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The Disciplined Trader - Mark Douglas

Trading Psychology & The Developing of Winning Attitudes.



When it comes to trading psychology and the developing of winning attitudes, there is no better teacher than Mark Douglas, author of the popular book Trading In The Zone.

In this review of The Disciplined Trader, we again look at the key concepts discussed by Mark and learn how we can apply them to our own trading.

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Mark makes a great quote which sits at the core of his teachings when he says:

“The problem is that preventing pain by avoiding losses can’t be done. The market generates behaviour patterns and the patterns repeat themselves, but not every time. So again, there is no possible way to avoid losing or being wrong”.

Once we fully understand this statement, the journey to becoming a disciplined trader will become much easier.

Emotional control is arguably one of the main differentiators between being an unsuccessful trader and one that takes a more disciplined route.

So how do we become a less emotional, more disciplined trader?

In the book, Mark links the many trading challenges to that of a trader’s perception of the market.

The first lesson is to know that the market is always right, only you can be wrong, never the market.

Second, the market does not care about you, it does not care how much money you have won or lost, it has its own rhythm. It is only through experience, trial and error, that you begin to accept that the market has no emotion, only you do.

Remember, the market is an unstructured, irrational, uncontrollable and demanding environment.

Once we have the right perception of the market we can then look inwardly at our own psychology.

Mark suggests that there are three steps to trading success;

Perceiving opportunity. Executing Trades. And accumulating profits.

However, each are marred by emotional pitfalls, and no trader can succeed unless these emotions are addressed, ensuring they do not interfere with trading judgments.

One of the ways we can address these emotions is to create rules. These rules will help us identify opportunities, execute our entry, or exit trades, and manage position size and risk.

These rules take away subjectivity, and help our emotions from getting drawn into irrational market behaviour.

Having these rules however is not the complete solution, if we hit a series of losses following our rules, we start to doubt them. Such losses can create irrational blind spots in our cognitive reasoning. The more we are hit by losses the less likely we are to follow the rules, this comes despite knowing the market is itself irrational.

This cycle repeats endlessly until we accept that losses will occur, we must manage them accordingly with solid risk management and allow the market to do its thing. It’s important to note however that rules should not be followed blindly, they must be considered from past performance and analysis which supports the viability of the strategy. It goes without saying that following rules to a flawed or unproven strategy could lead to financial ruin.

Another important aspect discussed in the book is expectation and goal achievement.

Many new traders start with an expectation, maybe targeting $500 per day, or achieving 100% annual returns. Giving too much focus on such targets inhibits the trader from developing a robust process, after all, the returns are simply a by-product of the process. New traders tend to have this in reverse, focusing on returns first and thinking about the process last, an approach Mark is strongly against. The focus and energy must always be given to the strategy and process first. Mark adds;

“No man ever reached to excellence in any one art or profession without having passed through the slow and painful process of study and preparation”

After completing the study, preparation, and creating the rules and process, we need the discipline to ensure we always stay within that framework. Be as mechanical as you can without focusing on the financial reward.

Psychology is clearly at the forefront of Mark’s philosophy in terms of becoming a disciplined trader, but there are several flawed psychological biases which we should understand. None more so than the Gamblers Fallacy, or sometimes referred to as the Monte Carlo Fallacy. Although the myth is linked to gambling the same belief is associated to trading.

Let’s first take the game of roulette.

Imagine a table has seen the colour of red four times in a row, would you be more inclined to bet black on the next spin?

What if the table had eight spins all seeing red, would you expect black to have more of chance on the next spin?

Well, in both scenarios there is absolutely no reasoning as to why the next spin would be black, or red for that matter. Remember the wheel has no memory, the probability of either colour appearing has not changed. This is why it is called a fallacy, it is a mistaken belief based on unsound arguments.

You may be interested to know that the longest recorded streak of one colour appearing in roulette happened in 1943, the colour red appeared 32 consecutive times, and with each spin the participants were sure the next colour should be black…

But why is this important in trading? Well its because you may have a trading strategy that has an edge, just like the casino, but a losing streak in trading can also occur at any time without any rationale, and it does not mean the strategy is flawed. Just like a roll of a dice, or a toss of a coin, a trading candle has no memory.

Mark summarises these flawed psychological biases when he says:

“When you achieve complete acceptance of the uncertainty of each edge and the uniqueness of each moment, your frustration with trading will end”.

Understanding that losses are an integral part of trading, will provide some comfort when your results are not going your way.

Legendary trader Mark Minervini himself says that he builds failure into his system, meaning that he expects his trades to lose 50% of the time, and his other trades to win 50% of the time, albeit his winning trades will be larger than his losses when they occur.

If you step back and really accept that losses are at the core of most successful strategies, the acceptance of their occurrence is far easier to digest. It is the managing of these losses that really makes the difference, if you allow a loss to grow out of control it could make your winning trades less significant. Accept you will have many losses, keep them small, and make them a core focus of your strategy.

Ultimately, embrace the prospect that losses and wins are an inevitability within any strategy, and either outcome is just as likely as the other.

In fact, Mark Douglas says:

“When I put on a trade, all I expect is that something will happen”.

Another great quote by Mark links expectation with probability, and again provides foundation to becoming a less emotional, disciplined trader. Mark says:

“It’s the ability to believe in the unpredictability of the game at the micro-level and simultaneously believe in the predictability of the game at the macro level that makes the casino and the professional gambler effective and successful at what they do.”

Let’s break this quote down to better understand it in practice.

You may have seen the concept of a Bell Curve, the concept plots a distribution of data points and is used as a measure of probability and deviation.

In this example we keep the concept simple. In the middle we have trades with an average return, to the left trades with poor performance and to the right, good performance.

The neutral return is plotted centrally on the chart, and each trade, which remember is a random event, is plotted based on their return.

A trader makes perhaps 10 trades, providing random results.

At first glance, which Mark refers to as the micro level, the review would suggest a losing strategy or a strategy without an edge. But remember, a statistical edge should only be measured when we have enough meaningful data, not on a micro level with such a small sample size.

The predictability on the macro level which Mark refers, is determined by the law of large numbers.

Once we have a large data sample we can then determine if a statistical edge is present. We already knew from the position of the bell curve that the large majority of trades were positive in comparison to the losing trades, this provides some predictability on a macro level, the level at which a Casino bases its model.

The casino’s are aware that they will need to pay out some large winnings to the minority, but the majority of bets will far outweigh those costs.

As traders, once we understand the probability at a macro level, we can set the expectation, once we have an expectation, we can ignore the random results over the shorter term and stay disciplined to the strategy.

The strategy I share in our group also has a long-term macro expectation, I tend to measure this through the R distribution, which is simply the risk taken and the reward achieved.

For example, I know many of my trades will lose up to 1 R, whereas my winning trades are spread from winning 1 R through to winning 10 R, or 10 times my risk.

Having this predefined probability and expectation over a large sample of data, makes it easy for me to be unnerved when I get a series of losses.

Another great quote from Mark says:

“When you really believe that trading is simply a probability game, concepts like right or wrong or win or lose no longer have the same significance.”

In summary, the journey to becoming a successful disciplined trader requires us to accept that the market does not care about us.

We must expect that losses will always come our way, and we should build the management of losses into the core of our strategy.

Stop focusing on the rewards and stay focused on the process.

Understand that anything can happen, an event is unique and has no memory.

Know the longer-term statistics of your strategy, and ensure your expectations are aligned.

As always, thanks for watching.

If you find value in any of these videos please do hit the like button, or if you have any recommendations let me know below.

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