EXERCISE: LEARNING TO TRADE AND EDGE LIKE A CASINO’

Question 1

The object of this exercise is to convince yourself that trading is just a simple game of

Answer 1

probabilities
(numbers), not much different from pulling the handle of a slot machine.

Question 2

At the micro level, the
outcomes to individual edges are

Answer 2

independent occurrences and random in relationship to one another

Question 3

At the macro level, the outcomes over a series of trades will produce

Answer 3

consistent results

Question 4

From a
probabilities perspective, this means that instead of being the person playing the slot machine, as a
trader, you can be the casino, if:

Answer 4

1. you have an edge that genuinely puts the odds of success in your favor;
2. you can think about trading in the appropriate manner (the five fundamental truths); and
3. you can do everything you need to do over a series of trades. Then, like the casinos, you will own the
   game and be a consistent winner.

Question 5

SETTING UP THE EXERCISE
Pick a market.

Answer 5

options trading

Question 6

Choose a set of market variables that define an edge.

Answer 6

This can be any trading system you want. The
trading system or methodology you choose can be mathematical, mechanical, or visual (based on
patterns in price charts).

Question 7

It doesn’t matter whether you personally design the system or purchase it from
someone else, nor do you need to take a long time or be too picky trying to find or develop the best or
right system. This exercise is not about system development and it is not a test of your analytical
abilities.

Answer 7

In fact, the variables you choose can even be considered mediocre by most traders’ standards,
because what you are going to learn from doing this exercise is not dependent upon whether you
actually make money.

Question 8

If you consider this exercise an educational expense, it will

Answer 8

cut down on the amount of time and effort
you might otherwise expend trying to find the most profitable edges.

Question 9

Trade Entry

The variables you use to define your edge have to be

Answer 9

absolutely precise

Question 10

The system has
to be designed so that it does not require you to make any subjective decisions or judgments about

Answer 10

whether your edge is present.

Question 11

If the market is aligned in a way that conforms with the rigid variables of
your system, then you have a trade; if not,

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then you don’t have a trade. Period! No other extraneous or
random factors can enter into the equation.

Question 12

Stop-Loss Exit.

The same conditions apply to getting out of a trade that’s not working. Your
methodology has to tell you exactly how much you need to

Answer 12

risk to find out if the trade is going to work.

Question 13

There is always an optimum point at which the possibility of a trade not working is so diminished,
especially in relationship to the profit potential, that you’re better off

Answer 13

taking your loss and getting your
mind clear to act on the next edge.

Question 14

Let the market structure determine where this optimum point is,
rather than

Answer 14

than using an arbitrary dollar amount that you are willing to risk on a trade.

Question 15

In any case,
whatever system you choose, it has to be absolutely exact, requiring no

Answer 15

subjective decision making, Again, no extraneous or random variables can enter into the equation.

Question 16

Time Frame. Your trading methodology can be in any time frame that suits you, but all your entry and
exit signals have to be done on

Answer 16

same time frame.

Question 17

For example, if you use variables that identify
a particular support and resistance pattern on a 30-minute bar chart, then your risk and profit objective
calculations also have to be determined in a

Answer 17

30-minute time frame

Question 18

However, trading in one time frame
does not preclude you from using other time frames as

Answer 18

filters.

Question 19

For example, you could have as a filter a
rule that states you’re only going to take trades that are in the direction of the

Answer 19

major trend.

Question 20

There’s an
old trading axiom that “The

Answer 20

trend is your friend.”

Question 21

“The trend is your friend.” It means that you have

Answer 21

a higher probability of success
when you trade in the direction of the major trend, if there is one

Question 22

“The trend is your friend.”

In fact, the lowest-risk trade, with the
highest probability of success, occurs when you are buying

Answer 22

dips (support) in an up-trending market or
selling rallies (resistance) in a down-trending market.

Question 23

To illustrate how this rule works, let’s say that
you’ve chosen a precise way of identifying support and resistance patterns in a 30- minute time frame
as your edge. The rule is that you are only going to

Answer 23

take trades in the direction of the major trend.

Question 24

A
trending market is defined as a series of

Answer 24

higher highs and higher lows for an up-trending market and a
series of lower highs and lower lows for a downtrending market.

Question 25

The longer the time frame, the more
significant the trend, so a trending market on a daily bar chart is more significant than a trending
market on a 30-minute bar chart. Therefore

Answer 25

the trend on the daily bar chart would take precedence over
the trend on the, 30-minute bar chart and would be considered the major trend

Question 26

To determine the direction of the major trend, look at what is happening on

Answer 26

daily bar chart.

Question 27

To determine the direction of the major trend, look at what is happening on a daily bar chart. If the
trend is up on the daily, you are only going to

Answer 27

look for a sell-off or retracement down to what your edge
defines as support on the 30-minute chart. That’s where you will become a buyer.

Question 28

On the other hand, if
the trend is down on the daily, you are only going to look for a

Answer 28

rally up to what your edge defines as a
resistance level to be a seller on the 30-minute chart.

Question 29

On the other hand, if
the trend is down on the daily, you are only going to look for a rally up to what your edge defines as a
resistance level to be a seller on the 30-minute chart. Your objective is to

Answer 29

determine, in a downtrending market, how far it can rally on an intraday basis and still not violate the symmetry of the
longer trend.

Question 30

In an up-trending market, your objective is to determine

Answer 30

how far it can sell off on an
intraday basis without violating the symmetry of the longer trend.

Question 31

. In an up-trending market, your objective is to determine how far it can sell off on an
intraday basis without violating the symmetry of the longer trend. There’s usually

Answer 31

very little risk
associated with these intraday support and resistance points, because you don’t have to let the market
go very far beyond them to tell you the trade isn’t working.

Question 32

Taking Profits. Believe it or not, of all the skills one needs to learn to be a consistently successful
trader, learning to take profits is probably the most difficult ____

Answer 32

to master.

Question 33

A multitude of personal, often
very

Answer 33

complicated psychological factors, as well as the effectiveness of one’s market analysis, enter into
the equation.

Question 34

There is a way to set up a profit-taking regime that at least fulfills the

Answer 34

objective of the fifth principle of consistency (“I
pay myself as the market makes money available to me”).

Question 35

If you’re going to establish a belief in yourself that you’re a consistent winner, then you will have to

Answer 35

create experiences that correspond with that belief.

Question 36

If you’re going to establish a belief in yourself that you’re a consistent winner, then you will have to
create experiences that correspond with that belief. Because the object of the belief is

Answer 36

winning
consistently, how you take profits in a winning trade is of paramount importance.

Question 37

You would have to be an
extremely sophisticated and objective analyst to make the distinction between a

Answer 37

normal retracement,
when the market still has the potential to move in the original direction of your trade, and a retracement
that isn’t normal, when the potential for any further movement in the original direction of your trade is
greatly diminished, if not nonexistent.

Question 38

If you never know how far the market is going to go in your direction, then when and how do you take
profits? The question of when is a function of your ability to

Answer 38

to read the market and pick the most likely
spots for it to stop.

Question 39

In the absence of an ability to read the market and pick the most likely
spots for it to stop to do this objectively, the best course of action from a
psychological perspective is to

Answer 39

divide your position into thirds (or quarters), and scale out the position
as the market moves in your favor.

Question 40

If you are trading futures contracts, this means your minimum
position for a trade is at least

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three (or four) contracts

Question 41

For stocks, the minimum position is any number
of shares that is divisible by three (or four), so you don’t end up

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with an odd-lot order

Question 42

. On average, only one out of every ten trades was an immediate
loser that never went in my direction. Out of the other 25 to 30 percent of the trades that were
ultimately losers, the market usually went in my direction by three or four tics before revising and
stopping me out. I calculated that if I got into the habit of taking at least a

Answer 42

third of my original position
off every time the market gave me those three or four tics, at the end of the year the accumulated
winnings would go a long way towards paying my expenses.

Question 43

I was right. To this day, I always, without
reservation or hesitation, take off a portion of a winning position whenever the

Answer 43

market gives me a little
to take.

Question 44

Using a three-contract trade as an
example, here’s how it works:

Answer 44

If I get into a position and the market immediately goes against me
without giving me at least four tics first, I get stopped out of the trade for an 18-tic loss, but as I’ve
indicated, this doesn’t happen often. More likely, the trade goes in my favor by some small amount
before becoming a loser. If it goes in my favor by at least four tics, I take those four tics on one
contract. What I have done is reduce my total risk on the other two contracts by 10 tics. If the market
then stops me out of the last two contracts, the net loss on the trade is only 8 tics. If I don’t get stopped
out on the last two contracts and the market moves in my direction, I take the next third of the position
off at some predetermined profit objective.

Question 45

If I get into a position and the market immediately goes against me
without giving me at least four tics first, I get stopped out of the trade for an 18-tic loss, but as I’ve
indicated, this doesn’t

Answer 45

happen often. More likely, the trade goes in my favor by some small amount
before becoming a loser.

Question 46

If it goes in my favor by at least four tics, I take those four tics on one
contract. What I have done is reduce my total risk on the other two contracts by 10 tics. If the market
then stops me out of the last two contracts, the net loss on the trade is only 8 tics. If I don’t get stopped
out on the last two contracts and the market moves in my direction, I take the next third of the position
off at some

Answer 46

predetermined profit objective.

Question 47

This is based on some longer time frame support or resistance, or on the test of a previous significant
high or low. When I take profits on the second third, I also move the stop-loss to my

Answer 47

original entry
point

Question 48

Now I have a net profit on the trade regardless of what happens to the last third of the

Answer 48

position.

Question 49

In other words, I now have a “risk-free opportunity.” I can’t emphasize enough nor can the publisher
make the words on this page big enough to stress how important it is for you to experience the state of

Answer 49

“risk-free opportunity.”

Question 50

When you set up a situation in which there is “risk-free opportunity,” there’s no
way to

Answer 50

lose unless something extremely unusual happens, like a limit up or limit down move through
your stop

Question 51

If, under normal circumstances, there’s no way to lose, you get to experience what it really
feels like to be in a trade with a

Answer 51

relaxed, carefree state of mind

Question 52

you get to experience what it really
feels like to be in a trade with a relaxed, carefree state of mind. To illustrate this point, imagine that you
are in a winning trade; the market made a fairly significant move in your direction, but you didn’t take
any profits because you thought it was going even further, however….

Answer 52

instead of going further, the market trades all the way back to or very close to your original
entry point. You panic and, as a result, liquidate the trade, because you don’t want to let what was once
a winning trade turn into a loser. But as soon as you’re out, the market bounces right back into what
would have been a winning trade

Question 53

If you had locked in some profits by scaling out, putting yourself in a
riskfree opportunity situation, it s very unlikely that you would have

Answer 53

panicked or felt any stress or
anxiety for that matter. I still have a third of my position left. What now?

Question 54

I still have a third of my position left. What now?

Answer 54

I look for the most likely
place for the market to stop. This is usually a significant high or low in a longer time frame.

Question 55

I still have a third of my position left. What now? I look for the most likely
place for the market to stop. This is usually a significant high or low in a longer time frame. I place my
order to liquidate just below that spot in a

Answer 55

long position or just above that spot in a short position. I
place my orders just above or just below because I don’t care about squeezing the last tic out of the
trade.

Question 56

I have found over the years that trying to do that just isn’t worth it. One other factor you need to
take into consideration is your

Answer 56

risk-to-reward ratio.

Question 57

The risk-to-reward ratio is the dollar value of how
much risk you have to take relative to the

Answer 57

profit potential.

Question 58

Ideally, your risk-to-reward ratio should be at
least

Answer 58

3:1

Question 59

Ideally, your risk-to-reward ratio should be at
least 3:1,

Answer 59

which means you are only risking one dollar for every three dollars of profit potential.

Question 60

If your
edge and the way you scale out of your trades give you a 3:1 risk-to-reward ratio, your winning trade
percentage can be less than 50 percent and you will still

Answer 60

make money consistently.

Question 61

A 3:1 risk-to-reward
ratio is ideal. However, for the purposes of this exercise,

Answer 61

it doesn’t matter what it is, nor does it matter
how effectively you scale out, as long as you do it.

Question 62

Do the best you can to pay yourself at reasonable
profit levels when

Answer 62

when the market makes the money available

Question 63

Every portion of a trade that you take off as a
winner will contribute to your belief that you are a

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consistent winner,

All the numbers will eventually
come into better alignment as your belief in your ability to be consistent becomes stronger.

Question 64

Trading in Sample Sizes.
The typical trader practically lives or dies (emotionally) on the results of

Answer 64

most recent trade

Question 65

If it was a winner, he’ll gladly go to the

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next trade;

Question 66

. If it was a winner, he’ll gladly go to the next trade; if it wasn’t, he’ll start

Answer 66

questioning
the viability of his edge

Question 67

he’ll start questioning
the viability of his edge. To find out what

Answer 67

variables work, how well they work, and what doesn’t work,
we need a systematic approach, one that doesn’t take any random variables into consideration

Question 68

he’ll start questioning
the viability of his edge. To find out what variables work…this means

Answer 68

that we have to expand our definition of success or failure from the limited trade-by-trade
perspective of the typical trader to a sample size of 20 trades or more

Question 69

Any edge you decide on will be
based on some limited number of market variables or relationships between those

Answer 69

variables that
measure the market’s potential to move either up or down.

Question 70

From the market’s perspective, each trader
who has the potential to put on or take off a trade can act as a force

Answer 70

on price movement and is,
therefore, a market variable

Question 71

No edge or technical system can take into consideration every trader and
his reasons for putting

Answer 71

on or taking off a trade.

Question 72

No edge or technical system can take into consideration every trader and
his reasons for putting on or taking off a trade. As a result, any set of market variables that defines an
edge is like a snapshot of something

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very fluid, capturing only a limited portion of all the possibilities.
When you apply any set of variables to the market, they may work very well over an extended period
of time, but after a while you may find that their effectiveness diminishes.

That’s because the
underlying dynamics of the interaction between all the participants (the market) is changing.

Question 73

New
traders come into the market with their own unique ideas of what is

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high and what is low, and other
traders leave.

Question 74

Little by little, these changes affect the underlying dynamics of how the market moves. No snapshot
(rigid set of variables) can take these subtle changes into consideration. You can compensate for these
subtle changes in the underlying dynamics of market movement and still maintain a consistent
approach by trading in

Answer 74

sample sizes.

Question 75

Your sample size has to be large enough to give your variables a
fair and adequate test, but at the same time small enough so that if their effectiveness diminishes, you
can detect it

Answer 75

before you lose an inordinate amount of money

Question 76

Testing.

Once you decide on a set of variables that conform to these specifications, you need to test
them to see how well they work.

Answer 76

In any case, keep in
mind that the object of the exercise is to use trading as a vehicle to learn how to think objectively (in
the market’s perspective), as if you were a casino operator. Right now, the bottom-line performance of
your system isn’t very important, but it is important that you have a good idea of what you can expect
in the way of a win-to-loss ratio, (the number of winning trades relative to the number of losing trades
for your sample size).

Question 77

Accepting the Risk.

Answer 77

A requirement of this exercise is that you know in advance exactly what your risk
is on each trade in your 20- trade sample size.

Question 78

. As you now know, knowing the risk and accepting the
risk are

Answer 78

two different things.

Question 79

I want you to be as comfortable as possible with the dollar value of the
risk you are taking in this exercise. Becuse the exercise requires that you use a 20-trade sample size, the
potential risk is

Answer 79

is that you will lose on all 20 trades

Question 80

It is as
likely an occurrence as that you willwin on all 20 trades, which means it isn’t very likely. Nevertheless,
it is a possibility. Therefore, you should set up the exercise in such a way that you can

Answer 80

accept the risk
(in dollar value) of losing on all 20 trades.

Question 81

For example, if you’re trading S&P futures, your edge might require that you risk three full points per
contract to find out if the trade is going to work. Since the exercise requires that you trade a minimum
of three contracts per trade, the total dollar value of the risk per trade is $2,250, if you use big contracts.

Answer 81

The accumulated dollar value of risk if you lose on all 20 trades is $45,000, You may not be
comfortable risking $45,000 on this exercise.

Question 82

If you’re not comfortable, you can reduce the dollar value of the risk by trading S&P mini contracts (EMini). They are one-fifth the value of the big contracts, so the total dollar value of the risk per trade
goes down to $450 and the accumulated risk for all 20 trades is $9,000.

Answer 82

They are one-fifth the value of the big contracts, so the total dollar value of the risk per trade
goes down to $450 and the accumulated risk for all 20 trades is $9,000.

Question 83

You can do the same thing if
you are trading stocks: Just keep on reducing the number of shares per trade until you get to a point
where you are comfortable with the total accumulated risk for all 20 trades. What I don’t want you to
do is change your

Answer 83

established risk parameters to satisfy your comfort levels.

Question 84

If, based on your research, you have determined that a three-point risk in the S&Ps is the optimum
distance you must let the market trade against your edge to tell you it isn’t worth staying in the position,
then leave it at

Answer 84

three points

Question 85

Doing the Exercise.

When you have a set of variables that conforms to the specifications described,
you know exactly what each trade is going to cost to find out if it’s going to work, you have a plan for
taking profits, and you know what you can expect as a win-loss ratio for your sample size, then

Answer 85

you are
ready to begin the exercise

Question 86

The rules are simple: Trade your system exactly

Answer 86

as you have designed it.

Question 87

This means you have to commit yourself to trading at least

Answer 87

the next 20 occurrences of your edge

Question 88

not
just the next trade or the next couple of trades, but all

Answer 88

20, no matter what.

Question 89

You cannot deviate, use or be
influenced by any other extraneous factors, or change the variables that define your edge until you have
completed a

Answer 89

full sample size.

Question 90

By setting up the exercise with rigid variables that define your edge,
relatively fixed odds, and a commitment to take every trade in your sample size, you have created a
trading regime that duplicates how

Answer 90

a casino operates.

Question 91

Why do casinos make consistent money on an event that has a random outcome? Because they know
that over a series of events, the odds are in

Answer 91

their favor

Question 92

They also know that to realize the benefits of the
favorable odds, they have to participate in every event. They can’t engage in a process of picking and
choosing which hand of blackjack, spin of the roulette wheel, or roll of the dice they are going to
participate in, by trying to predict in advance the outcome of each of these

Answer 92

individual events.

Question 93

. If you
believe in the five fundamental truths and you believe that trading is just a probability game, not much
different from pulling the handle of a slot machine, then you’ll find that this exercise will be

Answer 93

effortless

Question 94

effortless because your desire to follow through with your commitment to take every trade
in your sample size and your belief in the probabilistic nature of trading will be in

Answer 94

complete harmony.

Question 95

effortless because your desire to follow through with your commitment to take every trade
in your sample size and your belief in the probabilistic nature of trading will be in complete harmony.
As a result, there will be no

Answer 95

fear, resistance, or distracting thoughts.

Question 96

What could stop you from doing
exactly what you need to do, when you need to do it, without reservation or hesitation?

Answer 96

Nothing!

Question 97

On the other hand, if it hasn’t already occurred to you, this exercise is going to create a head-on
collision between your desire to think

Answer 97

objectively in probabilities and all the forces inside you that are
in conflict with this desire.

Question 98

The amount of difficulty you have in doing this exercise will be in direct
proportion to the degree to which these

Answer 98

conflicts exist.

Question 99

To one degree or another, you will experience
the exact

Answer 99

opposite of what I described in the previous paragraph. Don’t be surprised if you find your
first couple of attempts at doing this exercise virtually impossible.

Question 100

How should you handle these
conflicts? Monitor yourself and use the technique of

Answer 100

self-discipline to refocus on your objective

Question 101

Write
down the five fundamental truths and the seven principles of consistency, and keep them in front of you
at all times when you are trading.

Question 102

Write
down the five fundamental truths and the seven principles of consistency, and keep them in front of you
at all times when you are trading.
Repeat them to

Answer 102

yourself frequently, with conviction

Question 103

Every time you notice that you are thinking,
saying, or doing something that is inconsistent with these truths or principles,

Answer 103

acknowledge the conflict.

Question 104

Don’t try to deny the existence of conflicting forces. They are simply parts of your

Answer 104

psyche that are
(understandably) arguing for their versions of the truth

Question 105

Don’t try to deny the existence of conflicting forces. They are simply parts of your psyche that are
(understandably) arguing for their versions of the truth. When this happens,

Answer 105

refocus on exactly what
you are trying to accomplish.

Question 106

If your purpose is to think objectively, disrupt

Answer 106

the association process (so
you can stay in the “now moment opportunity flow”); step through your fears of being wrong, losing
money, missing out, and leaving money on the table (so you can stop making errors and start trusting
yourself), then you’ll know exactly what you need to do

Question 107

Follow the rules of your trading regime as best
you can. Doing exactly what your rules call for while focused on

Answer 107

the five fundamental truths will
eventually resolve all your conflicts about the true nature of trading.

Question 108

Every time you actually do
something that confirms one of the five fundamental truths, you will be

Answer 108

drawing energy out of the
conflicting beliefs and adding energy to a belief in probabilities and in your ability to produce
consistent results.

Question 109

Eventually, your new beliefs will become so powerful that it will take

Answer 109

no conscious
effort on your part to think and act in a way that is consistent with your objectives.

Question 110

You will know for sure that thinking in probabilities is a functioning part of your identity when you
will be able to go through

Answer 110

one sample size of at least 20 or more trades without any difficulty,
resistance, or conflicting thoughts distracting you from doing exactly what your mechanical system
calls for. - Then, and only then, will you be ready to move into the more advanced subjective or intuitive
stages of trading.

Question 111

Try not to prejudge how long it will take before you can get through at least one sample size of trades,
following your plan without deviation, distracting thoughts, or hesitation to act.

Answer 111

It will take as long as it
takes. If you wanted to be a professional golfer, it wouldn’t be unusual to dedicate yourself to hitting
10,000 or more golf balls until the precise combination of movements in your swing were so ingrained
in your muscle memory that you no longer had to think about it consciously.

Question 112

what are advanced subjective or intuitive
stages of trading.? (this is a self question of curiosity)

Question 113

When you’re out there
hitting those golf balls, you aren’t playing an actual game against someone or winning the big
tournament. You do it because you

Answer 113

believe that skill acquisition and practice will help you win.
Learning to be a consistent winner as a trader isn’t any different. I wish you great prosperity, and would
say “good luck,” but you really won’t need luck if you work at acquiring the appropriate skills.

Question 114

The first stage is the mechanical stage. In this stage, you:

Answer 114

1. Build the self-trust necessary to operate in an unlimited environment.
2. Learn to flawlessly execute a trading system.
3. Train your mind to think in probabilities (the five fundamental truths).
4. Create a strong, unshakeable belief in your consistency as a trader.

Question 115

The second stage is the subjective stage of trading.

Answer 115

In
this stage, you use anything you have ever learned about the nature of market movement to do
whatever it is you want to do. There’s a lot of freedom in this stage, so you will have to learn how to
monitor your susceptibility to make the kind of trading errors that are the result of any unresolved selfvaluation issues I referred to in the last chapter

Question 116

The third stage is the intuitive stage

Answer 116

Trading intuitively
is the most advanced stage of development. It is the trading equivalent of earning a black belt in the
martial arts.
The difference is that you can’t try to be intuitive, because intuition is spontaneous. It doesn’t come
from what we know at a rational level. The rational part of our mind seems to be inherently mistrustful
of information received from a source that it doesn’t understand. Sensing that something is about to
happen is a form of knowing that is very different from anything we know rationally