Rules of the Trade [Secure eReader]
Click on image to enlarge.
eBook by David S. Nassar
eBook Category: Personal Finance
eBook Description: Like the information that continuously flows onto their computer screens, active day traders want guideBooks to be fast, no-nonsense, and reliable. Rules of the Trade gives traders of all levels the concise, common-sense insights of a day trading pro. Beyond simply listing the rules, however, it goes on to explain what the rules mean, why they are important--and the high costs of overlooking them even once. Packed with real-life examples to illustrate key points, this book--from best-selling author David S. Nassar--details popular axioms that traders often forget in the heat of action. All the basic rules are covered, including: *Only trade stocks you know and trust *Set goals and frequently measure progress *Understand the difference between gambling and trading
eBook Publisher: McGraw-Hill Companies, Published: 2002
Fictionwise Release Date: July 2002
Many books have been written on the subject of trading stocks and securities, and most focus on the mechanical side of the market such as chart reading, mathematical indicators, electronic trading systems, and other methods that would fall under the cognitive thought process of trading. Fortunately, there is an abundance of information available for understanding the mechanical nature of the market. But because the market is so dynamic, mechanical techniques and trading styles such as "scalping" are the most prone to change. With the explosion of electronic trading, recognizing this now is vitally important.
The most recent phenomenon to help make the point could be traced back just a few years ago to the "SOES bandits," as they have been called. Trading opportunities often were found by examining the depth of buyers and sellers at the inside market and determining how strong a market maker's propensity was to buy or sell a given stock by witnessing how long he stayed at the bid or offer and by how much he traded at a given price level. At that time, market makers would show size on average of 1000 shares, and the spreads were much wider between the bid and ask at the inside market shown horizontally on a Level II screen. Note: Horizontal simply means the difference between the prices at which market participants would buy and sell a security, theoretically the most favorable price at any given time. Vertical is the spread in price on the same side of the market (buyers or sellers). For example, if Morgan Stanley (MSCO) is the best buyer of BRCM at the inside bid of $112 and the next buyer on the Level II is not indicating until $111, it would suggest a wide vertical spread among buyers of BRCM and therefore a thin or illiquid period of time for BRCM stock.
SOES traders traded these opportunities created by wide spreads, attempting to make money on market inefficiency, and many did! But much of that has changed due to changes in rules, much tighter spreads, lower size being shown to the market by market makers, and other events that have limited the opportunity for this mechanical trading style. Trading today for spreads alone is a mistake. While the opportunity still exists to a lesser degree, the spreads are so tight that success is not as attainable with this narrowly focused trading style. Therefore, traders must recognize changes in strategy and mechanical systems over time and adapt with the market.
Over the 30 plus years I have traded, including the time I spent on the floor of the Pacific Stock Exchange as a specialist, as a market maker, and currently as an EDAT trader, I have formed the opinion that enduring factors like personal and market psychology need much more attention. Cognitive, mechanical knowledge of the market is important, but what plays on a trader's emotions and how he or she reacts to events is of much greater importance and much less prone to change. That is what is so unique about this book and why I have agreed to contribute to and endorse it.
David concentrates on methods and insights that have been used by traders for many many years. Although there are few common denominators that are present in all markets, the few that do apply are the focus of this book. This book is a rulebook for trading, focusing more on the intangible assets that traders need over time than on the mechanical methods that will change and leave those that don't vulnerable.
The rules covered in this book are written from a trader's perspective. Few rules are new and original; most have been discovered over many years from many traders. These rules have grown and survived because they are not prone to change. Much is gained by "checking your ego at the door" and opening your mind to what could be taught only from many years of experience -- experience that has been passed on through generations of great traders and multiplied exponentially over trading floors, hedge funds, institutions, and brokerage houses around the world and that cannot be duplicated by any one person in a single lifetime.
Those that understand this have already acquired the first and most important rule down: The market has little room for arrogance and ego. You must have the humility to admit when you don't know or understand something. To admit failure early when you are wrong and to cut your losses, and to learn from everyone, new or experienced, is the attitude the market rewards.
David makes the point that you need to be driven to build knowledge through your passion. I would add that if you think you already have the answers or possess the magic mechanical methods and techniques to trade, this book is not for you. Ego may have lead you to believe such "self-actualization" has been achieved in your trading, but time will correct that -- just give it a chance. Many of us have gone through this stage of our trading, including me. Once you humble yourself and put your ego in check, your trading will improve directly with your wisdom. And wisdom is not as much mechanical cognitive knowledge as it is emotional intelligence. Both will be covered, with an emphasis on the latter.
Most books start with a wonderful promise of excitement and mystery and give you the feeling that if you only begin reading, you will find the destination you are looking for. This book's message is the opposite: You must learn the cold hard facts about the market and the rules that must be employed to engage it. I believe this lesson must be learned early, while keeping early excitement at bay. This book does an excellent job of introducing you to it. David approaches the subject of trading with the same honesty and humbleness you must approach it with. This approach centers on the fact that the market is not a destination; it is a journey. If you are expecting a book that will lead you to some destination at which you will find the financial rewards you hope to achieve, your expectations will not be met. Neither this book nor I support such illusions.
This book is a beginning of a journey. It relays the obvious as well as the more subtle nuances between successful traders and unsuccessful traders. Rules are an interesting institution. They are almost destined to fail on one hand because humanity has spent its existence testing them, stretching them, and certainly breaking them. On the other hand, where would we be without them? In the end, we all profit by following them to some degree and by breaking them to another.
Wall Street has had unwritten and written rules for too long. Thankfully day traders have had the courage to test them, stretch them, and even break them in order to create a brand new industry that now properly includes the average person. In this sense, we certainly have all profited from the breaking of the "old guard" and rules that have unfairly punished (financially) those who were not market insiders.
With the emergence of this new industry and pioneers of change, you will on the other hand find abuses of the rules that are put in place to protect us. Manipulations through chat rooms, margin requirements, lending practices, and hype certainly have found their way into this exciting new genre of electronic trading as well.
What David brings out in this book is a balance of rules that leads the electronic trader through the quandary of information that sends conflicting messages to what all market participants hope to achieve: clarity. I define clarity in the world of trading as a clear plan of action that leads to a statistical edge large enough to justify the implementation of an idea as to where stock prices are heading, called a trade. In the absence of such a plan, clarity will never be found consistently enough to yield sustainable results. Although the rules covered in this book focus on some of the mechanical practices required to find clarity, the psychological rules and attributes that have stood the test of time are rightfully covered in much more detail.
The question I ask others and myself is, Why do people trade?
I think the answer is in part that the market is a seductive institution. Experts from all walks of life have engaged it with all their expert skills, trying to find the perfect fit with the market based on what they know -- mathematicians, psychologists, psychiatrists, floor traders, engineers, rocket scientists, software programmers, athletes, and on and on. Many have applied their deep understanding of their respective fields to trading, trying to pigeonhole their specialized skill and understanding into some literal solution to trading. Because many industries make up publicly traded markets, the market is a huge melting pot of services and industries. The irony is that, just as no one industry or discipline makes up the market, no one style or market mechanic will provide the trader with what he needs to trade. Hence, trading is more an art than it is a science.
Drawing from many fields of thought, many psychological, some mechanical, will be the melting pot of ideas that will give you the greatest chance for success. Diving too deeply into any one idea or any one mechanical system through software, technical studies, or mathematical formulas is too narrowly focused. Only by constantly reading and enriching yourself through exposure to the market can you gain the well-rounded base of knowledge you need.
I have read psychology books that make sense and have great application to trading, and I have read other books on mathematics and technical study that also do the same with explanations of how the math can quantify the psychology. But the lesson to take from this book, in my opinion, is to apply a combination of many views to ultimately form your own recipe for success. This recipe will be a living recipe that will continually change with your experience.
Among the tools and attributes most would choose to create the ideal recipe, magical software and technology seem to top the list. I have developed and contributed to some highly sophisticated trading systems. I was involved in the world's first electronic trading system on the Pacific Stock Exchange, and continued as the chairman and CEO of Instinet from 1983 through 1988. More recently as the cofounder and chairman of OptiMark Technologies, I can tell you that while technology has significantly enhanced the markets, it has yet to replace the essential characteristics that only the human mind possesses.
Unfortunately, in most cases, knowledge, research, and the psychological characteristics of traders often take a back seat to technology through excitement and greed. Technology and software unfortunately have been sold to the public as the solution or "holy grail" to finding the trading rewards that so many aspire to, but this ideology is no more effective than chasing leaves in the wind. Software has yet to replace the need for thinking, research, discipline, passion, commitment, and certainly the adherence to the critical rules of trading. These critical rules, as stated, have evolved over time through the mistakes, experience, and pain of many traders who have unknowingly written them by making the mistakes that you undoubtedly already have made or have yet to make.
David has done an excellent job assembling the key characteristics and attributes traders need that are often ignored. This book builds on the backs of many market pioneers who have, like the trail blazers of the old wild west, carved a pathway that, if trusted, will prove to make your journey toward your trading goals less painful and more profitable in much less time.
Software has certainly impacted electronic trading in a very dramatic and positive way, but software will come and go and change. The critical rules to trading are timeless, and they may change to some slight degree, but they will remain steady beacons of light for all to follow who engage the markets.
Because critical rules are never based on the opinion of just a few but rather on the experience of many, the rules stated are not all original. Some may even sound like clichés because they have been heard around trading pits for decades, but remember clichés become clichés because they are worth repeating and hold value. This book gives these time-tested rules a new coat of rhetorical paint and has added new rules based on the beliefs and attitudes of some of the best traders in the world. Regardless of their origins, if you put the axioms you find in this book into practice, it will make a real difference in whether you succeed or fail as a trader.
Because rules are more often broken than followed by new market participants, let me highlight an example that relates to the psychological demons that every trader has to deal with on a regular basis. When day trading, fighting demons becomes exaggerated because you have less time to rationally deal with them. You see a position run uncontrollably lower, knowing it must find support soon; but greed rears its ugly head and causes you to hold on, and before you know it, you are licking your wounds eating a major loss. Or perhaps you are in a trade going into the close and it moves against you, and you decide to hold the position overnight because you hope it will recover. "It's a good, solid stock" speaks the two-headed monster of greed and fear, who repays your misguided trust by taking a bite out of your net worth.
Greed and fear are just two of the many adversaries to the mind of a trader that will prevent many from reaching their potential. Fear of failing. Fear of succeeding. Fear of pulling the trigger. Fear steals confidence and paralyzes traders. Greed, on the other hand, creates exuberance at the expense of doing valuable research, which, in most cases, gives you exactly the opposite of what this useless emotion elicits, the desire for money. Unfortunately, in trading, the more you chase it, the harder it is to catch up to. Ultimately, you will recognize that doing the work born through your passion for the markets will build confidence through knowledge that replaces greed and fear.
Adopt the critical rules highlighted in this book and massage them to fit your own trading style and personality, and the enigma of the market will quickly dissipate.
Another example and component of this book David covers relates to technology. Technology has not just impacted trade execution. Imagine trying to conduct research today without the sea of information available through the Internet. In the last five years, the technology needed for the average person to trade fast and efficiently has come into its own, and if you are not taking advantage of it yet, the most likely reason is that you lack passion to trade or you are afraid of it. The first reason is a good reason not to trade; the second is not, and it is the result of ignorance. The point is, technology is here and will continue to impact many facets of our lives, and to remain ignorant and fearful of it will only spell regret in the long run. By reading now, I suspect that you have the passion to trade. As we say in the business, "Don't fight the tape!" Embrace your passion for the market; it is an advantage. For two centuries, the securities industry attempted to convince the typical investor that he or she was not capable of understanding the complexities of the stock market. The industry maintained that the market was so esoteric that only a highly trained, extremely experienced stockbroker could comprehend its intricacies. Today, you have the power to control your own investing destiny. Along with that power and control comes added responsibility in making your own stock selections. To push the envelope of responsibility, once in a trade, you must also decide when to exit -- and that's often the most troublesome question for the amateur trader.
Remember that the word amateur is better defined as a state of mind than defined as a level of experience. I know many new traders who are true professionals because of their approach to the market, and I know even more amateurs who have been in the market for years. Their survival kit is made up of five parts luck, three parts hope, and two parts knowledge. This group has yet to face the music and in the meantime is being ground down by poor trading and blaming its dismal results on factors that it can't change, like interest rates, market volatility, bad brokers, commissions, and any other external factors it can think of. The truth is, these individuals will constantly blame others or events outside their control for what they don't have. They are usually very vocal, and they talk the most and accomplish the least, which earns them the title of "amateur." Professionals take responsibility, admit when they are wrong, learn from their mistakes, and move on down the road toward results. Results are the only true measure in the market, which is why the market is not political, but pure. Professionals believe that in most cases, like life, you get out of trading what you put into it. Professionals take responsibility for these results and often feel proud of where they are in their journey of learning, and they continually learn, while the amateurs are justifying and rationalizing to anyone who will listen and join their plight. The amateur stays in constant pursuit of the holy grail of market mechanics and technology that alleviates the responsibility to do the work. You decide which category you fall into, but if your past suggests some of these amateur characteristics, I strongly suggest avoiding electronic trading. It rarely works out for this type of individual.
While these words are tough and hard to hear, I told David when he asked me to write the foreword, "Don't expect me to 'run for mayor' and hold anything back." These are the facts I would tell a good friend or family member who aspired to be an electronic trader. This way, you can quietly and privately categorize yourself now, which may save you many thousands of dollars later. The fact is, trading is not easy and not for everyone, and only you can decide.
I share the same beliefs as David, and commend him on his candid and honest approach, which is the reason I have agreed to endorse this excellent book.
William (Bill) Lupien
Copyright © 2001 by The McGraw-Hill Companies, Inc.