September 4, 2007

Book notes – Way of the Turtle - I

I referred in my previous post about a book on trading – Way of the turtle which I have been reading for the past few days. Now why should a guy who displays a mental block against trading, read a book on the topic? The short answer is to challenge my own biases against trading.

I can definitely say that this is a good book and anyone wanting to learn about trading or wanting to evaluate a trading system (in a book or being sold by someone) should read this book. What follows over this and the next few posts is my own summary (not review) of the book with my own thoughts and comments (which I cannot resist putting :) )

The book is written by curtis faith who was one of the turtles (traders) recruited by richard dennis and william eckhardt as a part of an experiment that trading can be taught. The author was one of the original recruits (and probably one of the most successful) who made more than 30 million for Richard.

The book describes the difference between an investor and a trader. An investor buys stocks, but is really buying an underlying business. A trader in contrast is concerned only about price and is essentially buying and selling risk. The second chapter of the books talks of the turtle mind, which I think is equally relevant for an investor.

As we all know that markets are populated by individuals who are driven by fear, greed and all other cognitive biases, which create opportunities for a trader. The book refers to various biases such as loss aversion – higher preference to avoid losses over gains, sunk cost effects – tendency to treat money that has already been committed as more valuable than money to be spent in the future, disposition effect – tendency to lock in gains and ride losses, outcome bias – tendency to judge a decision by the outcome than by the quality of the decision at the time it was made and several other biases such as recency biases, anchoring etc.

The second chapter describes each of these biases in detail and how it affects a trader. The chapter continues with various trading styles such as trend following, counter-trend trading, swing trading and day trading.

One the key points I realised from the initial chapter was that each of these trading styles are valid for specific types of market. Curtis refers to various markets such as stable and quiet, stable and volatile, trending and quiet and trending and volatile. For example, trend followers love markets that are trending and quiet where they can make more money than a volatile market which is more punishing to trend followers. In contrast counter-trend traders love markets that are stable and volatile.

Another key learning for me in the chapter – successful traders never try to predict the market direction. Instead they look for indications that a market is in a particular state and trade accordingly.

I will be posting the rest of my notes over the next few posts. You can find the author’s blog

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