- 1997: Volume 6, No. 5 International Corner: The Trader's Evolution

Traders seem to go through "stages" on the road to success. It is curious that many things come in threes in the markets. Major trends can be sub-divided into three, there are three key trading rules, etc., etc. The three key trading rules, in fact, equate to the three stages through which traders must pass: Greed Oriented, Fear Oriented and Risk Oriented. However, these labels are not meant to be too literal. They are merely an attempt to approximate the three key stages.

The Greed Challenge

The "Greed Oriented" stage is characterized by ignorance and the thought that the markets will provide "easy money." The actual emotion driving the new trader may not be greed, indeed it is often something else. A successful businessman or professional may be seeking a new challenge. A similar individual may just be a little bored with his lifestyle and want something to spice it up. Others may be compulsive gamblers. One of the first problems facing a new trader is the very motivation to trade. Most people do most things emotionally. The decision as to which car to buy, which holiday to go on, etc. is usually based on emotional criteria. Just think why you own the car you do, why you married (or did not) the person you did (or did not). It is no surprise we come to the market and continue to make emotional decisions. But these will not work in the market because it is an emotional animal itself and when the emotion is screaming "sell," the successful trader is more likely to be buying. If we think about the trader who is in the market to relieve boredom it becomes clear that the strongest impulse to trade will come when he is most bored. There is no reason why this emotional point should correspond with a good time to trade the markets. Other traders suffer from self-esteem problems, indeed we all do from time to time. If so, an argument with another person can again set the trader up for taking a position, to counterbalance the low self esteem.

All of these problems have to be dealt with before a trader can find success and, in my opinion, the only way in which the trader can "see" himself is by using a fairly mechanical "system" so that he knows what he should be doing. In this way the trader can begin to see when his actions do not correspond to the system and start to question why this should be. It is through this process that we can begin to understand ourselves. This is a key requirement for trading success.

Because of these and other problems as outlined above, the beginning traders lose a sufficient amount of cash to cause pain. Many lose all of their cash. The key point is that they became fearful as a result. At the same time, they begin to realize the first secret of trading... cut your losses. It is this concept which marks the move to "Fear Orientation."

Fear of the Market

At this point stops are used, but they are generally placed too tight. The trader has realized that trading is not easy and that a lot of hard work is required. Many fall by the wayside around this point. But those who persevere do show the necessary commitment for success. But greater tests may still come and that commitment is not always enough.

Fear Orientation is inevitable given the nature of the beast, i.e., the human being. The market is not terrifying, or bad, or difficult. It just is what it is, and it gets on with its own business. It is how we perceive the market and how we act that causes the problems. We must realize that we are responsible for our results... nobody else, least of all the market itself. It is only when we accept responsibility that we can start to win. If our losses are someone else's fault, then we are in effect saying that we have no control. If we have no control, how can we win? This stage can last a long time as we work out our various problems. Fear is not helpful in the markets because scared money never wins. We cut losses too quickly and we take profits too quickly. Our trading is characterized by nervous or inappropriately quick action.

To become Risk Oriented we must make progress on all fronts. Knowing ourselves, changing as need be, understanding the trading process better, adjusting our trading methodology to suit ourselves, learning to relax when trading, are a few of the necessary requirements. Most people should immediately at least halve their trading size and that can bring immediate relaxation.

The Proper Orientation

"Risk Orientation" gets its name from the fact that you need to understand risk in order to win. Trading is a risk business. When you become risk oriented, your orientation is right for the market.

The key trading secret is letting profits run. It is at this point that you may start to make consistent profits in the market. Before you reach that stage you should never trade more than the minimum size, i.e., one contract. Why pay more in tuition fees than you need?

Once Risk Oriented you may learn the final trading secret-trade selectivity. Once you have that down pat it can all be rather boring. I make money consistently but I still find myself taking too many trades. To master trade selectivity you have to become an expert in your chosen approach. The key aspect of your approach is that you filter out a vast amount of market information and just focus on those factors which you need to know. It is a lot easier becoming expert in a narrow field than a wide one. The various sources of market information are so vast that it is not possible to take it all in. Let alone become an expert in it. You must decide what information you want, design your approach and then use it. Become an expert and you will find that you become intuitive. That is when you can select only the best trading positions, the low risk ones. Then it will all go the right way.

The Three "Stages" of Trading

Stage One: "Greed Oriented"

Loses money because:

1. Market Problems

1. Not zero sum game, "very negative" sum game
2. Market Psychology-doing wrong thing at wrong time
3. Majority always wrong
4. Market exists on chaos and confusion

2. Own problems

1. Overtrading
2. No knowledge
3. No discipline
4. No protection against market psychology
5. Random action through uncertainty, broker's advice for example
6. Market views

Result: The "Greed Oriented" trader takes a beating and becomes "Fear Oriented."

Stage Two: "Fear Oriented"

Loses money because:

1. Market Problems as above
2. Scared money never wins
3. Own problems

1. Overtrading
2. Fear brings on what it fears
3. Tries to cut losses too tight creating bigger losses
4. Still no real understanding of what it takes

Result: If trader perseveres he "travels through the tunnel" and becomes "Risk Oriented."

Stage Three: "Risk Oriented"

Makes money because:

1. He develops a methodology which gives him an edge.
2. He uses an effective money management system.
3. He develops the discipline to follow his methodology.
4. He erases "harmful" personality traits.

John Piper, FCA, ATII, MSTA, is the editor-in-chief of The Technical Trader and resides in Italy where he writes, trades and offers one-to-one consultancy on all elements of trading.