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Background

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Trading in the Zone

Master the Market with Confidence, Discipline and a Winning Attitude
Mark Douglas • FT Prentice Hall © 2001 • 216 pages

Life Advice / Personal Finances / Investing / Trading

Take-Aways
• Trading skills can be learned or acquired.
• That so few traders are consistently successful is due to their mistaken perceptions of what it means to be
a trader.
• The market operates in ways that can appear counterintuitive.
• The market is neither good nor bad, and neither right nor wrong – it just is.
• If you see trading as a personal challenge and success as personal validation, you are doomed to
inconsistency.
• Taking responsibility is the core attitude of all good traders.
• Successful traders embrace the uncertainty of the market.
• They maintain faith in trends.
• Profitable traders think in terms of probabilities, not results.
• The best traders are not afraid or reckless. They have confidence in their systems.

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 Recommendation
Mark Douglas compares a great trader to a world-class athlete: Both have honed their skills, reflexes,
instincts and wills to a fine edge. Both have reached the point at which a winning performance is an
automatic, utterly unconscious process – that’s when they are operating in the zone. To reach the zone,
Douglas contends, traders must impose mental self-discipline and adhere to a consistently strict system.
Would-be investors and tyro traders will value this enlightening text for its underlying message that great
traders are made, not born.

Summary

Fundamental vs. Technical Analysis

As recently as the late 1970s, fundamental analysis was by far the dominant orthodoxy among professional
traders. Fundamental analysis is about creating mathematical models that incorporate all the variables that
might affect the supply-demand equation of any particular stock, commodity or financial instrument.

“Ninety-five percent of the trading errors you are likely to make – causing the money
to just evaporate before your eyes – will stem from your attitudes about being wrong,
losing money, missing out and leaving money on the table.”

Technical analysis, which has always existed in one form or another, has come to dominate the thinking
of professional traders for a good reason: Technical analysts make more money. Technical analysis is all
about patterns and the ways traders interact with the market. Certain behavioral patterns are observable,
quantifiable and predictable; therefore, they can be profitably exploited.

Mental Analysis

Within the framework of technical analysis is the realm of personal analysis. After all, if technical analysis
were the ultimate solution, you’d expect to see everyone who uses it getting rich, but in fact the opposite is
more nearly true. Traders, in general, lose. That’s a fact of the market. For every dollar made, a dollar is lost
somewhere else. Every buyer is buying from a seller. When one trader scores big, many others have lost to
fuel that profit. The difference between winners and losers, when all is said and done, is attitude.

“If you have ever found yourself blaming the market or feeling betrayed by it, then you
have not given enough consideration to the implications of what it means to play a zero-
sum game.”

A properly grounded trader is one who embraces the uncertainty of the market and is not thrown for a loop
if a trade fails to show a profit; the trader moves on to the next trade without a backward glance. But average
traders are motivated by the wrong things. They have a competitive mind-set, a “me vs. the market” attitude.
They use their trading for personal validation and have an emotional stake in being right. The end result?
They hold on to losing trades in the hope those trades will turn around, and they prematurely cash in
winners to realize the attendant profits. The effect of all this is to lose more and win less.

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 Discipline and Focus

Discipline and focus are the keys to success. The defining characteristic of consistent winners is their mind-
set. They are able to remain confident when faced with adverse conditions because they have the discipline
to focus on the big picture. Consequently, they are essentially unsusceptible to the common fears that
bedevil the vast majority of traders and, accordingly, do not fall prey to the trading errors that can plague the
average investor.

“Although few would admit it, the truth is that the typical trader wants to be right
on every single trade. He is desperately trying to create certainty where it just doesn’t
exist.”

Emotional pain and financial disaster are all too common among traders. Market trading is, by its very
nature, fraught with paradoxes. Perspectives, principles and attitudes that work well for people in everyday
life are strikingly counterproductive when applied to trading activities. For example, trading is inherently
risky. Since no trade has a guaranteed outcome, there is always a possibility of being wrong and losing
money when any given trade is initiated.

“You will need to learn how to adjust your attitudes and beliefs about trading in such
a way that you can trade without the slightest bit of fear, but at the same time keep a
framework in place that does not allow you to become reckless.”

Does this mean that when you trade you can consider yourself a risk taker? Obviously, the answer is yes,
right? Wrong. This is one of the fundamental paradoxes of trading: the belief that taking risks classifies you
as a risk taker. Nothing could be further from the truth. To be a risk taker means accepting the consequences
of risk. It means being able to exit a losing proposition with no emotional pain whatsoever and fully
accepting that a certain percentage of all your trades will not show the desired outcome. Acceptance of risk is
the most important skill a trader can learn.

Transcending Fear

The critical difference between consistent winners and everyone else is this: The best traders aren’t afraid.
They have adopted and honed an attitude that gives them terrific mental flexibility. They are able, at the
same time, to listen to what the market is telling them and to move in and out of trades fluidly while still
not succumbing to recklessness. They have no emotional stake in the outcome of any particular trade. Their
single concern is the condition of the balance sheet at the end of the day.

“Even though you cannot will yourself into a zone, you can set up the kind of mental
conditions that are most conducive to experiencing the zone by developing a positive
winning attitude.”

By contrast, the average trader lives between the extremes of recklessness and fear. When things are going
well, such traders throw caution to the wind, believing themselves invincible. When the inevitable significant

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 loss occurs, this invincibility is shattered, and it is replaced by fear. In other words, they have created the
kind of experience for themselves that breeds and reinforces fear.

“You cannot expect the collective actions of everyone participating in the market to make
the market act in a way that gives you what you want. You have to learn for yourself
how to get what you want out of the markets.”

The four primary fears of traders are being wrong, losing money, missing out and leaving money on the
table. These fears often dominate or override everything else. You can’t see situations or opportunities
accurately, you can’t act on them objectively, and you find yourself immobilized. The source of these fears is
not the market itself; it is your attitude toward the market or toward life itself. This is extremely difficult for
most people to perceive.

“The best traders have evolved to the point where they believe without a shred of doubt or
internal conflict that anything can happen.”

Consider the example of a child bitten at a young age by a dog. This child has grown up into an adult with a
pronounced fear of dogs. While the dread is understandable, it is not universally valid: The child was bitten
by a dog, not all dogs. And this fear is keeping at bay a whole slew of alternative realities that include the
possibility of a dog as a positive force. At the same time, it is highly likely that no dog will ever again bite this
individual, so the fear is counterproductive and debilitating.

“Traders who have experienced being tapped into the collective consciousness of the
market can anticipate a change in direction just as a bird in the middle of a flock or a fish
in the middle of a school will turn at the precise moment that all the others turn.”

It’s like that with the market: “Once bitten, twice shy” may be a hoary old cliché, but it doesn’t help one bit if
performance in the arena in which the bite occurred is essential to the bitten individual.

Addiction to Random Rewards

Several studies have shown clearly the psychological effect of random rewards on monkeys. As expected,
if you consistently reward a monkey for accomplishing a certain task, it will repeat the task often in order
to receive the reward. Also, as expected, if you stop giving the reward, the monkey will stop performing the
task.

“Self-discipline is a technique to create a new mental framework. It is not a personality

trait; people aren’t born with self-discipline.”

However, a fascinating sidelight to this is the reaction of the monkey to random rewards. If the successful
completion of the given task may or may not result in a reward, the monkey will continue performing
the task in the hopes of receiving the reward. This is strange but critically important behavior. Once the
possibility of reward has been established, the tendency is to go on performing the task repeatedly in the
hopes that that rush of pleasure will materialize again. This amounts to an addiction to random rewards, and

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 it is closely akin to the gambling impulse. You see it over and over again in market traders, and it is a sure
path to financial disaster.

Taking Responsibility

The words are simple: Take responsibility. The concept is anything but simple, however, especially in the
context of trading activities. It is similar to creating a new version of yourself by reshaping your mental
environment. Successful traders eliminate both fear and recklessness from their trading. The other part of
the equation is the need to develop restraint: to acquire the ability to focus your attention consistently and
unrelentingly on productive actions and behaviors.

Traders operate within the market; they are a part of it. The market itself is neither good nor bad; it is simply
the sum total of the inputs – trades – that define it. Consistency cannot be found in the market itself: The
consistency you must seek is in your mind. You must accept that all results, good or bad, come from your
interactions with the market, not from actions of the market itself. In this sense, attitudes produce better
overall results than either analysis or technique. Ideally, you have both, but without the correct attitude you
cannot be consistently successful.

The market is basically a group of people interacting with each other to extract money from one another. It’s
a zero-sum game. In that context, does the market have a responsibility to the individual trader? Of course
not – the market just is. Accordingly, if you have ever suffered a trading loss and blamed the market, if you
have ever felt betrayed by the market, you are not thinking things through, you are not reacting correctly to
your loss and you are not properly playing the game.

Taking responsibility means just that – you are completely responsible for your success or failure as a trader.
The market generates information about itself, but all the results of your trades derive from decisions you
have made based on the information you have gleaned. To whatever extent you react personally to the
market (“It was a great trade, but the market screwed me over”), you have doomed yourself to failure as
a trader. The market is an endless stream of opportunities. Some will pan out, others will not. Profitable
traders understand the ebbs and flows of the market. They give themselves license to get into the flow, and
they begin trading in the zone. By contrast, unsuccessful traders are less concerned with winning than they
are with avoiding pain. Since losses are always painful to them, they soon enough find themselves trapped in
an approach to the market that cannot succeed. The more that traders fixate on winning (not losing) on any
given trade, the less tolerance they will have for any information that seems to indicate that they will not get
what they want from this trade, and down that road lies catastrophe.

All successful traders implicitly understand that trading is all about probabilities, not individual outcomes.
They set a mental framework that recognizes “five fundamental truths”:

1 . “Anything can happen.”

2 . “You don’t need to know what is going to happen next to make money.”
3 . “There is a random distribution between wins and losses for any given set of variables that define an
edge.”
4 . “An edge is nothing more than an indication of a higher probability of one thing happening over
another.”

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 5 . “Every moment in the market is unique.”

Good traders commit themselves to making every trade that conforms to their definition of an edge. They
never attempt to predict specific outcomes; they think in terms of the big picture. Accomplished traders have
eliminated from their universe the potential threat of unrealized expectations. They have no expectations of
any individual trade but instead a belief in the big picture.

Thinking Like a Trader

At its simplest level, trading can be described as a numbers game, a game of pattern recognition. Market
analysis helps identify patterns, define risk and determine when to take profits. In the end, the trade works
or it doesn’t work. Either way, you move on to the next trade and the next, never dwelling on past failures or
becoming emboldened by a streak of successes. The more you think you know, the less successful you’ll be.
Skilled traders don’t need to know anything; they just properly manage their expectations. At the mechanical
level you can accomplish this by trusting yourself to operate in an unlimited environment, learning to
flawlessly execute a trading system, training yourself to think in terms of probabilities and nurturing an
unshakable belief in your own consistency as a trader.

“To even start this process, you have to want consistency so much that you would be
willing to give up all the other reasons, motivations or agendas you have for trading that
aren’t consistent with the process of integrating the beliefs that create consistency.”

From the mechanical level you can move on to the subjective stage of trading, in which you begin to apply
whatever you have learned about the market, always maintaining your sense of absolute responsibility for
your own decisions and results. Finally, you can advance to the intuitive stage – the trading equivalent of a
black belt – in which the rational part of your mind sits back and lets the intuition of experience take over
to guide your trades. And this is where it’s at for the best traders, who, with little conscious thought but with
anticipation and reaction working seamlessly, steer a probability-driven system to positive results.

About the Author

Mark Douglas is president of Trading Behavior Dynamics. He has developed programs and coached all
levels of traders on how to achieve and sustain a successful trader’s mind-set. He is also the co-author of The
Complete Trader and The Little Book of Trading Performance.

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