Books

by
Steve Burns
New Trader,
Rich Trader
Show Me Your
Options
How I Made
$2,000,000 In
The Stock
Market. Now
Revised And
Updated For
The 21st
Century
How I Made
Money Using
the Nicolas
Darvas System

How to Get
Followers on
Twitter

Books by
Janna Burns
New Trader,
Rich Trader
All rights reserved. No part of
this publication may be
reproduced, stored in a
retrieval system, or
transmitted in any form or by
any means, electronic,
mechanical, photocopying or
otherwise, without the prior
permission of the copyright
owner.

© Copyright 2014 by Steve

Burns, Janna Burns Published
by BN Publishing
 Cover Design: J.Neuman

www.bnpublishing.com

info@bnpublishing.com

For information regarding

special discounts for bulk
purchases, please contact BN
Publishing at
sales@bnpublishing.net
 CONTENTS

Foreword
Introduction

Part I: Managing the

Mind to Stay in the
Game
Chapter 1 A good trade is
 taken with complete
confidence and
follows your trading
method; a bad trade
is taken on an
opinion.
Chapter 2 A good trade is
taken with a
disciplined entry and
position size; a bad
trade is taken to win
back losses the
market owes you.
Chapter 3. A good trade is
 taken when your
entry parameters line
up; a bad trade is
taken out of fear of
missing a move.
Chapter 4 A good trade is
taken to be profitable
in the context of your
trading plan; a bad
trade is taken out of
greed to make a lot of
money quickly.
Chapter 5 A good trade is
taken according to
 your trading plan; a
bad trade is taken to
inflate the ego.
Chapter 6 A good trade is
taken without regret
or internaly conflict;
a bad trade is taken
when a trader is
double-minded.

Part II: Creating a

Robust Methodology
Chapter 7 A good trade is
based on your trading
plan; a bad trade is
based on emotions
and beliefs.
Chapter 8. A good trade is
based on your own
personal edge; a bad
trade is based on
your opinion.
Chapter 9 A good trade is
made using your own
timeframe; a bad
trade changes
 timeframe due to a
loss.
Chapter 10 A good trade is
made in reaction to
current price reality;
a bad trade is made
based on personal
judgment.
Chapter 11 A good trade is
made after
identifying and
trading with the
trend; a bad trade
fights the trend.
Chapter 12 A good trade is
made using the
trading vehicles you
are an expert in; a
bad trade is when
you trade unfamiliar
markets.

Part III: Managing

Risk to Stay in the
Game
Chapter 13 A good trade risks
 only 1% of total
trading capital; a bad
trade does not have a
set amount of risk.
Chapter 14 A good trade risks
$1 to make $3; a bad
trade risks losing
more than it plans on
making in profits.
Chapter 15 A good trade
follows a trading plan
even during draw
downs in account
equity; a bad trade is
 a big trade made to
quickly get even after
a string of losses.
Chapter 16 A good trade has
a limited downside
but an unlimited
upside; a bad trade
has unlimited risk
and a limited profit.
Chapter 17 A good trade has
an optimum position
size for that trade
setup; a bad trade is
based on feelings,
financial need, or
confidence in a trade.
 FOREWORD

I have had the great honor

of knowing Steve Burns for
several years now and so was
thrilled to hear of the
authoring of a sequel to his
trading classic, “New Trader,
Rich Trader”. Throughout our
friendship, Steve has
consistently demonstrated the
uncanny ability to analyze
various problems and biases
of the New Trader and
articulate such issues in a
unique and accessible
manner.
As a result, when Steve
and Janna asked me to write
the Forward to, “New Trader,
Rich Trader 2”, I knew I was
in for an entertaining and
insightful journey. Their book
did not disappoint. In contrast
to its precursor, “New Trader,
Rich Trader”, where New
Trader struggled with basic
issues such as development of
a positive expectancy
method, position sizing as
well as determining which
assets to trade; in this
manuscript all those issues
have been resolved and so at
the book’s inception one
might imagine New Trader
would simply be relating his
successes to Rich Trader.
 As anyone who has
successfully transitioned from
“New Trader” to “Rich
Trader” can attest, this is not
the case and our authors
brilliantly navigate New
Trader’s journey from
knowing how to trade “in
theory” towards flawless
implementation of his
positive expectancy model
despite draw downs, missed
opportunities, price shock
events, and so on. As in all of
Steve’s books, I am
consistently amazed at how
despite his obvious mastery
of our business he can recall
with intimate detail what it
was like to make the full
gamut of “New Trader”
mistakes.
“New Trader, Rich Trader
2” will have New Traders
reaching for their highlighters
while Rich Traders smile
knowingly at distance
memories of painful missteps.
Wherever you are in the
journey from New to Rich
Trader, this book is an
indispensable tool filled with
lots of “Aha” moments. To
Steve and Janna,
congratulations on a job well
done, to all the New Traders
reading this, pat yourself on
the back for having found an
indispensable aid in your
journey from novice to pro.
 Richard L. Weissman,
Professional Trader and
Author, Trade Like a Casino
“Trading is not the
path to free money;
profits must be earned
through homework,
discipline, courage,
patience, and
perseverance in the
markets.”
– Rich Trader
 INTRODUCTION

There are many questions

that a trader has to answer
before entering a trade. There
is a big difference between a
good trade and a bad trade.
The primary difference
between good traders and bad
traders is that good traders
consistently make good
trades, while bad traders
make consistently bad trades.
A good trade does not always
make money and a bad trade
is sometimes profitable.
However, this does not
change the definitions of right
and wrong, good or bad.
Trades should be measured
by the quality of the
reasoning for taking them. If
traders consistently take
trades that exercise their edge
over the markets, they will
make money in the long term.
The worst thing that can
happen for a new trader is
being rewarded for a bad
trade. This short-term win can
result in long-term failure
when his luck runs out and
the market changes.
My purpose and goal in
this book is to show the
reader the difference between
a good trade, one that is made
inside the parameters of a
trading plan with an edge,
and a bad trade that is
emotionally based on greed,
fear, or opinion. In the long
term, traders are a success or
failure based on the quality of
their trades.
The creation of bad trades
is easy: trade your opinion,
trade big, don’t cut your
losses, just hold on and hope.
Bad trades fight trends; they
put out a lot of money with
the risk of making little. The
entry and exit signals for bad
trades are hope and fear, with
the ego stepping in and
refusing to honor the stop
loss.
Good trades require work.
The right trades come only
after doing the required
homework: chart studies,
researching historical price
action, or back testing along
with research of chart
patterns. In markets, price
action can stay inside a range
or they can trend. The job of
the trader is to discover how
to profit from these patterns
over the long term. Trading
price action is only the first
part of a good trade; without
risk management and
discipline no trade is a good
trade.
The purpose of this book is
to take the reader through the
principles and the differences
between good trades and bad
trades.
 PART I

MANAGING THE
MIND TO STAY IN
THE GAME

“Dramatic and
emotional trading
experiences tend to be
negative; pride is a
great banana peel, as
are hope, fear, and
greed. My biggest
slipups occurred
shortly after I got
emotionally involved
with positions.”
– Ed Seykota
 Chapter 1

A good trade is taken

with complete
confidence and
follows your trading
method; a bad trade
is taken on an
opinion.
“It’s not the
mathematical skill
that’s critical to
winning; it’s the
discipline of being
able to stick to the
system.”
– Blair Hull

New Trader walked

through the rain to Rich
Trader’s front door. He
knocked twice. When Rich
Trader arrived at the door,
what a sight New Trader was:
drenched and dripping wet
from head to toe.
“Can you not afford an
umbrella?” Rich Trader
asked.
“I can, it is the planning to
keep one with me that I fall
short on,” he answered.
 “Well, come in out of the
rain. It has been awhile,”
Rich Trader motioned him
inside.
After New Trader took off
his wet coat and shoes and
got settled in a comfortable
chair, he sat drinking hot tea
by the fireplace, pondering
the past year. Rich Trader
appeared as comfortable as
ever in loafers, a polo shirt,
and slacks.
 “What brings you to my
humble abode today? It has
been quite a while,” he asked.
“Well, I did not want to be
a nuisance after you so
generously gave me so much
of your time last year. You
taught me all the fundamental
principles for successful
trading and I felt it was up to
me to go use them,” New
Trader said appreciatively.
“So how did you do?” he
asked.
“I finished up 22% last
year in my trading account,”
New Trader answered
proudly.
Rich Trader gave him a
look of disappointment. “I
didn’t ask about your returns,
I asked how YOU did. One
year’s return has very little to
do with you; that can be pure
random chance. My concern
is you, your discipline, your
focus, your risk management,
your stress management, your
system-building and system-
following skills. So how did
you do?” Rich Trader asked
again.
“It was a learning
experience. With real money
on the line I discovered things
about myself that I thought I
had moved past. I once again
experienced fear of losing,
greed of wanting to trade too
big, my ego wanting to be
right. I found myself trading
more against my own
negative emotional states than
the market’s price
movements, “New Trader
explained.
“That is a normal
experience with new traders
moving from the classroom to
the arena. You want to prove
something to yourself and to
others. A trader’s goal is to be
above those impulses which
lead you to making wrong
decisions. Instead, most
traders allow their fear, greed,
and ego to send their money
to the accounts of the
disciplined traders who
simply follow the price
action,” said Rich Trader.
“Isn’t that the truth! The
more I traded, the more I
realized trading is a mental
game, not a numbers game. I
found myself making up
excuses to override my rules,
only to discover that this
interference only hurt my
performance in the long
term,” he responded.
“The best trader you will
ever be is that person who
does research and
development outside market
hours. The worst trader you
will ever be is someone who
sits on a string of losses in a
drawdown and wants to get
back to even. While the
market is closed, you as the
trading analyst and researcher
must decide what you the
trader will do when the
market is open. Your entries,
exits, and position sizing
should be determined by your
mind when the markets are
closed, not by your fear,
greed, and ego while the
market is open,” Rich Trader
said.
 “My mistakes have been in
my management of my own
mind; that is where my
trouble started. Trading is just
not as fun as I had imagined it
would be. Profits can be
taken back after they are
made so there is not really
much to celebrate during
winning trades. The losses
were out of my control. The
market goes where it wants.
All I can do is to respect my
stops and choose the size of
my losses,” New Trader
responded.
“Exactly, and you are not
your trading; you are the
trader. You are simply
following your plan. Trading
is one of the few professions
where even most successful
practitioners have low
winning percentages. Most
professions, like being a
doctor, a lawyer, engineer, or
the like, demand huge
winning percentages. For a
doctor to fail in surgery is a
catastrophe. The best lawyers
win a large percentage of
their cases. Traders are
different. Some of the best
trend-following traders have
low win percentages like 30%
or less, but still make money
based on their huge wins
being greater than all their
losses. Oddly enough there
are options sellers with 90%
win rates who end up losing
money in the long run
because one loss in ten is
bigger than the other nine
wins; worse, the options
seller blows up with one huge
loss due to over leverage and
the unexpected move that
happens when they have no
hedge in place. They high
winning percentage traders
are the rare ones and even
they must keep their few
losses small to stay profitable.
Most traders have 50% or less
winning percentages and their
profitability emerges from
their wins simply being
bigger than their losses.
Most traders are more like
batters in baseball than any
other profession. Regardless
of how good a batter is,
hitting and getting on base is
only accomplished one-third
of the time. Batters have to
follow their process of when
to swing and when to not
swing for the greatest odds of
getting a hit. Two strike outs
in a game are quickly
forgiven if the third at-bat
results in a grand slam
homerun. The best
professional baseball players
do not have a self-esteem
crisis after a strikeout or a
few in a row; they know who
they are and how they got to
the big leagues and move on
to the next at-bat. The success
of a trading career and of a
baseball career is based on
the long-term process of
sticking with what works,”
Rich Trader explained.
New Trader replied: “That
is the hard part, sticking with
the process when you lose
over and over again. It is
when doubt about myself and
my system creeps in.”
“The fuel that takes a new
trader from wanting to be a
successful trader to being a
success is desire, passion,
faith, resources, and
knowledge. If one of these
elements is missing, the new
trader may not make it over
the bridge to get the prize.
Desire knows what you want.
The odds of you getting what
you want start increasing
once you have a target.
Desire is the fuel that gives
you the energy to do the work
required to be a successful
trader.
 Passion gives you the
energy to research, do back
tests, and not stop until you
find the system that works for
you. Passion is the fuel of
perseverance. With enough
perseverance, the only thing
that separates you from your
goals is time.
Faith knows the outcome
before you begin. You know
who you will become and you
are willing to do the work to
get there. Faith is a very
powerful force. Many times
your life will line up the way
you believe it will; through
the power of your actions,
your subconscious starts
taking you where you want to
be.
Traders have to have the
resources to make the journey
to success. You have to build
yourself enough capital to get
in the game. You need access
to the right mentors and like-
minded traders for support.
You have to have the mental
resources to deal with failure
to get through to success.
You need to build up your
knowledge through study –
the study of successful
traders, the study of charts,
price action, and risk
management. Mentors can
help you build the
foundational knowledge of
what works with trading the
markets. Mentors can only
teach you and show you and
tell you how to swim. You
have to swim over the river
yourself.
So why are you having
trouble consistently
swimming over the river
using the right form?” Rich
Trader asked.
New Trader answered after
three minutes of staring at
Rich Trader with a puzzled
look.
“Fear of drowning, fear of
waves, fear of whether or not
I am a good swimmer.”
“So does your problem
with trading a system
consistently lie within your
own mind or with the quality
of your chosen trading
method?” he asked.
New Trader paused again,
and then answered.
 “I am the problem, or
better yet, my lack of
controlling my thoughts and
emotions is the root of all my
problems.”
“The trader is the weakest
link in any trading system.
The trader, more than even
the system he is trading, is the
ultimate determiner of
success or failure. Once a
robust system has been
chosen, it is the ability to take
entries and exits consistently
with discipline while
managing risk which makes a
skilled trader. This is what
leads to trading success. This
is the Holy Grail so many
traders seek, yet so many
can’t even understand,” Rich
Trader concluded.
New Trader sat back in his
chair listening to the fire
crackling in the fireplace with
an empty cup of tea in hand,
pondering why Rich Trader’s
explanation sounded so easy
yet was so hard to do with
real money on the line.
 Chapter 2

A good trade is taken

with a disciplined
entry and position
size; a bad trade is
taken to win back
losses the market
owes you.
“Ninety-five percent of
the trading errors you
are likely to make –
causing the money to
just evaporate before
your eyes – will stem
from your attitudes
about being wrong,
losing money, missing
out, and leaving
money on the table.”
–- Mark Douglas

“I will be right back,” New

Trader said, getting up from
the company meeting he was
attending.
One of the other managers
sent him a knowing frown as
he left, but he really didn’t
care. The market was
dropping, and it was all he
could think about.
So, for the third time in as
many hours, he pulled out his
phone – which he normally
loved but hated the app’s tiny
stupid buttons – and looked
up his stock.
It had dropped another
point, and his stomach
dropped.
Pull out. His mind was
screaming, don’t lose any
more money! Forget the
signal, just get out now!
He gulped, his palms
feeling sweaty… his plan said
to wait for the signal, but it
had been going down all day
and it was almost at the
stopping point.
He pressed the buttons,
feeling a migraine coming on.
It was too late now, though,
and he had lost about $1,300.
Well, that and the
commissions.
 When he left that day
checking his phone, he could
have smacked himself. In
fact, he almost did. If he had
followed his plan, he’d have
been up almost $1,000 and
still rising.
Stupid, stupid, stupid!
Follow the plan, not your
fear!
He scowled as he drove to
the little cafe he and Rich
Trader usually met at. Once
he got there, he found his
mentor and greeted him with
a tight smile.
“Thanks for coming to
meet me.”
“Well, of course. I do
rather enjoy eating here, they
have the best coffee.”
New Trader smiled at him,
lest strained this time.
“What’s troubling you?”
the older man asked, sipping
his coffee as his eyes
searched for the waitress.
“Oh, it’s nothing, I just…”
he began with a sigh. “I did it
again. I let my fear take over
and I lost a lot of money; but
if I had followed my system
and waited for the signal, I
could have made money!”
Rich Trader shook his
head. “But that’s not the most
important part. It’s not about
the actual money gained or
lost; it’s about discipline and
controlling emotional
impulses. Though this is also
a prime example of why you
should follow your system.”
“Yeah, I know…” New
Trader said with a sigh,
stirring the coffee Rich
Trader had already been
considerate enough to order
him. “But now it’s just…
how did you deal with
losses?”
 “Well, first I had to learn
the hard way that I didn’t
know better than the market,”
Rich Trader began with a
chuckle. “I would sit here at
this very cafe and watch the
market rise or fall, thinking I
knew it all, that I could
predict the market better than
my plan that I had spent
hours upon hours making.
Other times the market would
scream at me to go short as I
continued to buy support
levels even as they broke one
after another. Then it was all
hope, not thought. My
predictions and my pride
replaced the reality of what
was taking place.”
He paused to take a sip of
coffee. “And then you also
have to consider what a loss
actually is. For me, a loss is
not when I lose money; it’s
when I don’t follow my
plan.”
 New Trader smiled
guiltily.
“So in that respect, it is
very rare that I lose anymore.
I might lose money, but I
don’t lose confidence. Ah,
thank you, Jane.”
Their usual waitress smiled
at him as she gave them both
their usual: the Tuesday
special, minus the sauce.
“No prob, boys,” she said,
winking at New Trader
playfully as she left.
“She’s a rather nice girl,”
Rich Trader commented and
his younger companion
scowled.
“I have a girlfriend, thanks.
Anyways, it doesn’t matter.
How do I deal with these
strings of losses?” New
Trader asked, taking a bite.
“Well, unprofitable trades, I
suppose I should say.”
“Well, I would begin with
shrinking your position sizes.
This means that as you lose
money you lose less and are
at your smallest position
sizing, as well as minimizing
your exposure during losing
streaks. Then you would start
to grow your position size
again as you start to win. The
way I trade in volatile,
choppy, and range-bound
markets is to risk very little or
stay fully in cash. I wait for a
breakout or trend to emerge. I
will also buy into reversals at
key levels that have a high
probability edge. I’m in no
hurry to rush into anything.
I’ll still eat if I trade. There’s
no reason to rush into more
losses. Much of our trading
comes down to a battle
between our patience and our
impulses.”
“That… makes sense,”
New Trader said, pondering
his words as he stared at his
food. “It makes perfect sense,
actually. I hadn’t thought of
that as an angle for position
sizing. Most people new to
trading increase position size
to get back to even during
draw downs but end up
hurting themselves in every
way – financially, mentally,
and emotionally. It makes
sense to turn down the heat
when you’re getting
smoked.”
 Rich Trader chuckled,
mildly impressed. “That is an
excellent analogy there, for
sure.”
New Trader continued,
encouraged by his mentor’s
praise. “So it’s really just my
passion fanning the flames
and making me wound up and
tense… how should I cool
myself off?”
“Passions have to be
channeled into what will help
you the most: research,
development, and further
educating yourself. Live
trading is where strong
passions and desires are least
needed. Improperly used,
passion and desire will make
you want to push for more
and take bigger risks. The
calm, rational trader is the
best trader. He won’t press
and want things to happen;
this is dangerous. We cannot
will the market to do what we
want, we can only watch and
wait. So save your intensity
and use it outside market
hours, where your real money
isn’t at risk.”
New Trader nodded.
“Right, it’s all about getting
centered and following the
process. Not trying to hit the
ball out of the park every
swing. It’s about form and
composure and taking the
right swings at the plate.”
 Rich Trader chuckled.
“You remembered that?”
“Of course,” New Trader
said. “I remember everything
you teach me… I just don’t
always learn it the easy way.”
“Fair enough,” Rich Trader
said with a fond smile. “Well,
when a trader has the right
process down, their wins and
losses are defined by their
ability to follow that system.
That’s when the breakthrough
occurs. A trader isn’t their
results or their P&L; they’re
just the witness of what’s
happening to their system.
Losses should inspire
curiosity, not a crisis of faith.
And once you’ve
accomplished that feat, a
trader will cross the road
from the majority to the
minority with a mental edge
over the other participants.”
New Trader finished his
meal, resting his napkin over
his plate.
“Trading isn’t just about
short term profitability …” he
murmured thoughtfully.
“Profits come from traders’
consistency in trading the
markets they’re in, whether
that’s daily, weekly, monthly,
or over the course of their
lives.”
“Exactly,” Rich Trader
said, back to sipping his tea.
“Trend followers do great in
trends, option sellers make
money when the strike price
isn’t reached in their short
option, and reversion-to-the-
mean traders do well inside
range bound markets. It’s not
the trader, it’s the system.
Our job as traders is to build
those systems and trade with
a methodology that we can
follow consistently through
different market
environments.”
 “When the stars align we
have to be there to collect our
bucket of money,” Rich
Trader said with a smile that
bordered on a smirk.
“Trading is not about
outcomes; it’s about the
process. Outcomes can be
random but the process must
be robust. A good trading
process will lead to capital
appreciation over the long
term as long as the trader can
follow that process and not
drift from it in unfavorable
market environments.”
“So basically, a good trader
is one who finds the robust
system, then trades it with
discipline and focus? And
that’s the game? Profits and
losses are completely out of
our hands?”
“Of course not… Traders
choose the size of their losses
when they honor their
original stops. Traders also
choose to have bigger wins if
they allow a winning trade to
run and let a trailing stop
decide when the run is over –
rather than deciding based on
a target, opinion, or fear of
losing profits. And all these
choices should be made
ahead of time, inside a
trailing plan and outside
market hours.”
“So the trading plan is my
boss?” New Trader said
blandly.
“Well, I suppose in a way.
But it’s a boss that you have
full control over, whereas
your emotions and ego is a
boss you would be hard-
pressed to restrain.”
“So I am a planner first and
foremost?” New Trader asked
as the bill arrived and their
plates were taken away.
“Well, it’s the first piece of
the puzzle perhaps. What will
most determine your trading
success is your ability to
build a robust system based
on a method with an edge.
Then you formulate a trading
plan which follows that
system in a way that can be
profitable in the long term.
The hardest part is actually
following your plan and
letting it play out without fear
or pride getting in the way. “
“Right,” New Trader said,
leaving his usual tip on the
table. “That sums it all up
rather nicely. I’ll get right to
it.”
Rich Trader laughed,
shaking his head.
He remembered those
days.
 CHAPTER 3

A good trade is taken

when your entry
parameters line up; a
bad trade is taken
out of fear of missing
a move.
“Essentially, what you
fear is not the markets
but rather your
inability to do what
you need to do, when
you need to do it,
without hesitation.”
– Mark Douglas

“So it’s really about the

mindset, not your predictions.
Like when I…” He could see
it happening. Her eyes stared
to glaze, her head tilted, and
when he was done she would
say…
“That’s great, honey. It’s
so good that you’re making
all that money on the stock
market.”
He gave her a dull look.
That wasn’t even what he
said. But most people seemed
to go off into their own world
once he started talking about
trading, so it really wasn’t
that surprising.
“Right.”
“Maybe one day you can
quit and do it full time!”
“Yeah, that would be nice.
I’d get to wear my pajamas to
work!” he said with a laugh,
though the look on her face
said she wasn’t fond of the
idea.
 “You’d make so much
more money doing that
anyways. Why don’t you just
do it?” she said – a discussion
they’d had many times.
“Because I still want a
steady income to supplement
my losses; I’m not
comfortable doing that yet.”
She rolled her eyes. “Buy
low, sell high… it can’t be
that hard.”
 For a moment, he had no
reply to her comment.
“Then why don’t you do
it?”
“I don’t have enough
money to start an account,
and it all looks so
complicated. But you
understand all those charts
and things, so you should
make money like crazy! Isn’t
that what you’re always
saying?”
 “It is so much more
complicated than that! Were
you listening at all to what I
was just saying? It takes
discipline and… You know
what? Let’s just drop this.
There’s no reason to argue
and I’m about to run late for
my lunch with Rich Trader.”
“Oh, I see.”
“What?”
“You’re going to see ‘Rich
Trader,’ right?”
 “Yes.”
She rolled her eyes.
“Whatever.”
He gave her an incredulous
look before leaving for his
usual cafe.
Women.
When he arrived, Rich
Trader was laughing at
something Jane had said. She
looked up as New Trader
entered, smiling at him.
 “The usual?”
He nodded, his smile back
strained.
She left, his coffee already
on the table with two packets
of sweetener.
“So, how are you on this
beautiful afternoon?” Rich
Trader asked, stirring his tea.
“Fine. Just trying to figure
everything out.”
“You mean with your
trading mentality?”
New Trader nodded.
“Well, what were your
biggest errors last year?”
“Well… I wasn’t patient. I
wouldn’t wait for the right
entries or I’d start chasing
after some trades. Sometimes
it worked out, but not
usually.”
Rich Trader laughed.
“Good trades are like buses.
If you miss one, you just wait
for the next one to arrive. The
world is full of buses and just
as full of good setups for
trading. As a trade breaks out
at your buy signal, the further
the move away from its key
level and the more risks there
are in chasing it.”
“Yeah, and if you miss the
entry you might also miss the
bulk of the move,” New
Trader said, thanking the
waitress when she brought his
food.
“Even when a trend really
runs it will usually give you
another shot at entry as it
pulls back to the nearest
support on the way to going
back up. In the long run,
patience pays better than
boldness for traders,” Rich
Trader said. “The ability to
consistently trade only the
highest probability entry
setups will be one of the
determinants of a trader’s
long-term success in the
markets. Continuously
chasing moves that are
already out of the gate is a
sure way to grind your
account down with losses.”
Rich Trader took a moment
to sip his coffee before
continuing.
“The reason the vast
majority of new traders never
make it is that they take entry
signals based on their
emotions. They’re afraid to
miss a move so they chase
after a stock after it’s already
broken out and run. It
becomes too tempting after
they’ve watched it day in and
day out, so they just can’t
take it anymore and buy. And
this low probability trade is,
many times, right at the time
other traders who entered at
the right price level are taking
their profits and exiting. So
the move is over or the price
is going back to base.”
New Trader nodded. “Or
going short when you should
be going long.”
Rich Trader nodded. “Yes.
The wrong time to short is
usually when a stock is
finally breaking out of a price
base into all-time new highs
and the new trader thinks it’s
time to go short. What the
new trader doesn’t understand
is that the stock is going from
range-bound to trending and
they are shorting when they
should be going long. The
breakout signals that sellers
in the old price range have
been overcome by buyers
wanting in, and the stock is
under accumulation so it’s
searching for a new price
range and will trend until it
finds one. Usually, a short at
all-time highs is ego-based
because the new trader wants
to be the one who can say that
they shorted at the highs.”
New Trader nodded,
finishing his mouthful of food
before replying.
“It’s strange how my
emotions flood to the surface
when it’s time to take entries
and exits. Fear, greed, ego…
they all want me to stray from
my written trading plan.”
“Yes, but your trading plan
is written to make money in
the long term, while your
emotions are trying to protect
you from losses in the short
term. Your fear is trying to
protect your profit from
turning into a loss, while your
trading plan wants a small
profit to turn into a big profit.
Your greed wants to chase a
trade that has already
happened while your trading
plan wants to enter a trade
before it has the big moves.
Your ego wants to be right
about a trade in the short
term, while your trading plan
wants to make money in the
long term.”
“So, basically, as usual, my
biggest battle is trading my
actual plan, not my
emotions.”
Rich Trader chuckled.
“Yes… very frustrating, isn’t
it? Finding an edge over price
movements is a job in and of
itself; don’t compound the
difficulty of trading with an
edge by having to battle your
emotions. Coming up with a
trading plan is not the hardest
part of trading; once you get
this far, following it with
perseverance, discipline, and
risk management is what
separates winning traders
from losing traders.”
“So after you’ve gone
through all the trouble of
doing research and
development and built your
trading plan, then you have to
actually follow what it’s
telling you. The researcher
and scientist in you did all the
work; now it is up to the
trader within to do what it’s
being told to do.”
Rich trader nodded. “You
have to root out all the
reasons why you broke your
trading plan. Look inside
yourself and ask: Why? What
caused me to panic, sell,
chase, risk too much, try too
hard, and generally do what
most losing traders do? You
have to answer these
questions if you are to be
successful.”
They paused to eat their
food. Minutes later, Rich
Trader broke the silence.
“Do you know the single
primary determiner of trading
success?”
“…Self control?”
“Yes. Your success will be
based on your ability to
control yourself in your
trading.”
New Trader paused in
thought.
“If I’m not in control, then
my emotions are: my
impulses, bad attitude,
preconceived beliefs about
how things work, the fight or
flight instinct, maybe even a
self-constructed ego that feels
threatened by failure or even
by success.”
Rich Trader nodded.
“You’re none of these things;
don’t let them take you over.”
“Yet… if none of these
things are me, then what
exactly am I?”
“You are the witness of all
these things. If you change
perspective and see these
things for what they are, you
are not them; you are human
consciousness witnessing
what arises in your field of
consciousness. You can let
them take over or you can see
them for what they are and
make decisions based on your
mind and your will. You can
make decisions that take you
where you want to go in life
or you can let external
elements influence you and
take you where you don’t
want to go. It’s a choice of
staying in control or allowing
yourself to be swept away by
waves of external factors
which warp your decision-
making process.”
So following a trading plan
is to simply trade it in the
present moment without any
other meanings attached to it?
It’s just one trade of many?”
“Exactly, to follow a
trading plan you have to
disconnect any one trade’s
meaning from anything other
than what it actually is. It is
not a battle for self-worth. It
is not the determinant of your
financial future. One trade
should not have any impact
on your emotions or life; it’s
just one trade of the next 100
if you’re doing it right. If it
has more meaning than just
one trade of the next one
hundred, then you are trading
too big. Your system’s draw
downs are too big, you have
too much risk at one time, or
you are trading for a living
when you should be building
your capital and paying off
bills.”
“So trading should just be
trading. There should be no
internal story, no external
meaning beyond the P&L? ”
Rich Trader nodded.
“Yes. If there’s more to
your trading than just trading,
you’re doing something
wrong. Find out what it is,
correct it, and then move on.”
 CHAPTER 4

A good trade is taken

to be profitable in the
context of your
trading plan; a bad
trade is taken out of
greed to make a lot of
money quickly.
“Experienced traders
control risk,
inexperienced traders
chase gains.”
– Alan Farley

“What happened now?”

New Trader looked at his
girlfriend with a newfound
sense of annoyance.
 “I lost money,” he said.
Best to keep it simple.
“Again?” she asked with a
frown.
“I told you it would take
time to learn. And no one
wins every time!”
“Well, maybe you
shouldn’t be doing it then!
It’s just gambling away your
money.”
He groaned, rubbing his
temples. “No, it’s… I really
don’t want to have this
conversation again.”
She narrowed her eyes at
him. “Fine. Don’t listen to me
and just gamble all your hard-
earned money away!” she
exclaimed before storming
off.
He rubbed his eyes.
Sometimes she just made him
so tired. It’s like the more he
tried, the worse everything
got.
Sort of like my trades
recently, he thought with an
inner laugh. He and Rich
Trader had talked about it
recently.
“Greedy trading is bad
trading,” Rich Trader had
told him. “You want to
always be trading the
probabilities, not what you
want to happen. The worse
entry signal that any trader
can take is based on their
greed. The worse exit signal
is based on fear. Entries and
exits have to be built around
the probability of winning, no
on what profits you want to
make.”
It was strange, because he
remembered Jane standing in
front of the table for a good
while before collecting their
plates.
“You can work as hard as
you want in research to
develop a trading system and
a plan that works for you.
However, you then have to
follow that plan. Athletes can
train and practice all they
want, but when they enter the
real game they have to follow
the rules or they won’t win.
Breaking your own trading
game rules defeats you.”
He thought about it some
more.
 “Trading in more like a
sport of finesse than a sport
of effort. Golfers win because
of the right technique and
method, not by trying harder.
If you are a bad golfer,
practice and effort mean
nothing in a game. You are
simply reinforcing bad habits
and wasting time and energy.
The real point of golfing and
trading is to have the right
technique, then use it with
discipline and mental
toughness over and over
again. Success comes from
using winning principles with
perseverance and discipline
over a long period of time
until they pay off in a big
way. “
He remembered reiterating
the fact that work, effort, and
homework were for when the
market was closed; discipline
and self-control were for
when the market was open.
 “A trader is like a surfer
who cannot control the size of
the waves. All he can do is to
ride the waves the best he
can. He can study the times of
day and weather conditions
that create different-sized
waves to get an edge on what
to expect, but all he can do
after all the practice and
study is ride the waves.”
His own wanting to make
money had led him to make
the mistakes of trading too
big and risking too much,
putting effort where there
should have been patience
and trading when he should
have waited.
Once again, he was the
weakest link in his own
trading system. He seemed to
have two trading impulses:
the Analyst and the Greedy
Trader. The Analyst went
through the charts and back
tested calmly, seeing what
worked over long periods of
time. The Analyst was calm
and self-controlled. He
enjoyed trading and looked
forward to when the markets
opened.
Then there was Greedy
Trader who wanted to make
money at all costs. He
believed he was much
cleverer than the other
traders, though there was
little evidence of this. Greedy
Trader believed he could
override Analyst’s trading
plan and do whatever he
liked.
Greedy Trader liked to
trade big, with false
confidence in his skills as a
discretionary trader. He
proved to be a fool in most
circumstances but continued
to try to make big profits.
New Trader had to kill the
egoism that gave life to this
aggressive, internal Greedy
Trader before it killed his
account – sort of like his
girlfriend who sometimes
tried to kill his checking
account.
He sighed. He wanted to be
a successful and profitable
trader so badly.
So he knew what he
needed to do. He needed to
focus on self-control and
process and let the results fall
where they may. He needed
to give up control of results
and focus on his role in the
process.
His true focus had to be to
manage risk, follow his
method, and stay mentally
disciplined, letting the results
fall where they may. If he
wanted to rework his system
or trading plan, that had to be
done in the off-market hours
and planned before the
trading day began.
Of course, as Rich Trader
told him, his desire to make
money was misplaced. He
should desire to be a great
trader who follows process.
After all, trading profits are
the outcome of following a
robust process, not trying to
make sudden decisions with
no context. Your mind must
be that of an entrepreneur
running a business, not the
mind of a gambler at the
roulette wheel.
Traders get themselves in
trouble when they stray from
the risk/reward probabilities
of a situation and trade
according to their self-
delusions of being a special
trader who can outsmart the
markets. Eventually and
inevitably, that will end
badly.
 “I am a businessman, not a
gambler,” he said quietly
before getting up to work on
his system.
 CHAPTER 5

A good trade is taken

according to your
trading plan; a bad
trade is taken to
inflate the ego.

“The most important

change in my trading
career occurred when
I learned to divorce
my ego from the trade.
Trading is a
psychological game.
Most people think that
they’re playing against
the market, but the
market doesn’t care.
You’re really playing
against yourself. You
have to stop trying to
will things to happen
in order to prove that
you’re right. Listen
only to what the
market is telling you
now. Forget what you
thought it was telling
you five minutes ago.
The sole objective of
trading is not to prove
you’re right, but to
hear the cash register
ring.”
– Martin Schwartz

“Do you know what a

trader’s biggest obstacle to
success is?” Rich Trader
asked, stirring his sweetener
into his coffee as he watched
the sun disappear into the sea.
The days always seemed to
end so early now.
What answer was he
looking for? Risk
management, trading with the
trend, not fighting the
market? It could be so many
things…
“Fighting the actual price
action?”
“Close,” Rich Trader said
with a smile, sipping his
coffee."Not managing the risk
of ruin?’ New Trader tried
again.
“Why would you fight
price action or trade so big
that you could blow up your
account?” the older man
asked genuinely, brow raised.
“Because I really want to
make a lot of money and I
don’t want to admit when I’m
wrong.”
“And what causes you to
want to make a lot of money
and hold on to a losing
position?”
“I want to prove I’m a
great trader to myself and to
my family and friends?”
“Is that a question or an
answer? And if it’s a
question, why?”
 “I suppose because I’m not
yet sure myself.”
“These are all things that
you must know before putting
real money at risk. Trading in
the markets is a very
expensive place to ‘find
yourself.’ Counseling is much
cheaper than trading. Fear,
greed, and ego are very
expensive monkeys to have
on your back while trading.
They spend all day telling
you to let losing trades run,
cut winners short, and forget
your trading plan to prove
you are right. Your biggest
competitor in the markets is
not other traders but yourself.
You determine your entry and
exit plan, no one else.”
“So my trading success is
all about my own self-
control?” New Trader asked.
“If you listen to nothing
else I say, hear this: You have
the proper sequence of events
reversed. First, realize you
are a trader. That is who you
are and what you decide to
be. Then your identity is not
based on trading results; it is
based on who you are. You
have nothing to prove to
yourself or to anyone else.
There is a big difference
between knowing who and
what you are and hoping to
become it in the future. An
acorn will become an oak,
regardless of any other
opinions. The potential is
always there. With the
potential inside, all that’s left
is for the acorn to grow and
become what it was meant to
be. An acorn simply grows,
unleashing what is inside
with no self-doubt or
reinforcement from other
acorns.
If a crop fails, a farmer is
still a farmer. He doesn’t
have to question his own
identity based on results. A
farmer’s self-worth is not
shaken by a bad drought or
storm because he has decided
to be a farmer. While there
may be pain of loss and
financial battles, he still
knows who he is through both
success and failure.”
Rich Trader paused,
looking over the landscape
before settling deeper into his
lounge chair.
“If you truly want to be a
trader, you must know who
you are and where you want
to go. Once you believe in
your own identity and know
what your goals are; only
time separates you from your
destination. Once you are free
from internal conflict and
self-doubt, you have energy
to do the work required to
take you where you want to
go. Trading is a difficult
game to learn and be
successful at continually.
Traders do not have the
luxury of being double-
minded about themselves.
Either we are or we are not
traders. Every day we have to
make that choice and get to
work. Our self-worth and
identity cannot fluctuate with
our account capital.”
“How I see myself and my
internal identity is a source of
so much of my stress and
inner conflict. I can certainly
see how that can lead to
anxiety.”
“The traders who really
make it in this business
started out trapped in a new
trader’s body with a new
trader’s account to work with.
You will notice that didn’t
stop them from realizing their
potential. The key was that
they made a decision based
on their conviction that
trading is what they would be
doing. Most had no Plan ‘B’
or had a strong motivation
never to have to use it. They
made their decision of what
they were before any results
confirmed that they would
succeed. The big secret is that
once they decided on their
path, the only thing that
separated them from their
goals was time. If they got up
every morning and made
decisions that kept them
going in the direction of their
passions and dreams, they
were literally unstoppable
from the outside; only they
could stop their own
momentum from the inside. It
is very hard to beat the trader
who never stops learning,
never stops growing, and
never gives up.”
“So being mentally locked
into a long-term goal could
really ease much of the
stress,” New Trader said
thoughtfully.
“Yes, a new trader must
understand that a trade is just
a trade; he has to know he is
playing for the big picture –
his trading career. And that is
a long process that should
dilute much of the daily
stress. One day should be just
1/365th of a year of trading,
and one trade should just be
one of the next 100 trades.
The ego should not even
show up on the charts. The
charts should be traded for
what they are, and the
trader’s emotions and ego
should never become
entangled with price action.”
“Keeping that principle in
mind, it’s like having a
volume dial on your
emotions. Putting any one
trade into that kind of
perspective makes it lose the
egotistic and emotional
interference.”
“Exactly,” said Rich
Trader. “Trading success
comes from first researching
what the right decisions are to
be profitable and then being
able to stick to those right
decisions when the time
comes and not be stopped by
internal barriers.”
 New Trader nodded; then
his phone buzzed.
When are you coming
home?
He frowned.
“The misses?” Rich Trader
asked.
“Yeah, I guess I should
head home. As always, thank
you for your wonderful
advice and coffee.”
“Any time,” Rich Trader
said as he watched his pupil
leave with slumped
shoulders.
 CHAPTER 6

A good trade is taken

without regret or
internal conflict; a
bad trade is taken
when a trader is
double-minded.
“A double minded man
is unstable in all his
ways.”
– James 1:8 KJV Bible

It was a beautiful
afternoon, the sky bright and
clear. The birds were singing
and New Trader was enjoying
his weekly meal with Rich
Trader.
 “Most traders make the
mistake of focusing on a
trading method when they
first start out, when they
really need to focus on
themselves,” Rich Trader
began as their food was taken
away and their usual waitress
filled their drinks. “The
dividing line between winners
and losers in the markets is
not their trading method; it’s
their self-control and ability
to manage risk. The trader
can’t control the profitable
outcome of a trade, only the
downside stop if they’re
wrong – and all traders would
do well to focus on the area
under their control. This is
good news because the
success and failure of any
trading method is determined
by risk management and
position sizing more than
anything else.”
“I see,” New Trader said as
his phone buzzed.
His girlfriend was calling
him again.
He sent it to voicemail
before they continued their
conversation.
“There are many robust
systems that can be found
with diligent research through
back testing historical price
data, but a system in and of
itself is not as important as
the trader trading it.
Boredom, impatience, fear,
and greed are typically a
trader’s undoing, not their
method,” Rich Trader said.
“Most new traders get to step
one, having a method, and
think they’re done, when
really that’s when the work
begins: trading that method
with discipline, consistency,
and self-control over and over
again without quitting when
they meet resistance and
failure.”
 New Trader nodded,
waiting for the inevitable
analogy.
“That’s where the rubber
meets the road. Not in some
fancy delusion of finding the
magic Holy Grail to
profitable trading. If someone
ever did find free money they
would quickly become
wealthy beyond imagination
until they were unable to
scale it any higher due to
trading size. I’m fairly certain
that the Holy Grail trader
would not be selling it for
$19.99 online. The day a
trader quits looking for a
magic recipe and just trades
the best system available,
that’s the day he grows up.”
“So it seems the biggest
problem I’ve had in the past
year is that I stopped focusing
on my method and put it on
myself instead. It was all
about me and how my self-
esteem was connected to my
results. I became my trading;
my wins made me a winner
and my losses made me a
loser. I got too emotionally
wrapped up in the money and
lost my perspective.”
“Yes, that’s it exactly.
Traders can’t mix their
emotional capital with their
financial capital. Those
accounts need to be separate.
Your wins and losses
shouldn’t be making deposits
or withdrawals from your
emotional accounts. Those
currencies should never be
exchanged. They should be
maintained far apart from
each other.”
“And how should I do
that?”
“Just like one trade is only
one of the next 100, your
trading should only be a small
percentage of your life. If
your entire self-worth is tied
up in being a successful
trader, it will greatly amplify
every win and loss. Every
weekly, monthly, and annual
P&L will have a greater
impact on you emotionally
and mentally,” Rich Trader
said. “If your life is
diversified, if you’re a spouse
in a good marriage, a parent,
enjoy time with friends, have
hobbies, enjoy social settings,
entertainment, take care of
your health through diet and
nutrition, and continue to
learn and improve yourself,
then trading results will have
far less impact. The beauty of
trading is that for most traders
there is forced downtime,
when the markets close or in
market environments that are
not conducive to the trader’s
methodology. We have to
take some time off from
active trading. And if you’re
trend trading and just riding a
wave, you have plenty of
time to go enjoy life and then
check in at the close.”
“Well, that is another
problem I had: Too much
unnecessary screen time and
too much obsessing over
results 24/7. So basically
you’re prescribing me a ‘chill
pill’?”
“I’m saying always do
what you should be doing,
and part of that process
involves doing nothing at
times and balancing your life
to avoid burnout or damage to
your mental health. The same
work ethic and drive that can
make us successful can also
hurt us if we don’t stay
focused on why we are
trading in the first place. The
real reason we trade is to
pursue happiness, whatever
that looks like for us. Some
enjoy the game itself while
others do it for freedom or as
a lifestyle choice. The thing
is, we’re going in the wrong
direction if we become
unhappy as a result of
trading. We are not trading
for the pursuit of
unhappiness; when that dark
cloud comes, it is time to stop
and reevaluate what we’re
doing wrong and why we are
on the wrong path.”
“I suppose the parameters
of risk/reward and maximum
equity draw downs play a
huge part in this pursuit of
happiness.”
“A robust trading method
does a trader no good if they
can’t mentally and
emotionally deal with the
stress of trading it,” Rich
Trader said with a quiet
laugh. “You have to trade
within your own comfort
zone and only add position
sizing and more risk as your
strength to handle your stress
is no longer an issue. Trading
is a process of growth, not
quantum leaps. Nothing good
comes from trading above the
level you are comfortable
with.”
“So what else do you
prescribe for strengthening
the weakest part of the
trading system, otherwise
known as ‘me’?”
 “Each trader has to find a
personal philosophy that’s
bigger than they are to ground
them and give them internal
strength and faith. Some
traders understand their place
in the greater universe and
that gives them perspective
on the size of their problems.
Others seek a spiritual path
that leads to increasing levels
of enlightenment about who
they are. Many traders
practice daily meditation to
understand how to bring the
internal chatter of thoughts
and emotions under control,
or they find power in
practicing mindfulness
throughout the day. Some
traders find comfort in prayer
and faith in a higher power.
These practices bring
perspective to how big of a
deal trading really is in the
greater schemes of things and
may make it easier to take
your entries and exits.”
 New Trader nodded. “I see.
I’ll think about this.”
“Of course,” Rich Trader
said, relaxing in his seat,
evidently in no rush to leave
as their checks were delivered
by a smiling Jane.
New Trader’s phone
buzzed again, and this time
when he looked down his
expression quickly shifted to
one of surprise, then
confusion, before going
blank.
It’s over. I’m done.
Seriously.
For a moment it felt
crushing, devastating.
But then he felt a huge
weight lifted off his
shoulders. He shouldn’t feel
this way about his girlfriend
of three years. But really, this
had been a long time coming.
 PART II

CREATING A
ROBUST
METHODOLOGY

“In order of
importance to me are:
1) the long-term trend,
2) the current chart
pattern, and 3) picking
a good spot to buy or
sell.”
– Ed Seykota
 CHAPTER 7

A good trade is based

on your trading plan;
a bad trade is based
on emotions and
beliefs.

“To anticipate the

market is to gamble.
To be patient and
react only when the
market gives the signal
is to speculate.”
– Jesse Livermore

New Trader was out at the

coffee shop feeling
strangely… at peace. His
girlfriend had moved out and
he could focus on his trading.
But something still felt out
of place…
“Well, hello there,
stranger.”
He looked up to see a
pretty girl in a blue dress.
Her brow rose. “Don’t
recognize me? I’m Jane…
from the cafe?”
“Oh! Right, Jane, the
waitress!”
 She rolled her eyes, taking
a seat beside him. “Yes, Jane
the waitress…”
He chuckled nervously,
feeling uncomfortable. It’s
not like they had ever shared
any real conversation.
“So how’s your trading
been going?”
“…What?” he asked after a
slight pause.
“How’s your trading been
going?” she repeated. “I hear
you and Rich Trader going on
about it all the time.”
“Well…” he replied
slowly, trying to make sure
he had it figured out before
he spouted off like he
sometimes did for Rich
Trader. “I think I’ve
improved, but I’m still my
own worst enemy.”
“What do you mean?”
“I think I get in my own
way,” he said with a laugh,
expecting the conversation to
quickly degrade or become
awkward. To his surprise, she
continued with a thoughtful
expression.
“You know what Rich
Trader told me once? The
wisdom is in the price action,
not our opinions. Our skills in
trading are based on how well
we’re able to hear what the
charts are telling us and trade
accordingly. It’s when we
start to predict what’s going
to happen instead of reacting
to what actually happens that
things start to go bad for our
equity curve.”
“Yeah…” New Trader
agreed. “Our opinions and
biases are based on illusions,
not actual price action. And
our job is to trade the price
action that unfolds, not our
opinions, predictions, or egos,
which get in the way of our
ability to make money.”
She laughed. “Yeah, we’re
traders, not fortune tellers.”
“We’re traders?” New
Trader thought to himself. He
liked the sound of that.
“We have to… let’s see,
how would Rich Trader put
it? Surfing the waves is good,
but flowing like the waves is
best. The most money is
made by following where the
market takes you, not
guessing or hoping or
believing or fighting the
current. Even most traders
who play off reversals wait
until it’s actually happening
instead of trying to play off
extreme peaks and valleys.”
“So you consider yourself
a reactive trader and not a
predictive trader?”
“Well, when we take an
entry before a signal is given,
we’re predicting it will be
given later. When we trade a
stock at $600 simply because
we believe it will go to $700,
we are predicting.”
She nodded. “Yeah, the
best way to discover a
trader’s motivation is to ask
them WHY they entered a
trade. If they say: ‘I bought it
because it can’t go any
lower,’ or ‘I bought it
because I believe it will go to
$100,’ or ‘I sold the stock
short because it just can’t go
any higher,’ then they are
predicting not reacting. A
reactive trader says things
like: ‘I bought it because it
broke out over resistance of a
3 month price base to all-time
highs,’ or ‘I shorted it
because it broke down under
long-term price support
levels,’ or ‘I bought it
because it bounced up off a
key support level or it broke
out over short-term
resistance.’”
She took a dainty sip of her
coffee.
“A reactive trader needs a
reason to take a trade based
off a price action that appears
to give them a probability of
success; a predictive trader
needs only a belief or opinion
to take a trade. A reactive
trader trades based on
external reasons and chart
price action; a predictive
trader trades based on internal
reasons and beliefs. Reactive
traders trade for specific
reasons, letting the charts
guide them in entries, exits,
and position sizes.”
“Yes,” New Trader said.
“A typical long entry for a
trend trader would be based
off of strength in the price
move overcoming a key
resistance area. If a stock
goes from $100 to $200, it
has to first go to $101, $102,
$110, $150, etc. If a growth
stock is trading between an
$80 support level to a $100
resistance level for three
months and then after
earnings closes at $103, all
the sellers have been
overcome below $103 and the
odds are that it will go even
higher. Before the breakout
happens, there’s no real
reason to expect a stock will
go higher than $100. Many
stocks never break out and
could fall back to $70 or $50.
A trend trader is looking to
buy a stock that is making
higher highs and higher lows
day after day. That is proof of
a trend. A break above
resistance proves it has gone
higher and it is possible to
keep going higher and can go
higher still. For swing traders,
a bounce off a support level is
confirmation to buy if the
bounce does not lose support
and roll over. The reactive
trader is looking for
confirmation. A predictive
trader is just guessing,” New
Trader said, his excitement
palpable.
Jane nodded and smiled
her eyes clear and bright as
she continued his thoughts.
“A reactive trader will exit
a losing trade when the price
move proves they are wrong.
A reactive trader also exits a
winning trade when it stops
moving in their favor, not at a
target price. Say a stock
moves from $103 to $200 and
never falls back below a $5
trailing stop until it goes to
$200 and reverses to $190.
The trader didn’t exit at a
$125 price target or a $150
price target because he rode it
all the way until it finally has
a strong reversal back
through a key support level at
$190. Of course, these are
principles that you need in
trading. You need a better
reason for an entry than a
warm, fuzzy feeling and a
nebulous belief.”
He laughed.
“Yeah, your position sizing
should also be a function of
the volatility of the stock’s
price range. If you are trading
a $100,000 account and want
to risk no more than 1% in
any one trade, or rather a
$1,000 loss, then the recent
trading range will help your
position size. If your stock
moves $10 a day on average,
then you can only trade 100
shares of the stock and risk a
$10 move against you. If it
trades in a $5 daily range,
then you can trade 200 shares
and risk a $5 move against
you. Of course, you may want
to trade smaller and ensure
that your entry is at a spot
where a move against you in
those dollar increments will
not just be noise inside the
trend you are trying to
capture. The bottom line is
that if you want to be a
successful trader there must
be a reason for everything
you do, based on the facts of
actual price action and on the
charts.”
She nodded. “Being a
factual trader is much more
profitable than being a
fictional trader.”
“Traders who start telling
themselves stories and
believing their own bull
generally head down the road
of capital destruction. There
must be a quantifiable reason
to take a trade. There must be
real reasons for entries, exits,
position sizing. Trading on a
whim almost never works.
Trading based on actual price
action, on the other hand, has
a great chance of working
because you’re flowing in the
same direction as the markets.
The markets don’t care what
we think or believe. They’re
like a train. We can either
ride them or be run over.”
Jane sighed. “I suppose this
means I’ll have to throw
away my crystal ball…”
New Trader laughed. “I
guess we both will… I didn’t
know you were a trader.”
She gave him a half smile.
“Yes… a bit… I’m working
at the cafe to bring up my
capital. My goal is to be able
to trade full time. I’ve been
talking to Rich Trader too, a
bit. He’s an amazing help.”
“I know, he’s a veritable
fountain of knowledge.”
“You haven’t been by for a
while. Did something
happen?”
 He looked at her, not sure
if he really wanted her to
know or if she really even
wanted to know, but he
decided to go ahead and say
it.
“I broke up with my
girlfriend.”
“Oh… I’m sorry.”
He shrugged. “At least I
didn’t marry her.”
She laughed. It wasn’t the
usual response he got,
especially from women, but
he found that he rather
enjoyed it – as well as the
company of another trader
who wasn’t quite so
seasoned.
 CHAPTER 8

A good trade is based

on your own personal
edge; a bad trade is
based on your
opinion.

“A trader should have

no opinion. The
stronger your opinion,
the harder it is to get
out of a losing
position.”
— Paul Rotter

“Do you know what one of

the hardest things for new
traders to wrap their mind
around is?” Rich Trader
asked when New Trader had
finally settled in to a
comfortable chair as he
showed up to meet with him
again.
“What’s that?”
“That the best traders are
very flexible in their
opinions,” the older man
continued. “The vast majority
of rich traders aren’t trying to
predict what will happen or
how far a price move will go;
they’re trying to understand
what’s happening in the
current market and what has
happened historically. Rich
traders try to merge their own
trading with the chart and
price actions, trying to move
in sync with the market
moves. They understand that
the market doesn’t care what
their individual opinion is.
You don’t become a rich
trader by forming an opinion
but by seeing the pattern
prices have formed and may
form again based on the
nature of the human
psychology of greed and
fear.”
New Trader nodded.
“Because the market will
go where it pleases and trends
will feed off themselves.”
“Exactly, trying to trade
against a trend with
momentum is like trying to
argue with a speeding train.
The train will eventually run
out of fuel and stop but it is
unprofitable to bet against a
moving train until you can
identify it is actually slowing
down and losing momentum.
The key is that trades should
be made based on facts, not
personal opinions. The most
dangerous thing a trader can
do is develop a mental bias
and let the bias affect the way
they see price action and
chart patterns. A stop loss and
a trailing stop are powerful
ways to follow actual price
action and avoid opinions.
Many great traders let stop
losses and trailing stops do
the heavy lifting for them.”
“So a trader has to know
why they entered a trade,
what the signal was, and
where the exit signal is.”
“Yes… There are three
main types of traders. The
first are purely mechanical
traders who have done their
homework in back-testing
historical price action, seeing
what works and what doesn’t.
Mechanical traders do their
discretionary work in
building their trading model
and then let the model run.
They know 100% what they
will do under different price
action circumstances. Their
discretionary work continues
after the market closes for the
day, when they question the
continued validity of their
system. Mechanical traders
do a lot of homework before
changing a mechanical
system. They do not trade
their opinions; they trade the
validity of the opinions they
back-tested that were
historically robust in different
market environments. The
discretion happens in the
research so that the trading
can be mechanical in the live
action of the markets,” Rich
Trader said, taking a sip of
coffee before continuing.
“The next group is rule-
based discretionary traders.
While these traders believe
that their own decision-
making process gives them an
edge, they still trade inside a
framework of rules that keep
them safe and profitable.
Discretionary traders can
decide if they want to take a
signal or not and how many
trades to put on at any one
time along with position
sizing. Most traders have
rules about risk management,
maximum risk exposure,
draw downs, entry signals,
exit parameters, and even
rules about their trading
psychology. The rules are
based on many years of
personally learning what
works and what doesn’t and
are created as a safety net to
avoid past mistakes. The
trading rules aren’t meant to
keep traders from the
freedom to trade; they are
meant to keep traders safe
from themselves.”
“And I suppose the last is
Mr. Know-it-all?” New
Trader said.
Rich Trader nodded.
“That is the mindset of
most new traders against the
rocks of reality. Even some
professional money managers
trade their own opinions
above any real research or
trading education. The Know-
it-all Traders’ strategy is very
simple. They buy what they
‘like’ and sell what ‘has to go
down.’ They believe their
intellect and gaming skills are
far greater than the majority
of traders and the market as a
whole, even though they have
no facts confirming this. They
are loud and opinionated and
believe deeply in their
convictions of what price
action will happen next. Their
trading is little more than
spur-of-the-moment decision-
making based on their beliefs.
These are the traders who
think they are special and
very clever; unfortunately,
many times they start their
trading careers in markets
that are conducive to their
styles. Many times they
confuse bull markets with
stock-picking skills and
personal genius. They
confuse huge monthly returns
with being smart when really
they are setting up for an
eventual account blowup due
to positions sizing and too
much open risk, which gives
them big returns but which
also gives them big losses
when the market dynamic
changes. They confuse their
feelings of superiority during
long winning streaks with the
mental strength to come back
from draw downs in capital
and losing streaks. The know-
it-all-trader has no edge – just
a lucky rabbit’s foot and self-
delusion. While this trader
may be profitable for many
years, eventually the markets
take back every penny of the
profits given away by luck,
and lucky money is taken
back much faster than it is
given away. These lucky
traders slowly climb the stairs
of profitability but then fall
down the elevator shaft as
they quickly give back all
profits and learn the dangers
of leverage and position
sizing as all profits are
returned to the market and
maybe even most of the
original trading principle due
to a lack of respect for
extreme risk events.”
“So which have you
been?” New Trader asked.
Rich Trader chuckled.
“Why, I’ve been all of them,
of course. The better question
is… which are you?”
“I suppose I’m still stuck in
the know-it-all phase… I’ve
let my opinions drift into my
trading, and it’s one of my
biggest adversaries. I get into
trouble when I start fighting a
trend I should be following,
or buying support levels
when I should be waiting for
a snap back rally with
strength. My biggest problem
is that I drift from my trading
plan while the market is open
and think I’m smarter than
the trading plan I wrote while
the market was closed – even
though I have proven time
and time again that I’m not.
My opinions have been…
expensive, to say the least.
And it also seems that the
stronger my opinion is, the
more prone I am to trade too
big, and that almost never
ends well since I don’t want
to stop out and admit I’m
wrong. Further, the bigger
size of the trade, the more
engaged my emotions are,
which compel me to do
foolish things that I would
never do when trading
smaller.”
“The key to trading
without opinions hurting
trading performance is to
trade using a systematic
approach. You need to have
quantifiable reasons for all
entries and exits that are hard
to get around if you follow
your trading plan. Many
traders find a mechanical
approach easier to follow
because it removes the
discretionary, emotional
trader entirely, which of
course is the weakest link to
any trading system. A
discretionary trader needs to
have entry rules that put them
on the right side of the
market: break outs, trading
above a key moving average,
focusing on higher highs or
lower lows in their time
frame, etc.”
“Replacing my opinions
with a systematic approach
seems to be an edge in itself.”
“Exactly, the ability to
follow the price action
without a personal bias is a
very powerful edge that few
traders ever get to or even
understand. Always seek to
ride the wave that is
occurring now as best you
can rather than sit back with
opinions on how far the wave
will go or when it will end
and miss the ride altogether.
In the markets money is made
by trend capture in your time
frame, not opining on what
should be happening now.”
New Trader nodded,
glancing around the cafe.
He was strangely
disappointed not to see Jane.
 CHAPTER 9

A good trade is made

using your own
timeframe; a bad
trade changes
timeframe due to a
loss.
“The key is
consistency and
discipline. Almost
anybody can make up
a list of rules that are
80 percent as good as
what we taught our
people. What they
couldn’t do is give
them the confidence to
stick to those rules
even when things are
going bad.”
– Richard Dennis

“A good trade is based on

predetermined parameters,”
Rich Trader began as they
drank their favorite coffee in
the quaint coffee shop New
Trader had discovered not too
long ago. It was nice and
quiet, decorated in subtle
blues with comfy chairs and
quality beverages – a perfect
place to meet and talk.
“That means the trader
knew the position size they
would trade before they
entered. The trader had a
quantified entry signal based
on price action at the right
level, and would the position
be held until the stop loss was
hit and taken, acknowledging
that the trade was wrong. The
stop loss would be triggered
at a price level that showed
the trader they were wrong
and it was time to exit. The
amount of money lost would
be within the guidelines of
total trading capital that could
be risked and lost on one
trade without putting the
trader in the risk of ruin zone
over the course of many
trades. The trading vehicle
that was traded was on a
previous watch list and the
trader had researched price
action history to understand
what did and did not work.
That is the formula for a good
trade. A bad trade is when the
trader strays from quantifying
a trade to following opinions,
emotions, and ego.”
“So basically, a trade is a
serious business transaction,
based on the risk/reward
ratio, probabilities,
possibilities, and managed
risk? You should know
exactly what you’re doing in
every single move in every
single trade?”
Rich Trader nodded.
“Creating the trading plan
isn’t usually the problem. The
problems generally begin
when the trader tries to stay
disciplined while the market
is open. Greed, fear, ego, and
stress weren’t there when the
plans were created, but all
show up and want to be heard
when the market is open. A
good trader is disciplined and
able to follow a plan rather
than emotions and opinions.
That’s hard enough, but when
the market environment
changes and a string of losses
occur, that amplifies
everything. The trader has to
pre-plan how to handle draw
downs in capital by trading
smaller, by having fewer
positions at one time, or by
just not trading until there is a
signal indicating that the
market environment may be
favorable again. Traders find
out very quickly that they are
the weakest link in any
trading system the moment
they go live and it’s time to
follow the predetermined
plan.”
“So most traders lose
because they just can’t stick
to the original plan?”
Rich Trader took a sip of
his hot coffee before replying
with a sigh. “They may have
a great trading system and
just be in a bad market.
Instead of getting through the
market environment, they try
to fit their system and style to
the market they are in. That
really starts messing them up
when a trend follower tries to
day trade or a swing trader
tries to start selling options. It
takes a lot of time and work
to get an edge in any type of
method and it is not easily
transferred to trading on a
different timeframe. If you
want to trade multiple
systems with different
methods, that’s fine, but each
must be researched properly
before they’re needed. A
major change in trading style
based on the market
environment should be
preplanned, not a spur-of-the-
moment adjustment because
of a losing streak. Large
samples of trades should be
researched before considering
adjustments to back-tested
trading systems.”
“I see. So you’re saying
plan, trade on paper before
you trade with real capital. I
need to make well thought-
out decisions based on facts
and not just based on losing
money or losing control of
my emotions. My decisions
should grow out of research
and planning rather than
reacting to outcomes that may
be random and temporary and
just noise in the greater
scheme of the next 100
trades.”
“Style drift in trading
usually doesn’t work out,
while researching and trading
multiple methods is all right
if you have put in the work to
determine that they have
robust back test history. Of
course, risk exposure has to
be determined with all open
positions, as well as the level
that the trading vehicles are
correlated to determine total
open risk exposure. I think
Bruce Lee summed it up the
best.”
“Bruce Lee?”
 Rich Trader chuckled.
“’Knowing is not enough; we
must apply. Willing is not
enough; we must do”. Bruce
Lee may not have been a
trader, but he knew a thing or
two about discipline.”
“That’s the real difficulty,
leaping from theory to
practice, from learning to
doing, from principles to
action. It’s a lot like training
for a sporting event with
plenty of time for reflection
and practice but then having
to compete live with all the
stress and strain of
performance. It’s a very
different experience; the live
event is the time to do or die.
Results will be judged on
success and failure yet
emotions and stress show up
that were not there during
practice. There’s an audience
and there are expectations
from the fans and the
athlete.”
“Yes,” Rich Trader said.
“What usually separates
athletes at the highest
professional level is their
mental edge. All professional
athletes are gifted physically,
but the winner is usually the
one who is able to function at
the highest level at the most
important time. Many traders
have an audience such as a
spouse, a family, or other
traders who add to the
pressure of success. At least,
that has been my experience.
Study and research had little
to do with my live trading.
My trading with actual large
amounts of money seemed to
be an exercise in my ability to
be disciplined and manage
stress.”
New Trader sighed. “Yes,
well, I don’t have much of an
audience right now, except
you, of course.”
“Well, don’t let it bother
you. It was probably for the
best in any case. After all,
target practice is a very
different experience than a
gun fight. The best traders
come down to those who are
able to manage stress the
best, persevere, and keep
their egos in check. The best
chart readers and analysts are
rarely the best traders.
Trading is performing live on
stage; analyzing is like being
a judge on the sidelines.
Judges are paid for showing
up at work while performers
on stage are paid for
performance over the long
term.”
“I’ve learned that a top
trader skill is the ability to do
in real time what you had
planned to do before the
market opens. Following a
trading plan seems simple
until green and red numbers
are flashing in front of your
eyes and money is growing or
evaporating. I’ve also learned
that my real test as a trader
comes after strings of losses
and strings of wins. Losing
streaks activates my ego to
want to trade big and get back
those losses quickly and my
big wins and winning streaks
decreases my fear of losses
and makes me feel invincible
and like a genius who has no
need for risk management. I
have to grow up and stop
going down either of these
paths and just focus on
consistency. All this has been
golden advice today.
Thanks.”
“Of course, anytime,” Rich
Trader said with a kind smile.
“I always enjoy our little
talks.
 Chapter 10

A good trade is made

in reaction to current
price reality; a bad
trade is made based
on personal
judgment.
“Pure price systems
are close enough to
the North Pole that
any departure tends to
bring you farther
south.”
– William Eckhardt

“Quantify, quantify,
quantify, you must know
where you’ll be getting in and
where you’ll be getting out
once you are in. You have to
know your numbers; your
entry price, your exit price,
your positions size and what
you’ll be trading. No trade
should be taking place in the
real world until it’s first
planned out on paper. The
price is your guide and your
plans have to be based on the
potential probabilities of
different price action
scenarios playing out,” Rich
Trader began. “It’s your job
as a trader to plan how you
will react to different price
action, patterns, and increases
in volatility. Your plans can
make you money because
you’re not trying to predict
what will happen; you’re
adjusting in real time to what
is happening. In essence, you
are not trying to beat the
market; instead you are trying
to be the market. There is a
big difference.”
“So I have to have a laser-
like focus on trading price,
not emotions, not opinions,
and certainly not my ego.”
“Reactively trading price
action as it unfolds versus
trying to predict what will
happen in the future is one of
the biggest secrets of rich
traders. Rich traders know
that they don’t have a crystal
ball or time machine and they
understand that they’re not
prophets. And it seems that
many new traders, talking
heads, and gurus skipped that
day of trading school. While
bad traders go in search of
“market calls, “hot stock
picks,” “gurus,” and “Holy
Grail trading systems,” rich
traders are busy studying
historical price action, price
patterns, back testing trading
systems, and studying chart
action for clues as to what is
actually happening in the
present moment.”
“I see… So rich traders are
more like scientists than
traders, and bad traders sound
more like gamblers than
traders. Rich traders try to
scientifically figure out what
works through experiments
and confirming data, while
bad traders look to pick up
easy money lying on the
street.”
 “I can tell you from
personal experience there’s
no easy money in trading that
will just jump into your
pocket. I know now that all
trading profits come from
work, taking on risk, and
managing positions in the
right way,” Rich Trader said.
“You need to always be
trading the facts about price
action. Don’t let your view of
the price action be skewed by
the open position you are
holding. Always do what the
price says to do inside the
parameters of your system
and timeframe. Take the
entry, ride the trend, buy the
bounce, trail the stop, take the
loss. Price action needs to
drive your trading bus. Your
job is to make sure you are on
the right bus.”
“Money is made in the
markets by going with the
current flow. A profitable
strategy is learning to identify
the potential for a trend and
then capturing that trend with
the right entry; letting your
winner run until you are
stopped out as the price
breaks near term support
levels for the trend in your
timeframe. Trend capture is
best done by following price
action, not having an opinion.
A market can run farther than
you expect and it can also fail
to trend. A mechanical stop
set at a price level indicating
you are wrong can save you a
lot of mental and financial
capital. A stop that tells you
to exit is a better plan than
arguing with the market price
action.
It is much better to let a
bounce off the bottom of a
low price level happen first,
then take a position long after
confirmation has happened
instead of trying to predict
when it has gone too low and
is “due” for a bounce.”
“So one key to trading
price action is to wait for
confirmation for an entry,
instead of just anticipating
what I think is going to
happen.”
“Yes, exactly, your odds of
a successful trade are usually
better by buying into strength
and selling short into
weakness. This way you’re
going with the flow of your
timeframe. The next step is
trailing the winner with a stop
or taking a stop loss at the
level that shows you are
wrong. It’s not about
prediction; it’s about
reacting.”
“A big mistake many
traders make is trying to go
short in a bull market because
they think prices are too high.
In a bull market, indexes and
individual stocks tend to have
support levels but not long
term resistance bull market
trends tend to keep making
higher highs and higher lows.
Easy money is made to the up
side until the market rolls
over to lose support and goes
into a downtrend. While some
really good day traders can
scalp shorts intra-day, the
majority of longer-term swing
traders would do better to buy
at support levels than try to
sell resistance levels short.
And of course, trend
followers should stay long in
the trend as it continues to
hold up. Always trade in the
direction of the longer-term
trend of your time frame
where the easiest money is
located. Betting on a reversal
of a longer-term trend is
wrong more times than right,”
Rich Trader said.
“Running with the bulls in
a bull market and riding with
the bears in a down trend
seems like it would be a
better trading experience than
trying to fight against the
flow of price action,” said
New Trader.
Rich Trader nodded.
“Another consideration for
traders who are trading price
action is that markets go from
low volatility to high
volatility in cycles, with daily
price range expansion, gaps,
and sharp quick reversals in
price action trends. Many
trading systems fall apart in
volatile markets, especially
shorter-term trend trading
systems which key off short-
term moving averages.
Others, like long option
strangles and straddles, do
very well if exited at the right
time. There are even traders
who sell options to get the
bigger implied volatility
premium that is priced in and
profit when the volatility falls
back to lower levels and is
priced out of the options. Just
as price trends, volatility,
chart patterns, and trader
psychology also trend in the
markets. ”
 Chapter 11

A good trade is made

after identifying and
trading with the
trend; a bad trade
fights the trend.

“The answer to the

question, ‘What’s the
trend?’ is the question,
‘What’s your
timeframe?”
– Richard Weissman

“I know that trading

following a trend is where the
money is made and that is
how I try to trade, but how do
you identify the trend?” New
Trader asked one sunny
afternoon as he sat on Rich
Trader’s patio.
“Well, it depends. The first
thing the trend depends on is
your timeframe. A long-term
trend following trader may be
long based on the weekly or
monthly chart, while a day
trader may be short based on
the intra-day 15 minute chart.
Both make money in their
position when they exit. The
key is looking at the direction
of the price in your
timeframe. Examine and
quantify support and
resistance levels along with
moving averages. Some
traders also use Elliott Waves
and Fibonacci price levels.”
“There are many ways to
measure the path of least
resistance,” Rich Trader said
as he led the younger trader
to his office and sat at his
computer, pulling up daily
charts from his favorite
website.

Moving averages are one

way to quantify where
the current price is in
relation to an average of
prices over a specific
timeframe. If the current
day’s price is over the 5-
day moving average, it
could be said to be in an
uptrend in that
timeframe on the daily
chart.
 Chart courtesy of
StockCharts.com

With higher highs and

higher lows over a time
frame it could be said
that the market is in an
uptrend.
 Chart courtesy of
StockCharts.com

Lower highs and lower

lows are an indication of
a down trend.
 Chart courtesy of
StockCharts.com

A break out of a trading

range with a new price
above or below the
established range of
support and resistance
can also be a signal and
indicate a new trend
emerging out of a price
consolidation period. A
break down out of a
trading range that makes
a new low means that
buyers are no longer
willing to pay the asking
price of support and that
sellers are willing to sell
for less than support in
that timeframe.
 Chart courtesy of
StockCharts.com

In a break out over

resistance sellers will no
longer sell for less than
resistance and buyers
have to pay more than
resistance to get in.
 Chart courtesy of
StockCharts.com

“A trend is best entered at

the point where something
quantifiably changes in price
action, like new highs or new
lows in a trader’s timeframe.
All-time highs and all-time
lows is a favorite break out
strategy for many trend
traders. Really, all traders,
regardless of their method,
are trying to profit by
understanding and betting on
a trend,” Rich Trader said,
continuing his impromptu
lecture.

Buying all-time highs is

trying to capture a
breakout trend.
Selling short all-time
lows is trying to capture
a break down trend.
Buying a strong reversal
off the bottom is an
attempt to capture a rally
back to resistance.
Selling short a
breakdown at resistance
levels is trying to profit
from a retracement to
support.
A trader who shorts over
extended markets in
either direction is trying
to capture a trend where
the market reverts back
to its mean.
Out-of-the-money option
buyers are betting on a
strong trend to their
strike price.
Option premium sellers
are betting that the trend
is already priced into the
option they are selling
and that it will not go
farther than that.
Day traders are trying to
profitably capture daily
trends.
 Intermediate term
traders are after
profitable trends on the
daily chart.
Long-term trend
followers are looking for
the big trends on weekly
charts.

“Almost all traders are

trend traders, whether they
know it or not. The trader has
to focus on quantifying how
they will identify and capture
trends in a profitable way on
their timeframe,” Rich Trader
said as he turned to look at
New Trader. “The entry
should be at a high
probability moment after
confirmation that something
has changed in the price
action which may indicate a
move in one direction. The
entry level should have a
good potential risk/reward
where the trader is exposing
1% of trading capital at risk
for the potential of making a
3% profit on total trading
capital.”
“So I really need to be
focusing on price action to
identify potential trends – not
opinions, beliefs, or listening
to others.” “The success of
your trading method will be
determined by your ability to
identify, enter, and exit
trends.”
“How do you best identify
where an exit door is?”
“You’ll want to be in the
trend for as long as possible.
You need the big wins to pay
for your small losses. You
look for warning signs in
your trend trades that tell you
the trend may be nearing its
end. In fact…” Rich Trader
continued, pulling out a piece
of paper. “Here are the
warning signs I look for as I
trade trends off the daily
chart.”

If an uptrend suddenly
takes out a previous
day’s lows for the first
time in many days, that
could be a good place to
take profits or be
cautious.
If a downtrend suddenly
takes out a previous
day’s highs for the first
time in many days, that
could be a good place to
take profits or be
cautious.
If the price violates a
key short-term moving
average that I am using
and then price is going
to close on the other side
of that line for the first
time since entry, I will
exit there.
An expansion in
volatility and the
average daily range will
make me cautious if I
am on the long side or
make me lower position
sizing if I am short.
The loss of a support or
resistance level for a
recent gap in the chart is
one exit signal.
A huge gap and reversal
against the direction of
my trend trade would
make me believe it is
ending and I would exit.
 “The key is that you must
quantify what will make you
enter and exit based on
principles and chart study, not
personal opinion; once you
have that method planned out,
follow it and adjust as you
learn and grow as a trader.”
New Trader nodded,
looking over the list
studiously. “Yes… thank you
for this.”
Rich Trader just smiled.
“Of course. How are you and
Jane getting along?
New Trader flushed. “I
don’t know what you mean. I
haven’t seen her in days.”
“Well, perhaps you should
do something about that…”
New Trader scowled.
“I don’t know why you
keep trying to set us up…”
Rich Trader looked at him
with sad, knowing eyes. “You
seem lonely.”
And there was nothing
New Trader could say to
refute that.
 Chapter 12

A good trade is made

using the trading
vehicles you are an
expert in; a bad trade
is when you trade
unfamiliar markets.
“My strategy works
well because it’s my
strategy. I know the
strengths and more
importantly the
weaknesses of what it
is I do. It also works
well because I allow it
to work and stick with
it even when it runs
into difficult times.
Nothing works well if
you keep changing
your approach. To be
a master you must be a
specialist, not a jack of
all trades.”
– Mark Minervini

“The reason I make money

is because I am a top expert
in the world for the markets I
trade and the method I use.
I’ve spent thousands and
thousands of hours studying
my market’s price history,
trends, charts, different
trading environments,
volatility, and seasonality. I
win because I am in the
minority that has done much
more work than the majority.
In the markets you will see
that money flows from those
who have not done their
homework to those who
have,” Rich Trader said.
“So if I want to be
profitable, I have to do more
homework than my
competition?”
“Of course. Just like in
sports where the athlete who
trains the hardest usually
wins, it’s the same for traders.
Traders who prepare the most
before they trade will likely
be on the right side of the
market. What most
bystanders confuse for lucky
performance by professional
money managers and traders
is usually the product of
learning what the right
method to trade is and then
trading that way after doing
much homework and back
testing.”
“I don’t think I spent
enough time in preparation
for actual trading before I
went live. I entered trading
with superficial knowledge
after a few books and a
seminar, without really
understanding the historical
performance of many of my
trading methods,” New
Trader said with a sigh. “I
didn’t really understand how
different market
environments completely
changed the dynamics of how
my method played out. I
thought I was an expert on
what I was trading and I
entered trading with a mere
pocket of knowledge and far
too much hope. I should have
had a truckload of knowledge
and a bucket full of reality.”
Rich Trader chuckled. It
was an all too common
mistake.
“You have to be so
knowledgeable and so secure
in your faith that you can
trade your markets profitably
that it will put your mind at
ease. You can’t just hope you
know what you’re doing; you
have to know for a fact that
what you’re doing will work.
You need quantifiable data
that shows in print that your
methodology works. You
need to go through price
charts line by line, using back
testing tools, software
programs, or forward testing
a large sample size to show
that what you are planning
will work. You need a large
enough sample size over
enough data point and
different market
environments to prove to
yourself that what you want
to do will really work. You
need this not only to save
yourself the trouble of losing
real money while you learn
the hard way if your method
works or not, but you also
need to develop in yourself
the faith and determination
that it will work over the long
term.”
“I suppose so… After all,
there’s a huge difference
between believing, hoping,
and thinking what you’re
doing is going to work and
actually knowing it will work.
But if I’m a discretionary,
rule-based trader, then I
cannot quantify and test
everything I do.”
 “No, everything in trading
cannot be quantified and
tested, but you can take large
enough sample sizes of what
happened in similar
circumstances and get an idea
of probabilities. If an index
failed to break above a 75
RSI nineteen of the previous
twenty times, it could be said
that the odds are 1 in 20 or
5% that it will break above it
this time. The odds may be
even less that the upside risk
is more, even if it does go
higher. These kinds of
principles can be embedded
into a rule-based method.”
“So an example for me
would be that since an index
like the S&P 500 is primarily
a reversion to the mean type
instrument, then once I can
see through historical price
action that the 75 RSI acts as
resistance for advancing
prices in the majority of
circumstances, that is a great
spot to initiate a short play as
a reversion to the mean
system trade?”
“Exactly. And those who
have not studied that
indicator will have no idea
where the price ceiling is
likely to be.”
 Chart courtesy of
StockCharts.com
“I really need to narrow my
watch list and master a few
trading vehicles,” New
Trader muttered, thinking
aloud.
“If you find the rhythm of
a few things and understand
their tendencies and price
history, you can do very well.
My money came from
focusing on a few, not
struggling with many.”
“What do I need to be
focusing on to learn about
them?” New Trader asked.

“Well, let’s see…” Rich
Trader said as he started
naming them off.
Typical patterns they
trade in
Current trading range
Key moving averages
that act as support and
resistance
Longer-term support and
resistance
How it acts historically
after different types of
news events
Time of the month
behavior
Seasonality
First day of the month
behavior
Does it tend to trend or
revert to the mean?
How does it usually act
in relation to key
technical indicators?
What is its current daily
average trading range?
What is its current
weekly average trading
range?
What is its current
monthly average trading
range?
How liquid are the
options?
 What is its history for
volatility?

“And of course, the most

important question: How will
you use this information to
create a profitable system?”
“Well, now that I know
what work needs to be done,
it’s simply a matter of doing
it. It’s time to get out the old
spreadsheets and get to
work.”
 PART III

MANAGING RISK
TO STAY IN THE
GAME

“The key to long-term

survival and
prosperity has a lot to
do with the money
management
techniques
incorporated into the
technical system”
–Ed Seykota
 CHAPTER 13

A good trade risks

only 1% of total
trading capital; a bad
trade does not have a
set amount of risk.

“There is a random
distribution between
wins and losses for
any given set of
variables that define
an edge. In other
words, based on the
past performance of
your edge, you may
know that out of the
next 20 trades, 12 will
be winners and 8 will
be losers. What you
don’t know is the
sequence of wins and
losses or how much
money the market is
going to make
available on the
winning trades. This
truth makes trading a
probability or numbers
game. When you really
believe that trading is
simply a probability
game, concepts like
‘right’ and ‘wrong’ or
‘win’ and ‘lose’ no
longer have the same
significance. As a
result, your
expectations will be in
harmony with the
possibilities.”
– Mark Douglas: ‘Trading in
the Zone’

When New Trader went to

meet Rich Trader at the cafe,
he saw Jane getting ready to
leave, looking pale and a bit
ill.
 “Jane, are you all right?”
he asked her with a slight
frown.
“Oh… yes, I’m fine, thank
you… I just made a crucial
mistake, is all…” she said,
muttering under her breath.
“What do you mean?”
She looked up at him,
seemingly guilty.
“I didn’t count how big my
loss was going to be… I got
so swept up with dollar signs
in the high that I didn’t see
the risk or the chances of my
being wrong.”
“I see,” New Trader said.
“That must have been hard.”
She laughed. “I felt like I
was going to – well, you’re
about to eat so I won’t
describe the feeling. But
honestly, if I spent half the
time managing risk as I did
with my silly get-rich quick
scheme that I should know
better than to use, I’d
probably survive this learning
curve better and be on my
way to being a profitable
trader.”
New Trader smiled. “Don’t
worry. I’m sure you’ll get
through this. You have to
stop focusing your time and
energy on your entry and
potential profits and put more
effort into risk management.
You aren’t just looking at
potential profits, right? You
have a setup and entry
signal?”
She rolled her eyes, some
color returning to her face.
“Of course I do!”
“All right, so you’re
probably concerned about the
perfect setup and taking your
entry signal for a good chance
at a profitable trade. Then
after your entry, you’re
thinking about a target price
and where to take future
progress. Am I guessing
about right?”
“Maybe,” she said with a
weary smile.
“Right. I did the same
thing. It’s actually the
backwards way to do things if
you want to survive in
trading. The first thing you
need to think about is how
many losing trades in a row
you can have and still survive
with your account intact.
That’s crucial, because while
investors hold assets that
fluctuate in value, traders
actively enter and exit trades
and can lose over and over
again, grinding down their
account value and destroying
their capital. It’s especially
crucial for traders who use
options and futures to trade
with extra leverage. If you
trade too big and lose too
many times, you can end up
with nothing or even worse,
owing the broker money if
they were on margin or sold
options or futures short.
“Oh, I see,” she said. “So
I’m trying to survive even
before I try to profit?”
New Trader shrugged.
“Pretty much. The potential
for blowing up is pretty real
for a trader who isn’t
respecting risk or the
potential for blowing up their
account. The risk of ruin is
how likely you are to blow up
your account capital. Most
people consider a 50%
drawdown to be ruined
because then you need a
100% return to get back to
even.”
“What do you mean 100%
to get back to even? Wouldn’t
it be 50% to get back to…”
she paused, thinking a
moment. “Well, no, that’s
right, isn’t it? As your capital
is lost, you have less to
rebuild with, so compounding
works against you on the way
down. If you have $100,000
and you lose 50%, then you
have $50,000 left, so if you
have a 50% return you only
have $75,000. You need to
double it, as in a 100% return,
to get back to even. If you
lose 10% it takes 11% to get
back to even, 20% and it
takes 25% to get back to
even… Goodness, a 75%
drawdown would need a
300%return!”
New Trader nodded. “Yes,
that’s why Rich Trader has
always advised me to never
have the draw down in the
first place. It’s a lot easier to
grow capital if you don’t have
to deal with draw downs over
10%.”
“Well, that certainly puts it
in perspective… I need to just
cool down my risky trading
and my desire to win so badly
that I try too hard.”
“You can still have big
wins; you just have to
manage your position sizing,
entries, and trailing stops. All
I’m saying is to just not have
any big losses. You should
never lose more than 1%,
max 2%, of trading capital on
any one trade. It’s just too
hard to get your capital back
if you run into a long losing
streak when the markets get
tough.”
“Yeah, they’re rough on
the psyche too…” she
grumbled.
“Rich Trader told me once
that a trader risking more than
5% of their capital per trade
is doomed to un-profitability
in the long term. After five
losses you’re down 25%,
after ten you’re down to 50%.
And there are very few
traders, even if they have
high winning percentages,
that don’t lose five to ten
trades in a row per year. You
have to be able to survive the
duration of losses. Your
probability of survival
increase dramatically as you
lower your percentage of
capital at risk. So if you’re
risking 1%, your risk of ruin
is almost 0 if you use it with a
good trading system.”
Jane nodded, “So if I’m
wrong, I’m losing only 1% of
my trading capital, and if I’m
right I can make 2 or 3%…
depending on exactly how
right I am. The upside is left
open, but the downside is
capped. And my losses
should all be about the same,
with no outlying huge losses.
The only outliers should be
the big ones in the winning
column.”
“Yeah, you have to get
your trading to a place where
the losses won’t kill you but
the wins can make you a lot
of money.”
“Any advice for using the
1% max loss of total trading
capital per trade rule?” she
asked. “Well, let’s see…”
New Trader began. “You start
with your trading account
first, say you have $50,000.
Now you should never lose
more than $500 on any one
trade if you’re wrong. Your
next step is to study the
volatility of what you want to
trade. If you are trading a
stock that moves in a $5
average trading range each
week, then you should likely
only be trading 100 shares of
this stock. If it is currently
trading at $85 and it triggers
an entry for you, then you can
buy 100 shares and set your
stop at $80 while you see
based on the chart that it has
the potential to be at $100
before it falls back under
support to $80. You are in
effect risking 1% of your total
trading capital to make 3% of
your total trading capital if
the chart plays out.”
“Right. So I figure out
what I should risk in the trade
first, then figure out my
position sizing before I
enter.”
“Yeah, you’ll be doing the
opposite of the traders who
don’t make it in the markets.
Risk will be your priority and
this will enable you to keep
the profits you make. Risk
management is the Holy Grail
of survival and long-term
profitability in trading.”
“Right. Well, thanks, New
Trader. That was some really
useful advice. Honestly, it’s
like I’m talking to a younger
version of Rich Trader,” she
said with a laugh. “But I
really do have to go now. I’ll
see you later.”
“See you later,” he said,
watching her go, a warm
feeling swelling up inside his
chest as he made his way
over to Rich Trader.
Comparing him to Rich
Trader was probably the best
compliment he’d ever
received.
 CHAPTER 14

A good trade risks $1

to make $3; a bad
trade risks losing
more than it plans on
making in profits.

“At the end of the day,

the most important
thing is how good you
are at risk control.”
– Paul Tudor Jones

“Do you want to hear one

of the most crucial aspects to
trading success?” Rich Trader
asked as they sat down for a
meal.
“Of course.”
 “It’s not very glamorous or
exciting, but here’s one of the
keys to profitability versus
losing money: Risk a little to
make a lot. If you risk 1% of
your trading capital, do it for
the opportunity to make at
least a 3% return on your
capital. Risk $1 only for the
opportunity to make $3. Only
buy a stock at $100 with a
$95 stop loss if it has the
potential to run to $115. The
reason successful option
buyers make money even
with a 50% winning
percentage is because the
wins are so big that they pay
for the losses. Trend
followers are profitable long
term because they set
themselves up for the really
big wins.”
Rich Trader took a sip of
tea before continuing.
“The whole thought
process behind the old Wall
Street saying, ‘Cut your
losses short and let your
winners run,’ is that it creates
a favorable asymmetry in
your trading methodology. A
1:3 risk/reward ratio means
that you are profitable with
only a 33% winning percent
and break even with a 25%
winning percentage,” he said,
bringing out a napkin to write
on.
Lose -$100
 Lose -$100
Make +$300
After three trades your profit
is +100 with a 33% winning
percentage 1:3 Risk/Reward
Next Example:
Lose -$100
Lose -$100
Lose -$100
Make +$300
Break even with $0 with a
25% winning percentage 1:3
Risk/Reward (Before
commissions and slippage).
Another example!:
Lose -$100
Lose -$100
Make +$300
Make +$300
Profit $400 with a 50%
winning percentage 1:3
Risk/Reward
“If a trader can get the
right risk-versus-reward
ratios in their trading system,
they can have an edge that
doesn’t require a winning
percent greater than 50% to
be profitable. Having only
small losses with big wins is
an edge in itself and leads to
profitability.”
“I see,” New Trader said.
“Being right half the time
with these sizes of losses
versus wins is a very
profitable risk management
system. A very favorable
risk/reward ratio creates
robustness in your trading
methodology from a money
management perspective and
eliminates the risk of ruin…”
“Yes,” Rich Trader replied.
“This frees the trader to focus
on a great methodology that
gives him key entries with a
potential upside three times
greater than the potential
downside. Keeping the losses
asymmetric versus the wins
also alleviates a problem that
most new traders experience:
A few big losses giving back
long-term profits quickly as a
market environment changes,
and what used to work stops
working. While the
risk/reward ratio is by no
means a perfect science, it’s a
great blueprint to try to work
inside of as a trading plan and
method is built. Of course,
the trader will have to deal
with some price gaps in open
positions that make losses
bigger than planned and there
will also hopefully be some
really big wins that are even
more than three times the
losing trade during trends if
profits are allowed to run
with a trailing stop. ”
“It changes much of the
dynamics of entries when you
are looking to risk $1 to make
$3 instead of risking a lot to
make a little,” New Trader
said contemplatively. “It
makes the trader consider the
wisdom of selling option
contracts even with high
probabilities of wins because
the losses during random
outlier events can be
devastating and wipe out
long-term profits in one
massive loss. Option buyers
can be profitable if they trade
small enough to survive the
string of losses to get to the
big winning trade which may
be 10 to 20 times the size of
the previous losses. Option
buyers with a high winning
percentage can be very
profitable due to the built-in
asymmetry in option
contracts where they are
constructed in a way that
limits losses to the size of the
contract, but have an
unlimited upside as their delta
expands.”
Rich Trader nodded.
“Most trend-following
systems work because they
are trades on the side of the
huge trends in plunging bear
markets or parabolic bull
markets. It’s not magic; it is a
favorable risk/reward ratio
that is used while managing
risk until they get the big
payoff. A trend-following
system is designed to find key
points for entries which give
good probabilities for a trend
to begin. If the trend fails,
they stop out for a small loss
and try again for that big win.
Many trend-following
systems have very low
winning percentages but at
the same time huge winning
trades which more than pay
for all the losses given
enough time. That is the real
reason they are profitable,”
Rich Trader said, pausing as
his tea is refilled.
“Regardless of whether a
trader is trading a trend,
swing trades, day trading,
trading options, futures,
Forex, or anything else, their
profitability is based on only
one thing: Their overall
profits are bigger than their
losses. That is the final judge
of a trader. Can you risk a
little to make a lot while
surviving a string of losses?
Risk management is really
the final judge on whether we
make it as traders or not, even
if we have a great trading
method and have the right
mindset,” Rich Trader said.
“This is really a shift in the
way I should be looking at
my trading,” New Trader said
thoughtfully. “A winning
percentage of 50% should be
accomplished even if entries
were random. The weight is
not on winning all the time
but finding the big wins while
capping the losses to keep
them small. A few really big
wins in a string of small
losses will make a trader
profitable. In building my
trading system I should be
looking for trades with a
limited downside and
potential to trend up from my
entry. I will be looking at the
probabilities of my trade
being a winner that is three
times the size of my stop loss
level. This shifts my focus
from winning trade
percentage to trend
identification and capture.”
“All of trading is really a
bet on identifying a trend in a
certain timeframe, but profits
come from making more
money than you lose,” Rich
Trader said.
 CHAPTER 15

A good trade follows

a trading plan even
during draw downs
in account equity; a
bad trade is a big
trade made to
quickly get even after
a string of losses.
“Trying to trade
during a losing streak
is emotionally
devastating. Trying to
play “catch up” is
lethal.”
– Ed Seykota

“Do you know what the

most dangerous moment for
any trader is?” Rich Trader
asked.
“What’s that?”
“When they are down over
10% in their trading capital
and want it back immediately.
Draw downs lead to
emotional and mental pain
and the ego wants to prove
that it is a great trader by
getting the lost capital back as
quickly as possible. This
emotional urgency to get
back losses quickly can set
off a chain of errors for the
new trader and maybe even
more experienced traders,”
Rich Trader began. “Under
the internal pressure to be
made whole and relieve the
mental pain of losses, traders
will leave their trading plans
so they are free to get their
accounts back to even quickly
without the bothers of risk
management and proper
position sizing. Some traders
believe their decision-making
process and opinion are better
than the trading plan that took
their capital down 10%. Then
the fever strikes: They just
need that one really big trade
to take them back to even. So
they increase their position
sizing during a losing streak.
They push down hard on the
accelerator when they are
driving in the wrong direction
at a time when they should be
tapping the brake to slow
down.”
“I can see how that could
happen,” New Trader said.
“But when you’re in a losing
streak, that’s the last thing
you want to do, right?”
“Exactly, generally, if you
have built a solid trading plan
around a robust system with
the right position sizing, then
draw downs are more of a
function of the markets
simply not being conducive
to your trading method. It is
time to trade smaller and be
patient until the market
dynamics return to your type
of trading. Trading big
position sizes always leads to
big losses; it is just a matter
of time whether it is now or
later. The way out of a draw
down is to stick to your plan
and survive it, not try to be a
hero and get out of it in a few
big trades.”
 “Yes, that’s one of my
biggest weaknesses. It’s like I
turn into a different person
after I start losing money
trade after trade. It’s usually
when the market suddenly
changes dynamics from
trending to chopping or range
bound to trending. Suddenly
my best trade setups quit
working. Buying dips that
don’t hold, buying breakouts
that don’t follow through, or
the volatility spike makes it
necessary to trade smaller.
When I have many losing
trades in a row, my emotions
and ego are activated,
creating noise that lays
dormant during winning
streaks.”
“Yes, but you can’t listen
to those small voices. You
have to believe in your
trading plan and methodology
more than those whining
voices in your head! This is
the major line that separates
rich traders from new traders:
the ability to follow a plan
and ignore emotions and
ego,” Rich Trader said, his
voice taking an unusually
stern tone. “The way you
handle losses and losing
streaks determines your
success as a trader more than
any other thing. Even
winning trading systems
don’t work if you cannot
handle losses correctly.
Traders cannot be successful
unless they can manage their
emotions along with their
money. Most traders lose
when they abandon their
discipline for whatever reason
and trade freestyle. Survival
as a trader is based on the
ability to stay disciplined
with entries, exits, and risk
management. Once discipline
is abandoned, the clock starts
ticking to eventual ruin.”
 “Yes, you’re right,” New
Trader replied. “That really
hits home. I need to work on
my skills of being bored
without the need to do
anything, the patience to trade
only when the setup is there,
and the ability to find
something to do when I can’t
trade due to market
conditions. A lot of the
mistakes I make during draw
downs stem from my desire
to do some kind of work to
get my money back. Not
doing anything and just going
to see a movie or read a book
seems counter to the work
ethic I’ve been raised with.”
“Well, we make our money
in trading not by simply
doing something but by doing
the right things – and
sometimes the right thing is
doing nothing. Trend traders
have to leave winning trades
to run. They have to leave
choppy markets to chop. The
way out of a draw down is
simply to trade smaller and
smaller until you start
winning again and then trade
bigger back to a normal size
as the markets give entry
signals that work,” Rich
Trader said. “It’s crucial as
you enter a losing streak to
not be ruined financially,
emotionally, or mentally.
When you are down with
multiple losing trades in a
row, it is time to cut your
position sizing in half and
stop the bleeding, not
increase it. If the losses
continue, get down to trading
a quarter of your normal size.
It is crucial to lose the least
amount possible in a losing
streak and win the most
possible during a winning
streak. You do not want to
compound a losing streak by
trading bigger or miss an
opportunity in a winning
streak to maximize big wins.”
“So I have to replace my
urge to get back to even
quickly with a desire to keep
the draw down as small as
possible. I need to see the
possible trap and stop trying
to get the cheese,” New
Trader said.
“When traders can see the
dangers first instead of the
potential money to be made,
they have moved to a new
level in their trading. When
your account is underwater,
that is the most dangerous
time because you feel you
must get back to the surface
quickly. You start to drown in
self-doubt and criticism about
whether you are a good trader
or your method works. You
have to have enough faith in
yourself and your system to
stay the course, allow as little
damage as possible to your
account, and patiently take
your trades until the winning
begins again. Traders cannot
base their decisions on their
feelings or opinions during a
losing streak; they must trade
the facts and the plan
regardless of circumstances.
If there are tweaks to be made
due to flaws in the plan, those
should be done logically
based on facts away from live
trading and market hours, not
based on emotional reactions
to money lost or a draw down
from a certain market
environment.”
New Trader nodded
thoughtfully.
“So when I start to feel like
I am drowning I should stay
calm and focus on swimming,
not panic and start flailing
about. The way out of a
losing streak is to keep
trading positions as small as
possible and then get on a
winning streak. That is made
difficult if I turn a losing
streak into a bigger losing
streak with big emotional
trades.”
“Exactly… The biggest
danger in losing streaks and
draw downs is when traders
blow themselves up
emotionally and mentally and
turn a losing streak into
financial ruin with a few
really bad trades fueled by
desperation. Traders can
come back from losses of
capital but they can’t come
back from a complete loss of
confidence in themselves to
make the right decisions
under pressure.”
“I think I understand.”
 CHAPTER 16

A good trade has a

limited downside but
an unlimited upside;
a bad trade has
unlimited risk and a
limited profit.
“What’s really critical
is that you understand
that you make money
by cutting losses short
and letting profits run.
This will give you a
positive expectancy
system.”
– Van Tharp
 “You know what?” New
Trader said as he pushed his
meal around with his fork. “I
think the closest a trader can
get to the Holy Grail of
trading is to have very small
losses and very large wins in
their trading system. After all,
a trader can be profitable
even with a very low win
percentage if their wins are
big enough. On the flip side,
even a very high winning
percentage system can be
unprofitable if the losses are
big enough. A high winning
percentage winning system
can even lead to the ruin of a
trader’s account if their stop
losses and proper position
sizing is not used to control
and manage losses. The
problem, I suppose, is how to
keep your losses as small as
possible…”
“Well, when you get into a
trade, you have to know
exactly where you are going
to get out of it if you’re
wrong. The stop loss and exit
has to be set just outside the
normal price action. A stop
could be set at a close below
a key support, or a few
percentage points below a
key moving average,” Rich
Trader said, taking a sip of
coffee. “The biggest losses
generally come from either
being so confident in a trade
that the trader has no exit
plan or not taking your initial
stop loss plan but instead
holding and hoping that it
comes back. These are
formulas for really big losses.
If you add in improper
position sizing and trade too
big at the same time, you are
walking the tightrope with no
net and the losses can be
staggeringly huge. This is the
formula for unprofitable
trading.”
 New Trader nodded.
“Another way to control
losses is to only put as much
capital in a trade that you are
willing to lose. A stock trader
may put only 10% of their
total trading capital into one
stock position and an option
trader may buy an option
contract using 1% or 2% of
their trading capital and risk it
all since it has a capped
possible loss but a
theoretically unlimited upside
potential.”
“That makes sense… so
what about techniques for
having huge wins?”
“Well, for a big winning
trade you have to have a great
entry, either off a key support
level to give a margin of
safety or a break out above a
defined price range. There are
also chart patterns like cup
with handles, flags, pennants,
wedges, and others that can
give you key high probability
entries with the potential for a
trend to emerge in your
timeframe,” Rich Trader said,
pausing to thank Jane for
refilling his coffee.
“After the right entry you
have to set your stop loss at a
level that proves you are
wrong, not one that will take
you out of the trade on mere
noise inside a normal price
range for your time frame.
Stop losses have to be wide
enough to allow you to stay
in the trade and not be shaken
out with stops, but be tight
enough to keep your losses
small and contained if the
entry does not work. Traders
must position size so that it
will be hard to be shaken out
of a good trade with a little
noise and movement against
them.
 After you’re positioned
correctly you have to let the
trade run as far as it will go.
One way to do this is to use a
trailing stop instead of a price
target. A short-term moving
average as a stop or a
percentage trailing stop will
keep you in a trade until it
reverses all the way back and
through your moving stop
loss. So you will be in a trend
for as far as it will go without
predicting, guessing, getting
out at a target price too early
and missing a huge trend. The
reason many trend traders and
trend followers are so
profitable is that they have
trading plans that open them
up to truly outlying huge
moves in commodities,
indexes, and growth stocks.
Some markets provide moves
that can change a trader’s life
or at least their account size
permanently if they are on the
right side of the parabolic
moves. The key is to let the
appearance of the end of the
trend appear on the chart and
in the price action without
judging or anticipating it and
taking profits prematurely,
lock in profits at the end of
the trend when it really
bends.”
“That sounds like trend
trading.”
“Well, while trend trader
and trend follower trading
methods by their very nature
are designed to do this
systematically, all traders can
benefit from cutting losers
short and letting winners run
as far as they will go. If a
swing trader enters at a key
support level and it is lost
then breaks to the down side
and starts a downtrend, they
still need to cut their losses.
At the other end of the chart,
if a swing trader has their
trade travel all the way from
support to resistance and it
breaks out, they can still trail
their stops and let it run.”
New Trader looked up,
smiling at Jane as she took
away his plate.
“Also…” Rich Trader
continued. “Option traders
who trade from the long side
have built-in asymmetry for
their trading because they can
only lose the capital it costs
to hold the option contract,
but they have built-in
leverage and an uncapped
upside profit potential if they
let a winning option trade
keep growing in a trend.
Many types of traders can
benefit from small losses and
big winners, not just trend
traders.”
“So where do you go
looking for these big potential
trends?”
“The primary driver of
trends is fear and greed.
Traders’ desire to make
money or not to lose money
is the cause of the majority of
truly strong trends which
create higher highs or lower
lows for a longer period of
time. Most years there are
themes in each market cycle;
there are different bull
markets and bear markets
going on all the time. They
could be in gold, oil, a
currency, equities as a whole,
or a single growth stock that
is believed to be changing the
world.”
New Trader nodded
thoughtfully.
“I look for a strong trend
emerging out of a very long-
term price base. Gold could
be in its own bull market and
trend higher because the
common belief is that the fiat
currencies are doomed due to
central banks printing too
much money. The belief in
peak oil and possible
shortages looming could send
oil to $150 a barrel during a
parabolic uptrend. A growth
stock can double or triple or
even more in a very short
period of time when the
market believes that its
product, technology, or
business model will
completely change the world
and could have the growth
potential to take over a sector
or industry. My job is to find
that fear and greed and trade
that chart based on its price
action for huge wins by
participating in the trend and
keeping my losses small.”
“That’s trend following,
but what other trading
techniques do you
recommend?”
“The principles I have been
explaining to you in our
conversations work in all
timeframes and almost all
methods. If you are going to
be a day trader or a swing
trader, I believe it is crucial
that you limit your watch list
to just a few things to trade
and become an expert and
master of your trading
vehicles. If you have done
your homework and price
research and have been
trading one thing for many
years that in itself gives you a
nice edge over others because
you know exactly the
personality and character of
what you are trading and how
it tends to act at key levels
and based on different
popular indicators.
Remember though that
profitable trading simply
comes down to all your
winning trades being bigger
than all your losing trades.
That is a key area to focus on
above all else because that
determines whether you are
profitable or not regardless of
your other statistics for your
trading method. Big wins and
small losses will make all the
difference on your trading
journey and determine if you
make money trading or just
keep paying tuition to other
traders through your losses.
All traders are trying to
quantify and capture a trend
in their own time frame while
managing risk, their own
emotions and ego. That is the
core of all trading.”
“Right,” New Trader said
with a quiet laugh, looking
for their waitress.
He’d decided to take a risk
in his personal life that day.
He was going to ask her out.
 CHAPTER 17

A good trade has an

optimum position
size for that trade
setup; a bad trade is
based on feelings,
financial need, or
confidence in a trade.
“I’ve talked to many
folks who have blown
up their accounts. I
don’t think I’ve heard
one person say that he
or she took small loss
after small loss until
the account went down
to zero. Without fail,
the story of the blown-
up account involved
inappropriately large
position sizes or huge
price moves, and
sometimes a
combination of the
two.”
– D. R. Barton, Jr.

It was a windy, rainy

Wednesday when New
Trader went to visit Rich
Trader. This time he even had
an umbrella.
They settled in front of the
TV, paying no attention to the
newscast.
“When the probabilities of
your trade being right are
best, you should trade your
full position size at that time.
It is a great advantage to
understand the basic
probabilities of different trade
setups in different market
environments. A gap up for a
hot growth stock after
earnings has a different
success rate than a break out
to all-time highs out of a
price base for the third time
in a month. Buying a third
bounce off support of an
index has a different chance
of working than a break to
new all-time highs out of a
base for the same index.
Different chart patterns and
different trading vehicles
have their own personalities
and it is crucial that a trader
does enough homework to
understand those dynamics.
What you want to do is have
the biggest trade sizes when
right and the smallest trade
sizes when wrong. That
comes from knowing the
basic odds of each entry point
working or not,” Rich Trader
said.
 “So it’s the different
quality of setups? A trader
needs different position sizing
based on odds?”
“Yes, exactly. One
example of this for me is that
my trades on the short side
are much smaller than my
long trades. Going short the
stock market is really trading
against the historical long-
term flow of capital and the
down trends tend to be much
more short-term and broken
up by rallies even in bear
markets overall. The long-
side trends tend to be much
smoother with less whip saw
reversals because I am simply
trading with the flow of
capital.”
“So what’s an example of a
very high probability trade
for you?”
“One of my favorite trades
is for a growth stock to break
out of a one-month price base
range to new all-time highs
leading up into earnings.
Another is a gap up after
earnings for a growth stock.
Of course with these types of
trades I need the company of
the stock to be unique and
change the world in some
way to create momentum
from buyers piling into the
stock. Of course, when I say
full position I still mean to
never risk more than 1% of
trading capital through proper
position sizing based on
volatility and your accounts
trading size,” Rich Trader
said, glancing at the door.
He seemed to be expecting
someone.
“There is a very big
difference between wanting
to trade maximum position
sizing allowed because of a
high probability setup and
getting greedy and risking a
blow up of your account.
Knowing the difference is
crucial for long term survival
as a trader. Most new traders
do not understand the
mathematical probabilities of
the risk of ruin. The risk of
ruin can be determined based
on their capital risked per
trade and winning percentage.
No matter how sure you are
of a winning trade, never
expose your trading account
to a position size that would
put it at risk of ruin. A
maximum position size may
be risking 1% of total trading
capital while a normal trade is
risking 0.75% and taking
ordinary trades may risk half
a percent. Of course, the
parameters you set are
personal choices on your own
personal trading plan.”
“I have seen that. So much
of what you have been trying
to teach me is simply pointing
me in the right direction, not
giving me a system or
method.”
“Trading is a very personal
undertaking, like many other
things in life. If you went a
matchmaker to learn the best
way to get a spouse and have
a happy marriage, the
counselor would not give you
their own wife. Instead, he
would teach you the big
universal principles that work
in dating, in having a fiancée,
and how to have a happy
marriage so that you can go
find your own wife. The
specifics he uses for his own
life and how he found a wife
may not fit yours because you
are a different person and
your potential wife will be
different.”
New Trader’s brow rose at
that. It was an unusual
comparison, but accurate.
 “In relationships there are
universal principles like
listening, communication,
respect, and romance, and the
same applies to trading. The
universal principles of trading
are risk management,
psychology, and a robust
methodology. The difference
lies in the specifics of both
endeavors. One person’s wife
may like red roses while the
other prefers dark chocolate.
This does not mean one of
these is bad. They are just
opinions and both wives can
be happy and both husbands
can be successful,” Rich
Trader said.
“What if all winning
traders are using the same
principles but think they are
all different because of
different methodologies?”
“Yes, that is very true on
many levels. Traders who
agree on trader psychology,
risk management,
risk/reward, and even trend
can get into heated debates
with a religious fervor about
why their specific
methodology is best and point
out the flaws in others. If a
trader is ignorant of another
trader’s method it can get
heated quickly through
disrespect and judging.”
“Isn’t that the truth,” New
Trader muttered, thinking of
his own little blog that had
spun out-of-control
conversations.
That was when the door
opened and New Trader’s
expression became one of
confusion.
“Jane?”
She looked up at him,
smiled, and waved. “Oh, hi
there, I just came by to drop
off some things for my Dad.”
 “Your…” New Trader
said, looking at Rich Trader
incredulously. “Dad?”
Rich Trader grinned. “Of
course. And honestly Jane,
can’t you even afford an
umbrella?”
 ABOUT STEVE:

Steve Burns has been an

active and successful in the
stock market since the late
nineties. He is the author of
six books published by BN
Publishing (available at all
major Internet retailers).
Steve consistently ranks in
the top 500 of all reviewers
on Amazon.com; he is also
one of the site’s top reviewers
for books on trading. He has
been featured as a top Darvas
System trader on Darvas
TraderPro.com. He is a
frequent contributor to
TraderPlanet.com, Traders’
Online Magazine, and See it
Market.com. His reviews of
trading books have been
featured on
BusinessInsider.com. Steve’s
NewTraderU.com blog is
frequently featured in the
news at Forexfactory.com
and on The KirkReport.com.
The author has been
interviewed for the online
version of The Wall Street
Journal. He lives in
Nashville, TN with his wife,
Marianne, and they have five
children: Nicole, Michael,
Janna, Kelli, and Joseph, and
one granddaughter, Alyssa.
 ABOUT JANNA:

Janna is an avid reader

and writer of fiction. She has
read hundreds of books on the
art of fiction writing and is a
huge fan of fantasy fiction
novels. She was the co-author
of the top selling book “New
Trader, Rich Trader,”
applying her skills to
character development and
plot.

CONTACT STEVE:

E-Mail:
stephenburns@bellsouth.net
Twitter:@SJosephBurns
He blogs at
www.NewTraderU.com
He created a Facebook page
for New Trader U:
https://www.facebook.com/New
Steve runs the Facebook
traders group: New Traders,
Rich Traders, and Good
Traders.
You can request to join
through his personal
Facebook page:
https://www.facebook.com/Ste
 REFERENCE
SOURCES

http://www.tischendorf.com/qu
http://www.businessinsider.com
tk-best-things-paul-tudor-
jones-has-ever-said-2011-8?
op=1
https://www.facebook.com/thee
http://www.vantharp.com/tharp
concepts/position-sizing.asp
 RECOMMENDED
READINGS

You Can Still Make It In The

Market by Nicolas Darvas
The Richest Man in Babylon
- Illustrated by George S.
Clason
Invest like a Billionaire: If
you are not watching the best
investor in the world, who are
you watching?
New Trader, Rich Trader:
How to Make Money in the
Stock Market by Steve Burns
How I Made $2,000,000 in
the Stock Market: Now
Revised & Updated for the
21st Century
By Nicolas Darvas, Steve
Burns
Stock Options: The Greatest
Wealth Building Tool Ever
Invented
By Daniel Mollat
Show Me Your Options! The
Guide to Complete
Confidence for Every Stock
and Options Trader Seeking
Consistent, Predictable
Returns
By Steve Burns, Christopher
Ebert
How I Made Money Using
the Nicolas Darvas System,
Which Made Him $2,000,000
in the Stock Market
By Steve Burns
TRADING SMART: 92
Tools, Methods, Helpful
Hints and High Probability
Trading Strategies to Help
You Succeed at Forex,
Futures, Commodities and
Stock Market Trading
By Jim Wyckoff
How to Get Followers on
Twitter: 100 ways to find and
keep followers who want to
hear what you have to say.
By Steve Burns

Available at
www.bnpublishing.com