TRADING IN THE ZONE

1 TRADING IN THE ZONE. MASTER THE MARKET WITH. CONFIDENCE, DISCIPLINE AND. A WINNING ATTITUDE. MARK DOUGLAS. Foreword by Thorn Hartle NEW YORK INSTITUTE OF FINANCE. wcw VHDV Tnnnurn . cvnucv Tnrvn cinr. pnpc Library of Congress Cataloging-in-Publication Data Douglas, Mark (Mark J.). TRADING in the zone : master the market with confidence, discipline, and a winning attitude / by Mark Douglas, p. cm. ISBN 0-7352-0144-7 (cloth). 1. Stocks. 2. Speculation. I. Title. HG6041 .D59 2001. dc21 00 045251. 2000 by Prentice Hall All rights reserved. No part of this book may be reproduced in any form or by any means, without permission in writing from the publisher. Printed in the United States of America 10 9876 5 4321. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered.

2 It is sold with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought.. From the Declaration of Principles jointly adopted by a Committee of the American Bar Association and a Committee of Publishers and Associations. ISBN D-73SE-DmM-7. ATTENTION: CORPORATIONS AND SCHOOLS. Prentice Hall books are available at quantity discounts with bulk purchase for educational, business, or sales promotional use. For information, please write to: Prentice Hall, Special Sales, 240 Frisch Court, Paramus, N] 07652. Please supply: title of book, ISBN, quantity, how the book will be used, date needed.

3 NEW YORK INSTITUTE OF FINANCE. An Imprint of Prentice Hall Press Paramus, NJ 07652. NYIF and NEW YORK INSTITUTE OF FINANCE are trademarks of Executive Tax Reports, Inc. used under license by Prentice Hall Direct, Inc. DEDICATION. This book is dedicated to all of the traders I have had the pleasure of working with over the last 18. years as a TRADING coach. Each of you in your own unique way is a part of the insight and guidance this book will provide to those who choose to trade from a confident, disciplined, and consistent state of mind. o TABLE OF CONTENTS. FOREWORD .. xi PREFACE .. xm ATTITUDE SURVEY .. xvii _____CHAPTER 1_____. THE ROAD TO SUCCESS: FUNDAMENTAL, TECHNICAL, OR MENTAL ANALYSIS? IN THE BEGINNING: FUNDAMENTAL ANALYSIS .. 1. THE SHIFT TO TECHNICAL ANALYSIS.

4 3. THE SHIFT TO MENTAL ANALYSIS .. 4. _____CHAPTER 2_____. THE LURE (AND THE DANGERS). OF TRADING . THE ATTRACTION .. 17. THE DANGERS .. 20. THE SAFEGUARDS.. 25. Problem: The Unwillingness to Create Rules.. 27. Problem: Failure to Take Responsibility .. 28. Problem: Addiction to Random Rewards .. 30. Problem: External versus Internal 31. _____CHAPTER 3_____. TAKING RESPONSIBILITY. SHAPING YOUR MENTAL ENVIRONMENT.. 34. REACTING TO LOSS .. 38. WINNERS, LOSERS, BOOMERS, AND BUSTERS .. 50. _____CHAPTER 4_____. CONSISTENCY: A STATE OF MIND. THINKING ABOUT TRADING .. 58. REALLY UNDERSTANDING RISK.. 61. ALIGNING YOUR MENTAL ENVIRONMENT .. 64. _____CHAPTER 5_____. THE DYNAMICS OF PERCEPTION. DEBUGGING YOUR MENTAL SOFTWARE .. 70. PERCEPTION AND LEARNING .. 74. PERCEPTION AND RISK.

5 79. THE POWER OF ASSOCIATION.. 80. _____CHAPTER 6_____. THE MARKET'S PERSPECTIVE. THE "UNCERTAINTY" PRINCIPLE .. 88. THE MARKET'S MOST FUNDAMENTAL CHARACTERISTIC.. 93. _____CHAPTER 7_____. THE TRADER'S EDGE: THINKING IN PROBABILITIES. PROBABILITIES PARADOX: RANDOM OUTCOME, CONSISTENT RESULTS.. 102. TRADING IN THE MOMENT.. 106. MANAGING EXPECTATIONS .. 113. ELIMINATING THE EMOTIONAL RISK .. 120. _____ CHAPTER 8_____. WORKING WITH YOUR BELIEFS. DEFINING THE PROBLEM .. 125. DEFINING THE TERMS .. 128. HOW THE FUNDAMENTAL TRUTHS RELATE TO THE SKILLS .. 130. MOVING TOWARD "THE ZONE".. 135. _____CHAPTER 9_____. THE NATURE OF BELIEFS. THE ORIGINS OF A BELIEF.. 139. BELIEFS AND THEIR IMPACT ON OUR LIVES .. 142. BELIEFS vs. THE TRUTH.. 147. _____CHAPTER 10_____. THE IMPACT OF BELIEFS ON TRADING .

6 THE PRIMARY CHARACTERISTICS OF A BELIEF .. 153. SELF-EVALUATION AND TRADING .. 167. _____CHAPTER 11_____. THINKING LIKE A TRADER. THE MECHANICAL STAGE.. 173. THE ROLE OF SELF-DISCIPLINE.. 179. CREATING A BELIEF IN CONSISTENCY .. 184. EXERCISE: LEARNING TO TRADE AND EDGE LIKE A. CASINO .. 189. A FINAL NOTE .. 201. ATTITUDE SURVEY .. 203. INDEX .. 209. FOREWORD. The great bull market in stocks has led to an equally great bull market in the number of books published on the subject of how to make money TRADING the markets. Many ideas abound, some good, some not, some original, some just a repackaging of earlier works. Occasionally, though, a writer comes forward with something that really sets him or her apart from the pack, something special. One such writer is Mark Douglas.

7 Mark Douglas, in TRADING in the Zone, has written a book that is the accumulation of years of thought and research the work of a lifetime and for those of us who view TRADING as a profession, he has produced a gem. TRADING in the Zone is an in-depth look at the challenges that we face when we take up the challenge of TRADING . To the novice, the only challenge appears to be to find a way to make money. Once the novice learns that tips, brokers' advice, and other ways to justify buying or selling do not work consistently, he discovers that he either needs to develop a reliable TRADING strategy or purchase one. After that, TRADING should be easy, right? All you have to do is follow the rules, and the money will fall into your lap. At this point, if not before, novices discover that TRADING can turn into one of the most frustrating experiences they will ever face.

8 This experience leads to the oft-started statistic that 95 percent of futures traders lose all of their money within the first year of TRADING . Stock traders generally experience the same results, which is why pundits always point to the fact that most stock traders fail to outperform a simple buy and hold investment scenario. So, why do people, the majority of whom are extremely successful in other occupations, fail so miserably as traders? Are successful traders born and not made? Mark Douglas says no. What's necessary, he says, is that the individual acquire the trader's mindset. It sounds easy, but the fact is, this mindset is very foreign when compared with the way our life experiences teach us to think about the world. That 95-percent failure rate makes sense when you consider how most of us experience life, using skills learned as we grow.

9 When it comes to TRADING , however, it turns out that the skills we learn to earn high marks in school, advance our careers, and create relationships with other people, the skills we are taught that should carry us through life, turn out to be inappropriate for TRADING . Traders, we find out, must learn to think in terms of probabilities and to surrender all of the skills we have acquired to achieve in virtually every other aspect of our lives. In TRADING in the Zone, Mark Douglas teaches us how. He has put together a very valuable book. His sources are his own personal experiences as a trader, a traders coach in Chicago, author, and lecturer in his field of TRADING psychology. My recommendation? Enjoy Douglas's TRADING in the Zone and, in doing so, develop a trader's mindset.

10 PREFACE. The goal of any trader is to turn profits on a regular basis, yet so few people ever really make consistent money as traders. What accounts for the small percentage of traders who are consistently successful? To me, the determining factor is psychological the consistent winners think differently from everyone started TRADING in 1978. At the time, I was managing a commercial casualty insurance agency in the suburbs of Detroit, Michigan. I had a very successful career and thought I could easily transfer that success into TRADING . Unfortunately, I found that was not the case. By 1981, I was thoroughly disgusted with my inability to trade effectively while holding another job, so I moved to Chicago and got a job as a broker with Merrill Lynch at the Chicago Board of Trade.