Trading Psychology Manual

by Dr. Barry Burns 1

TRADING PSYCHOLOGY: SUCCESSFUL TRADER.

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Dr. Barry Burns Copyright 2007 Wealthstyles LP IMPORTANT-READ CAREFULLY: Reproduction, translation, or distribution in any form or by any means, or storage in a data base or retrieval system, of any part of this work beyond that permitted by Section 107 or 108 of the 1976 United States Copyright Act without the permission of the copyright holder is unlawful. Requests for permission or further information should be directed to: Wealthstyles LP

1534 N. Moorpark Rd, #222 Thousand Oaks, CA 91360-5129 (805) 491-3541 This publication is sold with the understanding that neither the publisher or author are engaged in rendering legal, accounting, investment or other professional services. Trading and investing involves substantial risk. Financial loss, even above the amount invested, is possible and common. Seek the services of a competent professional person before investing or trading with money. By accepting this trading course you agree that use of the information of this course is entirely at your own risk. Neither the author nor the publisher is a registered investment advisor or a broker dealer. You understand and acknowledge that there is a very high degree of risk involved in trading options, futures and securities. Past results of any individual trader are not indicative of future returns by that trader, and are not indicative of future returns which may be realized by you. Neither the author nor publisher assume responsibility or liability for your trading and investment results. This course is provided for informational and educational purposes only and should not be construed as investment advice. The author and/or publisher may hold positions in the stocks, futures or industries discussed here. You should not rely solely on this Information in making any investment. The information in this course should only be used as a starting point for doing additional independent research in order to allow you to form your own opinion regarding investments and trading strategies. It should not be assumed that the information in this manual will result in you being a profitable trader or that it will not result in losses. Past results are not necessarily indicative of future results. You should never trade with money you cannot afford to lose. The information in this product is for educational purposes only and in no way a solicitation of any order to buy or sell. The author and publisher assume no responsibility for your trading results. There is an extremely high risk in trading. This course is sold "AS IS," without any implied or express warranty as to its performance or to the results that may be obtained by using the information. Factual statements in this course are made as of the date the course was created and are subject to change without notice. HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS HAVE CERTAIN INHERENT LIMITATIONS. UNLIKE AN ACTUAL PERFORMANCE RECORD, SIMULATED RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, SINCE THE TRADES HAVE NOT ACTUALLY BEEN EXECUTED, THE RESULTS MAY HAVE UNDER- OR OVER-COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN.

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TABLE OF CONTENTS Trading Psychology

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The 10 Commandments of Discipline

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The 7 Deadly Sins

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Tracking your Business

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Daily and Weekly Trading Log Explained

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Daily Trade Log

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Weekly Trade Log

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POSTERS

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TRADING PSYCHOLOGY If you’ve had any education in trading at all, you’ve heard that self-discipline is the key to successful trading and I just want to take a few moments to reinforce that. A book, video, course or mentor cannot give you self-discipline. That has to come from you. That’s why they call it SELF-discipline! In Market Wizards, Jack Schwager interviews some of the world’s most successful traders in search of a commonality that can lead to success for others. His conclusion after the interviews: “What set these traders apart? Most people think that winning in the markets has something to do with finding the secret formula. The truth is that any common denominator among the traders I interviewed had more to do with ATTITUDE than APPROACH.” In his follow-up book, The New Market Wizards, Jack Schwager wrote: “’We has met the enemy, and it is us.’ The famous quote from Walt Kelly’s cartoon strip, “Pogo,” would provide as fitting a one-line summation of the art of trading as any. Time and time again, those whom I interviewed for this book and its predecessor stressed the absolutely critical role of psychological elements in trading success. When asked what was important to success, the Market Wizards never talked about indicators or techniques, but rather about such things as discipline, emotional control, patience, and mental attitude toward losing. The message is clear: The key to winning in the markets is internal, not external.” By the way, these are EXCELLENT books you should read if you haven’t already. They give you great insight into the reality of what it takes to be a successful trader. There are 2 aspects to trading psychology: 1. You must trust your trading methodology. 2. You must trust yourself. It’s obvious that to be a successful trader, you need a viable trading method with setups, rules and a plan that works. Without that, no amount of “psychology” is going to help you. Unfortunately there are many traders who have a viable trading method, who never know it, because they have never tested the method divorced from their emotions. For this reason I highly recommend that you PAPER trade my method for at least 3-6 months before you put a single real-money trade on the line. This paper trading must be done in realtime, not after the fact.

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If you’re a day trader, you should not actually do it on paper. Rather, get a good electronic simulator (such as the one offered by NinjaTrader for free) and actually enter your orders in real time so you can’t cheat by later saying you would have taken this trade or that trade. If you’re a swing trader, you can use real paper, but record your trades in black and white on the day you would enter them. Don’t allow yourself the benefit of hindsight. You must practice trading just as you would with real money. Swing traders don’t get as much practice as day traders, so I recommend you paper trade for at least a year before using real money. This gives the additional benefit of helping you learn the timing of the entries. Learning to enter your orders without hesitation is a critical trading behavior for your success. It will also help you learn whether the methodology fits your personality. By paper trading for 3-6 months, and keeping track of every trade (using the trading logs in the back of this manual), you will find that the method works … as long as you trade it without emotion. Before you can trade successfully, you need to have confidence in your method. Without the utmost confidence in your method, you will second-guess the rules, get discouraged during draw downs, and pass on good setups. The ONLY thing that will create that confidence is success. And the best way to achieve a winning track record is to trade without emotion … and at the beginning, that means trading without money. Once you’ve successfully paper traded for an extended amount of time, then you know your method works and it’s time to start trading with a SMALL AMOUNT of real money. Now if you start losing, then you know the variable is the emotion of trading with money. Once we solve the problem of finding a successful trading method, then we have to deal with the problem of YOU! Another one of my favorite books is Alan Farley’s The Master Swing Trader. In that book he writes: “The markets require a level of discipline that most fail to achieve in the rest of their lives. So why should it be any different with trading? Stock positions offer endless opportunities to break rules and ignore danger. Wise participants recognize NONMARKET LIMITATIONS and deal with those before proceeding on the path to profit. Losing weight, quitting smoking, and exercising regularly all improve the odds for trading longevity. Add stress reduction and watch performance improve faster than taking a weekend stock course. SWING TRADING FRUSTRATES THOSE WHO FIND GREAT ACHIEVEMENT IN OTHER WALKS OF LIFE. Few other disciplines require constant loss to reach their goals. The pain of losing money stands beside profit throughout the road to success. Accept this unpleasant fact and prepare for the emotional rollercoaster. Both winning streaks and drawdowns test rational behavior and trading strategies. Stay focused and stick to the plan. Participants who lose concentration face a gamblers paradise. And just like all games of chance, expect to leave the bright lights with very empty pockets. Greed and fear bring out the extremes in human behavior. But swing traders can control the impact of emotion with solid rules and strict self-discipline.”

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Read those paragraphs a couple of times. There’s a lot of wisdom there. “The Master Swing Trader” is also a great book I highly recommend by the way! The sad truth is that most traders who eventually succeed only find that elusive discipline after the market has taken their money “one too many times” and the issue becomes so painful for them that they either have to change their behavior or quit the markets. Most people quit the markets at this point. Discipline has everything to do with patience. It means waiting for everything to line up according to your rules and not taking a trade that violates your rules because it’s “close” or “looks good anyway.” That means letting some trades go that made money, but didn’t meet your criteria … and not feeling bad about missing “a winner.” Overtrading is one of the biggest challenges to new traders. But one of the hallmarks of successful traders is that they actually trade very little. They wait for the PERFECT setups because they know that is the ONLY time that the odds are really with them, and that makes the difference between trading and gambling. Even in the gambling world, however, the professionals know this. Profitable poker players fold on more hands than they play. If they don’t have a strong opening hand with a high probability of winning, they simply fold and wait for a better one. “People who are way better educated than me rip my theories from here to Hades and back. They claim gambling is all math and statistical analysis. They will never grasp the true meaning of gambling – because they have never been there. … People who think that a math equation is gonna give them a leg up on winning ought have that leg whack them in the area where they sit on their brains. … you absolutely must have money management … Topped off with a healthy dose of discipline.” … [The pros] don’t make MISTAKES, and they don’t have tells. Patience is a virtue, stupidity is a one-way street to disaster, talk is minimal, and mercy is absent. Make a MISTAKE and seven vultures circle the wagons, waiting to divide the spoils. When the night is done and you are fortunate enough to escape with a small profit, the ride home gives you only a short time to count your blessings and your money.” John Patrick in MONEY MANAGEMENT FOR GAMBLERS

If you’re trading every day of the week and you’re not trading well according to this methodology, it’s most likely because you are making mistakes. So is there a way to eliminate mistakes? No one ever becomes a perfect trader, but the first step to reducing your mistakes is to identify them.

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First, let’s look at 10 Commandments which are general rules. Then we’ll translate them into specific “mistakes” as they would relate to the rules of our trading methodology.

“The 10 Commandments of Discipline” 1. Thou Shalt Not Chase a Move. If you missed the best risk/reward entry, just let the trade go. Never chase the market. 2. Thou Shalt Not Trade in Choppy Markets. Trading is not a zero sum game. You lose money on every trade on both the bid/ask slippage and commissions/fees. Without clear directional momentum on your side you do not have an “edge” and without an edge you will not have a profit! Never trade when the 50 MA is flat! 3. Thou Shalt Not Trade “Kamikazes! (shorting Higher Highs or buying Lower Lows).” These can look SO good, but because momentum is against you it’s like trying to push a Sumo wrestler out of the ring. 4. Thou Shalt Not Trade Too Many Contracts for your Account Size. If you lose more money than you are comfortable with, then you will trade badly. Everyone, even the best traders, go through periods of days, weeks, and occasionally even entire months of losses. You need to keep your losses per trade and per day small enough that you can financially survive a major losing streak without having to refund your account. 5. Thou Shalt Not Trade for the “Action.” Trading is a business, not an extreme sport! Like any good businessperson, your primary objective is to increase your bottom line. 6. Thou Shalt Guard Your Capital; it is your lifeblood. Without it you can’t trade. 7. Thou Shalt Never Try to Recover Losses. When you have a losing trade, that money is gone and the trade is done. Trying to get the money back by bending your rules will only result in more losses. Remember, your rules are what make you money. They’re what is proven to give you the high-probability trades. 8. Thou Shalt Not Worry About “Missing the Boat.” Your goal is not to catch every move, in fact you won’t and no one does. Your ONLY objective is to trade your rules, and take the money the market will give you each week according to those rules. Even though we talk about “trading the market, in the strictest sense you cannot trade the market, you can only trade your rules. 9. Thou Shalt Not Place Your Stops Too Close. If you are doing this it’s an excellent indication that you are not in the right frame of mind for trading and you should not be trading right now. You can’t trade scared. Stops should be placed where the pattern you are trading would be broken, and no closer. You must give the market room to wiggle. It doesn’t move in a straight line. Allow for the bids/asks of individuals to move the market around messily within your trading setup. 10. Thou Shalt Not Take Profits Too Soon. It’s nearly impossible to make money based on win/loss ratios alone. Scalping is for the true pros, mostly the floor traders. Your money will be made by having a respectable win/loss ratio (in the area of 40%-60%) and having your winning trades be larger than your losing trades. Be patient with the trends and let them ring up big money for you.

Now lets’ translate those into how they intersect with our trading method in what I call the “7 Deadly Sins.”

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7 Deadly Sins (“MISTAKES”): 1. Not exiting 1st position soon enough. Keep EXIT #1 to keep losses small. THIS IS PRIORITY ONE! 2. Missing Trades. Take ALL trades today. Need to take all trades for statistics of the methodology to work and you don’t want to miss the ONE big winner today. Look to stop and reverse at end of every trade 3. Trading Kamikazes Can’t time them. Get stopped out 2-3 times before they work. 4. Trading Flat Markets. When the 50 MA is flat or market is going above/below the 50 MA … stay out! 5. Overtrading. Forget trades that worked if don’t meet setup. Never try to make up for losses, missed trades, or trade from boredom. I WILL LOSE LOTS OF MONEY if veer from my method at all Profits come from CONSISTENT AND PERSISTENT action. Keep max money loss per day stop. 6. Micromanaging trades. Don’t get out unless it hits a stop. Don’t be afraid of setups in opposite direction that haven’t yet triggered. Let trades run since that is where my weekly profits are. Weekly income is made from a couple of big trades per week, so must take EVERY trade and trade min of 4 contracts and use LT trails . 7. Not Focused like OLYMPIC ATHLETE. Stay in ZONE! Don’t let mind wander or be lazy. Don’t trade if you’re tired. No emotion. NO FEAR. Most trades are small winners/losers. Don’t care what happens today. When OUT: constantly analyze & look ahead for next potential setup & then watch for it. When IN: quick on the draw to protect self & not let things turn against me. If not in state, don’t trade! Implement the rules

and let what happens happen

One of my favorite sayings in trading is: “Successful Trading is Simply a Matter of NOT MAKING MISTAKES.” I have found this to be a great truism in my trading life. As long as I don’t make mistake, I come out ahead at the end of the week or month. The “mistakes” I refer to are the 10 Commandments listed above. This is my list and I encourage you to add or subtract to it. Make it your own. Use this as a springboard for creating your own list. Your goal is to trade the method as strictly as possible and without making any of these mistakes. Avoiding mistakes is a matter of self-discipline.

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Although I can’t give you self-discipline, I will give you an exercise that can help you tremendously with the issue. You still have to actually stick to it, but if nothing else it can serve as a mirror as to how out of control your trading may actually be. When most people think of getting help with the issue of trading psychology, they think of being hypnotized or getting counseling. Those things can be useful, but what I’m about to share with you has helped me with my own trading MORE THAN ANYTHING I’ve ever done. Are you ready for it? Here it is Use a trading log, such as the one I include in this manual and keep track of every trade you make. Many trading courses encourage you to do this, but here’s the twist – On your trading logs you will have a place to enter the mistakes you made (if any) and a place to write what you were thinking and feeling when you entered the trade. This gives does 2 things: FIRST: It gives you a record of your mistakes. which you will then transfer to your Weekly Log. After several weeks, you will be able to look at the Weekly Log and see patterns of your behavior. This is the key. The trading log is like a mirror, reveling your bad habits! On the trading logs you will also keep track of how much money you would have made if you DIDN’T’ make any mistakes. That’s the killer! When you see how much money you could have made by avoiding mistakes, compared with how much money you did make with the mistakes … it makes a real impression on your mind! Especially when you do this week after week, month after month. The repetition really works on your mind. For example, if you make an average of $500/week, but your trading log shows that if you didn’t make any mistakes you would have made $5,000/week … it has a way of getting your attention! That’s a powerful motivator to change your behavior because it ties together 2 things: The fact that your method works, and the fact that big profits are right at your fingertips if you just change your behavior.

SECOND: By entering your thoughts and feelings on each trade, you have an instant bio-feedback mechanism. As you review how trades worked (or didn’t work) that you felt good about, that you just “knew” were going to be winners … it will most likely reveal to you that you can’t trust your own opinions and feelings!

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This is a good thing. Most people aren’t aware of the extent to which they continue to do the exact same (wrong) things. By keeping a disciplined record of your thoughts and feelings when you take trades, over time it will prove to you that your own thoughts and opinions are not to be trusted when it comes to trading. Why is this so important? To reduce, and eventually eliminate impulsive trading and the bending and breaking of your trading rules because of how you feel about any given trade.

To help avoid overtrading, only print out enough sheets each day to log 6 trades. This is a way of telling yourself that you will only allow yourself to take 6 trades the entire day so you better wait for the best setups, otherwise you’ll waste your trades on sub-par setups and not be able to take the good ones should they come along later in the day. Another practical technique for avoiding overtrading is to get a timer (I like to have it on a wristwatch so it will be with me wherever I go) and the alarm to go off every 27 minutes. Go and pay bills, watch TV, play video games, or do whatever you need to do. When the alarm goes off, then go back to your computer and look at the charts. This will get you in front of your charts every 3 bars on a 9 minute chart (obviously this works better if you’re using minute charts than if you’re using tick or volume charts). If you see a good setup beginning to develop, then stay and watch to see if it triggers. Otherwise, just leave and return to your other tasks until the alarm goes off again in ½ hour (3 bars later). The idea is the same one used in dieting where you remove all the junk food from the house. It’s the same in trading: If you have a serious overtrading problem, it is best to remove the temptation. You only need to check in with the charts every 27 minutes to see if anything is developing. If the long-term and short-term charts are in complete conflict, the markets are badly bifurcated, the 50 SMA is totally flat, or there is nothing close to a good setup developing, then remove yourself from the temptation! There is nothing useful for you to do in front of the charts, so go do something else that IS useful.

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TRACKING YOUR BUSINESS Trading is a business and like any business, you need to track your results so you can reinforce what you are doing right and change what you are doing wrong. There is NO excuse for not taking the time to do this is. Trading is not just about placing trades during market hours, it’s about managing your business. MAKE THE TIME! There’s a basic principle of success: “Successful people do what unsuccessful people are unwilling to do.” Notice that it doesn’t say …what unsuccessful people “can’t” do, but rather what they are “unwilling” to do. What most traders are unwilling to do is keep an accurate trading log day in and day out, monitoring the things I’m sharing with you in this report, and analyzing the data. Most are also unwilling to do this for a long enough period of time (minimum of 3 months) to ride through market ups and downs in order to get meaningful statistics and develop ingrained habits. This is what would actually turn a person into a profitable trader. But it isn’t glamorous, and it’s hard, tedious work, so instead they spend their time taking more courses, looking for more charting patterns, seeking out more gurus, subscribing to more newsletters, doing more back testing, playing with more indicators … all the stuff that all the other losers are doing. So right now, as you read this, you have an opportunity to make yourself stand out from the crowd – and believe me, to succeed in trading you will have to do things the crowd is not doing. You have the opportunity to commit to doing what the amateurs, the losers, are not willing to do. You can commit to this process for the next 90+ days, or you can go back to the same old vain search for the holy grail – looking for love in all the wrong places! Most people think that successful trading is about finding the right indicator, formula or price pattern. WRONG! Successful trading is more like a competitive sport than mathematics (refer back to John Patrick’s quote above). It’s performance based. It’s about developing good habits, and good habits are developed through perfect repetition, which is why the exercise I’m sharing with you is so effective.

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DAILY TRADING LOG Complete this log for EVERY trade you take as you take it. If you feel you’re too busy to complete this form for every trade, then YOU ARE OVERTRADING! SUCCESSFUL TRADING IS SIMPLY A MATTER OF NOT MAKING MISTAKES That is ALL that separates the pro who makes money from the educated amateur who loses money. The WAY that we evolve from an “educated amateur” to a “profitable pro” is through a DISCIPLINE of continually eliminating our mistakes. It is not a process of adding, but of subtracting! But “HOW” do we do that? The best tool is your Daily Trading Log. I’ve included a copy of the exact trading log I use. You’ll notice that there is a yellow section for recording any mistakes you made on each and every trade. This is the most important part of the log and of your trading process! How do you know what you did wrong? All mistakes come from violating something in the “7 Deadly Sins” or the “Method” lists (as found on the Trading Plan). Keep these records in a binder and review them at these intervals: Every night, review that day’s trading on the charts. Either print out your charts or go through them on the computer bar-by-bar and review where you got in and out, and compare that with where your rules indicated you should have gotten in and out. Every morning, review yesterday’s Trading Log before trading today. Every weekend, review the entire weeks worth of trading logs By doing these disciplines, you will see patterns develop. You will find that you are making the same mistakes over and over and be able to correct them. Again, this is not something anyone can do for you, but you MUST do for yourself. You will neglect this to your own financial peril!

WEEKLY TRADING LOG This log gives you the big picture of your trading. Daily results are not very meaningful, but weekly and monthly results are very meaningful. I review my Weekly Trading Logs most every day because they remind me of good and bad patterns I’ve had. This is where you will also be able to track your actual win/loss ratio and your actual risk/reward ratio, the key numbers to your trading success. Finally, a lot of people are very surprised to see how large a percentage of their winnings are reduced by commissions. Be sure to record them on your log as well.

The exact way to use these trading logs is explained in the videos that accompany this manual.

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POSTERS The following pages contain some posters that I personally have hanging by my monitors. They remind me of the most important psychological trading principles.

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