Sunday, January 8, 2017

Basics of Trading - Part 3 Mother Market

3rd in a series of post's on the Basics of Day Trading for beginner traders. Will be archived so can be used in conjunction with trades I post, and my trading plan which doesn't cover the basics.

Part 3: Mother Market, respect her and her rules.

Mother Market is the markets. She rewards those who maintain their discipline and focus on the process over greed. In turn she will beat down those who don't respect their risk tolerance, the markets signals, or put in the time to learn how to trade. Trading is similar to venturing onto the ocean, if you enter that vast blue unpredictable sea unprepared you will end up with the Titanic.

Trading comes down to protecting your capitol through proper risk management and discipline. In the last post I touched on risk and highly suggested not risking more than $25 per trade until you can consistently trade well. If you lose 10 trades in a row with a maximum risk of $25 a trade while maintaining your stop you will only be out $250. That is less than a 3 month course at a community college or a new cell phone. You will learn more from your losses than any winning trade or trading book you lose cheaply!

As stated by expert trader Ed Seykota - "The elements of good trading are: (1) cutting losses, (2) cutting losses, and (3) cutting losses. If you can follow these three rules, you may have a chance."

So what happens when you don't implement or follow your rules, trade outside your risk tolerance and lack discipline? Well then Mother Market shows up and she can be cold, ruthless and without mercy on your account and mindset.
The video attached if from the Movie the Last Samurai - excellent movie simulating what its like to learn a skill outside your comfort zone and the work that must be applied. In reality most people "talk" of what they want or will put into a goal or vision they have - few follow through, be one of those who do.
This scene portrays what happens when Mother Market shows up at your front door.

The Story:

You are Tom Cruise in this video. You want to find an easy way to make extra $ for the family, your retirement, your kids future and his kids future. You want to be one of the 10% who actually make it as a day trader. You have thoughts of traveling and trading, being financial independent and showing your kids how to trade. You start off by googling Day Trading. You read an article or two, buy a basics book and now believe you a firm understanding of trading as reading red and green candles and following a trend is nothing more than a video game.

You open your account and have a basic trading plan. You are determined to keep to your stop and exit points. Your are feeling confident and instead of risking $25 per trade you start at $200. You start off with a few winners and you are feeling good as your account has grown. Your thoughts now turn to - how much more can I make by increasing my risk - and what will it take to quit your job and do this on a daily basis.Yes you are on the fast track to your financial freedom - so you think.

After a week of trading, feeling your an expert, you up your risk to $1000. You then hit another winner. Now your mind is swimming with thoughts of all the big things your going to buy as the market feels like an ATM. Your walking around like Mr. Wall Street thinking of the resignation letter your going to send to your boss, calling your buddies about your new found success,taking your kid on a spending spree at TOY R US, and looking into a new car for your wife. While your on cloud 9, Mother Market is lurking in the background.

The next day you up your risk to $2000 and buy 2000 shares of XYZ at 20 a share because you heard some guy on the business channel say the stock is ready to explode upwards. You don't research the chart (it was actually in a down trend) and you reason that XYZ should have no problem hitting 21 so you can sell for an "easy" 2k profit. The markets opens, you buy at 20 and XYZ trades up to 20.50. You are high fiveing everyone..the mail man, your kid, your unemployed buddy who came over to raid the refrigerator, and your calling the wife letting her know that your anniversary dinner wont be at The Sizzler this year but the 5 star retreat. All the while your mind is calculating what earning 2k a day will add up to over a a full year.. 10K week x 50 weeks is 1/2 mil a year working 60 minutes a day! Damn Life is great, I am a genius!!

So as the trading day develops it starts to rain as XYZ starts to drop in price, and with the falling price a Dark Cloud appears - its Mother Market and she is warning you to sell and cut your losses now. Mother Market doesn't like greedy traders and can be especially cold and ruthless with new traders. At the end of the trading day XYZ sits at 19.50, and now your down 1K. Your plan is to always sell at the end of the day, which would still put you up for the year - but you don't like losing, you rationalize that the Market is off and will correct itself and send XYZ to 21 tomorrow. You decide to break your rules and hold on overnight and defy Mother Market. Big Mistake.

The next day the Market opens and you stare down Mother Market refusing to sell. Mother Market starts her beat down and by the end of the day XYZ has dropped to 18...your now down 4K. You are stung, but instead of taking your loss you decide to hold on overnight as the market must be wrong. All night long you cant say a word, don't have the energy to play with your kid, or get to sleep. The only thing on your mind is XYZ. So you formulate what you think is a brilliant plan - you are going to double up and buy 2000 more shares of XYZ!! - rationalizing if XYZ goes back to 19 you will get out at break even - with no thoughts of what to do if XYZ drops more.

You follow this "brilliant plan" the next day, and stare down Mother Market and buy 2000 more shares at 18 a share. XYZ starts to trade up, hits 18.75 after the first hour of trading and you are feeling good as XYZ is almost to 19 and this nightmare will be over. You walk away from the computer, start to get your son ready for the park, promise him a Micky D's Happy meal after the park as he smiles ear to ear...........and then it happens..... you glance back at the screen and Mother Markets unleashes her final beat down as XYZ starts to drop and drop and drop. Your in shock and you just stare at the screen for the next 6 hours. Finally at the end of the day, as your kid looks on upset because you broke your promise, your feeling mentally exhausted and over ridden with guilt, you sell XYZ for a 9K loss. Yes you are the Titanic - what should of been a $25 loss for a beginner trader 3 days ago turns into a 9K loss. Your trading career is about done. Three days ago you were Warren Buffet and now you feel like the Cleveland Browns and your confidence is shattered. Yes Mother Market is wicked to those that don't respect her rules, proper risk tolerance, and that put greed before the process.

For the next 6 months the only thing your hands will be permitted to touch is a paint brush as you repaint the house for 3rd time with the computer in the trash. Each paint stroke its met with you replaying what happen over and over in your mind as you deliberate if your going to make a comeback and take one more shot or if you should just move on from trading.

While this short story and video may sound like fiction - its not - happens all the time to new traders as this was my story and introduction to Mother Market. In a way I was lucky, could of been worse as XYZ kept dropping days after.
Mother Market only feeds those with the respect and discipline for the markets. Having money on the line can do funny things to the mind if your not prepared or have the experience. Its why Casinos roll in the money, they want you to panic and bet more. You may get lucky for a short time but it will catch up to you and put you in a hole.

Set a plan, start small, get a mentor, trade with a buddy, make it fun and expect to spend a year or more learning the basics. Look at trading as a game of chess as everyday in the markets is a new chess board. If you start off trading from this point of view you will be one of the 10%.

Next Post: - Time, practice and study are what you will need when you face off with Mother Market again.... and Bankroll, commissions, more on risk, time frame to trade, your health and trading.

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