Saturday, February 21, 2009


Back in mid-2008, I had a friend who lost over 60%. I offered to sit next to him for one afternoon while he was trading and I made sure he was free all day. This was in early September. I told him to initiate short positions and "leave them alone for a few days". He closed out the positions within minutes. He started freaking out because aswing trade was going 5-6% against him.

I told him to re-add all the short positions. I then told him to come over to the window where a large metal pipe was running, and I handcuffed him. You can imagine how berserk he went, calling me all sorts of shit while at the same time feeling hopeless. I uncuffed him after the close. If you're thinking "What the hell am I doing with handcuffs in some dude's room", well, chill the fuck out and keep reading.

This is sort of extreme, but it's also a personal experience. Many years ago, I used to handcuff myself during trading hours to avoid impulse trading and succumbing to my emotions. If I had to go to the bathroom or eat, I had to call my neighbor to unlock me. I did this for two full weeks and it was one of my most profound experiences in my trading career. Psychologically, I had no choice but to withstand the pain and I forced it upon myself like a madman.

Now that I have students, I can't cuff them, but I tell them to completely walk away from the computer if they get urges. Since I am primarily a swing trader, I can withstand bounces and giving up large gains in anticipation of closing out trades for 20%, 30%, even 50% or more. In fact, I could be eating a sandwich and watching Youtube videos while my gains fade away because I have my trade's purpose and goal always in mind with the end result in focus. The psychological aspect of trading must be your foundation, for without it, you will not succeed as a trader.

It doesn't matter what system you trade, what programs you use, or what you subscribe to in your search for the holy grail, or "THE" answer to trading. I found that keeping it simple was the best way for me. If you notice on my daily charts, I hardly ever use technical indicators and only rely on candle charting, price action, volume, and moving averages to make an informed decision. That is really all you need to find the best set-ups that produce highly successful and high probability trades with the greatest time value of employed capital.

I use the most unconventional methods in my trading as well. Many times, I do go 100% all-in, but in the best of circumstances. I believe I will be all-in this week, switched around from long then to short, mid-week. What I do may be risky, but I am so conditioned to take calculated risks that it is second nature to me. In addition, I don't involve myself in conventional portfolio theory or asset allocation. That is a waste of time for my resources. I trade to get the biggest bang for my money in the shortest amount of time. I don't fool around with 1-2% movers. That's a waste of my day.

Everything I said above may or may not apply to you. What someone might do may not be appropriate for you and your tolerances. Most people are conservative and cannot or or are unwilling to employ the strategies that I use, all of which are 100% discretionary and technical and for some, proprietary. It is important for you to figure out what kind of trader you are, what your style is, how your personality fits, etc. This will not come overnight, but rather over months and maybe even years. You must know yourself before throwing your hard earned money in the market.

With that said, there are 4 stages of Learning:

  • Stage I - Unconscious Incompetence: You have no idea what you know or don't know.
  • Stage II - Conscious Incompetence: You admit that you don't know, and you want to know how.
  • Stage III - Conscious Competence: You finally know how, but only if you think things through.
  • Stage IV - Unconscious Competence: You fully know how and you instinctively take action.

During Stage I or Unconscious Incompetence, the trader doesn't know what's going on, and doesn't know much about trading except for the fact that you could make millions! Also, these traders have no trading plan whatsoever. In fact, they don't even know that they need one! Finally, the trader is unaware of the important aspect of trading psychology. We've all been here, done that.

During Stage II or Conscious Incompetence, the trader is all pumped up and excited about the potentials of trading. These traders look at charts all day long and flip through research reports. Finally, they open up a brokerage account anticipating great riches. This group probably reads 1 or 2 books, gets some kind of newsletter subscription, and they think they're ready to run circles around the Market Makers. Not so fast. Unfortunately, these traders lose a lot of money and they realize that all the services and subscriptions and advice they got are no use to them This is also where the individual trader gets a taste of the emotions that come with trading (fear & greed).

This is also where traders test various strategies. Stage II is especially difficult because the trader suffers disastrous losses and may become depressed or overwhelmed. His personal life may be severely affected. It is at this point that they decide to either move forward or quit trading. This is also where positive and negative judgments and thoughts are formed ("Am I too stupid to trade?, "Trading is too hard for me"). The trader has lost money, is afraid and confused, and has jumped into a financial and emotional abyss. You hear the statement, "90% of traders lose money", right? This is the stage where it happens. Even if they can afford to take the financial losses, the psychological losses are excruciatingly painful for the new trader.

When the trader makes a conscious decision to take his losses and move forward, then they have reached Stage III or Conscious Competence. Usually, traders look into the abyss and somehow make it out alive. Whatever their motivation, they decided to pull themselves out. In the process, they have also accepted a few things:

  • Trading is learned until the day you die. You never stop learning.
  • Whatever they did in life, how well they did in their past occupation, and their previous successes do not equate to success in trading.
  • Being wealthy or being really smart also does not equate to success in trading. In fact, some of the biggest losers are doctors, lawyers, engineers, scientists, programmers, analysts, business owners, CEOs, retirees, etc. Why? Because typically, these people have this desire to always be right and for some reason, they refuse to take losses until they are annihilated.
  • They cannot control the markets or "will" it to do whatever they want. More importantly, they accept that they don't need to "control the markets" to become successful in trading.
  • They must have a trading plan. Seriously though, seeking advice from traders/websites/brokers/programs/ etc. as a primary method to trade is like trying to drive to Cali from DC without a map by stopping along the entire way asking all sorts of people for directions. You might end up at Sir Stanford's gf's house in Fredericksburg, VA.
  • They must be psychologically prepared to trade.

Knowing where you are is important, because you now know where you need to be. Once Stage IV is reached, you must do several things:

  • Create a trading plan. Goddammit. Would you start a business without a business plan? I didn't think so.
  • Test out the various strategies and see what "fits". Are you a day trader, swing trader, position trader, a zombie buy-and-hold investor?
  • Do not abandon any plans just because they don't work. There's always a time and place for everything in such a fluid market.
  • Increase recognition and repetition. Practice, practice, and practice some more. Don't bullshit yourself.
  • Accept the fact that taking losses, is part of the game. If you don't like losing, stop trading immediately. I mean it. You 'll thank me later.
  • Do whatever is necessary to condition your psyche. Whatever is necessary, even handcuffing yourself.

After a while, you'll be able to understand odds and probabilities, differentiate for market conditions, learn to capture the meat of profits, scale in-and-out of positions, accept multiple & consecutive losses, learn to hold positions during heavy pressure, develop the "trader's intuition", place trades without hesitation and finally, become consistently profitable, week after week, month after month.

Hope this helps some of you out there.

Where are you within the 4 Stages of Learning?

Stage I - Unconscious Incompetence
Stage II - Conscious Incompetence
Stage III - Conscious Competence
Stage IV - Unconscious Competence

Current Results


Moneymonkey said...

Article doesn't get more valuable than this. Trying to reach stage four end of this year! haha(yeah right) I think i'm still at stage zero.. lol i'll write an article about stage zero haha..

PS: Hmm.. hand-cuff + dude's house = SOME TING WONG man SOME TING WONG.


slqzl said...

Haven't heard it said any better! Only thing I wish were there were more ways to help at the various stages (ie: how to develop a trading plan, what resources to refer to when developing a strategy) but I say that because I am still chillin' in stage 1. Thanks again, never seen it written any better!

inequilibrium said...

Every word is true. This is the best article on trading I have ever read. Unfortunately, I went through stage I and II learning things the hard way. I am working my way through Stage 3 (and out of losses) using a weekly journal and trade plan. There is no real help, because you have to figure it out yourself (your own psychology of comfort) as the article states so well.

Ted said...

I enjoyed your commentary. The main things seems to be keep it simple. I have found in my experiences that keeping things simple can be hard work. But as you mentioned, have a good plan. Work that plan and develop simple strategies.

I am new to covestor and to your web site. I would like to see what top 5 stocks your interested in and why you chose them. Also, I would like to share my stock choices.

ancap said...

You totally ripped off the 4 stages of learning idea from a poker pro, I forget who.

Good article nonetheless.

John C. Lee said...

Don't be late, Steve. I'm going to cuff you to a metal pipe.

I wish to be long financials for 1-2 days, Ted.

Ancap - I don't play cards, but I did read these stages applied in other areas in several psychology books.

Katsu said...

I really should get handcuffs for my self... I am so sick and tired of not being able to follow my plan! I 2/13 I bought FAZ at $45 and the plan was to let it run, but I sold it for $55 after I saw big gap up on 2/17. I was scared of losing profit.

Moneymonkey said...

OMFG JOHN U CALLED LONG ON FRIDAY LOL FINANCIAL FRIDAY~!! FUTURE up 100% indeed. lets see how morning plays out! GO BAC FAS!!!!

Moneymonkey said...

OMFG JOHN U CALLED LONG ON FRIDAY LOL FINANCIAL FRIDAY~!! FUTURE up 100% indeed. lets see how morning plays out! GO BAC FAS!!!!

John C. Lee said...

I told you, didn't I. Easy 20%+ in BAC for me.

Don't be fucking late. 8:30AM EST.

John said...

You said it all. That's trading, right there. It's learning, reading books, working, and admitting your mistakes, staying disciplined and following your rules. I'm still in stage 2, I know that I'm ignorant, I've seen what's out there, I've seen the success that others have accomplished, I know there's so much to learn and understand. That's the "holy grail" to trading, the realization that YOU are it, that YOU can do it, that it's on you, all you have to do is research, gain knowledge, read books, study charts, follow your rules, build discipline, repeat all of the above and then trade! Sorry if I got carried away, but that was one hell of an inspiring article.

John C. Lee said...

John -

I wish you much success in the future. Feel free to ask any questions. Your mindset is perfect.

John C. Lee said...


It's all part of the game. It is developed over a period time. Sometimes letting go is the best thing to do.

If the set-up lines up, then you have to have some faith in it. Let it do what it's highly likely to do.

Cliffynator said...

Great post, John! Do you think you could give us an outline of a trading plan some day?

John C. Lee said...

When I have as much time as I did when writing this article.

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