Although 1994 might not register in your memory—there was no presidential election, no significant geopolitical events, no recession, or stock market crash—it remains a year that ought to be remembered because, in 1994, the bond market suffered its worst selloff in sixty years. 

Fixed income securities lost $1 trillion in value. For the first time since its inception in 1976, the Lehman Brothers Aggregate Bond Index showed a negative total return.  

By September 1994, investors had pulled roughly $900 million out of hedge funds, and the withdrawals were still coming. Financial magazines pointed out indignantly that hedge funds were not actually hedged, and Forbes magazine proclaimed, not for the first time, “The hedge fund party is over.” 

Paul Tudor Jones handed back a third of his capital to investors, while Bruce Kovner decided to give back two thirds; both cited the difficulty of maneuvering in and out of markets with too much capital. 

On December 20, 1994, Paul Tudor Jones sat down to write a letter to all his traders. He was excited about the opportunity to trade on a much smaller capital base.  

He explained that he is increasing Tudor’s risk exposure to his own trading relative to the past. Where a 10 percent drawdown from original capital or starting equity was historically tolerable, he was now focused on even tighter risk parameters. 

He then outlined his plan. Allow me to read from his letter: 

The key to putting together a good year is to never fall behind early in the year. I can only remember one instance when a trader has been down at mid-year and recovered to have a really good year. At best, people claw their way back to even which in itself is only a mental victory. 

Occasionally someone does turn around spectacularly at year-end but those are few and far between. It is so critical to be disciplined, patient, and precise in the early going. Similarly, it is just as important to press early profits into much more highly leveraged bets because that is the only possible way of having a home run year. 

I certainly do not want to gamble with my hard earned profits.

I will always have a trend portfolio, no matter what. 

I will not enter any substantial position which does not have at least a 4 to 1 reward risk ratio. 

I will treat profits radically different than I treat original capital. 

I am a strong believer that good trading begets good trading and bad trading begets bad trading. 

Discretionary trading necessarily entails an unquantifiable and sometimes undetectable psychological element that implies traders have different levels of peak performance and perform at different psychological states over the course of any time period. If we could be completely aware of our psychological state then this leveraging and deleveraging process would not be necessary, for we would simply never trade unless we were at peak. 

Five times a day on each and every trading day, I will break from the momentum of the moment and take control of all trading situations by reestablishing my vision, my game plan, and my invincible physiology. I will enter my Power Room, drink fresh water, take three deep abdomen breaths, and take the following five steps:  

1.      Separate the forest from the trees

a.       Sentiment (if it looks bad, buy it; if it looks good, sell it)

b.      Time (recognize how fast it moves away from low or high)

c.       Price (implications of cross-over, volumes extreme, violations of specific points)

d.      Bias (explore that which is not obvious!)

e.       Make the hard trade, not the obvious trade

2.      Be Mr. Tough and hold contempt for the Weak Trader

a.       Destroy the guy who can’t make the hard trade! 

b.      Destroy the “Cookie Monster” and “Mr. Easy” 

3.      Visualize and experience the rewards and the purpose of my work! Refocus and get associated to what this means to me and to all those I empower today and will empower in the future. Because of what I’m doing today, I will be able to give and contribute more for a lifetime!  

4.      Visualize numbers! Visualize achieving 12+ consecutive winning months! Visualize the growth and experience the excitement of your NAV growing. See the growth that has already occurred from 61k to 70k. Now grow it from 70k to 75k—now grow it to 80k, now grow it to 90k, now grow it to 100k! 

5.      Take pain! Take pain! Take pain!  

This risk control manual is in recognition of the fact that no trader can maintain quality performance over time without a systematic approach to risk-control in conjunction with risk-control rules that will not be violated at any time. This is not to say that there are not times to take extraordinary relative amounts of risk. This is only to say that these instances should have a set of criteria that define them before they occur.

No trade can be entered without concurrently committing to paper a stop loss and profit objective for that and any trade. If possible, these stops should be given to an associate to ensure execution Canceling stops almost inevitably leads to larger losses.

No trade can be entered unless the reward/risk ratio is greater than 4-to-1. The reason that 4-to-1 has been chosen is twofold: a) slippage on losses is typically greater than one’s original estimate, and b) traders are generally wrong on their opinions.

At the close of everyday every position should be re-evaluated on a reward/risk basis using the close as the “new” entry point. This reward/risk ratio generally has to remain relatively high throughout the month if one is to win. Clearly, it one begins the day with a ratio between one and two, the account is at risk.

Just as Michael Jordan and Joe Montana need a coach, and a heavyweight boxer needs a standing eight count, so too does every trader need someone to help them in times of severe stress (i.e. during a drawdown). 

Determining a pre-defined unit is absolutely key to making money. Anyone who arbitrarily or intuitively buys or sells a “hundred,” or “ten,” or “one,” is doomed to failure. That style of trading consciously or sub-consciously ignores maximizing profitability through a portfolio approach to trading and abandons scientific inquiry as a cornerstone for managing risk.

Pre-defined risk control allows the trader to better define his/her downside exposure, thereby keeping him/her in the game longer.

One of the best ways to make money in a world of continuously leveraged bets is to figure out how not to lose it.

We are trying to develop traders that can quickly recognize when to lever up and more importantly, when to delever. This is absolutely critical to a trader's success.

We have found it necessary to force traders to sit out of the market when these drawdown levels are reached for many reasons, including the following:

1.      They are usually so emotional and angry, time out gives them a chance to cool off, detach from the market, and develop a rational game plan again. 

2.      This gives them time to evaluate their goals and objectives, reasons for failure (always money management in cases of quick drawdown) as well as their trading methodology.

3.      It gives them time to do some psychological self-evaluation, isolating those behaviors that may be sabotaging their success.

4.      It gives them a chance to interrupt negative behavior patterns and create new behaviors more conducive to profitable trading.

Traders who are likely to succeed over time are those who take complete responsibility for their trades by (1) unit determination, (2) stop and profit objective evaluation (reward/risk) (3) daily trade re-evaluation and qualification and (4) total risk identification each and every day as a percentage of capital. 

Traders must never let temporary defeat or setback take them out of the game. Do not let a temporary crisis turn into ruin. It’s a part of the game—traders must learn to bounce back from defeat. 

The key is to transform financial crisis into financial opportunity. Turn all defeats into a challenge. Traders need to make new distinctions that they can take with them so they can make better decisions in the future. They need not let yesterday’s crisis become today's mistake.  

A trader must have absolute faith in his or her ability to bounce back. Successful traders are larger than anything that can happen to them financially. Overcome today’s adversity and make it happen tomorrow.

Traders need to learn to evaluate how they link emotions to every aspect of trading and then eliminate disempowering emotional linkages and reinforce empowering ones.

Traders must avoid saying that a negative behavior is okay if in actuality it is really not okay. Traders most avoid justifying negative behavior thereby avoiding success. Traders must realize their day to day actions may jeopardize their trading destiny. Traders need to learn to take solid, consistent, positive action each and every day based on knowledge and preparation.

Once a trader has learned a method that generates market opportunities with positive expectations and has learned to manage risk through time, he must then learn to manage his emotions in order to take this knowledge to the market for profitable results. Only traders that are able to consistently stay in a resourceful state on a daily basis achieve successful results through time in this business.

Successful trading then requires a trader to first, avoid making negative associations in the present tense so that negative behaviors are not reinforced impacting future performance. Secondly, work on eliminating any negative associations or patterns that have already been developed and replace them with more positive associations and behaviors so that future outcomes are impacted positively as well.

Traders must never ease up no matter what degree of success they are experiencing. Do not get lax on your financial responsibilities. Continue to follow through with quality analysis, execution, money management, and state management every single day. Those traders that do well with what they have continue to get more as they grow and expand with each new success. 

The biggest reason traders fail to make money is because they don’t follow through. They don’t practice the daily fundamentals required for continued success. It takes absolute commitment, dedication, belief, and discipline on a daily basis to make it happen. 

Successful traders are more committed and more willing to do more and give more than unsuccessful traders. Follow through each day and take control of your financial destiny.

Traders are instructed to determine what they may be doing physically and mentally to create negative disempowering emotions and behaviors. Negative emotional states destroy a trader’s profitability and can result in a serious losing spiral if not interrupted. 

Traders need to learn exactly how they are generating their results whether positive or negative. Only a trader that can master his state on a daily basis will find consistent success in the markets.

Psychological questions:

Do you have a ritual to get you into a peak state, fully prepared to take advantage of market opportunities each and every day?

Do you have a tendency to get too euphoric after a winning series?

Do you have a tendency to get too depressed or frustrated following losses?

Do you have a tendency to carry negative feelings with you into the next trading day?

Do you have a tendency to avoid taking responsibility for your losses?

Do you have a tendency to look externally rather than internally to find the cause of problematic trading? 

Do you know how to distinguish between justifiable losses and unjustifiable losses?

Do you know how to distinguish between justifiable wins and unjustifiable wins?

Do you have a tendency to emphasize the downside or the upside potential of a trade?

Do you have a tendency to thoroughly plan a trade and then fail to execute the plan when market reaches your levels?

Are you satisfied with starting out with a basic position you can maintain for the campaign or do you feel compelled to start with excessive?

Do you have a tendency to watch the screen excessively resulting in second guessing or doubting the potential of your position?

Do you have a tendency to trade your analysis or trade your money? 

Do you have a tendency to get obsessive about a trade strategy?

Do you try to learn from every trade taken whether the results were profitable or not?

The primary emphasis on the psychological aspects of trading are the elimination of fear and self-doubt that can act as a barrier to trading success. Traders are taught to profit from all mistakes by learning how to identify losing behaviors and replacing them with winning strategies.

There are many psychological barriers that can stand in the way of a trader and ultimate success. We will try and focus on some of the more subtle psychological influences that may impact a trader’s performance. We cannot stress enough how important a role emotional self-discipline plays in the trading process. 

This section is designed to focus attention on some of the most common psychological trade barriers we continually encounter that sabotage trading success. Recognition of these potential threats is a strong starting point to helping traders develop and maintain winning habits so critical to a trader’s ultimate success.  

Below is a list of numerous psychological trading barriers that we encounter on a regular basis.

1.      Letting the Past Affect the Present: Often traders get euphoric and careless after a win and then give back substantial profits, or they become frightened and defensive following a series of losses generating self-fulfilling negative expectations. This results in trader taking profits too quickly in an attempt to cover previous losses or prevent trader from pulling the trigger and entering quality positions. Traders must learn to approach each day as a new day breaking completely with the past. A trader never knows when that profitable trading run is about to occur.

2.      Looking Externally for Causes of Losses: Often traders will abdicate responsibility for their losses. This habit prevents a trader from learning from potential mistakes and perpetuates negative feelings. (i.e. Excessive anger, blaming others, blaming the market.) A trader cannot look externally to find the cause of problematic trading but must learn to look internally and confront potential weakness. Only then will a trader find true success. 

3.      Not Adequately Analyzing Losses: Traders need to distinguish between justifiable losses and unjustifiable losses if they are going to avoid repetition of the same mistakes. Traders that fail to properly evaluate trading results will end up torturing themselves unnecessarily and doom themselves to repeating the same mistakes. Traders need to review trade journals periodically so positive trading habits are reinforced and poor ones can be eliminated.

4.      Fear of Losing: If a Trader is overly fearful of losing, he will reinforce this fear by failing to take well developed trades. This will result in total trade paralysis, and likely lead to a habit of making excuses for noninvolvement in the market place. The whole concept of risk control involves skillfully committing risk capital to the market for gain, not to avoid losing. Traders must learn to de-emphasized the downside and learn to trust their analysis and good judgement and just let trades happen while staying within pre-established risk control guidelines. Only then will traders ride out their positions and avoid the fear of loss, or fear of leaving money on the table.

5.      Overtrading: This can be both a symptom and a cause of psychological barriers. It can be a symptom of greed or desperation when a trader is up or down. It can cause psychological barriers to develop because it puts undue pressure on a trader when risking more than he or she can comfortably lose. The internal pressure that is generated by assuming excessive risk will force a trader’s hand and cause a mistake of some type to occur. (i.e. Using too tight of a stop, exiting a quality position to alleviate internal pressure, or second guessing analysis.) Traders need to stay within their volatility adjusted units and learn to regulate risk through time if wealth accumulation is to occur.

6.      Trading Analysis Rather Than Money: This occurs when a trader lets his or her ego interfere with trading objectives. When a trader allows the emotional need to prove analysis correct override the true goal of making money serious losses can occur. A fund manager’s goal is to make money not predictions. Losing sight of this fact is analogous to a football player running for the sideline rather than the end zone.

7.      Getting Emotionally Attached to Positions: Traders must avoid getting married to a single trading idea. This obsession can lead to severe losses if not derailed by a strict money management program. Traders need to allocate a certain percentage of risk capital to any one idea per month and when this benchmark is reached they must take themselves out before serious financial damage occurs. 

8.      Lack of Discipline and Commitment: This can cause any number of psychological barriers and will lead a trader to believe losses are a result of something other than his or her lack of hard work. Slacking off reinforces the failure cycle and could result in the beginning of a crippling negative spiral. Traders that repeatedly fall into this trap deceive themselves into believing that the markets are difficult thereby displacing their failure, rather than owning up to the poor results. Only traders that are totally committed to trading success, that are disciplined and fully prepared each and every day, will find profitability through time.

9.      Trading In a Sub-Optimal Mental State: Often traders will treat their vocation like any other job and take profitability for granted. The markets are far too competitive for this type of attitude. Traders need to mentally prepare themselves daily if they are to achieve continued success. Lack of emotional self-control has probably destroyed more traders in time. Traders need to get themselves into a peak state fully prepared to take advantage of whatever market opportunity presents itself. 

10.     Letting Faulty Beliefs Inhibit Trading: Quite often a trader will be restricted in performance by limiting beliefs. These conflicts need to be identified and eliminated when they arise. Unfortunately there is no way to isolate these until they become evident.  

11.      Reinforcing Negative Beliefs or Behaviors: Traders need to avoid over reacting to a loss or series of losses. To excessively punish yourself every time a mistake is made can create an enormous amount of negativity and frustration that will carry over into the following trading day. If this disempowered state continues to linger indefinitely, a chain reaction can take place resulting in a losing spiral. Successful traders learn everything they can from a loss, then they detach themselves and move forward, leaving it behind. Traders need to master their internal positive dialogue so they avoid reinforcing any of these negative emotions. Rather than saying “How could I have been so stupid?” They need to ask themselves “What can I learn from this trade so future results are positive?” Successful traders do not let their self-respect fluctuate with daily performance, rather they believe in themselves and what they are trying to accomplish. They have mastered their emotions and are able to maintain emotional equilibrium.

12.    Impatience: Trader impatience is more a function of inexperience than anything else. Novice traders are notorious for taking their trade strategy to the market incorrectly because they believe they will miss out on a move. Poor entry creates unnecessary stress forcing traders out of a quality position before actual analysis is proven wrong, because of the increased risk. This problem usually resolves itself in time. 

Those traders who can really look into themselves and realistically evaluate the person that they are, and not become frightened by what they find, those that can address weaknesses and develop plans to overcome those deficiencies are the traders that eventually achieve stellar results. Those traders that become flustered, that get angry, when others try and help, that are unable to find reasons internally for their lack of progress will usually peak out early and never achieve great things in the market.

A trader needs to think and believe he or she deserves success. A trader needs to stay fixated on positive expectations, on the desired results he or she is working for, and the daily rituals that are required for success. The more positive reference points a trader has, the greater his or her ability to draw upon those positive resources resulting in the positive results they are after.