Trading routes

Read the book only if you want to benefit from investor psychology or if you are an aspiring trader with strong fundamentals.

twitter-logo Sameer Bhardwaj        Print Edition: January, 2010

Most stock market studies focus on quantitative factors like company financials, GDP and interest rates. While these have a significant influence on market movements in the long run, in the short term, qualitative factors also matter. These include psychology and behaviour of participants, the latter comprising investors or traders. The two differ in that the former invest with a longterm view, while the latter, also called day traders, have a short horizon.

The participants' psychology is a critical element in market trading as it's associated with greed, fear and confusion, which can create large variations or volatility and lead to uncertainty and risk. If you want to understand the factors that influence the participants' behaviour and demystify their trading psychology, John Piper's The Way to Trade will be handy. However, only short-term investors or those aspiring to excel in trading should pick this book. The book also explains advanced trading strategies beyond the basic technical analysis and covers derivative markets.

The Way to Trade can be broadly classified into two sections: understanding investor's behaviour, and learning trading methods and strategies. In the first section, the author analyses various reasons for failure in market trading, and considers human emotions to be a critical one. Emotions dominate the trader's mind, creating fear and anxiety, which in turn force him into hurried decisions. The stages that an amateur trader goes through during the learning phase are explained brilliantly. He enters the market with greed, which gradually turns into fear and ultimately into risk orientation. In the last case, the trader begins to understand the risk involved and learns to minimise or eliminate it.

The first section also describes a 10-stage trading pyramid that can be a useful tool for success. The pyramid explains the importance of commitment and discipline, and the key concepts of money management and risk control. However, most of these stages deal with the concepts of market profile, minus development, which are based on the theory of normal distribution (bell curve). Though the concept is explained in another chapter, the basics of bell curve theory are missing. So one needs to be well versed with it to understand the pyramid.

The second section explains trading strategies based on F&O markets and technical analysis. The former are for experienced traders as they ignore the basics of options. The section deals with the applications of advanced option strategies like straddles, bull call spreads and option hedging, but fails to the demystify trading terms like OTM, ATM, time value and intrinsic value. The readers who know options basics will find the description of the relationship between intrinsic value and time value satisfying as it meticulously explains how the price of an option is affected by the change in intrinsic or time value. For the futures markets, the author explains advanced charting signals, some of which are based on market trends and market gaps. However, these are explained very briefly and lack simplicity. The reader needs to have a basic understanding of technical analysis concepts like moving averages, range and support-resistance levels to understand these.

The author also highlights the importance of news in the stock markets. No news by itself is good or bad; it's the way participants react to it that affects the markets. He warns investors to avoid trading prior to substantial news events as these can lead to risk.

The book is primarily for knowledgeable readers as it fails to dejargonise important terms. It concentrates on applications and ignores the fundamentals. While the language is simple, there is lack of clarity on technical terms and, hence, novice readers will find it difficult to grasp. However, the book can be useful for professional option traders, technical analysts and day traders.

Trading essentials

Commitment: One should avoid emotions and fear while trading and should understand that money generation via markets is not easy.

Discipline: This is extremely necessary for adopting a systematic approach while trading. Without discipline, one will not able to overcome one's emotions and instincts.

Money Management: One should not risk the entire capital while trading. One should try and keep the risk limited to 10 per cent of the trading capital.

Risk Control: Use options for controlling risk as option buying limits losses.

Trading Methodology: This is vital for stock trading. One needs to determine the time frame, trading instruments, trading capital and the maximum downside limit.

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