Book Review: Trading For A Living (1993) By Dr. Alexander Elder
This succinct section conveniently comprises of 3 chapters about risk management: (1) Emotions and Probabilities, (2) Money Management, and (3) Exiting Trades. While the title is already telling of what’s to come, the content is actually no less surprising. That is, you would likely have heard of much of what follows.
Note, however, that it is often not what is being said, but how it is said that drives the point across.
Use your intellect, not your emotions. Greed and fear destroy you as a trader. It also helps to understand probability (mathematical expectation) to determine if there is a player’s edge (positive expectation) or house advantage (negative expectation) (p.256).
Get rich slowly, and already have a pre-determined amount that you can risk on any one trade. Amateurs adopt the martingale systems because it appeals to their emotions (p.261). They believe that at some point, their luck will reverse. So they keep doubling up.
That is poor money management both in plan and reality.
Remember that it is ultimately the quality of your trades which matter. If you use indicators as in Technical Analysis to enter, use it to exit a trade as well. Set your stop-loss, and progressively upgrade it to a break-even order, and eventually a protect-profit order.
3 Key Takeaways
#1 Why Johnny Can’t Sell (pp.254-256)
“Dreaming in the markets is a luxury that nobody can afford.” (p.255)
I love how in-your-face this is.
But before that, the sub-title “Why Johnny Can’t Sell” is actually borrowed from Roy Shapiro, a New York psychologist, whom Dr. Elder quotes. Apparently, when it comes to trading, there is also an “endowment effect” whereby one (“Johnny”) is attached to things he buys. So it is not just goods of desire, but also stocks which he may get attached to.
Besides not wanting to part from the stock, it could also be that Johnny wants to dream – to hope that the losing position would have a reversal. As Dr. Elder puts it matter-of-factly – if your trades are based on dreams, you would be better off investing in some psychotherapy.
#2 How Much To Risk (pp.259-261)
To be honest, I’m not sure how many of you will follow this.
But here goes: “Extensive testing has shown that the maximum amount a trader may lose on a single trade without damaging his long-term prospects is 2 percent of his equity.” (p.260).
This 2% is inclusive of slippage and commissions. Thankfully these days we have easy access to low-cost brokerage firms!
For many who are just starting out, a maximum 2% loss on any single trade is likely to deprive them of trading opportunities. After all, the account size is not that large to begin with.
However, it is designed that way to keep you out of riskier trades. It will also ensure that even with a string of losses, you will still have sufficient funds to continue putting up trades.
Amateurs think about how much there is to be gained, but professionals consider how much they have to lose. Supposedly, 2% is too high for them – they do not allow themselves to risk more than 1-1.5% on a single trade.
#3 Quality Before Money (p.264)
As is often said, focus on the process. Here, the process is to focus on making the best trades.
Once that is done well, the money will naturally come.
If the focus is on counting the money instead, that is a red flag as it is a precursor for emotions to kick in. Are we winning? Great! Are we losing? That’s terrible!
Once the trading becomes emotional, intellect gets inevitably thrown out of the driver’s seat.
Just like how professionals like doctors, lawyers and teachers focus on the quality of their work, traders too should focus on honing their skills. Find the best trades, have good entries and exits in place, and practice good risk management. Once the trade is over, then may you count the money.
You will see good returns if you do what is right in the markets.
How Do I See Myself Applying What I’ve Learnt
Everyone starts as a beginner. But it is also true that no matter how advanced you have become, the lessons should continue growing with you.
This section serves as a reminder that hopes and dreams are a poor strategy. That emotions have no place in trading. To risk no more than 2% in any single trade and focus, focus, focus.
Oftentimes, patience is needed to await the best set-ups. When these are available, the next step is to stick with the entry and exit plans.
Perhaps it is also a case of it being easier said than done. But that is precisely why there is a need to constantly hone this skill. Even though you know what needs to be done, getting down to the execution can be a challenge.
But if I am going to stay in the game, then I need to do what is right to keep me ahead of my past self.
TLDR; 1-Liner To Sum Up This Review
If you have problems like Johnny and can’t sell, you need to revisit how much you have to risk and get focused on quality trades instead of counting the money.
Who Should Read This Book
It is best if you have yet to begin trading to read this. It will set you on the right foot, giving you an advantage over clueless or greedy peers. Plus, avoid having to lose more than you would like.
Having said that, it is often not until we experience some pain that we remember our lessons well…
So perhaps you have paid some of your learning fees to Mr. Market, and are here to see what you might have missed.
Well, I hope that this is precisely what you need. Especially so if your goal is like that of the book title, to trade for a living, you definitely need to know how to do this in a sustainable manner.
Because when it comes down to it, there are only that couple of reasons why you couldn’t stay in the game.
“A book is a gift you can open again and again.” – Garrison Keillor. But… So many books, so little time! Since our time on earth is finite, may this book review (series) also serve as a sneak preview to help enable your decision. Will this book be the gift that you open again and again?
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