The One Simple Idea That Enabled Me Become a Full-Time Trader

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1 About the author: Jim Neihart graduated in 1980 from the University of Arizona with a degree in Finance. After a commitment with the United States Navy as a Naval Aviator, he became a Commercial Loan Officer with Citibank. Jim and his wife subsequently owned and operated their own business for seventeen years. Jim routinely trades the securities and futures markets with trading styles that include investment (2 weeks to several months), swing (2-6 days), day (2-6 hours) and scalping (lasting only minutes). Jim has actively managed and invested his portfolio for the past twenty-six years. The One Simple Idea That Enabled Me Become a Full-Time Trader Trade To Trade Well, Not To Make Money! I have repeated this statement hundreds of times to my students. It seems like a contradiction but it really is not. Traders who routinely make enormous amounts of money trading don t mentally count the dollars while they re trading. They don t keep a mental calculator continuously running in their head to constantly keep track of how much money they ve put into their account. Let s see, I bought 1000 shares of Halliburton and it s up one point, times one dollar a share, equals 1000 dollars! Nothing and I mean nothing, will blow your concentration and cloud your judgment faster than keeping that calculator running in your head, calculating the dollars you ve made or lost each minute that goes by during the trading day. Another booby trap is to announce to the world, your husband, wife or even your dog that you re going to make a specific amount of money trading today. You re setting yourself up for failure. Setting as specific dollar amount you must bring home each day, especially if you re a beginning trader, assures that it probably won t happen. This need to make a specific amount of money colors your view of the market and pressures you to open positions that are marginal trades because you have promised yourself or worse yet, someone else - that you re going to bring home the cash! Your pledge echoes in your mind, so you force trades. Odds are, you lose money. Now you re embarrassed with yourself and you start questioning your self-esteem, which automatically leads to more losses. The cure for this illness: From this point forward, your goal is not to make money. Your goal is to trade to trade well! Money is a by-product of trading well. A very interesting thing starts to happen when you focus on trading well. Your profits will start to add up a lot faster than they did when making money was your primary goal. This is simply because traders who focus on trading well cut their losses and let their winners run. They protect their capital and leave unnecessary risks to others. They recognize a choppy market and sit on their hands and don t trade. They make promises to no one, including themselves, about the money they want to take home. Traders who trade well let the market come to them. They are extremely patient and disciplined. They wait for the perfect setup and entry point. If that perfect point doesn t come along, oh well, they wait for the next one knowing that another chance is just around the corner. Once in the trade, they mechanically and methodically manage their position, taking profits at specific points, and moving their stop loss to protect their principal.

2 Traders who trade well don t trade simply for the excitement of the trade because they have become addicted to the thrill. They don t trade out of boredom or when they are sick or tired. They don t trade especially if they have stress in their life that disallows their full focus on the market. Successful traders always abide by their trading rules and never stray from them. Traders who trade well are perfectionists and are very wealthy as a result of their unwavering discipline. You too should have this goal. Greed and Fear - Our Constant Companions Without question, the two emotions that rule the financial markets are greed and fear. These emotions are omnipresent and motivate nearly all market players. The size of the player is of no consequence. They can be institutional managers, stock brokers; traders like you and me or even your hairdresser or barber who gives you a hot tip. Absolutely no one is immune from these emotions including you. No matter how you try to convince yourself otherwise, there they sit, one on each of your shoulders as you trade with each one rearing its ugly head at the most inopportune time. As a brand-new trader, greed and fear will be your constant companions. Never, ever be embarrassed that you are experiencing these emotions as you trade because these emotions are part of trading. Take solace in knowing that everyone who has ever traded has experienced these bedfellows just as you have or are now experiencing them. Your goal as a trader is to face these emotions head on and, the key, learn to understand them. It is in understanding that we cross a magical barrier that leads to control. We cannot control unless we understand what it is we are attempting to control. And it s a very good idea to control these two demons because if we don t they can certainly assist in the destruction of our trading accounts. What am I talking about? Let s look at the following examples: You ve run your scans and you find the perfect setup. You check earnings and no news is forthcoming. No news is good news. You confirm that the stock is trending the direction you want it to move and the entry time frame is good to go. You open the position and the stock immediately moves as you expected. Suddenly, a little voice whispers in your ear, This stock is going to the moon, why don t you double your position size. You ll make a killing! Ladies and gentlemen, please let me introduce you to an emotion I have become very familiar with. Greed. Or, you open a position and it moves to your predetermined profit target and you think, This is the profit target but look how this stock keeps moving in my favor. I ll stay in it for just a little bit longer and make some more money. Greed. Typically, when stocks explode in a bull market, greed explodes in direct proportion. The downside to this is that stocks can fizzle as fast as and usually faster than they mushroomed. As fear starts to set in, everyone heads for the hills and sends those pesky market orders to exit their position which in turn fuels the mass exodus. Unfortunately, most everyone hits the exit door with less money than they came in with.

3 Here s another example. You are convinced a stock will shoot up at the markets open the following morning. You take a larger than normal position home the night before (greed). The next morning the market opens on a huge gap down. Your stock is now in an inverted spin and on fire. There is no way to exit this crashing plane. Panic starts to set in as you see your losses mount. The blood literally pounds in your head as you watch a large portion of your trading account dissolve with the red blinking prices on your monitor. Ladies and gentlemen, Fear. Any trader worth his or her salt has been there. We have all felt greed and fear more than most wish to discuss. How do we as traders learn to control these emotions? I say control because we will never eliminate them. We must simply learn to control them. We control them through continuing education and discipline. When you learn to trade the focus initially cannot be on making money. We must learn to trade to trade well and in the beginning trade with a small number of shares so that we can remove as much of the emotion that we possibly can. There s a lot less emotion in trading ten shares versus one hundred shares. Through education, discipline and initially trading with a small number of shares, we learn to trade. Once we learn to trade well, the emotional affects of trading are less and less influential and the money then follows. Protect Your Capital! Time and time again I have discussed the necessity to trade to trade. One thing that goes hand in hand with this trading commandment is the other commandment which is to protect your capital. Successful professionals in occupations throughout the world use tools to accomplish their goals. Whether the tools are tangible such as a doctor s stethoscope or intangible such as knowledge and discipline, these tools are cared for by the professional who uses them. A surgeon doesn t drag his stethoscope on the floor as he walks down the hall and a mechanic doesn t leave his tool box open and out in the rain. As a professional trader, your tools consist of your ability to read and understand charts as well as mental and emotional discipline to follow your trading rules. Don t treat this in a reckless, careless fashion. Money in your trading account is your most cherished tool and you must guard it with your life. Statistically, 90 percent of all traders lose the money in their trading accounts in the first six months to one year of trading. If you can hang in there for one year, the statistics for success get much better. After two years it really improves dramatically. As you sit and read this, somewhere in the world someone is chasing a trade, moving their stops to give the trade more room, overtrading, buying at a retail point, selling at wholesale or opening a position that s simply to large. In other words, they are treating their capital in a reckless fashion. They get

4 caught up in the excitement of the trade. I ve been there as well early on in my career and I have the losses to prove it. Always keep in mind that even in what seems to be a perfect set-up for a trade, when you open the position, anything can happen. Even though you may have done your homework extremely well to avoid all unnecessary risks, a certain percentage of your trades will lose money. Don t add to this eventuality by making careless moves or you to will become a statistic in the trader bone yard. Traders who make six or seven figures a year protect their trading accounts like a mother bear protects her cubs. They are cautious with every trade and their discipline is unwavering. Remember, trading is a business and you are going to have the typical expenses involved in owning and operating your own business. A trade in which we lose money is not a loss; it is an expense trade a normal part of doing business. Professional traders look at this as a routine business expense as well. They don t compound the problem with carelessness. The famous Jesse Livermore was once quoted as saying, I made most of my money sitting on my hands. In other words he never felt compelled to trade unless conditions were perfect. Always ask yourself three questions prior to opening a position: ~ What is the purpose of this trade and why am I opening this position. Is the setup perfect and is the market moving in the same direction. ~ Is my entry time frame also set up perfectly for an entry? If not, I ll wait. ~ Have I planned my trade in terms of a stop loss point and profit targets. Plan your trade and trade your plan, discipline, discipline, discipline! Once you become consistently profitable at trading, it truly becomes a very mechanical process. With practice you ll soon be able to answer the questions above in two seconds or less. In this odds based business we want to put as many odds as possible in our favor. Having a solid trading plan and having the patience to wait for those high probability trades will put you well on the path to success and preservation of your capital. What Type of Trader Are You: Part-Time or Full-Time? Before you start to trade, you need to establish goals in terms of how much time you can devote to trading. Are you going to trade on a full or part-time basis? Always keep in mind, as with any business, the more time you can devote to the business in the beginning, the better the business will be. Many traders I know spend the entire day in front of the market. They are glued to their monitors from one to two hours before the opening bell until well after the market closes in the afternoon.

5 They take advantage of every profit opportunity offered during market hours. I also know many traders who work other jobs and trade two to three days a week. Their style takes advantage of trades that take two to six days or weeks from start to finish. I ve even traded with some hot shot traders who only trade one to two hours a day and make a fortune doing so. O.K., now that you ve decided how much time you can devote to trading, here are a few more considerations: ~ How many trades do you plan to make each day. Three or fewer? ~ How long do you intend for the position to be open? Six days or possibly six weeks? ~ How much time do you intend to devote to homework? As much as possible with no intention of doing it 24/7? ~ Do you plan on focusing on trading after work and on weekends? If you answered yes to the questions above, you are a part-time trader. This style fits most of the trading population. Most folks have a full-time job and three and a half kids at home. Time can be limited and, realistically, there is only so much time in a day and we all know that unless you devote some extremely focused time to trading, it can get very expensive. If you are fortunate, and can focus every hour of everyday on the market, the following tendencies would define a full-time trader: ~ You will be in front of the market every day from before the open until after the closing bell. You will also know when it is best not to trade and sit on your hands or step away from your machine should market conditions so dictate. ~ You strive to execute and manage your trades with workman like precision. ~ Your goal is to make fast profits, sometimes being in trades for only a few seconds. ~ You study more than you did in high school or college and love hearing those magical words from your spouse as you duck into another book store, Are you going to spend more money on another stock trading book?! ~Your objective is to trade stocks for a living. Establish your goals early and your ability to focus will be much clearer and easier. What Market Are You Talking About? The ETF s, the e-minis, the cash market, the futures market and on and on and on. Anyone new to trading has heard these terms over and over again and I am constantly asked by students what it all means. You can get a headache listening to and trying to understand what all these markets represent. All you ever wanted to know was how the market was doing!

6 When people refer to the market they usually mean the entire stock market. Within the market you have three main exchanges that trade the vast majority of stocks. The three main exchanges are the New York Stock Exchange (NYSE), the NASDAQ stock exchange, and the American Stock Exchange (AMEX). Stocks are always being added or removed from these exchanges but the largest is currently the NASDAQ with about 3300 stocks trading. The NYSE is next with approximately 2700 stocks and the AMEX is trading about 800. One of the easiest ways to view the market is by following an index. Think of an index as a basket of stocks. Certainly you ve heard of the S&P 500, the Dow 30 and the NASDAQ 100. Let s take the S&P 500 and use it in our discussion. Think of it as a basket of stocks that contain 500 of the leading companies in the U.S. Because it contains 500 of the leading stocks in America, the S&P is considered the best indicator of the equities market in the U.S. You have no doubt heard the phrase the broader market. This phrase refers specifically to the S&P 500. As an aside, whenever one refers to equities, they are referring to stock. When you buy a share of stock, you own a piece of the company in which you have purchased stock. Since you own a piece of that company, you now have equity in that company. The NASDAQ 100 index includes 100 of the largest domestic and international non-financial companies. This index includes companies that are primarily technical in nature such as computer hardware and software, telecommunications and biotechnology, for example. The Dow is an index of only 30 stocks. In designing this index, the idea was to include a cross section of the entire market. The Dow is used to represent the U.S. market globally. Many people are often surprised to learn that stocks in this index are chosen and maintained by the editors of the Wall Street Journal. When looking at these indices, keep in mind that there are times when an individual stock can be included in more than one of these indices. Intel Corp. (INTC) is in the NASDAQ 100, the S&P 500 and the Dow. Now let s talk about ETFs. ETF is an acronym for Exchange Traded Fund. Think of an ETF also as a basket of stocks designed specifically to track an index. When you trade an ETF, you trade it like you would any stock. There are more than 800 ETFs with the most common being the ETFs for the NASDAQ 100, the S&P 500 and the Dow 30. The difference between an index and an ETF is where the confusion arises. By tracking the S&P index for example, you are tracking the performance of the 500 stocks in that basket of stocks. If you look at a chart of the index, you will notice a graduated scale on the chart that tells you where the index is trading. The S&P close when I wrote this was at You can t trade the index itself but you can, however, trade the ETF for the S&P 500. One ETF for the S&P is called the Spiders (SPY). If you bought one share of the spiders, it would cost you $ today. With that one share of the S&P ETF, you effectively own a little piece of every stock in the S&P 500! Many people love the idea of buying the ETF and knowing that they own the market. The ETF for the Dow is the Diamonds (DIA) and the NASDAQ is the Q s (QQQQ). Since virtually all mutual funds and other investment instruments annually compare their performance to these indices, many people buy the ETF s which, as they trade, mirror their respective indices.

7 In addition to everything we ve touched on so far, there are also futures. A futures contract is an obligation to receive or deliver a commodity or financial instrument sometime in the future for a price that is agreed upon today. Trading futures should not be confused with options trading as options also trade in contracts. When trading options, a contract is 100 shares of stock. In futures trading, a futures contract is, once again, a basket of whatever it is you are trading whether it s gold, corn, stock, etc. Trading futures introduces the trader to an enormous amount of leverage. Most people are familiar with the commodities futures of corn and pork bellies, but futures have also been designed for the investment markets as well. The most popular of these are futures which are based on the indices for the S&P 500, the NASDAQ and the Dow. For many years financial institutions traded big futures contracts that are typically cost prohibitive for folks like us who have limited trading capabilities in terms of the size of our trading accounts. In the mid nineties, miniature versions of the big contracts were designed that could be traded electronically on the internet. Hence, the e-minis were born. Now most people can trade the futures on the indices and afford to do so. What s the difference between trading an ETF versus the e-mini on the indices? When you trade an ETF it s the equivalent of buying a share of stock. For every penny the ETF moves up or down, your account moves up or down a penny as it mirrors the movement of the index. When you trade the futures on the same index, tremendous leverage is engaged. For every point the future contract moves up or down, you earn or expense significantly more money. To give you an example, a ten cent move in the S&P ETF is the equivalent of a one point move in the S&P e-mini future. That one point move in the e-mini is a $50.00 move! Yes, ten cents versus $50.00 for the identical move. That s a little bit of leverage! Hello!!! How much does it cost to trade the e-minis? A good faith deposit is set aside in your trading account for each contract you trade. Once you close your futures position, your broker returns the deposit to your trading account. The size of the deposit varies from broker to broker for each one of the indices you wish to trade. The moral of the story.you DO NOT trade the futures markets until you know how to trade and until you have the experience necessary to do so!! So, how many ways could you trade the S&P 500? Well, you could trade the cash index, the ETF, the big futures contract and the e-mini. People always ask if there s a difference in the chart patterns. Since they are all tied to the same underlying instrument, the charts are all virtually identical at the end of the day. Depending on what is happening in the market during trading hours, the intra-day price action may vary slightly as one of these may move slightly ahead of the others. But for all intent and purposes, the charts are virtually identical. I hope this clears the air a bit and gives you a better idea of what you re looking at. What Is Margin? This week one of my students asked me what the buying power entry meant on the summary page of their on line trading platform. I proceeded to explain margin and thought it would be wise to explain it today so we could all have a better understanding going forward.

8 When you open a trading account, one of the questions you ll be asked is whether or not you want to designate it as a standard margin account. The standard margin you will receive is called a fifty percent margin account. Simply, this means is that for every dollar you deposit into your trading account, your broker will match your deposit with a loan of equal value. For example, if you open an account with $30,000, your broker will give you the ability to borrow $30,000 more on top of your initial deposit of $30,000. You now have $60,000 that you can trade with! Or, in other words, you have $60,000 worth of buying power. When I spoke in terms of the matching money being a loan, that s exactly what it is. Just like a bank, your broker will charge interest on the loan. The interest rate will vary from broker to broker. The interest rate is usually low and no interest is charged until you actually use the money. Two very good reasons exist in support of opening a margin account. First of all, as you become a more experienced trader, the margin will give you some extra horsepower in the form of additional buying power. The idea is that you will eventually be leveraging your money and hopefully making more money than the interest on the loan will be costing you. Secondly, in order to place a short position and make money as the stock price declines, you will have to open a margin account. In the volatile market we trade, shorting stocks can reward you with significant profits. As I ve mentioned in previous articles, introducing leverage too early in your trading career can be a very dangerous thing. You never want to use leverage until you have the experience under your belt and until you are consistently making money in the market. The focus is to learn to trade well. Money is a byproduct of trading well. If you are a beginning trader, a good strategy is to open a margin account and then immediately forget that you have the extra buying power. Once you have forgotten about the extra buying power, use only your original equity to trade with. Keep a portion of your account in cash at all times. No, it s not going to be boring. Believe me when I tell you that trading in today s marketplace will provide you with plenty of entertainment and excitement as you learn to trade. Happy Trading!