SEP 29 209) TRADING FOR A LIVINGWILEY FINANCE EDITIONS FINANCIAL STATEMENT ANALYSIS Martin S Fridson DYNAMIC ASSET ALLOCATION David A. Hammer INTERMARKET TECHNICAL ANALYSIS Joho J. Murphy INVESTING IN INTANGIBLE ASSETS Russell L. Parr FORECASTING FINANCIAL MARKETS Tony Plummer PORTFOLIO MANAGEMENT FORMULAS Ralph Vince ‘TRADING AND INVESTING IN BOND OFTIONS M. Anthony Wong ‘THE COMPLETE GUIDE TO CONVERTIBLE SECURITIES WORLDWIDE. [Laur A, Zubulake ‘MANAGED FUTURES IN THE INSTITUTIONAL PORTFOLIO Cates B. Epstein, Editor ANALYZING AND FORECASTING FUTURES PRICES ‘Anthony F. Herbst (CHAOS AND ORDER IN THE CAPITAL MARKETS. Edgar E. Peters INSIDE THE FINANCIAL FUTURES MARKETS, 32D EDI “Matk J Powers and Mark G. Casein RELATIVE DIVIDEND YIELD ‘Anthony E- Spare SELLING SHORT ‘Joseph A. Walker ‘TREASURY OFERATIONS AND THE FOREIGN EXCHANGE CHALLENGE Dimitris N. Chores ‘THE FOREIGN EXCHANGE AND MONEY MARKETS GUIDE Julian Walmsley (CORPORATE FINANCIAL RISK MANAGEMENT. Diane B, Wunnicke, David R. Wilson, Brooke Wunnicke MONEY MANAGEMENT STRATEGIES FOR FUTURES TRADERS, Nauzer J Balsara ‘THE MATHEMATICS OF MONEY MANAGEMENT Ralph Vince ‘THE NEW TECHNOLOGY OF FINANCIAL MANAGEMENT Dimis N. Chorafas ‘THE DAY TRADER’S MANUAL ‘William F. Eng OPTION MARKET MAKING Allen J. Baird ‘TRADER VIC II: PRINCIPLES OF MARKET ANALYSIS AND FORECASTING ‘Vieior Sperandeo with T. Solivan Brown ‘TRADING FOR A LIVING. De. Alexander Elder ‘STUDY GUIDE FOR TRADING FOR A LIVING Dr. Alexander ElderTRADING FOR A LIVING Psychology TradingTactics Money Management Dr. Alexander Elder Director Financial Trading Seminars, Inc. ® John Wiley & Sons, Inc. New York * Chichester * Brisbane Toronto * SingaporeCompuTrac™ is a trademark of CompuTrac Software Inc. PageMaker® i a registered trademark of Aldus Corporation. In recognition of the importance of preserving what has been written, itis a policy of John Wiley & Sons, Inc, to have books of enduring value printed on acid-free paper, and we exert our best efforts to that end. Copyright © 1995 by Dr. Alexander Elder Published by John Wiley & Sons, Inc. All rights reserved, Published simultaneously in Canada. Reproduction or translation of any part of t Section 107 or 108 ofthe 1976 United States Copyright Act without the permission of the copyright owner is unlawful. Requests for permission or further information should be addressed tothe Permissions Department, John Wiley & Sons, Inc. ‘This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. Iti sold with the understanding thatthe pub- lisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert asistance is required, the services of a competent pro- fessional person should be sought. From a Declaration of Principles joinly ‘adopted by a Committe of the American Bar Association and a Commitee of Publishers. Library of Congress Cataloging-in-Publication Data Elder, Alexander ‘Trading for a living : psychology, trading tactics, money management / Alexander Elder. Includes bibliographical references and index. ISBN 0-471-59224-2 1,Stocks. 2.Futures. 3. Options (Futures) I. Title. HG4661.E43 1992 32,64" —de20 92-35165 Printed inthe United States of America 109To Lou Taylor — @ trader, a wise man, a true friendContents Introduction 1. Trading —‘The Last Frontier 2. Psychology Is the Key 3. The Odds Against You I Individual Psychology 4. Why Trade? 5. Fantasy versus Reality 6. Market Gurus 7. Self-Destructiveness 8. Trading Psychology 9. Trading Lessons from AA 10. Losers Anonymous 11 Winners and Losers Il Mass Psychology 12. What Is Price? 13. What Is the Market? 14, The Trading Scene 15. The Market Crowd and You 16. Psychology of Trends 17. Managing versus Forecasting u u 2 7 24 27 29 33 38 43 47 SI 56 61 65vi CONTENTS Ii Classical Chart Analysis, 18. Charting 19, Support and Resistance 20, Trend and Trading Range 21. Trendlines 22. Gaps 23, Chart Pattems IV Computerized Technical Analysis 24, Computers in Trading 25. Moving Averages 26. Moving Average Convergence-Divergence (MACD) and MACD- Histogram 27. The Directional System 28. Momentum, Rate of Change, and Smoothed Rate of Change 29. Williams %R 30. Stochastic 31. Relative Strength Index ZIV The Neglected Essentials 32, Volume 33, Volume-Based Indicators 34, Open Interest 35. Herrick Payoff Index 36. Time VI Stock Market Indicators 37. New High-New Low Index 38, Traders’ Index and Other Stock Market Indicators ‘VII Psychological Indicators 39. Consensus Indicators 40. Commitment Indicators 69 69 8 80 87 95 101 us us 120 127 135 142 151 156 162 167 167 172 178 183, 187 194 194 201 209 209 21sCONTENTS VIII New Indicators 41, Elder-ray 42. Force Index 1X Trading Systems Triple Screen Trading System |. Parabolic Trading System Channel Trading Systems X Risk Management 46. Emotions and Probabilities 47, Money Management 48, Exiting Trades, Afterword Acknowledgments Sources Index 220 220 227 235 235 244 247 284 254 237 263 269 2m 278 279TRADING FOR A LIVINGIntroduction 1, TRADING—THE LAST FRONTIER You can be free. You can live and work anywhere in the world. You can be independent from routine and not answer to anybody. This isthe life of a successful trader. Many aspire to this but few succeed. An amateur looks at a quote screen and sees s of dollars sparkle in front of his face. He reaches for the money —and loses. He reaches again—and loses more. Traders lose because the game is hard, or out of ignorance, or lack of discipline. If any of these ail you, I wrote this book for you. How I Began to Trade In the summer of 1976, I drove from New York to Califomia. I threw a few books on psychiatry (I was a first-year psychiatric resident), several histo- ries, and a paperback copy of Engel’s How to Buy Stocks into the trunk of my old Dodge. Little did 1 know that a dog-eared paperback, borrowed from a lawyer friend, would in duc time change the course of my life. That friend, incidentally, had a perfect reverse golden touch—any investment he touched ‘went under water. But that’s another story. | gulped down the Engel book in campgrounds across America, finishing it on a Pacific beach in La Jolla. 1 had known nothing about the stock mar- ket, and the idea of making money by thinking gripped me. Thad grown up in the Soviet Union in the days when it was, in the words of a former U.S. president, “an evil empire.” I hated the Soviet system and ‘wanted to get out, but emigration was forbidden. I entered college at 16, ‘graduated medical school at 22, completed my residency, and then took a job2 INTRODUCTION as a ship's doctor. Now I could break free! I jumped the Soviet ship in Abidjan, Ivory Coast 1 ran to the U.S. Embassy through the clogged dusty streets of an African port city, chased by my ex-crewmates. The bureaucrats at the embassy fum- bled and almost handed me back to the Soviets, I resisted, and they put me in 1a “safe house” and then on a plane to New York. I landed at Kennedy Airport in February 1974, arriving from Africa with summer clothes on my back and $25 in my pocket. I spoke some English, but did not know a soul in this country. Thad no idea what stocks, bonds, futures, or options were and sometimes got a queasy feeling just from looking at the American dollar bills in my wallet, In the old country, a handful of them could buy you three years in Siberia. Reading How to Buy Stocks opened a whole new world for me. Returning to New York, I bought my first stock —it was KinderCare. Ever since then, 1 have avidly studied the markets and invested and traded stocks, options, and now mostly futures. My professional career proceeded on a separate track. I completed a resi- dency in psychiatry at a major university hospital, studied at the New York Psychoanalytic Institue, and served as book editor forthe largest psychiatric newspaper in the United States. These days, I am busy trading and go to my psychiatric office, across the street from Camegie Hall, only a few after- noons a week, after the markets close. I love practicing psychiatry, but I spend most of my time in the markets. ‘Learning to trade has been a long journey — with soaring highs and aching lows. In moving forward—or in circles—I repeatedly knocked my face ‘against the wall and ran my trading account into the ground. Each time 1 retumed to a hospital job, put a stake together, read, thought, did more test- ing, and then staried trading again. My trading slowly improved, but the breakthrough came when I realized that the key to winning was inside my head and not inside a computer. Paychiatry gave me the insight into trading that I will share with you. Do You Really Want to Succeed? For the past 17 years I've had a friend whose wife is fat. She is an elegant dresser, and she has been on a diet for as long as I have known her. She says she wants to lose weight and she does not eat cake or potatoes in front of