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Eddie Kwong Chats With Mark Douglas

By Eddie Kwong

Hi folks. I’m here today interviewing Mark Douglas, the
author of

Trading in the Zone. Mark, whom I’ve known for several years, is an
authority on the psychology and discipline it takes to achieve long-term success
as a trader. He has helped thousands of traders improve their trading
performance by overcoming self-defeating behaviors. I truly believe Mark to be a
credible source of information on this topic because he himself is a trader. He
built his mental strategies on the foundation of having successfully fought his
way back from his own initial shortcomings as a trader. Now let’s get down to
business.

Eddie Kwong:
How are you doing, Mark?

Mark
Douglas: Tired.
Very tired. These hockey games wipe me out. The average age on the team is
probably about 27 or 28. And I’m in my 50s.

Kwong:
Wow, that’s incredible. So do you find that staying
physically active helps your mental focus trading?

Douglas: Oh, sure.
Absolutely there’s a correlation. People should stay physically fit no matter
what they do, Eddie. I’m not saying they should play ice hockey. It just so
happens I played organized hockey in high school. The last time was 1966. But I
didn’t play again until 1995. So I was off for about 28 or 29 years. It was
strange getting back into a team, competitive sport, when I hadn’t played since
I was a kid. After all those years, it took me probably about 2 to 2½ years to
get adjusted to it.

Kwong:
So
Mark, tell me how you got started in the business. I recall reading

The Disciplined Trade and it told a little bit about your background. How
did you start trading and how did you get involved in trading psychology and
discipline?

Douglas: I was in
the commercial casualty business around 1978 and I got a call from a broker.
Probably like many people, I was bored with what I was doing. I always thought
that managing an insurance agency was something I really wanted to do. And I was
very successful at it, but not particularly challenged by it, at least at that
point.

I got
that call from a broker, and opened up an account. Another odd thing about my
trading career is I started trading futures right off the bat. It never occurred
to me to trade stocks. I can’t really tell you why. It just didn’t. And I think
the first trade I put on was a potato futures trade when they used to trade
potatoes at the Chicago Mercantile Exchange. And then from there, I started
trading gold and silver, mostly.

Kwong:
And how did you do?

Douglas: Oh,
typical. You make money in the very beginning. You know, you put on “X” number
of winning trades, however many it takes to get into your blood; the winning
trades, the exhilaration, the euphoria. And at some point, you start making
mistakes; you start doing things that are counterproductive to what it means to
be a consistently successful trader. Of course you don‘t know it at the time.
But it all seems very easy, like your panacea of instant wealth is right before
your eyes.

And
like most people, I had winning trades and then losing trades, and losses to the
point where I lost my initial stake. I saved up some more money and lost that
and then saved up some more money. And what really got me—and
this is something that’s not in my book–-what really got me involved
in the business was just before silver made the big run-up to $49 an ounce
around 1979 or ’80. I was long two, 5,000-ounce contracts of silver at around
9.60 an ounce or 9.68. And the market dropped about 20 cents. And my broker
said, “Well, you know, you don’t want to get out of this position. So what I’m
going to do is spread you — put on a spread between New York and Chicago.”

So he
sold 10,000 ounces in New York. So I was at about a 20-cent spread where I was
short New York and long Chicago. And he said when the market went back in my
favor, he’d take the short end of the spread off. And so what happened is that
the market rallied about 20 cents and then he took the short end of the spread
off and then it dropped another 15 or 20 cents and he put the spread back on.
And then the market rallied again and he took the short end of the spread off
and then it dropped another 15 or 20 cents and he took the short end. And then
he put it back on. And he kept locking in deeper and deeper losses. And I didn’t
know what I was doing and I didn’t know that he didn’t know what he was doing
either other than just generating a lot of commissions.

And eventually it got to the point where all my equity was
gone and I couldn’t sleep. And it was really disturbing.
I mean basically the
silver market at the time was just in a 20-cent range and he was buying the high
end of it and selling the low end of it. It was crazy. But like I said, I didn’t
really know what I was doing. And so I just kind of woke up and decided that I
was just going to blow out of the whole position. So I called him up and I did.
And of course that was the day that the market rallied.

Kwong:
Oh, man. Sounds
like a defining moment in your life.

Douglas: Yeah. And
that was the day that it started shooting up to $49 an ounce. And I’m thinking
to myself, I could have made $400,000. I mean at the time — again, not knowing
the dynamics of what it means to be a successful trader — I’m thinking that I
was sitting on $400,000 and I was that close to it. And from that point on, I
mean I was really hooked.

Kwong: That horrible experience got you
hooked?

Douglas: Yes.

I blew out of the whole position. I blew out of the whole spread. I mean it was
just — you know, all my equity was gone and I was looking at losses and margin
calls at that point.

Kwong:
Did you just want revenge on the market?

Douglas: No.

Kwong:

Then were you determined to succeed no matter what?

Douglas: Yes.
Right. But I’ve never been a revenge trader. That never occurred to me to get
revenge on the market.

Kwong:

I see. Did this affect you psychologically and
emotionally? Would you say that it was a productive sort of impact, in that it
made you want to go back and do the research and analyze yourself, or did you
find that it was debilitating?

Douglas: Yes, it was definitely debilitating because it was always on my
mind. It was always swirling through my mind that I was that close to that much
money and now I was in a situation where I couldn’t even trade because I didn’t
have the money. Watching the market go all the way to $49 an ounce and
thinking–erroneously–that I’d been able to stay in the trade to $49 an
ounce was ludicrous because I didn’t have the skills to be able to stay in a
trade like that, at least at that time.

But I
didn’t know that then. And so, yes, I found it very emotionally debilitating.
But at the same time, it was also inspiring because I was determined to learn
everything I needed to learn about what it meant to be a successful trader.

Kwong:
So what did you do then? What did you do at that point?

Douglas: Being able to put on a winning trade and being able to produce
consistent results and a steadily rising equity curve are two universes apart.
And so I went on a knowledge quest. I started going to all the seminars,
I started buying the books, and just dove right into it. I even got to the point
where I sold out my interest in the casualty agency. I was thinking, hey, if I’m
going to do this, I’ve got to do it where people are doing this and I can find
out what’s going on. So I moved to Chicago and got a job with Merrill Lynch at
the Chicago Board of Trade. I went into the brokerage business.

Kwong:
I see. What kind of milestones can you think of that
during the course of your educating yourself where you can look back and say
those were the significant steps upward that you made, not only in increasing
your knowledge, the type of knowledge that you teach people now, but also in
proving your ability as a trader? Or did it just happen steadily?

Douglas: It just happened steadily. I don’t know if I’d call it a milestone,
but one of the things that was kind of interesting was the first trading book I
ever bought: Jake Bernstein’s Investors Quotient. I always inherently
knew that trading was psychological.

Kwong:
Yes, I read that book too.

Douglas: The group of people focusing-in on the psychology of trading back
in the late ’70s and early ’80s was really small. Back then most of the trading
community–especially the academic community and the Wall Street
community–looked at technical analysis as a form of mystical hocus pocus.

Kwong:
Yes, I remember that.

Douglas: We’ve evolved a lot in the last 20 years, haven’t we?

Kwong:
Yes, exactly. Looking forward to the present, what did
you learn that has had a major impact on you? What do you do differently now and
what do you try to teach people?

Douglas: Well, what I teach people now
is that there are four primary areas that have to be mastered to create
consistent results. One is learning how
to identify an edge, and that’s basically learning how to read the markets,
right? Learning how to think in the market’s perspective. This is big.
Learning how to think in the market’s perspective, which is in
essence, learning how to think in probabilities. Learning how to identify and
neutralize self-sabotaging beliefs. And before one is going to learn to
identify and neutralize self-sabotaging beliefs, they have to have some
awareness of how beliefs act on their perception of information and their
behavior in a way that can cause them to do things that lose money–whether they
are conscious of it or not.

They have to come to that
point to realize the inner dynamics of how their beliefs interact with
the market environment, and how to monitor their susceptibility to euphoria.
Because once you start winning and start winning consistently, if you
don’t have a framework, if you don’t have a mental framework to at least be able
to recognize when you cross the threshold into euphoria (and there is a
difference between a normal state of mind where you’re in a state of confidence
and when you cross the threshold into euphoria: once you’re in euphoria,
you are in what I call a risk-less state of mind) than you cannot perceive
risk.

Kwong: I see.

Douglas: That’s the difference. When you’re in the normal state, a normal
confident state of mind, you do what you need to do when you need to do it. And
all the boundaries and limitations that you have in place when you trade are all
operative.

Kwong:
Most people consider themselves to be competent in
different things that they do, say as a doctor or lawyer. But when it comes to
trading, they lose their nerve, or something knocks them off the horse. What
happens?

Douglas: That falls into the second category of what people have to learn to
be consistently successful. And that’s learning how to think in the market’s
perspective or learning how to think in probabilities.

There’s
a direct correlation between your ability to think in probabilities and your
state of confidence as a trader. See, when you learn to think in probabilities,
basically you’re taking a stance. Your perspective that you’re taking with the
market is that I don’t need to know what’s going to happen next to make money.
Every moment is unique.

Now if
you operate from the perspective of believing that every moment is unique, what
does the word uniqueness imply? That this next moment in the market is like no
other that’s ever existed. It may be similar, but it’s truly unique, meaning
that I don’t know what’s going to happen next. And if I believe that I don’t
have to know what’s going to happen next but I also know that I have an
edge–meaning that there’s a higher probability of one thing happening over
another–and I also know that I know how much I have to risk to find out if that
edge is going to work. And if I also have the confidence to know that I’ll cut
my losses if the market behaves or indicates to me that that edge isn’t working,
then what do I have to be afraid of?

One of
the problems is the way we define success in society: that we’ve mastered the
environmental forces. Now, what are those environmental forces? In any kind of
profession, what I do to be successful at it is I master all the principles of
success of that profession, right? In other words, I am in a state of knowing.
And not only am I in a state of knowing, but let’s say I’ve also climbed the
corporate ladder or some social structure in which I have power over other
people and I can exercise that power: that’s what makes a person successful in
those other chosen professions.

Then
these otherwise successful people get into trading and find that they don’t have
power over the market.
And not only do they not have power over the market,
but they don’t know what’s going to happen next, although they believe
they can know what’s going to happen next. Now, if they’re psychic, they
do. If they’re incredibly intuitive, they do. But even then, using your
intuition in the market without the proper psychology will have disastrous
results, not only financially but also psychologically.

So the whole point is that you
will be confident when you truly accept and let go of the fact you don’t have
to know what’s going to happen next to make money.
So once that framework is in place, there’s nothing to be afraid of
anymore. The less fear that you’re operating out of, the less fear that’s
running through your body and running through your mind. Fear is an energy. The
more confident I am, the less fear that there is.

As you
approach this state of confidence, you’re able to interact with the market
objectively. Objectively means that I do not have
the potential to perceive the up-ticks, down-ticks, patterns, and market
information as threatening. And the only
way that I’m going to define market information in threatening ways is based on
what I believe. If I believe that
I think I know what’s going to happen next, than I have an expectation
of what’s going to happen next. And see, the problem is there isn’t
anything more painful than an unfulfilled expectation. So if the market
fulfills my expectation, I feel great, right?

But if
the market generates information that tells me that my expectations will not be
fulfilled, then any number of things can happen. What normally happens is
our mental defenses start coming into play, meaning we start blocking,
rationalizing, or actually altering that information in a way where
we think there is something else going on than what the
market is actually telling us. And
so now we’re operating in a state of illusion or delusion and therefore
subject to any number of trading errors.

Kwong: Tell me something: One of the things that
you probably encounter all the time is somebody approaches you at a conference
or something and say, “you know Mark, I just bought this great, fantastic
system. And in reading the brochure, that system looks like it will make all my
decisions for me. And I’m willing to follow that system religiously and take all
the buy signals and all the sell signals mechanically. So what do I need with a
trading psychology approach?” What do you tell a person who is thinking that
way?

Douglas: I don’t tell them anything unless they ask me.

Kwong:
Okay–

Douglas: No, I really mean that, Eddie, because there isn’t any point in
telling them anything because they’re going to find out on their own anyway.

Kwong:
And what do you think they’ll find out?

Douglas: I don’t think. I know.

Kwong: What will they find out?

Douglas: Well, let’s put it this way: If they understand how technical
systems interact with the way the market moves, if they understand those
dynamics and they have the kind of personality that can actually execute this
system as the rules were designed to be executed, then they really shouldn’t
have a problem. The only problem they are going to have is if the system doesn’t
generate a positive edge. You know that technical systems only have to be right
even a little less than 40 percent of the time if they have a 3-to-1
reward-to-risk ratio.

But
here’s the problem. Most technical systems — and this is where anybody is going
to have a real problem because most technical systems can give you real good
entry and exit points and define when the trade isn’t working– you know exactly
what your loss is. There are very few technical
systems that have really mastered how to take profits, assuring themselves of
getting a 3-to-1 reward-to-risk ratio.

It is
very difficult to mechanize taking profits. And that’s where they are going to
run into problems. What’s going to happen is that even if they execute their
system perfectly in terms of entry, if they don’t understand how to take
profits, they’re going to invariably end up leaving money on the table. And if
they have any particular emotional problems with the idea of leaving money on
the table, in other words, not realizing that it’s just a function of the
business, they’ll start tweaking the system and they’ll
probably start making trading errors.

Kwong: I’m sure this is exactly the experience many
traders have when they first start out.

Douglas: Right. And Eddie, that was one example, right? Let’s take an
example of someone who doesn’t really understand what’s going on and thinks that
the system is going to tell them what’s going to happen next.
That guy has no chance at all.

Kwong: I like you candour on that.

Douglas: See, the problem is that the system is going to be right a certain
percentage of the time. But there’s a huge gap between
understanding probabilities and actually thinking in probabilities.
People have a normal aversion to taking losses. And if this person is normal and
has a normal aversion to taking losses (has a normal aversion to being wrong),
buys a system because he thinks that the system is going to tell him what’s
going to happen next, and then takes a series of losing trades, well, what’s
going to happen? He’s going to throw the system away.

I’ll
give you an analogy. If I flipped a coin a thousand times, what’s my average
distribution between heads and tails of a thousand flips? It’s going to be
50/50, right? That’s a pattern. But within that pattern, meaning on an
individual flip-by-flip basis, I will have several streaks where I might get
heads eight times in a row or tails six times in a row, right? That’s exactly
the way a technical system works: that over a large sample size of trades, I
will have a system that gives me, say 60% winning trades.

The
problem is on an individual, trade-by-trade basis, there’s a random distribution
between wins and losses. And if I don’t really understand that, if I don’t
really believe it — not just understand it, but believe it, then I will
be susceptible to trading errors.

Kwong:
I see your point very clearly. When people come to you, they ask for help, what
are some of their most common problems?

Douglas:
That’s it right there. What I do is I teach people how to think in probabilities
because it virtually ends all these problems.

Kwong: I presume that most of this is contained in
your new book,

Trading in the Zone.

Douglas: Not everything, but a lot. I can give you four or five points that
would really help.

Basically what Trading in the Zone does is this: I set out to prove to
the trader that more or better market analysis is not the solution to his
trading difficulties or lack of consistent results. I set out to convince a
trader that it’s his attitude and state of mind that
determine his results, to provide the trader with the specific beliefs
and attitudes that are necessary to build a winner’s mind set, which means
learning to think in probabilities so they can eliminate the potential to define
market information in threatening ways and therefore eliminate their potential
to make trading errors.

I also
attempt to address the many conflicts, contradictions and paradoxes in thinking
that cause a typical trader to assume that he already does
think in probabilities when he doesn’t. That’s a big part of it too
because most people understand probability from college or reading a book; they
think that they are already thinking that way. In other words, that they’ve
integrated that strategy at a functional level when they haven’t. And number
five is to take the trader through a process that integrates his thinking
strategy into his mental system at a functional level. That’s what

Trading in the Zone does.

Kwong:
Thank you for your insight, Mark.

Douglas: You’re welcome, Eddie.