Week Ending 12/8 - Long IBM, and Precisely Measuring Risk

Let's start with a look back at IBM. 2 weeks ago I talked about lining up the technicals and fundamentals to make trades. IBM was used as an example. The fundamentals were decidedly bullish, so I looked at the technicals to make a trading decision. Recall:

The pink line was the technical that I was watching. If we closed above it, I would get long with a stop under the last major swing low and a target at level D (see last post). We did close above the pink line, so an entry was made on the opening of the next day, at $152.00. The next 2 days saw some sideways action at this level, and then we rallied for 4 days. This past week we mostly corrected, but so far, the trade is still intact. We are far from the target, but this is a long-term trade, so I am just going to sit with it. On the chart below, the we entered at the blue arrow.

On this particular trade, reward/risk ratio is roughly 4/1. Meaning I am risking $1 to make $4. Over a long serious of trades, you don't need a very high winning percentage of trades to make money with a reward/risk ratio like this. It allows more room for error in making trading decisions. I think measuring your risk is key to being able to make less emotional trading decisions and being able to stick to your game plan in times of draw-down.

Every trading system or method has a different level of reward/risk. System A might have winning trades 80% of the time. With a rate this high, your winners can actually be smaller than your losses. I think achieving this level of consistency is very difficult, if not impossible. System B might have winning trades only 20% of the time. With a rate this low, you need to be making $5 for every $1 that you risk, at the very least, or else you will not be profitable over many trades. It takes a certain level of mental fortitude to stick with a system in which you are losing money on most of your trades. For example, in System B, your risk of having 3 losses in a row is 51.20%. Your risk of having 5 losing trades in a row is 32.77%, and your risk of 10 losing trades in a row is 10.74%. Meaning if you trade System B long enough, you will have 10 losses in a row at some point. However, if you understand your trading system and know that this is just a matter of probability, then you will more likely be able to tough it out.

I want to use this as an opportunity to look at my own trading metrics. My sample size of trades at the moment is small. Over the past 3 weeks I have made 20 trades. Some days I make 0 trades, some days I make 3. Out of those 20 trades, I have had 5 winners and 15 losers. So my winning percentage is 25%. That is lower than I would like, but I am working on getting it slightly higher. 35%-40% would be my sweet spot. My average win to average loss is 3.72. Based on this, I made the following spreadsheet:

The first thing is the Account, which is irrelevant in this case. What matters is the Risk Cap, which is what I am stuck working with right now. With this $2,000, I decided I do not want to risk more than 5% per trade. That means I am not risking more than $100 per trade. I can further deduce that the maximum number of losses in a row I can have starting at the initial balance is 20. This is just the Risk Cap divided by the Per Trade Risk.

I know my W/L ratio is 3.72. I have a separate spreadsheet containing more data that I am drawing this from. Same goes for my W/L rate, which is .25, or 25%. Based on this, I know my average win (Avg W in column D) is $372. Dividing my Avg W by average loss (Avg L), I know my expected value per trade is $18.00. So over 100 trades, I can expect to be up $1,800.

I also know that my risk of 3 losses in a row is 42.19%, so if I have that many, I'm not going to worry too much. However my longest losing streak so far has been 6. I calculated that the change of 6 losing trades in a row is 17.80% (not shown) so also not a huge deal. So overall, I think this strategy is performing decently. But like I said, I want to increase my winning percentage of trades by a bit. In trading, incremental improvements can have large and lasting effects on the bottom line. If I increase my winning percentage to 35% and my W/L Ratio to 4, this is how things would look:

There is no need to go through every single metric again, but it is obvious the results have improved dramatically with a few small tweaks.

I believe that having a good understanding of the risk in your strategy is important. It gives you a road map for what to expect. It helps to reduce the impact of losers on your trading psyche. If I know that every trade I put on has a 35% chance of being a winner, by default I am expecting each trade to be a loss. Which is great! Because then I don't care or get emotional when I take that loss. I know that it is simply the cost of doing business, and over time if I stick to the strategy, I will make money.

Lining up the Fundamentals and Technicals

Making trading or investment decisions based on both the fundamental and technical picture is not a novel idea. There are analysts or portfolio managers with both a CFA and a CMT. Many trading firms, hedge funds, and advisories keep technical analysts on board so that they can have an understanding of what the market itself is saying. One story that Ralph Acampora likes to tell is, when fighting on behalf of the technical analysis, a SEC lawyer held up a chart, and said, "Ralph, what is fact on this?" Ralph responded that the PRICE was fact. Price is what is happening right now. It sums up what all market participants think. Earnings are history. Earnings get revised. Stocks get upgraded to buy, and then often when it is too late, they are downgraded to sell. In the realm of technical analysis, there are hundreds of different oscillators, indicators, bands, moving averages, and candlestick set-ups. But those are still just a derivative of the only thing that really matters: price.

Does that mean that fundamentals and technical indicators should be ignored? Certainly not. Using one or two technical indicators can help eliminate bad trading decisions. Understanding the fundamentals of a company can help to see the bigger picture. Then when you get price confirmation, you can be right in a big way. 

Let's look at an example of lining up the fundamentals and technicals of a stock, IBM, and see how it plays out. We will check back in every month or so. The fundamental work I leave to Barron's. I like to read Barron's on the weekends, and since they came out with a bullish piece on IBM, I thought it would be a good example. I will sum up what they say, look at the chart, and come up with a thesis.

Firstly, IBM has massively underperformed the S&P 500. Barron's believes that the stock is at a bargain price. Since the new CEO took over in 2012, shareholders have seen a loss, even with dividends. Compare that to the S&P over the same time period, which is up 130%. IBM is now leaving its lower margin businesses behind. Their gross profit could grow this quarter for the first time in years. We don't need anymore than that. If you require more evidence, go buy the paper. Barron's make a compelling case, and based on that alone, the stock is a buy. But that is not all you can base a decision on. You need to look at the chart.

To the right is the monthly chart. Right away we can see that the stock topped in 2012 at above $215 a share. It has steadily fallen since then, having put in a few lower highs. At this time frame, the stock seems pretty directionless. It might continue to consolidate until the apex of this triangle is reached. Let's zoom in. 

There are 3 lower highs and 3 lower lows that are circled on the weekly chart below. A 52-period EMA is also on the chart. The EMA has started to move sideways following its decline. That is one possible sign that the stock is beginning to stabilize. So, the lower highs and lows are circled. The more recent high, which is a higher high, is displayed in the first rectangle. The second rectangle shows that we now have a possible higher low, provided that it holds. Another sign that the stock might be stabilizing. 

So if we have a case that the stock might potentially be shifting, what now? Since we want to keep this trading decision in line with the fundamentals, we are looking for an area to be a buyer. The most obvious spot that sticks out to me would be a close above the recent high at $183. That would confirm a bull market in the stock. We can also extrapolate a possible price target by using the ABC method. 

This is a super simple technique. Just take B-A, and then add it to C. We would subtract 116.90 (A) from 182.79 (B).  The result is 65.89. Adding that to C, or 139.13, gives us our potential price target of $205.02. However, waiting to buy upon a close above B provides poor risk/reward. Where do you place your stop? Below C you are risking more than you can make. You would need to enter earlier in order for this set-up to work. Let's zoom in to a daily chart and see if there is another signal we can look for. 

The most apparent thing on the daily chart is the gap up. This followed earnings. Since then, the stock has given back nearly all of those gains. The most important thing for the stock to do right now is hold C, which is our higher low. On the daily chart it is displayed in the rectangle. Our stop, if we enter a trade, will go below that level. Buying right now would keep the risk/reward low, but possibly at the expense of having a higher probability trade. You'd only be risking $10 to make $57 (based on our ABC target of $205.02). That is great, but I need to see a little more confirmation that the stock is ready to move higher. And since the earnings gap and fill, I haven't. The high of that move was $162.51. Coincidentally, or not, that level is also where we gapped down to back in April. Above this, there is a lot of empty space. So if we get some momentum as we move higher, we could certainly propel through. The level that sticks out to me as a possible entry is at the link line. If you look back to July, we gapped down from there, and then on the most recent decline, it acted as resistance. If we get above this level, which is $151.90, I would be looking to be a buyer. Initial stop would go below C, or $139.50, and our target would be D, or $205.02. 

We will track IBM and see how it develops over the coming weeks. If C is taken out, then the trade idea is invalidated. Without that low holding, this potential reversal is moot. We would then need to wait for another signal. The stop will be moved as the position moves in our favor. It will not be set to trail, but rather be moved manually to key technical points. Finally, the entire position will likely not be closed at D. Should we fail to hold above B, we will exit some. And a small portion will be held until there is a clear reversal of trend. 

Week Ending 11/10 - An Update on the Yen, Crude, ES, Corn and $ECYT

Last week we looked at a few different markets where I saw interesting things happening. As tends to happen in the markets, levels were tested, breakouts were reversed, and new patterns formed. So let's take at the same markets as last week and break down their behavior.

If you recall from last week, the yen was on major lows and ready to breakdown. We looked at how we were testing support for a third time, but in a very different manner than the first two times. The first two times we briefly traded in the general vicinity of the .8750 level and immediately reversed and rallied. The most recent test was different in terms of duration and attempted breakdowns (more time spent at the level and more tests of it; see last post). We did indeed breakdown, but for now, it appears that this was a "fakedown." On the 6th, which was Monday of this week, we broke through .8750 decisively, but we were unable to facilitate trade at these lower levels. A strong rejection took place, and that daily candle ended up being quite bullish. I don't think we are going to see a strong rally to swing highs like we did the last two times. I think the dynamic of this market has changed now. There are new shorts and longs at these levels. The .8750 level being breached is going to change the perception of participants. Perhaps a smaller rally is needed to lure in some longs, and then a retest of .8750 will result in a shakeout of these positions. This new selling could be the fuel for the next leg lower.



There are two daily bars circled here. The first is the bar that actually broke the low. Notice how we rallied back and closed on highs that day. I think it is highly likely that new shorts entered the market upon breaking the .8750 level, and they were forced to cover upon rallying back above it.

The next circled daily bar is the day in which volume was unusually high. Obviously, a lot of trading was done in this area. Let's zoom in and take a look at the hourly and see what signs, if any, are there.



There are a few trendlines that may act as possible support should we fall back again. The breaking one of these trendlines would be significant. The circled region is where heavy trading took place. A new high was tested, and then we settled into a range. I would like to see some confirmation of further downside before taking any shorts. A close below this current range low, a breaking of one of the trendlines, or another failed attempt to move higher would all qualify. The immediate trend is up, as evidenced by the higher highs and higher lows. Until that trend is invalidated, being short isn't an option for me. Being long is also not an option given the clear downtrend on a slightly longer-term time frame. No position is a position.

Crude oil ripped higher on Monday. The previous Friday, we had closed strongly, so this was not a huge surprise. The strength of the move was impressive however. Since Monday's move, we have seen consolidation as longs take profits, new longs enter, and new shorts enter in anticipation of a reversal. I normally find that after such an explosive move is a terrible time to trade. You can expect a lot of desperate longs that missed the move to come in, only to be countered by new shorts. Generally the action is choppy and there is not any direction to be had. This can be seen on a daily chart or a 1 minute chart.

The most interesting thing about the above daily chart is the highest support line. A test of this level is marked with the blue arrow. On this time frame, you can't see where this level comes from. But, if we zoom out a bit...
It is actually the low of a range from 2015, and the level from where we broke down! That gap has now been filled and retested. The market indeed has a memory.

Finally, let's go the other direction and zoom in on this chart. Not a pretty week to be trading. Following Monday's move, we have seen a tight, sideways market with one spike higher (DOE data on Wednesday) followed by more sideways action. A trend trader's nightmare. The trend is up, but buying in the middle of this range would be ill-advised.

We will only look briefly at ES. No need to look at a daily, because everyone knows exactly what that looks like. The hourly is a little more interesting, with a potential double-top being confirmed this week. This followed a fresh all-time high of course. Today's trading shows us continuing to hold below where the double-top was confirmed. Yesterday, Thursday, we had broken down to test and hold last week's low. A rally back up to 2585 followed, and then today's decline takes us back to a range just below the double-top confirmation level, as aforementioned. That level is one to watch. As long as we are below that, being short is an option.



We are also not going to dive into corn too deeply. No need to look at the daily. If you remember last week there was a clear pennant forming. This pattern continued to develop this week as we fell and tested the lower end of it.








And finally, let's take a look at $ECYT again. If you recall from last week, we were looking at a possible "W" pattern forming. We did not follow through fast enough, so that pattern has been invalidated. I guess it could be sort of a "W" plus a "V" when all is said and done, but we'll see. This week we saw continued buying in the stock and we are aiming at a potentially important resistance zone at $5.62.

OK one last chart. Natural gas. This market has been stuck in a tight range since May. Obviously this is a very seasonal market, and this is its season. We broke out decisively this past week, gapping higher and then closing at highs. Does this mean higher prices to come? A fakeout followed by a fall back into the range? It is too early to tell, but this was a nice example of a breakaway gap, and so far there has been strong follow-through. Take a look at the weekly and 4h chart below.

Yen Breaking Down

The Japanese Yen broke to its lowest level since March when BoJ's Kuroda began speaking tonight. Additional data was also released from Japan shortly after. The level we are breaching (.8750) was tested in May and in July of this year. The decline to this support area this most recent time was more gradual. We also spent more time consolidating right above it. I notice that when markets reject a level, it is often done quickly. When markets pause and consolidate, I think the chances of big levels being breached are increased. So, let's first look at how the Yen acted the first two times we tested this support level versus how it acted this most recent time, and then we will talk about the outlook.

First, here is the daily chart. The supportive area is marked with a few lines. I don't like to mark exact levels as support or resistance because I think markets can be a little too noisy for that much accuracy.



Let's also look at the Nikkei 225 futures. They have staged a massive rally since August. This is around the time that the Yen began its recent descent, albeit at a much more moderate pace than the rally in the Nikkei. Technically, the Nikkei ripped through resistance and never looked back. Fundamentally, this rally, and the decline in the Yen, is on the back of ultra-loose monetary policy in Japan.

That is the theme in Japan right now. Weak currency, strong stock market. Now let's zoom in on the last two tests of the support level that we broke tonight. The first, in May, followed a gradual decline off of the most recent major swing high. .8758 was tested the 9th. We pushed higher, and then over the next 2 days we attempted to get through again. This time we did trade a touch lower to .8752, but rejected it, confirmed a double bottom, and then rallied. The double-bottom confirmation is indicated by the arrow.

A rally almost took us back up to .9200, lower than the previous peak, before turning lower to test support for the second time. Zooming in on this test in July, we can see that this was an even faster rejection. We tapped .8760 twice, then promptly turned around and rallied again. This time we put in a new high above .9300 (again, refer to the daily chart above)




And now, let's look at the most recent test of this level. We have spent considerably more time trading in this area. In May, we were here for 2.5 days, testing the level twice. In July we were here for only 1 day, and tested it twice. This time, we have been sitting here for 2 weeks, and you can count 5-10 tests, depending on how you qualify them. The point is, the market stayed here and seemed to accept these new prices instead of rejecting them right away. I believe that this generally bodes well for a breakout (or breakdown, in this case).



So what now? Since I started writing this tonight, the Yen has rallied, almost pulling back into its old consolidation area. For now, this appears to be a rejection of those lower levels. I think it is too early to call it a final rejection, and there will be some testing of support-turned-resistance. Was this move new shorts coming in? Was it just the big guys 'banging the hive,' trying to shake out weak longs? We will see how trade develops this week and then check back in. My bias remains short.

Week Ending 11/3

Another week, another all-time high in the stock market. ES has been up for 8 weeks in a row now. 7 of those 8 weeks closed at a new all-time high. Tech stocks are on a similar trajectory, with the last 6 weeks closing at all-time highs. Small caps are lagging. This first chart shows $IWM versus $SPY (as this chart moves lower, it indicates $IWM is falling relative to $SPY).




It seems like any economic data that comes out these days is automatically interpreted as bullish by the stock market. There was plenty to go around this week. Inflation data came in as expected, with PCE Core registering a 1.3% gain YoY. US Consumer Confidence surged to highs, coming in at 125.9, beating the 121 expectation. ISM Manufacturing was a miss on Wednesday. In the minutes prior to that reading, ES had put in what would be its high for the week (until today, when we tied it in the last 2 hours of trading). The FOMC also came out and kept rates on hold, as widely expected. Thursday, Trump named Powell as the new Fed Chair, and finally today, we had employment data and ISM Non-Manufacturing. Change in non-farm came in at 261k, and the unemployment rate dropped to 4.1%. ISM was a beat, coming in at 60.1. So overall, the data this week actually was quite positive.

To the right is a 30m ES chart. We came into the week right off of fresh all-time highs. Monday afternoon, we fell into a range and closed there. The overnight session saw a rally leading up into the US session where we continued to push higher. Wednesday we went straight up to a new high, then pulled back on the close. Thursday we tested lower twice. Should the market turn back, this would be an area to watch as potential support. There are a few lines drawn down there (2565-2566.76); I think the market is a little too random to label just one point as support or resistance. There are also 2 potential trendlines in play. A high-volume area worth keeping an eye on is between 2571.75 and 2573.25. That could act as a sticky area if we retrace back to it. The situation here seems pretty simple. We are at all-time highs and there is no reason to short. If we closed below Thursday's low (red line) I might start looking, but for now, the plan is to buy strength and buy pullbacks.

The bullishness in crude oil continued this week. We closed at the highest level since July of 2015. Looking at the weekly, there is some empty space above the market now. Back in 2015, we gapped lower from the rectangle and then had the big decline into the $20 handle. The specific rectangle/range I am talking about is circled. You can see that there is a gap from where we broke down. If we fill that, I think that we will test the upper end of that range ($62). I also think that it is possible that this current move higher turns out to be a fakeout, and we fall back and form a range between $51 and $55. However with 4 positive weeks in a row, I think the safer bet is to the upside. It is worth noting that hedgers are net short and small speculators are net long.

One market that I have found particularly interesting as of late is the yen. We have declined to a major support level that has been tested in the past, and now we are just hovering here (if you're looking at the spot pair, USD/JPY, the opposite applies). Big data from Japan on Monday failed to propel the market in either direction. Their policy rate remains negative. On the first chart below, the general area that is acting supportive is clear. It is roughly .8750 and was tested in April and July. The fact that we are spending much more time just above this level this time around tells me that the market is accepting this current price, so more testing to the downside is likely. .8690-.8715 will likely act as support should we break lower.

Zooming in a bit, let's look at how we have been testing this .8750 level. We came into the week at .8870 and steadily declined to .8770 following the BOJ announcement and outlook report. Thursday we retested this area, and rejected it quickly, shooting up to .8823. This same sort of rejection took place again today, when we quickly shot up to .8820 after failing to move lower. This second rejection was actually a result of the unemployment data, which caused initial dollar weakness. That was quickly reversed following the ISM data, and we got as low as .8752, which was the lowest level on the week. It seems like there is some perception of value down here, and like I said, I think further downside testing is very possible.

Corn has been EXTREMELY boring, but it might be gearing up for a move. On the daily, there is a pretty clear pennant forming. This kind of sideways behavior has been pretty typical of corn for the past year. Small speculators are net long and hedgers are net short. Could that mean a squeeze of the small specs is in order?

Looking a bit closer at corn, it is easy to see that the market is forming smaller and smaller ranges. Indeed, ATR confirms this. Being in the middle of the pennant like this doesn't provide any good risk/reward trading set-ups in my opinion. I think you need to wait and see if there is a decisive move in either direction, and go with it.

One last thing I find interesting is $ECYT. I don't really look at individual stocks, but this rallied hard at the beginning of October, topped out, fell back to support and held it, then began rallying again. There is a potential free-fall zone beneath the support level of 4.15. We tested this area between October 12th and October 17th, and then again on the 25th and 26th. This formation following the rally is starting to look like a W, so we will see if there is more upside to come.

The Anatomy of a Losing Streak

This lesson applies specifically to traders, but it can also be more broadly applied to anyone who is in a business or endeavor in which performing under pressure is essential.  We have all heard of the “hot streak.”  You are “on a roll.”  For a trader, this might mean that everything she touches turns to gold.  For a basketball player, he is hitting every shot.  Of course there is also the opposite scenario, the “slump.”  The “cold streak.”  No matter what you do, it doesn’t work.  You will never be able to regain your touch.  You have just been lucky this whole time. 

Some statisticians might argue that purely based on odds, streaks are a mathematical certainty.  But, it turns out there is much more to a streak.  There are actually some deeply-rooted biological dynamics involved.  Anyone who has read what I write knows how important I think evolutionary biology is; it is everything, and understanding it can provide a huge edge. 

I want to take a look at the “Anatomy of a Losing Streak.”  Having experienced a brutal losing streak in my own trading during the month of September, I took away some lessons, and was also fortunate enough to stumble upon some new knowledge that helped tie everything together. 

The specifics of my losing streak certainly defy all statistical possibilities that would be a result of just “bad luck.”  No question, there was something seriously wrong with my perception of the markets.  I was not seeing what was going on in an objective manner at all.  I perceived the market as a threat, as opposed to the opportunity that it really is.  So what had changed inside of me?  What biological mechanisms were at play? 

“Financial risk taking is as much a biological activity, with as many medical consequences, as facing down a grizzly bear,” says John Coates, in The Hour Between Dog and Wolf.  It is worth noting that Coates is a Research Fellow in Neuroscience and Finance at Cambridge University, with experience in the financial markets.  There might be no better source on this topic than him.  

He goes further in stressing that trading is also a physical task, and how could it not be?  Our mind and body is one; a cohesive organism that provides feedback within itself.  “Few professions, with the exception perhaps of air-traffic control or the military during times of war, compare with finance for the amount of information that must be sifted and processed in real time,” says Coates.  Information is processed physically, not just mentally, as many seem to believe.  This has very important ramifications in understanding the anatomy of a losing streak: when you are in a losing streak, serious physical changes are taking place.

During short-term stressful situations, we experience a release of cortisol and dopamine in our brains.  Small amounts of moderate stress are actually quite healthy.  However, long term stress that comes from a losing streak turns on the cortisol drip and leaves it on.  When you are in this state, your body is prepared for an immediate emergency, but stays that way for an extended amount of time.  Humans are really not meant to deal with this sort of prolonged response.   Our stress response is meant to turn on, and then turn right back off.  So, when it stays activated, your immune system weakens, digestion becomes much more difficult, and your sex drive diminishes.  The reason is that when your body perceives an immediate threat, all resources go to dealing with that threat – so metabolically expensive processes like those mentioned above, shut down. 

At some point, after a certain amount of losing trades or losing trading days, my stress response turned on and stayed on.  This helped to exacerbate the “streak” that I found myself in.  Instead of looking for opportunities, I looked for ways to AVOID risk.  I was looking for trades where I wouldn’t have to take risk, which is of course not possible.  So I was making foolish decisions in the hope of avoiding further damage. 

I also found myself seeing patterns where there were none.  This is very common in trading, and is often referred to as forcing trades.  “Shell-shocked traders…become pray to rumor and imaginary patterns,” Coates explains.  To use the basketball analogy, it would be like a desperate point guard trying to take a foolish shot under heavy coverage.  The boxer takes wild swings without using proper technique and defense.   Our minds (and bodies) start desperately searching for patterns when under the stress response; and this literally caused me to start interpreting meaningless noise as opportunity.  Armed with this knowledge now, I am much more equipped to recognize when I am prone to making a decision based on desperation, rather than one based on sound technique. 

Another important consideration is the “winner effect.”  This is another very real phenomenon.  “When two animals face off they experience a pronounced rise in their testosterone levels…Testosterone thus prepares an animal for a competition, but it is what happens next that drives the winner effect.  After the fight is over, the winning animal emerges with even higher levels of testosterone, the loser with lower levels…if you have just lost a fight, you had better retire into a bush and nurse your wounds; while if you have won, you can expect an increased number of challenges to your newly elevated status in the social hierarchy,” explains Coates.  So what is the implication for trading?  Well, if you are experiencing losses, you are actually becoming more prone to more losses!  The response your body has is one of caution, so you are naturally going to be more risk-averse! 

Hopefully, this provides more insight into what actually happens during a losing streak.  Winning streaks are similar.  The importance of recognizing our biological reactions to either winning or losing cannot be understated.  Realizing when you are susceptible to making desperate decisions based on noise that, because of the stress response, appears to have meaning, can save the trader a lot of money.  Escaping the dregs of a losing streak requires a trader to gain their confidence back, but you will keep making foolish decisions unless you are able to compensate for your distorted perception.

Holistic Trading

I’ve said it before and I have no problem saying it again: trading is one of the most demanding and challenging businesses in existence.  This is marked by the failure rate for a beginning trader, which is in excess of 90 percent.  If you started trading today, you would likely lose all of your money. 

Why is this likely?  What is interesting about trading is that anyone can access the markets.  It takes no degree, no connections, and no superior level of intelligence to start placing trades. This leads to a fascinating fact: most people who get into the markets are wildly unqualified.   Many of these individuals would not find success in another endeavor, and so they also don’t find success in trading.  However, simply because it is so easy to get into, novices think that the business of trading must be easy to succeed at.  This presumption often leads to complete emotional and financial devastation for those who aren’t fit to be traders.

What about those who are the right type?  By “right type” I mean the kinds of people who would likely find success in another career such as law, medicine, academia, or sports. These are the kinds of people who often have an extremely high level of emotional intelligence, akin to that of a pilot or an air traffic controller.  These are the kinds of people who work hard, have discipline, and lead balanced lives.  These types of people are far more likely to succeed in trading, but their path to success is still a very long one that will inevitably be laden with sweat and tears, but hopefully not blood.

Would you feel confident going under the knife for a major surgery if the surgeon was a person who was “giving it a try” as a potential career.  I sure wouldn’t.  But this is the attitude a lot of traders.  They just “give it a try.”  They don’t come in ready for years of hard work, emotional toil, and the horrific feeling of total self-doubt that one inevitably must endure while trying to make it in trading.  Successful traders approach their trading education like it is medical or law school.  Their tuition is the money they are prepared to lose while learning, in addition to the hard work and sacrifices they will have to make.

Anyone who has a realistic expectation of the trading game knows that they will be directly competing with some of the most intelligent people in the world.  Trading can pay big bucks, so naturally it attracts the best and brightest alongside those with little more than trading hopes and dreams.  This means that, in order to rise, a trader must have every single possible edge in addition to the will to work harder and be more disciplined than the next person. 

Any day that you sit down in front of your computer to trade you must be 100 percent, absolutely no exceptions.  Problems at home?  The market doesn’t care and will gladly part you from your money while your attention is elsewhere.  A bit tired from being out late?  Mr. Market says “thank you.”  99 percent is not good enough.

So what other edge, outside of the statistical meaning, do you need to succeed?  I call it “holistic trading.”  Normally when I think of the term “holistic” I think of all of the vegans (why do they always look so angry?) I see at Whole Foods.  Frankly, the term is a bit of a turn off because of this association, but the term truly is best to describe my approach to trading.  Essentially, this approach rests on the idea that the body and mind are one entity.  The healthier the body, the healthier the mind, and vice versa.  This healthy reciprocity can be gained in a myriad of ways. 

It isn’t necessary to look like you belong on the cover of Men’s Health to make it as a trader, but having the energy that comes from being in shape is a definite edge.  Trading requires intense focus, and as studies have shown, exerting self-control actually requires a lot of energy.  If you aren’t eating properly, that is going to be a disadvantage.  If you aren’t spending some time every day getting exercise, then that is also a disadvantage.  I love to think of things in terms of evolutionary biology.  If cavemen did it, then it is probably good to do.  Our DNA hasn’t changed much at all since their time, so it is important to respect that.  This isn’t hippy-speak, it’s simple logic.  Our ancestors had to run and were constantly on the move.  Processed foods loaded with chemicals and sugar didn’t exist either.  So, to boil this down: exercise and don’t eat that crap.  The relationship to trading is actually pretty simple: feeling more awake and alert every day is going to be a big benefit to your bottom line.

Meditation is also a powerful tool, with short-term and long-term benefits for traders (as well as others).  Ray Dalio is one of many large fund managers/traders who are into meditation. According to Ray, who, mind you, is worth $10 billion and manages around $154 billion, meditation is the single biggest contributor to his success.  It “makes him feel like a ninja,” allowing him to better process things as they happen.  Sound important to a trader?  He is not alone in his view on meditation either, but you can google that on your own.  One description that I have heard about meditation is that it is like a shower for the brain.  I think this is accurate based on my experience.  Meditation is also a useful exercise to help relax in the morning before the trading day begins.  Again, this can be a big advantage for the trader.

Your relationships with friends, family and significant others is also important.  Negative relationships sap your energy.  Positive relationships have the opposite effect.  If you are in some type of relationship that isn’t healthy or positive, either change it or end it.  Because, guess what?  The market doesn’t care what else you have to worry about.  If you need to, take some time off from trading while you resolve whatever issues need resolving, so you can give 100 percent of your focus to your trading. 

To consider this approach in action, let’s take a look at a day in the life of a trader, Gus, who doesn’t find value in this “holistic” approach.  Gus might wake up and have a breakfast consisting of coffee and a donut or something else with a hefty dose of sugar.  Actually, let’s make it an energy drink instead of coffee, just to ensure that a sugar crash is inevitable a few hours down the road.  Gus trades for a bit, gets tired, and takes his lunch break.  For lunch, a deli sandwich is something that most people seem to think is mildly healthy, so a deli sandwich it is.  After lunch, Gus comes back and finishes up the trading day and heads home.  Chances are that, at this point, Gus is tired.  When he gets home, maybe he will take a nap or watch some TV.  Exercise is not on the agenda, but a fight with the significant other is.  Perhaps not even a fight, just the usual, dull, interaction.  Dinner time finally arrives and Gus orders a pizza and has a few beers.  Due to that nap he took earlier, he has trouble getting to sleep after dinner, and when he finally does his quality of sleep is slightly diminished because, well, that is the effect that alcohol has on sleep.  So, the next day he wakes up, grabs his energy drink and donut breakfast, and the routine repeats. 

It is easy to see how this negative cycle easily perpetuates itself.  If you feel crappy after work, you probably won’t want to hit the gym.  If you don’t hit the gym, you don’t get that extra boost of energy and confidence.  You don’t sleep as well, and then…well you can take it from here.

Now onto the next trader, Marsha, who lives a more healthful lifestyle.  Marsha recognizes the advantages of having extra alertness and clarity of thought.  Marsha wakes up, probably a bit earlier than Gus.  She might start out her day with a run or a quick meditation session.  Either way, she is already setting up to have more energy in the morning than Gus.  She cooks some eggs and blends a veggie juice.  Marsha doesn’t eat a huge breakfast that will take inordinate amounts of energy to digest.  Instead she eats a bit more lightly than Gus, and brings a snack to have mid-morning, perhaps after the European close at 10:30 AM.  Lunch time comes around and Marsha meets up with her trader friend, Archie.  They grab Chipotle (avoiding the tortilla and sour cream), talk as friends do, and then go back to work.  Marsha finishes up the trading day and goes home.  At this point, she is probably a bit mentally exhausted, but not in dire need of a nap.  She might go for a walk or review her trading day.  She chooses to forgo the mindless exercise of watching TV.  Marsha eats a dinner of quality, real food, maybe has a glass of wine, and then gets a good night of high-quality REM sleep.

In contrast to Gus’ situation, here we can see how this positive cycle perpetuates itself.  Marsha will wake up feeling more energized and more likely to have a positive mentality toward engaging in her healthy habits, and therefore her positive cycle is more likely to continue.

So, summing up this approach is simple: eat well, exercise, and meditate. Keep wary of things that introduce stress or negativity:  Don’t drink too much or do drugs.  Don’t eat crap.  Understand that all of the elements in your life are connected to your success as a trader and the importance of building a positive cycle. 

Note: While some of this “wisdom” comes from my own experience, the book “Market Mind Games” by Denise Shull touches on a lot of these topics.  Additionally, basically any modern book you read about evolutionary biology or performance will highlight the connection between mind and body.  Feel free to email me for some names.