Trading For A Living - Dr Alexander Elder - An animated book review
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Who is Dr Alexander Elder?
Dr. Alexander Elder is a professional trader and the author of a number of books. He was born in Leningrad and grew up in Estonia. At the age of 16 he studied the medical profession. At 23, while working as a ship's doctor, he received political asylum in the United States. He worked as a psychiatrist in New York.
He now consults private traders and financial institutions. His company produces books on stock trading. This book “Trading for a Living" has been translated into 12 languages and has become one of the most popular books in the history of stock exchanges.
The book explores the three pillars of success—psychology, trading tactics, and money management—as well as the factor that ties them together—record-keeping, Which DR. Elder says is very important.
Elder, a trained psychiatrist, analyzes both individual trader behaviour and mass psychology—that is, the behaviour of trading masses.
Dr Elder quoted:-
“The public wants gurus, and new gurus will come. As an intelligent trader, you must realize that in the long run, no guru is going to make you rich. You have to work on that yourself ”.
The key aspects of the book we aim to cover are; Classic chart analysis, technical analysis, Psychology and risk management. Those traders who have not yet developed their own successful strategies will profit from this balanced, suggestive overview.
Dr Elder suggests we must first consider risk management, Because even with the best tactics the trader will fail if he does not exercise proper risk management.
As Elder writes, “Markets can snuff out an account with a single horrible loss that effectively takes a person out of the game, like a shark bite. Markets can also kill with a series of bites, none of them lethal but combined they strip an account to the bone, like a pack of piranhas”
Dr Elder provides two rules, or what he refers to as the two pillars of risk management.
the 2% and 6% Rules
The 2% Rule will save your account from shark bites and the 6% Rule from piranhas.” The first rule prohibits the trader from risking more than 2% of his account equity on any single trade. The second prohibits the trader from opening any new trades for the rest of the month when the sum of his losses for the current month and the risks in open trades reach 6% of his account equity.
If you want to implement this rule, there are several factors that you need to consider.
Here is an example:
Imagine that the trading capital that you currently have in your account is £50,000. By following the 2% rule, you are only allowed to risk £1,000 per trade. So, if you wish to buy a stock, you need to set a stop order to limit your risk to 2% or £1000. Whenever the stock prices fall to the predetermined amount, the stop order will automatically sell.
In this chart example we assume the current stock price is £10, we also assume that the ideal stop loss price should be £9, perhaps based on a support level.
Knowing that the 2% rule will allow us a maximum risk of £1000 on this trade, we can equate that the position size to hold this stock is £10,000. Equal to 20% of the overall trading account.
The 2% rule is considered by many experts one of the most effective ways that traders can use to minimize their losses, OR stop a big bite sized loss.
The 2nd rule that Dr Elder recommends is the 6% rule. This rule prevents traders from opening new trades whenever their monthly losses reach 6% of their trading capital. We stop from making any more trades during the current month.
“To help ensure success, practice defensive money management. A good trader watches his capital as carefully as a professional scuba diver watches his air supply.”
The importance of disciplined record-keeping is paramount according to Dr Elder and is comparable to weight control. If you don’t know how much you weigh and how much you are gaining or losing, it is impossible to get the results you want.
This also applies to trading. If you are not aware of how much money you have, how much you are gaining or losing, improving your future strategies becomes impossible.
“The mental baggage from childhood can prevent you from succeeding in the markets. You have to identify your weaknesses and work to change. Keep a trading diary—write down your reasons for entering and exiting every trade. Look for repetitive patterns of success and failure.”
A trading diary is not only an effective way to keep records of your trades and progress, but it will also keep you disciplined, another key component that Dr Elder emphasises.
One aspect that needs continual measurement from your diary entries is the personal equity curve. The personal equity curve will reveal if your trading system is efficient and will help you understand whether you’re making money or losing money in the long-term. If you notice a downtrend in your equity curve, you might need to be more careful with your system and find the issue that needs to be fixed.
Crowd trading psychology.
As an actively practicing psychiatrist and trader Dr Elder emphasizes the importance of psychology in the market. He links crowd psychology, the individual investor's psychology and technical analysis to trading stocks. It is clear through his thoughts that crowd psychology is connected with the markets, and that the market is nothing more but a collection of peoples trades around the world.
He says ;
“People change when they join crowds. They become more credulous and impulsive, anxiously searching for a leader, and react to emotions instead of using their intellect. An individual who becomes involved in a group becomes less capable of thinking for himself.”
Dr Elder points out in his book that it really goes back to people’s primitive desire to be part of a crowd. In the days of the jungle if you’re with a group then you were normally safer than if you were alone.
So what does this mean for trading?
Dr Elder alludes that emotions go up and down with the fluctuations in price. People follow the trend and when the trend changes, people sell their positions in a panic. However, does this mean you shouldn’t trade with the crowd? Not necessarily. It means that you need to be able to know when to trade with the crowd.
Trading with the crowd and with the trend can be a very powerful tactic to catch some strong moves. But the art is to think rationally while trading as a part of that crowd. Dr Alder says you must have a trading strategy and a trading plan in place before you get into a trade. Try to think for yourself and ask whether the crowd movement is something you agree with, otherwise you may fall into the trap of blindly trading as part of a crowd.
Chart & technical analysis
Dr Alder says;
“To be a good trader, you need to trade with your eyes open, recognize real trends and turns, and not waste time or energy on regrets and wishful thinking.”
He also expands on the importance of understanding support and resistance levels.
He suggests that a support level exists due to traders having memories. If the prices of certain stocks were falling and stopped at a certain level and then increased again, a lot of traders would remember this pattern and will become more likely to invest when they detect it again. Likewise, when an uptrend is reversed or interrupted by selling, we say that the market is currently demonstrating resistance.
He again alludes that the mass of individual trading memories can give some guidance and probability as to where the stock price ‘could’ move next. Remember trading is about probabilities.
In combination with support and resistance Dr Elder discusses patterns within price and how to benefit from them. But in order to gain a profit, you need to know how bar charts are constructed. It is important to know that there are five main elements that you need to take into account: closing and opening prices, the highs and lows of a bar, and the distances between the bar highs and lows. As a general rule, the opening prices indicate what the amateur traders’ opinion of the value is since they are generally taking action in the morning before they go to work. The closing prices, however, indicate the opinion of value of professional traders.
When the closing prices are significantly higher than the opening prices, that means that the professionals tend to be more bullish than the amateurs, and vice versa. This is precisely the type of knowledge that beginner traders need in order to be able to identify whether they are in a market of bulls or in a market of bears. The power of bulls is reflected by the high of each bar, while the power of bears is indicated by the low of each bar. When deciding when to buy and when to sell your shares, you need to keep a close eye on these bars.
Dr Elder’s message is here consolidated into one paragraph; If you have a good understanding of individual and crowd trading psychology, you are comfortable with classic chart analysis, and you are disciplined in your approach and risk management, then you are on your way to becoming a professional trader.
I also leave you with this last quote from Dr Elder
“Every winner needs to master three essential components of trading; a sound individual psychology, a logical trading system and good money management. These essentials are like three legs of a stool – remove one and the stool will fall, together with the person who sits on it.”