Buy low, sell high. Short high, cover low. Traders are like surfers, trying to catch good waves, only their beach is rocky, not sandy.

Professionals wait for opportunities but amateurs jump in, driven by emotions-they keep buying strength and selling weakness, bleeding their equity into the markets. Buy low, sell high sounds like a simple rule, but greed and fear can override the best intentions.

A professional waits for familiar patterns to emerge from the market. He may notice a new trend with rising momentum, indicating higher prices ahead. Or he may detect the feebleness of momentum during a rally, indicating weakness. Once he recognizes a pattern, he puts on a trade. He has a clear notion of how he'll get in, where he'll take profits, and where he'll accept a loss if the market turns against him.

A trade is a bet on a price change, but there is a paradox. Each price reflects the latest consensus of value of market participants. Putting on a trade challenges that consensus. A buyer disagrees with the collective wisdom by saying the market is underpriced. A seller disagrees with the wisdom of the entire group, believing the market is overpriced. Both the buyer and the seller expect the consensus to change, but meanwhile they defy the market. That market includes some of the most brilliant minds and some of the deepest pockets on Earth. Arguing with this group is dangerous business, and it has to be done very cautiously.

An intelligent trader looks for holes in the efficient market theory. He scans the market for brief periods of inefficiency. When the crowd is gripped by greed, the newcomers jump in and load up on stocks.

When falling prices squeeze the fingers of thousands of buyers, they dump their holdings in a panic, disregarding fundamental values. Those episodes of emotional behavior dilute the cold efficiency of the mar ket, creating opportunities for disciplined traders. When markets are calm and efficient, trading becomes a crapshoot, with commissions and slippage worsening the odds.

Crowd mentality changes slowly, and price patterns recur, albeit with variations. Emotional swings provide trading opportunities, while efficient markets chop up and down, offering no edge to traders, only piling up their costs. Technical analysis tools will work for you only if you have the discipline to wait for patterns to emerge. Professionals trade only when markets offer them special advantages.

According to chaos theory, many processes-the flow of water in a river, the movement of clouds in the sky, the changes of prices in the cotton markets-are chaotic, with transient islands of order, called frac- tals. Those fractals look similar from any distance, whether through a telescope or a microscope. The coast of Maine looks just as jagged from a space shuttle as it does when you drop down on your hands and knees and look at it through a magnifying glass. In most finan- cial markets, the long-term weekly charts and the short-term 5-minute charts look so similar, you cannot tell them apart without markings. Engineers have realized that they can achieve better control over many processes if they accept them as chaotic and try to capitalize on tem-porary fractals, the islands of order. That's exactly what a good trader does. He recognizes the market as chaotic and unpredictable much of the time, but expects to find islands of order. He trains himself to buy and sell without quibbling when he finds those patterns.

Successful trading depends on the 3 M's-Mind, Method, and Money. Beginners focus on analysis, but professionals operate in a three- dimensional space. They are aware of trading psychology-their own feelings and the mass psychology of the markets. Each trader needs to have a method for choosing specific stocks, options, or futures as well as firm rules for pulling the trigger-deciding when to buy and sell. Money refers to how you manage your trading capital.

Mind, Method, Money-trading psychology, trading method, and money management-people sometimes ask me which of the three is more important. It is like asking which leg of a three-legged stool is the most important. Take them away one at a time and then try to sit down. In Part 2 we focus on those three foundations of market success.

Traders come to the markets with great expectations, but few make profits and most wash out. The industry hides good statistics from the public, while promoting its Big Lie that money lost by losers goes to winners. In fact, winners collect only a fraction of the money lost by losers. The bulk of losses goes to the trading industry as the cost of doing business-commissions, slippage, and expenses-by both win- ners and losers. A successful trader must hop over several high hur- dles-and keep hopping. Being better than average is not good enough-you have to be head and shoulders above the crowd. You can win only if you have both knowledge and discipline.

Most amateurs come to the markets with half-baked trading plans, clueless about psychology or money management. Most get hurt and quit after a few painful hits. Others find more cash and return to trad ing. We do not have to call people who keep dropping money in the markets losers because they do get something in return. What they get is fantastic entertainment value.

Markets are the most entertaining places on the face of the Earth. They are like a card game, a chess game, and a horse race all rolled into one. The game goes on at all hours-you can always find action.

An acquaintance of mine had a terrible home life. He avoided his wife by staying late in the office, but the building closed on weekends, pushing him into the bosom of his family. By Sunday mornings he could take no more "family togetherness" and escaped to the basement of his house. There he had set up a trading apparatus, using the equip-ment loaned to him by another loser in exchange for a share of future profits. What can you trade on a Sunday morning in suburban Boston? It turned out that the gold markets were open in the Middle East. My acquaintance used to turn on his quote screen, get on the phone (this was in the pre-Internet days), and trade gold in Abu Dhabi!

He never asked himself what his edge was over local traders. What has he got, sitting in a bucolic suburb of Boston, that they haven't got in Abu Dhabi? Why should locals send him money? Every professional knows his edge, but ask an amateur and he'll draw a blank. A person who doesn't know his edge does not have it and will lose money. Warren Buffett, one of the richest investors on Earth, says that when you sit down to a game of poker, you must know within 15 minutes who is going to supply the winnings, and if you don't know the answer, that person is you. My Boston buddy wound up losing his house in a bank- ruptcy, which put a whole new spin on his marital problems, even though he no longer traded gold in Abu Dhabi.

Many people, whether rich or poor, feel trapped and bored. As Henry David Thoreau wrote almost two centuries ago, "The mass of men lead lives of quiet desperation."

We wake up in the same bed each morning, eat the same breakfast, and drive to work down the same road. We see the same dull faces in the office and shuffle papers on our old desks. We drive home, watch the same dumb shows on TV, have a beer, and go to sleep in the same bed. We repeat this routine day after day, month after month, year after year. It feels like a life sentence without parole. What is there to look forward to? Perhaps a brief vacation next year? We'll buy a package deal, fly to Paris, get on a bus with the rest of the group, and spend 15 minutes in front of the Triumphal Arch and half an hour going up the Eiffel Tower. Then back home, back to the old routine.

Most people live in a deep invisible groove-no need to think, make decisions, feel the raw edge of life. The routine does feel com fortable-but deathly boring.

Even amusements stop being fun. How many Hollywood movies can you watch on a weekend until they all become a blur? How many trips to Disneyland can you take before all the rides in plastic soap dishes feel like one endless ride to nowhere? To quote Thoreau again, "A stereotyped but unconscious despair is concealed even under what are called games and amusements of mankind. There is no play in them."

And then you open a trading account and punch in an order to buy 500 shares of Intel. Anyone with a few thousand dollars can escape the routine and find excitement in the markets.

Suddenly, the world is in living color! Intel ticks up half a point- you check quotes, run out for a newspaper, and tune in for the latest updates. If you have a computer at work, you set up a little quote win- dow to keep an eye on your stock. Before the Internet, people used to buy pocket FM receivers for market quotes and hide them in half- open desk drawers. Their antennae, sticking out of desks of middle- aged men, looked like beams of light shining into prison cells.

Intel is up a point! Should you sell and take profits? Buy more and double up? Your heart is pounding-you feel alive! Now it's up three points. You multiply that by the number of shares you have and realize that your profits after just a few hours are close to your weekly salary. You start calculating percentage returns-if you continue trading like that for the rest of the year, what a fortune you'll have by Christmas!

Suddenly you raise your eyes from the calculator to see that Intel has dropped two points. Your stomach is tied in a knot, your face pushes into the screen, you hunch over, compressing your lungs, reducing the flow of blood to the brain, which is a terrible position for making deci sions. You are flooded with anxiety, like a trapped animal. You are hurting-but you are alive!

Trading is the most exciting activity that a person can do with their clothes on. Trouble is, you cannot feel excited and make money at the same time. Think of a casino, where amateurs celebrate over free drinks, while professional card-counters coldly play game after game, folding most of the time, and pressing their advantage when the card count gives them a slight edge over the house. To be a successful trader, you have to develop iron discipline (Mind), acquire an edge over the markets (Method), and control risks in your trading account (Money)

There is only one rational reason to trade-to make money. Money attracts us to the markets, but in the excitement of the new game we often lose sight of that goal. We start trading for entertainment, as an escape, to show off in front of our family and friends, and so on. Once a trader loses his focus on money, his goose is cooked.

It is easy to feel cool, calm, and collected reading a book or looking at your charts on a weekend. It's easy to be rational when the markets are closed-but what happens after 30 minutes in front of a live screen? Does your pulse begin to race? Do upticks and downticks hypnotize you? Traders get an adrenaline rush from the market, and the excitement clouds their judgment. Calm resolutions made on a weekend fly out the window during rallies or declines. "This time is different . . . It's an exception . . . I won't put in a stop now, the mar-ket is too volatile" are the giveaway phrases of emotional traders.

Many intelligent people sleepwalk through the markets. Their eyes are open, but their minds are shut. They are driven by emotions and keep repeating their mistakes. It is OK to make mistakes but not OK to repeat them. When you make a mistake for the first time, it shows that you are alive, searching, experimenting. Repeating a mistake is a neurotic symptom.

Losers come in all genders, ages, and colors, but several stock phrases give them away. Let us review some of the common excuses. If you recognize yourself, use that as a sign to start learning a new approach to the markets.

Blame the Broker

A trader hears his broker's voice at the most important and tense moments-when placing buy or sell orders or requesting information that may lead to an order. The broker is close to the market, and many of us assume that he knows more than we do. We try to read our broker's voice and figure out whether he approves or disapproves of our actions.

Is listening to your broker's voice a part of your trading system? Does it say to buy when the weekly moving average is up, daily Force Index is down, and the broker sounds enthused? Or does it simply say to buy when such and such indicators reach such and such parameters?

Trying to read your broker's voice is a sign of insecurity, a common state for beginners. Markets are huge and volatile, and their rallies and declines can feel overpowering. Frightened people look for someone strong and wise to lead them out of the wilderness. Can your broker lead you? Probably not, but if you lose money, you'll have a great excuse-it was your broker who put you into that stupid trade.

A lawyer who was shopping for an expert witness recently called me. His client, a university professor, had shorted Dell at 20 several years ago, before the splits, after his broker told him it "could not go any higher." That stock became the darling of the bull market, went through the roof, and a year later the professor covered at 80, wiping out his million-dollar account, which represented his life savings. That

man was smart enough to earn a Ph.D. and save a million dollars but emotional enough to follow his broker while his life savings were doing a slow burn. Few people sue their brokers, but almost all begin ners blame them.

Traders' feelings towards brokers are similar to patients' feelings towards psychoanalysts. A patient lies on the couch, and the analyst's voice, emerging at important moments, seems to carry deeper psychological truths than the patient could have possibly discovered himself. In reality, a good broker is a craftsman who can sometimes help you get better fills and dig up information you requested. He is your helper-not your advisor. Looking to a broker for guidance is a sign of insecurity, which is not conducive to trading success.

Most people start trading more actively after switching to electronic brokers. Low commissions are a factor, but the psychological change is more important. People are less self-conscious when they don't have to deal with a live person. All of us occasionally make stupid trades, and electronic brokers allow us to make them in private. We are less ashamed hitting a key than calling a broker.

Some traders manage to transfer their anxieties and fears onto elec tronic brokers. They complain that electronic brokers do not do what they want, such as accept certain types of orders. Why don't you trans fer your account, I ask-and see fear in their faces. It is the fear of change, of upsetting the cart.

To be a successful trader, you must accept total responsibility for your decisions and actions.

Blame the Guru

A beginner entering the markets soon finds himself surrounded by a col-orful crowd of gurus-experts who sell trading advice. Most charge fees, but some give advice for free to drum up business for their brokerage firms. Gurus publish newsletters, are quoted in the media, and many would kill to get on TV. Masses are hungry for clarity, and gurus are there to feed that hunger. Most are failed traders, but being a guru is not that easy. Their mortality rate is high, and few stay around for more than two years. The novelty wears off, customers do not renew subscriptions, and a guru finds it easier to earn a living selling aluminum siding than drawing trendlines. My chapter on the guru business in Trading for a Living drew more howls and threats than any other in that book.

Traders go through three stages in their attitudes towards gurus. In the beginning, they drink in their advice, expecting to make money from it. At the second stage, traders start avoiding gurus like the plague, viewing them as distractions from their own decision-making process. Finally, some successful traders start paying attention to a few gurus who alert them to new opportunities.

Some losing traders go looking for a trainer, a teacher, or a therapist. Very few people are experts in both psychology and trading. I've met several gurus who couldn't trade their way out of a paper bag but claimed that their alleged expertise in psychology qualified them to train traders. Stop for a moment and compare this to sex therapy. If I had a sexual problem, I might see a psychiatrist, a psychologist, a sex therapist, or even a pastoral counselor, but I would never go to a Catholic priest, even if I were Catholic. That priest has no practical knowledge of the problem-and if he does, you want to run, not walk away. A teacher who does not trade is highly suspect.

Traders go through several stages in their attitudes towards tips. Beginners love them, those who are more serious insist on doing their own homework, while advanced traders may listen to tips but always drop them into their own trading systems to see whether that advice will hold up. Whenever I hear a trading tip, I run it through my own computerized screens. The decision to buy, go short, or stand aside is mine alone, with an average yield of one tip accepted out of every 20 heard. Tips draw my attention to opportunities I might have overlooked, but there are no shortcuts to sweating your own trades.

A greenhorn who has gotten burned may ask for a guru's track record. Years ago I used to publish a newsletter and noticed how fright eningly easy it was for gurus to massage and slant their records, even if they were tracked by independent rating services.

I've never met a trader who took all the recommendations of his guru, even if he paid him a lot of money. If a guru has 200 subscribers, they'll choose different recommendations, trade them differently, and most will lose money, each in his own way. There is a rule in the advi sory business: "If you make forecasts for a living, make a lot of them." Gurus offer convenient excuses to sleepwalking traders who need a scapegoat for their losses.

Whether or not you listen to a guru, you're 100% responsible for the outcome of your trades. The next time you get a hot tip, drop it into your trading system to see whether it gives you a buy or sell signal. You are responsible for the consequences of taking or rejecting advice.

Blame the Unexpected News

It is easy to feel angry and hurt when a sudden piece of bad news blows a hole in your stock. You buy something, it goes up, bad news hits the market, and your stock collapses. The market did it to you, you say? The news may have been sudden, but you are responsible for handling any challenges.

Most company news is released on a regular schedule. If you trade a certain stock, you should know well in advance when that company releases its earnings and be prepared for any market reaction to the news. Lighten up on your position if unsure about the impact of a coming announcement. If you trade bonds, currencies, or stock index futures, you must know when the key economic statistics are released and how the leading indicators or the unemployment rate can impact your market. It may be wise to tighten your stops or reduce the size of your trade in advance of an important news release.

What about a truly unexpected piece of news-a president gets shot, a noted analyst comes out with a bearish earnings forecast, and so on? You must research your market and know what happened after similar events in the past; you have to do your homework before the event hits you. Having this knowledge allows you to act without delay. For example, the stock market's reaction to an assault on a president has always been a sharp hiccup to the downside, followed by a complete retracement, so a sensible thing to do is buy the break.

Your trading plan must include the possibility of a sharp adverse move caused by sudden events. You must have your stop in place, and the size of your trade must be such that you cannot get financially hurt in the case of a reversal. There are many risks waiting to spring on a trader-you alone are responsible for damage control.

Wishful Thinking

When the pain grows bit by bit, the natural tendency is to do nothing and wait for an improvement. A sleepwalking trader gives his losing trades "more time to work out," while they slowly destroy his account.

A sleepwalker hopes and dreams. He sits on a loss and says, "This stock is coming back; it always did." Winners accept occasional losses, take them, and move on. Losers postpone taking losses. An amateur puts on a trade the way a kid buys a lottery ticket. He waits for the wheel of fortune to decide whether he wins or loses. Professionals, the contrary, have ironclad plans for getting out, either with a profit or a small loss. One of the key differences between professionals and amateurs is their planning for exits.

A sleepwalking trader buys at 35 and puts in a stop at 32. The stock sinks to 33, and he says, "I'll give it a little more room." He moves his stop down to 30. That is a fatal mistake-he has breached his disci pline and violated his own plan.

You may move stops only one way-in the direction of your trade. Stops are like a ratchet on a sailboat, designed to take the slack out of your sails. If you start giving your trade "more room to breathe," that extra slack will swing around and hurt you. When the market rewards traders for breaking their rules, it sets up an even deeper trap in their next trade.

The best time to make decisions is before you enter a trade. Your money is not at risk, and you can weigh profit targets and loss parameters. Once you're in a trade, you begin to form an attachment to it. The market hypnotizes you and lures you into emotional decisions. This is why you must write down your exit plan and follow it.

Turning a losing trade into an "investment" is a common disease among small private traders, but some institutional traders also suffer from it. Disasters at banks and major financial firms occur when poorly supervised traders lose money in short-term trades and stick them into long-term accounts, hoping that time will bail them out. If you are los ing in the beginning, you'll lose in the end. Do not put off the hour of reckoning. The first loss is the best loss-this is the rule of those of us who trade with our eyes open.