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This book doesn’t tell you what successful traders think, it teaches you HOW to think like a successful trader. And that’s what makes all the difference in every game that humans play. Alpha Trader will help anyone become an effective player of games. The book is written to help you understand yourself as a trader, it’s about great decisions and dumb mistakes. It is about how to be rational and why smart people do stupid things ALL THE TIME. Alpha Traders work hard (even when they don’t feel like it), seek to continuously improve, and love markets more than they love money.

How does one unleash Alpha? The answer is mindset, methodology, and math. The caveats are:

No one can achieve trading perfection; that is not the goal. To achieve excellence, though, we must first identify what perfection looks like, then head in that direction.
Trading involves a deeply personal journey of struggle, continuous adaptation, and self-improvement. The journey never ends because whenever you think you’ve almost mastered the game, the game changes.
Bruce Lee said: Research your own experience. Absorb what is useful, reject what is useless…and add what is essentially your own.

Know Yourself

Good traders are introspective and self-aware. When trading the enemy is YOU. Know the enemy and know Yourself – Sun Tzu
You will not succeed in trading without self-awareness and discipline.

Chapter 2: If it was easy, it wouldn’t Pay So Well

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Research shows that success in trading is hard to achieve and harder to sustain.
Trading is a negative-sum game.
The success rate among traders is low. And it makes sense since it is roughly consistent with success rates in other sought-after skill-based professions with low barriers to entry, such as fiction writing and pro sports.

Chapter 3: Understanding Success

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Shortcomings of IQ: Just to clear the air, let’s note first that whatever an intelligence test measures it is not quite the same thing as we usually mean by intelligence. It neglects such important things as leadership and creative imagination. It takes no account of social judgement or musical or artistic or other aptitudes, to say nothing of such personality matters as diligence and emotional balance.
The Big Five Most studies of personality and its impact on life outcomes use the Big Five Personality Traits. These are the five personality traits that dominate the literature on personality. The five traits use common language descriptors to classify people on five key domains. These five domains incorporate nearly all aspects of human personality, and extensive research shows that these five factors explain the majority of human character. The model is sometimes known as OCEAN because the five traits are:

Openness to experience (inventive/curious vs. consistent/cautious)
Conscientiousness (efficient/organized vs. easy-going/careless)
Extraversion (outgoing/energetic vs. solitary/reserved)
Agreeableness (friendly/compassionate vs. challenging/detached)
Neuroticism (sensitive/nervous vs. secure/confident)

Each Big Five trait runs on a continuum. The five traits capture most or all aspects of human personality, and there are many facets or more specific traits that fall under each heading. Some of these traits are more relevant to us than others. For example, I want to highlight grit and self-control as critical facets under the heading of conscientiousness, because those are important in trading.
Grit captures characteristics like perseverance, resilience, ambition, and the pursuit of long-term goals. Multiple studies show that grit is highly correlated with conscientiousness so it falls under that heading, but I think it is specifically important to trading and thus worth mentioning separately. Same story with self-control, which has a lower correlation with conscientiousness than grit, but still falls in the same bucket.
Most research shows that the Big Five traits are fairly stable over a person’s lifetime. There is just one trait that changes significantly over the lifetime of an average person: conscientiousness. There is a steady and meaningful rise in conscientiousness as we age. Conscientiousness evolves differently in specific individuals over time. Some people will massively increase their conscientiousness as they grow. Some will flatline their entire life or even become less conscientious

THE BIG FIVE AND FINANCIAL SUCCESS

Income has a strong positive correlation with conscientiousness and extraversion. It has a weak negative relationship with agreeableness and neuroticism.
Conscientiousness is the most important positive predictor of success.
IQ is also an important positive predictor.
Neuroticism is a less important, negative predictor of success.
Finally, Luck is an extremely important contributor to success in any specific activity and life overall. What we perceive as luck is often just a combination of good observation skills and the ability to seize unexpected opportunities.

In other words, conscientiousness and neuroticism are the most important traits because they are positively correlated to success in the trading arena. Remember that most of your traits are not fixed. You can improve and evolve. You can increase your conscientiousness over time.

Neuroticism leads to many negative outcomes. It can be broken down into these facets:

Irritability
Insecurity
Anxiety
Hostility
Depression
Self-consciousness
Impulsiveness
Vulnerability

If you score high in any of those traits (they are all sub-traits of neuroticism), think about how you can reduce their presence or impact. Work on these negative traits using meditation, mindfulness, reframing, yoga, professional therapy, self-reflection, and other techniques. Neuroticism will make it harder for you to achieve your goals.

If neuroticism is a kryptonite, conscientiousness is a superpower.

Here is a breakdown of the facets or sub-traits that psychologists consider part of conscientiousness:

Orderliness / order / tidiness
Industriousness / hard work/energy
Reliability / responsibility
Impulse control / self-control
Decisiveness (opposite of procrastination)
Persistence/perseverance

With the knowledge that these facets of conscientiousness are major predictors of life success, think about how you can improve in one or more of these areas. This will help you not just as a trader, but as a human being. This is especially true if you are young because conscientiousness is the trait that can most easily be boosted over time. Personality traits are not fixed, they can be moulded and improved.
Here are a few ways you can boost your conscientiousness:

Don’t say things like: “I’m just like that”, “I’m disorganized” or that’s just who I am” when it comes to conscientiousness. Being organized or on time or proactive is a choice. Think of your mind as plastic, not fixed.
Read the book: “Willpower: Rediscovering the Greatest Human Strength”, by Roy Baumeister and John Tierney. It is packed with research and anecdotes about how to improve not just your willpower, but your organizational skills and your metacognition. Acknowledge your willpower is not perfect and create systems to protect yourself from this weakness.
Create friction in places where you engage in activities you should not. An example of friction is when people turn off their phones while at dinner to avoid checking them. By making it a hassle, you are less likely to perform habitual or addictive behaviour. On the other hand, reduce friction to reinforce desirable habits. For example, if you want to get in shape, don’t make yourself decide whether to work out or not each day. Work out every day. And go to bed in your workout gear so you have one less step to take in the morning before working out. When the decision is already made, there is less friction. In trading, this means you need to build systems and install processes that protect you from unwanted behaviours like overtrading while working to automate desirable behaviours like stop-loss discipline.
Set specific and realistic short-term action goals. Instead of saying: “Man, I need to get in shape.” Say: “This month, I’m going to eat zero potato chips and work out 15 times.”
Break long-term or difficult tasks into smaller chunks and focus on doing one chunk at a time. Writing a book is daunting. Writing a few pages is not. If you focus on writing a few pages each day, a few months later you magically have the rough draft of a book. Same thing in trading. Try not to focus on your year-to-date P & L too much. Come in each day and do your best. Each year is only around 250 trading days. Take them one at a time and do your very best each day. Let the year-to-date P & L take care of itself.
Make lists. Do not expect yourself to remember everything, even if you have an excellent memory. Outsource your memory to a notes app or a piece of paper.
Be on time. Even if you don’t care about punctuality, many people do. It is rude to show up late for meetings, events, or dinner. It is sloppy and unprofessional to submit work after a deadline. Even if it doesn’t bother you when others are late, forget about your preferences. Your values around this topic are not the most important thing. Understand that punctuality is part of becoming a more considerate, thoughtful, and conscientious person. It is not OK to say “that’s just who I am.”
Adopt a continuous improvement mindset. You don’t need to make huge changes all the time. Instead, be on the constant lookout for tiny improvements you can make that don’t require Herculean effort.
Learn about inbox zero. It sounds impossible at first, but it’s not. Don’t be one of those people with 1,431 unread messages who I have to contact three times before I get a reply. That is not good!
Turn off notifications for desktop e-mail and turn off nearly all notifications on your phone. You should check your e-mail once per hour or less. It is not that urgent. Each pop-up every time you get an e-mail is a pointless distraction and will take you out of the zone when you are trading. Access your technology when it makes sense to do so; don’t be a puppet controlled by your apps.

Chapter 4: So You’re Saying There’s a Chance?

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Why do some traders succeed but most fail? After poring through all the research on trading success, two critical traits jump out:

Rationality is the human trait that best predicts trading success. People who are rational and do not jump to quick conclusions using mental shortcuts (heuristics) are more successful in trading. This characteristic can be measured as the Rationality Quotient.
Overconfidence is the human trait that best predicts trading failure. People who overestimate their ability to outsmart the market perform worst.

Are you rational?

It makes a ton of sense that rational traders outperform those who are not. Good traders study behavioural finance because humans, as a group, act in predictably irrational ways and this predictable irrationality can be exploited for profit. So, by extension, it seems reasonable to say that those who do not exhibit this irrationality will outperform.
Stanovich and others have conducted a great deal of research on how rationality and intelligence relate and while the two are correlated, there are areas where particular types of rationality are uncorrelated to intelligence. For example, highly intelligent people suffer more from confirmation bias than less intelligent people. This is why experts often underperform laymen in tasks where one would expect the expert to outperform. Confident experts have trouble taking in new information if it contradicts their existing view of the world.

Rationality Quotient (RQ) is more important than IQ.

Here are a few quotes of interest from research papers:

A common thread running through each of these behavioural biases is the individual’s inability to refrain from using automatic responses and simple heuristics.
Individuals tend to mistakenly believe that they observe predictable patterns in randomly generated data.
Studies show that people who are immune to commonly known behavioural biases perform the best in experimental asset markets.
While traders are no different in their use of ‘intuition’ or ‘gut feeling’ to other people, the majority of them are markedly improved in their propensity to engage in reflective thinking and are less susceptible to ‘cognitive impulsivity’.
The main driver of the underperformance from trading too much is transaction costs, but even in experiments where there are no transaction costs, the subjects that trade most perform worst. Good traders wait for outsized opportunities, they don’t trade frenetically, reacting to every bit of flickering price action.
It is clear from the research that rational thinking is the number one trait of a successful trader. High intelligence, numeracy and financial literacy are also important. Trading with our gut feel, intuition and similar soft skills is less important, and sometimes counterproductive.

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Chapter 5: Level Up

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The traits and habits you need to succeed

The tricky thing with market probabilities is that unlike probabilities in gambling, they are not known or measurable. You have to estimate them. Accurately estimating probabilities is a skill that gives you an edge in trading. Incomplete information is one of the challenging hallmarks of markets as an exercise in probability.

Independent Thinker

Important: An independent thinker is not someone who is contrarian all the time, disagrees with everyone, or loves playing devil’s advocate. That is not independent thinking; that is reflexive opposition. That is not good!
Independent thinking means that you analyze information using your own framework and come to logical conclusions. You develop your own beliefs, incorporating as much information as possible. “Information” can include the curated beliefs of others.
Sometimes your conclusions agree with the crowd and you hop on the trend. Sometimes you are on the other side of consensus, so you take a contrarian view.
When humans have incomplete knowledge, their instinct is to follow the group. Many people in the Asch experiment did not follow the group, but the experiment involved an easy question with an obvious answer. Everyone should have answered correctly yet almost 37% of people did not.
In markets, where incomplete information and group behavior are an intrinsic part of the game, you need to make sure you are always thinking for yourself. Don’t get caught up in the CNBC (bullish) or Twitter (bearish) hype or get sucked in by what the “smart guy at the big hedge fund” wrote in his opinion piece in the FT.

2. Think for Yourself

Also note that if your reaction when reading about the Asch experiment was: “I would never pick the wrong line in that experiment,” you are just like almost everyone else who believes that bias is something that happens to everyone else, but not to them. Groupthink and conformity bias are real and impact smart people and dumb people alike!
When it comes to independent thinking, Peter Thiel nails it with this quote: The most contrarian thing of all is not to oppose the crowd but to think for yourself.

3. Flexible and open-minded

The cure for many forms of bias in trading (and in life) is to be flexible and open-minded. This is captured by the concept of “strong opinions, weakly held”, a framework for thinking developed by technology forecaster and Stanford Scholar Paul Saffo. Here is his description of how to think:
Allow your intuition to guide you to a conclusion, no matter how imperfect — this is the “strong opinion” part. Then – and this is the “weakly held” part – prove yourself wrong. Engage in creative doubt.
Look for information that doesn’t fit, or indicators that point in an entirely different direction. Eventually your intuition will kick in and a new hypothesis will emerge out of the rubble, ready to be ruthlessly torn apart once again. You will be surprised by how quickly the sequence of faulty forecasts will deliver you to a useful result.
This sounds a lot like Bayesian updating, right? Start with a prior and update it as you get more information. You react, using your System 1 or gut instinct, then you quickly analyze your action and look for confirming or (most critically) contradictory evidence. You look not just at your chosen hypothesis, but other competing ones.
If you have a strong view, share it with your coworkers and see what comes back. Drop it on Twitter (if you are thick-skinned enough to withstand the corrosive “SOMEBODY IS WRONG ON THE INTERNET!” culture there). Send an e-mail to a few traders you respect with your thesis laid out in one or two paragraphs.
If you are an introvert, don’t feel like you have to remain an introvert forever. Push yourself to make new connections.
When you send your thesis out into the wild, the responses will inform you, not just by their content, but also by their tone. If you get a series of agitated replies with a bunch of rebuttals you can easily bat away, you are probably onto a good trade idea. Strong pushback indicates that people are positioned the other way. If you can easily refute their arguments, then happy days. On the other hand, sometimes you might get a bunch of well-reasoned replies that highlight facts you omitted from your analysis. Then it’s time to reassess.

STEP-BY-STEP OUTLINE OF ANALYSIS OF COMPETING HYPOTHESES

Identify the possible hypotheses to be considered. Use a group of analysts with different perspectives to brainstorm the possibilities.
Make a list of significant evidence and arguments for and against each hypothesis.
Prepare a matrix with hypotheses across the top and evidence down the side. Analyze the “diagnosticity” of the evidence and arguments— that is, identify which items are most helpful in judging the relative likelihood of the hypotheses.
Refine the matrix. Reconsider the hypotheses and delete evidence and arguments that have no diagnostic value.
Draw tentative conclusions about the relative likelihood of each hypothesis. Proceed by trying to disprove the hypotheses rather than prove them.
Analyze how sensitive your conclusion is to a few critical items of evidence. Consider the consequences for your analysis if that evidence were wrong, misleading, or subject to a different interpretation.
Report conclusions. Discuss the relative likelihood of all the hypotheses, not just the most likely one.
Identify milestones for future observation that may indicate events are taking a different course than expected.
Be thoughtful and look at alternative hypotheses with an open mind. Lay out the arguments against your view and see how you feel about them. Do they make sense? Are they easily refuted?

Staying Organised

Have a plan each day. Writing a quick plan in the morning anchors you and forces you to stop and think, before you start trading.
If you read a story on Bloomberg or the WSJ that includes the phrase “unnamed sources”, that is your first clue that the article could well be trash. A journalist can publish any sort of nonsense on the internet and there is very little consequence if it turns out to be inaccurate. The news cycle moves on and nobody goes back and rates reporters on their past accuracy. The #1 thing they get rated on is: number of clicks.
I should be making trading decisions based on market factors, not based on how I feel about my P&L or random, meaningless chart points.

Think Forward. Think Forward. Think Forward.

Spend most of your time thinking about the future path of markets and how you can predict and capitalize on that path. Spend as little time as possible thinking about trades that happened earlier today or yesterday or six weeks ago. The time to look back is when you are consciously in process-analysis mode, looking thoughtfully back on your trades and trading patterns in recent weeks or months. Otherwise, think forward.
Hindsight Harry is annoying. Nobody likes Hindsight Harry. He bothers the heck out of the people he talks to because he has a negative mindset that emphasizes past outcomes when he should be focused on process and the future. Clear your mind of past trades and focus on the next opportunity. Good traders thoughtfully review their decisions in quiet moments, long after the fact. Bad traders say “woulda”, “coulda”, and “shoulda”.

Varying Bet Size

Varying bet size when huge opportunities come along is an important determinant of trading success.
Good traders understand the importance of varying bet size based on opportunity, market volatility and their current performance. Bad traders always trade the same position size regardless of the opportunity set, volatility or P&L.
Cooling off levels. If a trader draws down X from high water or over-earns by Y, she should enter a two or three day cooling off period. During cooling off periods, all risk is cut in half. This helps stabilize P&L after weak periods and avoids winner’s tilt after strong periods.

Here are some more points to ponder over:

Be aware that when you are in a position, you are not objective. You are under the influence of bias when you are in a trade. You own something (the trade and the view that led to it) and people don’t like giving up what they own. Therefore, if you are feeling uncomfortable about a position, the best bet is to take it off. Then, once you’re flat, you can analyze with an open, unbiased mind.
Flat is the strongest position. When in doubt: Get out.
It is easier to honestly evaluate competing hypotheses when you are flat, open-minded, and flexible.
The number one way to build and cultivate self-awareness is to maintain a trading journal.
God, grant me the serenity to accept the things I cannot change, courage to change the things I can, and the wisdom to know the difference.
Come in to work each day with a positive attitude. Do the work. Focus. Behave rationally. Go home. Do it again tomorrow.
The only God of Trading is Probability
You control your own fate. Never blame external factors when you lose money.
Think about your manager’s (and investors’) incentives. Does your strategy and behavior align?
Make a concerted effort to build a strong network of trading peers.
Rule-based limits and risk-taking framework
Management Risk Appetite
A mentor
A clear connection between performance and pay

Chapter 6: Kryptonite

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Bad Habits, mistakes, sloppy thinking, and leaks

Most bad trading follows a few specific patterns. This chapter will focus on everything else that holds traders back, other than irrational and biased thinking.
Today, stock market trading is “free” in theory for many individuals. But you know the saying: if the product is free, then you are the product. In the past, you paid a transparent commission and the bid/offer spread. Now, you still pay the bid/offer spread and you pay a hidden transaction fee which is the profit earned by a high-frequency market maker which receives an ultra-short-term “free” option as it chooses how to execute your trade. Trading costs continue to trend lower but are more and more difficult to observe or measure. And they still matter.
Let’s look at some of the most common reasons traders lose money.
1. Bad discipline
2. Not enough edge
3. Overreliance on simple indicators
4. Too much focus on trade ideas and not enough focus on risk management
5. Emotion

Bad Discipline

The number one reason that traders lose money is bad discipline.

Learning the Rules is Easy, Following them is Hard

I am highly qualified to talk about the importance of discipline in trading because my best and worst trading always depends on my level of discipline. The market is like a siren from Homer’s Odyssey, always trying to get you to crash your boat into the rocks, constantly trying to make you break your own rules.
Overtrading is my kryptonite and I could write an entire book about my own battles with bad discipline. One of the great contradictions of trading is that conservative, disciplined people tend to be risk-averse while risk-loving people tend to be compulsive and undisciplined. This is not a truism, just a general relationship between overlapping character traits.

The great paradox of trading is that it demands you be both risk-loving and highly disciplined.

Most people are one or the other. You need to be both. This is the essence of the tight/aggressive philosophy described earlier. You follow the rules, you wait, you analyze, you stay patient, you ignore low-quality ideas and then (finally!) a juicy trade presents itself and you attack aggressively.

TOO MUCH FOCUS ON TRADE IDEAS AND NOT ENOUGH FOCUS ON RISK MANAGEMENT

There is a particular level of P&L where I know I tend to get sloppy so I use conditional formatting in my P&L spreadsheet to create an alert. The month-to-date cell turns orange as the “I’m doing too well” level gets close and then the cell turns red once the overearning threshold is crossed. For me, trading well seems to lead to more good trading up until a point and then eventually I hit a point of overconfidence/sloppy trading which sometimes leads to a big drawdown.
This phenomenon is also called “Winner’s Tilt”. Tilt is usually a condition associated with traders or poker players that are losing or on a run of bad luck. They go on “tilt” which means they start chasing with bad cards in bad situations because their minds are flooded or they are seeing red.
In contrast, Winner’s Tilt is another way of describing the house money effect: temporary madness brought on by a series of winning trades or winning days. I can feel this coming on now as usually I feel a bit giddy when it’s happening and might even find myself singing or joking around more than usual on the desk.
The takeaway here is that you need to be aware not just of your own general level of risk appetite but also of how your risk appetite changes under different conditions. I described the house money or “Winner’s Tilt” effect in that story and you probably have similar personal experiences.

Chapter 7: Smart People Do Stupid Things

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In Chapter 3 you learned that superior performance on the Cognitive Reflection Test (CRT) predicts trading success. In other words, traders that rely on System 1 and heuristics (thinking fast) will underperform traders that favor System 2 and logic (thinking slow). There is a conundrum here though: trading requires fast decision making!
It’s important for you to internalize the fact that mere awareness of a bias does not make you immune to it. So first we will examine the different types of trader bias, then discuss techniques to deal with each. This chapter will outline the types of bias that vex traders, and present specific methods you can use to avoid, or at least reduce, their potential damage.
Perhaps surprisingly, research shows that the more difficult a task, the more overconfident people tend to be. This is obviously a problem when it comes to finance, given its extraordinary challenges. Research shows that training and experience can reduce miscalibration (of confidence), but only to a minor degree. You must appreciate and understand that we all tend toward overconfidence. Remain humble and do your best to consider what you don’t know or might be missing in a given situation.
If the market was always right, you could never make money. On the other hand, markets are generally very efficient; they are usually right, or correct themselves quickly. You should always give the market the benefit of the doubt and think about what you might be missing before you decide to challenge the wisdom of the crowd (i.e., the current market price) by entering a trade.
You must come to grips with the fact that trading often involves sitting there doing nothing, just waiting for a great opportunity. Unfortunately, the numbers moving up and down on that screen are like squirrels, and you are a dog.
Various commentators, including Jean-Paul Sartre, have commented that war is “…hours of boredom interspersed with moments of terror”. Trading can often be the same.

Your default mode should always be to do nothing

Flat is good. A trader with no position has no bias.
You should not be cancelling your take profit sell order just because “it looks bid”. It always looks bid at the high.
A good trading process usually involves some sort of written trade plan. It is not always practical to completely write up a trade before you put it on, given that short-term trading often requires quick thinking and rapid execution. That said, once you have the trade on, you usually have plenty of time to write it up afterwards. By doing so, you justify the trade, you game plan it and you may find out that the trade was a dumb idea before you get stopped out. Have the flexibility to get right back out of a trade if you realize as you write it up that the idea is weak.
Stop staring at the screen. Take a break from the screens once in a while. Staring at price action will lead to suboptimal decisions triggered by price action and random noise. Once you have a position on, let it breathe. Price action is mostly meaningless. Staring at the screen ups the amount of stimulus you receive each day and may lead to excess action.
Set a maximum number of trades per period. This needs to be logical and based on your trading history. Answer this question: When I am trading well, how many trades do I execute per day or per week? Then set a maximum that you feel is close to optimal. A lower number forces you to be more selective (and tight/aggressive). On the other hand, your returns will suffer if you set the limit too low. Market conditions should be the primary determinant of when and how much you trade, but a maximum trades figure anchors you around the appropriate level of activity.

When in doubt: Do nothing

Remember this: All other things being equal it is a fundamental truth of trading and investing… The more you trade, the more you pay.

Make fewer, higher quality decisions

While Kahneman and Tversky tend to be the names we most associate with behavioral bias, confirmation bias was discovered by British psychologist Peter Wason. His experiment was simple. He gave subjects the series: 2-4-6, then told them it satisfied his Pattern Rule. He then told subjects they could construct other sets of three numbers to test their assumptions about the Pattern Rule. Each time the subject showed the experimenter their three numbers, the experimenter would tell them whether or not it satisfied the Pattern Rule until the subject was confident they figured out the rule.
Subjects would test either a series like 8-10-12 (satisfies rule) and 22-24-26 (satisfies rule) or 3-6-9 (satisfies rule) and 5-10-15 (satisfies rule) or 4-8-12 (satisfies rule) and 10-20-30 (satisfies rule) until eventually most would answer that the Pattern Rule is either:
Count up by 2’s; Count up by a multiple; Some formula like add the first two numbers to get the third number.
But whatever answer people came to, they tended to get an idea and then test it over and over until they were certain it was right. What they did not do, generally, was try deliberately-wrong sequences to see if those might work.
The actual Pattern Rule was “any three numbers that increase in value”. Anyone that tested 1-2-3, for example, would have instantly ruled out all three patterns listed above. But subjects were always busy testing patterns that fit their rule without ever thinking to test those that did not. Instead of looking for more and more evidence that their hypothesis was correct, they should have tried sequences that did not fit their hypothesis, in an attempt to invalidate it.
The longer you trade, the more you will notice that when news comes out and you are flat, you react quickly and without bias. When news comes out that goes against your view and position, you will often hesitate or freeze or explain away the news. Watching yourself make a decision influenced by confirmation bias in real time is the first step toward beating the problem. Until you see yourself doing it, you have not really recognized how confirmation bias negatively impacts your decision making.

Actively consider other hypotheses

Once you have a great trade idea: poke some holes in it for a few minutes.
Be a Bayesian
Create a quick pros and cons sheet for any trade that involves meaningful risk.
It is important to know that confirmation bias is not strongly related to intelligence. This is consistent with the idea that rational thinking and intelligence are not the same thing. That should be one of your main takeaways from this book.

Smart People do Stupid Things, All the Time

To succeed in trading, you can’t just be smart. You also have to be rational. You have probably spent most of your life getting smarter. Now it’s time to train yourself to be more rational. To quote from an article titled “Why Intelligent People do Foolish Things”:
The absence of knowledge in areas important to rational thought creates a mindware gap. These important areas are not adequately assessed by typical intelligence tests. Mindware necessary for rational thinking is often missing from the formal education curriculum. It is not unusual for individuals to graduate from college with minimal knowledge in areas that are crucial for the development of rational thinking.
Everyone, including you, suffers from confirmation bias.
This is not forecasting—it’s extrapolation. The default and easy view to take in the market is to assume that whatever is going on right now will continue. But that is often not how the world works. Periods of outperformance are very often followed by reversion to the mean.
In markets, there is another reason why price reverts to the mean. Extremely low or high prices change the supply and demand profile for the asset. If oil goes to $100, new rigs come on board and increase supply and this pushes the price lower. If oil goes to $20, people buy more fuel-guzzling trucks because gas is cheaper. This increase in demand for gasoline pushes oil prices back up. If the price of corn triples, companies will substitute other commodities that are cheaper. And so on.
Watch for changes in supply and demand in your market after large price changes. Are medium or long-term sellers or buyers entering the market to take advantage of high or low prices? This change in participant behavior can mark the beginning of the end of a trend.
The number one input into almost every forecast is the current level and trend of the asset. There are notable exceptions, such as the fact that everyone has been (mostly) calling for higher US yields despite a 40-year trend lower, but generally you will see that when something is going up, it is forecast to go up more and when something is going down, forecasters expect it to keep going down.
Extrapolation bias is a form of recency bias. Humans tend to overweight more recent information in most analysis simply because that information is more available (i.e., top of mind). Events from years ago are harder to remember and incorporate. This is why you see analysts put out bullish predictions for oil when it’s trading at $100 and bearish predictions for oil when it’s trading at $25.

It always looks great on the highs and terrible on the lows

When there is a strong trend and you have faith in it for multiple reasons, that’s not extrapolation bias. That’s a rational expectation that the thing will go up. When a stock rallies three bucks out of nowhere and your instinct is to buy it because “someone must know something” you are making an irrational extrapolation.
This is really important: good traders go with the trend, or fade it, depending on the regime, the setup, the fundamentals, the technicals and so on. They don’t identify themselves as trend or mean reversion experts. Don’t say “I’m a mean reversion guy” or “I’m a trend follower”. Different styles work at different times.

You should identify and trade what works in the current market. Don’t commit to one trading style and hope the market cooperates. It won’t

Always remember, anything can happen

The more asymmetric (lotto-like) the payout, the more likely traders, investors, gamblers (and regular folk) will overbet the longshot.
There are three main reasons for the existence of favorite / longshot bias:

The marginal utility of a large win is often higher than the marginal utility of a small win, even if the odds of the small win are near 100%. With a fixed amount of capital at risk, small payoffs don’t really “move the needle” financially or psychologically. Say you are a hedge fund manager who wants to generate a 10% return this year. You are offered two trades, both risking 5 bps if wrong: Trade 1 has an 80% chance of making 5 basis points (expected value = +3 bps) and Trade 2 has a 5% chance of making 80 basis points (expected value = -0.75 bps). Even though Trade 1 is clearly more attractive mathematically, many traders (whether they will admit it or not) are more attracted to Trade 2 because it moves the needle for their YTD P&L while the first one does not, unless they place a huge bet.
Betting on favorites is not as fun as betting on longshots. Bettors and investors looking for excitement or stimulation prefer longshots.
Human beings tend to overestimate the likelihood of lower-probability events and underestimate those with higher probability (see Figure 7.7). Keep this in mind when assessing odds. If you think something is a 5% shot, you are probably too high. If you think something is an 85% shot, you are probably too low. In contrast, humans are good at evaluating probabilities in the middle of the spectrum (the 25% to 60% zone).

Since estimating probability is a critical skill in trading, you must understand: It is more difficult to estimate high and low probabilities than those near the middle

In trading, the longshot bias effect shows up in language like “levered bets”, “outstanding risk/reward”, and the ever-popular “asymmetric payout profile”. Looking for asymmetric payouts makes sense in aggregate: if you are always betting $1.00 to win $0.50 in a game where the odds are not known beforehand (only estimated), it is hard to achieve persistent success. On the other hand, this preference for longshots can sometimes lead to bad trades with good optics (like those 5% one-touches that are always so hard to resist).
The longshot mentality is bolstered by financial media features that shower adulation on tail risk managers in the rare moments their highly-levered insurance bets pay off. There are no stories written about the tail risk fund that bleeds for four straight years while the VIX is pinned at 12! The takeaway here is: be aware of favorite/longshot bias. Don’t get sucked in by bad trades with good optics.

Round Numbers

When you fill your car with gas, do you sometimes have the urge to round it off to the nearest dollar, even though you are paying with a credit card? Do you get a tiny thrill watching a car’s odometer roll over from 99,999 to 100,000? For many amateur marathon runners, a finishing time of 3:59:58 is a great success while 4:00:02 is a disappointment. These are examples of round number bias.
* Human beings tend to pay attention to round numbers and treat them as special or more important than other numbers. OK, sure Brett… Who cares? You should.

Humans are built to see patterns, even when none exist

Seeing patterns where there are none may be superior evolutionary behavior, but it’s not helpful in trading.
This is my simple four-step method for accepting or rejecting patterns:

Identify a pattern or relationship.
Generate a hypothesis. The best patterns have some sort of underlying logic. If gold goes down every day from 9 a.m. to 10 a.m., maybe that is the window when gold producers sell? If you can logically explain why a pattern works, it is much more likely to be non-random and persistent.
Analyze the data
Accept or dismiss the pattern.

Anyone who took a science class as a kid should recognize this as a shortform version of the scientific method. Most patterns you analyze will be worthless. You will dismiss them and move on. On the other hand, the few patterns you find that are non-random can be incredibly valuable to your future trading.
The harder you have to look, the more likely whatever you find is bogus or biased. Let’s say you want to see how the stock market performs the Monday after a 3% drop on Friday. You find nothing interesting. So then you test how it performs after a 4% drop on Friday. Still nothing. Then, you up the threshold to 5% and find the subsequent Monday averages a 2% further fall. Then you test, “What if stocks fall 2% or more Thursday AND 5% or more Friday” … The more you mess around with your parameters, the more likely you are to find “interesting” results. This is called “p-hacking” in the research business. You keep tweaking the inputs until you get an interesting result. That is not good research.
Don’t torture your data in an effort to make it confess. Keep your analysis simple. For the best ever and super simple explanation of how p-hacking, snooping and data-mining work, Google “xkcd green jelly beans”.
For example: Turnaround Tuesday (discussed in more detail below) is well known and has existed for many years. It is founded on a reliable and repeatable pattern of human behavior and a persistent fear and greed cycle that repeats around weekends, even if statistically savvy investors know about it. Also, as a short-term strategy, it is fairly expensive to execute (in terms of transaction costs) so large institutions are unlikely to quickly arbitrage it away.

Most patterns in finance are random. You need to find evidence and use logic before accepting a pattern as meaningful

Turnaround Tuesday

During periods of market fear, there is a common intraweek pattern that stock markets often follow. This sequence is shown in Figure 7.12. Markets don’t always follow this pattern but they do follow it a surprising proportion of the time.
The most reliable part of this pattern is “Turnaround Tuesday”. This is the tendency for stocks to rip higher on Tuesday if they sold off the Friday and Monday before. It is a simple human pattern that occurs because when the news appears bad, traders get nervous into the weekend and sell some of their holdings on Friday. Then, they read all kinds of negative media reports about the big scary thing and that scares them into selling more on Monday.
Investor selling pulls in momentum traders who go short on Monday. This adds to the selling pressure. Then, Tuesday comes and there is nobody left to sell. Then the shorts get squeezed and that triggers Turnaround Tuesday.
In case you think this sounds silly, have a look at this evidence. First, here is how the S&P performs in the most extreme Turnaround Tuesday setup which is when it falls Thursday and Friday and then is down more than 5% on Monday. This is rare but check out the returns in Figure 7.13.
In contrast, if you study all days after a 5% one-day drop, the average return the next day is just +0.9%. Not terrible, but nothing amazing.
Second, to give you more evidence supporting Turnaround Tuesday, Figure 7.14 shows SPX performance for Tuesday vs. all other days in 2008. Note that 2008 was one of the worst bear markets in history so Turnaround Tuesday was a thing almost all year. If you traded in 2008, you probably find this chart pretty mind-blowing.

In markets, anchoring bias manifests in four main ways

We anchor on our entry point.
We tend to anchor on price level highs and lows.
We also anchor on P&L highs.
Economists anchor on prior economic data.

Recognise when you are thinking or behaving irrationally and stop it

You must learn to love small losses

When you take a small loss, try to feel good about it. Say: “Taking small losses is the way to achieve trading success.” Say it over and over: Taking Small Losses is the way to achieve Trading Success
As a beginning trader, you will no doubt hear yourself thinking “This trade feels wrong. As soon as I get to break even, I’m out.” Two problems here:
Problem One: “This trade feels wrong” is not rational analysis. Unpack why it feels wrong. Is there something inherently wrong with the price action, or is the stock just not moving and you’re bored? Those are two completely different things. Often your instincts are just your impatience and emotions trying to sabotage a perfectly good trade.
Problem Two: “As soon as I get to break even, I’m out” is not logical. Do you think the market cares where you got in? As if there is something magical about your entry point? If you have determined, via logic, that the trade is not worth holding onto, get out. If you have not determined you should get out of the trade, maintain your existing parameters.
Every trade you put on should have a stop loss and a take profit. After that, you need a solid reason to cut the trade. Otherwise, stick to your original plan. Don’t keep recalibrating based on every emotion you feel. Emotions are fine but overreacting to them is not.
Just remember: Your entry point is meaningless.

One great paradox of markets is that they are mostly driven by the wisdom of the crowd but occasionally by its madness. Separating the two is a key source of alpha

Instead of a bunch of undergrads guessing how many jelly beans are in the jar, imagine 1,000 highly-trained quants who have millions of dollars to invest in jelly bean estimation technology. Do you think you can beat them? That’s a more apt analogy for the markets.

Assume the crowd is wise most of the time and look for moments when you can explain exactly why it is wrong or identify that it has gone mad

It is much easier to believe in and respond to a narrative than it is to value securities.
Quite often, herding is caused by career risk. It often feels riskier for a trader to go against the herd than it is for him to just follow along. Doing the opposite of what everyone else is doing is hard! It goes directly against human nature. Most people react strongly to incentives and so instead of solving for: “How can I make my investors the most money?” they solve for: “What will give me the best chance of keeping my job?” Even if they are not doing this consciously, there is a good chance their subconscious is busy doing it for them.
To recap: wisdom of the crowds works when the crowd is diverse, unbiased and motivated by aligned incentives. When you see a market where these conditions are not met, start to think about going the other way.

How to detect and combat herding

Embrace independent thinking. Humans are built to conform: fight this instinct and make confident, independent judgments while staying humble at the same time. This is not easy!
Get comfortable with feeling uncomfortable. Humans are social animals that find comfort from doing what others do, and success in trading requires you to go against that instinct somewhat regularly, so successful traders are going to feel uncomfortable a fair amount of the time. Get used to feeling uncomfortable.
Study and quantify sentiment. Sentiment data is widely available and comes in all shapes and sizes. We’ll talk sentiment in Chapter 10. Whatever asset you trade, investigate the best ways to collect and analyze sentiment data. While it’s great to listen to the market noise and try to come up with your own view on sentiment, data usually beats anecdote. This is especially true in our current world where people on Twitter are constantly calling for the end of the world and bitcoin to one million. Data is much more useful than randomly-collected snippets.
Use overbought and oversold indicators. My experience with over-bought and oversold indicators is that your threshold for putting on trades should be as extreme as possible. I like signals that come up a few times per year, such as Jake Bernstein’s Daily Sentiment Index below 10 or above 90. The reason is that sentiment is not extreme most of the time. Sentiment that is rather bullish or kinda bearish means nothing. The market will spend most of its time in the space where sentiment has no predictive value. In fact, sentiment is a “go with” most of the time. The only time it’s contrarian is at the mega-extremes. But if you can identify these mega-extremes, you can hit some huge winners.
Always be on high alert for turns in sentiment. If you ever notice bullish sentiment at the low or bearish sentiment at the high: pay attention. Generally, sentiment almost always follows price. If something is going up, people will be bullish. If the price is falling, most people will be bearish. There are exceptions (many are always bearish the stock market, even when it’s at the highs) but in general, that’s how sentiment works. Very rarely, though, you will see the opposite and those moments are meaningful.

A prime example is the US dollar in March 2020. The COVID-19 pandemic triggered a liquidity crisis and there was a mad scramble for dollars. The Great Dollar Shortage drove EURUSD from 1.1300 to 1.0800 in very short order (stronger dollar, weaker euro). Then, the Fed went all-in, announcing a massive QE and dollar liquidity program. Due to ongoing pressures in emerging markets and equities, though, the USD remained in demand.
At that time, you could see a subtle but important change in sentiment happening. The market, which had been raging bullish USD, started to think about the future impact of all this new USD liquidity and sentiment slowly turned from bullish USD to modestly bearish USD. But the USD was still at the ding dong highs! This is a rare but extremely high EV setup. If you notice a subtle shift away from a popular narrative, but the price hasn’t moved yet, get ready to go the other way. Often price will lag sentiment. A market that is bullish on the lows or bearish on the highs is getting ready to turn.
6. Stay objective. Understand the bias of the media you consume and look for unbiased sources of data. Twitter leans bearish stocks and bullish bitcoin and gold. CNBC is almost always bullish stocks. Zerohedge tends to be bearish Wall Street and bullish gold. Whatever you read, always consider which way it leans. I prefer to read analysts who are flexible because those who constantly stick to the same view tend to be locked in and plagued by confirmation bias.
One of the best financial-market-guru business models is to pick a view (hopefully a popular one) and pound the table on it year after year. You attract a following of like-minded people and you deliver the echo chamber that they need to reinforce their views. And they will pay you for it. This is not analysis or forecasting, it’s marketing. Be aware when you receive information from people like this; they will never change their view and as such their view is probably not worth much. Good analysts will change their view (at least once every few years!) Good marketers will stick to one view and beat it until they have paid off the summer house in East Hampton.
Don’t go on Twitter and see 400 bearish stock market posts and conclude that the market is short. It might be; it might not be. Collecting anecdotal information can be extremely useful but you need to know the bias of the source. Data is always better than anecdotes so look for objective sources of sentiment and positioning data and focus more on those than what you consume via traditional or new media.

Here’s the thing about bubbles

Ok, sure, it’s a bubble. Even if you agree with me, what do you do? First of all, let me clarify that I believe this is a retail bubble in a specific group of stories, not a broad market bubble. If you are a professional asset manager, you should know what stocks are being bid up by retail right now and think about your dream exit levels.
Here’s the thing about bubbles. Just because you have identified one, that does not mean you should be short. Often the real money is made by identifying a bubble and jumping on for the bullish Wave 5 insanity.
For example, while it was obvious that bitcoin was a classic bubble by May/ June 2017, it did not crash until seven months later after rallying another 500%.
Correctly identifying bitcoin as a bubble in June 2017 would have cost you a ton of money.
Identifying something as a bubble just frames the volatility to expect (high) and lets you know you should use your imagination when setting upside and eventual downside targets. It also tells you that the endgame is a high-speed collapse of 75% to 90% off the ultimate high. It does not mean you just go short and collect the free money. In fact, it’s often easier to make money long a bubble, not short. So what do we do?
Identify bubble assets that you own and find a moving average or other technical signal that will tell you when to get out. Bitcoin had already rallied from $300 to $3,000 when people called it a bubble. Then it went from $3,000 to $20,000. Missing the last leg of a bubble can be costly. Shorting the last leg of a bubble can be deadly. In the 2017 bitcoin rally, the 100-day moving average defined the trend the whole way up. Fit a moving average to the current price trend of whatever bubble assets you own and liquidate on a daily close below.

Remember that it’s OK to be long during a bubble. It’s also OK to be short! I worked at a day trading firm 1999/2001 and the people that went bust in that period mostly fell into two categories:
People that believed religiously in the future of the internet and the unlimited upside of the internet stocks and lost all their money trading from the long side. People that believed it was a bubble and lost all their money trading from the short side.
I know I said two categories, but there was a very small third category: The gold bugs. There were two guys off in the corner that were like: “These sheep are stupid, we’re long gold and PAAS (silver). This will all end in tears.” They were right! But they couldn’t hang on long enough and both had to liquidate and find “real” jobs in mid-2001.

The people that did well in 1999/2001 were the most flexible and open-minded. We never got married to a side. We didn’t think the bull market was dumb and we didn’t think the internet was a world changing miracle. We were not overly philosophical about anything; we just wanted to make money. Getting philosophical about markets (i.e., “The Fed is manipulating markets, this is dumb!”) makes it way harder to win. Try not to do that.
Look for signs of blow off tops. One clue that it’s over is when bubble stocks don’t respond to good news. In 2. People that believed it was a bubble and lost all their money trading from the short side. 3. I know I said two categories, but there was a very small third category: The gold bugs. There were two guys off in the corner that were like: “These sheep are stupid, we’re long gold and PAAS (silver). This will all end in tears.” They were right! But they couldn’t hang on long enough and both had to liquidate and find “real” jobs in mid-2001. The people that did well in 1999/2001 were the most flexible and open-minded. We never got married to a side. We didn’t think the bull market was dumb and we didn’t think the internet was a world changing miracle. We were not overly philosophical about anything; we just wanted to make money. Getting philosophical about markets (i.e., “The Fed is manipulating markets, this is dumb!”) makes it way harder to win. Try not to do that. Look for signs of blow off tops. One clue that it’s over is when bubble stocks don’t respond to good news. In 2000, many internet stocks topped out after failing to rally on blowout earnings reports.
When someone hears that a market is a bubble, they generally want to go short. Watch for the inevitable burst but don’t get married to either side.
Detour complete! To sum up: When you see what looks to be a bubble, there are just two things to remember.

Be rational… And be flexible

Before we wrap up this section on trader bias, let me first give you a few blurbs on other important forms of bias to watch out for.

Bad traders see price moving on the screen and think somebody knows something. Good traders know 97% of all price action is noise

“Apple’s gapping lower! Somebody must know something!”
Nope. No. No. They probably don’t. There is an endless series of buys and sells going through the market and the overwhelming majority of those buys and sells have no particular edge or informational advantage. It could be a guy selling to pay for his divorce. It could be an asset manager reducing risk before she goes on vacation. It could be tax loss selling that has nothing to do with the company in question. Don’t assume that someone knows something when you see price moving.
If you are bearish Apple for six different reasons, and you have been watching a key level all week, and Apple finally breaks down through that level, then by all means, sell! But don’t be the trader that just jumps on whatever is moving just because it’s moving. If you find yourself doing that… Stop. That is what bad traders do. That is what traders with no plan do. It is the trading equivalent of Homer Simpson chasing the squirrel.
Be aware of this leak and catch yourself chasing price. Step away from your computer and give yourself a firm talking to. Chasing price without a plan is a recipe for persistent losses and frustrating performance.
Journalists are often storytellers, not traders or financial professionals. They are always trying to make up stories to explain moves that are often driven by non-macro factors like flow and positioning.
There are many excellent finance journalists but there is also the obligation for the financial media to tell a story based on fundamentals and macro when often that is not the driver of a market move.
You will never see a headline like “USDCAD rallies as macro portfolio manager stops out of huge short because he’s going on vacation.” If this is the reason USDCAD rallies, journalists will fabricate some sort of narrative that seems to fit in hindsight. That’s their job! Overall, you should be extremely skeptical of most articles in the financial press. They are not intentionally false, but they are biased almost exclusively to trying to fit a macroeconomic explanation even when short-term moves in markets are often explained by other factors.
One way permabears justify imminently lower equity prices is by referencing the bond market. If yields are going up, that’s bad for earnings, bad for margins, bad for borrowers, bad for severely indebted sovereigns, etc. If yields go down, it’s “What do bonds know!?” or “The rates market don’t lie!”
The relationship between stocks and bonds is fluid and for most of my lifetime, stocks have been going up and bonds have been going up. This is not to say it will go on forever, only to say that stock market bears need better reasons than “yields are going up” or “yields are going down”. In times of plentiful liquidity, it is perfectly logical for both stocks and bonds to go up, up and away.

Bears sound smarter than bulls

Research shows conclusively that humans perceive people who present negative or pessimistic opinions as more intelligent than those who express positive or optimistic opinions. Bearish analysts are viewed as “cutting through the noise” while bulls are often viewed as naïve fanboys banging pompoms together on CNBC.
Strangely though, the path of human progress is an undeniable upward trend. As Deirdre McCloskey put it: … _pessimism sells. For reasons I have never understood, people like to hear that the world is going to hell, and become huffy and scornful when some idiotic optimist intrudes on their pleasure. Yet pessimism has consistently been a poor guide to the modern economic world._
Similarly, stocks mostly go up, most of the time. Morgan Housel put it like this: _In investing, a bull sounds like a reckless cheerleader, while a bear sounds like a sharp mind who has dug past the headlines – despite the record of the S&P 500 rising 18,000-fold over the last century._
Yet many of the best-known Wall Street pundits are persistently pessimistic and many of them have been around for decades. Think of all the famous bears in finance. I could make a list 20 names long without even Googling. Plenty of them have cool nicknames and there are even two different celebrity economists nicknamed Dr. Doom. I find that funny.
These are all incredibly smart guys who do amazing analysis that mostly points to an imminent large-scale bear market. And yet the evidence shows these forecasts are almost always wrong. Why do we keep reading their stuff? Because it sounds really smart! The forecasting business has very little accountability and is mostly about marketing and sounding smart, not accuracy.
These permabears are famous and they are highly paid. How is this possible when stocks have spent most of their time in a bull market since 1980? If you always call for a bear market, and then one happens, were you right? Answer: it doesn’t matter. Pessimism sells, even if it’s the wrong view most of the time. When you read a “crash is imminent!” piece ask yourself: is the author preying on my inherent negativity or is she actually providing useful and actionable analysis supported by a verifiable track record?
There is an entire industry of permabears because there is steady demand for them. Don’t stoke that demand. Permabears sound smart, they are entertaining and they reassure us that our intelligent skepticism is not misguided despite mountains of evidence to the contrary. The funny thing is, if these permabears ever change their view, they lose followers and subscribers.

Probability has no memory

There are, however, many examples of persistent, non-random seasonality and price patterns. The Halloween Effect, more commonly known as “Sell in May and Go Away” has been in existence for more than 300 years and has worked out-of-sample for decades after it was discovered. It is almost impossible to dismiss this effect as an artifact of randomness. It is far too persistent.
If a pattern is persistent, then we try to explain it. In the case of “Sell in May and Go Away”, the explanation could be a pattern of human optimism where we start the year optimistic, eventually overshoot, pull back from that bit of irrational exuberance, then rally into year end.
Similarly, there are micro patterns of seasonality and repetition that make sense and repeat for a reason. The first day of the month is a day when a big lump of automatic contributions go into US employee 401k retirement plans. A good proportion of these contributions end up in index funds and as such the first day of the month tends to be a bullish day for stocks. Same goes for the start of the year.
The paper “The hot hand belief and the gambler’s fallacy in investment decisions under risk” is an excellent summary of two ways in which investors fail to understand that most events are independent. Here is the abstract: _We conduct experiments to analyze investment behavior in decisions under risk. Subjects can bet on the outcomes of a series of coin tosses themselves, rely on randomized ‘experts’, or choose a risk-free alternative. We observe that subjects who rely on the randomized experts pick those who were successful in the past, showing behavior consistent with the hot hand belief. Obviously the term ‘expert’ suffices to attract some subjects. For those who decided on their own, we find behavior consistent with the gambler’s fallacy, as the frequency of betting on heads (tails) decreases after streaks of heads (tails)._
There are literally 100s of ways behavioral bias influences traders and investors. I have gone through a short list of some types of bias that I believe are particularly important but there is an entire academic field (and a library-full of books) devoted to the topic. At some point, make sure you read Thinking, Fast and Slow (Kahneman), Fooled by Randomness (Taleb), and Irrational Exuberance (Shiller). Those are my three favorite books on behavioral finance.

Counterintuitive Math Facts

Education has made all the difference for me. It builds software for your brain. Mathematics taught me to reason logically and understand numbers, tables, charts, and calculations. Even more valuable, I learned at an early age to teach myself. EDWARD O. THORP, A Man for All Markets_
When it comes to trading, the more obvious the conclusion, the more likely it is already priced into the market and thus the more likely the trade you enter based on the conclusion will lose money.
A simple check you should always employ when analyzing data is to compare the average to the median. If they are similar, you are probably good but if there is a big difference, then something is up and you need to dig deeper.
The 1956 classic “How to Lie with Statistics” by Darrell Huff does a super job of explaining the basics of how to handle statistics like this. I think every human being should read that book, even if they don’t care about statistics or finance.
In a random walk process, there is not a uniform distribution of highs and lows throughout the day, week, month or year. Instead, we see a U-shaped pattern with more highs and lows near the start and the end of the series. This fundamental property of random walks is described by a counterintuitive branch of probability known as Arcsine law.

Even Simple Problems can be counter-intuitive.

People don’t always understand log returns.

People don’t always understand averages.

People don’t always understand random walks.

People don’t always understand probability.

People don’t always understand non-linear relationships

People don’t always think about whether their sample is complete or biased.

When trading your bet-sizing should:

Eliminate risk of ruin.
Be proportionate to conviction level.
Be large enough (even if it’s a low conviction trade) to move the needle toward your goal.

When analyzing data, look for missing evidence

Numbers on their own do not always tell the full story. You need to think more deeply about conclusions and treat even the most obvious answers with rational skepticism.
Remember, skepticism is not cynicism. It doesn’t mean you assume everything is wrong and everyone is lying and nothing is true. Alpha Traders filter information with slow System 2 thinking, even if the conclusion drawn from that information seems simple or obvious at first.
Skepticism is a healthy state of mind that represents quality thinking. The healthy skeptic understands that most knowledge is uncertain to some degree and looks to support statements with evidence. She listens to experts but does not take their claims or forecasts at face value. She uses research and logic to see through false claims and avoid hasty, incorrect conclusions.
The goal of this section was not to provide examples of counterintuitive math that you could apply directly to your trading. The idea, instead, is to get you thinking on the next level. Don’t just scan the surface of information you receive and let it make its way into your mind, unfiltered. Think deeply. Seek accuracy and truth, and identify and ignore bad thinking when you encounter it.

Be curious. Be open-minded. Seek evidence.

High Interest Rates are bad for stocks. Fact Check: Sometimes true

The stock vs. bond relationship is dynamic and unstable. Any statement about correlation or cross-market signal between stocks and bonds needs to be evaluated with a heavy dose of critical thinking and analysis. Mostly, your starting point should be: bonds don’t predict stocks. Then work from there.

Gold is a safe haven. Fact Check: kinda, but not really.

Bad Economic News is bad for stocks. Fact Check: Sometimes True

2020 was the most glaring example in history of a feature of the stock market that really bothers some people (especially journalists, pundits, and noob traders): the stock market is not always a reflection of the economy, nor is it a reflection of social mood. It reflects supply and demand for stocks.

The stock market is going to crash this week, this month, any day etc. Fact Check: Almost Always False

Regularly predicting a crash is for people that want clicks and followers, not for people that want to make money

It is true that stocks have a left tail, which means that the fastest, craziest moves in the stock market are down, not up. This is part of the reason it is more fun to be bearish than bullish. You are more likely to get instant gratification.
There is a crash (15% drop in one month) about once every five to eight years. Still, despite the four crashes between 2000 and 2020, the S&P went from 1,320 to 3,420 in that period (including four separate months when stocks ripped higher by more than 15%).
If your goal is to make money trading, you should be comfortable shifting between long or short risky assets depending on market conditions. You should trade without a directional bias. It’s fine to be bearish, just don’t let it become your religion. Don’t be a permabear, and Don’t be a permabull either__

Keep an open mind and analyze the evidence, then make a rational and unbiased short-term forecast of market direction. That’s the essence of good trading.

Chapter 8: Understanding Microstructure

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Assume Markers are very, but not perfectly efficient

Never dismiss an idea on the assumption that someone must have already thought of it.
Unless you think you have a big edge on a number or event, go in flat and react.
When an entity is supporting the price of a security or currency pair, it is usually reasonable to assume that the price is out of equilibrium and the entity supporting it is the only source of demand. Unless you have an edge in predicting what that entity is going to do, you should stay away. These setups present huge gap risk and can lead to risk of ruin.

When a gap risk is extreme or hard to estimate, avoid it. The risk is not worth the reward

While volatility and volumes do not always move together, it is generally true to say that volatility and volumes correspond

Trade with your rational mind not your silly, silly heart

Chapter 9: Understanding Narrative

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The what and the why of market movements are never simple and as you gain experience, you will realize more and more that many explanations in the financial press are way off base.
Surprisingly, the narrative often turns before the price, because the price has momentum of it’s own and a propensity to overshoot.
Speculators invested in a trend have confirmation bias and will ignore the changing narrative until the turn in price forces them to pay attention. Those turning points when the narrative has changed but price remains in the old trend can be some of the most exciting and profitable moments in trading.
Quite often, the price rise itself will also change the supply and demand dynamic at this stage. There is a saying that “the best cure for high prices is high prices”, which means that higher prices ultimately reduce demand and increase supply and that eventually leads to lower prices. Be sure to understand what price levels in your market might lead to major or non-linear changes in supply or demand. If you are expert in your market and keenly attuned to its driving narrative, you will recognize moments when the story has changed but price is not yet paying attention. Those can be some of the juiciest setups in finance.

Understand the stories the market is telling itself and learn to identify when the market is falling in or out of love with a narrative

The first price a security trades after news comes out is called the NewsPivot. These are critical price points going forward. NewsPivots become significant reference points in the mind of the market and if price subsequently recaptures the NewsPivot, it often means that either a) the news wasn’t all that important or b) larger medium and long-term players are using the news as a liquidity event to go the other way. If bad news comes out and your stock goes back above the NewsPivot: watch out!
The narrative is the internal story of your market.
A big level isn’t a level that is important to you, it is a level that is important to the market. This is a big distinction. You need to have your own views and thoughts but Alpha traders are also inside the mind of the market and know what matters most to the market as a whole.
This concept is best captured by Keynes’ beauty contest analogy from The General Theory of Employment, Interest and Money (1936). Keynes asks us to imagine a newspaper which holds a contest where readers are rewarded for choosing which contestant will be chosen by the most other readers. The task is not to choose the most beautiful woman, but instead to choose the woman others will think is most beautiful. Sometimes that’s the same woman, but not always!

Strong up trends hold above major support, and they break through major resistance

There does not have to be an obvious exogenous catalyst for every market move, reversal, peak, or bottom

Generally, when stocks rise, volatility falls and when stocks fall, volatility rises. This is true almost all the time because investors buy puts to protect themselves as markets fall. In a normal rising market, investors sell calls to take profit, earn income and monetize gains. When volatility rises as stocks rise, it can be a warning sign… Something weird is going on.
Correlated variables give you a hint as to where your product is going, but not the answer.

Chapter 10: Understand Technicals, Sentiment and Positioning

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Nearly all my trade ideas start from either microstructure or narrative. They never come from looking at a chart or from any form of technical analysis. And
I never put on a trade purely because of sentiment or positioning. My highest conviction trades generally have multiple inputs, but they always start with fundamentals or microstructure and then get refined, streamlined (or filtered out) by other factors.
I use technical analysis, sentiment and positioning as timing tools, but not as trade selection tools. My thinking on this has evolved over the years partly because markets have evolved, but also because I have seen enough evidence to conclude that technical analysis is not a source of alpha or edge.
I want to make it clear though: I use technical analysis in my trading every day. I just don’t use it to predict markets.

Technical Analysis gives you an important set of tactical execution and Risk Management tools. It does not help you forecast market direction.

NewsPivots

A NewsPivot is the last trade in a market before important, market moving news comes out. I find that NewsPivots are the most powerful reference points in trading. You should be aware of all NewsPivots in your markets.
Your intention while reading about technical analysis is to find 2 to 5 simple indicators or patterns that you like. Use these as your primary risk management and market screening tools. Then, you can add a few more over time.
Make sure you allocate enough time to strategy (coming up with trade ideas) and tactics (entry point, stop loss, etc.) Many traders find it is more fun to come up with trade ideas and do not allocate enough resources to the tactics of extracting as much money as possible from the ideas.

Sentiment & Positioning

The market cycle is always a complex dance featuring narrative and sentiment. Sometimes the news drives the price but quite often, the price drives the news. In other words, sometimes a strong trend takes on a life of its own and unfolds faster than the story on the ground, which follows behind.

The CFTC data is slow-moving and trend-following and is directional, not contrarian. Do not use CFTC data by itself as a contrarian indicator.

Options markets often contain important positioning information. For example, when stocks rise and VIX rises at the same time, you know that something unusual is going on because the correlation is almost always inverted between those two. Stocks up / VIX up is a sign that the market is so bullish it is adding to upside with calls, instead of hedging the downside with puts. You can also look at the put/call ratio for a read on equity sentiment.
I want to repeat something critical here. You don’t always go against positioning. It’s a factor but it’s not the be all/end all. Traders who go against positioning all the time miss every major trend because price loves to trend and sentiment and positioning mostly follow price. Be flexible, smart, rational and open minded when it comes to positioning. (From Chapter 12 pasted here for context)

Chapter 11: You Feeling Lucky, Punk?

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Most of what I have learned from gambling is also true for investing. People mostly don’t understand risk, reward and uncertainty. Their investment results would be better if they did._EDWARD O. THORP, A Man for All Markets

Luck is a short-term thing. In the long-run, skill prevails.

The key with any risk management system is that it needs to match your free capital, your trading style and your time horizon. Daily stops don’t work with week-long ideas. Monthly stops don’t make much sense for day traders, other than as a backup or overlay to a daily stop loss system.

Position size = $ at risk / (entry point * stop loss level)

Good Traders Vary Bet Size

If you have a trade on, stick to the original plan until there is new information you cannot possibly ignore.

Learnings from Reminiscences of a Stock Operator

Fear and hope remain the same; therefore the study of the psychology of speculators is as valuable as it ever was. Weapons change, but strategy remains strategy, on the New York Stock Exchange as on the battlefield. I think the clearest summing up of the whole thing was expressed by Thomas F. Woodlock when he declared: “The principles of successful stock speculation are based on the supposition that people will continue in the future to make the mistakes that they have made in the past.
In other words, this time is not different.
A stock operator has to fight a lot of expensive enemies within himself.
Learning the rules is easy. Following them is hard. Self-awareness is key.
One of the most helpful things that anybody can learn is to give up trying to catch the last eighth— or the first. These two are the most expensive eighths in the world.
It feels SO GOOD when you sell the ding dong highs or buy the ding dong lows but it’s not something that can be done on a regular basis. Don’t bother trying.
It takes a man a long time to learn all the lessons of all his mistakes. They say there are two sides to everything. But there is only one side to the stock market; and it is not the bull side or the bear side, but the right side._
It took me longer to get that general principle fixed firmly in my mind. I also was better equipped than the average customer of Harding Brothers in that I was utterly free from speculative prejudices. The bear side doesn’t appeal any more than the bull side, or vice versa. My one steadfast prejudice is against being wrong
In other words, be nimble. Good traders are intellectually flexible; _strong opinions, weakly held_
Another lesson I learned early is that there is nothing new in Wall Street. There can’t be because speculation is as old as the hills. Whatever happens in the stock market today has happened before and will happen again._

Overtrading

What beat me was not having brains enough to stick to my own game – that is, to play the market only when I was satisfied that precedents favoured my play. There is the plain fool, who does the wrong thing at all times everywhere, but there is also the Wall Street fool, who thinks he must trade all the time. No man can have adequate reasons for buying or selling stocks daily – or sufficient knowledge to make his play an intelligent play.

Trade Your Own View

No, sir, nobody can make big money on what someone else tells him to do.
If you do not know who you are, the stock market is an expensive place to find out.

Ed Seykota quote: “Win or lose, everybody gets what they want out of the market.”

Of all the speculative blunders there are few greater than trying to average a losing game. Always sell what shows you a loss and keep what shows you a profit.

Cut your losses, run your winners.

The best way to learn about the psychology of trading is to experience mind-numbing losses. You don’t learn anything when you win.

Chapter 12: Bringing It All Together

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The Lifecycle of a Trade

Idea Generation
Filtering
Tactics
Position Sizing
Execution
Tracking
Performance Analysis

Beyond understanding the narrative as described in Chapter 9, there are three other primary ways I come up with trade ideas. Note that generally I have more than one reason for a trade. Part of the filtering process is to make sure that wherever your idea comes from originally, it is supported by the narrative, sentiment, positioning, technicals, correlated markets and seasonals. We want ideas that are supported by multiple types of analysis, but also please remember: There Is No Such Thing As A Perfect Trade

Perfect is the Enemy of Good

News and Events

Into Events: Flat = Strong
It is easier to react to events than predict them.

The Run-Up Trade

The run-up trade is a phenomenon where prices move in a logical and predictable direction in the days leading up to a major event. These run-up trades are often easier to predict and monetise than the events that follow.
The idea behind the run-up trade is to identify an upcoming market event and then estimate what traders will do before the event. If AAPL earnings are coming up this week, which way are traders likely to play it? If non-farm payrolls are a few days from now, what might the market do in the days leading up to the release? The run-up trade is usually a function of three things:

Positioning: Medium-term traders, investors and systematic strategies tend to reduce risk into major events. They do this because volatility tends to be higher and more difficult to predict through events. If they are sizing their bets using forecast volatility (which most do, because that makes sense), they need to reduce their exposure as high-vol events near. If everyone is long, expect prices to fall in the run-up to the day of the event.
What is the obvious trade? Quite often, the obvious trade works! Plus, traders feel stupid missing obvious macro catalysts so they will tend to position for them in advance then take them off quickly if they do not materialize. If the US economy has been hot, the Fed is thinking about hiking rates, and most indicators point to strong job growth… Expect bonds to sell off in the days leading up to the jobs report as traders get set for a blockbuster figure.
What is the lotto ticket trade? If a biotech company is announcing Phase 1 results on Friday morning and it looks like a good result could cause the stock to triple while a bad result will cause it to drop 20%… Expect the stock to rally into the news, even if the probability of a positive outcome does not justify the trade from an expected value point of view. Asymmetrical bets will always attract speculators, even if they are bad trades with good optics. So the run-up trade ahead of an event will often be driven by speculators putting on lotto tickets beforehand.

Sometimes, all three factors above will apply: that’s a top-quality run-up trade. When you catch a run-up trade, you will be tempted to keep it through the event because you have a nice cushion by that point. Resist that temptation! It is often easier to forecast the madness of crowds going into an event than it is to forecast the outcome of the event itself. Furthermore, the very fact that you caught the run-up trade means the security has moved a fair bit already into the event and thus it is probably getting crowded in that direction and offers asymmetric risk/reward (in a bad way).

Everybody’s Bearish and nobody’s short

Sticking with the topic of events, there is a subtler way that upcoming events can influence markets. Often, when a major risk event is coming up, risk managers and traders lean on the conservative side until it is out of the way (due to gap risk and concerns about extreme volatility). They reduce their risk as the event nears, regardless of their view.
Once the event passes (regardless of the result), risk appetite returns to normal and a move that probably should have happened before the event happens afterwards.
Speculators put on the trade they wanted to have before, because now that the event (and associated gap risk) is out of the way, it’s safe to do so. This is one of my favorite setups. When there is a strong consensus view but no positioning to match the view, you often see highly impulsive moves. Once the event passes, the consensus move is free to unfold at high speed. Often the event itself contains no new information, it is simply the passing of the event (and thus the elimination of gap risk) that allows the move that should have happened earlier to happen now. This setup is powerful and has a high expected value, so watch for it.

Month End Dollar Effect

On the morning of the last trading day of the month, European pension funds execute massive rebalancing trades. Any month that saw significant moves higher in US equities will see large USD selling by pension funds as 4 p.m. approaches while any month where US equities tumbled will see large USD buying. This pattern has existed since at least 2005. It does not work every time (nothing works every time) but it is about as reliable as patterns get.
This hedging goes the opposite direction of stocks and only matters when US equities have moved meaningfully during the month. Here is why it happens: imagine a foreign holder of US stocks who owns a billion USD of S&Ps and is short one billion USD to hedge the position. If stocks rally 10%, he now has 1.1 billion of stocks and 1.0 billion of USD hedges. So he needs to sell 0.1 billion ($100 million) USD to rebalance his hedges.
These asset managers are benchmarked to 4 p.m. London on the last day of the month so activity peaks at that time as managers attempt to match the benchmark rate. The huge volumes going through on the last day of the month create some large and often illogical moves and these dislocations can create significant patterns and opportunities for astute traders.

Bubbles tend to deflate by about 85 percent before rebounding.

If you’re looking to buy a deflated bubble asset, look for the 80 to 85 percent discount area. It is remarkably common for burst bubbles to bottom around there.

Highs and Lows are more likely on around Numbers than on other numbers

Bankrupt Stocks usually rally on the open

When stocks re-open after being halted for a bankruptcy announcement, that is often the ideal time for shorts to take profit. This is because once a stock trades sub-$1.00 after beginning bankruptcy proceedings, it can take months or even years before the stock is zeroed out. It is not worth it for speculators to stay short all that time where the is so little juice left in the trade.
This is kind of a ridiculous trade given you are buying the shares of a bankrupt company but it doesn’t always have to make sense. Often, buying the shares of a bankrupt company when the stock reopens after the halt for the bankruptcy announcement can be highly profitable as a short-term (1 day to 1 week) trade.

Be thoughtful about the product you choose to express your view. It matters.

Tactics are just as important as strategy. You need both to succeed in trading.

Reassessment Triggers

When you have a trade on, every price movement feels like a signal or a sign of danger for your position while in reality most price movement is noise. Every time price jiggles lower or ratchets higher, you will have an emotional reaction because you are invested. The idea with reassessment triggers is to codify what will make you change your mind and what will not before the price starts flickering and jiggling around and those dumb voices in your head start to react to that flickering and jiggling.
The last stage in the tactics phase is to write down or record your list of reassessment triggers. A trader who clearly lays out her plan is way ahead of most traders. She has cemented a concrete process and listed specific triggers for reassessment or exit.
Reassessment Triggers are important because once you have a trade on, you will be influenced by all sorts of new information that is mostly noise.
Reassessment Triggers will always include a stop loss and take profit but can also be other things such as
Time Trigger
Level at which to tighten the stop loss
New Information Trigger
Cross Market Variable Trigger
If you take the time to record these reassessment triggers, you should find very few occasions where you make on the fly decisions mid-trade. Once you have a trade on, leave it alone and let it bake. Don’t rush it. Don’t keep opening the oven to peek. The market doesn’t care about your time frame. A market that is not moving is boring, but it’s not telling you anything. Wait for your stop loss, your take profit or one of your reassessment triggers to hit. Stop white-knuckling.

The Best Action is almost always no action.

Position Sizing

Position Size is a function of Six Factors:

Conviction level (TYPE I, TYPE II or TYPE III)
Free capital
YTD P&L
Market volatility
Distance from entry point to stop loss
Gap and liquidity risk

Here’s a quick summary of how to determine position size.

a. Decide on your conviction level (Type I, II or III as discussed in chapter 11).
b. Given your YTD P&L and free capital, decide on a percentage of your capital to put at risk. This tells you how many $ (or bps) to risk on the trade.
c. Using market volatility and technical analysis, choose the appropriate stop loss.
d. Calculate the position size: ($ at risk) divided by (risk per unit) … To get the total number of units.
e. Think about liquidity. Is this a reasonable position size? Can you get in and out without much of an issue? If not, can you scale in and out and maintain the economics of the trade?
f. Think about gap risks. What major events are coming up? How has the product been trading? Do you need to worry about limit up and limit down? Is there enough liquidity for this position size? In this step, you might reduce your position size because of gap risk, or consider exiting the trade before an upcoming event.

There is not one correct execution method for all markets and all regimes

Smart Execution Improves Performance

Chapter 14: Adapt or Die

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Adapt or perish, now as ever, is nature’s inexorable imperative. (H.G.Wells)

Study and adapt to ongoing changes in market structure.

Correct Position Size is the difference between winning and losing in a crisis.
Keep an open mind and use your imagination.
In crisis markets, there is no such thing as overbought and oversold.
Have Courage.

Volatility

Fast markets are temporary, but changes in volatility can be more permanent. Do you know how to size your risk correctly to reflect current levels of volatility? Does your methodology respond systematically to changes in volatility? It should. For example, higher volatility means you should be trading smaller positions. Lower volatility means larger positions.

Bad traders always put on the same position size.

Many traders are not very good at adjusting their position size and risk management strategies in response to volatility. If S&P futures are moving 1% per day, should you have the same position size or stop loss parameters as if they are moving 3% per day? Clearly the answer is no. Actively adjust your trading as volatility changes.
The easiest way to volatility-adjust (or vol-adjust, as most professionals say) is to use a spreadsheet that determines position size and stop loss parameters based on a volatility input. This does not have to be complicated.
I cannot emphasize this enough. Your position size should change as volatility changes. This is the easiest and most automatic adaptation you can make as markets change.

Realise no trading method works always and forever.

If everybody is doing the same thing, the odds are low that it will make money.

Efficient Markets usually prevail. Always.

When there Is a major change to the structure of markets, STOP AND THINK.

Since the market is a huge, adaptive system, you need to constantly adapt to it. As the Red Queen in Through the Looking-Glass (Lewis Carroll) says: Now, here, you see, it takes all the running you can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!
You need to work twice as hard as everyone else if you want to get ahead. Understand the market regime and fit your trading strategy to that regime. Don’t embrace a trading style and hope the market complies with it. “Trading style” should describe your time-horizon, risk management approach and preferred analysis methodology, it should not describe the specific strategies you prefer. Specific strategies work in specific market regimes and you need to adapt your overall style to the regime.

Chapter 15: Thank God It’s Monday!

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In this chapter, I offer some final thoughts on how proactive goal setting, selfawareness, and attitude shape our trading experience and impact trading success. Before we dive in, let’s start with a Chinese fable.

There was once a farmer in ancient China who owned a horse. “You are so lucky!” his neighbors told him, “to have a horse to pull the cart for you.” “Maybe,” the farmer replied.

One day the farmer forgot to latch the gate and his horse bolted. “Oh no! This is terrible news!” his neighbors cried. “Such terrible misfortune!” “Maybe,” the farmer replied.

A few days later the horse returned, bringing with it six wild horses. “How fantastic! You are so lucky,” his neighbors told him. “Now you are rich!” “Maybe,” the farmer replied.

The next week, the farmer’s son was breaking in one of the wild horses when he fell off and broke his leg. “Oh no!” the neighbors cried, “such bad luck!” “Maybe,” the farmer replied.

The next day soldiers came and took away all the young men to fight in the war. The farmer’s son was left behind due to his injury. “You are so lucky!” his neighbors cried. “Maybe,” the farmer replied.

This story because it is a great reminder that we never know how the movie is going to end. Your life is a big, long story and everything that happens along the way is driven by six heaping spoonfuls of variance. Don’t get too triggered by any specific short-term outcome.

It is impossible to succeed without the right attitude.

Professionals who self-evaluate, set specific goals, and create clear action plans outperform those who do not.

Don’t suppress your emotions, observe and understand them.

If you’re feeling super high or super low, square up and go for a walk.

Even the Gods of Trading experience huge failures. Here’s a passage from Stan Druckenmiller’s famous speech at the Lost Tree Club in 2015. In this excerpt, he recalls the devastating moment in 2000 when he paid the ding dong highs for size at the peak of the dotcom bubble.

So, like, around March, I could feel it coming. I had to play. I couldn’t help myself. And three times during the same week I pick up a – don’t do it. Don’t do it. Anyway, I pick up the phone finally. I think I missed the top by an hour. I bought $6 billion worth of tech stocks and in six weeks I had left Soros and I had lost $3 billion in that one play. You ask me what I learned. I didn’t learn anything. I already knew that I wasn’t supposed to do that. I was just an emotional basket case and couldn’t help myself. So, maybe I learned not to do it again. But I already knew that.

“Good judgment comes from experience. And experience comes from bad judgment.”

The number one reason to trade is that you love trading

Conclusion – Alpha Trader

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The first rule of trading is: Don’t blow up.

To succeed in trading, you must be rational, and you need to put in the work.

It’s OK to be wrong.

Variance is part of trading. Deal with it.

There is no single trading methodology that will work always and forever.

Trading should be fun (most of the time).

One Last Story Before You Go

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Four lessons learned:

Markets don’t stay inefficient forever. The NASDAQ was wildly inefficient from 1998 to 2002. If you find an inefficiency, make hay while the sun shines and then stash away as many nuts as you can for winter. Winter is always around the corner.
If you are overconfident, the market will swiftly and harshly beat that overconfidence out of you.
Trading can be incredibly fun.
Indexes don’t tell the full story.

21 Ways to Succeed at Trading and 13 Ways to Fail

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Excellent traders:

Adapt.
Are rational.
Are self-aware.
Do not blow up.
Study metacognition.
Don’t mind being wrong.
Can clearly describe their edge.
Love trading more than money.
Understand process vs. outcome.
Use the tight/aggressive approach.
Are experts in the markets they trade.
Are creative and independent thinkers.
Understand variance and the meta game.
Fall down, get back up, and keep running.
Work hard, even when they don’t feel like it.
Have the discipline to both make a plan and stick to it.
Recognise biased thinking (in themselves, and others).
Employ a rigorous and systematic risk management process.
Have an unshakable belief in themselves, but are not overconfident.
Are intelligent problem solvers with above-average quantitative skill.
Have courage to put on high conviction trades in max appropriate size.

Losing traders:

Overtrade.
Have no edge.
Hate to be wrong.
Are overconfident.
Can’t pull the trigger.
Rely too much on simple indicators.
Think much more about trade ideas than risk management.
Always trade the same position size.
Are impulsive and undisciplined.
Rely on System 1 thinking
Don’t read much.
Lie to themselves.
Gamble.

Come in to work each day with a positive attitude. Do the work. Focus. Behave rationally. Go home. Do it again tomorrow.

That is the 22-word recipe for trading success.