Introduction
In "The New Trading for a Living," Dr. Alexander Elder provides a comprehensive guide for aspiring traders who want to make a living in the financial markets. This book offers valuable insights, strategies, and practical advice for both beginners and experienced traders. Elder's approach emphasizes the importance of psychology, risk management, and technical analysis in successful trading.
Key Ideas
The Pitfalls of New Traders
New traders often face several challenges when entering the world of financial markets. One of the most significant pitfalls is the cost of commissions. Every trade incurs a fee, and these fees can quickly add up, eating into potential profits. For example, an active trader making two trades a day, four days a week, paying $10 per trade in commissions, could end up spending $4,000 in commissions annually. This represents a significant portion of their trading budget, especially for those starting with smaller capital.
To minimize commission costs, it's crucial to research different brokers and banks, comparing their services and fees carefully. This due diligence can help traders avoid paying more than necessary for their transactions.
Another common issue new traders face is slippage. Slippage occurs when an order is filled at a price different from what was expected, usually resulting in paying more for a stock than intended. To mitigate this risk, traders should use limit orders instead of market orders. A limit order specifies the maximum price a trader is willing to pay for a stock, ensuring they don't overpay due to sudden price fluctuations.
Trading vs. Gambling
Many people mistakenly equate trading with gambling, but successful trading is far from a game of chance. While poor trading practices may resemble gambling, professional trading involves careful analysis, risk management, and emotional control.
Signs that a trader might be approaching the market like a gambler include:
- An irresistible urge to trade
- Emotional reactions to individual trades
- Self-sabotaging behaviors
Professional traders maintain emotional detachment from their trades, viewing them as simply a means to make money rather than a personal reflection of their worth or abilities. They take responsibility for their actions and decisions, avoiding careless mistakes that could wipe out their capital.
Avoiding the Herd Mentality
One of the key challenges in trading is resisting the urge to follow the crowd. Human instinct often drives us to seek safety in numbers, but in trading, this can lead to disastrous outcomes. The market is essentially a mass of people following trends, and successful traders must learn to think independently.
Historical examples like the Tulip Mania in 17th century Holland demonstrate the dangers of getting caught up in market hysteria. To avoid falling into this trap, traders need to understand and identify different types of group behavior in the market, particularly the dynamics between bulls (those betting on prices going up) and bears (those betting on prices going down).
Understanding Bar Charts
Chart analysis is a crucial skill for traders looking to identify price patterns and make informed decisions. Bar charts are a fundamental tool in this analysis, consisting of five key elements:
- Opening prices
- Closing prices
- The highs of a bar
- The lows of a bar
- The distances between the highs and lows
Opening prices often reflect the opinions of amateur traders, while closing prices tend to represent the decisions of professionals. The relationship between these prices can provide insights into market sentiment and potential trends.
The highs and lows of each bar show the maximum power of bulls and bears, respectively, while the distance between them indicates the intensity of the conflict between these two groups. This information can help traders gauge market activity and avoid entering overheated markets where slippage is more likely to occur.
Support and Resistance Levels
Two critical concepts in chart analysis are support and resistance levels. Support is the price level at which buying is strong enough to reverse or interrupt a downward trend. It can be visualized as a floor that prices bounce off of. Resistance, on the other hand, is the price level at which selling is strong enough to reverse or interrupt an upward trend, acting like a ceiling that prices struggle to break through.
Traders can identify support and resistance levels by connecting two or more lows or highs on a chart with horizontal lines. These levels are important because they often represent points where traders make decisions to buy or sell. Many traders buy at support levels and sell at resistance levels, which reinforces these price points over time.
Understanding support and resistance can help traders make more informed decisions about when to enter or exit positions. For example, buying near a support level when prices are low and selling near a resistance level when prices are high can potentially maximize profits and minimize risks.
Liquidity and Volatility
Regardless of the financial instrument being traded (stocks, options, ETFs, futures, etc.), two crucial factors to consider are liquidity and volatility. Liquidity refers to the average daily volume of traded shares. Higher liquidity makes it easier to enter and exit positions without significantly affecting the price.
The author recommends focusing on stocks that trade at least a million shares per day to ensure sufficient liquidity. This helps avoid situations where a trader might get stuck with shares that are difficult to sell without incurring significant losses.
Volatility, on the other hand, measures the average short-term price movements of a stock. Higher volatility offers more opportunities for profit but also increases the risk of losses. Volatility can be measured using beta, which compares a stock's volatility to a benchmark like a market index.
For beginners, it's advisable to focus on stocks with lower betas to limit potential losses while learning the ropes of trading. As traders gain experience and confidence, they can gradually explore more volatile instruments if it aligns with their risk tolerance and trading strategy.
Risk Management Rules
Effective risk management is crucial for long-term success in trading. Dr. Elder recommends two simple but powerful rules to minimize risk:
The 2% Rule: This rule states that a trader should never risk more than 2% of their trading capital on a single trade. For example, if a trader has $50,000 in their account, they should not risk more than $1,000 on any single trade. This rule helps protect against catastrophic losses and ensures that a string of losing trades won't wipe out the entire trading account.
The 6% Rule: This rule dictates that a trader should stop opening new positions for the rest of the month if their total losses for the month plus the risk in open trades reaches 6% of their trading capital. This rule acts as a circuit breaker, preventing traders from digging themselves into a deeper hole during periods of poor performance or unfavorable market conditions.
These rules provide a structured approach to risk management, helping traders maintain discipline and protect their capital even during challenging times.
The Importance of Record Keeping
Successful trading requires meticulous record-keeping. Just as tracking weight is essential for effective weight management, monitoring trading performance is crucial for improving strategies and results over time.
One of the most effective ways to keep records is by maintaining a trade journal. This journal should include details about each trade, including entry and exit points, reasons for the trade, and any observations or lessons learned. Reviewing these entries one or two months after a trade can provide valuable insights and help identify patterns or mistakes that might not have been apparent at the time.
A trade journal can also help prevent emotional trading by providing concrete evidence of how impulsive or feeling-based decisions have affected performance. Many traders find pre-existing templates online that can be adapted to their specific needs.
One key element to track in the journal is the personal equity curve, which shows whether a trader is making or losing money over time. A downward trend in the equity curve may indicate a need to reassess trading strategies or improve discipline.
The Psychology of Trading
A significant portion of "The New Trading for a Living" focuses on the psychological aspects of trading. Dr. Elder emphasizes that successful trading requires not only technical knowledge but also emotional control and mental discipline.
Some key psychological factors discussed in the book include:
Emotional detachment: Traders need to view their trades objectively, without becoming emotionally invested in the outcome of any single trade.
Patience: Successful traders often wait for high-probability setups rather than forcing trades out of boredom or impatience.
Discipline: Adhering to a well-defined trading plan and risk management rules is crucial for long-term success.
Continuous learning: The markets are constantly evolving, and successful traders commit to ongoing education and improvement of their skills.
Handling losses: Every trader experiences losses, but how one responds to these setbacks can make the difference between success and failure.
Technical Analysis Techniques
While the book covers various aspects of trading, it places a strong emphasis on technical analysis. Some of the key technical analysis techniques discussed include:
Trend analysis: Identifying and trading with the prevailing market trend.
Moving averages: Using these indicators to smooth out price data and identify potential trend changes.
Oscillators: Employing tools like the Relative Strength Index (RSI) or Stochastic Oscillator to identify overbought or oversold conditions.
Volume analysis: Incorporating trading volume into price analysis to confirm trends and potential reversals.
Chart patterns: Recognizing common chart patterns like head and shoulders, double tops/bottoms, and triangles.
Developing a Trading System
Dr. Elder advocates for developing a personalized trading system that aligns with an individual's personality, risk tolerance, and goals. This system should include:
- Clear entry and exit rules
- Risk management guidelines
- Position sizing strategies
- A method for tracking and analyzing performance
The book emphasizes the importance of thoroughly testing a trading system before risking real money. This can be done through backtesting (applying the system to historical data) and paper trading (simulated trading with real-time data but no actual money at risk).
The Importance of Continuous Learning
Throughout "The New Trading for a Living," Dr. Elder stresses the importance of continuous learning and improvement. The financial markets are dynamic, and successful traders must adapt to changing conditions and new information.
Some ways to continue learning include:
- Studying market history and past trends
- Keeping up with current financial news and economic indicators
- Analyzing personal trades to identify strengths and weaknesses
- Attending trading seminars or workshops
- Reading books and articles by successful traders and market analysts
- Participating in trading communities or forums to share ideas and experiences
Final Thoughts
"The New Trading for a Living" provides a comprehensive framework for anyone looking to succeed in the financial markets. Dr. Alexander Elder's approach emphasizes the importance of combining technical analysis with sound psychology and risk management.
Key takeaways from the book include:
- Understand and avoid common pitfalls like excessive commissions and slippage.
- Differentiate between professional trading and gambling by maintaining emotional control and discipline.
- Develop skills in chart analysis, focusing on support and resistance levels.
- Consider liquidity and volatility when choosing trading instruments.
- Implement strict risk management rules to protect your trading capital.
- Keep detailed records of your trades and continuously analyze your performance.
- Focus on developing a strong trading psychology, including emotional detachment and discipline.
- Learn and apply various technical analysis techniques.
- Develop a personalized trading system that suits your individual needs and goals.
- Commit to continuous learning and improvement in your trading journey.
By following these principles and putting in the necessary time and effort to develop their skills, aspiring traders can increase their chances of success in the challenging world of financial markets. However, it's important to remember that trading involves significant risks, and there are no guarantees of success. Aspiring traders should approach the markets with caution, start with a solid educational foundation, and be prepared for both successes and setbacks along the way.