory is based on
the assumption that markets are efcient.
“Luck, continued the gambler reectively, The market is one where a large number
is a might queer thing. All you know about of equally well informed people actively
it is it’s bound to change, and it’s nding compete to try and maximise prots. In
out when it’s going to change that makes such a market, at any time, the price
you.” will reect all available information as
Berte Harte - The Outcasts Of Poker Flat well as all events expected to occur in
the foreseeable future. The theory holds
We stated earlier that when we trade we that as all current and future events are
confront an unstructured environment and, discounted, the individual’s chances of
to operate effectively, we need to create over performing or under performing the
a structure for ourselves. The reason market as a whole are even, i.e. you can
we need rules is we need to combat the never put the odds in your favour, and
destructive emotions referred to earlier therefore will not be able to earn consistent
and give us discipline. Assuming you prots. If the theory is correct, our rules
have educated yourself and developed a and all our trading efforts will count for
trading method, you will now need to nothing.
execute it with condence, entering and
exiting trades in a consistent manner. It is amazing this theory has become so
Without rules your emotions will dictate widespread and so many people believe it.
your decisions and lead you to nancial It is, however, completely incorrect as it
disaster. assumes that the decision-making process
conforms to scientic theory. It quite
clearly does not; the facts are there for
HOW THE MARKETS REALLY
all to see. However, we all make personal
WORK subjective judgements based upon our
knowledge, understanding and emotions.
“It is remarkable that a science which Given the same information, we do not all
began with the consideration of games of reach the same conclusions.
chance should become the most important
object of human knowledge … the most If we discount the Random Walk theory and
important questions of life are for the most say that human behaviour is unpredictable,
part only problems of probability.” then how can we put the odds in our
Pierre Simon De La Place favour? The answer lies in probabilities
Theorie Analystique Des Probabilities discussed earlier. To trade the markets
1812 you need to trade to minimise risk, and
maximise gains. The way to do this is to
catch the trend. Take any chart over a
Take a coin and toss it into the air. As the period of time and you will notice trends
coin spins in the air you have no idea and and recurring patterns. If all humans think
cannot predict which way it is going to fall. differently, how and why do these patterns
Yet over many tosses the outcome can emerge?
reasonably be predicted. Just as we can The answer can be found in the theory
predict the tosses of a coin with probability, of “chaos”, which postulates that certain
types of natural activity are chaotic except ofce. Human psychology has remained
in terms of probability. To give an example, constant over time, and it is this fact that
the heartbeat of a person can be charted helps us predict the probability of price
but given certain conditions, a heart will movement via technical analysis.
go into random brillation during which
time the heartbeat cannot be predicted 2. It disproves Random Walk theory;
or modelled. Mathematically, weather although market movements may appear
forecasting is another area where chaos random, under statistical tests they are
theory applies. The unpredictability of not.
weather forecasting comes from what
is called sensitivity to initial conditions. 3. If it disproves that the markets are
Mathematical models fail in forecasting random, it also shows why the quest for the
because the slightest divergence between “Holy Grail” computerised or mechanical
simulated and actual conditions multiplies trading system is doomed to failure. It
in a complex chain of cause and effect also confronts those disciples of such
relationships, giving rise to results in the analysts as Gann and Elliott who believe
model totally different than in nature. The the Universe is ruled by law.
best meteorologists can do is to forecast
weather within the limits of probability. 4. It helps us to operate in an
unstructured environment by giving us a
While admitting that certain events in greater understanding of it. The best you
nature don’t follow a perfect mathematical can do is understand the original conditions
order, chaos theory says that they can still that give rise to probable future events,
be understood, predicted and controlled. It and act accordingly. This may sound
directly challenges Random Walk that there disheartening, it is not. By understanding
is no way of predicting market movement. chaos, you will be able to keep the odds
There are no certain predictions but there rmly in your favour. If you can do that,
is order to the chaos, and forecasts can you will end up making a lot of money
be made on the basis of probability. To from your trading, year in year out.
understand probability in nancial markets,
we need to look at the psychology of the
THE MADDING CROWD
participants.

“Whosoever be the individuals that

Why chaos theory is so compose it, however like or unlike be
important. their make of life, their occupations, their
character, or their intelligence, the fact
“The organisation of the Universe demands that they have been transformed into a
that matters abandon itself to the games crowd puts them in possession of a sort
of chance.” of collective mind which makes them feel,
H. Reeves - Atoms of Science think and act in a manner quite different
from that in which each individual of them
The theory of chaos is not a theory to would feel, think and act were he in a state
help you make investment decisions, its of isolation.”
usefulness lies in the greater understanding Gustav Le Bon 1897
it gives us of the trading environment and
how we should cope with it. Chaos theory postulates that we can
make accurate predictions in terms of
1. It shows us how human psychology probabilities and this is certainly true of
inuences price movement, why trends market behaviour. Although all investors
occur, and how they can end up being think differently, in the investment arena
understood in terms of probability. The people change in crowds. In crowd’s
herd mentality is fully explained in our investors, as a whole, react to their
Special Situations Report available from the emotions rather than their intellect, and
it is these basic instincts that can be What inuences his behaviour? Since
predicted and controlled by those investors the ancient Greeks dened Psyche as the
able to stand aside from the crown and Goddess loved by Eros, philosophers have
think in a rational manner. produced numerous conicting theories of
human nature.
Typically a bull market starts ina period of
uncertainty or fear. As more buyers enter In 1762 J.J. Rousseau wrote his famous test
the market, prices rise and condence “Emile”, which introduced a revolutionary
appears. As prices rise, the more greed theory of childhood and human nature that
and hope that prices will continue upwards is still relevant today. Rousseau argued
for the foreseeable future. After a period that man’s nature was essentially good;
everyone has bought, and there is no however, his nature was inuenced and
one left to push prices higher, a small corrupted by society. Rousseau believed
number of investors exit the market, fear that a child’s mind was “Tabula Rosa” or
emerges, and there is a mad scramble to a clean slate when the child was born,
exit the market. This scenario to a greater and it was at this stage that the child
or lesser degree occurs in all investment has the potential within itself to develop
markets. almost unlimited talents. The clean slate
has experiences and rules written upon
1. Human nature in investment markets it as the child learns and develops. As
on mass is constant and repetitive over a child moves from birth to adulthood,
time. he effectively becomes a reection of his
experiences.
2. Investors tend to be followers, not
leaders, and this causes trends to Rousseau’s theory is very idealistic and
develop. perhaps naïve; however, he does pose
3. Investors tend to generally exhibit two very important questions. First, how
the basic emotions of greed, fear and hope much of human behaviour is learned and
when making investment decisions. how much is genetic? Secondly, how
much inuence does society have upon
4. The more bullish or bearish the us? There are undoubtedly instincts and
market becomes, the greater the primary needs that we are born with,
probability of a reversal. and no two infants are exactly alike, i.e.
children have different responses to stress.
Human nature has remained constant However, it is the environment that is
for thousands of years, and although all the major inuence on our behaviour.
humans think differently, the inuence of Children take on the attitudes, behaviour
the crowd allows ut to predict market and opinions of those around them. With
turning points and market trends with a investment there is no doubt that all
degree of accuracy. I have covered the aspects of investment behaviour can be
predictability of man’s investor behaviour learned.
in greater detail in my “Special Situations”
essay, which should be read in association “It’s the psychosomatic form in which man
with this work. experiences his estimate of the benecial
or harmful relationships of some aspects
of reality to himself.”
UNDERSTANDING OUR NATURE
Denition of Emotion

“A man’s character is his fate” As we have stated earlier, method and

Heralatus knowledge by themselves are simply not
enough. If there is one crucial factor that
What actually is man, why does he think makes an investor a winner, it is emotional
and act in the way that he does? What is discipline, which gives the will and ability
the relationship between mind and body?
to execute knowledge. In order to acquire ability to see this pain in a positive way
it we need to look at our desire and that will help us reach and full our desires
motivation, and how these two conicting and give us happiness. In the case of
emotions need to be reconciled in order the language course, it is working with
that we can trade successfully. boring repetitive material; with the diet it
is the pain of being deprived of food we
All of us, at certain times, lack motivation. crave. If you think of the pain/pleasure
We may desire a whole host of different relationship in trading, you should consider
goals, yet we lack that spark of motivation the fundamental rule of trading: cut your
to get us there. To full our desires and losses and let your prots run and you will
reach our goals, we need to channel our see why the majority of investors nd it so
desire through positive motivation. difcult.

Positive motivation is needed to get us to Taking a loss, however small, is painful

our goals. Without it, all our knowledge and ego deating. It means an admission
and desires are useless. Consider the of being wrong. Rather than take the
area of weight loss. You can go into loss, people hold on and hope that it will
any bookshop and you will see countless turn around and become protable, and
scientically proven methods of losing therefore pleasurable. In the world of
weight. Yet out of every 100 people who trading this very rarely happens - the
start a course, only 10 succeed in losing result is normally a bigger loss and greater
weight, and only 2 in 100 keep it off pain. Similarly, when we see a prot in the
for more than a year. The success rate market, the pleasure we derive from this
is less than futures trading! Ever seen means that most investors take it before it
those step-by-step language courses - just has the chance to turn around and cause
follow the tapes and in no time at all you pain. To be successful, it is clear that one
will be speaking your desired language needs to be able to positively accept short-
with uency. Now everyone can learn term pain to reach our ultimate goals and
a language, yet the success rate here is desires.
about the same as in the area of weight
loss. “Let me tell you the secret that has led me
to my goal: my strength lies solely in my
“People who deal with stress believe that tenacity.”
an increase in the pain and strain must L. Pasteur
happen before the pain will go away. Their
approach to stress and life is similar to To achieve positive motivation you need
Nietzche’s statement ‘whatever does not to set clear, long-term goals and motivate
kill makes me stronger.” yourself towards them. An acceptance of
Salvadore Madd short-term pain, therefore, is inevitable. If
you make a complete honest commitment
There are two fundamental emotions that on what you want from life, why you
stand in the way of positive motivation. want it, and how you intend to full your
The two emotions are the need to avoid desires and goals, this personal honesty
pain and the desire to achieve pleasure. In will release you from the pain/pleasure
order of importance, the need to avoid pain paradox that most investors suffer from.
dominates. If our desires remain unfullled
we will, however, feel empty, depressed
INVESTOR PROFILES
and dissatised. Our motivation to reach
our goals is continually undermined by
conicting emotions. I have worked in several commodity
brokerages, introducing accounts, and now
To achieve our desires and feel fullled, write books and newsletters in addition
we need to suffer some pain. It is the to running my own commodity brokerage.
I have probably introduced around 6,000
investors to trading over the years, and The Educated Fool
have encountered a broad cross-section
of investors. In his book “Beyond the Just like Jake Berstein, I have come across
Investors Quotient” J. Bernstein puts the this investor numerous times over the
investors he has come across into years, highly intelligent, knowledgeable,
categories. I have done a similar exercise with a string of degrees and letters after
below, and tried to put investors into six their name. The problem they encounter
main categories. They are not etched is they feel the application of knowledge is
in stone and some categories obviously all that is needed to make money. They
overlap. create vastly complicated trading systems
that look great, and then totally collapse
The Universe is governed by law There in the market place. These people cannot
is a huge marketing campaign in futures translate theory into practice. They have
trading based around Holy Grail systems no grasp of psychological aspects of trading
that are able to accurately predict future and normally have great problems
price movement based upon scientic law. admitting their approach is wrong.
They normally claim fantastic results and
yet will only cost you a few hundred It’s everybody’s fault but mine This
dollars. person refused to take responsibility for
his trading decisions. If he makes a prot
Many systems are based around investors he shouts how wonderful he is, and when
who are dead, and two of the most famous he loses he blames everyone from his
are R. Prechter and W.D. Gann. These broker giving him bad advice, his wife and
two are promoted by a number of books, even the market, which is acting illogically.
courses and software companies as two of This investor is normally insecure, unable
the most successful investors of all time. to take responsibility, lacks condence,
The fact that they are dead means that and exhibits a lot of emotion in trading.
they cannot answer some basic questions
like if they were so good at predicting The Opinion or Advisory Service Junkie
price movements, why did they not make This investor has found the secret of
much money? The reality is, Prechter died investing. His logic is to get as many
a pauper and W.D. Gann, who allegedly advisory services as possible and wait for
amassed a $50 million fortune, had to them all to be looking at the same trade.
sell courses and books, as he could not Several heads are better than one he
support his family by trading. When he concludes. Once he has a trade that ts
died, his estate was valued at a modest these criteria, he gains additional advice
$100,000. You will see all types of scientic from brokers and friends. This trader’s
systems, many are based on astrology logic is awed in that if everyone is looking
- how accurate are they - probably as at a trade to go in a specic direction, it
accurate as your horoscope. will normally go the other way. This trader
needs to study the theory of contrary
It amazes me how people fall for this opinion. The old saying “if it’s obvious,
hype. Clients who fall for sure re systems it’s obviously wrong” applies to his way of
vary from highly intelligent traders to picking trades.
newcomers. Alas, they don’t last long,
normally the rst couple of trades shatter The Action Man
the illusion and it’s back to the reality of
working for a living. There are some good This investor likes to trade all the time, he
mechanical systems around however. Just loves the action. He will trade in and out
like any good trader, they suffer periods of of the market continuously, rarely holding
drawdown. positions for any great period of time.
This trader normally has a reasonable
understanding of market movements, but
rarely makes any money. He cuts his themselves from trading.
prots and eventually his losses and
commission charges erode his account. I 3. Losing money can and will occur,
have seen traders like this trade for ve and is acceptable to these investors.
or six years every day, not making money,
yet still cheerfully trading. 4. Prots will occur over a period of
time and these can be run to a signicantly
The Inability To Pull The Trigger larger size than their losing trades.

This investor is one who has great difculty 5. These investors love and enjoy what
in placing an order and there are far more they are doing, and therefore have no
of them than you would probably think. problem devoting regular time to trading.
Sometimes traders have a problem making
the rst trade, and this stems from a lack 6. Open-mindedness and adaptability.
of condence. They’re always agonising Successful traders remain open-minded
over the perfect trade to so, and end up and receptive to new ideas when it is
doing nothing. It also happens after a necessary. They nd it easy to adapt and
losing trade, condence that was there change and they are not concerned with
goes. It’s like the skier at the top of admitting when they are wrong.
the hill who has had a bad fall and can’t
go down again. The problem is, if you A well thought out and logical trading
are afraid to go downhill, you can’t be a method, combines with the above beliefs,
skier. If you fear to trade, you should nd will give any trader an edge in the quest
another profession. for prots.

So far the above traders fall into losing

BECOMING A DISCIPLINED
categories, and represent the bulk, say,
90-95%. The other 5% are all different INVESTOR
individually, however, there are some
points they all have in common that are “A key to self management is the capacity
for self-observation, it is not the same as
outlined below.
over-criticism … it is rather a consistent
monitoring of one’s performance from a
SUCCESSFUL INVESTORS perspective signicantly detached to allow
accurate evaluation.”
Successful investors may use different A. Gareld
systems or approaches to the market, have
different educational backgrounds and be It is clear that knowledge of oneself is
of various ages. However, they would have just as important in trading as knowing
the following beliefs that enable them to facts, economic theories, news or trading
reap prots from the markets: methods. In the trading world, often
emotion reigns supreme, facts are ignored
1. Self-condence. This comes from and there is no wrong or right. The person
both knowledge of the markets and who has control of himself due to his
self-knowledge of their strengths and discipline and emotional self-control will
weaknesses. They effectively believe that ultimately emerge from the battleeld a
they will make prots in advance. They winner.
believe the game has been won before they
begin. If you are not self-condent in your However, coming to terms with our
own ability, it is unlikely you will ever strengths, weaknesses and personal traits
become a successful trader. is not easy. It is not easy to analyse
yourself objectively because you will
2. Money itself is not important; this naturally have a subjective perspective.
allows them to emotionally detach
When trying to understand yourself, you the truth. The truth, however, is elusive,
must be willing to be totally honest with as there is no scientic method to get
yourself. This can be difcult and painful. us to the truth. The truth is difcult to
The person must have the ability to accept see as it can be totally different to what
the results of looking within. Most people, your emotions and natural instincts are
however, nd it difcult to admit they made telling you. Furthermore, the fact that the
a mistake. Ask a room full of people how majority of people agree or disagree with
many of them are happy admitting their you has no relevance in the pursuit of the
mistakes and you will see few, if any, hands truth.
go up. Admitting mistakes, however, is a
positive not negative attribute in trading, To succeed in trading you need to
as it is in life. The world is full of people understand that there are no certainties,
who want to be right, but the reality is only probabilities, and to seek the truth
everyone cannot be right all of the time. you need to have a deep understanding
“Learning is after all not whether we lose of yourself and the market you operate
the game, but how we lose and how we in, and how you relate to it. You need to
have changed because of it, and what stand-alone and, from your perception of
we take away from it that we never had what is going on around you, decide what
before to apply to other situations’ losing the truth is.
in a curious way is wining.”
Richard Bach I started this essay with a quote from Lao
Tzu, who founded the Chinese philosophy
All of us have physical and mental of Taoism over 2,500 years ago. Many
disabilities, which prevent us from of the beliefs of Taoism are relevant to
achieving all our goals and desires. No trading.
one is perfect. It is possible, however, to
isolate and work on weaknesses. This is Trading is a reection of life. This is
similar to reviewing and working on your why there are so many contradictory ideas
trading method. You must understand the and shades of grey instead of black and
strengths and weaknesses of the system white answers. Just like life, trading is
and try to improve it, but realise perfection unpredictable; people who believe that
is impossible. Remember, in the nal there is a scientic law to investing that
analysis you have inherent weaknesses and can predict commodity price movements
may not have all the required attributes are missing the point. Trying to reduce
for trading, but neither does anyone else. everything to numbers if, in Lao Tzu’s
The more traits you possess, the greater words, like trying to catch running water
your advantage, but the more you work in a bucket.
at obtaining these traits, the better your Many elements of Taoism hint at the
chances for success. psychological course of events. This is
particularly relevant in trading. Tao in
English means “the way”. Tao is the
THE SECRET OF MARKET
missing link in trading, it is effectively the
SUCCESS ability to see an event before it is denitely
known, that is the key. It is really the
“For surely we are not … no simply intuitive ability to see and then to act.
contending in order that my view or that
yours may prevail, but I presume that we In the world of Taoism you need the
ought both of us to be ghting for the ability to use both analytical and intuitive
truth.” skills. Relying on both right and left
Socrates hemispheres of the brain to process and
analyse information, this is the key to
The aim of any investor is to make money identifying and acting upon the truth. Once
by correctly identifying and acting upon you have brought your thoughts to bear
on the facts of a situation, then you need reading list for further information.
to let go. This is the incubation stage
where you are letting your thoughts go
FURTHER READING
where they may, without the inuence of
anyone else. When you learn to think and
Some of the information enclosed has
act in this manner, you will be surprised
been from direct experience. However, a
how you see many situations the crowd
considerable inuence on my trading has
will never see.
come from the enclosed material.
Investors spend millions each year on “Holy
Recommended:
Grail” trading methods, books and tapes
1. The Disciplined Trader
that they believe will give them regular
Mark Douglas
and consistent prots from the market,
with low drawdowns. These people will
2. The New Investors Quotient Jacob
never make money; in trading there are
Bernstein
no certainties, only probabilities, and a
trader must accept this if he is to make
These books cover all aspects of
money. psychological problems encountered in
trading and give clear guidance on how
FINAL WORDS to avoid the emotional traps that destroy
most traders’ equity. These two books
A scorpion wants to cross a river, but he complement each other, and are essential
can’t swim. He asks a frog, who can, if he reading.
can hitch a ride on the frog’s back. “You’ll
sting me,” says the frog. “It would not
be in my interest to sting you,” says the
scorpion, “because then I would drown.”

The frog thinks about the scorpion’s logic,

nds it impeccable, agrees to take the
scorpion on his back, and then braves
the waters. Halfway across the river, the
frog reels a burning spear in his side; the
scorpion has stung him after all. As they
sink beneath the waves, the frog cries out,
“Why did you sting me Mr Scorpion, for
now we both will die?” “I can’t help it,”
replies the scorpion, it’s in my nature.”
(From the movie “The Crying Game”
1992)

We are all human, and we all have emotions

that are inherent in our biological make-up,
we can’t rid ourselves of them. What we
can do is understand them, and try to
control them. If we don’t, our trading will
be doomed to failure.

Obviously there is limited space in this

essay to cover all the psychological aspects
of trading. I would, therefore, strongly
recommend you consult the enclosed