"Follow-Through" -- It's Significance for Your Market Position

Patience is a virtue in most endeavors in life, and it's certainly a valuable asset in futures and stock trading. You will many times hear me use the important term, "follow-through," when I discuss significant market moves such as price breakouts or trend changes.

"Follow-through" trading activity is really just a confirmation of the previous trading session's bigger price move. If one day's (or one price bar's) move is really that technically significant, then prices should be able to show some follow-through in the same direction the next trading session (or next trading bar on the chart).

Many times that all-important follow-through price action does not occur. What many times does occur is the market retraces much of the previous trading session's bigger gains or losses, and when all is said and done at the end of the day, prices are not that far from where they were two sessions (or two price bars) ago.

I am not a perfect trader and I, too, am continually learning (or trying to learn!) from past trading missteps. I want to provide you with a specific example of when I did not wait for a market to show me that important follow-through strength on what I thought to be an upside breakout--but instead was a false breakout.

I had the corn market on my "Radar Screen" for several weeks a while back. I was waiting for the market to break above and negate a longer-term downtrend line. On a Wednesday, corn did show a strong up-move and prices pushed just slightly above a longer-term downtrend line--but did not come close to negating it. Well, I had to be out of the office for the next two days (Thursday and Friday), and would not have any access to my broker or price data. So I called my broker that Wednesday afternoon and put in a buy-stop order for corn at a price level far enough above the downtrend line so that if the buy stop was it, I thought it would be a strong enough price move to negate the downtrend line and signify an upside breakout on the daily bar chart.

So I took off out of town that night, with a little gremlin in the back of my brain that was saying, "You are still not waiting for follow-through price strength the next trading day to confirm the upside breakout in corn!" Sure enough, corn futures opened up on Thursday morning and moved high enough to touch my stop and get me into the market on the long side--only to have that price level be the high for the month. Prices then reversed lower and I was stopped out of the corn market about a week later.

Of course, hindsight is always 20/20. However, this particular trade reconfirmed to me the importance of having the patience to wait for a market to show follow-through price action to confirm a potential trading "set-up." In waiting for follow-through strength or weakness, a trader does run the risk of missing out on some of a price move. But more times than not, it is prudent to make a market confirm a bigger price move with follow-through activity the next session--or the next price bar for intra-day charts.

By the way, a market sometimes can exhibit a small-trading-range "rest day" after a bigger price move, and then confirm that bigger move the next trading session. But usually, if follow-through strength or weakness is going to occur, it's the very next trading session after the bigger move.

How to Handle a Losing Streak

A trader emailed me a while back, asking for some advice on a good money manager for him. He said he was a "lousy trader" and tired of losing money.

I doubt there is one non-rookie trader reading this story who has not experienced at least a small run of poor performance in trading futures. I've said before that most successful veteran traders have more losing trades than winning trades in any given year. The key is maximizing profits on the winning trades and minimizing losses on the losers.

I will also argue that at one point or another in most traders' experiences, they, too, have felt like "lousy traders." I certainly have. (Those who say they have never had a run of poor trading performance or felt "lousy" about a trade or trades are likely either lying or completely out of touch with futures trading reality.)

So what's a trader to do when losses start to pile up and winners become scarce. Here are a few tips that I've picked up over the years from some of the very best traders in the business:

Don't overtrade. If you are trading several markets and not having any success, cut back to trading one or two markets. You can follow fewer trades more closely and document your success or failures more easily. Plus, your trading account won't be drawn down so quickly.

Keep a detailed trading diary. If you keep a good trading diary, you can go back and see if there is a common thread among your losers--and your winners, and possibly make the proper adjustments.

If you are not trading that many markets and still racking up losers, take a break from trading for a while. Gather your thoughts. You may want to "paper trade" for a while to get your confidence back. Then, if you are still losing on paper, you will want to look for other trading methods.

If you are losing money trading, DO NOT (I REPEAT) DO NOT try to make a big home-run-type trade that will get you back to even or the plus side in a hurry. In fact, do just the opposite. Make smaller trades that risk less capital, until your performance starts to turn around and you can resume your normal asset allowances for trades. Successful traders survive the rough waters by hunkering down and being conservative.

Exhibit patience and discipline. I've preached about this before. Are you following a trading plan that you devised before you put on the trade? If not, you should be. You are not shooting from the hip (no exit strategy in place) once a trade gets initiated, are you? If so, that could be part of your problem. On the patience issue, are you impatient? I've talked to successful position traders who may only trade a few times a year, because they wait for what they feel is that "perfect set-up" to occur. If you are a position trader (as opposed to a day trader), you don't have to be "in the market" all the time. Wait for the good trades to develop and don't chase markets.

Be confident. Have faith in your trading methods. And if you don't have faith in your methodology, why don't you? If your methods are really not successful, find something else. Read some of the many books out there by the successful traders, and how they have traded successfully. But be cautious of the person who wants to sell you some so-called successful trading method for big bucks. (See the next item on hard work.)

Work harder. Don't expect to produce winning trades if you are not working very hard at trading. Do you know well the fundamentals of the markets you are trading? Even if you know technicals well, you should have at least a good understanding of a market's fundamentals. Here's an example: Let's say the charts and technical indicators look bullish for corn and it's the day before a major USDA report. Smart traders likely won't initiate a trading position in corn the day before a big government report is out.

In case you're wondering what I told the reader who emailed me and told me was a "lousy" trader, here's what I said: Don't give up just yet. The fact that he admitted he needed some help (before he lost all of his trading assets) is a positive first step. I then told him I would write this feature because there were likely many traders who feel the same way, at times, that he feels, and that there are steps to take on the road to recovery and eventual successful trading.

Getting What You Really Want

I used to do an exercise in the Peak Performance 101 workshop entitled "Getting What You Want". The exercise starts out with a question: If you could have anything in the universe, what would it be? Perhaps your answer might be $10 million dollars. However, the exercise doesn't end there. It just triggers another question: What would that get you? So to carry our example forward, you'd now ask, "What would the $10 million dollars get you?" Perhaps you might answer, "Security… I'd feel secure in my retirement."

It doesn't end with that answer. The second answer merely triggers another question: What would that get you? And to continue the example, you now ask, "What would security get you?"

This process continues at least five times. Each time you get an answer, the new question becomes, "What would that (i.e., the answer to the last question) get you? At the end of five iterations, I then survey the class for what they have come up with at the end of their questions What do you think everyone comes up with? The answer is important because it really says a lot about you. But before I give you the results, do the exercise for yourself. Answer each of the following questions:

1. If you could have anything in the universe, what would it be?
2. What would that (answer 1) get you?
3. What would that (answer 2) get you?
4. What would that (answer 3) get you?
5. What would that (answer 4) get you?
6. What would that (answer 5) get you?

I'm actually curious to know what percentage of you started out with "trading success." Perhaps a lot of you, but I doubt if anyone ended up there.

There are some universals about this exercise. With five repetitions of the question about 90% of all people end up with a mental state. Examples of mental states include security, freedom, confidence, happiness, etc. But we can take it further. If you do enough repetitions of the question, everyone ends up with a universal mental state such as Oneness, Love, Ultimate Happiness, etc. What's interesting about the exercise is that it flat out tells you what you really want! The final answer is always one of those universal mental states (and I'm not sure that they really are not all the same).

Yet what do we do with our lives? We spend it pursuing things such as money, power, career or perhaps trading success. But that's not what we really want. And that's true for everyone.

Now, what if there was a course that you could take that would give you as a result of doing the course, one of those ultimate states. Would you want to take that course?

Well, let me tell you a true story about a man named Lester Levinson. Lester had advanced degrees and was a very successful entrepreneur. In that sense, he was probably a lot like most of you. However, he was very unhealthy. One day his doctors basically said, "Lester, there is really nothing we can do for you. You are going to die in a few months." So Lester retreated to his Manhattan apartment to die. But before he did so, he did an exercise similar to the one I just took you through and concluded that what he really wanted out of life was LOVE. He looked at his life and concluded that he was the happiest when he was LOVING, rather than when he felt people loved him.

As a result, Lester started a series of mental exercises designed to help him be more loving. And as he continued to do those exercises over the next few months, he didn't die. Instead, some remarkable things happened:

First, all of the symptoms of his illness just disappeared. And whenever something happened to his body he could heal it instantly.

Second, he found that he could materialize whatever he wanted just by thinking about it. He played with this for a while, soon materializing millions of dollars worth of real estate. But knowing that he could get those material things any time he wanted them just by thinking about them, he soon lost interest in them and just gave them away. Besides, what he really wanted was LOVE and he was getting that by being LOVING.

Third, he basically started operating in the world at the level of a very advanced spiritual being.

In the spirit of being loving, Lester started to teach what he had learned. As a result we all have that core process that Lester went through to heal himself and become happy and loving available to us through a series of five books entitled "Happiness is Free." Each book is a seven week course, so the series is basically a 35 week course on attaining happiness. And if you do the course, I believe that you can attain a level of happiness that is way beyond what you experience today or probably what you've ever experienced.

However, I didn't write this article to sell these courses, but more to convey some very important points. Logically, if you decided, after doing the exercise, that what you ultimately wanted was love or happiness, then I would expect that we'd get at least 1,000 orders for the course. Of course, you'd have to believe that you'd actually get "ultimate happiness" out of doing the course to order it. And perhaps you don't think you really want happiness or perhaps you don't think the course will help you attain it. That's a personal choice.

Anyway, I was so impressed with this course initially, that I ordered a few sets and gave them to some very special people associated with my company. Later on, I then ordered ten more copies of the course to sell. And interestingly enough, we still have most (if not all) of them in stock. Most people either don't think that they want happiness or they don't believe that they can get it simply by completing a course (i.e., doing all the exercises). It's rather amazing. This is what people want but they are not likely to do anything about it.

I'm so fascinated by this process that I plan to interview each of the people I gave the course to just to see what they've done with it. I haven't done the interviews yet, but I think I know the results. I'll report the actual results to you later in another article for Tharp's Thought's. And I'll also tell you about the exercise that I just completed that motivated me to write this series of articles.

A Healthy Psychological Profile is Needed for Successful Trading

Excerpted from Van Tharp's Peak Performance Home Study Course

Many mental health professionals define an "uncertain" condition as being stressful. Uncertainty occurs because of too much information or because of too little capacity. The very fact that we cannot deal with available information is stressful.

Available trading information far exceeds one's capacity for making basic trading decisions, so one can only attend to some of this data. Limited capacity is a major factor in trading success and in understanding stress.

Three factors are essential to successful trading:

1. a healthy psychological profile,
2. the ability to make accurate decisions from a large amount of information, and
3. money management and discipline.

A weakness in any of these areas reduces one's capacity for processing information, resulting in stress, poor trading decisions, and losses. Losses, in turn, can produce stress, resulting in more losses. Readers who have taken the Investment Psychology Inventory Profile™ may recall that their test results were split into these three major areas.

A Healthy Psychological Profile

A healthy psychological profile might easily encompass all aspects of trading. However, certain psychological characteristics appear distinct from decision making and money management.

Everyone has a different set of past experiences. As a result of those experiences, one develops certain attitudes toward life. These attitudes may be open or restrictive. Open attitudes produce growth, encompass change readily, orient people toward self-improvement, and produce happiness and success. The successful trader, for example, might describe himself as follows:

I enjoy life to the fullest. I am constantly exploring new ideas, visiting new places, experiencing change, and having fun. I try to get everything I can out of life, and I eagerly look forward to each day.

I am in the best of health because I eat proper foods, get plenty of exercise, and sleep well. I am never overly stressed because I do not feel pressure - only challenge.

Although an open attitude is not essential to trading success, most successful traders are quite open. An open attitude will help a trader in the market because it enhances information processing capacity. Although the successful trader still has a limited capacity, his attitudes toward life keep his capacity at the highest possible level.

The losing trader, by contrast, often has a closed attitude toward life. Part of this closed attitude includes a number of defense mechanisms against winning, such as the fear of success or the fear of failure. Any form of defensiveness results in isolation, building protective walls, and resisting change. Consider the following statements that a losing trader might use to describe himself:

I am really unlucky. Every time I try to trade, something goes wrong. I end up losing. Other people make it impossible for little guys like me to be a winner. Perhaps that is why I am so depressed all the time. Money sure has been my downfall.

Trading is very stressful to me, perhaps because I worry about what will happen all the time. But I also worry about what will happen if I get out of the markets. I'll probably never be able to get ahead in life.

The losing trader has closed himself off from the world. Some information still gets through, but it is all darkly colored by his restrictive attitude. His closed mind severely restricts his capacity for dealing with information, and he feels "stressed."

This is only a brief introduction to this concept. To learn more about the relationship between stress and capacity, and how this relationship affects you as a trader, refer to Chapter V in Volume Two of the Peak Performance Home Study Course for more.

Self-Sabotage Revealed

In my peak performance training with traders, I give a strong psychological slant to the concept of self-sabotage. Self-sabotage typically occurs when one lacks the discipline to act in one's own best interest. For example, when you have dessert, knowing it's taboo because you are trying get healthy, you might call that self-sabotage. Or perhaps you know you need to exercise and you really feel good when you do so, but somehow you just feel lazy and want to skip the exercise period. Self-sabotage occurs in trading in many instances:

• When you know you should follow the ten tasks of trading, but you don't.
• When you know you need to determine if your system will really work, but you just trade it anyway.
• When you know you should develop a business plan for your trading, but somehow that just seems like too much work.
• When you know you need to put a stop loss order in on a trade, but you don't.

These and numerous other examples characterize self-sabotage. And these examples of self-sabotage typically occur when you have internal conflict between various parts of yourself and when emotions pop up that result in behavior that is not in your best interest and when you just avoid doing what's important for success.

Many traders, however, avoid thinking about self-sabotage in this manner because they don't like to go inside of themselves to see what is going on. They prefer to think technically about systems rather than notice what their beliefs are and whether or not they are useful. As a result of this tendency, I've developed another definition of self-sabotage that everyone can relate to: repeating the same mistake multiple times.

My definition of a mistake is when you don't follow your rules. And if you don't have rules, then everything you do is a mistake. And self-sabotage occurs when you keep repeating the same mistakes over and over and over again.

For example, you don't raise your stop when the market makes a new high. When you skip it once, and your rules say you must do it, then it's a mistake. When you do it three times in the same week, then it is self-sabotage. When you develop this attitude, can start keeping track of your mistakes and see how much they cost you.

For example, suppose you are about to be stopped out for a 1R loss. (The definition of a 1R loss and R-multiples in general is explained in my book Trade Your Way to Financial Freedom and there is a brief description in my Tharp Concepts section of the website.) You don't want to be stopped out, however, so you cancel the stop – which is your mistake. The position keeps going down and eventually you get out with a 3R loss. That mistake cost you 2R (i.e., instead of a 1R loss you got a 3R loss).

Now suppose you have a system that makes you 100% per year. However, you make a 2R mistake each week. At the end of the year, instead of being up 100%, you have lost money just because of your mistakes. Now can you begin to understand how trading reflects your behavior and that one of the critical things that you must do as a trader is to eliminate mistakes

Hank Pruden on "Behavioral Finance" and Technical Analysis

Hank Pruden’s theory of "Behavioral Finance" proposes that human flaws are consistent, measurable and predictable, and being aware of and utilizing this phenomenon can benefit a trader.

"For the better part of 30 years, the discipline of finance has been under the thrall of the random walk\cum efficient market hypothesis. Yet enough anomalies piled up in recent years to crack the dominance of the random walk. As a consequence, the popular press has been reporting the market behavior," said Pruden. One of these new methods discussed is "behavioral finance."

Pruden is a professor in the School of Business at Golden Gate University in San Francisco. He was a featured speaker at the 20th annual Telerate Seminars Technical Analysis Group Conference (TAG 20).

Behavioral finance is "the use of psychology, sociology and other behavioral theories to explain and predict financial markets. Behavioral finance describes the behavior of investors and money managers and their interaction in companies and securities markets. It recognizes the roles of varying attitudes toward risk-framing of information, cognitive errors, lack of self-control, regret in financial decision-making and the influence of mass or herd psychology," said Pruden.

Predictable human behavior can and does impact markets, said Pruden. One example is the "crowd psychology" or "bandwagon" theory. For example, if a market is coming up from a basing area on the charts, "smart money" is responsible for the majority of the initial buying. "As people jump on board, we see the bandwagon effect, and that bandwagon pushes prices up. Volume tends to surge at its peak, certainly on the buy side, during the mark-up phase in the middle. Later on, toward the end of the trend, smart money is not doing the buying; somebody else is. The smart money is doing the selling. The market tops by curving over, or sometimes with a spike top. So, we can see express that in price and we can see under it in volume," said Pruden.

Regarding the type of trading approach to the bandwagon effect, Pruden said, "We align our indicators to show a distribution pattern or a breaking of trendlines, and we should see a post-volume peak. Volume will typically peak before a big change in sentiment."

Pruden said he puts time, price and sentiment together to come up with a composite to look at all those parameters at once. This composite would help in any trading decision, he said.

In the four major elements of technical analysis - price, volume, time and sentiment - recognizing and factoring in human behavior is certainly a major portion of the sentiment element, said Pruden.

At Golden Gate University, Pruden developed and teaches accredited courses in technical market analysis.

Make An Honest Self Appraisal

If you are willing to accept total responsibility for your investment results, you will realize that you are the most important factor in your trading or investment success. If you have done that, you are way ahead of the crowd.

I once had a call from a gentleman in England who had been working with my home study course. He said, "I've been working through the course for over six months. It's helped me realize a lot about myself, but there is one thing it hasn't done. It hasn't given me a positive expectancy system." The ironic thing about that statement is that I had not attempted to give a methodology. There are several reasons for that: 1) If you want to be good, you must design something that fits you. That only is possible if you design the methodology. 2) Psychology is far more important than methodology. In fact, psychology is part of methodology. For example, when we attempt to help people develop a reasonable method that works, they resist it strongly because they have so many biases that keep them focused on the wrong aspect of trading - areas that have nothing to do with success. And it is very difficult to show them the correct direction.

As a result, the best thing you can do for yourself to increase your income from the market is to determine how you are blocking yourself. This should be done at two levels. Whenever you develop a trading business plan a great deal of that plan should have to do with introspection. Take a look at all of your beliefs. Are they useful beliefs or do they hinder you in some way? What are your strengths and weaknesses? What about you can't you see clearly because you are part of it? You should look at doing this sort of assessment at least once each quarter.

The second self-appraisal you need to make is at the beginning of the day - and perhaps even hourly throughout the day. What's going on in your life? Are you ready to face the markets? How are you feeling? Is there some sort of self-sabotage surfacing in you? For example, are you starting to get too confident? Are you starting to get too greedy? Do you in any way want to override your system? The best traders and investors are constantly doing this sort of self-assessment. If you want to make money in the market, then perhaps you should start doing the same.