Trading in the Zone and The Disciplined Trader: Developing Winning Attitudes – A Review
Trading in the Zone and the Disciplined Trader are two books written by Mark Douglas who is an experienced commodities trader and who describes himself as a ‘trading coach’, with the ultimate focus of both books being on the psychology of trading. Both books can be looked as ‘self-help’ books for traders and their style is such that all the points are made clearly and advice given in the book can then be implemented easily. Some of the points made are covered in both books and thus they do overlap significantly in places, however I shall proceed with first looking at Trading in the Zone and conclude with The Disciplined Trader, talking about points that act as an addition to Trading in the Zone.
The first lesson that I gained from Trading in the Zone is that trading is more about your mental prowess and toughness. While tools such as technical and fundamental analysis are key in ‘finding your edge,’ the shift to mental analysis is what sets traders apart. The fact that technical analysis is widely available means that potentially there could be a lot of successful traders, if you believe that this is the most crucial aspect of trading. Mark Douglas makes the valid point however that successful traders are ones that can enter the market when the opportunity arises to make money. They believe in themselves and have the conviction to make correct decisions at the correct time; they can take advantage of opportunities and will not let emotions get in the way of cutting a losing trade, when you have been proved wrong.It is the fact that they are disciplined enough to do this that sets them apart. This discipline is the basis of becoming a consistent trader, which should be your ultimate goal.
One of the key lessons that I learnt from Trading in the Zone was the perception you have of the market and ultimately taking responsibility for your own actions. The market cannot be held responsible for bad trades, it is your own decision and ultimately your own responsibility, the market is only there to give you the opportunity. If you can accept that taking losses is part of the nature of being a trader and you can deal with this concept of being wrong sometimes then the emotions of dealing with a loss can be marginalised and therefore have less effect on subsequent trades. This comes with experience and the idea of having a positive frame of mind.
It is impossible to say that the market is going to act in a certain way because it has done it before. Essentially, the market is the interaction of people with differing views all looking to make money. Therefore, it is not plausible to say that two trades are exactly the same because there will be a different number of people in the market and their expectations could be changing. Therefore, each trade is independent of others done in the past. You use tools such as technical analysis to form an opinion and create your ‘edge.’ It is on the basis of this edge, that you look for an opportunity in the market to exploit. This is the point where you have to act with conviction and take full advantage of the opportunity. You don’t want to be in a situation where you are regretting not getting involved at the correct time and missing an opportunity, or leaving money on the table. This could potentially cause more pain then actually making the wrong decision and losing money. A key point made was that you have to think in probabilities. Using your edge, you believe that you can put on a winning trade, with the probability of it being correct in your favour. However, there is still a chance that it may not work out. After all it is a probability not a definitive. This means things will not always go your way, but if you have the mental capacity to deal with it and move on, then you have some of the basics of being a good trader. If your edge is present, then over a large sample, you should have more winning trades than losing trades, just on the basis of probability. (This is the basis of the exercise that the author sets out at the end of the book). Each trade is simply an edge with a probable outcome, statistically independent of every other trade. This is why it is crucial to have the correct mindset and be able to get over setbacks. By taking complete responsibility for your trades and thinking in probabilities will help you achieve the correct mindset. If you take full responsibility, you realise that there are no boundaries in trading, you choose entry and exit from the market. This is opposite to life, where people have grown up with set rules and boundaries that you have to adhere to. In the market, there are no such boundaries, but market discipline is essential to be a good trader, therefore understanding and embracing this paradox is key. Operating in a no rule environment can bring great joy but also pain. It is essential that you act without fear and not fight the market. This will mean that you are not fighting against yourself and therefore able to place trades when you believe that you have your edge. This will ultimately to a more consistent performance. Consistency is a state of mind and you have to act on the premise that solutions are in your mind and not in the market. You have to be able to act without resistance or hesitation, but with the appropriate amount of positive restraint to counteract the negative effects of overconfidence or euphoria – this is a unique state of mind – a trader’s mindset!
It is essential that you understand risk. The market can do anything at any time. It has an almost infinite number of ways to express itself. Only the best traders consistently pre-define their risks before entering a trade. Only the best traders cut their losses without reservation or hesitation when the market tells them the trade isn’t working. Only the best traders have an organised, systematic, money-management regimen for taking profits when the market goes in the direction of their trade. These are the 3 areas where most people fall down in trading if you eliminate errors regarding these areas, you will become a lot more consistent.
The author defines a probabilistic mind-set pertaining to trading consists of five fundamental truths:
- Anything can happen
- You don’t need to know what is going to happen next in order to make money.
- There is a random distribution between wins and losses for any given set of variables that define an edge.
- An edge is nothing more than indication of a higher probability of thing happening over another.
- Every moment in the market is unique
By accepting these truths and training your mind, you can avoid emotional pain. Emotional pain is a perception, if you can train your mind to interpret a loss not as pain or a mistake but as a natural occurrence, you will learn to accept it as part of being a trader and not let it effect you.
The author talks a lot about creating winning attitudes and beliefs that you are a consistent winner. He identifies seven building blocks to provide the underlying structure for what it means to be a consistent winner:
- I objectively identify my edges.
- I predefine the risk of every trade.
- I completely accept the risk or I am willing to let go of the trade.
- I act on my edges without reservation or hesitation.
- I pay myself as the market makes money available to me.
- I continually monitor my susceptibility for making errors.
- I understand the absolute necessity of these principles of consistent success and, therefore, I never violate them.
I believe that these seven points are the most valid and best things you can take from Trading in the Zone. The Disciplined Trader is divided into four parts: An overview of the psychological requirements of the trading environment; A definition of the problems and challenges of becoming a successful trader; Basic insights into what behaviour may need to be changed, and how to build a framework for accomplishing this goal; How to develop specific trading skills based on a clear, objective perspective on market action. As mentioned before, a lot of ideas overlap in the 2 books, but some of the more lucid points are explained below.
In the overview of the market environment, various facts about the market are made that are sometimes misconstrued or misinterpreted leading to irrational trading. The market is always right; there is unlimited potential for profit and loss; prices are in perpetual motion with no defined beginning or ending; the market is an unstructured environment; in the market environment, reasons are irrelevant. These ideas about the market have to be kept in mind and you can realise that you create your experience of the market. Once this is ingrained then your perception of opportunity and execution of trades will become more efficient. You have to be able to act without fear and accept the fact that the market only causes pain if you let it. This would then help you to accumulate profits. Working as a trader, you will face what’s inside of you on a moment to moment basis, the market reflects your mental conditions, it doesn’t create them. Therefore, your journey as a trader has to start with self-acceptance, this will give the basis of self growth as you incorporate the ideas needed to become a good trader, adjust beliefs and strive for consistency by having a winning attitude.
The author demonstrates that by understanding the psychological forces inherent within traders’ actions, you can easily determine what they believe about the future by just observing what they do. Once you know what traders believe about the future, it’s not that difficult to anticipate what they are going to do next, under certain circumstances and conditions. This can give a sense of the actual potential that exists for the market to move in any given direction. You have to learn to let the market tell you what to do by understanding the forces behind its behaviour and then learning to differentiate between pure, uncontaminated market information and how that information is distorted once it starts doing something to you. In other words, you have to keep a cool head, think of the facts and not let emotions take you over; it’s all about self discipline.
There are seven steps that the author identifies to successfully becoming a disciplined trader. These are the learning points that are crucial and by sticking to them you would have done some of the ground work to becoming successful. The seven steps are:
- Staying focused on what you need to learn
- Dealing with losses
- Becoming an expert at just one market behaviour
- Learning how to execute a trading system flawlessly
- Learning to think in probabilities
- Learning to objective
- Learning to monitor yourself
The key lesson that I have gained from reading these two books is that you don’t have to be a brilliant analyst to be a good trader but rather you have to have a strong mentality, be prepared to work on mental strength and to adjust your beliefs. You have to challenge yourself and be self-disciplined. This will lead to you becoming a consistent trader. 90% of being a good trader is in your head, your mentality and having a winning attitude is key.