Lesson Video Part 1

Lesson Video Part 2

“There are three primary factors involved in duplicated success – Beliefs, mental states and mental strategies” – Van Tharp, Market Wizard

By immersing yourself in the mentality of some history’s greatest traders, the understanding of what it takes to be successful becomes subtler, and more integrated in your trading, significantly increasing your returns.

Here are six common themes amongst how the market wizards think. They:

  • Credit their success to discipline
  • Take a rational and practical approach to money management
  • Have no boundaries and are open to everything
  • Think against the herd
  • Play the good hands and drop out of the poor hands
  • Trade bigger when they are trading better

By adopting these mindsets for you own, I can guarantee you will become a much better trader.

The exception that proves the rule

One of the more interesting things about the market wizards is that one might hold the exact opposite view from another, yet both are highly successful in their own right. Aside from this, speaking to the fact that it’s important for a trader to have a method that suits them, it means that it’s possible to find contradicting evidence for many of the mindsets in this lesson.

One obvious example is the concept of cutting your losses short and letting profits run. There are examples of traders who either let their losses run, or cut their profits short and make spectacular profits doing so.

This does not mean that the overall mindset is wrong, just that there are many ways to be successful. So what I attempt to do in the lesson is create a “glide path”.

I look for the commonalities between top traders and focus on the things that we, as retail traders, can apply in our approach to the markets. I will outline the contrary view where I can. Let’s get started with one of the most commonly known but least well understood master trader mindsets – discipline.

The most important thing is discipline

Imagine a trader with no discipline. They fail to follow their own rules. They enter and exit on a whim or, perhaps, much worse, they fail to have any trading rules at all.

Contrast a highly disciplined trader, who executes their plan flawlessly (at size) without exception, even when it seems like the most difficult thing to do. Which one would you rather be? The answer is obvious, but perhaps somewhat elusive to achieve. So, how to be disciplined?

There are a number of mindsets that highly disciplined traders share.

Trading is a game

“I like the game. I think it’s a great challenge. It’s also an easy game to keep score of.” – Bill Lipschitz, Market Wizard

Many of the traders interviewed in the Market Wizards books viewed trading as a game. If you view trading as a game, then making a mistake is necessarily a failure to follow your own rules. Viewed through this lens, perfect play becomes a lot easier to work towards.

Whether you make or lose money on any individual trade is NOT important. What is important is that you follow the rules of the game.

Money is not important

 “In our business you have to have a total disregard for money. You can’t trade for money.” – Tom Baldwin, Market Wizard

Top traders view money as not important. Of course they want to make money, and they are very respectful of their capital and profits, but it’s not about the money. It’s about following the correct trading processes. If they do that, then the money will come.

Instead, if your focus is on the money you are making or losing, you tend to make emotional decisions based on fear and greed. Focus your total attention on trading well, and let the results take care of themselves.

Don’t care if you win or lose on a trade

“I usually don’t get excited by winners; I’m too busy looking for the next trade” – Steve Watson, Market Wizard

Not every trade you place is going to be a winner. Some will win, and some will lose. It’s important as a trader not to get invested in the results of any one trade.

When you trade, control your emotions. Strive for a sense of balance, no matter what the market does. If you have a win, don’t get elated. If you have a loss, don’t get upset about it. Instead, be happy at all times just to follow your own rules, and play the market game in your own way.

Trading is like rolling a dice loaded in your favour

When you place a trade, it’s helpful to think that it’s like rolling dice loaded in your favour. Trading is a game of probabilities, where the results of any one trade does not matter. Over time, if you “continue to roll the dice”, your losses will be far outweighed by the profits from the wins generated by your system’s edge (your “loaded dice”).

This means that as a trader, your job is to follow your system, irrespective of whether the last trade was a win or a loss. If your system does something that results in losses, that’s just part of the system, and so it’s nothing to be greatly worried about.

Think of the next trade as the first in the next 1000 you are going to do

As humans, we tend to over-value recent results, so it is helpful to put the trade in the context of your trading lifespan. The reality is the trade is one of potentially thousands you will place over your career as a trader. While it might be nice for the trade to go for you, the market is going to do what it does irrespective of your feelings.

If you can put the trade in this perspective, it becomes much easier to calmly accept the results – good or bad.

A plan forces discipline

“Planning to get out before putting on the trade is a means of enforcing emotional discipline.” – Victor Sperandeo, Market Wizard

Without a written plan, it is incredibly difficult to be disciplined. If you trade with no plan, you are what is termed a “non-rules based” discretionary trader. That is, a trader that enters positions on feeling, tips, or simply what looks good at the time.

By having a set of written rules that you follow when you trade, you are exercising discipline. You enter the realm of “rules based” discretionary traders, where Market Wizard Van Tharp suggests that 90% of successful traders live (the other 10% are mechanical traders).

Have a core philosophy; without a core philosophy you are not going to be able to hold onto your position

“You must fully understand, strongly believe in, and be totally committed to your trading philosophy.” – Richard Driehaus, Market Wizard

As well as having a plan, it is very useful to develop a core trading philosophy. By knowing what you are trying to achieve, and by being very comfortable about your trading, you can continue about your trading business with a minimum of fuss or emotion.

It’s by really truly knowing what you are about as a trader that your trading discipline goes to another level. This is why it is difficult to trade someone else’s plan.

You can have a great set of rules, but if you are not in tune with the reasons behind the rules, then you will find them tricky or even impossible to follow mistake free. This is particularly true when it comes to trading at larger sizes, or holding on to a winning position.

Without understanding why you are holding on to the position, you will be tempted to grab your profit prematurely.

Objectively evaluate your progress

If you are holding yourself accountable for following your plan, you will instil a large degree of discipline in your performance.

By being honest with yourself when evaluating your progress, you will pick up on the things that are hampering you, or areas where you are making mistakes. A good way to do this is to establish a review process for your trading.

This could be done daily, weekly, or on each individual trade. This is one task that comes highly recommended if you want to achieve peak trading performance. Furthermore, it will force you to accept unpleasant truths about your trading.

Perhaps you think you have been disciplined when you have not been. There is a story in the Market Wizards books about an amateur trader who believes his wife is hiding his trading statements, when in fact he is subconsciously hiding them himself to avoid facing his losses.

While this is an extreme example, sometimes we are doing things we don’t realise we are doing until we take the time to review it.

Have a rational and practical approach to risk management

“Ironically, even though money management is more important than the price model, mathematically, it’s the more tractable problem” – William Eckhart, Market Wizard

Risk management.

We all hate buzzwords, but it’s hard to get away from them. Initially, when we hear the term “risk management”, we are intrigued. After a while, we realise everyone is using the damn words, and they lose their meaning.

But, if you want to trade successfully, risk management is not something you should dismiss.

All the Market Wizards heavily emphasise risk management as crucial to their longevity. It is ingrained in their trading mindset. Thankfully, risk management is not rocket science (though some Market Wizards are quite complex in how they implement it). Rather, it is a matter of being practical, and taking a logical approach. It’s generally about keeping track of what you are doing, and applying common sense.

This starts with the old trading adage of cutting your losses short and letting your profits run.

Cutting losses short and letting profits run

“Two of the cardinal sins of trading – giving losses too much rope and taking profits prematurely – are both attempts to make the current position more likely to succeed, to the severe detriment of long-term performance” – William Eckhart, Market Wizard

A trade that works 50% of the time can be very profitable, if you apply a good money management plan that keeps your losses smaller than your wins.

While it is not universal amongst the Market Wizards, some of whom practice high probability trading (a high percentage of small winning trades), a lot of them attribute a large part of their success to holding on to their winning trades and quickly getting rid of losing ones.

Play great defence first

“To commit very little capital, take on very little risk, and still make a significant return consistently – They are a very smart firm” – Alphonse Fletcher Jr, discussing Bear Sterns philosophy

A powerful risk management mindset is to manage the downside, and not to worry about the upside.

If you have a good system, the upside will come as long as you avoid any psychologically damaging large losses. Good traders have very little tolerance for losses. First and foremost, this starts by preserving your core capital.

If you lose your core capital, you are out of the game. It’s as simple as that. This is particularly true for retail traders. The longer you are around, the greater chance you have of learning what you need to do to start making money.

It’s also important to protect your profits; not just your principal capital.  Don’t be cavalier when you are in profit. Just because you are playing with market’s money does not mean you should be any less respectful.

You can exploit your profits, as long as you do so sensibly. Remember. Risk management. Finally: if you think you are wrong, or the market is moving against you and you don’t know why, take in half. Don’t hold on and hope, be proactive in taking action to protect your capital. Remember, defence first.

Trade size is more important than the entry point

“Varying the position size can be as important as the entry methodology” – Edward Thorp, Market Wizard

A common theme amongst Market Wizards is that the “how much you trade” is more important than the entry price.

Your position size will determine your profit or loss on the trade. Controlling the size of your loss is the key to risk management, so this area should receive a lot of your attention.

The trade size impacts not only the profit or loss on the position, but also liquidity. You need to manage the liquidity on the trade so you can get out quickly when you are wrong. If you get stuck in a large position that you cannot easily exit, you could be faced with a risk management disaster.

Risk management becomes more complicated when you are managing multiple positions. Don’t concentrate too much of your capital on any one trade or group of trades, and make sure you always know exactly where you stand on an account level.

You can be right and still end up losing if you use too much leverage. If your highly leveraged position experiences an adverse move, you might not be able to bear it, and your broker could close your trade out at an inopportune moment – even if it would have eventually gone for you in the end. If you wake up thinking a position is too big, cut down on your trade size.

Know your risk/reward potential

A critical part of risk management is knowing the potential risk/reward on the trade. You should only take trades where you can generate a decent risk/reward ratio.

Generally, you will want to structure your trades to be right skewed – that is, the maximum loss is limited, but the potential upside is unlimited. In addition, it’s important to understand the risk/reward of the trade as it stands dynamically (not just when you put it on).

Be prepared to deal with situations that might seem statistically impossible

Always expect the unexpected from the markets. Statistically improbable events occur far more often than they theoretically should. Work out what you will do when you experience one of these events in your risk management plan.

Just ask the founders of Long Term Capital Management about how they brought the financial markets to the brink of disaster in the late 1990’s by assuming that the “statistically impossible” would not happen.

Ask anybody who experienced the 1987 Black Monday crash, or any of the several flash crashes that should “never” have happened in a rational market. If you are not prepared, and stick around when the market is severely against you, eventually they are going to carry you out.

Have no boundaries, be open to everything

The market wizards are remarkably open-minded.

Though they may hold a strong view in a particular move, if they see evidence to the contrary they will turn on a dime. They are also uniquely adept at identifying opportunities based on what they see in-front of them. Stuart Walton sums up the attitude colourfully when he states:

“My philosophy is to float like a jelly fish and let the market push me where it wants to go.”

This flexible mindset is essential both in avoiding losses and in uncovering opportunities.

Being wrong is acceptable but staying wrong is totally unacceptable

“The main thing is that every trader has to be honest about his or her weakness and deal with it. If you can’t learn to do that you will not survive as a trader.” – Mark Cook, Market Wizard

Good traders have humility. They have the ability to admit when things are not going their way and make a new decision. They know that part of trading is being wrong.

Sometimes well-constructed ideas just don’t play out as hoped. This is OK, it’s a natural part of trading. But what is destructive to your trading account is being wrong and stubborn. If your ego gets in the way of admitting that the market is not doing what anticipated, and causes you ignore the signs that you need to make a change, then that is totally unacceptable.

It’s not about being right: it’s about how much money you make when you are right

Good trading is not about being right – it’s about making money.

In fact, for many people, the need to be right gets in the way of making money. In Stock Market Wizards, Stephen Cohen suggests that his top trader makes money only 63% of the time, and that most traders only get 50-55% of their ideas correct, even though in the end they come out way in front.

To make money, you have to be prepared to change your opinion. You should hold no loyalty to your positions. Anything that has happened up to the present time is history, and if things change you need to change with them too.

Clinging to wrong beliefs is a recipe for sub-optimal returns. If you are wrong, get out and focus on something that is looking more promising.

The mind is like a parachute; it’s only good when it’s open

“I sit back and try to see what idea rises to the top.” – Stuart Walton, Market Wizard

Don’t be picky about how you make your money. Keep an open mind to the opportunities the market is presenting you. This is about being conscious. Consciousness is one of the trader’s most critical tools – be self-aware and open to ideas that are presented to you.

Keep your trading models as flexible as possible, so that you give yourself the ability to jump on the opportunities when they come your way.  Have a curious mind and continually ask why – why do you have that view, what is the evidence, and what can you do to best capitalize on it?

Be your own person and think against the herd

“It’s not enough to simply have the insight to see something apart from the rest of the crowd, you also need to have the courage to act on it. It’s very difficult to be different from the rest of the crowd the majority of the time, which by definition is what you are doing if you’re a successful trader.” – Bill Lipschitz, Market Wizard

A critical ingredient of a master trader mindset is a maverick mind. The market wizards have the courage to act against conventional wisdom. If you can do the opposite of what the people around you are going to do, you should be able to make a good return.

The market wizards tend to have a large dose of contrarian thinking. They are quite comfortable acting against the herd. They tend to hold little regard for the opinions of Wall Street analysts and are relaxed in taking a contrary view.

To win you need to act like the minority, but timing is important

“In order to win as a contrarian, you need to get the timing right.” – Michael Steinhardt

When no one wants to do it, sometimes there is a great opportunity, but being a contrarian also has a large degree of risk. If you are trading against consensus, you need to be very careful about the timing.

For example, Michael Steinhardt took a huge position short US bonds when the interest rates were near 17%, and experts were calling them to go to 30%.

Many others who thought bonds were too high at lower levels were wiped out, but this turned out to be Steinhardt’s best trade up to that point in time. He credits his success to getting his timing right, but even he came close to being wiped out.

To get the timing right, many of the market wizards look to find catalysts that trigger the move down. This could be a news event, or it could be price acting contrary to expectations when news is announced.

It’s a big mistake to surrender the decision making responsibility to someone else

“You have to follow your own light.” – Michael Marcus, Market Wizard

A number of the market wizards had large losses when they first began trading. Generally, this was due to poor discipline and risk management. For some, it was also a result of not trusting their own judgement, or from following tips from brokers or friends.

If you surrender the decision making process to others, it becomes difficult to follow through on the trade. Should you close it out, or hold on? Because it’s not your decision to enter, you will find it difficult to know when to exit.

Jack Schwager, the author of the Market Wizards books, relates a story where he followed a tip from an accomplished Elliot wave trader and continued to break all his rules as the trade went against him. He continued to hold it, losing money, and not knowing when to get out. Along with this, never let your market decisions be restricted or influenced by what others think when you are in the trade.

When Mark Minervini first began trading, he held onto a large losing trade because he did not want to get teased by his broker for picking a losing stock. Needless to say, that experience did not end well for him. Be your own man or woman, and have the courage to walk your own path.

Play the good hands and drop out of the poor hands

“By trading less, I was picking my best spots.” – Mark Cook, Market Wizard

Top traders know when to go for the kill. If they have a great deal of conviction about a trade, they have the courage and discipline to trade a much larger size. Similarly, if they don’t know what’s going on, they simply just don’t play.

Their trades are very calculated, and they have very good reasons for putting them on. They only enter the market when their edge is clear and they are quick to drop out of those trades that don’t give them the best opportunities for a large return.

The elite traders combine risk management and discipline with the patience to wait for high conviction ideas and then the courage to act on them by taking a large position and holding on until either they are proven wrong, or they have reached their maximum profit potential.

This is perhaps the crux of what it means to be a Market Wizard. If you can adopt this mentality and have half decent ideas, then you are going to be a very successful trader.

Wait until there is money lying around the corner and then go and pick it up

“I just don’t play.” – Jim Rogers

The first ingredient of this mentality is patience.  Top traders will wait until the stars align before getting into a trade. Your top 10 ideas will perform better than your top 100, so if you have the patience to wait for the very good ones, it will reflect in your performance.

There is no need to rush as the opportunity will come. You can’t control when acceptable opportunities appear, but you can conserve your capital until those opportunities appear.

Trade bigger when you have conviction on a trade

“The speculator can choose to only bet when the odds are in his favour. That is an important positional advantage.” – Larry Hite, Market Wizard

When you do see an opportunity, go at full force or don’t go at all – simply don’t dabble. Be confident in varying your position size to trade much bigger when you have conviction. This does not mean you should not be placing trades in the meantime.

A lot of good positions eventuate over time from a small start. If you have a good idea, you can take an initial position and see how it plays out. By placing a trade on your idea like this, it focuses you attention.  Many of the Market Wizards practice this type of scale-in approach.

But don’t place trades for the sake of it. Operate with real intent to go for your good ideas and be aggressive in making the most out of them. When you get it right, you want to get it right in a big way. Trade smaller for lower conviction trades and larger for higher conviction ones.

If you are uncertain, then tread very lightly with your risk capital, and err on the side of caution if you lack conviction on the trade.

Don’t confuse activity with accomplishment

“I don’t do anything until all the pieces fit.” – James Rogers, Market Wizard

Many traders spend a lot of time trading, but only a small amount of their trades generate the majority of their profits. It’s the old 80/20 rule. 20% of their activity generates 80% of their profits. I would bet that a lot of traders make profits on their long-term trades, and then run their short-term trading at a loss – even though that takes most of their energy.

You may think that you can be a lot more profitable trading short-term, but on slower long-term positions you can trade much larger sizes and potentially have more winners. Of course, maybe it is the reverse and your short-term trades do well, and you are holding onto long-term trades that are stuck in big losses – it’s about what’s right for you.

See if you can isolate the things that really work for you. Work out which types of trades are the ones that make you the most profit and focus on those. Less is often more when it comes to trading.

It takes discipline and self-awareness to stop doing what is not working, but you can dramatically improve your trading by focusing on what works best for you and putting the rest aside.

Pick an area and become an expert

To develop high conviction ideas, you don’t want to spread yourself too thin. If you can become an expert in a particular area or technique, it can provide you with a significant advantage over others who are trading with a lesser degree of expertise.

It can be good to remember that a number of the market wizards have the same degree of access to information that you have, making it very much possible to become an expert in a chosen field.

For example, you could choose to be an expert in a particular currency pair, or you could be an expert in news trading, or macro fundamentals, depending on which is the best fit for you. This will allow you to really focus on the trades with the best potential and drop out of the ones that are less likely.

Don’t participate in too many markets at any one time

Once you are in your high conviction positions, you need to be very focused on them. If you look to diversify into too many positions, your best trades might not get the attention they need.

Give yourself a limit of a number of trades you will have on at any one time. This might mean you miss out on some opportunities, but that is ok. Your job is not to be on every trade, but to make as much as you can from your best ones. In saying that, you should still be looking for the best potential performance at the current time.

If a better trade comes along, be comfortable rotating out of your current trade into the new one.

The better you’re doing, the bigger you can play

Some traders are able to turn small amounts of money into very large amounts.

It might be tempting to believe that this is because of risky trading practices, and sometimes it can be. If you take large positions compared to your account size, you could get lucky. If you are willing to take big risks, you can earn big rewards.

Of course, while this may work for a while, it’s not a recipe for long-term success. As Market Wizard Ed Seykota says, success in trading is about longevity, and taking big risks in your trading account is not the way to stay in the game for the long run.

The thing that separates the top traders from the traders that do not make it, is they learn to temper their risk taking with risk management. They have developed processes for risk taking that protects their capital, while really letting them profit when things are going well.

You can be far more aggressive when you are making profits

To make large profits, you can increase your bet sizes after periods of high profitability. This allows you to take large position sizes whilst avoiding risk to your core capital.

This is the “market‘s money” concept. Market’s money is where you risk your profits, either on a trade or on your account, to trade at a larger size.

To do this, once you’re comfortably in profit, you simply increase your position size on a high confidence trade. This process means that you can only get hit when you are being paid, but not from a standing start, and you give yourself the best chance to be successful when you are risking more.

If you get too careful about risking your gains, you’re not going to be able to extract a large profit.

When you are feeling more attuned, gradually increase your position size

When you are doing things correctly, you can expand your involvement in the market. This is a very common mentality amongst the top currency traders, along with the flipside of trading smaller when things are not going well.

If you are picking it well, and the market is going in your favour, be prepared to gradually increase your trade size. This will mean that you make the most out of the good times when you are most attuned.

It takes courage to be a pig

“The way to build long-term returns is through preservation of capital and home runs.” – Stanley Druckenmiller, Market Wizard

Stanley Druckenmiller, the heir apparent to George Soros’s Quantum Fund, colourfully suggests that for truly superior returns you need to have the “courage to be a pig”. In one of his particularly insightful interviews, he says that the way to make truly superior profits is to grind it out until you are up 30-40% and then (if you have the conviction) go for a 100% year.

You work hard with well-contained risk, until you have achieved a moderate return. Then, you really go for it and increase the position size on your best ideas. Again, this method allows you to keep your risk to your core capital small, while still having the potential for very large returns.

Increasing your position size on a winning streak can lead to large loss

“I’ve always had my biggest setbacks after my biggest victories. I was careless.” – Marty Schwartz, Market Wizard

This is the downside to increasing your position size when you have profits. If you are on a winning streak, and you increase your position size, you are guaranteed to have your biggest loss. Other good traders, particularly those involved in system trading, preferred to keep their risk small and constant. This is the exception that proves the rule. It depends on the personality of the trader, or the requirements of the system.

Integrating the master trader mindset

There is no denying the importance of your mindset when it comes to trading. To integrate your newly adopted mindset, you can follow this three-step process.

  1. Firstly, write down your mindset, and keep it by your trading desk (you can do this by creating a trading manifesto).
  2. When you are making trading decisions, refer back to what you have written.
  3. Notice when you make mistakes, and conduct self-work so that you stop making them.

If you do this, your trading performance should go up several notches. Trust me, you’ll notice the difference.

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