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There have now been enough occasions where people I’ve met have inquired on how I make money in the stock market. I honestly don’t have an answer. The reality is I’m still learning and developing my trading methodology. However, while I don’t have much experience to share, I do have some that should at least help beginners avoid a few of the more… expensive pitfalls. After all, The University of the Stock Market charges a rather hefty tuition. You should avoid paying this tuition whenever possible! I hope the information in this primer will give you a better head-start in the world of retail trading. With any luck, you won’t have to give up thousands of dollars in tuition fees.
In general, there are two groups of retail traders1A retail trader is an individual investor who buys and sells securities for their personal account and not for another company or organization. Also known as an “individual investor” or “small investor”. – Investopedia Dictionary: the brave retailer trader and the overly cautious retail trader. I rarely meet anyone who fits somewhere in between these two extremes. The former tends to figure things out themselves eventually (hopefully, before their account blows up). Usually, these are individuals with a more aggressive personality who are less willing to listen to anyone else’s experience. This is an immense advantage as trading is artistic in nature and such an individual will test and forge their own trading style. But at the same time, they are disadvantaged as few people want to engage with them due to their constant desire to debate. As a result, they miss out on opportunities to learn invaluable trading lessons for free. The latter group is the scared trader who sits on the sidelines humming and hawing at whether they should dip their small toe into the financial markets. They’ve heard all the scary stories of how friends and family members have lost untold sums of hard-earned money to the ether of the financial markets. Perhaps they themselves have had the experience of losing great sums of money. The disadvantage of being in this group is that they’ll never gain invaluable market-sense2Market-sense is a term I made up. It is the trading equivalent of game-sense for gamers. That is, an intuition developed from practice & experience – whether it is in gaming or trading. because of their non-participation. Yet, they are the most receptive to listening and learning from others’ mistakes. It is my hope that the following information will impart confidence and wisdom to the latter group.
What books should I read before I start trading?
When I first started, I wish I knew which books to read. If I had, I would’ve saved myself from a great many hits to my trading account. I would recommend every aspiring trader to read the following in this order:
- Reminiscences of a Stock Operator by Edwin Lefèvre. This is a semi-autobiography of Jesse Livermore – one of the greatest stock traders of the modern world.
- How to Trade in the Stock Market by Jesse Livermore. Jesse Livermore wrote this book shortly before he committed suicide. It is packed full of his thought-processes and principles. This isn’t a trading strategy or methodology – it is all about the principles of trading.
- Summary of Trading in the Zone by Justin Miracle. This book summarises the contents of Mark Douglas’ Trading in the Zone book. In my opinion, the summary is much more concise and I prefer it over the actual book.
- The Richard D. Wyckoff Method of Trading and Investing in Stocks: A Course of Instruction in Stock Market Science and Technique (1931) by Richard Wyckoff. This is a price-based reading of the tape methodology. It is an invaluable read in every trader’s toolkit.
Are there other resources that I should read?
Absolutely! There is plenty to read and you’ll probably find yourself reading a great deal in the first two years of trading. Be careful though – not everything you read is of value and some can even be harmful. Here are six resources that teach key principles that every trader should learn:
- The 6 Stages of a Trader. There are many variations of this concept – the 4 stages, the 5 stages, etc. But they all refer to the same general concept: that every trader goes through certain common stages of learning & development before they become successful traders.
- How institutional traders trade. The majority of the market’s liquidity comes from institutional trading. They are the ones “making the market”. It becomes useful to understand how these people trade. (Answer: no different from anyone else but definitely a lot less complex than what most people are led to believe.) I recommend reading the following thread carefully from ForexFactory especially Skenobi’s comments. He skirts around the key questions and answers them indirectly. You need to read his comments carefully.
- An example of good market-sense. Vlad maintains this website and has a dedicated page where he shares insight into his trading habits. You can tell that he has market-sense by how he approaches trading. Pretty much everything he says on this page is correct insofar that it’s almost identical to my experiences and that of many other traders as well.
- Avoiding Fraudulent Trading Courses. Emmett Moore went to prison for securities fraud. After he served his time, he built the Trading Schools website to review trading courses and to expose the fraudulent ones. It’s a useful tool to see which techniques and strategies don’t work in the markets.
- Golden Zones. These are not magical zones that result in amazing profits (to the author’s credit, he says elsewhere that he has trouble making money from the strategy). But what it does teach is how to draw proper support and resistance lines on your chart. And it also teaches the concept that the line is not a solid line – it is a zone. Price doesn’t have to touch the line, it just has to come close to it. In addition, certain levels (these golden zones) are remembered by the market. The market tends to slow down when price approaches these areas. It may or may not reverse its course but it does respect the levels to a degree. Lastly, by virtue of the difficulty in making money with the golden zones, we can learn that there is absolutely no point to guess where price will go next based on key support and resistance levels.
- A Primer on Trading Based on Price. This primer from dbphoenix teaches the principles of trading based on price.
Sure! I would be delighted to share some of the things I learned with you. And for your reading pleasure and convenience, I also included the tuition prices (in USD) where appropriate.
- There is no perfect system/technique and what works for one person isn’t likely to work for another. Trading is like painting – it’s all based on the artist’s personality. Develop your own technique that works for you. I recommend all beginners to stick with equities until you master it. Don’t venture into Forex (currency market), futures, or other derivatives (options, etc.). Equities is the best route because it is constantly manipulated3When I refer to market manipulation, I am not referring to illegal activities. Rather, I refer to it in a neutral manner; institutional traders know the value of a given stock and as a result, they place their positions in a similar manner (from one institution to another). In this way, because they are the largest stakeholders, the market is effectively stacked in their directional bias. This is the “manipulation”. by institutional traders. The key then is to figure out what they want to do with the price. I learned this: by the time price moves in a big way, it’s too late – the institutional traders had already determined and placed their positions at least 1-2 weeks before the actual event. The actual event is a result of supply & demand dynamics and sometimes, even major news announcements become a catalyst to move price in the pre-determined direction. The retail trader generally does not have access to the type of resources that institutional traders have. The only thing we can rely upon is price. If you can figure out how to know what they’re doing through price, then you will win big often.
- Everyone loses and everyone loses regularly – it’s how you handle the loss that matters (that is, get out right away). The key is to manage and to protect your money. Don’t ever, ever average down losses. It is the few big wins that makes the money and covers all the small losses. In other words, a game of numbers. This is called “the edge”. Put more simply, this is practical financial risk management. This lesson was learned with a 6-month loss of trading time and approximately $15,000.
- All chart and pricing indicators (such as MACD, Simple Moving Averages, etc.) are lagging. They are also completely useless – not even if used sparingly or for confirmation of a trade idea. They are utterly worthless. A simple, clean chart with volume and perhaps Average Trading Range (ATR) is all one needs. If you feel up to it, you can throw in a volatility indicator but even that’s not very helpful. I have seen volatility reach extreme lows and highs but the price did not move in the expected direction. In other words, fairly useless. The less you have on your screen, the better. The private tutoring for this lesson cost about $5,000.
- Drawing some support and resistance lines is a good and helpful thing. As Skenobi notes from ForexFactory (see additional resource #2 above), the market has “memory”. However, not every line is useful. Just focus on the super obvious lines.
- Candlestick price action is useless. All of that Japanese candlestick reading is the same as reading tea leaves. Oftentimes, the “perfect candle” appears and the market does the exact opposite of what everyone teaches. You need to actually go “into” the candle and figure out what’s going on with price. Most of the line drawings and shapes are also equally useless (triangles, flags, pennants, double tops, bottoms, etc.). People draw what they want to see and every time without fail, people see the bunnies in the clouds. This is confirmation bias. If you need to draw the pattern, then the pattern is not easily identifiable – in other words, the pattern doesn’t exist! The “correct” patterns are ones that are super obvious at a mere glance! Plus, you shouldn’t really be relying on patterns – these can be wrong. Only learning how to read price and what it means will result in solid profits. The visual patterns merely confirm what price should’ve already told you.
- Price and volume go hand in hand. This is the only truly “leading indicator” available (technically, it’s not really an indicator since it’s raw data).
- Diversification loses money. Focus on one or two stocks and become an expert in those.
- Fundamentals are mostly useless. It works similar to news from mainstream media that is, it acts as a catalyst for the pre-determined move. It does sometimes help provide a well-rounded picture of the particular security or general market sentiment. But price is the only thing that can tell you anything worthwhile.
- Don’t trade any stock with less than 3 million volume. I paid for this particular semester with a $14,000 tuition.
- Understand how supply and demand works (some people refer to it as “market auction theory” which has its place but supply & demand is actually far simpler than M.A.T.). For example, why does Bitcoin move like it does with huge price swings? This is because there is no supply (shares) available. The shares are tied up somewhere – someone has the shares or someone has borrowed the shares by shorting the market. Either way, they are not letting go. Therefore, the few shares available are at a “premium” (low supply with high demand = you pay a premium for the shares). As a result, there is also low volume. This is what causes the enormous price swings. This is also one of the few signs of a “bubble”. Once you understand supply & demand, you will be able to do so much more with reading price and you’ll be able to avoid high-risk trades that can destroy your trading account in a matter of seconds.
- Don’t over-trade. I over-traded this year (2017) and suffered for it. Losing due to over-trading is the equivalent of “death by a thousand cuts.” I paid for the lesson with about $10,000.
- Don’t trade in reaction to a news event. Remember what I said above? News is at most a catalyst to any major move. If you were paying attention to price, you wouldn’t be caught in this situation. Also, rallies or bear moves after major news is released has a tendency to reverse within a day or two. I see it all the time. If I have a directional bias formed on sound price analysis, I always wait patiently and I walk away from the screen to do something else for the day.
- Follow the trend. Don’t trade against it. Also, notice how the lows of most consolidation ranges tend to touch the original breakout level. This popular course has a high enrollment rate among traders. It cost me roughly $20,000 – $30,000.
If you add up all my tuition fees, you would undoubtedly realise that I lost about $74,000. But that only includes the amounts that I mentioned – there were other losses. At the end of the day, it was $74,000+ of profits that could’ve stayed in my account. Comparably, a Harvard, Caltech, or MIT undergraduate degree costs around $100,000; my degree from The University of the Stock Market is almost as expensive – and I don’t even get a certificate! The only saving grace from all this is that the majority of the losses were paid by profits that I fortuitously managed to take out of the market. I would have much preferred to learn the hard lessons from someone else’s losses!
How does your screen look like?
Here are some examples of what my screen looks like.
First image: on the left, I have my watchlists – general lists of specific market sectors that I trade and watch closely. On the main part of the screen is the chart. Below that is a volume histogram overlaid with a volatility indicator. Below that is an Average Trading Range (ATR) histogram. I don’t use anything else – this is it. You might have also noticed that I’ve drawn some horizontal lines on my chart (the thick black lines, the light blue lines, and the yellow lines). These are the areas of support and resistance. The black lines represent major levels, light blue lines represent minor levels, and the yellow lines represent a golden zone (see additional resource #5 above). In this particular example with Alcoa (AA), notice how price dropped from the high of $50.31 down to the golden zone. If you look at the candlesticks in the zone, they have been moving sideways for a little under 5 weeks! This is actually a perfect example of how the golden zones work – price respects this level immensely and it slowed its downward advance when it hit the zone.
Second image: this is my options chain screen. On occasion, I trade options (a derivative of stocks). But I only do so because I started out learning options (specifically writing options – that is, selling options contracts). I started out in this manner because I used to be a commercial lines insurance underwriter and writing options contracts is very similar to writing an insurance policy. It just felt like a natural transition from the insurance world. Most of you are unlikely to have the professional training I received in underwriting P&C and financial risk. As such, I would recommend beginners to learn trading regular stocks first (and by stocks, I exclude ETFs, ETNs, etc. – only company stocks like Apple, Rio Tinto, Microsoft, and ad nauseum).
Third image: this is what I usually look at throughout the day. The first three columns are the most important columns – instrument (stock symbol & name), the mark (current trading price – changes throughout the day), and the trade price (my purchase or selling price). I don’t stare at these numbers! But I do check them periodically throughout the day. This is what I mean by trading through price. All I’m doing is looking at the mark and as I do so, my mind begins to see patterns. It is the strangest thing indeed! The mind notes certain numbers at certain times of the day. Then it somehow forms patterns and as a trader, I begin to notice certain re-occurring behaviour of the price. With these patterns imprinted on my mind, I am able to create a directional bias4A directional bias is simply a person’s idea of the direction they think price is heading towards.. This is also part of the reason why I suggested, in the previous section, to trade only a few stocks and become an expert at them. If you trade too many stocks (diversification), your mind will experience difficulty in creating these patterns.
What websites and tools do you use?
For trading, I use the ThinkorSwim (TOS) software. It’s only available through TD Waterhouse (Canada) or TD Ameritrade (US) and it comes with “practice mode” (paper money). In Canada, there is no access to the futures market or Forex (currency market). In addition, TOS is not perfect – you can find plenty of online complaints and commentary on its problems. However, it is one of the best available out there that’s provided under a major bank name. I have also heard good things about Tradestation so you might consider exploring that software. Disclaimer: I have not used Tradestation before, ever.
I primarily use TD Waterhouse as my broker. I have used HSBC InvestDirect in the past (didn’t like it – their online software at the time was a fossil and their fees are generally high). I have also used a smaller broker once upon a time as well (Suretrader) but they got hit by the SEC for securities fraud. You can read more about what happened on Emmett Moore’s blog. Even a large broker like FXCM has been shown to commit securities fraud. Suffice it to say, I only rely on brokers owned or backed by major banking institutions.
I use Stock Trader to track my trades. It’s a free resource for equities trading. It does not work for derivatives, futures, or currencies. but you can sort of “trick” the software into registering the prices.
I also have notebooks where I hand-write my thoughts and observations. I rarely refer to my notebooks. Rather, it is the physical act of writing that forms the synapses in our brains. This is how I train my brain to understand and analyse price. Lately, I have been typing some of the material, printing it out, and sticking it into my notebooks. This is actually not as effective as writing things down. (You should be aware that before I type out my thoughts, I’ve already hand-written and analysed a particular idea in great detail.)
I don’t rely on news but I do read a ton of it. In fact, when news says to do one thing, I have a tendency and itch to do the exact opposite. In my opinion, news from mainstream media (insofar as stock trading is concerned) is mostly misleading. You can read more about it in the books I recommended at the beginning of this primer. Besides, if you have been paying attention to anything I’ve written so far, you’ll realise that news is a lagging indicator. By the time you read the news, the major move is probably over or recovered! Only price is leading, accurate, and unbiased.