The Tao of Trading
The Tao of Trading

The Tao of Trading

Today, the best investors have the best filters of information. (Location 29)

Finance, in particular, is a field where conventional wisdom can really trip you up, or at least lead you to some less-than-stellar results. (Location 148)

Why do we continue to struggle when access to information on how to become wealthy has never been faster, cheaper, and more abundant? (Location 292)

When someone tells you that 10 percent per annum is a great return, they are almost certainly not lying to you intentionally. It’s just that they have never been shown how to generate returns of 50 to 100 percent or more on a single trade. I’ll show you how this is possible later in this book. (Location 319)

If you are already rich, Wall Street firms can do a decent job of keeping you rich. But if you are looking to grow your wealth quickly, you must take on this responsibility yourself. (Location 341)

Investment houses are nearly always cautiously optimistic. But what does this even mean? (Location 357)

The fact is finance can be made to be damn complex and difficult. But it absolutely doesn’t need to be in order to make money from the markets. (Location 370)

When it comes to trading, simpler is almost always better. Adding layers of complexity only serves to increase uncertainty. And increased uncertainty leads to doubt, doubt leads to fear, and fear is the place where all of your worst nightmares can thrive. (Location 372)

Over the course of my career I have met literally thousands of people who participate in the stock market. If asked, the clear majority of them—I estimate at least 90 percent—would characterize themselves as investors in the market. (Location 376)

Real investors are owners of a business. They buy stock in a company because they understand the business, they believe they’re buying in at a fair price, they look forward to participating in the profits of the company over many years, and intend on holding the shares for a long time, often indefinitely. (Location 383)

Real traders understand that trends in markets form and persist because of strong, human emotions. They buy and sell stocks because fear and greed create opportunities to profit from the identifiable patterns that form within these trends. (Location 386)

Many people who think they’re good investors will buy into a stock based on logic and sound reasoning. However, after they’ve bought in, they will often succumb to the emotions of fear and regret and end up selling winners and hanging onto losers. (Location 407)

Not knowing what to do with a losing position is the path to disaster for any investor or trader. Most traders (investors) fare poorly in the stock market because they do not have a set plan in place for when the unexpected happens. (Location 413)

The fact is most investors have no idea what to do when something unexpected happens because they are completely unprepared for the unexpected. (Location 427)

This is what so few investors are taught to do. “Buy and hold” and they are told, “Invest for the long term,” but this tepid advice does nothing to help the investor who, during a bear market, is in the grip of fear as markets fall day after day. (Location 429)

Often, they will find new reasons to hold on as greed—or fear of missing out (FOMO)—has taken over and they don’t want to leave potential gains on the table. (Location 436)

To be a profitable trader, you must follow a robust set of trading rules and develop strong risk management discipline; you must apply them with consistency. This will take emotions out of the equation as much as possible and keep you on the right side of the market. (Location 444)

When someone buys an ETF or index fund, they are not a long-term investor in a company whose cash flows they have modeled and whose valuation they understand. They are buying a financial asset with the expectation that they’ll be able to sell it at a higher price at some point in the future. (Location 453)

People don’t go to their regular day jobs hoping that today is the day it will be announced that they’ve won $1 million from their employer. (Location 508)

“Risk tolerance” is defined as the degree of uncertainty that an investor can handle regarding a negative change in the value of his or her portfolio. (Location 530)

Until you have lived through a bear market and seen equity markets get cut in half in real time, you have no idea what your risk tolerance really is. (Location 533)

“Asset allocation” is a strategy that promises to reduce risk by dividing an investment portfolio among different categories such as stocks, bonds, real estate, private equity, and cash. Traditional asset allocation (also known as diversification) sounds great in theory, but it will fail you when you most need it…i.e., when the shit is hitting the fan! (Location 536)

Asset classes tend to become more correlated during market corrections, somewhat muting the benefits of diversification and necessitating a downside protection strategy that goes beyond traditional diversification. (Location 543)

Having the ability to make money in rising AND falling markets means you can approach the market without emotion. (Location 558)

Financial pundits teach us to “invest” in mutual funds or “discretionary portfolios,” and to sacrifice our current desires and potential to achieve some imagined, far-off goal. (Location 562)

We only ever live our lives right now. We will never live our life tomorrow. Yesterday is a dream. Tomorrow is an illusion. So, we should do what we can to make right now awesome. (Location 588)

In order to achieve prosperity, you need to approach life with a growth mindset rather than a scarcity mindset. (Location 593)

The great news is that trading is the quickest, easiest way I have discovered to generate a second income (get a second battery!). Trading requires minimal capital outlay, it can be learned relatively quickly, it can be done part time, and you don’t need to hire any staff! (Location 598)

If you are one of the rare individuals who is prepared to acquire the knowledge, and then complete the ongoing work of finding high probability trade setups while properly managing your risk, you can enjoy exceptional returns. (Location 625)

The markets are like a mirror. They will reflect back to you whatever deep-seated attitudes you may have about money, success, your sense of self-worth, and what you believe you deserve. (Location 649)

An intermediate trader will ask “what should my position sizing strategy look like?” and “what risk management rules should I follow?” Now the golfer has played a few rounds of golf and wants to know how to shape their shots and get their score down. (Location 664)

Trading is like sex in that if you can just focus on enjoying (and getting good at) the process—without having any specific objectives in mind—the outcomes will be all-the-more rewarding. (Location 676)

To drive the sex metaphor all the way to its climax logical conclusion: trading profits are like orgasms—the more you focus on having them, the harder they are to obtain! (Location 684)

Trading becomes easy once a trader learns to ignore her own personal opinions, stops trying to be right, stops focusing on making money, and instead focuses on the process of trading. (Location 686)

I’ve taught winning setups to many traders, but the ones who don’t “get” or won’t incorporate the psychology part always end up losing money eventually. (Location 704)

Your ONLY job as a trader is to manage the net liquidating value (NLV) of your trading account, such that it rises over time. That’s it! (NLV is the cash value (Location 717)

of your account if all of your positions were closed at market.) (Location 718)

The need to be “right” is what ties so many aspiring traders up in knots. The goal of trading is to be consistently profitable, not consistently right. Yes, there is a difference. (Location 720)

As professional traders, we will have losing trades! Our responsibility is to mercilessly cut them off at the knees before they have the opportunity to destroy our trading account. (Location 744)

Understand that so long as you have followed your trading plan, you have not made a mistake, regardless of the eventual outcome of the trade. (Location 753)

An edge is “something” that stacks the probabilities in our favor. And that “something” is a trading method that: (Location 756)

You certainly don’t need to be in the top 1 percent of intelligence to make money in the market. You just need to be in the top 49 percent of being able to recognize and control your emotions. (Location 763)

Choose the nonemotional response to ANY life situation, and you will see how much easier your life becomes. (Location 767)

When trading, you must keep your emotional brain from making the decisions at all costs. The executive brain (the pre-frontal cortex) must remain in control. (Location 768)

In short—emotion is the enemy of successful trading. The markets are literally set up to take advantage of and prey upon human nature. (Location 775)

The two most damaging emotions a trader will encounter are fear and euphoria. (Location 779)

Approach the markets the same way you would a large dog. If you approach the dog fearfully, thinking “oh I’m scared, I wonder if the dog will bite me,” your interaction with the dog is unlikely to be a satisfying experience for either of you. If you approach the dog with a calm attitude of “good dog, I bet you’d love a scratch behind the ear,” the odds of a favorable outcome increase dramatically. And so it is with the markets. (Location 782)

One of the keys to successful emotional control is position sizing. Regardless of your level of trading experience, it is of paramount importance not to trade a position size that freaks you out. (Location 790)

A consistent trader isn’t hanging onto losing trades, hoping and praying they become good. They are ruthlessly pruning them from their trading account. (Location 854)

Don’t spend a minute worrying about something you can’t control. You can’t control what the Fed does, what the President says, or what the unemployment rate is. (Location 865)

Focus instead on becoming the best trader you can be. Do your homework, follow your process, and don’t deviate from this path. (Location 867)

Outcomes only become relevant after dozens of trades. If you focus on adhering to a strong process and to enjoying the process of sex trading, the odds of a pleasing outcome are stacked in your favor. (Location 871)

Successful traders move beyond the fear of making mistakes. They accept that lots of small losses are part and parcel of a trader’s life. Successful traders instead focus on probabilities. (Location 907)

Traditional trading psychology focuses on eliminating what’s bad, such as poor consistency or discipline, not following our trading plan, etc. THIS STUFF IS IMPORTANT! (Location 925)

As we were preparing to drop the raft into the river, everybody watched which way the river was flowing. And nobody thought, even for a second, about trying to paddle the raft upstream. (Location 955)

At its essence, trend following is determining the dominant trend of the stock you are looking to trade and following that trend, rather than fighting it. (Location 963)

First, trends are easy to spot, when you know what to look for. And I’m going to teach you exactly how to start identifying them in this chapter. (Location 974)

Third, trends often exhibit remarkable persistence. This has to do with basic human nature, which hasn’t changed much over the millennia and is unlikely to do so in the foreseeable future. (Location 979)

Fourth, when trend following, it’s quite easy to determine when you are wrong on a trade. This makes risk management quite straightforward. (Location 981)

Fifth, if you’re a trend follower, you are in great company. Many of the most successful traders in the world are trend followers including many doyens of the hedge fund industry such as Bruce Kovner, Paul Tudor Jones, and Louis Bacon—all of whom are billionaires thanks to trend following. (Location 985)

The first thing we need to do is determine what direction the lady is walking in. This is how we identify the dominant trend. Then we need to watch the dog…and wait for the dog to run into our “action zone” before we take a trade (I will explain this in chapter 7). (Location 1001)

The three major trends that confront traders in the market are: uptrends, downtrends, and sideways trends (or lack of trend). (Location 1005)

As human beings we are constantly extrapolating the recent past into the future. Furthermore, even though we are often unconscious of it, humans love to go with the flow of the crowd—the so-called “bandwagon effect.” (Location 1073)

Stocks that are trending strongly therefore tend to develop strong momentum. And anything with strong momentum—whether it’s a freight train, a sports team, or a stock—is going to be hard to stop. (Location 1079)

This is how we end up with chief investment strategists raising and lowering their year-end index targets for the stock market in reaction to the market rising and falling throughout the year. (Location 1099)

The momentum factor—the tendency for winning stocks to keep winning and losing stocks to keep losing—is one of the best documented factors in equity markets. As traders, we want to be buying the best performers and shorting the worst performers. We want exposure to stocks with momentum. (Location 1297)

That is to say, if price moves a long way away from its mean (which for our purposes is the 21 EMA), or spends a long time away from its mean, it is going to come back and find its mean (the 21 EMA) at some point. (Location 1525)

Enter trades when the stock price is near its mean. Exit trades when the stock price is far away from its mean. (Location 1548)

I have found that by sticking to these guidelines, I have greatly reduced my number of losing trades (and dumbass FOMO trading mistakes). (Location 1552)

With mean reversion trading you are never chasing. You are simply waiting for the market to take a breath and come back to its mean. (Location 1563)

That’s right, as option traders…we don’t make money from buying shares. We make money from renting them! (Location 1648)

This is what leverage means: large returns on a small capital outlay! (Location 1988)

Risk management is the “secret sauce” that will preserve your trading account as well as your hopes and dreams as a trader. (Location 2648)

A better definition of risk is the possibility of a permanent loss of capital. Does that sound serious enough for you? Good. Risk management is a serious business! (Location 2654)

Correct. I want you to GIVE UP on the idea of always wanting to be right. Successful traders excel at taking lots of SMALL losses and flowing from one opportunity to another. (Location 2675)

Trade with an edge but always be open-minded to the possibility that ANYTHING can happen and plan your trades accordingly. (Location 2681)

When we impose our expectations on a trade, we ruin the trade. Expectations rob a trader of the ability to appreciate their current reality. (Location 2687)

Your job as a trader is to manage the net liquidating value (NLV) of your trading account so that it grows consistently over time. That’s it! (Location 2717)

In trading, this means focusing on what actions will lead to better trading results, rather than focusing on “more money.” These actions are what I refer to throughout this book as the process. (Location 3010)

As you know from chapter 5, the 200 SMA is the line in the sand between a bull market and a bear market. When the S&P 500 is trading above its 200 SMA, it is in a long-term uptrend. It will have periods of volatility, but our base-case working assumption is that the index will be inclined to work its way higher. (Location 3027)

Often traders will start to screw up their own trading because either consciously or subconsciously, they think to themselves, “it can’t be this easy.” (Location 3297)

Professionals realize that successful trading largely comes down to maintaining a calm, decisive state of mind while trading. Amateurs are never going to be consistently profitable until they can achieve that state of mind. (Location 3409)