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  • TRADING IN THE ZONE

  • MASTER THE MARKET WITH CONFIDENCE, DISCIPLINE AND

    A WINNING ATTITUDE

    MARK DOUGLAS Foreword by Thorn Hartle

    NEW YORK INSTITUTE OF FINANCE wcw VHDV • Tnnnurn . cvnucv • Tnrvn • cinr.«pnpc Library of Congress Cataloging-in-Publication Data Douglas, Mark (Mark J.) Trading in the zone : master the market with confidence, discipline, and a winning attitude / by Mark Douglas, p. cm. ISBN 0-7352-0144-7 (cloth) 1. Stocks. 2. Speculation. I. Title. HG6041 .D59 2001 332.64—dc21 00 045251 © 2000 by Prentice Hall All rights reserved. No part of this book may be reproduced in any form or by any means, without permission in writing from the publisher. Printed in the United States of America 10 9876 5 4321 This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold with the understanding that the publisher is not engaged in rendering legal, accounting, or

  • other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought. . . . From the Declaration of Principles jointly adopted by a Committee of the American Bar Association and a Committee of Publishers and Associations. ISBN D-73SE-DmM-7 ATTENTION: CORPORATIONS AND SCHOOLS Prentice Hall books are available at quantity discounts with bulk purchase for educational, business, or sales promotional use. For information, please write to: Prentice Hall, Special Sales, 240 Frisch Court, Paramus, N] 07652. Please supply: title of book, ISBN, quantity, how the book will be used, date needed. NEW YORK INSTITUTE OF FINANCE An Imprint of Prentice Hall Press Paramus, NJ 07652 http://www.phdirect.com NYIF and NEW YORK INSTITUTE OF FINANCE are trademarks of Executive Tax Reports, Inc. used under license by Prentice Hall Direct, Inc.

  • DEDICATION

    This book is dedicated to all of the traders I have had the pleasure of working with over the last 18 years as a trading coach. Each of you in your own unique way is a part of the insight and guidance this book will provide to those who choose to trade from a confident, disciplined, and consistent state of mind.

  • o

    TABLE OF CONTENTS

    FOREWORD . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xi PREFACE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xm ATTITUDE SURVEY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xvii

    _________________CHAPTER 1___________ THE ROAD TO SUCCESS:

    FUNDAMENTAL, TECHNICAL, OR MENTAL ANALYSIS?

    IN THE BEGINNING: FUNDAMENTAL ANALYSIS . . . . . . . . . . 1 THE SHIFT TO TECHNICAL ANALYSIS . . . . . . . . . . . . . . . . . 3 THE SHIFT TO MENTAL ANALYSIS . . . . . . . . . . . . . . . . . . . 4

    _____________________CHAPTER 2_______________ THE LURE (AND THE DANGERS)

    OF TRADING

    THE ATTRACTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 THE DANGERS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 THE SAFEGUARDS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 Problem: The Unwillingness to Create Rules. . . . . . . 27

  • Problem: Failure to Take Responsibility . . . . . . . . . . 28 Problem: Addiction to Random Rewards . . . . . . . . . 30 Problem: External versus Internal Control........ 31

    _______________CHAPTER 3______________ TAKING RESPONSIBILITY

    SHAPING YOUR MENTAL ENVIRONMENT. . . . . . . . . . . . . . . 34 REACTING TO LOSS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38 WINNERS, LOSERS, BOOMERS, AND BUSTERS . . . . . . . . . . 50

    ___________CHAPTER 4_______________ CONSISTENCY: A STATE OF MIND

    THINKING ABOUT TRADING . . . . . . . . . . . . . . . . . . . . . . . . 58 REALLY UNDERSTANDING RISK. . . . . . . . . . . . . . . . . . . . . . 61 ALIGNING YOUR MENTAL ENVIRONMENT . . . . . . . . . . . . . . 64

    ___________CHAPTER 5________________ THE DYNAMICS OF PERCEPTION

    DEBUGGING YOUR MENTAL SOFTWARE . . . . . . . . . . . . . . . 70 PERCEPTION AND LEARNING . . . . . . . . . . . . . . . . . . . . . . . 74 PERCEPTION AND RISK . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79 THE POWER OF ASSOCIATION. . . . . . . . . . . . . . . . . . . . . . . 80

    ___________CHAPTER 6_____________ THE MARKET'S PERSPECTIVE

    THE "UNCERTAINTY" PRINCIPLE . . . . . . . . . . . . . . . . . . . . 88 THE MARKET'S MOST FUNDAMENTAL CHARACTERISTIC. .. 93

  • _____________CHAPTER 7__________ THE TRADER'S EDGE: THINKING IN PROBABILITIES

    PROBABILITIES PARADOX: RANDOM OUTCOME, CONSISTENT RESULTS. . . . 102 TRADING IN THE MOMENT. . . . . . . . . . . . . . . . . . . . . . . . . 106 MANAGING EXPECTATIONS . . . . . . . . . . . . . . . . . . . . . . . . . 113 ELIMINATING THE EMOTIONAL RISK . . . . . . . . . . . . . . . . . 120

    _______ CHAPTER 8__________ WORKING WITH YOUR BELIEFS

    DEFINING THE PROBLEM . . . . . . . . . . . . . . . . . . . . . . . . . . 125 DEFINING THE TERMS . . . . . . . . . . . . . . . . . . . . . . . . . . . . 128 HOW THE FUNDAMENTAL TRUTHS RELATE TO THE SKILLS . . . . . . . . . . . . . . . . . . . 130 MOVING TOWARD "THE ZONE". . . . . . . . . . . . . . . . . . . . . . 135

    ___________CHAPTER 9_________________ THE NATURE OF BELIEFS

    THE ORIGINS OF A BELIEF. . . . . . . . . . . . . . . . . . . . . . . . . 139 BELIEFS AND THEIR IMPACT ON OUR LIVES . . . . . . . . . . . 142 BELIEFS vs. THE TRUTH. . . . . . . . . . . . . . . . . . . . . . . . . . . 147

    ________CHAPTER 10__________ THE IMPACT OF BELIEFS ON TRADING

    THE PRIMARY CHARACTERISTICS OF A BELIEF . . . . . . . . . . 153 SELF-EVALUATION AND TRADING . . . . . . . . . . . . . . . . . . . . 167

    __________CHAPTER 11___________ THINKING LIKE A TRADER

    THE MECHANICAL STAGE. . . . . . . . . . . . . . . . . . . . . . . . . . 173 THE ROLE OF SELF-DISCIPLINE. . . . . . . . . . . . . . . . . . . . . 179 CREATING A BELIEF IN CONSISTENCY . . . . . . . . . . . . . . . . 184 EXERCISE: LEARNING TO TRADE AND EDGE LIKE A CASINO . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 189

  • A FINAL NOTE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 201 ATTITUDE SURVEY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 203 INDEX . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 209

  • FOREWORD

    The great bull market in stocks has led to an equally great bull market in the number of books published on the subject of how to make money trading the markets. Many ideas abound, some good, some not, some original, some just a repackaging of earlier works. Occasionally, though, a writer comes forward with something that really sets him or her apart from the pack, something special. One such writer is Mark Douglas. Mark Douglas, in Trading in the Zone, has written a book that is the accumulation of years of thought and research—the work of a lifetime—and for those of us who view trading as a profession, he has produced a gem. Trading in the Zone is an in-depth look at the challenges that we face when we take up the challenge of trading. To the novice, the only challenge appears to be to find a way to make money. Once the novice learns that tips, brokers' advice, and other ways to justify buying or selling do not work consistently, he discovers that he either needs to develop a reliable trading strategy or purchase one. After that, trading should be easy, right? All you have to do is follow the rules, and the money will fall into your lap. At this point, if not before, novices discover that trading can turn into one of the most frustrating experiences they will ever face. This experience leads to the oft-started statistic that 95 percent of futures traders lose all of their money within the first year of trading. Stock traders generally experience the same results, which is why pundits always point to the fact that most stock traders fail to outperform a simple buy and hold investment scenario. So, why do people, the majority of whom are extremely successful in other occupations, fail so miserably as traders? Are successful traders born and not made? Mark Douglas says no. What's necessary, he says, is that the individual acquire the trader's mindset. It sounds easy, but the fact is, this mindset is very foreign when compared with the way our life experiences teach us to think about the world. That 95-percent failure rate makes sense when you consider how most of us experience life, using skills learned as we grow. When it comes to trading, however, it turns out that the skills we learn to earn high marks in school, advance our careers, and create relationships with other people, the skills we are taught that should carry us through life, turn out to be inappropriate for trading. Traders, we find out, must learn to think in terms of probabilities and to surrender all of the skills we have acquired to achieve in virtually every other aspect of our lives. In Trading in the Zone, Mark Douglas teaches us how. He has put together a very valuable book. His sources are his own personal experiences as a trader, a traders coach in Chicago, author, and lecturer in his field of trading psychology. My recommendation? Enjoy Douglas's Trading in the Zone and, in doing so, de

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