Many traders treat their specific entries and exits as if they were “Eye of newt, and toe of frog, wool of bat, and tongue of dog.”
Trading is not magic. Profits don’t respond to incantations, potions or elixirs. They come from ideas that have a basis in reason.
If you don’t understand the basis for your profits then you will have a hard time when your methods appear to stop working. How will you know if the markets have changed? How will you have the fortitude to keep on trading?
Many traders borrow ideas from other traders or trading gurus. They trade using methods which are not ones they themselves have developed. This can be dangerous because it leaves open the possibility that you may end up trading a setup or method which you do not understand. You may end up trading magic formula or incantation.
If you want to be successful over the long term you need to know why the particular methods that you trade are likely to make you money. To do this requires an underlying theory of the markets. You need to have your own particular understanding for why the markets behave in the ways that they do. Again, you need a theory of the markets.
If you have a theory for how the markets work then your trading strategies have a foundation. They are built upon principles and ideas which will carry you through the tough times. These principles and ideas can also be tested for validity. This can be done through a combination of historical analysis, paper trading, and trading itself.
When you have a theory of the markets, your trading methods will reflect that theory. Your trading strategies will capitalize on certain repeating patterns that your theory postulates.
My personal theory of the markets is based on a lifelong study of price behavior and human psychology. I believe that price is an entirely psychological phenomenon. I believe that certain patterns repeat over time because traders tend to respond to the same phenomena in the same way over time. The repeating nature of human response serves as the the foundation for each of my trading strategies.
In upcoming blog posts I will outline the basis for my personal theory of the markets in greater detail.
Trading From Your Gut
Way of the Turtle
Inside the Mind of the Turtles
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Thanks for sharing with the world about your trading secrets. The most important theory to me is the Dow’s theory, which helps me to follow trends by recognizing important lows and highs. In the end of an upward trend, market stops to create new high and usually gives me a lower high, that’s the signal of possible reverse, so I put a sell stop lower than the recent low and a stop loss a little bit higher than the lower high. If the order can be executed, that means market is creating new lows, all I can do at this moment is sitting tight, expecting second, third, …, new lows.
I spent several years as a stockpicker/fund manager within m father’s firm. During that time, it always haunted me that the way I had learned to invest was not what was “natural” to me. I always felt that the markets were simply emotional measurements of people’s perceptions. There is perhaps some validity that over the longer term, a company’s health and business fundamentals will drive it’s value, but that is totally unforcastable in the shorter run, and is so dependant on other influences. I am reentering trading in my late 40’s using my own portfolio, but now reading and learning as much as I can about systematic trading. It is very clear, at least to me, that markets are a measure of human emotion and fear than fundamentals. This fact explains recurring patterns even though the world looks much different every 10 years or so. thanks for you books Curtis…..