Book Report for Free Market Traders
April 16, 2012
by David Rager
Trading in the Zone
by Mark Douglas
New York Institute of Finance
Prentice Hall Press
Copyright 2000
Also Authored
The Disciplined Trader: Developing Winning
Attitudes
President – Wizard on Wall Street, Inc,
Editor of eCharts.com
Former Editor of Technical Analysis of
Stocks and Commodities magazine
1.
2.
3.
Fundamental Analysis
Technical Analysis
Mental Analysis
Which should you use?
1.
2.
3.
Fundamental Analysis
Technical Analysis
Mental Analysis
Which should you use?
a All of the above, in different ways.
In the Beginning: Fundamental Analysis
In the late 1970’s, the predominant method.
Now it is virtually extinct.
Why? Money.
It is inherently difficult to make money with a pure
fundamental approach to the market.
 Fundamental approaches fail to take the actions of
other traders into account.
 People that trade don’t always react in a rational way.
 You may have a model that says where the price
should go, but the market may be so volatile that you
could not stay in a trade until it reaches that price.
The Shift to Technical Analysis
 Not new. Has been around since there have been
exchanges.
 Traders exhibit behavior patterns on a consistent basis
– these are observable and quantifiable and repeat with
statistical probability.
 It keeps the trader focused on what the market is doing
now in relation to the past.
 Technical analysis opens up limitless opportunities to
trade because the same repeated trading patterns occur
in every time frame.
The Shift to Mental Analysis
If Technical Analysis is so good, why change? Money.
 Huge gap between what you know about the market,
it’s limitless opportunities, and your bottom line.
 The psychological gap – the difference between
“knowing” what the market will do, and executing it.
 Can trading be mastered? Yes, by resolving this gap.
 Winning traders have attained a unique set of attitudes
that allows them to remain disciplined, focused, and
confident in spite of adverse conditions.
The Shift to Mental Analysis (cont’d)
 The worse traders are doctors, lawyers, engineers,
CEO’s, financial analysts, etc.
• Highly educated people have difficulty with being
wrong.
 All trades are risky, but the best traders accept the risk.
• They take a trade with out hesitation, and get out
without conflict.
• Getting into or out of a trade too soon or too late is
symptomatic of this.
 95% of trading errors are due to internal attitudes
about
• Being wrong,
• Losing money,
• Missing out, and
• Leaving money on the table.
The Attraction
 The biggest attraction – Independence.
• There are few restrictions or boundaries on how we
express ourselves.
• But – we can engage in activities where we fail
without even knowing why.
• Most successful traders have blown out their
accounts multiple times before they learned how to
trade successfully.
The Dangers
 Our needs and desires are generated in our mental
environment, but fulfilled in the external environment.
• If they correspond we are happy and satisfied.
• If they are in conflict, we are dissatisfied, angry and
frustrated.
• This often results in trying to force the external
environment to conform to our mental environment
which often turns out to be destructive (blowing out
an account).
The Safeguards
 To trade effectively we need rules and boundaries to
govern our behavior. The markets are in constant
motion – they don’t start, stop or wait. Even when
closed, prices are being determined.
• Creating Rules – Most agree to this, but most also
refuse to follow their own rules.
• Taking responsibility – Trading is pure,
unencumbered personal choice with an immediate
outcome. Only you are responsible for the results.
• Addiction to Random Rewards – We never know
why we were rewarded, and never improve.
• External/Internal Control –We cannot depend on
the market to do anything for us. We cannot
manipulate or control what it does. We can only
control our perception and interpretation of it, and
our own behavior.
Shaping your Mental Environment
 The tools required: A willingness and desire to learn;
and a passion to be successful
 The best traders have eliminated the effects of fear
from, and developed restraint in their trading.
 The consistency you seek is in your mind, not in the
market.
 Attitudes about being wrong, losing money or
becoming reckless when things are going good that
cause the most losses.
 Attitude produces better results than analysis or
technique. (But, ideally you have both.)
 What makes trading so fascinating and at the same
time difficult is that you don’t really need a lot of
analytical skills, you just need a genuine winning
attitude.
Reacting to Loss
 Losing and being wrong are inevitable realities.
 Ideally one should accept that
• A loss is a common outcome of trading
• A loss is solely the responsibility of the trader
• The trader has accounted for such results, both financially and emotionally.
• Move on to the next trade.
 The market is a zero-sum game, with all the players
interacting with each other to extract money from the
market.
• Losses are inevitable, and self-generated, based on our own
interpretations of market data, and the actions we take.
• Our responsibility is to trade a plan with a winning edge
faithfully.
Winners, Losers, Boomers & Busters
 Winners - Many traders are tenacious students of the
market and have a sufficiently winning attitude so that
they eventually learn how to make money, but only on
a limited basis.
• The problem: counteracting the negative effects of euphoria,
and compensating for the potential for self-sabotage.
• Euphoria and Self-Sabotage are powerful psychological forces.
• Euphoria – When you start winning, you are least likely to
concern yourself with potential problems.
• Self-Sabotage – Usually the result from attitudes about
deserving to win.
 Losers – 30 to 40% of traders are consistent losers.
 They either have illusions about the nature of trading, or have
destructive addictions to it. They cannot become winners.
Winners, Losers, Boomers & Busters
 Boomers & Busters – About half the traders have
learned how to make money, but have not mastered a
whole body of trading skills necessary to keep it.
• The symptom: Account results show nice, steady assents with
steep drop-offs, in repeated cycles.
• These are usually due to euphoria leading to carelessness.
• If “nothing can go wrong” there is no need for rules or boundaries
to govern our trading behavior. (Need for analysis, position sizing,
stops, taking profits, etc.
• Losses from self-sabotage can be just as damaging.
• Selling when you meant to buy (and vice-versa) and indulging in
distracting activities at inopportune times are typical examples of
ways that we can indulge in self-sabotage.
 The market does not create our attitude – it reflects our
attitude back to us.

Thinking About Trading
 Answers are all in the way you think about it .
 Your state of mind is a by-product of your
beliefs and attitudes.
 If you depend on outside conditions to make
you happy, it is unlikely that you will find
happiness on a consistent basis.
 Work on neutralizing the beliefs and attitudes
that prevent you from having fun.

Really understanding Risk
 Accepting risk means accepting your trading
results without emotional discomfort or fear.
• Must accept that the possibility of being wrong, losing, missing
out, or leaving money on the table and make sure that they
don’t cause your mental defense mechanisms to take you out of
the opportunity flow.
• Those who accomplish this learn to stop avoiding and to start
embracing the responsibility of risk.
• It is the risk that provides for the reward.
• It is the responsibility to participate that allows the risk to be
assumed and the reward to be realized.

Aligning your Mental Environment
 So far, what has been said was for the purpose of
preparing us to do the real work: to learn a new
thinking strategy that has at its core a firm belief in
probabilities and edges:
• To create a new relationship with the market;
• To disassociate trading from what it means to be right or
wrong; and
• To preclude perceiving the market as threatening in any way.

Debugging your Mental Software
A way to redefine your relationship to market information
so that it isn’t perceived as threatening.
 To Start – Perceive an opportunity.
• Without this, there would be no reason to trade.
• Think of every thing as a collection of forces that generates info
about its unique properties, characteristics and traits.
• These energies enter us and are stored in our mental
environment as memories that create attitudes, feelings, etc.
that cause us to react as we do.

Perception and Learning
 Our understanding and reaction to things perceived is
based on our learning about it (our experience with it).
 What we have not experienced is invisible to us.
 With price charts, there are a myriad of opportunities,
many of which we have learned about, and many
others that we haven’t, and remain invisible to us.
• Unless we are in a new situation or operating out of an attitude
of complete openness, we won’t perceive something that we
haven’t learned about.

Perception and Risk
 One person’s risk aversion may be foolish to another.
• Risk is relative, but may appear absolute and beyond question.
The Power of Association
 When we have an aversion, we project the outcome of
our interaction based on a prior encounter.
 When we experience paralysis based on an aversion,
we have to focus on the opposite outcome.
 I want to take the trade because there is an good opportunity to
win instead of focusing on the fear of taking the trade because
there is a small chance of losing.
For the most part, a typical trader’s perception of risk in a
trade is a based on the outcome of his two most recent trades.
The “Uncertainty” Principle
The secret to successful trading:
1) Trade without fear or overconfidence,
2) Perceive what the market is offering from its perspective,
3) Stay completely focused on the “now opportunity flow”, and
4) Spontaneously enter the “zone”, where you believe without any
uncertainty that anything can happen.
Make yourself available to the market – ready to act as soon as an
opportunity presents itself.
[Prof. traders don’t wonder when to trade, they want to know where.]
The Market’s Most Fundamental
Characteristic
(It can express itself in an almost infinite combination of ways)
 If traders believed that the market can do anything, any
time, there’d be more consistent winners and fewer losers.
 People trade to make money. A trader can do two things:
Buy or Sell, and there are only two outcomes: Profit or Loss.
 Price movement is the result of the actions taken by
individuals beliefs on what is a high or low price.
 There are three major forces: Those that are buying, those
that are selling, and those that are watching and waiting to
make up their minds about whether the price is high or low.
Paradox: Random outcome, consistent results
Casinos make consistent profits, facilitating random outcome
events, but most traders believe that the market’s outcome is
not random, but fail to make consistent profits.
 They believe in their edge, and stay relaxed event after event.
 What they know is that for any event, the probability is independent of
any other event.
 In trading, there are known and unknown factors in any event. The
unknown factors are all the other traders that may come into the market
and put on or take off a trade.
 If enough events occur, the outcome is relatively certain and predictable.
 The result is a consistent, predictable and basically reliable profit.
 The Trading Dichotomy – Belief that with a trading edge, for any single
trade level, anything can happen and the results are unpredictable, but
over the long term, the results will be profitable.
Trading in the Moment
Traders thinking in probabilities, approach the market from
virtually the same perspective.
 For any particular trade pattern to have the identical result as the prior
time would require every previous player to be present with the same
experiences and conditions, and react the same way as the previous time.
 But if a trade pattern has resulted in a desirable result the majority of
times in a large sample, the trader has an edge over many trades.
 Having an edge allows trading with confidence.
 Trading has nothing to do with being profitable on any individual trade.
Managing Expectations
Unrealistic expectations come from the way we perceive data.
 Expectations are how some future moment will look, sound, taste, smell
or feel like. They are reflections of our own personal version of truth.
 Problem – Expectations rise from what we know; we expect to be right.
 These cannot be projected on any single trade. It can make us ignore
evidence when we are wrong, and obstructs our action to get out.
 The trader needs to be rigid in his rules, but flexible in his expectations.
• The typical trader, in order to accommodate his expectations, becomes
flexible in his rules.
Eliminating Emotional Risk
To eliminate your emotional risk, neutralize your expectations.
The five fundamental truths of probability trading:
 Anything can happen.
 You don’t have to know what is going to happen next to make
money.
 There is a random distribution between wins and losses for
any given set of variables that define an edge.
 An edge is nothing more than an indication of a higher
probability of one thing happening over another.
 Every moment in the market is unique.
The goal of is to create a carefree state of mind that completely
accepts the fact that there are always unknown forces operating in
the market.
The Mechanical Stage
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 – prior slide.)
4) Create a strong, unshakable belief in your consistency as a
trader.
Create a Belief in Consistency
1)
2)
3)
4)
5)
6)
7)
Objectively identify your edge(s).
Pre-define the risk for every trade.
Completely accept the risk of the trade, or don’t take it.
Act on your edges without reservation or hesitation.
Pay yourself as the market makes money available.
Continually monitor your susceptibility for making errors.
Understand the absolute necessity of these principles and
never violate them.
Most of this summary was excerpted from chapters 1-7. The
last two slides are from chapter 11. Chapters 8 – 11 discuss
the mechanics of how to implement these wise observations.
Chapter 8 – Working with your Beliefs
Chapter 9 – The Nature of Beliefs
Chapter 10 – The Impact of Beliefs on Trading
Chapter 11 – Thinking like a Trader
I highly recommend this book.