10 How Memories, Associations, and Beliefs

Manage Environmental Information 99

11 Why We Need to Learn How to Adapt 121

12 The Dynamics of Goal Achievement 139

13 Managing Mental Energy 155

14 Techniques for Effecting Change 167

Part IV How to Become a

Disciplined Trader 181

15 The Psychology of Price Movement 183

16 The Steps to Success 201

17 A Final Note 223

Index 225

Foreword

My unique position in the financial community has allowed me the rare opportunity to talk to and question thousands of traders, brokers, and trading advisors since 1979.1 am not a broker or a letter writer. 1 am the chief executive officer of CompuTrac, a company that supplies technical analysis to stock and futures traders. I perceive my position as being neutral, one that allows people to open up and talk to me freely. I started trading for my own account in 1960 and very quickly became aware of the underlying psychological blocks to good trading and money management. This realization has been confirmed by all who have counseled with me.

As a result, I sincerely feel that success in trading is 80 percent psychological and 20 percent ones methodology, be it fundamental or technical. For example, you can have a mediocre knowledge of fundamental and technical information, and if you are in psychological control, you can make money. Conversely, you may have a great system, one that you have tested and has performed well for a long period of time, yet if the psychological control is not there, you will be the loser.

A good trader knows from experience that over a period of time

Foreword

he may engage in more losing trades than winning ones. But money management, and a careful assay of the risks protected by realistic stops, will keep the trader out of trouble and ensure that on the "big" moves, he will profit. Money management is composed of two essential elements: psychological management and risk management. Risk management stems from the psychological factors being truly understood by the trader and "in place" before risk is even considered.

I would especially caution new traders and market participants that reading and passively analyzing your motivations are certainly a necessity, but the acid test comes with active trading under pressure. Start slowly. Question every trade. What motivated it? How was the trade managed? Was it successful? Why? Did you lose? Why? Write down your assessment and refer to your comments before making your next trade.

At all major CompuTrac seminars I try to have a workshop leader address the attendees on the psychological aspects of trading. The grim reaper who kills off "your equity" and disappears with your profits is not the mysterious and ubiquitous "they" but a simple misguided "you." Medea said just before she murdered her children, "I know what evil Im about to do, but my irrational self is stronger than my resolution." If this sentiment reflects your mind set when you trade, then The Disciplined Trader is definitely the type of book you should be reading.

What a pleasure to read this book. My own education cost me a lot "the hard way." I can read myself into the pages-thats me, thats me! Mark has carefully fashioned his book into a comprehensive logical dialogue. It reads as if you are at his side and he is explaining it as a friend, which I know you will enjoy. You are fortunate because you are taking the time now, before you have made a serious mistake, I hope, to learn about yourself and to study your craft. The traders who take the time to reflect and practice will survive and possibly prosper.

Timothy Slater President

CompuTrac Software, Inc.

Preface

The Disciplined Trader is a comprehensive guide to understanding the psychology of self-discipline and personal transformation needed to become a successful stock or futures trader. This book will serve as a step-by-step guide to adapting successfully to the unusual psychological characteristics of the trading world.

I say "adapting" because most people venturing into the trading environment dont recognize it as being vastly different from the cultural environment in which they were brought up. Not recognizing these differences, they would have no way of knowing that many of the beliefs they acquired to enable them to function effectively in society will act as psychological barriers in the trading environment, making their success as traders extremely difficult to achieve. Reaching the level of success they desire as traders will require them to make at least some, if not many, changes in the ways they perceive market action.

Unlike other social environments, the trading arena has many characteristics requiring a very high degree of self-control and self-trust from the trader who intends to function successfully within it. However, many of us lack this self-control because as children we learned

Preface

to function in a structured environment where our behavior was controlled by someone more powerful than ourselves, whose purpose was to manipulate our behavior to conform to societys expectations.

Thus, we were forced by external forces to behave in certain ways through a system of rewards and punishments. As a reward, we would be given the freedom to express ourselves in some desired manner. As a punishment, we would either be prevented from getting what we wanted, causing emotional pain, or we were inflicted with various forms of corporal punishment, causing physical pain. As a result, the only form of behavior control that we typically learned for ourselves was based on the threat of pain-either emotional or physical-from someone or something we perceived as having more power than ourselves. And since we were forced to relinquish our personal power to other people, we naturally developed many of our traditional resources for success (the particular ways in which we learned to get what we want) from the same mental framework. Accordingly, we learned that acquiring power to manipulate and force changes upon things outside of us was the only way to get what we wanted.

One thing you will learn as a trader is that the mental resources you use to get what you want in your everyday life will not work in the trading environment. The power and control that are necessary to manipulate the markets (make them do what you want them to do) are beyond all but a handful of individuals. And the external constraints that exist in society to control your behavior dont exist in the market environment. The markets have absolutely no power or control over you, no expectation of your behavior, and no regard for your welfare.

If, in fact, you cant control or manipulate the markets and the markets have absolutely no power or control over you, then the responsibility for what you perceive and for your resulting behavior resides only in you. The one thing you can control is yourself. As a trader, you have the power either to give yourself money or to give your money to other traders. And the ways in which you choose to do this will be determined by a number of psychological factors that have little or nothing to do with the markets. And this will be so until you acquire some new skills and also learn how to adapt yourself to suit conditions as they exist in the market environment.

To operate successfully in this environment you will need to learn how to control yourself in ways that may be completely alien to you.

Preface

xiii

You will also have to learn how to grant yourself the mental freedom to shift your perspective to notice alternative possibilities to getting what you want in the trading arena, regardless of your expectations of how you are going to get it. There are only a few traders who have come to the realization that they alone are completely responsible for the outcome of their actions. Even fewer are those who have accepted the psychological implications of that realization and know what to do about it.

Rarely do any of us grow up learning how to operate in an arena that allows for complete freedom of creative expression, with no external structure to restrict it in any way. In the trading environment, you will have to make up your own rules and then have the discipline to abide by them. The problem is, price movement is fluid, always in motion, quite unlike the highly structured events that most of us are accustomed to. In the market environment, the decisions that confront you are as endless as the price movements you intend to take advantage of. You dont just have to decide to participate, you also have to decide when to enter, how long to stay in, and under what conditions to get out. There is no beginning, middle, or end-only what you create in your own mind.

In addition to the negative psychological implications that accompany these decisions, you must be aware that even if you make the minimum financial commitment of one contract per trade (as in the futures market), there is an unlimited potential for profit as well as an unlimited potential for loss. From a psychological perspective, this means that each trade has the possibility of fulfilling your wildest dreams of financial independence, and simultaneously presents you with the risk of losing everything you own. The constantly changing price movement makes it extremely easy for you to ignore the risk and tempt yourself into believing you dont have to follow your own rules, this time.

Here is an environment that offers complete freedom of expression combined with unlimited possibilities and unlimited risk. If you place in it a participant who is oblivious to these psychological conditions (one who operates from a mental framework oriented toward external structure, constraints, and expectations), then what you have is a formula for emotional and financial disaster.

This grim scenario certainly explains why so few people ever make money as traders. Actually, almost all of those who make an