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1.1 Getting Started

You don't need to be brilliant to make money in trading. You don't

even need to be smart. In fact, people with high IQs often nd
themselves losing money, and they have no idea why.

There is a reason for this. Trading is about eliminating emotion and

making good, sound decisions. If you can make a decision without
any emotional involvement, you have what it takes to be a smart
trader. If you are unable to emotionally separate yourself from your
trades, you are bound to lose money.

Let me give you an example.

When I began my trading career in college, I was up the creek without

a paddle. Despite having read every book on fundamental analysis,
technical analysis, and stock market indicators I could nd, I was still
losing money.

I thought if others can do this, why can't I. In frustration, I started

buying products that I believed would help me change my luck. My
purchases, some ridiculous in hindsight, totaled over $1,000. Still I
lost.

My strategy at the time was simple. First, I targeted certain stocks

based on advice that went the full range from credible people like
Jim Cramer, who heads an expensive stock-picking service, to some
no-name guy on the Internet. Next I stared at charts  the one year
and ve year, in my case  looking for every possible opportunity to
draw a pattern or a trendline, no matter how much of a stretch it
was. Then, as long as the stock wasn't acting bearish, I bought it.

Then I watched, to the point of obsession. If the stock ticked up by

twenty cents, I was overjoyed. If it ticked down, I panicked. As you
can imagine, after a month of this I was a nervous wreck.

Even when warning bells clanged, I still held on, because I knew I
had picked a good stock. With all the  expertise I had accumulated,
how could I have done otherwise? In fact, as my trades failed, I just
bought more of the stock given how much cheaper it was. In reality
I was getting deeper and deeper in the hole. What a way to blow up
an account!

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Whether this feels familiar to you because you've already had some
experience trading or is brand new for you, read on. In this book, I
will not only teach you the skills of a professional trader, but I will
also teach you how to avoid the common pitfalls of new traders.

I would have burned through my entire account if I had not had the
good fortune to meet a truly topnotch player. He was a former trader
for Morgan Stanley who had decided to go out on his own and was
now successfully trading from his home oce  my own dream way to
make a living. He became my mentor, and he taught me everything
he knew, not just the skills but the characteristics of winning traders.
I intend to pass these on to you.

You will need to be motivated to take this journey because the skills
I teach will be both complicated to learn and even more so to master.
However, if you stay the course you will be well rewarded.

1.2 How to Read this Book

This book is divided into three parts.

In part one,  Know Your Stu, I will discuss, in depth, the backbone
of successful trading, which is having a solid knowledge of technical
analysis. I will then teach you how to analyze various types of charts
until you can read them like a pro. Finally, I will wrap up section
one by discussing the dierent types of asset classes and show how
you can leverage them for protability, even with a small account.
In part two,  Know the Game, I will begin by teaching you the
basics of intermarket analysis. Within this section, I will cover the
various markets available for trading including the stock market, the
treasury market, and the options market. I will introduce the concept
of risk management as the basis of any successful trading career and
demonstrate three tried and true strategies for trading. I will discuss
how to exit your trades, whether for a prot or a loss. Finally, I
will run through some case studies of real trades I have made  both
winners and losers  to help illustrate the principles I am teaching.

Once you have learned and mastered the material in the rst two
parts, you will be ready for part three where I cover two more ad-
vanced topics, options theory and point and gure charting. I spe-
cialize in these topics and will demonstrate how you can be a winner
provided you use my well-tested strategies.

This book has been designed to accompany the workbook I have

provided. Each chapter has a corresponding set of exercises in the

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workbook. In order to get the most out of this course, I suggest
that you do every exercise, since practice and repetition are the only
methods for improving your skills. I also suggest mentally answering
the review questions at the end of each chapter. This practice will
dramatically help you internalize the concepts I am teaching.

Other than that, I ask that you keep an open mind as you read. Some
concepts may seem counterintuitive, but with dedication and practice
you will nd that it will all come together at the end.

Please do not risk real money until you have completed the entire
course. The skills you learn here will be essential to becoming a
protable trader. Even after completing the course, success will take
time and practice so you may want to consider opening a practice  pa-
per trading account where you can try out your new skills without
risking real money.

1.3 What is Technical Analysis?

Technical analysis is the art of reading price charts to make decisions

about trading stocks. Its use dates back hundreds of years and pre-
dates the modern stock market. In this section, we will discuss what
technical analysis is and how you can study it through understand-
ing of charts, Dow theory, support and resistance, trendlines, price
patterns, reversal patterns and continuation patterns.

A technician, or someone who practices technical analysis, tries to

determine future price movement in securities by analyzing their past
price movement.

Technical analysis diers from fundamental

analysis in that, in its purest form, it ig-
nores the fundamental aspects of the securi-
ties traded. Fundamental analysts study com-
pany  fundamentals like balance sheets and
cash ows as a way to determine their inher-
ent value and possibilities for growth. Tech-
nical analysis, on the other hand, is based on
the premise that all information about a secu-
rity can be conveyed through price action not
through whether the underlying company has
any fundamental value. Technical analysis as-
sumes that fundamental information is already
priced into a stock. Companies with strong
Figure 1: Many people
consider Warren Buet
to be the most succesful
3 fundamental analyst of
our time.
balance sheets will be priced high, and com-
panies with weak balance sheets will be priced
low.

In my view, the market is  smarter than I am.

That's because as an individual, I know I can't
have access to the resources  the ability to
meet with company management, for instance  that fund managers
at institutions have. Since I am at an  informational disadvantage,
I prefer to focus on technical analysis.

Fundamental analysts and technical analysts always argue over who is

right, so let's be clear here. There is no question that to be a success-
ful investor, you should be well acquainted with the fundamentals of
the company in which you are investing. But investing is not the fo-
cus of this book, trading is. And to trade successfully, you want to be
well versed in technical analysis. By charting the price of securities,
you can visually examine their fundamentals without reading balance
sheets and crunching numbers. As a trader, I am not interested in
the fundamentals of the companies I trade. What I want to see is a
good-looking chart. At this point in my career, I can look at a chart
for under a minute and make a well-informed decision about whether
or not to trade it. After reading this book, you too will have that
ability.

One caveat here: Technical analysis is not an exact science, it is an

art form. Now that may sound surprising, but even good traders are
proven wrong on their trades about 50% of the time. If you can get
to 60%, you are great. The dierence between winning traders and
losing traders is how they manage their trades. We will discuss this
in more detail later. We still have a lot to learn before we get there.

1.4 What Moves a Market

The rst thing we have to learn is what moves a market. The answer
to this is straightforward. Supply and demand, plain and simple,
moves the market.

The market is simply an engine for achieving a fair price, a price

dictated by the forces of supply and demand. Traders are the gears
that keep the market moving. As traders we can prot from the rises
and falls in price.

The market is most ecient when a high volume of securities is

traded. When this is the case, we say the market is liquid. For

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 Bid Ask Spread
63.82 63.85 0.03
Table 1: Shares can be purchased at the Ask price and Sold at the Bid.

traders, a liquid market is the best scenario. Most stocks priced over
ten dollars per share are liquid enough to trade. You should look for
stocks with at least 200,000 shares traded per day on average. These
are the situations where technical analysis works best, and as I said,
that is the name of the game.

In the stock market, there are three players  buyers, sellers, and
market makers. A market maker is someone who acts as an interme-
diary between buyers and sellers.

The market maker is responsible for buying shares from the sellers
and selling shares to the buyers. The price at which we buy shares
from the market maker is called the ask price, the price at which
we sell shares is called the bid price. The dierence between the
bid and the ask is called the spread. The more liquid the market, the
smaller the spread will be. The importance of the spread will become
apparent in a moment.

Here is an example of how prices move. Suppose we want to get long1

TM by buying 100 shares. We place a buy order with our broker,
who in turn, places an order with the market maker who controls
TM. Let's have a look at the information here:

This tells us that the market has currently priced shares of TM at

somewhere between 63.82 and 63.85. We place our order and the
market maker sells us 100 shares at 63.85 each. If we immediately
sell our shares, we will have to settle for a price of 63.82, which is the
price at which the market maker will buy our shares. This will result
in a loss of three cents per share, or three dollars, even though the
price hasn't changed. Notice how the spread can aect your trades
.
That is just one of the reasons to trade liquid stocks.

Now, imagine that a big hedge fund calls the market maker and places
an order for 500,000 shares. Let's assume the market maker agrees
to ll this order for the hedge fund at $65 per share. The demand for
this stock is essentially 500,000. 500,000 shares is a massive order,
and usually the market maker won't have enough shares. Assuming
1 Get Long: The process of buying assets to open a position, as opposed to getting short,

which is the process of selling assets to open a position.

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Figure 2: This chart shows hypothetical price action in TM when a large order
is placed for $65. This could play out over a time frame of minutes, hours, or
even days.

the market maker has 100,000 shares in his inventory, the supply is
100,000. Since supply (100,000) is less than demand (500,000), we
would expect prices to increase. How then do they increase?

The market maker will have to buy 400,000 shares on the stock mar-
ket in order to ll the order. In order to attract sellers, he will slowly
increase the price to draw sellers into the market. As the price be-
comes more attractive, more sellers will sell their shares to the market
maker.

The market maker does not want to increase his bid price too much
though, since it will decrease the prots he receives from his sale to
the hedge fund manager, so at some point he will reduce the price a
bit to keep his cost basis low. This phenomenon is called a pullback,
and although it temporarily changes the price of the stock, it does
not negate the underlying supply and demand equation, which points
to higher prices. When the sellers no longer wish to sell stock at
the current price, the market maker will have to increase the price.
Higher prices will tempt sellers to sell the market maker more of the
stock he needs to acquire.

If, however, the price approaches $65, the market maker will be in-
clined to use that price as a ceiling. If he has to buy shares at above

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$65, he will lose money when he sells them to the hedge fund at
$65. If and when the price reaches $65, the price will likely turn
down from that level. This will happen until the order is lled. The
ipside to this process is when supply outweighs demand and causes
prices to drop rather than rise. What is key is that whether we are
talking about one buyer or thousands, supply and demand ultimately
controls the price. Phenomena such as the pullback can occur over a
period of minutes, hours, or days. Your trading style will determine
what time frame you use.

As traders, we will use technical analysis to capitalize on these price

movements. With practice, you will be able to look at a chart and
identify the underlying supply and demand equation and then use
that information to be on the right side of the trade. Technical anal-
ysis will also help you make objective decisions about when and why
to exit losing positions. Those are decisions that might be dicult
otherwise.