INDEX

Trading Philosophy General Understanding of the Markets.

- Market and Logic History teaches us.
- The Dual Reality
- A Traders View of the Market traders job
- Information vs. Price information price divergence
- Trends and Reversals turning points how trends are born and how them
die.
- Changes and Consistency in the Markets Trading climate new or same
old.
- Manipulation in the Markets manipulation. Myth and reality
- News and Price Interaction news tradeem or fadeem
Building Trading System
- Role of Technical Analysis What do your camera frying pan and stochastic
have in common?
- How to Start method to madness
- Paper Trading paper trading. Waste of time or valid learning method?
- Type of Movement method to madness II
- Structure of the Setup method to madness III
- If-Then Scenarios bit about if and then scenarios
- Types of Entries how aggressive are you?
- Capitulation - how to trade it capitulation, how you recognize and
trade it.
Risk Control
- Role and Necessity of Stops non stop discussion of stops
- Stop Loss vs. Sitting It Out can you afford to be wrong for too long time?
- Averaging Down averaging down, yea or nay
- Basics of Stop Loss stops why and how.
- Deeper Look into Stop Loss stops deeper look
- Protecting Your Profits profit, how do you handle it?

Trading Psychology
- Basics of Trading Psychology psychology 101
- Novice trading psychology stage 1
- Intermediate trading psychology stage 2
- Experienced trading psychology stage 3
- Sophisticated trading psychology stage 4
- Psychology of a Stop Loss stops why dont we keep them
- Psychology of Relapse costly hiccups do you have
- A Traders Mental State mental state
- Staying on a Sideline trade what you can read
- Simplicity in Trading simplicity, whi dont we appreciate it?
- Trading is Not War is market a battlefield for you?
Day Trading, Scalping and Tape Reading
- What Is Scalping As you name boat or what is scalping.
- What Is Scalping II - As you name boat or what is scalping II.
- What Is Tape Reading whats in name or what is tape reading.
- Basics of Tape Reading philosophy

Miscelaneous
- Death by a thousand cuts?
- Surgeons, dentist and traders
- Death by a 1000 cuts- revisited.
- old ways, new results?
- Stephen King on trading
- Scan for your battles.
- lost and found, or does common sense works in trading?
- Security tax proporsal.
- Stupidity, hypocrisy or both?
- Market reversal setup.
- culprits and scapegoats
- Warning to the botton fishes
- Tao, Photography and trading
- Three kinds of crash- revisited
- How this market is unique.
- Unbeareble boredom of trading.
- A few questions for the goldbugs to ponder.

TRADING PHILOSOPHY GENERAL UNDERSTANDING OF THE

MARKETS
MARKET AND LOGIC
History teaches us Sunday, march16, 2008
As you know, I don't comment on current market conditions on this blog. Being an
educational blog, it's simply not the purpose. Being that, it would also be a crime
not to comment on immense learning opportunity provided by the market
conditions we are seeing.
Make no mistake, we are going through the crisis of historic proportions. It's almost
time to start coining a name for it. Great Liquidity Crisis? Credit Crunch of the
Century? The Day (insert bank name) Fell? If you as a trader went through this
market unharmed - good job protecting your behind while sharks circle around. If
you make money in this market - congratulations, you do not belong to majority
anymore. If you are a newer trader just starting your quest - consider yourself very
lucky. Yes, lucky, because if you learn in this environment - you will find the "normal"
market to be piece of cake to trade in.
Let us outline the lessons to be learned during such extreme times.
First and foremost, and the most important:

1. Logic of underlying events vs. logic of market movement.

This is one of the most confusing aspects of the market for many investors and
inexperienced traders. We are conditioned to see causes and outcomes as being
linked in a logical fashion. Bad news should send the price down. Good news should
cause rallies. We want to buy good news and short bad news. We want to trust our
analysis and act on our conclusions - and we, naturally, expect the market to follow.
So, shouldn't we feel perplexed seeing how the market stages stunning rally when
there is nothing but doom and gloom in all the sources of information? What else
can we do but dismiss it as manipulation?
Well, manipulation it is in many cases. However, this notion doesn't take us
anywhere as far as money-making is concerned. The major lesson in this is old as
the market itself: if something is exceedingly obvious, the market will act against it.
Market by its very nature cannot reward the obvious with money - simply because
majority follows the obvious, and majority cannot be profitable. It can't because
there is no pool of money set aside for the winner - money is being extracted from
other market participants. Who could majority extract the money from? And, if there
is no money for a group betting on certain direction, then this group in fact renders
this direction as wrong by simply being too big.
If this sounds confusing, let's put it in simpler terms. If there are just 10 participants
in the market and 9 out of 10 bet on downward move, who is left to sell more and
push the price lower? They all sold short already, so what are they going to do when
they see that the price is not dropping anymore? What other choice do they have
but to start closing their short positions, pushing the price higher? That single player
that took long position against those 9 may be wrong about the events in economy but he will be right on the market direction. He will make money by betting against
majority. Of course this is simplified way to look at things, the reality is much more
complex, with all the different timeframes, new participants jumping in or getting

out. This simple case, however, explains the divergence between the logic of the
market movement and the logic of economy events.
This is the major lesson of this market because rarely can it be seen as clearly as
these days. Do not fall into the trap of obviousness. Being right in a long run will not
protect you from the losses today. Being right about the meaning on events does
not mean the market hasn't priced those events in yet. Alternatively, market may
be preparing to move in your direction, and its way of preparation is to shake out
prematurely taken positions. Market is doing its best to move having as few
participants on board as possible - and it's doing it by means of moving against the
obvious. Price action overrides everything. We traders profit from price changes that's the ultimate market language. This divergence is your friend, not your foe - it
allows you to distinguish the Smart Money action from the Crowd actions and
position yourself on the right side. This is major difference between the way traders
think and the rest of population think.

2. Handling extreme volaitity.

If you are a short-term trader, imagine being an investor at the times when major
indices swing as wide as they do these days. 400 points range is almost a new norm
for Dow. NASDAQ rallying 40 points in a matter of minutes after talking head on
CNBC mentions a rumor? Gut-wrenching... How do you control your risk under such
circumstances, challenging even for a day trader?
- keep your position size reasonably smaller than usual
- shorten your holding period to limit your exposure and minimize your chance to
get caught into sudden move; book your profits. These are the times when investors
go to swing trading; swing taders go to day trading; day traders go to scalping;
scalpers.... umm, scalpers remain scalpers, some of them haven't even noticed that
there are some major changes underway. Lucky bunch eh?
- never ever let these wide ranges lure you into false sense of security of "it will be
back to my price on the next pendulum swing anyway" kind. Market can stay insane
much longer than you can stay solvent - keep your stops religiously.

3. Use this market as a tremendous learning opportunity even when you stay in
cash.
This is a lifetime opportunity to learn. A lot of things that are usually muted and
barely visible are very "in your face" right now.
Watch how major players react and interact - financial stocks, techs, metal-related.
Watch how market reacts on news and rumors. Watch how breakouts work, how
breakdowns work, how ranges hold. Watch market reactions on news and rumors.
Watch which moves get follow-through and which get faded; try to get a feel for the
difference so you would be able to tell in the future one from another. Watch when
the market becomes totally unpredictable and erratic so that in the future you could
recognize such situation as early as possible and go to cash.
Finally, one more thing to observe... it takes us back to our title:

4. History teaches us that it teaches us nothing.

Watch eternal cycle of hope based on denial and fear stemming from lack of
understanding of market inner workings. Every piece of "good news" spat out by
propaganda machine sparkles explosion of optimism - no matter how lame "news"
is. Someone comes to TV and says something, with agenda or just striving for
attention - and their words become a gospel or anathema, depending on listener's
positioning in the market. Positions are being held despite market going against the
holder. Positions are being taken and dumped out of pure emotions; rules are being
abandoned. Emotions run high making people do a lot of stupid things. Observe it
all as, just as in previous point, when the heat is that high all these things are seen
very clearly . Such heightened tension as we have now serves as a photo film
development.
It may sound a bit cynic at the time when the wealth is being destroyed at such
rate, but let's say it again... as a trader consider yourself lucky to have such
learning opportunity. Use it to its full extent. Oh, and by the way... The quote that
served as a title for this post is a cute simplified form. Full quote from Hegel is even
more telling. What experience and history teaches us is that people and
governments have never learned anything from history, or acted on principles
deduced from it.
THE DUAL REALITY

Traders come to the marketplace with pre-conceived ideas about how and why the
markets move. While some of these ideas are valid, most are based on untrue
assumptions . Many of these assumptions are found within the un-moderated areas
of bulletin boards and trading threads. Most of these assumptions, while seem
logical and true, are simply dead wrong. This leads traders down a road of failure
without offering a trader an explanation to why he was unable to make the trading
plan work effectively. This early failure leads to disgust and negativity towards
trading for living. Many turn this emotional state to blame of the market and its
participants in a manner that the trader is not able to apply what happened in their
trading plan to lead to a positive result. This lack of accountability moves traders
away from profitability over the long term and does not give the trader a solid
foundation to build his or her portfolio. All this stems from initial misinformation that
was presented to a trader and accepted blindly.

There is a true reality and a reality that traders create for themselves from such
misinformation that is accepted blindly. Unfortunately, these two realities are never
the same. However, the more a trader is a detached and objective observer rather
than an opinionated and emotional follower, the closer his reality to real market
reality becomes.

A TRADERS VIEW OF THE MARKET

A traders job. Tuesday, April 29,2008

As it happened before, during some unusual market events and/or very jittery
market action I get more visits and discussions from somewhat different sandbox long term traders. I mean, normally they won't even give a second look to my
measly 30 cents here, 60 cents there profts... OK, just kidding. Either current market
events drive them, at least for the time being, to shorter time frame, or something
they read in Techniques of Tape Reading stuck in memory and resonated with what
they encounter now... interesting thing though is, they usually come to seek a
change of a timeframe they operate in but what they find is a necessity to change
their philosophy - no matter whether they look at 1 min chart or monthly one.
Anyway, there was this lengthy conversation over a course of several days which,
with kind permission of my collocutor, I will cite here in as short form as possible.
My remarks are in blue.
- So, here is a problem I run into. At the beginning of March I took massive short
position based on negative read on the economy, on financial crisis etc, you know
what headlines say for quite a while. Now, things don't really seem to be improving
in general economy, so I know my read on it is right. The market action, however, is
totally different story. For a week or so it seemed to be rewarding my entry - and it
did nothing but go against it ever since. Now I am sitting on a massive loss, market
just won't let go, and I just can't bring myself to take the loss - after all I AM right!
banking crisis is far from being over, economy is in crapper, etc etc. Now, I did read
your post and the follow-up on this topic and understand the concept of "too
obvious" but still... shouldn't common sense prevail? How can I be punished that
severely for being right? What am I doing wrong?
- You are talking about being right about economy state. What you are trying to
profit from, however, is the market movement. You are coming from assumption
that market must reflect the economy. While connection is there, it's not that

straightforward. Ultimately, you are running into divergence between map and
territory. Your read on the economy is a map. Market you are trying to play is a
territory. If you see the differencies, will you insist on a map being right and a
territory wrong?
- No, of course not but isn't such drastic divergence a sign of manipulation?
- It very well could be, and probably is. You can call it manipulation, you can call it
market discounting the future, or come up with more explanations for this action.
The important thing is though: whatever definition you chose, what does it lead you
to?
- Explain this please.
- See, you can throw your arms up in desperation and say "this market is
manipulated, it's impossible to make money in it". Or, you can view it as
opportunity. Think of it this way: when you have this divergence between available
information and price action, this is great trading opportunity. Market moving
against the obvious is the one delivering maximum possible pain to as many
participants as possible. Isn't it exactly the situation where Smart Money take
advantage of the Crowd? That same situation that creates the very foundation of
Tape Reading principles? Nothing particularly new about it either - I can list quite a
few books describing just this.
- Come on... I just can't see this rally as real.
- What do you mean "real"? It happened, didn't it? I have a chart to prove it. You
must be thinking of how sustainable it is when you say "real" - now, that's another
matter and is a subject of continuous read of the market action. So far it's bullish in
one timeframe, still bearish in another - and both of those are right until they aren't.
Now, when I ask what your definition leads you to, I want to make one more
distinction. Don't ever forget what your job as a trader is. Your job is to make
money, not to lose it. If it's a market direction that makes you money, give it priority
over your fundamental read.
- OK, not to beat a dead horse, but just one more question on this. Obviously, as far
as market direction is concerned, I've been wrong so far and the pain is serious. Was
there anything to tell me it was coming?
- Have a look at this chart. First, double bottom came. Then it got confirmed by the
break of the top between those bottoms. That was your first warning sign. Then
inverted Head and Shoulders was formed. Then it got confirmed by retest of the
right shoulder line and bounce off of it. Second alarm bell... Then major resistance
at 1900 got broken. And notice, all this happens while all the headlines are still total
doom and gloom! If that is not a writing on the wall...
- So, when does it end?
- I think you already know. It ends when majority of participants decides that the
worst is really over and that they are missing on a bullish run. They jump on a rally
bandwagon, start chasing it with no regard to the price... and get trapped by market
reversal. Oh, and by the way - all this will happen with choire of cheerleading media
justifying the bullish case.
- This is wicked...
- This is market...
- This isn't right.

- What is your job as a trader?

- Right... You know, I just realized one fascinating thing. I repeated these slogans so
often, like "Don't argue with market", "Market is always right", "Don't fight the
tape"... and I thought I internalized them, made them my mottos. Yet when it came
to this situation, I found myself breaking all of them. I tried to outstubborn the
market, outsmart it. If I got stopped out and waited for better entry, I would be
totally fine. But no, I had to decide I was right and market was wrong... Got
emotionally attached to my opinion, married to my position. Let my ego take over.
- All I can add is one more motto for you. My favorite. Trade what you see, not what
you think. When you see markert action contradicting your thinking, chose territory
over the map. Give a priority to a market action over your trading idea.
- This is hard.
- This is liberating... and, isn't the hardest thing to do usually exactly the right thing
to do?

INFORMATION VERSUS PRICE

Information Price divergence. Saturday, October, 4 2008

This is one of the most reliable indicators helping you discern the market's
intentions. Some theory first, not too much, I promise... rather like a brief refresher.
Market is a discounting machine, meaning tomorrow's development is being
factored in by today's price action. That's why one who acts on known information is
always late - when information is known to everyone, it's being already acted on,
and late arrivals will be taken advantage of. As an example, think of upgrades and
downgrades issued AFTER a major price movements or earnings announcements.
Price action is an ultimate truth in the market - and it means that if there is a
divergence between what a price is supposed to do based on available information,
and what price does in reality - it's a price action that you need to go with. More
than that, such divergence serves as a very powerful indicator for you, because it
shows you that at this junction Smart Money clashes with Crowd. Crowd goes with
obvious - with what information says. Smart Money meanwhile takes contrarian
position. This is an ultimate case of "Trade what you see, not what you think".
Now, let's use fresh example as practical illustration of the principle. Yesterday,
while the markets were preparing to a 700B rescue bill vote (you can read a whole
transcript of our trading session in trading logs, Oct 3), I was asked:

[11:48] {member} so..whats your thoughts after passage on mkt for the day?
Here is the answer:
[11:49] {Threei} seems like selloff in cards... with or without initial short-lived spike
... and follow-up comment:
[12:10] bill passage is now all but sure, yet market doesn't really running
[12:10] makes you think...
[12:11] that dump may be an outcome in any case

Indeed, this is exactly what happened: immediately after bull passage market
dropped fast and hard. Let's see how I arrived to that conclusion (which naturally
kept us out of long trades at the moment of House vote). When a project of this bill
was first announced, market rallied for two days. When a bill was brought for a vote
first time and rejected, market dropped 700 points. Natural conclusion is, market
likes the bill and will go up when it passes the House. So, day of the vote comes,
comments clearly show that the bill is going to pass, yet we see failry lackadaisical,
if I may say so, movement. Market is positive but there is no serious upward
pressure, no boiling, no bruning desire to buy everything in sight. That's your
Information - Price divergence. Information says: bill will pass, market likes the bill,
it's a long. Price says: beg to differ. You saw what happened next. Price always wins,
and a trader makes money by being right on price, not on information.

TRENDS AND REVESALS

Turning points: how trends are born and how they die. Tuesday, October 28, 2008

There are a lot of lessons to be derived from the recent market events. In this post I
want to focus on two that have to do with identifying turning points. At the risk of
making post too long, I'll put them together since they are very interconnected.
Turning points are in effect change of the trend. Thus, it's important to look into
what maintains trends and what causes them to end.

Lesson 1. What causes trends to end, or pendulum effect.

System when pushed hard and far enough, pushes back. The harder and farther has
it been pushed, the harder and farther does it push back.
This concept is well described and explained in a brilliant book The Fifth Discipline:
The Art & Practice of The Learning Organization .

We all witnessed how, during oil stunning rally, all kinds of higher and higher targets
were assigned - 150, 200, 300. Part of those predictions that is related to what we
discuss is this: there were explanations to those targets and to continuing rise of the
price, that cited all kinds of equations, how much oil is out there and can be
extracted per day, and how much oil per day is consumpted and needed. Projection
of the growth in both parts of equation led to a conclusion that supply and demand
ratio will inevitably cause further price rise. Were those equations correct? Sure - if
you accept the fact that system will not push back. But it will (and it did) - in a form
of slowed down consumption (caused in no small part by the very cause of
imbalance in the system, fast and hard oil price rise), in a form of developing other
energy sources (yet to materialize to really meaningful degree). Similar predictions
put food prices above the clouds, and failed in a similar fashion. Similarly, rapid
increase of predators in a certain area eliminates their very food base and leads to
banace restoration when predators start dying of starvation. Similarly, explosive
expansion of a particular company often undermines its growth perspectives and
requires contraction to regroup and find the way to evolve in a more mature
fashion. Similarly, overheating of a certain area covered with water leads to
increased evaporation and forming of clouds that cool the area off. Finally, to return
to the markets, similarly excess of buying leads to exhaustion of buyers and
eventual trend reversal. Similiarly, abundance of short positions leads to short
squeezes. This phenomenon is known as "becoming a victim of own success". It's
also known as reversion to the mean. Nothing exists in vacuum - everything is a
part of the bigger system, and when a certain element of the system gets out of
balance, there will be parts of the system that push for balance restoration. Thus
trends are being born when a certain element upsets the system, and trends
reverse when system pushes back.

Lesson 2. What maintains trends, or inertia effect.

Markets tend to overshoot any reasonable targets on both sides.
This phenomenon is well known as well, but somehow rarely taken into account at
the time. When oil started showing signs of cooling off and reversal, very few people
called for such seemingly far away (at the time) targets as 80 and below. When
NASDAQ started running in 1998, no one could even think of such heights as 5000 and similarly, when it reversed in the spring of 2000, no one could imagine that it
could drop as low as it did. "Market can stay irrational longer than you can stay
solvent" - sounds familiar in light of recent events even to those who never heard
this sentence, doesn't it? If you want to see the most recent example of this, look no
futher than at intraday chart of UAUA for two days, Oct 16 and 17. It would reach all
reasonable targets, and still continued to go to unreasonable, and then some more,
and then a lot more. This phenomenon takes care (which in market terms means
deprives of profits or causes losses - cynical, I know) of those who trade on
"obvious" as they see the obvious - which is usually how the majority sees it.
"Deprives of profits" part is materialized when profits are being taken where
reasonable targets are reached - and market advances well beyond reasonable,
leaving those who took their profits in the dust. "Causes losses" part is materialized
when countertrend position is being initiated at reasonable targets (shorting oil on
the way up at 80? 90? 110? Going long on thwe way down at 120? 100?), and
market overshoots those targets and stays "insane" long enough to cause
desperation or margin calls.
Failure to take into account and to balance against each other both of these
principles leads to severe misreading of the market. Try to analyse what caused
billion-sized losses in Pickens energy fund, and you will see how this works. Having

made immense amounts of money in oil, where such mis-calculations came from?
From misreading the system as a whole first, thus believing in endless price rise?
From underestimating the inertia on the downside move, thus multiple calls (and
according actions or luck of such) of "oil will never lose $100" kind? You will see
numerous examples of miscalculations of this kind in analysis and trades of many
around you, and possibly in your own. Hopefully, this overview will help you
recognize the fallacies in thinking and balance these counteracting principles in the
future.

CHANGES AND CONSISTENCY IN THE MARKETS

Trading climate: new or same old? Saturday, August 29, 2009

Reading a lot of "market is not a place for a reasonable investing/trading anymore"

comments, I thought I'd chime in and offer my point of view.

To see where I am coming from, consider that I:

- have been trading every day (aside of vacations) for the last 13 years (2 months
shy as of this moment),
- made every trading mistake known to humanity and couple I invented all on my
own,
- recovered from them after 2 years of learning curve and trade for a living ever
since,
- conversed with hundreds if not thousands of traders of all thinkable backgrounds,
time frames and approaches.

Here are some of things I see similar in any market, I'll list them and you see if they
sound familiar.
1998 - 2000, tech boom, things go higher and higher and higher. Some are happy,
making tons of money and talking about "new paradigm"... and some are not, losing
their shirt on attempts to short the market, talking about how insane and irrational
the run-up is, predicting demise day after day, talking about manipulation and how
impossible it's become to trade. There are stocks here and there that turn into cult
names, and groups of fanboys cheering them up. XYBR is louded as next MSFT,
WAVX is predicted to go over 100, analysts say QCOM should go over 1000 when it
trades at 700. KTEL goes from 5 to 20 and 30, and "realists" (your faithful was one
of them and paid dearly for that) short it, and it proceeds to 80. Some make money
trading what's right in front of them; the rest is discussing how the market should
not be this way, trading their beliefs and losing money.
2001 - 2003, tech crash and consequent bear market. Trend reverses, yet
permabulls continue buying every new low thinking it's just a pullback (new
paradigm, remember?). Market proceeds lower and lower and lower, and seeing the
magnitude of drops, a lot of people start talking about selling being overdone. Now
it's a move down that is considered insanely big. Each new leg down is being
blamed on, guess what... manipulation of course. "Market became impossible to
trade" is being heard from every corner. Optimists average down and lose their
shirt. Yesterday's darlings start disappearing altogether - simply go bankrupt,
delisted etc. Some lucky names get bought out before the final crash, and its the
suitors that get killed now. Quality companies lose their value at unthinkable rate QCOM is nowhere near 700 anymore, and soon loses even 100; a lot of former
highfliers go to lows some call insane (NT, JDSU anyone?). Now.... one thing seems
to be the same: During all this some traders make money trading what's right in
front of them; the rest is discussing how the market should not be this way, trading
their beliefs and losing money.
Bull market starts in the spring of 2003. No internet crazies anymore, but hey, there
is always a place for "new new paradigm". Market goes higher and higher and
higher, and a lot of people say it's insane, housing is a bubble, financials are
overblown... and lose their shirt trying to short them... Now, one thing seems to be
the same: Some are making money... my reader, be a doll, save me some typing
and insert the end of the first two paragraphs.
Housing finally bursts, crash ensues, some of yesterday's darlings go bankrupt
(spectacularly I must say), bear market starts. Market proceeds lower and lower,
and attempts to buy each new low become common and lead to new bursts of
frustration and refrain of "insane, manipulation, impossible to trade". Some are
making money... etc, I know, get's annoying.

Market puts a low in March of 2009, and starts making new highs - insane new
highs, of course... you can finish this part now without me typing it all.
See some things repeating themselves over and over again? Patterns in who makes
money and who doesn't? Patterns in language, in assigning the blame, in finding
another scapegoat (day traders in tech boom, "frequent traders" now), in invoking
all-encompassing word "manipulation" that makes some feel better but still doesn't
help them make money? Patterns in going against the trend, effectively fighting the
market instead of being in tune with it? Patterns in trading ones own beliefs instead
of market's reality given us in prints on the tape? Patterns in thinking "if something
doesn't go according to my belief, it's the market that is wrong but never I"?

See where my favorite motto of many years TRADE WHAT YOU SEE, NOT WHAT YOU
THINK is coming from?

MANIPULATION IN THE MARKETS

Manipulation: myth and reality. Sunday, august 30, 2009

Always hot and contradictionary topic, causing emotional flare-ups all over various
boards and forums. Since the conclusion some make is that manipulated markets
are untradeable, it becomes a matter of practical interest for us. As traders though,
we are interested in reality, so let's try and analyze the matter at hand. Also, as
traders we want to do it not for the brain exercise but in pursuit of a practical
pragmatic purpose - and that's what we are going to arrive at.
Little qualifier before we begin: everything said below is said about normal liquid
markets. I am not discussing extremely thin markets where the smallest order can
move the market - those are disaster in the making for anyone who wants to play
them, manipulation or not. I am talking about those real markets, you know hundreds of millions of shares available, thousands of players involved.
Second qualifier: everything said below is said as a TRADER - someone who reads
the markets and strives to profit from his read. If you prefer to discuss social
aspects of this topic - that's for some other blog.
First things first: we need to agree on a definition - so we discuss the same thing.
Let's go over some versions and see which ones are realistic and which are not. So,
what do we mean when we say "manipulation"?

1. Assigning the price arbitrarily.

Here are couple phrases that you will find familiar; I have no doubt you heard them
many times.
"They keep the price down so they and their friends could load up on the cheap".
"They run the price up so they and their friends could unload".
Sounds familiar? Thought so. The premise here is, there is certain entity (THEY) that
is capable of making the price whatever they want. Practically assigning a price.
Woke up this morning, got yourself a price... How nice for THEM. I have couple
questions though.

First: HOW? Really, what is the mechanics of artifically keeping the price low or
running it high? Can you just say "stay low" or "run up" and so it will? Or you have
to actually SELL in order to keep it artifically low and BUY to run it artificially high?
Because if you have to sell, really sell real shares, then what is the point in doing
that? If you want to take advantage of the low price you kept low by selling, you will
need to buy, right? And that's when you are going to play right in hands of those
who bought from you earlier - lifting the lid and switching to buy side, you are going
to run the price up now, to the benefit of those who bought from you earlier. If you
are lucky, you may break even by buying back your shares at about the same
avereage price you sold at earlier. Most likely you won't. Same scenario plays out if
our brave manipulator runs the price up by his own buying. He does that for...
whose benefit? His own or his friends, right? And just what will he/they have to do in
order to take advantage of that inflated price? Why, sell of course. But he is not
supporting the price anymore since he turned into a seller. If he run the price up all
by himself, it's going to collapse as soon as he withdraws his bid, let alone starts
selling. (If you are tempted to say at this point "wait, but his actions could have
attracted others so he kind or provoked them and then they did his bidding for him"
- good thinking but hold your horses, we will get to it).

So, actual selling or buying in order to get price where manipulator wants it is not
really the way to achieve anything but get steamrolled. And, I still have second
question. Here it is:
Listen, if government/Fed (entities most often accused of manipulating the markets)
really have the ability to just make up any prices - why do we experience these gutwrenching crashes at all? Those wild fluctuations cost elected officials and public
servants their jobs, influence one's historic reputation - why wouldn't THEY just keep
markets going up forever and ever? Everyone's happy, everyone's wealthy, some
are rich, no mass revolt, no complications, THEY are cheered - what possible reason
would THEY have to let it all go down in flames making THEIR life immensely
difficult?
There is only one conclusion I can come to here answering "true or false" to this
one: FALSE!
If we agree that no entity can simply assign a certain price, let's move to the next
possible definition.

2. Manipulating information flow.

THEY present reports and numbers and analysis in a distorted way in order to
provoke certain reaction - that's the gist of this accusation. True or false? I don't
think anyone in their right mind would deny it's possible and it does take place. The
only question I have about this one: what else is new? Name me any society, any
civilization, any period in human history where and when it wouldn't be done. Let's
be real here: no one should endorse or condone or justify this practice - but there is
no reason to consider the markets being untradeable for this reason. How exactly
you trade the markets where information is being distorted is another matter, and
we did dicuss it earlier, for instance here. As far as traders' point of view goes: there
always was, is and, I'll venture to suggest, will be a divergence between what
available information says and how the market reacts. You will find confirmations of
this phenomena in the books written 100 years ago. Whatever you think about the
practice, whatever causes it - by no means it prevents anyone from correct reading
the market and profiting from its moves. It happened always and at all levels - BreX, anyone? UAUA false news last fall?
Interesting thing about this aspect is, many of those who express their outrage at
this kind of practices by government, Fed etc. also claim they they see through the
lies and know how things look in reality. I certainly don't claim anything even close
to this kind of understanding of these complicated economic issues, but... if what
THEY do is so transparent, then it must be possible to exploit, no? I mean if you
understand what manipulator is doing, then as a trader thank him and use his
manipulation to your benefit. And if you can't - well, either his manipulation is not as
transparent as you think (in which case what's with accusations) or your trading
skills are not as great (in which case, maybe best to focus on honing those) ?
My conclusion would be: TRUE, but old as the world itself.

3. Government's and Fed's own buying or selling of certain assets.

Sure. Why would anyone try to deny this if they themselves claim they are doing it.
The question though is, so what? They pursue certain goals, thei intentions can be
analyzed, so how is it different from any other market force? Read the tape and
trade accordingly. And, while we are on a subject of definitions, let's call it for what
it is: intervention. Because, if you want to call any entry into the market with certain
purpose in mind a manipulation, then any single buy or sell, yours included, will be
manipulations. Government intrusion, considering that the government is not, or
should not be, exactly market moving force can safely be called intervention then.

Conclusion: TRUE, but from a trader's point of view, how is it different from any
other market moving forces?
4. Faking intentions so other traders get duped into wrong reactions.
Ahha! Now we are talking my language (those of you who read our trading logs
know it as Threeiish). This is where we are going back to that suggestion that
manipulation can be done by provoking trading mases to act in a certain way.
There are two aspects to this kind of manipulation. One is what is known as
"painting the tape". The term refers to illegal activity in which manipulators buy and
sell the stock between themselves. While they remain net neutral, their actions
create a false impression of a certain activity. This is clearly and undeniably illegal;
if you know for the fact it's taking place on a certain security and have an evidence
- simply report it.
Another aspect is actual trades placed by manipulator in the market in attempt to
create certain reactions. Our manipulator may try to buy very quietly in order to
mask the fact that he is building position - and that's what in fact skillful player will
do at the early stages of accumulation. When his accumulation is mostly done, he
will try to make his buying more noticeable to attract new crop of buyers by
increasing volume and new highs in price. When and if he is successful, other
players will come and take the price higher - and he will start distributing his shares
to late buyers. And that's how The Game is played. This is readable. This is basics of
the method known as Tape Reading. If our manipulator is successful in doing it more power to him, AS LONG AS IT'S DONE BY HONEST RISK TAKING. Yes, that's my
criteria - because what I described means he takes the risk, fair and square. If he is
unsuccessful, he will lose money. Can it be that the company goes bankrupt on him
while he accumulates shares? Sure, if he didn't do his homework well. Can it be
overtaken by another company at the price lower than his average accumulated
price? Can the sector turn down before he gets a chance to distribute his shares?
Can some new technology come around and benefit a competitor while making the
company whose share he accumulated obsolete? See where I am going with this?
Unless our hypotetical manipulator acts on illegaly obtained inside knowledge, he
takes honest risk - and, most importantly for us trades, in a process of doing so he
creates readable opportunity for us. At least for those of us who have the skill to
read it - but isn't it the whole point?
Let's make out last conclusion: TRUE, and thank you trading gods for that.

Got other scenarios? Throw them in, let's discuss.

NEWS AND PRICE INTERACTION

News Tradeem or fadeem? Wednesday, September 28,2011

Having commented lately on the influence the news flow from Europe has on the
market and how sensitive this market is to those headlines, I received a very good
question which made me think that I should have written on this topic long ago.
Here is this, very valid, question:
"Vad, I am trying to reconcile these comments (on market sensitivity to Europe
news - V.G.) you made in your trading log and on your Facebook page with the idea
that you promoted many times before - that the news is usually priced in by the
past movement and by the time the news is known to everyone it's too late to act
on it, and a trader should start looking for info-price divergence to fade the news.
Sure enough, I've seen many times that this idea worked like charm - and I do see
now how market reacts on any peep from EU, just as you suggest. Could you
comment on this contradiction?"
To be able to tell these situations apart, we must define two different kinds of news
from the point of view of interaction between news and price.
First, and the most traditional for the "normal" market developments is what I call
FSN - Fleece Sheep News. This is exactly what it sounds like. The scenario is old as
the market itself. You've seen it 1000 times, and quite possibly were on a receiving
end of it at some point early in your trading career. Smart Money starts buying while
no one's even looking, it figures out the coming developments and accumulates
before these developments become common knowledge. Price moves up slowly at
first, then speeds up as an advance starts attracting attention and new passengers
climb aboard. Finally the news comes, price spikes sharply and Smart Money feeds
previously accumulated shares into such euphoric spike. No more buyers left, the
last crop of late arrivals is left holding the bag as the price declines - and it does so
against the background of a good news, with no single negative word, all to the
amazement, resentment and accusations of manipulation by those who never
bothered to study how the market really works... Examples of such news is
introduction of a new technology, new product or drug, changes in demand, general
industry trends, etc - things that keen observers can figure out with this or that
degree of accuracy well before they become obvious to the masses. FSN may be a
cruel name somewhat for this phenomenon but can you think of a more precise
one?

Second, and more rare kind is what I call GN - Genuine News. This is an event that
is either a) a surprise for everyone or b) known to come but with an outcome
impossible to predict. This is where Smart Money has little if any advantage. More
than that (although this is a somewhat side observation), often Big Money is at
disadvantage here because of bigger exposure and lesser mobility in moving in and
out... but this is separate topic. Example of the news catching everyone
unprepared? Earthquake; fire; sudden death of a key figure... you get the idea. It's
just "here is what happened," and no market participant could have taken the right
position before the event other than by an accident or an unrelated reason. Thus,
news is not discounted by the prior movement and causes genuine market reaction.
Example of an event with unknown outcome? Why, EU latest developments...
everyone knows something is going to happen, no one knows what. This is where
some stay away and some bet on a certain outcome - counting on their opinion
being correct, relying on their ability to calculate the most probable course of
events or simply gambling.
In the former case (FSN), a trader uses price - information divergence as his most
powerful weapon. I have written about this in the past (here and here for instance,
not even speaking of here and here), to show how a trader takes position with
Smart Money and stops being a part of the Crowd. As difficult as this concept may
be for a layperson, for a trader FSN is a normal trading environment, like water for a
fish.

GN on the other hand introduces huge uncertainty - instead of moving accordingly

to street signs, traders have to wait for new and often temporary signs to be
erected. In a news-driven market instead of smooth market flow we have lurching
movements in stop-and-go fashion. Time frame shortens to "between the
soundbites" - and those often come at unpredictable times.
Thus, in the latter case (GN) - be nimble. Be flexible. Keep your commitment light,
do not form an opinion and do not let your Ego lock you in that opinion. Don't be
afraid of missing the move by not being in before the move. Remember, newbies
chase potential - professionals control risk.

BUILDING TRADING SYSTEM

ROLE OF TECHNICAL ANALYSIS

What do your photocamera, frying pan and stochastic have in common? Monday,
April 9,2007

Have you ever heard "What a wonderful photo, you must have a great camera!"?
Does it make much sense to you? If yes, you are not alone; for some reason it
sounds reasonable. Let's try this: "What a wonderful food, you must have a great
pan!" I bet this doesn't make sense at all, does it? Quite obviously, the pan is
merely a tool which at best may limit or broaden the possibilities of tool user. It may
not be as obvious in case with camera, simply because modern camera is extremely
sophisticated gear enabling average user to take quite spectacular shots. Let's,
however, set the simple experiment: Give primitive $150 Point&Shoot to a
professional photographer and give state-of-art $3000 digital SLR to an amateur.
Send them in the field for 1 day. Ask each to bring 100 photos. Compare the
results.What's the point of all this? Well, both the photocamera and the pan,
however different the level of sophistication may be, are just tools. They don't do
the job themselves. They are as good as the person using them is. It's a nut behind
the wheel, as usual. For now, remember this important distinction that higher level
of sophistication makes it somewhat harder to see this point clearly.
Soooo... what does it all have to do with Stochastic? First of all, let me say it's not
about this particular indicator. It's about Technical Analisys in general. Just how
often have you heard and maybe said "TA doesn't work!" Or "MACD doesn't work"
(insert any other technical indicator or study known to human)? Or, how often have
you read yet another heated argument whether they work or not? Here is the deal:
unless your computer is broken, they always work! As in, they do what they are

intended to do. And this is where major misunderstanding lies: many think that TA is
intended to bring profits. Wrong. Indicator is intended to indicate. Something.
Anything.. As long as it indicates, it works. Yeah, but why doesn't it bring profits? For
the same reason that the camera doesn't take photos by itself even so as long as
shutter clicks it works. And for the same reason that the pan doesn't cook a dinner
even though as long as it heats up it works. It is designed to provide you with
certain tool - and that it does. How you utilize the tool is what defines success or
failure. Returning to particular example of stochastic: it indicated the reading below
20%, did it work? Sure, it indicated what it was designed to indicate. Now, what do
YOU do with it? Do you enter long for bounce? Do you wait to see whether the price
doesn't bounce so you short for downtrend continuation? Do you add another
indicator to get some combined reading? Rephrasing it all, it's about how you
incorporate certain TA in YOUR trading approach. If you do it right, profits come. If
not - this is your approach that doesn't work, not the TA. Or, you incorporated that
particular indicator in a wrong way and some tweaking is in order.This all seems to
be trivial when you go through this methodology of thinking and comparison; so
why is it not that obvious from the get-go? Well, remember the thing about
sophistication? In exactly the same way as it seems to be not so obvious in case
with camera vs. case with pan, many of technical indicators and studies are being
percieved as quite complicated (and they often are). Something so smart must be
doing some serious work and lead to solid results... can I relax while it's working and
harvest when it's done?Understanding of real purpose of TA is quite crucial for
working out the right trading approach. It also leads us to interesting and somewhat
controversial topic of trading systems.

HOW TO START
Method to madness Thursday, may 24, 2007
"Though this be madness, yet there is method in it."
Polonius, Hamlet by William Shakespeare

Couple posts ago I promised to return to the idea of the setup's structure. In order
to come to it, however, I need to start with more broad theme - one of the
adjustment and re-adjustment to changing conditions. Here is where the importance
of the topic stems from: for many trading presents enormous difficulties because
market is an unstructured environment. We are not readily wired to act correctly
under such conditions. Our comfort zone lies in having schedules, guides,
instructions, manuals, road maps and signs. When we are not familiar with the
structure of our surroundings, we overcome the difficulties by learning it - looking at
the map, reading the manual... but what do you do when you need to act with
certainty in uncertain environment? Environment that changes by minute, by day,
presenting new challenges, obeying new rules, being influenced by new factors? You
work out the method to your own actions. You create algorythm which governs not
only your course of action but also your course of adjustment - the way you change
your behavior when the surroundings change. Those who trade long enough know

very well how often they had to adjust to constant change. Fractions to decimals,
anyone? 25K rule? Order routing? Bull to bear to lull?
This kind of changes for an experienced trader is similar to finding a new route for
his routine trip when city authorities close the road for renovation. Not a biggie,
right? Inconvinient, sometimes time-consuming but not a big deal. However, for a
newer trader starting out in this profession the analogy would be more dramatic.
Moving from a ghost town in prairies to New York perhaps? Let's throw in different
language, absence of any prior information of what the big city is about,
unfamiliarity with the concept of municipal transport and apartment buildings... now
we are talking. Total chaos, no structure to dictate your action, strange life seethes
around... and you need to do something. Will your first steps be the right ones?
Most likely not. They will be much better when you learn the structure of what's
going on, what elements are there and how they interact. This is what a trader
starts with as well - providing he or she realizes the need to learn instead of diving
in headfirst (always amazes me how many do just that, what is it about this
profession that makes it look like it can be mastered without learning??).
So, you start with attempting to learn more about markets... and wierd thing happes
- it doesn't get you anywhere. You just mastered the concept of earning
announcements, EPS, price to earnings, learned to read balance sheets, you feel like
deep dark secrets known to few have been opened for you... yet price action
doesn't match your expectations. Wait, but what happened to our analogy? Learning
the layout of the streets in your new city and what transport is available and what
its schedule is, wouldn't you become capable of getting around? You would - but the
analogy has ended earlier. It described your lack of understanding of what was
happening around you, and that's it. Major differencies started after that - city is
STRUCTURED. Markets are NOT. Not in the way you expect them to be, anyway.
Next thing that is likely to happen to you is getting familiar with technical analysis.
Ahhh, that's where the problem was - there is this voodoo that for some reason
impacts the movement... or does it? Or does it just reflect the movement in a
certain visual way providing some hints for a scholar? Those are questions you start
encountering while studying MAs, BBs, dark clouds and hanging men hit by shooting
stars, and all other dolls and pins also known as studies and indicators. Your
knowledge grows by day... does your trading account? Ummm... most likely not.
By no means do I want to say that all I listed above is not needed. Why, all this
learning is necessary, or at least some elements of it - I for one still wouldn't be able
to tell the balance sheet of Microsoft from one of Bre-X. It's just that it's not enough
- not until you create YOUR OWN METHOD. Remember our very first article in this
blog? We talked about indicators not being able to create profit by themselves and
serving only as a tool. This is where we return to this theme. All this learning
provided you not with answers but with tools to get them. No hammer goes ahead
and drives nails in the wood without you. It just provides you with means to do just
that. Now it's time to create your trading approach utilizing those tools. What kind
of hammer do you need for the job? How do you hold it? How do you swing it? What
kind of nails? Answer these questions, practice a bit and your nails hold two wooden
details together.
What kind of questions do you ask (and answer) in order to create your trading
system? And finally, how do you form your setups and what is their structure?

PAPER TRADING
Paper trading: waste of time or valid learning method? Tuesday, December 8,2009

Numerous discussions of paper trading, and its value as a learning tool, usually see
participants divided into two camps. One claims total uselessness of paper trading,
another vows never to start without it. The scoffing camp points out the obvious
limitations of paper trading:
It doesnt allow you to estimate slippage during your execution.
It leaves unanswered the question of whether your order has a chance to be
executed at all.

It keeps you in a relatively relaxed state of mind as there is no pressure of

endangering real money.
It also doesnt allow you to master your order routing tools in full.
Finally, its very easy to cheat oneself, changing ones decision after the fact and
booking corrected results.

Is this all true? Why, of course it is. Does it render paper trading useless? By no
means. Paper trading can be extremely helpful if two conditions are met. The first is
applying this learning tool at the right time and with the right purpose. The second
condition is doing your paper trading right.
Lets try and build the rules of paper trading that will allow us to turn it into powerful
learning tool. We can identify three cases where paper trading instead of live
trading is in order:
A beginner getting his feet wet.
A trader testing a new trading system.
A trader hitting a losing streak.
The first case is the most common. Lets analyze the right way to structure paper
trading for this situation.
Paper trading allows you to ease into real trading and see if your theoretical
approach works. It is a stage where you start measuring your method against
market movements. You are going to have enough time to deal with the
psychological pressure and execution side later on, adding them gradually as you
start trading with a small size. However, before real money is used, theory should
be checked against the reality, and this first experiment should be as painless for
your trading account as possible. Obviously paper trading does not pursue any
meaningful target unless your trading system is structured so you can test it; thus,
start with constructing your trading approach, then proceed with testing it in real
time.
Paper trading is done in a fairly simple way. It is an imitation of your actions without
actually sending your orders to the marketplace. You define your setup with all of its
components: trigger for entry, stop level, signs of exit, possibly with partial exit and
stop trailing. Then when observing the market action you are imitating your
responses and writing them down. This is going to be your first encounter with the
market so take it seriously. Paper trading will teach you plenty about market action
without risking your money if you are watching carefully and acting responsibly.
Observe whether your setups are working. Watch the market action and define if
your response is reasonable. If you lose money on paper day-by-day, something is
not right with your approach. Try to make corrections, find out what factors have not
been considered. This is your troubleshooting stage look for problems to solve. If
you get negative results, do not get frustrated take them as a blessing in disguise.
Its much better to find out about a problem before committing actual money to a
flawed method.
Watch if your risk control is working. Do you lose within your defined limits on any
given trade and on any given day? Maintain strict discipline at this stage your
future trading results are going to suffer if disciplined behavior doesnt become your
second nature.

The crucially important purpose of paper trading is to find out the maximum
drawdown that you can run into. This element might require a somewhat prolonged
paper trading stage. The point here is, losses and wins are not necessarily
distributed evenly along the timeline of your trading. You can run into cluster of
losses. While the average loss might be affordable in terms of your trading capital,
such a cluster may not. It is very important to make sure that a losing streak is not
taking you out of the game.
Here are the rules of paper trading that allow it to be as realistic as possible and
make paper trading an effective learning tool:
Make your decisions real time only, not after the fact. Looking at the chart and
deciding where you would have entered and exited wont do you any good.
Everything is easy in hindsight and looks very different when you are up against
what Alan Farley called The Hard Right Edge end of the real-time chart leading you
into unknown. Write down your entry when your setup is triggered; write down your
exit when the chart hits your profit target or stop.
Keep you trading rules exactly as if you were trading real money. Any decision of
Ill do this although with real money I would do that kind renders your paper
trading worthless. If your stop level is hit, your paper trade is stopped and should be
written down as such, even if a stock immediately bounced back up. If your profit
target is not hit, do not write it down as less profit but still profit it negates the
very purpose of paper trading, which is to see if your targets are realistic and your
stops are placed correctly.
Take trades with the same degree of risk as if you were trading real money. A
decision to paper trade a risky stock that you do not intend to trade when doing live
trading makes no sense. You paper trade to test your strategy, not to play around.
Use the same set of tools as you intend for live trading. If your trading strategy
requires Level II, for instance, paper trading without it with idea that with it your
trading will be even better makes no sense. It wont be better, it will be different.
Consider your entry and exit executed only if there are actual prints at the price
you target. Just seeing bid or offer where you want them is not a guarantee that you
could get your order filled at that price.
Consider the amount of shares available at your price. If you intend to trade 1,000
shares but there are only 100 shares offered, chances are in real trading you
wouldnt get your order filled in full. Watch actual prints to determine how many
shares there really are.
Do not use paper trading to project what kind of money you are going to make.
This is not the purpose of this stage. It can only make you unnecessarily impatient
and eager to start trading live before you are ready. Simply write down the results to
see if your planned strategy is working.
One more purpose of this stage is to get comfortable with your tools. Configure
everything as you need it for live trading. Move windows around your screens to
have them placed as conveniently as possible. Start with your charting software.
Play with the fonts to have all the information that you need on the screen while
text is still easy to read. Play with the colors so that different windows are easy to
distinguish. Learn to quickly manipulate your charting software. Change symbols,
link windows, change time frames do everything that you will need to do in the
course of trading. Draw necessary lines on the charts, add and delete studies and
indicators that you are going to use. Do it long enough to make the process
automatic.

Learn your order routing software. Manipulate the controls, changing quantity of
shares, price of your order, type of order and route. Switch from limit order to
market order and back, practice changing the price quickly. Play with controls long
enough to make the process automatic. See how to set advanced orders. If
necessary, print out excerpts from order routing instructions and place it within easy
reach.
Finally, start routing orders in a way that keeps your money safe. Do it in the
following way.
Set small amount of shares from ten to fifty. Set the price far enough from the
market price to not get filled. If a stock is trading at $20, prepare your buy order at
$10 and short order at $30. Send the order. Observe how a confirmation appears.
Now cancel the order and observe the confirmation. Make sure that all the
messages you receive become familiar so you do not spend much time reading
them later. Make sure that confirmation pop-ups do not get in the way of observing
the action. Observe the reliability of your quote feed, especially in the most active
periods market opening produces fast conditions when the quotes are most likely
to lag. Make sure that you have trading desk phone number on a speed dial to be
able to reach help as fast as possible if something happens to your internet
connection or quote feed no technology is perfect.
Its often asked how long this stage should be. There is no fit-for-all answer. There
are traders that breathe through it in a week, and I know a trader that paper traded
for a full year. It doesnt mean he was a slow learner. He just was perfecting his
trading system until he was totally satisfied with it. Although a year is probably a bit
on an extreme side, a week or two is not really what suits most people. This is
usually not a matter of exact time that would be the same for everyone. Paper
trading serves certain purposes, and you should move ahead when those purposes
are achieved. Keeping all the rules of paper trading, do you show consistent profit?
Have you observed how your setups work and gotten comfortable with them? Have
you made sure that you know the drawdown your system can produce and that you
can sustain it? Have you become comfortable with your charting and order entering
software? If you can answer Yes to all these questions, then paper trade just for a
couple weeks more. If not for any other reason, do it to practice one of crucial
elements of your psychological makeover patience. The skill to sit on a sideline
will serve you well. It will also allow you to get into your first trading day with more
feeling of self-control.
We mentioned two more cases when paper trading is appropriate.
Testing a new system or to tweak an existing one is obviously calling for going back
to paper. You are changing something why risk real money before you make sure it
works well? Usually when a trader is doing that he already has enough experience
under his belt to know how to paper trade effectively. Just make sure that you give it
enough time so your results are statistically significant. I know a trader who does
this kind of new tweak testing not even stopping his live entries and exits. While
making real trades he simultaneously writes down optimized ones, comparing the
results and making conclusions about the quality of optimization.
Going through a losing streak, a trader wants to find out the cause of underperformance. Is it market conditions that change in a way that ruins his system? Is it
a trader himself acting in an undisciplined manner? If its the market, does
something get changed fundamentally or is it a short-lived fluke? Does a major

trend change? Is it just a temporary range contraction with no volume? What is

likely to come next? These kinds of questions are not easy to answer in the heat of
the battle. Thus stepping aside to re-evaluate things, to regroup and to regain your
confidence or to re-tune your approach is a good decision.

For whatever reason you go to paper trading, your major step to assure the success
of it is to define the purpose and to work out the steps to achieve it.

TYPE OF MOVEMENT
Method to madness II. Sunday, June 17,2007
So, how do you go about structuring your trading? First thing to ask yourself is, what
kind of movement are you going to play? Trend following? Trend reversal? Range?
This is going to define the kind of setups you are going to look for. Let's try to give
some examples.
If you are playing trend following, you are going to look for breakout setups
(breakdown too if playing short side, but let's limit it to long simplicity sake). In
terms of chart formations for instance, you are going to look for Cup and Handle,
JBE, Ascending Triangle etc. If you prefer candlestick formations, you will select
those that reflect trend continuation; similarly, with any other study or indicator you
want to use, you will be concentrating on those that match your chosen type of the
movement. I am staying with chart formations in this example because is easier to
envision and this is going to come handy when we finally get to particular setup
structure.
If you decide to focus on trend reversal, you will be on hunt for Double Bottom,
Head and Shoulders. Finally, if you want to play range, you will look for, well, range price locked in a certain horisontal limits.
Out of the universe of setups, you will pick several that match your approach. 3? 5?
About that, and could be just a couple at the beginning. No point in starting out with
10, you will get lost in their variations. If this step in structuring your trading feels
like a small one, it's a misconception. What you just did is a big step: you made a
transition from a very general idea (kind of movements to trade) to a very particular
thing (exact setups to learn and to hunt for). However mundane the task of
matching one to another seems, you would be amazed by how many say they want
to trade trend continuation and go ahead looking for double bottoms or tops.
What we are going to do in the next post on this topic is to start structuring our
setups - break them down by elements and see how you put those elements
together in order to come to a logical, meaningful, structured and controllable way
to trade.

STRUCTURE OF THE SETUP

Method to madness III Thursday, June 28, 2007
Let's break the setup down to elements so we can define our actions in terms of
that setup and price actions.
First, setup must have a trigger. Trigger will define a point of entry. In terms of
breakout setup for instance, a trade above the established resistance level is a
trigger for our entry for a trend continuation.
Second, setup must have a failure indication. This indication will give us an idea for
a stop placement. Again, if we are talking about breakout setup, such indication
would be a loss of a support level.
Putting these two together, we have an entry and risk control. To illustrate it on a
particular chart formation, let's have a look at the Cup and Handle. Rim level
defines a resistance to break while handle's bottom defines the closest support. Our
trigger for an entry is going to be a trade above the rim level, while our stop will be
located under the handle bottom.
Third, setup usually has certaing supporting factors that are in fact parts of the
setup. One of the most useful is volume configuration. You want volume to support
your chosen direction by increasing as a stock inches toward a breakout level and
drying up during a retreat. Among other supporting factors you may want to list a
broader market directional support, or cetain technical study you utilize.
Fourth, you need an idea of an exit level on a profit side. This is where your
particular setup intersects with your chosen style of trading and method of reading.
You remember the discussion of risk/reward ratio in articles on scalping. If you aim
for 1:1 ratio, you will look for a signs of exit around that level. What are those signs?
That depends on your method of reading - for instance as a tape reader you will
look for a sharp price spike combined with volume increase as this combination
usually signals an end of a current stage of a movement. If you use certain technical
indicator, you will watch for it to show the exaustion of the movement. The
important thing here is a logical alignment between the tools that you use for an
entry and exit indication. While it should be self-explanatory, I will mention and
example of horrible misalignment, simply because I do see this happening with
some traders. If you find your entry on a daily chart using japanese candlesticks and
look for an exit using MACD on one-minute chart, you ask for troubles.

Finally, fifth element of your setup structure is a fine-tuning of an entry in terms of

aggressiveness. While there is a trigger for a trade, you may find that in certain
markets entry in advance works better. Entering on a trigger would be a regular way
to initiate the trade. Entry in advance counting on a future trigger would constitute
an aggressive way which offers its trade-offs. Finally, there is a conservative way to
enter which would mean letting a trigger go and entering later on if certain
conditions are met. There are trade-offs to this way, too. Let's make it a matter of a
ceparate post. For now, you are armed with the way to structure your setup so you
have your actions defined by what's happening with your stock. Your ultimate plan
of action can now be put in terms of IF-THEN scenario where each IF is a market
action and each THEN is your response. This offers you a lot more than just entry
and exit points, and this is what we discuss in our next post.

IF THEN SCENARIOS
A bit about IF and THEN. Friday, july 6, 2007

The idea of IF-THEN scenarios in trading is often misconstrued one. I often see it
being interpreted in a sense of predicting stock's action. A trader trying to apply it in
this sense tries to think in terms 'If a stock does this, it's going to do that". This
approach is more acceptable if a trader thinks in terms of probability instead of
certainty in which case the above sentence becomes "If a stock does this, it's likely
to do that". Nothing's wrong with that as long as a trader realizes that probability is
just that - a probability that is going to work in a statistically valid number of
samples but will not predict the outcome of each given case.
I, however, apply IF-THENs in a slightly different manner. For me it's about defining
my own action in response to market fluctuations. My IF-THEN is a scenario where IF
is what market does and THEN is what i do in response. My intepretation thus
becomes 'If a stock does this, I do that".
Certainly, it's a derivation of the version above - you can arrive to it from "if a stock
does this then it's likely to do that, so I am going to react in such and such way". My
version is just more cut and dry.
What are the advantages of this aproach and why do we need to build a set of such
scenarios?
First, it takes guessing and predicting out of the equation. Our trading becomes
more systematic as we look for recognizable situation for which we have a precanned response.
Second, it takes emotions out of the equation. Since our actions are pre-determined,
we simply apply them to what happens. Stock does this - we do that. No room for

emotions, no room for surprize (well, almost - market has ways to offer something
unseen before even when you think you have seen it all, LOL).
Third, it takes ego out of the equation. Since you are not trying to predict future
events, there is no ego involvement in case if a stock does something unexpected.
You didn't expect anything, right? You were simply waiting for it to do something in
order to react in that pre-canned way. Since ego is not there to make you feel hurt,
you have no problem with taking your stop - it's just one of the prepared scenarios.
You don't feel as if you were proven wrong - you didn't commit to any prediction, so
you can't be right or wrong.
All above makes you kind of trading robot. See setup - take setup, see action - apply
reaction. Eyes to finger, no brain inbetween. Sounds boring? Great. I trade for profit,
not for excitement. No brain involvement is a side benefit, you feel fresh and rested
when the trading day is over.
I can assure you, it's a very liberating state of mind. Once you experience it, you
never want to go back to old "highly-strung overthinking it" ways.

TYPES OF ENTRIES
How aggressive are you? Wednesday, july 18, 2007

As we were going to, let's define different kinds of trade entry aggressiveness wise
in order to know their advantages ands shortcomings. This will help you find what
approach works better for your personal preferences and when to adjust things
depending on the market behaviour.

1. Regular entry.
This is an entry right at the trigger. If we are talking about breakout, regular entry
will be just above the resistance level when it's broken. With Cup and handle
forming day high at $20, tradeing at $20.01 will trigger the trade and be qualified as
a regular entry.
Advantages:
- you enter a trade after getting your confirmation that a stock is capable of
breaking the resistance, thus youre chance of profitable trade is higher
- this is popular spot for momentum players so you have a good chance of getting a
quick scalp on the backs of slower traders or those entering at market

Shortcomings:
- as the crowd hits the stock at this level it can be hard to get your fill;
- your stop level is below the nearest support which is not necessary tight enough
for your comfort

2. Aggressive entry
This is an entry in advance, closer to support level counting on future breakout
In the same Cup and Handle example, with breakout point at $20 and cup bottom at
$19.80 you enter as close to 19.80 as possible when a stock shows strength.
Advantages:
- very tight stop as your entry is fairly close to support level
- easy to get your order filled as the crowd is not really active at this point and is
likely to engage on an actual breakout
- better risk/reward ratio
- opportunity to dump your shares near breakout level if you lose faith in it and still
be profitable
- more manoeuvrability as you can partial out near the breakout level securing part
of profit and let the other part trade to catch more on a break if it occurs
Shortcomings:
- less confidence in a breakout as you have no confirmation
- your stops will be tighter but there will be more of them

3. Conservative entry
This is an entry where you let the trigger go, wait out first spike and try to get in on
a pullback IF new support level (former resiatnce) is holding. Citing the same
example uniformity sake, that Cup and Handle break of $20 will lead you into
watching a stock breaking, making new high and retreating to $20, where you will
enter on a first sign of strenghtening with stop under $20.
Advantages:
- you get as much confirmation as possible by seeing a stock not only being capable
to break the resistance but also holding above it on a pullback
- stop is fairly tight
- entry is relatively easy as you hit it at the point of uncertainty on a pullback which
usually offers a pause
Shortcomings:
- there is a good chance to miss an entry altogether if a stock moves too far after a
break never looking back
- less favorable entry price

There is no better or worse way to apply those. Obviously two major factors in
deciding between them are your personal preferences and the kind of market you
are in.
Some of my personal points:
Most often I go for aggressive and regular entries. The stronger market is the more
aggressive my entries are. The less confident about certain stock I am, the more
likely I am to go for conservative entry. The more volatile stock is, the more likely I
am to go for aggressive entry to minimize "natural-volatility shakeout" often
occuring on a break itself.

CAPITULATION HOW TO TRADE IT

Capitulation how you recognize and trade it Thursday, November 24, 2011

One of the well-recognized terms from the tape reading terminology is Capitulation often mentioned and often misunderstood. Many apply it in an overly broad sense,
labeling any new low as capitulation; some believe that buying into selloff makes
them winners almost by default - after all, everyone heard about necessity to go
against the crowd, right?
There are two important things to keep in mind about this concept.
First is, bottoms are not always being formed by the capitulatory selloff (V-shape).
Sometimes it's a slow grind shaping as a dish; sometimes even with capitulation it's
still not that easy - weak initial bounce often leads to another drop and new low is
being made sending a stock into panic.
Second, and most important to remember. You probably noticed that wherever you
find the description of the concept of capitulation, it's still just a concept - meaning,
there is no measurable component to it. There is, to my best knowledge, no
percentage of the drop that quialifies selloff as capitulation. Name any particular
number, and you will inevitably find a whole lot of cases where it was exceeded.

There is a good reason for that: if there were a certain measurement for capitulation
that guaranteed ultimate low, everyone would be insanely rich waiting for it and
buying it... and no one would be buying a second earlier. But then again, why would
anyone SELL at that ultimate low which has been already proven to be an ultimate
one?... And if the answer is "no one," then from whom the bottom hunters would
buy at that same bottom they were hunting?
Thus, capitulation is either:
- can not be computed and quantified as it's an emotional state, panic, total
disarray leading to a free-fall - but not being quantifiable, it's in the eye of a
beholder, which meakes "getting a read" on it quite discretionary;
or
- can be computed to a certain degree IF you somehow know the amount of shares
that were held by different stakeholders, and see that roughly that amount is being
traded in a very short period of time (again, discretionary component) during very
steep selloff (once again, steep by what standard? on what chart?).
No doubt, sometimes experienced traders get it right by gut feeling which is a
product of vast experience. By no means it's a fool-proof process for any of them,
and you will always see arguments about whether this particular selling already
constitutes capitulation or not yet, whether capitulation is going to be the case on
this particular bear market or not. This concept is necessary to understand, but it
doesn't mean that once you understand the concept you can spot the capitulatory
type of bottom. That's why I am always advocating for a different type of bottomfishing - one that is based on:
- letting go of the idea of buying THE low,
- waiting for a stock to come out of free-fall, form a recognizable reversal formation,
- buying when such formation offers chart-based opportunity free of emotions.
Such approach will never get you in on the exact low - leave that to amateurs to try
and brag about those rare instances when they get it right. In exchange, such
approach will give you a repeatable reliable method of trading the trend reversals.

RISK CONTROL
ROLE AND NECESSITY OF STOPS
Non-stop discussion of Stops. Monday, august 4, 2008

No matter how much I write about stops, this topic doesn't seem to go away. Like
Phoenix from ashes, time and again it arises. Recent discussion with a long-term
trader returned me to this endless source of questions, doubts, hopes and
frustrations.
Warning for overly sensitive types. The text below may seem harsh. Consider it
tough love. My counterpart in this discussion took it this way and, I am sure, stands
to benefit from it.
The story is probably all too familiar. A good trader in all other regards,
knowledgeable about both fundamental and technical sides of trading, capable of

picking right sectors and stocks, determining the direction and timing his entries.
Beautiful performance on winning trades. Overall performance, ummm... leaves to
desire. Threading water at best, losing money is more like it. Why? You probably
guessed it. Some of misses are so disastrously big that they manage to negate all
the wins and add some red on top.
I think I'll never understand why traders so stubbornly refuse to take stops. No, I
was not born with this skill ingrained or inherited. I had my share of blown stops in
early years, and they cost me dearly. But but but... how many times the same
lesson needs to be taught before we finally heed it?
Here is why I don't understand it. Are you, a trader who doesn't want to take stops,
compete for the title of Da Best Trader of All Times and Nations? Because if you
manage never ever to lose, you sure are going to be one. No trader in history
avoided losses. Not one, period. Whoever your trading idol is, be it Jesse Livermore
or the guy who taught you how to click Buy button (hint: GENTLY), did he win all of
his trades? No matter how skillful you are, you will lose on some of them simply
because of market's nature. Uncertainty Thy Name O Market. It works in odds, not in
certainties - meaning, even the best of setups and flawless trades executed
according to those setups will fail sometimes. Now, if you acknowledge this (and if
you don't, you have no business to be trading), why not limit your losses? This is
exactly what stop loss does - according to its very name it STOPS YOUR LOSSES.
Let me say this... the question above is rhetoric one. I know why you refuse to do it.
I already wrote about it in the past at
here (and discussed how to place them in two articles before that). One aspect of
this, however, I want to return to. This aspect is RANDOM REINFORCEMENT. It means
that not every time a market is going to reward you for doing the right thing or
punish you for doing wrong one. Sometimes a stock you just took a stop on will
rebound right away. Sometimes a stock you held against all rules will reward you for
breaking the rules. Each such case will lead you into temptation to abandon your
discipline. "Just this time, please, and I promise to be good again" Nope. Won't
happen. You will be bad again, because being bad was rewarded. This great
temptation by the market is like siren song - never what it seems to be yet who of
us can resist.
Cure is simple. Run the stats. Calculate the total of all losses that got out of hand.
Calculate the total of all the losses taken according to the rules - when the stop was
hit that is. See what those stocks did after you got out - rebounded? Died on the
vine? calculate where your portfolio total would have been should you take all the
stops in disciplined manner. Calculate the same fior the case where you would have
refused to take any stops. You got your answer.

Me - I take any stop whenever it's hit and consider it my salvation. Foe stop to me is
not.
STOP LOSS VS. SITTING IT OUT
For how long can you afford being wrong? Sunday, march 23, 2008

Response to the previous post warrants one more dip in the topic before I go back
and finish Psychology 101 series. While the concept of "being right on the reasoning
doesn't mean being right on the direction" is accepted by all who wrote back to me,
one more issue has rise in discussion. The question is, since price is bound to go

where it belongs sooner or later, why not just close one's eyes and let "them" play
their games? Wait it out, however stomach-churning the process is, and greet the
return of fairness and common sense with victorious throaty laughter?
It's surely tempting. Idea of closed eyes appeals to anyone who experienced the
phenomenon of the market kicking one's butt for doing the most sensible well
thought through and reasonable thing. The problem with this approach is this:
The market can stay irrational much longer than you can stay solvent.
I don't remember who said that but boy, was he right. I will go down the memory
lane for one of the most remarkable examples, to illustrate just how powerful
contra-obvious movement can be. I already talked about it as one of my prominent
lessons (learned the hardest way, too) - those of you who got Techniques of Tape
Reading (TTR) can open page 21. For those who for some incomprehensible reason
still haven't read it, reminder of how the story went.
K-Tel, NASDAQ symbol at the time KTEL, little company with tiny float, announced
that it was going to sell the albums with music of 60-70 over the Internet. Fine, who
cares, right? Wrong. It was the beginning of Internet era. Netscape already went into
stratosphere. K-Tel became a symbol of a new way of doing things. E-commerce was
a new word. And a new world - as usual, brave one. Stock shot up from under 5 to
over 20 in a couple days. Warranted? Heck no. Fundamentals were laughable.
Perspectives were bleak. No one believed this move could mean much for the
company's bottom line. So, every sensible trader on the planet, and I suspect some
for Mars, went ahead and shorted it. Stock danced a bit around 20, then slowly
moved closer to 30 (those were fractions times, they moved easier than under
decimal system these days). Next morning it opened at 31 and proceeded higher.
Then brokers called shorts in, to the horror or those who decided to close their eyes.
If you don't remember those days or haven't read TTR, try to guess where the stock
finally topped out? Eighty dollars!
Now, even if not for shorts being called in, would you be able to sit out such ride? I
highly doubt it (unless you ARE from Mars that is). Chances are, you would have
given up long before it was over, and the closer to the top your capitulation occured
the more insulting it would have been. Worse yet: let's suppose blue-eyed miracle
happened and against all odds you did manage to sit tight through this experience
(nothing short of being made to watch Inconvinient Truth five times a day two
weeks in a row). Do you think you would be able to profit from subsequent price
drop? I wager Victoria, biggest crater on Mars , that as soon as KTEL dropped closer
to $20 making you even, you would have covered your short with sigh of relief loud
enough to be heard from that same crater. And if I am right about this, then all this
horrible risk and gut-wrenching experience was for what, to get out about flat? Give
or take couple millions nerve cells?
Oh, and for the irony... K-Tel's CEO, when interviewed those days, said he was not
selling his shares because "he was told stock goes to 100". Now that KTEL is long
gone, I wonder... if that's what happened and he never sold, was it an ultimate case
of market killing both sides or what?

AVERAGING DOWN

Averaging down Yea or Nay Tuesday, Jun 23, 2009

"Averaging down" as a trading approach regularly causes controversy. While

difference of opinions is always good, let's have a deeper look into it to make sure
that opinions are informed and that we are talking about the same thing.

There is averaging down and averaging down. Not all of them are created equal. I'd
break them down by two kinds.
1. A trader buys, position goes against him, he fails to cut his losses, sees them
growing and getting out of hand. Eventually at some point he adds to his position
following the logic "If I liked it at $20, it should be even better at $10" and/or "it
can't go any lower". Both are false: anything can and often will go lower (no lack of
examples of that over last year, eh?); and who is to say it was any good at $20 to
begin with? And is $10 a better price or simply a proof that $20 was a mistake? This
kind of averaging down is a "bad" one; it's done out of frustration, and it adds to a
mistake. More often than not it increases eventual loss. In most cases what follows
is: your position does recover some, by some magic stalling right under new
breakeven level ($15 in our example). This gives you a chance to exit with a small
loss but you don't take it - after all, recovery has started, you are looking at
possibility of nice profits now (and on double size, no less). Sure enough, stock
reverses and drops under $10 where you either exit with even bigger loss or put it
in your long term portfolio, a.k.a. Grave of Short Term Trades Gone Bad. Another
frequent scenario is, stock dives briefly under your second entry level, you sell your
second position for a small loss, and that's where stock reverses and goes back to
that 15... you curse your decision to cut losses on second part and don't sell first
part - after all it's cutting the loss that killed your chance to get out even, right?
Sure enough, it reverses down and you are looking at ever-increasing loss again.
Those rare instances when this strategy works only reinforce the idea of it being a
viable approach, eventually provoking you to employ it again and again, until it
leads you into a loss exceeding anything you saw in your worst nightmares.

2. Averaging down is a part of planned strategy. When a stock comes into your
target zone but there is a lot of uncertainty in the markets, you don't feel confident
enough to fully commit and don't want to stay on a sideline. You break your
purchase in parts and plan a strategy for those parts. This strategy includes various
scenarios of building up to full position in a case of further drop, in case of reversal,
in case of stall. It also includes an "uncle point" - event or scenario which proves
that the whole idea of entry was an error, so whatever is accumulated up to that
point is being dumped. There is nothing's wrong with this kind of averaging down it's done by a design, to minimize exposure at the uncertain time and increase it as
events develop in a favorable way. I wouldn't even call averaging down but that's a
matter of semantics.

As we see with many other things, there are no absolutes in trading. There is,
however, need in clarity, in straigforward well-designed and thought through plan.
Such plan, among other things, wil include definitions - as we mentioned earlier in
this blog, "as you name the boat, so wil it float".

BASICS OF STOP LOSS

Stops: Why and how

Too many e-mails concerning stops, stop placement and different aspects of this
topic to omit it. Several articles will be devoted to this crucial part of trading.
A discussion of stop losses usually involves three parts. The first part is an
explanation of the absolute necessity of applying a stop loss to any trade. I am
going to assume that the reader knows very well that risk control is a crucial
element of their survival in the markets. The second part concerns psychology and
discusses the practical tricks that ensure a trader never goes into a reasoning
mode and blows his or her stop. I'll get to this later. The third part is purely
practical where should a stop be placed? What factors should be considered? How
should a stop be trailed when a trade moves in ones favor? A practical aspect of
placing stops is the topic of this article.
One very common notion says that a stop should be placed in such a way that it
limits your loss to a certain amount 1 to 2% of your trading capital is typically
recommended. While limiting your losses to this amount is a sound
recommendation, this approach is flawed if market movement is not factored in.
Here is why: the market has no idea about your capital, your risk tolerance or even
the fact that you are in trade. It moves by its own rules and patterns, and those
patterns must dictate your stop placement. In other words, its a signal of a trade
failure that tells you Get out! We will be back to the 1 to 2% rule later; at this
point lets define your major rule for a stop placement.
Your trade is stopped out when a reason for a trade is no longer there.
Lets see how it applies in practice. Our first example assumes you are trading a
Cup and Handle type of breakout (see Fig 1):

Fig 1. Cup and Handle

Lets look into your reason for a trade, to find out what defines a failure. A Cup and
Handle is a breakout setup that triggers your trade at the moment when a rim is
broken. A handle bottom forms a higher low compared to a cup bottom, showing
its closest support. The break of resistance, while holding support, serves as your

reason for your trade. It means that if a trade reverses on you and breaks the latest
support, your original reason for the trade is no longer there, and your trade is
stopped out. Thats why the stop level is placed just under the handles bottom on
Fig 1.

Lets look at another example: a reversal trade off a Double Bottom (see Fig 2):

Fig 2. Double Bottom

In this case your trade is based on an assumption that a stock has formed support
by testing it twice and is poised for bounce. Obviously, a break of this support
renders your rationale as invalid and, therefore, a stop has to be placed under this
level.

The two examples above refer to chart formations; but the same logic applies to any
other approach. For instance, if you trade off technical indicators and use, lets say,
a stochastic oscillator, a reading below 20 is an entry signal for a reversal trade. In
this case, if a stock pauses instead of bounces and a stochastic reading goes lower,
you read it as a no bounce signal and close the trade. Notice that the same logic
applies even to the trades based on fundamental data: remember the famous
saying If you buy a story, you have to sell when a story changes?

The next aspect of a stop placement is a trailing stop. It applies to a situation where
a trade moves in your favor and pauses, forming the next resistance. If you are a
scalper, you simply take your profit at this point. However, if your objective is to let
your profit run, you will want to protect your profits from evaporating. This is where
a trailing stop comes into play, and the logic of its placement is very similar: it
moves to any new support formed by a stock on its way. Here is the simplest
example of such trailing (See Fig 3):

Fig 3. Stop trailing

If a stock formed a new higher low after the first stage of movement, this level
becomes a new support and serves as an indication for a new stop level.

Now, armed with the logic of a stop placement you can apply it to any trading
strategy you employ. And what about that 1 to 2% rule that we mentioned at the
beginning of this article? Really, think about it. What do you do if a chart dictates a
size of a stop that exceeds your risk tolerance? You factor it in by position sizing.
Lets see how its done. Assuming your trading capital is $30,000 and you want to
keep your losses on any given trade to within 1%, you limit your losses to $250. If
your trading lot is 1,000 shares and your setup shows a stop level as .25 cents, you
are fine. If, however, a stop level dictated by the setup is .35 cents, you simply
decrease your amount of shares for this trade to fit your risk tolerance in this case
to 700 shares. Do not forget to make sure your stock is liquid enough to absorb your
shares if a stock is too thin, you will need to factor in possible slippage, decreasing
your shares even further.

Now, granted this way to place and trail stops is very common and overly
simplistic. In reality, everyday trading employs more sophisticated methods than
utilizing this common knowledge to enhance your edge. When a strategy is widely
used, it can become a subject of contrarian trading an approach that puts you
on the Smart Money side as opposed to the Public side. This strategy is going to be
the subject of the next article.

DEEPER LOOK INTO STOP LOSS

Stops: a deeper look

In previous post I described a general approach to stops placement and trailing, and
I also touched on the subject of contrarian trading. Lets expand on this matter.
Obviously, if a method of a stop placement becomes commonly known and broadly
used, sooner or later you will run into situations where the method stops working.
In practice it means that the way you place your stops starts producing a higher
percentage of cases where your stop gets hit just before the trade reverses and
returns into a profitable zone. This phenomenon reflects the very nature of the
market it works in a way that allows the minority of players to take the majoritys
money. According to this concept, every strategy goes through certain life cycles. At
first its used by minority and produces a high percentage of success. As it becomes
widely known, this percentage reverses and the strategy starts losing money. As the
majority gets frustrated and abandons the strategy, it starts working again. You
can read more on this in The Master Profit Plan .
So, how can we utilize this understanding? There are two approaches to this matter.
The first is defensive: Change your strategy in a way that puts you outside of the
zone targeted by Smart Money. In practice it means that you need to analyze the
charts of failed trades to find out more optimal level for your stops. Lets illustrate
this. Fig 1 shows a generally accepted approach to stop placement for a simple case
of range breakout.

Fig 1. Original strategy

This method works successfully while trades executed in this manner work as shown
in Fig 2: they reverse before hitting a stop (line 1) or, if a stop is hit, they proceed
lower (line 2).

Fig 2. Original strategy works.

However, if you run into an increased number of situations, where your stop level is
hit just before the trade reverses and returns into the profit zone (as shown in Fig 3),
your method is getting faded Smart Money has recognized the majoritys ways
as an opportunity and started trading against it. You have probably heard the
expression gunning for stops this is exactly what is shown on Fig 3.

Fig 3. Original strategy is faded.

In order to incorporate this change in your strategy you are going to have to change
your stop placement so that it is located under the point of reversal. It involves
observations to spot the most probable level of reversal after hitting the stop.
Obviously, you will also have to decrease your shares size since your stop became
wider. I would call this action an attempt to escape Smart Money stop-gunning.
While this approach is acceptable to remain profitable, my heart goes to another
method: an offensive approach. It essentially comes to placing yourself on the
Smart Money side. This is where your strategy gets way more sophisticated. If you
are in a choppy market where the breakouts are faded on a regular basis, start
fading them instead of trading them after all, pattern failure is a pattern, too. Or, if
you are still in trending market but the pullbacks like the one on Fig 3 occur on a
regular basis, change your entry idea: Instead of an entry at the breakout point,
look for the reversal under the conventional stop placement level, to utilize this new
pattern. This is a very powerful way to optimize your trading. By doing this, you
place yourself against the crowd and side with Smart Money.
You can feel that this approach requires constant monitoring of market conditions
and adds a certain creativity in your trading approach. This is exactly what

separates a seasoned trader from an amateur: being in tune with the market,
changing with it, spotting new opportunities and weeding out those that cease
working.
Now, if you review the second paragraph of this article again, you will probably ask
yourself: is it correct to say that the strategy stops or starts working again? This is a
valid question and thats why I put those expressions in quotes. A strategy never
stops working it changes the way it works, presenting you with a different set of
opportunities.

PROTECTING YOUR PROFITS

Profit: how do you handle it?
Consistency is a sign of professionalism.
Weird question, isn't it? You pocket it, you smile, brag, drink, spend on that even
bigger screen TV or even smarter phone... right? Well, yeah - under one condition:
after making that profit you managed to keep it. If you are anything like 99% of the
rest of the players then the following complaint will sound very familiar to you:
I started the day so nicely, got this and that trade right, and if I just fainted right
then it would be the best day of the month... but I pushed for more, lost some, felt
regret, wanted to get it back, pushed again, lost all my profits... then I just couldn't
accept that it all evaporated, and tried again and again... only to finish the day
deeply in red. WTF?? (which as we all well know means Why The Failure??)
If you can't related to the above, just skip the rest. You are not human, why bother
with our human problems. If you can though, here is the advice I regularly give in
the room when someone hits great winning streak in the morning. Make it your
standard operating procedure, and you will never find yourself in that frustrating
situation.

1. Decide for yourself how much of your today's profit you keep no matter what and
put a "stop on your account" so to speak at that level. My rule of thumb is 75%.
2. On all further trades manage the stop level and position size in a way that
doesn't jeopardize more than the rest of the profit made earlier (in that rule of
thumb it will be 25%).

3. Each time you make another profitable trade, move your account stop up to
protect some of this additional profit as well. My rule of thumb is 50% of new
portion. This is not unlike trailing stop, only applied to your trading account.
4. If your "trailing stop" is hit by a losing trade, you are done for the day. Go enjoy
life or switch to paper trading if you want - but no more actual trades. Switch to
demo mode if your software allows it. Go away from your computer altogether if you
suspect you have weak discipline and may give in to temptation.
5. If your winning streak continues, close to the end of the day start trailing even
tighter - 75% of all new profits (again, not unlike trailing stop principle where you
tighten it more and more as price advances in your favor).

To put it all into numbers for illustration purposes:

Let's say you made $1000 in the morning trades. Your stop is at $750 now (if you
want to go with my management; adjust to your risk tolerance if it's different from
mine). Now, if your next trade loses $150, you have only $100 to lose before you
stop trading for the day. You lose $250 - you are done, no live trades today
anymore. Your next trade made $300 - trail your stop by $150, so now it's at $900.
The next one made $400 - trail the stop by $200... etc, you got the idea.
This approach will save you a lot of frustration and make you much richer. Don't let
the idea of "but what if I miss a great trade" tempt you - there will be a market
tomorrow too. Trading is continuous process of many trades, and it's a combined
result of them all that matters. Consistency is a sign of professionalism.
I can't remember, nor can I find on the fly, who said this: market is the easiest
place to make money and the hardest place to keep it. Very true. If anyone knows
the author and gives me a clue, I will add the name.

TRADING PSYCHOLOGY
BASICS OF TRADING PSYCHOLOGY
Psychology 101 Saturday, February 2, 2008

One of those neverending debates among newer traders... role of psychology in

trading. Some claim it's all there is to trading. Some argue it's nothing but red
herring, and one just needs to follow his signals (system, indicators, whatever) and
no psychobabble will ever be needed. Yet some say psychology is important and
assign some weight to it - "80% of trading is psychology"... or 95%... Not sure how
they measure it, I personally like 76.364%.
Two things to say about this.
First, we are different. Some simply cannot change their behavior and no matter
what system they are given they just can't follow it. Their personality takes over
pushing them into all kinds of trading no-nos. Then there are others who don't seem
to experience any impact of their inner workings, they see the light and follow it.
Obviously, the role of psychology will be drastically different for those two types.
Second, and most significant for most of us. We go through different stages in our
learning curve. As far as trading psychology is concerned, I can clearly see three
stages that are most common among traders.

First stage is total ignoring or underappreciation of this aspect of trading. By

ignorance, by arrogance or for whatever else reason, a trader doesn't give it much
thoughts while focusing on technical side of trading.
Second stage is acknowledgment. Running into troubles with their inner gear,
reading books or listening to others, traders become aware of the ways their
personality interferes with their trading. They have met the enemy.
Finally, third stage is dismissal of psychology again. Maybe dismissal is not the right
word but that's how it feels for it's no longer needed. At this stage it becomes
unneeded as a trader overcomes his inner barriers, changes himself, learns to
behave in a right way and this correct behavior becomes second nature. Just as
learning to swim you stop thinking of how to move when swimming, in the same
way you stop giving time and thoughts to psychology of your trading again seemingly returning to a first stage, although it's obviously another level you reach.
You simply mastered it and stopped thinking about it.
It's important to understand that this third stage exists and make it your target to
achieve it. Too many traders simply get stuck at the second stage - they think of it
all the time, they make it their point of focus to such degree aand for so long that
they just can't seem to get out of it. Development stops, they become locked in this
endless inner digging. No need to rush through this second stage but to get stuck in
it forever is no fun either.
In the following posts I intend to discuss each of those three stages a bit deeper.
And, if you are lucky to belong to that second type, ignore this part of blog
altogether. Check out the fourth stage though which discusses the highest
craftsmanship of this side of trading.

NOVICE
Trading psychology Stage 1. Blissful Unawareness. Tuesday, Febrary 12,2008

As I mentioned in the previous post, first stage is usually the one where a newer
trader doesn't acknowledge the role of psyhcology in his trading. It happens out of
ignorance or arrogance.
In a former case (ignorance) it's simply lack of knowledge and mistaken notion that
one can trade succeffully if given "right" system or indicator ot tip or whatever
causes one to enter and exit his/her positions. It usually takes a while before a
trader starts seeing how his mindset influences his trading and how his personal
traits shine through his trading decisions. It comes as a surprize realization that
different traders will get different results while trying to apply the same system. It is
counter-intuitive, isn't it?
In a latter case (arrogance), a trader shows some kind of denial - it's "not me"
attitude, thinking that goes along the lines "maybe it's a problem for some but I am
in control of myself", "this stuff is for weak-minded" etc. Needless to say, it's rarely

the case... and even more importantly, it's not so much about weak vs. strong mind
as it is about influence one's personality has over one's trading.
In any case, the important thing at this stage is to come to appreciate this aspect of
trading. It happens when one sees how much truth there is in saying "everyone gets
what they want out of market" (Ed Seykota I think?) Again, seems counter-intuitive,
right? After all, don't we all want to succeed, to make winning trades, to make
money? Sure... but it's not what our conscious mind wants, it's about what our inner
core dictates, and that is not always easy to realize and control.*
Simple example to illustrate the idea: do you know people who repeat certain
behavior patterns harmful to themselves? Getting themselves into relationships
with types that make them miserable, over and over again? Repeating the same
mistakes in their interaction with others, obviously not learning from the past? I bet
you do (although you personally never act like this, right?) So, why do we do it even
though we see (or could see if we looked) that these behavioral patterns hurt us?
Because those patterns are not just some easy to break habits; rather tthey are part
of our personality, of who we are, and it takes much more than simple decision not
to do that anymore to change our ways. Pretty much the same thing happens in
trading - we know what not to do yet we continue doing it.
As soon as one realizes all this, the first stage is completed. The role of psychology
in trading is acknowledged, denial is over - and this forms the foundation for a
change.
*My favorite example of this phenomenon is one I referred to several times in earlier
writings, although not on this blog I think - Russian movie Stalker. Briefly: there is a
certain machine granting wishes (stalkers in the movie are people who take clients
to it through many dangerous traps). Machine grants wishes alright but there is
catch: it's not a wish that you stand in front of the machine and announce that will
be granted... it's a wish that constitutes your essence, your core, your deep desire and it's not necessary the one you realize and announce to yourself and to the
world. Pretty much what happens in trading and pretty much what the author of
that saying meant.

INTERMEDIATE
Trading Psychology Stage 2. Acknowledgement

So, our trader comes to realization that his inner mind a) greatly influences his
trading performance and b) isn't always under his, trader's, control. Naturally, he
wants to take control over himself - and this is what it is about, self-control.
You can view it in the same terms as you do in life in general. We all found
ourselves in a number of situations where the right way to act was not what our

emotions dictated. Boss whose thinking doesn not light up the office with
knowledge and wisdom? Kid right behind you whose only purpose in life seems to
be to pound your seat with his feet during whole flight? Chatty co-worker who
doesn't let your button go until he enlightens you about all the plot twists of the
soap opera you never knew existed? Leisure-minded driver in front of you who
doesn't seem to recognize green as permission to move his foot from brake to gas?
Go ahead, list all your gripes with the world, I'll wait couple minutes. OK, an hour.
... Done? Cool, let's continue. What is it that keeps you from giving all the offenders
listed above the piece of or your mind (providing you do keep yourself in check)? Or,
let's say, from grabbing the ice cream from the passerby when you happen to want
it and he happens to have your favorite kind? Discipline does, reinforced by society
customs that serve as limitations on our behavior. "Freedom of your fist ends where
the freedom of my nose starts." Now, imagine all those limitations being removed
and all reinforcements gone; and imagine that any negative outcomes of your
action are limited to you only so no moral or ethical brakes either. Are you
guaranteed to stay as disciplined and restrained? Heck, some can't even with all
those restraining factors in force. Are you more likely now to give in to temptation
and act your emotions out?
Probably yes. But that's exactly what we have in trading environment. There are no
external factors keeping you from causing harm to your account. If you allow your
emotions to take over and start governing your actions, no one stops to tell you
"hey mister, what the heck do you think you are doing?". No one calls 911. Do as ya
please and may it do ya fine - that's the psychological backdrop we deal with in the
markets. With this realization comes understanding that in absence of external
restraints we need much stronger self-discipline and self-control in order to continue
following the rules.
Next question is, naturally, how? It starts with right understanding of the very
nature of the market as an uncertain environment. Such understanding creates a
foundation for the proper mindset. It continues with some strategies and tricks
helping a trader form strong set of rules and motivations. My favorite are "Model
Trader" and "If I Were Smarter" described in The Master Profit Plan . The process
takes a while usually. How successful you are in creating the proper mindset and
strict self-discipline will actually define how successful you are in trading.
Let's move on to the description of the third stage so you have a clear idea what
you need to arrive to.

EXPERIENCED
Trading Psychology Stage 3. Clarity

Finally. Painful process of hatching is over, and a trader is born. You are no longer a
slave of your emotions, you are your own person. You are in full control of your own
actions. You don't jump in the middle of action or out of it on a whim - rather you are
capable of pausing and weighing your options and making your decisions in a cold
blood. You can see the crowd's emotions on a chart clearly, and you are no longer a
part of that crowd nor you are affected by their emotions. You can evaluate those
emotions and utilize them. This is an amazing state of clarity, and it's very
liberating. These two words (clarity and liberation) probably constitute the essence
of this stage of a trader's development. Ability to see clearly the reality of what
happens and the freedom of making your own choices as to how to react - this is
what makes you a master of your trading vs. being part of the crowd.
You are but detached observer of the market, never involved emotionally yet
constantly evaluating the emotions of other participants, waiting patiently for the
moment when the opportunity presents itself and the odds are the most favorable;
entrenching yourself where you anticipate the action to unfold; pouncing when the
right moment comes; having no problem to retreat if proven wrong; having no
emotional baggage over any outcome and ready to act again.
All above is the description of this stage and how it feels. Let's talk a bit of how you
arrive to it. The transition from stage 2 to stage 3 is not a single moment of
epiphany. It's a gradual process of many small clicks, each being another piece of
the puzzle falling in its place. Realization of how market's logic is different from
conventional Aristotle type of logic - click. Understanding how Smart Money acts vs.
how Crowd acts - click. Understanding how a chart reflects emotions - click.
Realization that you don't have to participate in any market event and are free to
choose your battles - click. Each click comes as a result of another lesson taught by
the market - and a good teacher it is for rarely does it miss a chance to put you
through another lecture or test. If you are an avid student of the market, you will
listen carefully and take notes, collecting knowledge and experience. Ore comes in,
steel comes out. This process takes time but it's so worth it, as all the sinter is being
discarded and the final result is extremely rewarding - Clarity and Liberation.
A little sidenote is in order: when you arrive at this point in your trading career, you
find out that this whole transformation has changed you not only as a trader - it
changed you as a person, reflecting in other aspects of your life, making you more
disciplined and in control of yourself, giving you the clarity in seeing "behind-thecurtain" happenings, better understanding people and events around you, better
ability to deal with them. This comes as a side effect and is an icing on a cake... or
maybe it's an ultimate achievement in and of itself, and better trading performance
is merely a side effect?
Now, all above sounds so good, I just have to throw a spoon of tar in all that honey.
The bad news is, this state of mind once being achieved is not necessary going to
stay with you once and for all. Now and then you are going to have unpleasant
lapses of sanity when old habits seem to return. We touched on this earlier in this
post. The process of kicking nasty habits is not a single event, it's a process. There
are sound reasons for those temporary setbacks. When we succeed we tend to stop
doing what made us success in a first place. Complacency, letting your guard down,
overconfidence, feeling that we became so good rules don't apply to us anymore...
However, as frustrating as it can be, there is a good news, too. As you move along,
overcoming another drawback and returning to the right path, your skill of dealing
with this phenomenon becomes better. Relapses become less frequent, you learn to
recognize them sooner and eliminate them faster and easier. They will finally stop
altogether when the right way to act in the markets becomes your second nature.
Or first.

So, is this all there is to the stages of psychological transformation from the sheep
to be slaughtered to the money extractor, aka trader? Almost... there is just one
little twist left, and that twist will constitute stage 4. Next post will go over it and
conclude this mini-series on trading psychology.
SOPHISTICATED
Trading Psychology Stage 4. Through the looking-glass Sunday, April 27, 2008
... and What Alice Found There.

This last stage of a trader's development in psychology department is fairly simple

to understand, maybe not very easy to implement... but give it due recognition and
make an attempt, and it will happen with not much effort - as long as you are ready
for this transition.
The idea is really simple. There are emotions that, at your early stages, plague your
trading and cause erroneous entries and exits. Those are the same emotions that
cause the crowd's mistakes. As you learn to deal with your emotions, take control
over them and diminish, then eliminate, their impact on your trading decisions, you
don't completely eliminate emotions themselves. You just learn to dull them and
separate your trading actions from what your emotions try to push you to. However,
you still should be able to observe them as detached cold-blooded observer, This is
a stage where you gain an ability to actually utilize them instead of being their
slave. If you can feel how huge selloff creates this feeling of panic somewhere deep
in you, this is what crowd feels. Feel the temptation to buy this parabolic upward
spike, seemingly unstoppable? Chances are, at the moment when you feel the
strongest urge to give up and just buy, that's when the last buyers desperate not to
miss the train hit their Buy at Market buttons.
You see the point now. Use this as a mirror, as your window into understanding how
crowd acts. Together with your strict self-control, such approach will put you on the
right side of trades - and as we know from Tape Reading principles, right side is
usually not the crowd's side. It's not a stand-alone method of trading of course but
it's a good supplement to your tape/chart reading skills. Overall, this approach is in
perfect alignment with a few Taoist principles described in our A Taoist Trader course
Two fair warnings. First, do not try to implement this element into your trading too
soon. You really need to be at Stage 3 and get steady and confident at it before you
try to move to Stage 4. No jumping over steps. Contrarian approach of this kind
requires a lot of experience and perfect self-control.
Second, somewhat humorous... as you progress, you may find that you stop
experiencing those crowd-like emotons altogether and your impulses are fully in line
with your own reading now. When it happens, your attempt to read YOUR impulses
as a window in CROWD's impulses may backfire as you start trading as a contrarian
to yourself rather than crowd, eseentially becoming a part of a crowd again. OK,
that was half-joke.

PSYCHOLOGY OF A STOP LOSS

Stops: Why dont we keep them. Thursday, may 10, 2007

With everything said and written on the subject of stops, it should be given that
everyone is conditioned to keep them religiously even before they start trading. No
matter what source a newer trader turns to, utter importance of stops will be
underlined and emphasized up to the degree that keeping them is heralded as the
ultimate key to success. We all heard adages like Take care of your losses, profits
will take care of themselves.
Do all the stern warnings work? Not really.
Time and again traders blow their stops, widen them in a course of a trade, hold
losing position in a false hope it will make them whole. If this destructive behavior
continues despite all the warnings, there must be deeply rooted reasons for this. As
with most trading flaws, failure to keep stops roots in fundamental misconceptions
about the very nature of the market and trading. Such misconceptions cause
incorrect psychological makeup which, in turn, results in behavioral patterns harmful
for a traders performance. In order to re-condition oneself it is necessary to work
out fundamental, even philosophical if you will, understanding of the market as an
environment in which a trader operates.
Let us list and analyze the misconceptions that cause failure to keep stops.
Right action must result in profit.
This misconception stems from misunderstanding of the very nature of the market
as an uncertain environment. Newer trader sees a market as a conglomerate of firm
links between reasons and outcomes. In such a conglomerate, every reason results
in single possible outcome. The simplest case of such link would be good news
up, bad news down. We know its not true price reacts to news in a wide variety
of ways.
Similarly, an inexperienced trader applying the setup he knows should work
expects every trade to be a winner, providing all the components of the setup are
right. Have you ever heard complaints like Everything was exactly like in that book,
yet the trade failed? That is direct result of this misunderstanding. Everything may
be right, yet the trade fails just because markets work in probabilities and not in
certainties.
If a system produces certain percentage of wins over time, its just statistics and,
as it is always the case with statistics, it cannot predict an outcome of a particular
trade. No matter how good the setup is, any given trade can fail. Thats why its
imperative for a trader to distinguish between two kinds of losses.
The first kind is a loss caused by a traders mistake failure to follow all the rules of
system applied, or impulsive entry without any reason at all. Such losses must be

taken as a lesson. The second kind is the case where every piece of puzzle was in
place, yet the trade failed such losses must be written off as a part of trading
game, as a tribute to uncertainty of the markets.
Of course, if you identify a component of your trading system that regularly causes
trade failure, you can and should tweak your system in order to minimize failures.
However, during the trade a stop must be taken as soon as signal of failure appears.
The line of thinking The setup was so good, it must work eventually is a disaster
waiting to happen.
Failure to perceive the market as an uncertain environment can result in another
misconception:
Losses can be eliminated.
In a paradoxical way, this erroneous notion leads to more losses. A trader tweaks his
system endlessly trying to get rid of losses completely. In such constant adjusting
and re-adjusting, the system evolves into something totally different, losing its
original logic, or even stops producing entry signals at all. As a result, a trader
either abandons his system, which was not a bad one to begin with, or in a worst
case, simply refuses to take losses. After all, he made his system so perfect by
eliminating all the reasons for failures, it just MUST work! Meanwhile, had he stayed
with original approach, maybe with some minor tweaks, it would continue producing
steady results.
My trade is who I am.
This is one of those hidden subconscious misconceptions that cause us to refuse to
take our stop. A trader perceives the result of his trade as a reflection of his
personality, his abilities. A trade failure makes him feel as though he is a failure.
Winning makes him feel "right", while losing makes him feel "wrong". Nobody likes
to be a failure, to be wrong. Thats why, in order to avoid being wrong, we refuse to
take our stop. You can be right and still lose on this particular trade. You can be
wrong and win, too.
Its important to differ between good and bad trade, and we will be back to this
later, in the Random reinforcement part. At this point its important to separate your
self-perception from the result of your trade. Taking a stop loss, you are stopping
your loss nothing foolish about that. The major trigger for the right approach here
is a realization that by accepting the market as an uncertain environment, we
already have accepted the possibility of losses. If we havent expected the market
to work in our favor every time, there is no reason to feel foolish when it doesnt.
A loss is just a paper loss until its taken.
This is a big mistake in thinking. If a loss gets out of hand, its very real. It paralyzes
you, it clouds your judgment, and it makes you miss plenty of other opportunities.
Instead of taking a pre-determined loss and moving on to another trade, you sit and
watch your losing one, twitching in pain and feeling remorse. Your chance to take a
small stop is long gone. You are agonizing now over big one that is going to deplete
your account too much and inflict serious emotional wounds. You hardly notice
many other opportunities. The market has moved on, other sectors and stocks are
in play, and you still nurture your losing trade, hating it and not being able to finally
drop it. At some point you will ask yourself "Why was this trade so important to me?
What made me hold onto it?" And this takes us to the next common error:
Putting too much importance into single trade.

A newer trader tends to see each trade as overly important, as if its going to make
or break him. The market is an endless stream of opportunities. The next trade is
right around the corner. No single trade is so important that it would be worth
abandoning all other opportunities. Perceive your trading as a process, not as
separate events. With the correct approach trading becomes natural, like breathing.
Each entry is inhale, each exit is exhale. Breathe in and breathe out. Dont choke
yourself trying to hold onto each given breath.
Random reinforcement.
This is an important concept to understand. The market is not always rewarding
right decisions and punishing bad ones. The practical implication is that a trader
runs a risk to stop applying proper techniques if he sees wrong ones being rewarded
sometimes. Take a stop, observe a stock reversing and going into profit zone and
you get tempted to skip your stop next time. If you try it and it works, there is
significant chance that you continue doing just that the bad habit gets reinforced.
You may win several times by breaking your rules. What happens eventually is that
one trade that does not reverse destroys your account. Its important to define what
good and bad trades are. Unlike many think, a good trade is not always a winning
trade; a bad trade is not always a losing trade.
- A good trade is a trade where you kept all your rules that you know to be working
in a long run. A good trade can be a winning one when the market acts accordingly
to what your system indicates. It can be a losing trade when the market acts
against it, but its still a good trade.
- A bad trade is a trade made against your better judgment, against your rules. It
can be a losing trade when a market acts as it should. It can be a winning trade
when the market rewards your bad judgment, and it can be a very dangerous trap
as a bad habit gets reinforced.
The last thing to say in conclusion is that a certain psychological barrier for a trader
to overcome to start applying his stops with no hesitation. When this barrier is
taken, things suddenly become so clear and automatic that a trader cant even
believe it was ever a problem for him. When this barrier is overcome, you feel that
stops became natural part of your trading, that you take them with no slightest
hesitation and forget about them instantly, moving on to search for your next trade,
that taking stops do not trigger any negative emotions. This is wonderful feeling of
total self-control. Not only will it do plenty of good to your trading performance, its
a very rewarding feeling in itself.

PSYCHOLOGY OF RELAPSE
Costly hiccups do you have any? Sunday, September 9, 2007

Summer fun seems to be nearing the end... wouldn't tell it by the weather, still
great, but amount of e-mails increases greatly so probably time to come out of
blissful unconsciousness... back to Earth.
One of the most frequent questions I get: "OK, I seem to have mastered a lot, I can
extract money from the markets and I have stretch of winning days BUT... one day
comes where I seem to be unable to follow my own rules, I start doing everything
against what I learned, dig deeper and deeper hole... and when the day is over I find
myself giving back all I made in a week before that! I feel groggy... then I remember
everything I learned, pick myself up, glue pieces together, start trading carefully,
start making money... only to have another blow-off just like the previous one in a
week or two! What's going on, why can't I control myself and how do I avoid these
frustrating days??"
If all above sounds familiar - it should. I didn't meet many traders who avoided this
problem. Good news is, it's a somewhat good problem to have since it appears at
the stage where your method is good enough and mastered well enough so you are
able to make money consistently inbetween those disgusting days. Bad news is,
there is no other way to overcome this problem but to understand the root of it.
This, however, is true for all psychological barriers we encounter in trading - no
magic button to push and turn the problem off, gotta understand where the problem
stems from so you can recognize it when it re-appears and apply the right patch.
And this problem is pure psychological - after all, what could change so drastically
on the fifth day after four days of winning? Aside of your own behavior that is.

(There is a need to say some general words about trading psychology but let's do it
in the next post.)
So, what gives? Why the Momentary Lapse Of Reason (yeah, I am old-fashioned
enough to love Pink Floyd)?
Mechanics of this phenomenon are fairly intuitive. Remember the saying "When we
succeed we tend to stop doing what made us asuccess in a first place"? This is
exactly what happens here. As we make money day after day we start feeling
invincible. Worst yet, subconsciously we start assigning the success to our genius.
It's not the rules we follow. It's not the system we apply. It's not the favorable
market (God forbid market helps us, we BEAT the market, we WIN against it! Right?
Right?). It's US - we are above the rules, above the system, we are THE trader.
If you had to put all above in a single word, which one would you pick? Right. EGO.
This eternal "enemy within" finds the way to undermine our success by convincing
us we are second coming of Einstein. All this happens quietly, in the background,
you don't even notice how paradigm changes... but it does, and somewhere deep
inside you don't believe anymore rules apply to you.
Catastrophe comes with the next losing trade. Instead of taking our usual predetermined stop we chose to ignore it. Why, we are the winner. We are having
winning streak, uninterrupted for days. And since it's our genius that makes it
happen, we won't lose this time too. Why take the loss, winning streak will continue.
Rules are beneath us. Market be beaten and crying bitterly. We be laughing.
Know the rest, right? Stock continues against us. Either we take the loss finally,
much bigger than the total of our losses for a week before... or we hold... oh, and by
the way, while we fought this one, another trade came along, and we went for it,
and it went in our favor, but we haven't taken the profit where we normally would.
Why, we needed the size of win to be a bit bigger, to compensate for this darn
stubborn losing trade... and new one reversed on us and became a loser too.
Long story short - when this day is over you dream of never waking up today. You
think of how little your loss for the day would be should you take the stop. Worse
yet, with that second trade you would even be positive for the day - providing you
have taken the profit at your usual level. Instead, week worth of good careful
trading is ruined. And why? Because you let your ego trade. It wasn't you who made
that decision to break the rules. It was your ego. But it were you who let it. Don't.
You are not above the market. You are not above the rules. When you win, it's not
because your greatness makes the rules irelevant. You win because you follow the
rules. Little humility will go a loooong way. Self-irony helps. As one of the best
traders in our trading room says every time when congratulated with winning trade
- "Lucky". And when pressed not to be so humble, adds: "Stops are skill. Wins are
luck". Whether it's so or not is irrelevant. Self-irony and humility makes a trader. Oh,
and bad spelling.

A TRADERS MENTAL STATE

Mental state

A positive mental state is an extremely important factor for successful trading. A

trader's inner state of mind directly impacts his performance. In short-term trading,
the right mindset plays an even bigger role. It ultimately defines whether a trader's
technical knowledge and mechanical skills will lead to success. Almost all the top
traders in this industry acknowledge the fact that the understanding of how the
market functions is just a foundation for success. Self-control is what eventually
makes a winner out of a trader.
One of the most difficult shifts in thinking that a trader has to develop is the switch
from Prediction" to Response". Instead of a trader always trying to predict or
expect an event to happen, they simply respond to the event that is before them.
The wrong assumption that is made by a trader is that he knows what the market
will do at a certain moment. No one ever knows with 100% accuracy what will
happen. The trader needs to shift his thinking in a manner that he will not try to
predict, but rather respond, to whatever the market decides to do. This type of
thinking requires that a trader develop a sense of absolute self-reliance. To achieve

this state, a trader must take full responsibility for any outcome of his actions (or
lack of actions). Any loss has to become a learning point. This is only possible if the
trader is willing to take undivided responsibility.
In order to read undistorted reality, the trader needs to read the market with no
emotions, as a detached observer. It's not easy to get rid of emotions but it's
doable. Accepting the fact that nobody can be always right, willingness to admit
mistake fast and thinking of trading capital as of tool rather than money are some of
steps in right direction. The trader can't progress unemotionally if every uptick puts
him in a euphoric state and every downtick scares him. A trader that experiences
strong emotions loses the ability to see the reality of the trade. From this, the trader
goes from hope to fear. These emotions dictate his actions and leads to almost
certain failure over time. A seasoned trader lets only one entity dictate his actions,
the market. Self-confidence, self-reliance, cold blooded reading of reality and
keeping emotions in check are the traits of successful trader. Our room provides a
powerful educational program devoted to development of a correct state of mind
that members can build their confidence upon everyday.

Morning Preparation Guide

Come to each day without preconceived ideas about what you think "should"
happen.
If you are watching stocks from the day before, determine support and resistance
levels that you may be able to derive and "IF/THEN" scenario. If the stock holds "x"
support, then I will enter long with a stop on the break of support.
Determine market sentiment or pre-market mood, mainly using futures figures.
However, do not feel that what the futures show, will be necessarily how the
morning or afternoon trading session continues.
Read news stories. Do not try to assess value to the news as we are not experts in
this field. We are traders that are simply interested in possible interest derived from
the news stories. Look for a gap up or down and volume. If stories are negative to
an extreme, use caution as the stock may become dangerous for trading. When a

stock receives interest shown in the gap or volume or both, place this stock on the
Level 1 screen for monitoring.
If you have access to a stock scanner or list of pre-market movers, place ones of
interest onto your Level 1 screen for monitoring. Together with news stories, try to
have 10 to 15 stocks during the pre-market session on the screen. Remember that
you dont need to try and monitor "all" the stocks with activity. Try to narrow your
focus for the open.
Near 9:00 EST, begin to take stocks from the Level 1 screen and place them on the
Level 2 screen for risk evaluation. On the Level 2 screen, look for levels between
prices to be tight, preferably 1/16 to 1/8. Also begin to look for larger sizes from
participants at each level. Showing 100 shares each doesnt show big sizes.
Showing 500 to 1000 shares is better. The idea is to find stocks that will not be hard
to execute and read when the market opens. Also, near 9:20 EST, stocks become
more clear on risk evaluation.
In the last 10 minutes of pre-market, narrow your focus for the open to 3 to 5
stocks. Place 3 to 5 stocks on a Level 2 screen that have moderate risk and looks
readable from the open. During the last 10 minutes of the pre-market session, try to
develop possible if/then scenarios on those stocks. If you do not have any
developed for the open, wait for the stock to define a range and trade from that.
Make sure volume is good enough and there is no risk for halt candidates. Often we
see stocks gapping up or down excessively on no news. Use caution on these
activity stocks as they are more apt to halt.
Calm yourself. Prepare for the open with a clear mind and readiness to trade. Do not
pressure yourself to trade however. Instead, let a trade setup occur and be ready to
take it if it shows. Even if a hour goes by and you havent made a trade, do not
feel like you need to force a trade. Many times Ive waited hours for my first trade.
Dont feel as if you have to trade. But be prepared to do so if a trade setup
presents itself. Some use meditation, breathing techniques or other "tricks" to keep
the clear mind for the open.

STAYING ON A SIDELINE
Trade what you can read. Sunday, September 11, 2011

One of the common mistakes among newer traders is the idea that a good chart
reader must be able to read ANY chart - that is, be able to create trading scenario,

analyze odds and so on. They tend to be surprised by "I have no idea" answer when
ask an opinion about certain situation they are interested in. Yet this is my fairly
frequent answer - and I don't hesitate to give it when I see nothing recognizable in
the chart I am shown.
You see, trading is not about being able to trade each and every movement.
Trading is about to be able to pick the right opportunity - right in terms of YOUR
trading approach, right in a sense of YOUR ability to read and understand the
movement and right in a sense of fitting YOUR risk and objectives profile. What
good a perfect breakout chart to you if you are a reversal trader, specializing in
trend change setups and having little knowledge of and experience with trend
continuation? It's not unlike a hunter who sits patiently in his hide waiting for his
prey, waiting for the right moment and acting only when everything is in place for a
successful shot.
Then there are situations which present no or almost no opportunity for anyone,
whatever their trading style is. If the chart is a mess with no pronounced levels, no
volume clues, no clear configurations - it's safe to assume that we are facing an
uncertain situation where nervous traders flee the risk, don't commit and engage
very carefully if at all. There will be a resolution of this situation, and that's when
you will get your signals, setups will shape up and trades will come your way. Until
then, feel confident in your lack of confidence - it takes a real trader to say "I don't
know." Good teacher teaches humility - and the market is a GREAT teacher. To quote
A Taoist Trader:
"The vulgar are clever, self-assured;
I alone, depressed.
Patient as the sea,
Adrift, seemingly aimless.

Its much more common

for a really knowledgeable experienced trader to sound reluctant, to be
unsure of the future developments and admit it openly. Knowing how
uncertain the market is, he is not so quick to express full confidence; he
accepts that events may develop in unforeseen way, and such acceptance
makes him better prepared for an unexpected turn of events. A Taoist
Traders plans and prognosis are usually tentative, with provisions for
various conditions. They will include many ifs and buts. He would
rather plan for multiple scenarios than put his full confidence in a single
one. "

SYMPLICITY IN TRADING
Simplicity: why dont we appreciate it? Tuesday, November 8, 2011

There is one curious phenomenon that I observe for a long while. You see, my
trading approach is fairly simple (let's make a distinction at once - simple doesn't
always mean easy). It's a few chart formations, reading the volume, assigning a
transparent and logical structure to the setup and following the standard procedure
once a trade is triggered. I admire the simplicity, I enjoy it, and I am a fan of an old
phrase by Leonardo: Simplicity is the ultimate form of sophistication.
Yet time and again I encounter people disappointed by how simple my trading
approach is. Yes, disappointed and skeptical - even though they see for themselves
that it works. Imagine my amazement when I hear something to the effect: "Yeah, I
observed you in action, followed some of trades, made money... read trading logs,
see that you are fairly consistent... But come on, market is much more complicated
than this! There is macroeconomics, there is stochastic, there is this, that, oh and
that - and you ignore all this stuff. It makes no sense. Hundreds of pundits devote
their life to all the analysis, and you are telling me you can do without any of that? It
makes no sense. It makes no sense."
- "Okkkay... but hey, you do see that it works, right?"
Awkward silence. Pause. Blank stare. Then life returns to my counterpart's eyes as
the needle finds the familiar groove: "See all these blogs? magazines? TV
channels?..." Etc. You get the idea.
So, why do we do this? Why is simplicity not enough? Worse yet, why is it not
enough even though it's proven as an effective approach to trading?
I have my answer to that. See if it's something you can relate to. It goes to the root
of the very reason for our trading. Why do we trade? Sure, everyone immediately
answers "to make profits" - but is it really so? Or rather, is it true for all of us? In my
experience, no. For many of us, it's an intellectual challenge that we are after - we
enjoy analysis, arguing points, proving our points to others... and all this stuff may
or may not be relevant to trading in its purest form (which is Enter, Exit, add to your
Profit or Loss column). If one's motivation is such intellectual exercise, my approach
won't satisfy that person. More than that, to some it feels almost as insult!
We discussed earlier how such analysis can and often do lead to entrenched
opinion which triggers Ego and leads to stubborn defense of one's losing position.
It's also a point emphasized in A Taoist Trader course. Let me cite a quote from that
course:

Much overcomplicated thinking obfuscates the simplicity and clarity of the real
world. Knowledge must be useful and practical.
...................

In comprehending all knowledge,

Can you renounce the mind?
In Taoist philosophy, there are two types of knowledge: useable knowledge that
contributes to the achievement of a goal (daily contentment), and knowledge that
does not. The only knowledge worth pursuing is the knowledge that serves the

purpose. Our ability to adapt to changes in an environment is a double-edged

sword. Our mind sometimes accepts external values without skepticism. These
values often conflict with our core nature and represent dysfunctional knowledge.
However, by using Taoist principles, we can accurately evaluate which knowledge
is worth keeping and which should be discarded.

The amount of information surrounding the markets is mind-boggling. Some of it is

useful in the process of decision-making and some serves no useful purpose at all. A
trader carefully observes which information helps him navigate the markets and
which wastes his time and adds to confusion. Practical usefulness measured by
actual performance is a traders criterion to evaluate which sources should be taken
into account and which should be dismissed. A trader must avoid paralysis caused
by endless and contradictive information flows..
If you ever catch yourself questioning simple trading approach merely because of
its simplicity, ask yourself: Why are you trading?

TRADING IS NOT WAR

Is market a battlefield for you? Monday, February 20, 2012

Have you ever heard something like "The market is a battle, be ready to fight with
all you've got," or "The market is a war," or any variation of this theme? I bet you
have, it's a fairly common theme. But is it true, or better question might be: is this a
mindset that you want to adopt?
Don't get me wrong - by no means do I want to present a marketplace as a happy
place where
refined gentlemen high-five your each win (hmm, do refined
gentlemen high-five at all? or they back-slap only?) and console you with fine
whiskey and cigar after each loss. No, they are out to get you just as much as you them. In that sense, anyone in the market is an enemy of anyone else. But that's
not really the point. The point is, is this kind of attitude toward the marketplace and
its happenings going to help you survive it, navigate it successfully? Or is it going to
undermine your success?
If the market is war for you, you are going to be in the fighting mode all the time.
Can you function well for long in a constant fight mode? It's extremely tense mode
which is going to wear you out rather quickly. Instead, allow me to offer you a very
different attitude - one where a market is a natural environment for a trader environment where certain patterns govern all the comings and goings. Is it a
dangerous place for a trader? Of course it is. Think of it as of ocean. It's a dangerous
place to be and swimming in it is a dangerous thing to do - just as trading the
markets.
But is it practically useful to think of ocean as a battlefield and sharks as enemies?
Try to approach it this way, and you start making your decisions based on emotions,
anger, frustration, feeling of being powerless and moving to inevitable defeat.
Instead, try to think of it as a place that is indifferent to you - not friendly, not
hostile - but simply a natural environment where incorrect behavior gets you killed.
Now instead of emotions you focus on studying patterns - which current goes where,
whether it will take you where you need to be, where the sharks are and what the
signs of them circling are, how you recognize their approach, how you spot fish that
you can catch and eat... That's your cold-blooded trading approach where you act
accordingly to the patterns and not to what your emotions would have you do.
Those who you may want to dub as enemies based on the concept of fairness and
other similar ideas (which are not the nature ideas but entirely man-made) are
those who create these patterns and are part of them. Consider them enemies - and
you find yourself fighting those patterns. Consider them part of the environment and you start studying and following those patterns.
Reread this paragraph above before you start your next trading day. See if it puts
you in a calm confident state of mind where you feel in control of your emotions and
actions.

DAY TRADING, SCALPING AND TAPE READING

WHAT IS SCALPING
As you name the boat, or what is scalping. Saturday, april 4, 2007

There is this Russian cartoon named The Adventures of Captain Vrungel. The
characters set out for a deep sea trip and name their boat Victory. As the boat
pushes off, they marrily sing "As you name the boat, so shall it float". Two first
letters immediately (and unknowingly for them) drop off turning Victory (in its
Russian equivalent) into Disaster.
Funny as cartoon is, this is what happens when we define things for ourselves. Our
definitions lock us into certain way of action that are defined by our definition. I am
not implying anything esoteric here, rather quite straightforward things like if you
decide that walking involves leaping ahead at each third step, that's how you are
going to walk. To you it may mean walking while side observers will see you as a
hybrid of a human and a frog, won't they?
I start some of my seminars devoted to scalping as a trading style with question:
What do you think scalping is? How would you define it? (Well, actually I start
seminars asking "Are you in the mood for some trading topics or let's go to the
nearest bar?" but that's irrelevant). Then I offer several possible definitions for
attendees to consider:
1. Scalping means taking profit on a first uptick, as soon as any profit is available.
2. Scalping means playing marketmaker - bidding and offering, trying to pocket the
spread.
3. Scalping means closing the trade within a certain, very short time period - 3
minutes, 5 minutes, whatever.
4. Scalping means taking certain size of profits -= 5 cents, 10 cents, whatever.
All of those definitions find their fans - I see hands raised when I ask who is in favor
of each of them. That's where the As You Name the Boat So Shall It Float kicks in.
Whatever definition you adopt, that's how you are going to trade, right? Let's see
what happens with any of those above.
1. Taking profit on a first uptick. Disaster in the making, IMO. If your stop loss is
defined by the chart, it's going to be more than one downtick, otherwise you are
going to be shaken out by simple noise. So, your stops are going to be bigger than
your profits. So much for "cut your losses short". Losing strategy for sure, as it
requires you to be right practically 100% of the time. Not going to happen unless
you are one of those who win a lottery each time they buy the ticket.
2. Playing the spread. This approach surfaces now and then; there was even a whole
book devoted to it (not sure what the rest of the pages beyond 1st described).
Sometimes I hear from some prop shop traders that their management demands

this to be the only strategy employed. This approach requires some very thick stock
(think SIRI) that stays practically immobile throughout the day, trading big volumes
at bid and offer, making rare ticks and returning back. This strategy (actually it's
more of a trick than a strategy, I shall do a post on this distinction in the future) can
work now and then; it fails misreably if a stock starts actually moving as you will be
forced to take couple cents stop while your targeted profit is just one cent (or even
less if you undercut bid and offers). Also, what does it all have to with trading? Of
course, in accordance to naming the boat idea, let's define trading as exploiting the
market movement - then this approach is something entirely different as it involves
no idea of reading that movement and in fact shies away from moving stocks. Not
my cup of tea.

3. Closing the trade within pre-defined very short period of time. Well, this one
doesn't make much sense to me. What if your stock hasn't moved within that period
of time? Or moved not enough to reward you for your initial risk? Or retreated but
hasn't hit your stop yet? If you decide on a 5 minutes period and stock started
ticking in your favor at the 4 minutes 55 seconds mark - do you get out, even
though the move you aimed for has just started? Better yet: let's say your stock sits
still near the high while the market drops for 5 minutes - isn't it a great indication of
its relative strength? Why would you want to get out of it just because 5 minutes
passed, even though it's more than likely to move up when the market bounces?
Why put yourself on a clock, as if the market cares about how many times you enter
and exit and is going to reward you for just taking positions? Once again, flawed
definition will lead to a flawed trading.
4. Taking predetermined small profits. OK, your stock ticks in your favor. You even
aligned the profit target with your stop - let's say your setup's structure (topic for
one a separate post I think) dictated 7 cents stop, your stock moved 10 cents,
things look logical and meaningful now. However, are you going to take your profit
now in ANY case? Even if a stock show no signs of slowing down? No pause, no pace
change in buying? Sure, scalper's regret is a natural part of scalper's life, but why
set up yourself for it even though the way your stock trades shows the potential for
more? There will be lean times when your stops are as numerous or exceed your
profitable trades, why deny yoursefl some cushion while you are hitting it right?
OK, time for a question - what's MY definition for scalping? What name did I paint on
this boat?
Next post will be about that. It's too nice outside, gotta soak in some sunlight and
shoot some photos.
Oh, and by the way - if you went over my articles on scalping before or own my
scalping course, thus familiar with my defnitions and my way to do it - you can still
make some use of the idea of the post - the way you define things will define how
things work for you. As you name the boat, so shall it float.

WHAT IS SCALPING II
As you name the boat, or what is scalping II. Sunday, april 22, 2007

Before I got distracted by the great weather that lures one outside, I promised to
give my definition of scalping. That's the thing with promises - sooner or later you
gotta keep them. So, let's do just that.
First, some simple definitions. There is such thing as a leg of the movement. Price
moves in stages, or legs - advance, pullback, advance (let's talk in terms of long
position, simplicity sake). Each advance is a leg.
Another important thing to define is pullback. For our practical purposes in the case,
pullback is not a simple price decline. It's important to make a distinction between
meaningful price retreat and noize. We will go deeper into that when in the future
we discuss such thing as setup structure. At this point let's say: pullback is a price
retreat that takes price back to entry point or close to it AFTER hitting target level or
close to it. Noize is that meanigless dribble - cent up, cent down - that creates an
impression of activity but doesn't jeopardize any support or resistance levels. This
distinction is important because if you don't make it, you will dump your trade on a
first sign of price retreat, and more often than not will exit a valid trade while it's
still valid. Again you can see how our definitions define our actions.
All this brings us to the definition of scalping.
Scalping is a trading approach where a trader takes the profits at the first leg of the
movement, not letting the price to pull back.
As a trading style, scalping is based on assumption that the first leg will be made
successfully by more stocks than the second will. Think of it as the race where all
runners are going to reach 1 mile mark. Weakest ones will drop out there; some
more will drop out at the next mark, and the process will continue until just one "last
man running" is left. So, if you want to bet on the biggest winner, you are going to
try and figure out this strongest one. Your payout will be huge if you succeed but
your chances to win this bet are not great. If you, however, want smaller but surer
bet, you will be betting on those that make the first mark. You will have small wins,
but your percentage will be great as you will be right in a lot of cases. And that's

exactly what scalping is about. A lot of smaller profits get booked; immediate
gratification keeps your moral high; your account experiences slow but consistent
and confident growth.
Are there tradeoffs to this style? Sure, just as to everything. Can't have yin without
yang.
If your stock moves way beyond your exit point, you are going to have a case of
"scalper's regret". It's going to happen often, and it's going to bother you. Gotta
learn to live with that. Self-irony helps. My favorite is (after ABCD goes couple
dollars and I am out with my 30 cents), "ABCD just phoned, made evil laughter
sound, called me an idiot and hang up". Another drawback is, while those smallish
profits add up nicely, this approach won't let you get rich quickly (I can hear howls
"awww how disappointing"). This is "trading for a living" approach, not "get rich
quickly" one. Sorry again, gold-diggers. More drawbacks? Try this: booking profits
consistently is addictive. Don't know about you but I can live with this addiction.
If I went into tradeoff issue, would only be fair to list advantages too, wouldn't it?
Let's. Steady consistent profits; high level of confidence; worry-free mind; staying
liquid, ready to pounce on the next hot play or clean setup; ability to sustain you
through the sideways market when there are no clear trends.
OK, one thing still remains unanswered. Where is that price level that defines first
leg of the movement? How does one know first leg is about to be completed? Most
often it happens around the level where profit roughly equals your initial risk. This is
what we call "1:1 risk/reward ratio". Obviously, for such level to be found
objectively, one needs some criteria for initial risk (you can call it stop size or stop
placement, same thing). This is where we go into the territory of the setup
structure, the subject of one the following articles. One quite important thing to
realize at this point is, scalping is NOT a trading system - in a sense that there are
no setups specific to scalping. This obviously follows from the definition for scalping
that I gave earlier. If you go for profits taken at 1:1 level, then the only thing that is
going to show you where that level is is your setup which defines the size of your
stop (initial risk). And in this sense scalping can be utilized within the framework of
any trading system - whatever setups you like, know, can read successfully, have
feel for, you can use for scalping.
Although the concept of setup structure is not purely scalping related, I will try and
make references to scalping applications when discuss it, to round this topic up and
tie loose ends.

WHAT IS TAPE READING

Whats in the name, or what is tape reading. Thursday, November 22,2007

Remember Dow theory? It talks, among other things, about waves. Were you ever
told that in order to apply that theory you need to go to a shore? Probably not,
noone is THAT literal. Well, almost... for some reason the term Tape Reading is being
often read THAT literally. "Your book shows charts, not Times & Sales, hence it's
CHART reading, not TAPE reading" - you wouldn't believe how many times I heard
this. Ah, the way we name things and derive meaning from the names - it can be
liberating or limiting, whichever you chose.
It makes no more sense than requirement to read the teletype tape instead of Times
& Sales - after all, that was what original tape readers of 100 years ago used. Think
about it: where does information on the chart come from? Is there anything to the
chart but the graphic reflection of those same prints on the tape? Chart is nothing
more than the way to visualize the tape. It's different medium for the same
information. Now, which one is more convinient?
- In order to observe the tape (ticker, Times & Sales) you need to stare at it nonstop. Missed bit means gap in the information. Meanwhile chart allows you to look
away - information is still there when you are back from the bathroom, just look
again.

- In order to see what happened before you started watching your stock you simply
look at the chart. With T&S what do you, scroll it back? And visualize all the price
and volume changes?
- Try to watch the tape of, let's say RIMM or AAPL or AMZN. Wave of green... wave of
red... mix... new wave... Do you buy and sell with each change? Fine if you are a
tick-by-tick scalper, but what do you do if you are a daytrader? Or swing trader?
What good will the tape do for you? You will have to drop this method of reading
alttogether then - but its principles are applicable in any time frame, why limit
yourself so severely? What could possibly so wrong with applying those principles to
any timeframe you fancy by deploying... gasp... charts?
- Try to evaluate the strain you put on your brain by watching the ticker print by
print. Fine if you are 22, full of energy and ambitions and intend to do it for a year or
two. But if you are doing it for living, year after year - how long before you burn out?
Don't forget, volume and speed at Jesse Livermore times were nowhere near what
we have now.
- Ah, but what about classics? Isn't it sacrilege to apply their ideas to modern
technology? Well, let's just see... I am opening my copy of Tape Reading and Market
Tactics by Humphrey B. Neill - classic enough for ya? Image at the page 35 shows
the ticker with purpose of explanation what symbols on it mean. Fine, thumbing
along, next image (they are called Plates in the book, for overly literal types - those
are not dishes) is at the page 63. Gasp... CHART!! US Steel, daily chart, 27 days in
1930, with closing prices and volume! Okay... what's next? Page 69, chart. Daily.
Volume at the bottom part. Page 71, chart. 74, chart. 79. Hey, here is a ticker at the
pages 83 and 84, only to illustrate particular moment of what is being discussed in
the chapter and shown on two other charts, daily and intraday. That's it. The rest of
the book is text and charts. Big sigh of relief - I am not overly sacrilegious.
Conclusion is obvious. Tape reading is a method that can and should be applied by
using modern technology and more convinient way to visualize things. It doesn't
necessary mean endless watching the tape itself without blinking.
Oh, and in case you are still not convinced - think of what you, if you insist to take
terminology at face value, are supposed to do if you want to scalp the market...

BASICS OF TAPE READING

The RealityTrader Tape Reading Philosophy

This provides a solid foundation for a better possible outcome in his trading plan.
Our philosophy is that the only reality of the market has to do with the price/volume
action of a specific stock. All other factors are either hints or distortions. A seasoned
trader distinguishes himself from a naive follower by his ability to see the true
reality through all the curtains provided by those with less than adequate
knowledge or misguided intentions. The stock market moves in its own manner.
Stocks themselves move not because financial circumstances of the company
dictate its direction. Otherwise, it would be too easy. Traders would simply buy what
has strong fundamentals and sell what has weak fundamentals. Obviously this is not
the case. Instead, interests of players in the stock and their emotions move the
price. This philosophy can be confirmed by strong moves in stocks with

questionable fundamentals. It can also be confirmed by a stock with great news that
declines in price following the release.
Furthermore, we can not possibly know all the circumstances surrounding stock
movements, all the shares accumulated or distributed, and what owners plan to do
with them. They might want to sell for reasons that have nothing to do with current
company situation. For instance, a fund needs free money for another operation and
we see selling when nobody expected it by trading from straight fundamentals.
That's why a seasoned trader will only look at what is going on in a stock, from a
price/volume action view, in a form he chooses, that lets him be closer to reality.
Our preferred way to read stock market is tape reading. This is also why only a
detached and unemotional state of mind allows us to make our decisions
objectively, with no emotions distorting the picture. The link from your mechanical
approach to the enhancement of your mental approach will develop your winning
and confident attitude each trading day. Reality defines what is happening before
you as you read it. There are no predictions or false expectations for what a market
or stock will do. There is just what you see that demands the response to enter and
exit a trade with as much profit or as little loss as the trade allows. There is no ego
to block that response nor is there a lack of accountability when the trade moves
against you. Trading resides within you and develops from a reality learned.

The RealityTrader Tape Reading Method

RealityTrader uses the RT method to teach traders our unique approach to the
market. It leads you through all the stages from the general outlook right down to
the exact moment of responding to the trade and execution technique.
Pure T&S/Level 2 reading is NOT Tape Reading

Many new subscribers are confused about what Tape Reading is. Tape Reading to us
goes into much deeper understandings of the information presented on a Time and
Sales (T/S) screen. Simple staring at T&S/Level 2, trying to gauge the strength at
this very moment leads to pure scalping for cents, while true tape reading is
capable of much more. Principles of tape reading allow to distinguish the smart
money action from that of the majority. Original tape readers of times of Jesse
Livermore used those principles, and they work today just as fine. They are
applicable in any time frame, and longer time frames would require looking at the
chart, from intraday and higher depending of trader's objectives.

Pure T&S/Level 2 reading narrows this method to very small time frame and tiny
profit objectives. While this style is valid, this understanding is just too narrow and
gives tape reading bad name among those that try to work for more than several
cents.

RT stands for Read and Trade.

READ means two things:
1. Forget the Aristotle logic, which in essence is trying to establish a firm link
between a reason and an outcome. Obviously this does not work in the market.

Learn to see what is hidden under the surface. Ignore what is being offered to you
by those that want you to see things at face value. Look at what is shown to you as
bait for you to go in a certain direction. Then ask who wants you there and for what
reason.
2. Learn to read what is really going on. We will provide you with the method to this
reading. Being truly universal, this method will serve you no matter what kind of
data presentation of choice you use: chart, technical analysis, particular set of
technical indicators or something else. You will see how tape reading helps you to
understand what the majority of market participants fails to comprehend. You will
learn how to weigh market action in terms of price and volume. Then you will realize
how to read the emotions that drive the market.

TRADE means:
1. Be in the right state of mind that successful trading requires. Be ready to execute
your decision flawlessly, in an automated unemotional manner when the moment
demands the response. Learn to control yourself and become the master of your
emotions. Only when you are in full control of yourself will problems like keeping
stops or hesitation to enter the trade cease to exist. From this, no external
influences can impact your performance. We will train you to reach this wonderful
inner state when trading becomes the source of joy as well as income.
2. Learn to execute your trading decisions in a manner that maximizes the
probability of your orders to get filled. It's really frustrating to see great
opportunities pass by just because your execution skill was not refined enough to
get the amount of shares desired or to route your sell order incorrectly. We will
provide unique real-time execution classes that will put a solid foundation under
your trading.
When your training is done, R and T are being put together. That's when you
become a RealityTrader. A RealityTrader is one that is able to see what lies beneath
the surface and to execute his decisions without hesitation. They are traders that
trade the reality of the market, not their opinion that is impacted by his position in
the market or from a neighbor's hot stock tip. They are traders that trade what they
see, not what they thinks. Reaching this state of trading is our ultimate desire for
you and will make us most proud of the hard work devoted. We want traders who
are in control.

Read and Trade.

Read the Tape and be Ready to Trade.
Become RealityTrader

Tape Reading 101

Tape Reading is one of the oldest methods of market movement interpretation. Like
any other methods applied by market players, it's intended to show "what's behind

the ticker". There is no tape itself anymore. It has been replaced by a scrolling
Times Of Sales Window and Electronic Tickers. But the term, and more importantly,
the principles are alive and are as useful as ever. They are based on aspects that
never change. These are human psychology and major accumulation/distribution
rules.
We prefer Tape Reading as our major method. There are plenty of technical
indicators used by traders in different combinations. Many of them are very
sophisticated and computers make it easy to watch them in real time. However,
Tape Reading is a truly universal method that can be combined with any technical
study, and we suggest it as a base for any other method traders like. Sophisticated
indicators based on complicated calculations tend to somewhat mask the reality of
a scenario happening. Tape Reading goes right to the roots of the stocks action.
This is necessary for newer traders.
Like no other method, Tape Reading deals with reality itself allowing traders to see
market moving forces in action and to judge which one prevails at that moment. It
provides us with a look into what other players try to hide and then allows us to
separate reality from our perception. The best example of this is as old as the Wall
Street situation of selling on news. There are numerous examples of XYZ is
selling on such a great news. Tape Reading shows why and how it happens. This
tells you when you should expect non-conventional action on the stock and how to
exploit it.
Tape Reading deals with two major categories of market players. They are the Smart
Money and the Public. You can replace these old terms with any pair you like (big
guys and small time traders, insiders and online traders, institutions and retail
traders, etc). However, the core of market events is the same. Tape Reading is a
method of analyzing which side is doing what at that moment. Analysis is done by
observing the only, and ultimately, truthful indicators of Price and Volume Action.
Tape Reading does not always answer all our questions. In the stock market, nothing
does. The stock market has no single ultimate answer. Otherwise this answer would
already have been discovered and the market would have ceased to exist. There is
no way price would ever change if traders knew the exact situation. Furthermore,
any absolute method, once discovered by someone, could not be kept a secret for
others. What Tape Reading does is:
1. It puts probability on your side as it allows you to read the truth to the extent it
can be read, putting as few "interpreters" between you and reality as possible.
2. It allows you to develop a detached state of mind that a side observer possesses.
The state of mind that traders want to experience is when they look at market
action with no emotions, seeing clearly what happens. This is in direct conflict with
cloudy judgement of emotionally involved traders with formed opinions that could
be right or wrong, but in any case has nothing to do with reality.

MISCELANEOUS

DEATH BY A THOUSAND CUTS? Tuesday, april 24, 2007

One of e-mails I recieved on a previous article deserves a separate post since I hear
this question often enough.

It essentially asked "Isn't scalping a way to death by 1000 cuts?" Well, if you lose
money trading, you lose it - scalping or not. What it comes to is whether you got
good at trading, whatever your style is, or not. With scalping, you will lose slowly, in
small increments - until you learn to win. In any other trading approach you will lose
probably faster, in bigger increments - until you learn to win. If you go through
"grinding it out" learning curve where losses are practically unavoidable, it's
imperative that you keep them under control so you are still in the game when the
critical mass of knowledge and experience is reached. In this sense, scalping is
doing exactly this: since the risk control is very tight, it slows down the rate of
losses thus giving you more time to learn.

Sure, slow bleeding is bad. I, however, fail to see how it would be better to blow up
one's trading account in a few broad strokes. Maybe it feels more heroic, but you
simply don't stand a chance to collect enough lessons (each loss is a lesson, right?)
if you experience fewer losses of a bigger size. Capital preservation is the name of
the game for the newer trader. If losses is inalienable part of this stage of learning
process, my pick would be small ones.

SURGEONS, DENTIST AND TRADERS Sunday, june 3, 2007

Those of you who read my books and/or listened to my periodic rants on trading
psychology topics remember analogy I use frequently when discuss the idea of
focussing on trading right and not on making money. For those who haven't, brief
outline: the idea is to focus on doing things right and to perceive money as a reward
for the job well done, as opposite to being focused on making money which serves
as nothing but distraction from the following the rules, working out correct strategy
etc - because the matter to focus on is reading the market movement and exploiting
it. The analogy I like to use in order to make the meanbing clear is one of a surgeon
who, in order to be a good one, must focus on performing the procedure right and
not on the money he is going to obtain for the surgery performed. And if he does
think of his reward while working on you, do you really want to be his patient, do
you have full confidence in his ability to deliver the result? If the answer is NO, as it
well should be, then the reason for such answer is very clear: our surgeon is not
focused on the subject of his job which is not the money - just as a subject of a
trader's job is a market movement, not the money.

So, yesterday I am having a dinner with a small group of friends one of whom is a
dentist of huge experience, many decades in the field, creator and a head of various
governmental programs, inventor of new technologies, highly respected by
colleagues etc etc. Conversation touches on education, the ways to bring up new
generations of trained professionals, he talks about his teachers, tells stories from
his student past... Now, can you imagine how fascinated I was when he told about
one teacher of his who would say often: Do not focus on money, do not see your
patient as a cash register, think of doing your job right, focus on that and money will
follow...

Seems to be universal principle, doesn't it :)

DEATH BY A 1000 CUTS, REVISITED Tuesday, September 18, 2007

We already talked about this topic here. I've got another e-mail with the same
question so maybe it's time to revisit the topic and give another way to look at it.
Qucik reminder - this is a "scalping is a way to lose money by a thousand of
papercuts" complaint.

Let me put it this way. What are your chances to win a lottery? Why, it's 100%. Don't
beliee me? Think of it this way then: there are two events, A (your win) and B (your
death). Of course you will win the lottery sooner or later, the real question is which
of those events comes first. Now, back to trading: event A is your learning to make
money in the market consistently, event B is you running out of money while on
learning curve. Now, you can say that you lost money because of scalping no more
than you can say that you lost because of swing trading. It's not the style of trading
that leads to losses, it's trading in a wrong way that does. Trade correctly and you
will make money in any style you fancy. Trade wrongly and you will lose - again, in
any style you chose. By utilizing a style that accumulates losses quickly, however,

you narrow your window of opportunity to learn - simply because you shorten the
time till your account exhaustion and number of opportunities to enter and manage
the trade. By going with style that increase both you have more time and
opportunities to learn and hone your skills. Simple as that.

OLD WAYS, NEW RESULTS? Sunday, November 18, 2007

The dialog below is from recent mentoring session. Brief history: trader M. comes to
critical junction in his trading career, as his losses accumulate over time to a point
where he questions his ability to make money trading. The most frustrating thing is
not even losses themselves but absence of any signs of improvement. In what can
be viewed as one of last steps to save his trading carrer he ask me for a few
mentoring sessions. During those we discover some flaws in his approach that put
him on a losing side on regular basis. Exact character of those flaws is irrelevant to
our today's blog post topic, suffice to say we are able to outline the plan and we
agree to make an interruption for a week so M. could trade for a while armed by
new understanding, then we are supposed to analyze the results, make corrections
if needed, outline new steps if needed. Week goes by, we talk.
I: Sending me the log?

M: Nah, not yet.

I: Why not?
M: Well, I haven't implemented any of changes we discussed.
I: Why not?
M: Well, I lost so much earlier that I feel I need to get a solid chunk of it back first,
then start changes.
I: Let's see if I got this right. You want to achieve better result by doing things the
old way, way that haven't worked before; then, AFTER you achieve those better
results, you want to implement the changes that are supposed to lead to those
better results?
M: Hmmm... it doesn't make much sense when you put it this way.

At this point I realized that I actually did hear this before. Variations could be
different, underlying message was the same. A trader blows his stops, holds his
losing positions indefinitely until they hopefully come back; we discuss it, come to
decision to free his mind and money by taking the losses and starting anew, he says
"Fine, but first I will wait for this and this positions to come back, I need to recoup
some of my losses". Another trader loses on his overnight holds regularly, we agree
that he quits his positions before day's end so we could analyze his criteria for
holding and decide whether to change them or maybe quit overnights altogether;
he says "Fine, but this one I will hold, it looks so promising and I lost so much, I
would like to get some back before starting major changes". See the similarity?
To me it sounds like this: You drive from A to B, it's a long drive, let's say 500 miles.
At some point you discover that you took a wrong turn a while ago and last 200
miles you were going in a wrong direction. Instead of turning back and making the
right turn this time, you decide to continue wrong way because YOU ALREADY LOST
SO MUCH TIME AND FUEL THAT YOU WANT TO CONTINUE GOING THIS WAY UNTIL
YOU ARRIVE AT THE POINT OF YOUR DESTINATION: ONLY AFTER YOU ARE THERE
YOU AGREE TO TAKE THE RIGHT WAY.
If you ever catch yourself thinking like those traders described above, re-read this
capitalized sentence above; see if it makes any sense to you.

STEPHEN KING ON TRADING Sunday, December 9, 2007

OK, he probably didn't write about trading... but you know, analogies can be found
anywhere and often they help see things in the right perspective. So, here is this
character, Gunslinger - hard-boiled, well-trained, capable of handling almost any
situation he encounters, "hard caliber" as they call him. Facing quite complicated
case with a lot of unknown interests involved, a lot of inter-connections,
relationships and conflicts interlaced, he acts as if he sees it all clearly and can
predict any turn of events. He in fact does - whatever happens, he already prepared

the antidote. When questioned by his crew, he tells them that he knows in advance
the rules by which this kind of situations evolve. "First smiles. Then lies. Last comes
gunfire" is his template for it.
First analogy is simple and lies right on a surface. Pretty often intrigue with certain
companies (and their stocks of course which is our subject of interest) resolve
themselves in just this sequence. Remember Bre-X? First came smiles - everyone
was in love with the story and stock which went from pennies to over $20. The lies
flooded the cyberspace - all kinds of false reports, interviews, fabrication of
samples, disappearance of main characters. Then gunfire started - disrobing, finding
out the truth, courts, punishments. This is rather normal way of resolution of such
intrigues and next time you come across something like this, you may want to
remember Gunslinger's lesson and get out when smiles start fading out. You will be
rewarded by saved profits, admiration of those around you and opportunity to shrug
indifferently with "seen it all" face expression.
There is one more level in this analogy though. To the main character's friends his
ability to foresee what happens next seemed almost supernatural. It was great
intuition indeed - but what was it based on? On simple recognition of the situation.
It's a newbie to whom every situation seems to be different. A seasoned trader has
seen enough of them to catch the similarities and find the guidance in those. Over
time, your arsenal of "been there, done that" situations will grow enabling you to
recognize them and apply pre-canned response to them.

SCAN FOR YOUR BATTLES Monday, may 5, 2008

At the beginnning of March I opined that under certain conditions we were going to
see market rally to 13000 DOW and 2000 NQ. Now that those targets and I
suggested liquidating long positions, are hit a few e-mails asked whether I see this

moment as a short opportunity. My negative response caused feedback along the

lines "If no long anymore, then why not short?"
Here is how I approach this. There is no such thing as continuous read on the
market or particular stock for me. In other words, I don't have a clear idea what to
do all the time. Sometimes there is a recognizable situation, and that's where I take
action by initiating a new trade. Sometimes there is nothing recognizable, and I sit
on a sideline or liquidate existing position - not because I see the tide turning but
simple because I have no read anymore. Thus, the reason for exit can be "I read the
move as exhausted" or "I can't read this move anymore". In a former case, yes, I
may start hunting for an entry on the opposite side. In a latter case - no, I exit
original position but do not look for an opposite direction trade yet.
All above has a broader implication for my trading approach. My process of hunting
for a trade is entirely based on an idea of having my favorite setups and waiting
until such setup shapes up and triggers an alert for me. I don't watch particular
stock and hunt for an entry - rather I wait for whatever matches my entry criteria.
View it as casting the net with certain mesh size and reviewing whatever got caught
in there. Such net for me is a scanner which I have configured accordingly to my
criteria and which scans the market constantly looking for what I asked it to.
Covering NYSE, NASDAQ, AMEX, TSX, TSX Venture, OTCBB, Pink Sheets and indices
and being easily customizable for any thinkable trading approach, it's all the search
tool I need. There are three things though it doesn't have: no dartboard, no tea
leaves and no "scan for winning trades only" setting.
Such approach can be construed as one of cases of "let the market come to you".
Usually it's applied in a sense of waiting for certain price treshold where you render
entry most favorable. This is just another way to apply this idea.

LOST AND FOUND, OR DOWS COMMON SENSE WORK IN TRADING? Sunday, may 25,
2008

There are things in trading that run contrary to common sense as we know it.
Recent conversation with a trader who asked for advice is a good example of such
occurence and illustrates often-made mistake.
First, a joke showing what common sense leads us to do. Fair warning: joke is silly
and decisively not funny. A drunk crawls under the street light looking for something
on the ground. Asked what he is looking for he says "Lost my watch on that corner".
Asked why he is looking here when a watch is dropped 15 yards from the spot, he
explains "It's dark over there, little chance to find anything, so I am looking here
where there is a street light".
... OK, I warned it was lacking in laughter department. Nonetheless, it indicates that
looking for a lost thing in a well-lit spot instead of where the loss has occured is silly.
Now, let's get back to our trader and his question.
- I have this pattern of suffering a string losses... it starts usually when I get onto
some very volatile stock or a stock making unusually big movement, looking so
lucrative because of a great potential. So I jump in, it moves against me, I take quite
a loss. Next thing I know, I make trade after trade on this same stock. It's like I got
addicted to it and just can't move onto something else. Loss after loss, the day turns
into total disaster. Got something to hit me with to cure this disease?
- Got a question for you. Why continue trading that same stock after couple tries
proved unsuccessful? Why not leave it be and move to something ou have firmer
grip on?
- Well... it makes big movements, I have better chance to get back all those
unusually big losses...
- But you don't have reliable read on this particular one. Isn't it more likely that you
will suffer more "unusually big losses"?
- Ummmm. I don't know. I just feel it's natural to stay with it until I get my money
back. Hasn't happened yet, even once.
That's when I remembered that joke. It's a common sense and natural thing to do in
every day's life to look for a lost something at the spot where you lost it. In trading,
not so much. Go to well-lit spot and look to get your money back there. Lost money
is not tied to a particular spot (stock), it's lost in the market. The market is a big
space; go where there is a streetlight that helps you read things well. A stock that
you have no read on is to be left alone. You have no personal relationship with it,
you don't need to get revenge; it has no idea about you and it's not after you. Free
yourself from things that don't work. Focus on what does.

SECURITIES TAX PROPORSAL. Sunday, February 22, 2009

I've got quite a few e-mails asking about my take on this proposal, enough to
warrant a blog post. For a someone making his living by trading the market my
answer may be somewhat unexpected: I don't worry about it too much.
Here is why: I don't believe it has any realistic chance to materialize; And if it does,
we will have much bigger problem on our hands than the end of active trading as
our way to provide for ourselves and our families.
Let me explain. Most of my correspondents are coming from the (absolutely correct)
assumption that such tax will end day trading. Imposing a prohibitve cost on the
transaction, it no doubt would do just that. Notice that it's not just an additional
burden, additional cost on the essential need that would help replenish government
coffers as for instance gas tax would - it's prohibitive cost that renders the activity
unprofitable and eliminates it altogether. There goes the idea of "let the Wall Street
pay for bailout" - there won't be financial benefit to the government. Instead, there
will be the destruction of the whole profession, sending more people to an
unemployment lines. And I am not talking about day traders only - what about
whole brokerage industry, discount brokers who suddenly lose their whole client
base? More uneployed, more unhappy, less taxes collected - who could benefit from
that?
Now, is the impact going to be limited to day traders and brokers that serve them?
If it were so, some political expediency in search for a scapegoat could still warrant
such proposal going through. After all, imposing $25K rule on day traders was no
less idiotic (although less damaging), yet it did pass. In this case, however, it's
about much more than just those pesky day traders. You don't really think it's just a
day traders who trade every minute and every second and whose prints fill the tape
with this endless flow, do you? Think of how many day traders there are and what
kind of volume they could provide - and compare it with every day's volume on
NASDAQ, NYSE and AMEX. What do those numerous trading desks of the banks,
brokerages, all kinds of funds are doing day in day out, all day long? Who provides
liquidity for longer term traders when they want in or out? Who makes the market
bidding and offering on each and every stock at each and every point in time?
Whom pension funds buy from and sell to when they reposition themselves? All
these people, all these organisations will suddenly be put out of business by such
tax. Now, imagine them all being out of the action. What happens to volume,
liquidity and bid/ask spreads? Can you apply any word to the US capital market
other than desert if that happens?
Let's talk about foreign investors - what are they going to do when they find
themselves in the market with no lliquidity? Does the government want mass
exodus of those?
Let's talk about companies listed on US markets. What are they going to do when
the markets all but cease to exist? This is their financing source and pricing
mechanism. Does the government want mass exodus of those?
Let's talk about the public. Does average member of the society benefit from the
cost of transaction being passed to him/her when their 401K etc are being
positioned and repositioned? Or from their self-directed transactions being burdened
with this cost? I mean, no one seriously thinks brokerages are going to eat this cost,
do they? Does the government want to load our, dwindling as it is, investments
with this additional expense?

Internet and globalization era, the markets all over the world are accessible with
unprecedented ease... do you impose such prohibitive measures on your market
and push people into the welcoming hands of competitors?

All above leads us to one question: who would benefit from that proposal? After all,
for any legislation to go through, there must be benefitting party influential enough
to push it through. I fail to see any single entity within the USA that would benefit
from it. We have Wall Street, Main Street, public and government as the suspects to
look at. Who of them benefits from this? Not the government, not the banks and
brokerages, not the public, not the companies. I just can't see it happening.
Now, as a last argument: not all things happening are being governed by the logic
and that dying creature called Common Sense; sometimes raw emotions, populism,
pandering to the lowest emotional reactions of the crowd takes over. That could
lead to such proposal still being seriously considered and passed. Well, I still prefer
to think that with no one particularly interested in the outcome, it won't - and if it
will, we, as I said at the beginning, would have much bigger problem on our hands.
We would have Powers That Be deliberately destroying the very fabric of the
society, contributing to the job losses, capital outflow and desrtuction of the
business - all for no good reason. If that happens, we better make sure we turn our
houses in fortresses and have means to protect them, because in the chaos and
insanity that will come, clicking Buy and Sell buttons will no longer be of any
concern.

ONE QUESTION TEST. Monday, august 24, 2009

As it often happens during the most uncertain times - at what potentially is a trend
reversal point - I get a lot of questions about signs of such reversal, in this case top.
As it often happens, a lot of those questions are asked in order to confirm author's
belief - and if no such confirmation is obtained, back and forth arguments ensue.
Over the last week or two, I expressed my point of view that we were not ready for
full blown reversal yet, and more upward action was likely to come.
One theme that constantly popped up in such exchanges (not a first time mind you,
it's rather typical way of thinking) was this: "but there is no job creation, commercial
real estate is imploding, A is weak, B is wrong (long list of what is wrong with
economy)... this market must drop, I am shorting it!"
Notice one thing that all those reasons have in common? Well, aside of them being
probably right. They all have no ties with market timing. Here is what I mean by
this: if you employ some idea for trading related decision-making, you have two
major questions to answer. One is the direction of your planned trade. Another is
timing of the trade initiation. All the ideas listed above have to do with direction...
do they have anything to do with timing? How do we distinguish which ones help us
pick the right entry moment and which do not, leaving us to seek more indications
to time our trade right?
Easy. There is a one question test that does just that. As you evaluate your trading
idea, ask yourself: IS IT A NEW TURN OF EVENTS OR WAS IT SO A DAY, A WEEK OR A
MONTH AGO?
Because if jobs creation wasn't there a month ago either yet market went up during
this month, how does this fact enable you to enter short now? It does not. Any
economy related, company related, sector related idea can be verified by this
question in order to find out whether it should be used in timing your trade or you
need to keep it as purely directional idea and look for something else to help you
with timing.
You would think this is something that concerns mostly position or swing traders...
but I get this from day traders too. 'I am shorting RIMM, I just analyzed their this and
that, and it's very weak". RIMM is up 2 and half points for the day, so I ask: Why
here? Is there any short setup, sign of reversal? What is it that makes you think
short right here and right now? The answer is: Well, I just finished reading that
report... Pause, then we both laugh as my counterpart realizes that his timing of
finishing the report is fairly dubious as a market timing event. OK, I start laughing
just a tad sooner as I am not polite enough...
Anyway, once again. Your one question test concept is, could this have been said a
week or a month ago just as well and did not impact market during this time? If so,
what makes me think it will do so now?

STUPIDITY, HYPOCRISY OR BOTH? Sunday, November 15, 2009

When I have the same conversation many times in a row, I know it's time to do a
blog post on the topic. This time it's a discussion (somewhat outside of usual scope
of my posts but relevant anyway) of the causes of financial crisis, framed as "who is
to blame" question. This thing is, I refuse to join the "darn banksters and their greed
got us where we are" chorus. Not because I have some particular reason to love
banks and bank people, mind you. I simply can't see how you blame something or
someone acting according its nature and doing so within the framework you
yourself created.
Any explanation, any description, any user manual is by definition simplification of
things. Let's simplify this.

If you put a carrot in rabbit's cage - carrot will be eaten.

If you put a rabbit in wolf's cage - rabbit will be eaten.
Putting carrot in rabbit's cage or rabbit in wolf's without understanding what fate
awaits for both is stupidity.
Bemoaning carrot's and rabbit's fate, blaming rabbit in carrot's "death" and wolf - in
rabbit's is hypocrisy.
Pushing lenders to lend to barely or un-qualified borrowers; Lowering lending
standards; Repealing laws and rules that kept such unsafe practices at bay;
Guaranteeing those unsafe loans via GSEs; Keeping super low rates for too long - all
this created a framework where profits could be had while risk was mitigated or
masked by those guarantees. Creating a situation where a profit-oriented by its very
nature organization can make a profit while relegating risk to someone else's
shoulders and not foreseeing the inevitable failure is stupidity. Creating such
situation, observing that organization doing just that and blaming it for following its
very nature is hypocrisy.
Should banks be excluded fully as entities having their hand in everything that
happened? Lord no. But the idea that the bank by itself is some kind of evil
organization or that people working in or for the banks are necessary bad is

ummm... how do I say it softly... stupid? Yet it's just the mindset that is being
propagated. Let's all hate banks and solve our problems by materializing this hatred
in this or that form - while real culprits are all too happy to channel the anger away
from themselves.

MARKET REVERSAL SETUP Monday, may 10, 2010

On Apr 30 I made this post describing my conditions for the market reversal:
Today's selling
Submitted by Vadym Graifer (1179 comments) on Fri, 04/30/2010 - 15:12 #61968
... is much closer to what I'd like to see for a trend reversal than anything we have
had in quite a while. Slow, orderly, sustainable... Not ready to call it full blown
reversal yet, but if SPY doesn't go over 121 and loses 118.20, that should do it.
Let me show the setup I had in mind making that call. To provide a background
which is fresh in memory today but will be a bit murky for readers in a while, the
market had huge rally for about 13 months, and last couple months we had almost
no pullbacks - just day after day of relentless upward climb. Search for the reversal
and calls for the top, made all too often during whole rally, became almost
hysterical. Time and again asked if "we are there yet" I was answering that I saw no
signs of reversal. This post above though described a trigger for market reversal.
Let's have a look at the chart where you will see a horizontal line showing the
trigger:

Looking at the top of the few bars forming the mini-range just above the breakdown
line, you can see also where the resistance $121 came from. So, what we have here
is: high at $122.12 made on 04/26, sharp retreat next day bottoming out at
$118.25, a few days of consolidation forming a range between $118.20 and $121.
That's the range that presented the setup mentioned in the call.
From here we had two scenarios. First is hypothetical now: SPY breaks $121 thus
invalidating the breakdown. From there would would be watching for possible
double top or abandon short idea if new high were made. Second is what took
place: support was broken, and the rest is history.

CULPRITS AND SCAPEGOATS Thursday, july 15, 2010

Over last few months, on several occasions I found myself involved in the (often
heated) discussion of High Frequency Trading (HFT), Liquidity Providers (LPs) and
related topics, ranging from false bids to flash crash. The exchange almost
invariably involves angry accusations of HFT as the cause of many market ills. Since
I get involved by pointing out the flaws in those accusations and errors in technical
assessments of HFT impact, I've got asked a few times: Why do you insist on
defending HFT and LPs, what's in it for you?
Here is the deal: because I've seen it already and I know where it's going. Let me
expand on that.
Remember tech boom of 1998 - 2000 and consequent crash of 2001-2002? As in all
boom-bust cycles, a lot of people lost a lot of money; as always in such cases,
blame game followed. Now, do you remember who was chosen as a guilty party and
what measures were taken? Funds chasing prices to stratospheric highs, throwing
newly contributed money in to support the run created by old(er) money, thus
creating what can be called an unsustainable pyramid? Market commentators and
TV personalities hyping "new economy" and promoting useless companies with no

substance? Monetary policies leading to yet another bubble? Lack of any

meaningful oversight allowing any hack with computer in the basement to create a
website and call himself a company? Yeah right. Powers That Be elected day traders
as a scapegoat. They, day traders, run the market up to those insane and
unsustainable highs, you see. In the process they also caused abnormal volatility,
those bas****s. And of course, they don't contribute anything to society, ya know...
darn parasites.
Stunned day traders meekly objected. We can't run the market anywhere in any
more or less meaningful time frame, they said - being very short term participants
we are generally net neutral by the end of the day, thus fully eliminating our
directional impact. If market goes up day after day, it's surely someone else's
buying that causes it. And we jump in with out bids and offers on intraday basis,
thus providing liquidity for longer term players, narrowing the spreads - after all,
each lower time frame players serve as liquidity providers for higher time frame
ones, isn't it ABC's of the market?
It all made perfect sense for anyone who understands what market is and how it
functions. But since when making sense mattered any? Blame had to be assigned,
fingers had to be pointed and measures had to be taken. Scapegoat was chosen.
What did we get as a result? Why, $25K rule. Remember? Can't day trade unless
have $25,000 in your trading account. What a fix, eh? Mission was accomplished as far as political expedience of the moment required. Did anything got fixed in
reality? Well, we moved right to the next bubble; market went through another runup and consequent crash; volatility during that crash reached unprecedented
magnitude; destruction of wealth occurred at the breathtaking scale and speed. Oh,
and just to add insult to injury - those same TV personalities continue their hype,
never bothering to acknowledge ever being wrong. Can you call that blaming day
traders anything but distraction?
Fast forward to these days. Is it time for new blame game to start? You bet. Will
Powers That Be try to find another scapegoat, allowing real culprits escape spotlight
once again, thus dooming us for another boom-bust cycle? That's exactly what is
happening in front of our very eyes, with the same arguments and purpose. This
time it's HFT. They cause unsubstantiated direction (never mind that they scalp tiny
spreads, often less than a cent, not causing any direction). They cause volatility
(never mind that in order to earn their rebate they must ADD liquidity by putting in
bids and offers, not taking someone's; thus they do provide liquidity for higher time
frames as design intends). They cause crashes when withdraw their orders (never
mind that if it were so then forbidding their activity would have caused crash right
away). There are many other accusations, most of them based on complete lack of
understanding how market mechanisms function. There are probably valid ones too
but it's hard to hear them in the choir. Nor there any interest in meaningful
discussion - just as there wasn't any back then, after tech boom. Just as back then,
there are those who fuel all this finger-pointing with purpose of shaping up yet
another scapegoat and diverting the spotlight from real culprits, while imitating
activity instead of resolving real problems. Then, there are those who simply
misdirect their anger, believing that it's HFT that really causes troubles in the
market...
Are there negative sides to HFT in my eyes? Sure, and they must be dealt with.
Quote stuffing (practice of submitting a bunch of orders and immediately cancel
them in order to overwhelm the system and take advantage of faster computing)
must go - and is very easy to deal with. Establish min time for an order to remain
valid (1/2 sec to 1 sec, for instance) - problem solved. Exchange presenting order
information to an HFT firm before order goes to open market - if that happens, it's
simply illegal (and it would be illegal with any other market participant so it's not

HFT-specific violation); jail them if you caught them doing that. Etc. But no, HFT
opponents insist on transaction tax and/or widening the spreads as a method of
reigning in the HFT. Talk about scorched earth tactics - cover the ground with
napalm to eradicate the mosquitoes; bears, rabbits and birds be damned.
So there you go. Instead of real solutions we are going to get tweaks to what needs
no tweaking, and measures that will harm retail investor. Blood-thirsty angry crowds
will be satisfied. Officials charged with market oversight will demonstrate that the
measures have been taken. Mission will be accomplished - once again.
That's why I express contrary view on this topic so adamantly. I've seen it already.
Same arguments, same volume increase, reaching crescendo soon. Same purpose.
Same outcome, too.

WARNING TO THE BOTTOM FISHERS Saturday, august 6, 2011

I know I've written about this a few times in the past. But it seems never enough.
Considering the market over the last few sessions and panic over last two, I
thought it was high time to scream it out loud once again. DO NOT guess on the
bottom. What you think is low today can seem awfully high tomorrow. Selloffs can

and do go for much longer than the "common sense" indicates. So do euphoric
spikes for that matter. Premature bet on reversal will cost you dearly; correct guess
will still be just that, lucky guess. NO ONE ever was able to pick exact reversal
points consistently. Attempts to nail exact reversal is second most common reason
for traders demise. Oversold gets oversolder, then oversoldest, and then sells some
more before reversing.
Bottom line: if you want to trade reversal, trade it on the RIGHT side of the reversal
- AFTER it happened, price retested the low and confirmed the strength. Trading it
on the left side is a childish bravery - cemetery of traders' accounts is sprinkled with
tombstones saying "He was a brave trader."
Disclaimer: this warning will be ignored by majority, just like 1000 similar warnings
before. If you, a single reader of this - yes, you - heed it and play it right, that's all
reward I count on. If there are two of you, I accomplished a lot today.

TAO, PHOTOGRAPHY AND TRADING Sunday, august 14, 2011

So, being a trader, a photographer and a student of Taoism, what am I to do when I

run into the (excellent) book named Tao of Photography? Why, look for analogies
with trading of course. I mean, two of the components are there, gotta look for the

third. Didn't take too long to see the similarities in how Tom Ang applies Taoist
principles to photography and I - to trading. Read on:
"The technique of the wise is ever-present, but never evident... Technique
empowers the individual but it does not dominate. It must be learned and absorbed
via a process of long training, but then falls from consciousness. The aim of
technique is to provide fluency - an unbroken movement flowing from thought and
conception through to production..."
Sounds familiar? It should. Automatic reactions on whatever market does reactions seemingly so instant as if events were foreseen... that's how experienced
trader's actions look to a side observer. Did he really foresee sudden news that just
hot the marketplace? Of course not - it's years of training that instilled this ability to
react instantly and unconsciously. Re-read this description of the third stage of
trader's development, and you will see the same motives. Re-read this post about
gunslinger in Stephen King's novel, applying templates to be ready to any
development (If - Then scenarios for traders?) Remember my often-said motto:
"Trading is simple, but it is through many complications that you arrive to this
simplicity." Finally, our trading room members will remember the slogan they see
when enter the room: Don't interrupt your brain's work by thinking.

THREE KINDS OF CRASH, RE-VISITED Sunday, june 10, 2012

Below is the article I have written on October 16 2011, with some forecasts about
most probable scenarios in the economy and market reactions. Interesting to look at
it now and compare the unfolding events with forecasts. Seems that the second
scenario, one that I deemed the most probable, takes place. Market reactions are
pretty much on target as well. IMO, everything remains intact, so let's re-read it.
Look Ahead: Three Kinds of Crash

Life never gets so bad that it can't get worse"

- Solomon Short

Putting together pieces of mosaic gathered over last few months by observing both
news headlines and market reactions, let me offer my view on the future big picture
developments. Everyone has one, why not add another voice and see how reality
matches the forecast (rather set of scenarios in my case but you get the idea). Want
to say from the start - this is a forecast that I will be happy to be mistaken about.
We will break it by two distinctive parts - economy and market developments. Let's
start with economy.
European Union is non-viable and not-salvageable entity. Its deep underlying
problem is discrepancy between various aspects of union. It's a monetary union but not fiscal. Economic - but not political. This patchwork creates situation where
decisions are difficult to make and even more difficult to implement, and solutions
help one member at the expense of another. Authorities would be happy to throw
more money at the problem but taxpayers of one sovereign state are not keen on
bailing out another - and those taxpayers are voters. Push for collateral and
austerity threatens autonomy of a debtor - and taxpayers start rioting over there
too. There is no third party that could bail it all out (rumors spiking now and then
about Latin America or China lending money to EU is pure nonsense and if anything,
show the degree of desperation). Thus, there are only two ways forward: crash or
money printing. Are these two really two? Not in my view - money printing does
nothing but stretches crash in time, turning it into slow motion crash. It's fine with
authorities though if they can stretch it by decades - today's decision-makers leave
the office till then. So, real choice is between three options, none of which is warm
and fuzzy.
First is Crash Now. No printing, no bailouts, let's rip the band-aid off, take the
(admittedly huge) pain and start healing and rebuilding, with lessons learned in
mind. Probability of this? Well, only if enraged taxpayers/voters find the way to force
the hand of their respective governments and abandon the attempts to save the
union. No politician wants to preside over collapse ("Crash?? Not on my watch!").
Thus,
Second is some printing now, masked as bank recapitalization, insurance
guarantees etc etc. As we were shown by Fed, there are many ways to create
money out of thin air. If Powers That Be manage to agree among themselves and
push some kind of package through their respective elected bodies before people
take on the street in numbers impossible to ignore, this will postpone the crash a
bit. Such solution is nothing but kicking the can down the road, and reality will catch
up with fantasy of salvation once again (after all, the debt remains as unsustainable
as it was, and even becomes worse). At that point political will to continue on that

path runs out, and we face second variation: Crash Later. How much later? Well,
depends on how much is printed. Odds? Feels to me, this is the most probable
option.

Finally, third option is printing gradually over extended period of time. That would
be politicians preferred way if they could find the way to do it quietly and as a trivial
matter, under the radar so to speak. This is Crash in Slo Mo. Pity the savers;
inflation tax forever.
One more aspect of the big picture is China (and Asia overall). My feel is, it's a
whole new can of worms down the road. It's not in a focus of attention much at this
point since European troubles are more imminent. China's turn is to come yet, and
unsustainability of economy geared to supply the West which cuts off its demand
and of putting money in ghost cities to keep people working and economy humming
- unsustainability of all this is going to reveal itself at some point.
Let's move to the market side of the picture. How is it going to react in each of the
scenarios? In the first one, Crash Now, it's will mirror the economy and crash with it.
Second - Crash Later - is what market is betting on over last couple weeks by
climbing in the face of grim news. If this option materializes, market will spike first
in relief, then drop quickly reflecting the part of reaction built in already by this
recent climb and killing later arrivals; then new news will overtake and new worries
(or lack of such) will start influence the movement. Finally, third option (Slo Mo
Crash) is what market will be most happy about, staging big long term rally, quite
possibly to new all time highs. After all, inflation is not only tax - it's also a wealth
transfer to those who has what to invest.
There. Hope life proves me wrong and things turn more rosy.

HOW THIS MARKET IS UNIQUE Friday, june 29, 2012

I have to say, current is the most unusual market environment I've witnessed over
almost 16 years of trading (sheesh, has it really been THIS long??). No, it's not algos
or HFT that make it so unusual. None of those things ever influenced the method I
deploy to read the market in any significant way. Here is what is so unique about it.
Normally market is in one of two states in relation to coming news. First, it has no
idea about news coming its way. This is usually what we call "Genuine News" earthquake would be a good example. So, the market trades in its own way,
reacting on this and that, until unexpected comes and changes the picture. Second
state is, market knows about news coming, evaluates it in advance and starts
discounting it. This is the most frequently seen state of the market and the one on
which whole trading methodologies are built. We called it Fleece Sheep News in that
same article linked above.
What we have right now though is a weird hybrid of those two modes - the market
knows about news ahead but isn't able to factor it in effectively. It remains a matter
of speculation and guesses for incredibly long time, and we are not much closer to
resolution than we were two years ago. Those who thought the whole EU charade
should collapse continue thinking so; those who believed it will print its way out of
debt burden still believe it. This very unusual mode for such unusually long time
causes very abnormal volatility and bi-polar market that soars like an eagle one day
and digs the hole like a mad rabbit another. Even intraday, market acts like a frog in
a football kicked by yet another headline. I suspect we will remain in this mode for a
good while. Higher volatility goes hand in hand with shorter time frames. Investors
turn into swing traders, swing traders become day trader, day traders become
scalpers, scalpers... well, they remain scalpers I guess.

UNBEARABLE BOREDOM OF TRADING

Ah, glamorous life of a trader... Shimmering monitors, scrolling news headlines,

whispering TV, hot coffee... You are alert, in control, overseeing and managing
complicated situations... Suddenly something big develops, you catch a whiff of a
big move coming, you are among the first to hear fresh news and evaluate just how
significant it is - and on a moment notice you spring to action, pounding the
keyboard, sending orders, talking into your headset. By the time mere mortals come
home from their mundane day jobs and find out about what transpired, you already
profited from it and moved on. When they ask you about that event at the weekend
party, you will remember (with some feigned effort) how it went down... And how
you moved right on to that next big deal between Japanese electronics company
and German concern, followed by FDA approving new miracle drug...
Fun, isn't it? Except of course it's nothing but adolescent fantasy that has zero to do
with reality. Well, almost... TV screen is there, monitors too - and even coffee if you
make it. News headlines are scrolling but by the time you got them, so did half of
trading world... and the other half just doesn't care. Now, I am not going to debunk
the parts about being in control etc.; we are on a somewhat different topic here so
let's assume you know what you are doing when pushing those buy and sell
buttons.
One crucial part of that image however is utterly and irreparably wrong: good
trading is not exciting. It's boring. And it should be. More than that - if it's exciting,
you are doing it wrong. Let's see why.
Some traders feel that they have to be in the middle of the battle, in the hottest
stock of the day. It's almost as though unless they take part in the "water cooler
topic" of the day, the trading day doesn't count. The truth is, however, those
scorching hot stocks are much more likely to cause heavy losses than bring you
profits. They tend to be extremely volatile, move with hard to handle speed, move
to extremes that provoke emotional reactions - and if all that was not enough, they
get halted. If you ever tried to find a bottom in one of those "oversold stocks cut in
half or so, you know what I mean. Ditto for shorting freight trains that just keep
going. Do these deliver in the excitement department? No doubt - but that's where
you have to ask yourself about your motivation for trading: is it profit you are after
or the exultation of being a participant in a hot event? If it's profit (and if not, just
stop reading this and go look for another huge mover to donate more of your money
to), then remember that the amateurs evaluate profit potential while professionals
gauge risk first. If you can't control risk properly, move on to another trade, no
matter how tempting the opportunity seems. Remember also that it looks just as
tempting to many others - do you want to be a part of the crowd which, as we all
know never makes money?
Another frequently seen reason for one's trading being exciting is creative approach
to each given trade. Yes, this is not a mistype (not that I am a stranger to those).

You see, good trading doesn't call for the whole thinking process to happen during
trade search, evaluation and development. All this process should take place during
designing your trading system, at the drawing board. Trading time is execution time.
You don't get creative during the battle when your decisions are more likely to be
influenced by emotions and made in a rush - you execute pre-planned solutions.
This takes us to the idea of correct trading approach. It should include IF-THEN
scenarios that make your responses pre-planned. Those scenarios are implemented
in a form of setups that are nothing more than a set of recognizable situations and
instructions how to trade them. In my case, those setups are chart formations; in
yours it can be something else. Time for thinking, for creative process is when you
create, test and tweak your trading system. Providing you have such setups in your
arsenal, got them tested, tweaked to perfection and adjusted for the current market
conditions, your trading turns into quite robotic affair. You are scanning for your
setups and as soon as they appear, its purely a matter of execution. Its pure eyefinger coordination, with no brain in-between. See setup take setup wait for the
market to tell you what its going to be, stop or profit. Take either with no secondguessing. Move on to the next. Repeat. Repeat. Shut down software at the end of
trading day, to fire it up the next morning and go over whole exercise once again.
Does the process described above strike you as boring? It should because it is. You
may sit for undetermined length of time waiting for your trade to come along and
doing nothing. Learn to do that, because when you start pushing for trades just to
break boredom, you start trading marginal setups. Automatic execution of your
trades isn't very exciting, it makes you feel like a robot and as far as your wallet is
concerned, its a good thing because your actions wont be influenced by your
emotions. You want excitement? Get your kicks, whatever you do for them, after
market close. Trading time is for profit, after hours time is for other stuff like life,
you know. Dull me with profits and I will yawn all the way to the bank.

A FEW QUESTIONS FOR THE GOLDBUGS TO PONDER. Sunday, april 21, 2013

Recent developments with severe gold price drop generated, predictably, a lot of
controversy, hair pulling, arm wringing and, even more predictably, widespread
accusations of manipulation. I want to address those of you who bought into great
story of gold going up, up and away, never to look back... and now searching for
answers to many questions this drop puts in front of you. Not that I can provide all
the answers but I want to offer you a framework in a form of a few questions you
need to ask yourself.
Before we continue however, let's define my audience. If gold is a thing you just
like to own whatever the price, stop reading. If gold is a cult for you and you must
own it to belong, whatever the price - stop reading. If gold is a form of a protest for
you, whatever the price - you are not my audience. We will simply talk past each
other since I speak of completely different aspects. So, without judging each other,
let's just part our ways, so I can address my audience. Now, if you view gold as a
part of your portfolio or a sector for your trading activity, if you do care about the
price, want to protect your account and trade for profit, not for abstract social ideas
- continue reading. If you read everywhere about how gold was/is/will be
manipulated and wonder what to do, continue reading. If you got caught in this
price drop and wonder what to do , or you are out of the gold market but are looking
to get back in - read on. You are my target audience. With that in mind, let's move
on to the questions I want you to ponder.
1. Manipulation (let's not discuss it itself here lest we cloud the real issue, we spoke
about it here before) manipulates PRICES. It doesn't manipulate YOU. It may cause
price to drop, but your account drop is still YOUR doing. Was it your choice to ignore
what charts said, or manipulator's fault? It's not like charts were silent on the drop
coming - many warnings were posted by solid chartists, and you, as a student of the
market, did look at the charts as you contemplated your course of action, right? You
might have noticed how the story said up but the price remained stagnant remember our discussion about Price-Information Divergence?
2. If manipulation, or intervention (the term I prefer for many reasons) is a fact of
life, why doesn't your trading system includes it as one of market forces? Sound
trading approach encompasses everything that influences the market. Each force

that moves the price is a factor to consider. Tape Reading for ages defined two
major classes of such forces as Smart Money and Crowd, advancing the idea of
Smart Money footprints being different and readable. If your friendly market
manipulator is not such entity representing Smart Money, then who is? What I am
trying to say here is, reading the market was always about decoding what Smart
Money is doing vs. what Crowd is doing, with idea to take the side of... well, you can
finish the sentence yourself. How in this regard is gold different from any other asset
that went up and then down in the past? Over last decade and half we went through
what, 3 major bubbles? Tech boom, real estate boom, oil boom? Oh, this time it's
different? Sure...
Now I want you to get really scared. Not with paralyzing fear that won't do you any
good but with healthy fear that is a necessary part of a trader's arsenal; it works as
a safety mechanism, keeping you careful and putting smoke detectors and fire
extinguishers at each level of your (financial) house. So,

3. Let's recall some details of the oil boom of 2008. It was quite recently, shouldn't
be too hard. Please do some simple math. Calculate the percentage of a price drop
that oil experienced, from $150 to $35 (rough numbers, we don't need them to be
accurate to the cent) before recovering to about $70-80-90. Calculated? Now apply
this percentage to the gold top of about $1950 and see what bottom price you
come to. I'll wait for you to finish the math, faint and return from your blackout.
... You are back? Good. Now, I am not saying this is what WILL happen. What I am
saying is, it's a possibility. If someone tells you it's not, ask yourself:

4. If it could happen with oil, blood of the economy, commodity needed by each
and every sector and country, why can't it happen with gold? Oh, I know, you've
read that cost of gold production is rising and that will put a floor under the price... I
remember reading the same about oil in 2008. Didn't help. Market tends to
overshoot on both sides, and while drop to $32 was certainly overdone, it still
poises the question:

5. Can you survive such drop should it come to pass? If you are in gold from $300,
sold part for solid profit and are holding core position only, you don't have to fear
much. If, however, you bought into the story closer to the top... Oh, I know, "but
the governments continue printing useless paper, gold is a hedge..." This IS the
story, and it's not confirmed by the charts. Sure, there is a cool chart circulating
where the rise of debt corresponds with rise of gold. What this chart doesn't show
you is a 2 years-long stall in gold while all kinds of QE were ramped up all over the
world. Thus, last question:

6. Is it possible that there is no intrinsic connection between debt and price of gold?
That this connection is mostly psychological, exists in investor minds, caused the
whole run from 2001 to 2011, and this story has played out? The idea of gold
priced in $30,000 or something like that based on the amount of debt is, in turn,
based on the assumption of gold standard return - so are you willing to invest in this
assumption?

I know, next question to me is going to be: so, what price your charts indicate? As I
said many times before, charts have no predictive value. They have instructive
value. At this point gold chart does not instruct a buy. The path of the least
resistance is still down. You want to hunt for a reversal, read this first.

Oh, and answering first e-mail I am likely to get: no, I don't hate gold. I trade it in
whichever direction chart instructs me. Not to go too far for an example, this is
where we went long GLD for an intraday trade.