Description

In this episode, we are discussing trading tutorial by Alexander Elder, a psychiatrist who applies psychological principles to financial markets. Elder emphasizes the crucial role of psychology in trading success, arguing that emotional control and self-awareness are as vital as technical analysis. He highlights the inherent "minus-sum" nature of trading, where commissions and slippage systematically disadvantage the average trader, making superior psychological discipline essential for profitability. The tutorial then details practical strategies, including the "triple screen trading system", risk management techniques (like the 2% rule), and analysis of market psychology through volume, open interest, and chart patterns (trend lines, support/resistance), all aimed at helping traders achieve consistent, long-term success by focusing on objective analysis and emotional control rather than chasing quick gains.

Main Themes:

1. The Primacy of Psychology in Trading:

• Elder asserts that trading is as much a psychological game as it is an analytical one. He states, "the key to winning was inside my head and not inside a computer." He argues that traders often lose because they are unable to manage their emotions, which leads to poor decisions.
• He connects trading performance directly to emotional states: "your feelings have an immediate impact on your account equity...if you feel frightened, arrogant, or upset your account is sure to suffer."
• He emphasizes that "the feelings of thousands of traders merge into huge psychological tides that move the markets." Traders are competing against the "sharpest minds in the world," and emotional control is essential to stand a chance.
• He introduces the concept of market "crowds" and their impact on price movements. He quotes Le Bon: "the fact that they have been transformed into a crowd puts them in possession of a sort of collective mind which makes them feel, think, and act in a manner quite different from that in which each individual of them would feel, think and act were he in a state of isolation."
• He uses an analogy with Greek sirens: traders must "tie themselves to the mast of a trading plan" to resist market "songs" (temptations).

1. The Importance of Money Management:

• Elder underscores the necessity of strict money management, stating that "inability to manage themselves leads to poor money management."
• He introduces the concept of "businessman's risk," recommending that no more than "two percent of account equity" should be risked on any single trade. He emphasizes, “A sensible Trader never risks more than two percent of account equity on any trade." He calls this limit critical for long-term survival.
• He emphasizes the need for detailed record-keeping, viewing poor records as a "sign of a gambler and a loser."
• He highlights that slippage and commissions, often overlooked, significantly impact profitability, stating they make "trading similar to swimming in a shark infested lagoon." He encourages traders to seek low commissions and use limit orders.
• He explains the difference between slippage types: common, volatility-based, and criminal slippage (the latter being illegal activities by floor traders).

1. Market Dynamics and Participants:

• He breaks down market participants into Bulls (buyers), Bears (sellers), Hogs (greedy), and Sheep (followers), warning that “Hogs get slaughtered.” He highlights how psychological extremes drive market trends.
• Elder highlights that prices reflect a balance between buyers and sellers, and that every price is a "momentary consensus of value of all Market participants expressed in action." He further explains how this consensus shifts constantly, creating market movements.
• He emphasizes that technical analysis is "applied social psychology...aims to recognize trends and changes in crowd behavior." He also shows how mass psychology affects market trends, referencing the behavior of bulls and bears and how they impact market behavior.
• He notes that institutions have inherent advantages but can be slow and bound by rules. “The Achilles heel of most institutions is that they often have to trade while an individual Trader is free to trade or stay out of the market.”
• He discusses the need for private traders to be patient and avoid overtrading, contrasting the approaches of institutions and individuals.

1. Technical Analysis and Trading Systems

• Elder introduces technical analysis by emphasizing it is "similar to poll-taking." It allows for observation of crowd behavior and anticipation of changes based on trends and momentum.
• He highlights that traders need to define what they are going to do and not just rely on what "appears" to be happening.
• He describes the importance of support and resistance levels which are a product of collective memory and emotional reactions of traders. He states that "Traders buy at support and sell it resistance making their effectiveness a self-fulfilling prophecy."
• He provides rules for using support and resistance, emphasizing the use of stops and understanding the impact of long-term versus short-term charts.
• He explains how to trade breakouts and the importance of waiting for confirmation. “The best time to buy an upside breakout on a daily chart is when your analysis of the weekly chart suggests that a new uptrend is developing.”
• He emphasizes the importance of understanding volume, as it reflects “the degree of financial and emotional involvement” in a market. He notes how falling or rising volume can indicate trend continuation or reversal. He states "a trend that moves on steady volume is likely to continue" but “falling volume shows that the supply of losers is running low and a trend is ready to reverse.”
• He discusses the significance of open interest, how it changes in relation to trading behavior and the number of contracts held by buyers or sellers, and how this relates to trend strength. "Rising open interest shows that a crowd of confident Bulls is facing down a crowd of equally confident Bears."
• He stresses the importance of identifying cycles and seasons within markets, using a farming analogy.
• He introduces the concept of consensus indicators as a way of anticipating major trend reversals by trading against the market.
• He explains the importance of monitoring the actions of successful groups such as commercials or hedgers, based on the reports from institutions such as the CFTC or SEC.
• He introduces and describes his "Triple Screen Trading System," which combines trend-following and counter-trend techniques, incorporating analysis across different time frames.
• He explains the value of trading within price "channels" using an analogy to how rivers flow.
• He states that a "good trading system" has to be both "crude and robust" and not based on complex elements that could easily break down.

1. Discipline and Self-Awareness:

• Elder emphasizes that self-awareness is critical for success, noting, "you may have to devote as much energy to analyzing yourself as you do to analyzing the markets."
• He contrasts professional traders with amateurs, noting that professionals focus on skill development and good process rather than quick profits.
• He explains that "the goal of a good Trader paradoxically is not to make money his goal is to trade well if he trades right money follows almost as an afterthought."
• He encourages traders to think of themselves as being in the market for the "long haul" and to learn as much as they can while staying skeptical and asking questions.
• He advises traders to "be aware that a trader is the weakest link in any trading system." This highlights the need for self-control and personal development.
• He encourages traders to keep learning and improving, citing a trader who stated, “If I’d become half a percent smarter each year, I’ll be a genius by the time I die.”

Key Quotes:

• "Psychology is the key."
• "The key to winning was inside my head and not inside a computer."
• "Your feelings have an immediate impact on your account equity."
• "A sensible Trader never risks more than two percent of account equity on any trade."
• "Trading is so exciting that it often makes amateurs feel high...emotional trading is the enemy of success."
• "The goal of a good Trader paradoxically is not to make money his goal is to trade well if he trades right Money Follows almost as an afterthought."
• "The markets are too complex to be analyzed with a single indicator."
• "Markets exist in several time frames simultaneously."
• "Do not confuse brains with a bull market."
• “You can succeed in trading only when you think and act as an individual.”
• "Prices reflect action or lack of action by all traders in the market charts are a window into mass psychology."
• "When a crowd becomes either spooked or elated prices begin to jump."
• "Technical analysis is applied social psychology it aims to recognize Trends and changes in crowd behavior in order to make intelligent trading decisions."
• "The market is a huge crowd of people each member of the crowd tries to take money away from other members by outsmarting them."

Conclusion:

These excerpts from "Trading for a Living" provide a strong foundation for understanding the multi-faceted nature of trading. Elder emphasizes that success is not solely determined by analytical abilities but requires a disciplined approach, emotional control, and a deep understanding of market psychology. By combining a robust trading system with meticulous money management and a strong awareness of one's own behavior, a trader can improve their probability of success. The book seems to caution against quick fixes and instead promotes patience, constant learning, and the importance of inner work in order to find long term success.