Trading in the Zone: Master the Market with Confidence, Discipline, and a Winning Attitude

by Mark Douglas

When we look at the market from this perspective, it’s easy to see that every potential trader who is willing to express his belief about the future becomes a market variable.

The point is that from our own individual perspective as observers of the market, anything can happen, and it takes only one trader to do it.

This is the hard, cold reality of trading that only the very best traders have embraced and accepted with no internal conflict.

only the best traders consistently predefine their risks before entering a trade. Only the best traders cut their losses without reservation or hesitation when the market tells them the trade isn’t working. And only the best traders have an organized, systematic, money-management regi...

Not predefining your risk, not cutting your losses, or not systematically taking profits are three of the most common—and usually the mo...

Remember that there are only two forces that cause prices to move: traders who believe the markets are going up, and traders who believe the markets are going down. At any given moment, we can see who has the stronger conviction by observing where the market is now relative to where it was at some previous moment. If a recognizable pattern is present, that pattern may repeat itself, giving us an indication of where the market is headed. This is our edge, something we know.

the best traders take these variables into account, factoring them into every component of their trading regimes.

What the typical trader doesn’t realize is that he needs an inner mechanism, in the form of some powerful beliefs, that virtually compels him to perceive the market from a perspective that is always expanding with greater and greater degrees of clarity, and also compels him always act appropriately, given the psychological conditions and the nature of price movement. The most effective and functional trading belief that he can acquire is “anything can happen.” Aside from the fact that it is the truth, it will act as a solid foundation for building every other belief and attitude that he needs to be a successful trader.

Most important, by establishing a belief that anything can happen, he will be training his mind to think in probabilities.

Exactly what does it mean to think in probabilities, and why is it so essential to one’s consistent success as a trader?

Gaming corporations are just like other corporations, in that they have to justify how they allocate their assets to a board of directors and ultimately to their stockholders. How do you suppose they justify spending vast sums of money on elaborate hotels and casinos, whose primary function is to generate revenue from an event that has a purely random outcome?

PARADOX: RANDOM OUTCOME, CONSISTENT RESULTS

Here’s an interesting paradox. Casinos make consistent profits day after day and year after year, facilitating an event...

At the same time, most traders believe that the outcome of the market’s behavior is not random, yet can’t see...

What casino owners, experienced gamblers, and the best traders understand that the typical trader finds difficult to grasp is: Events that have probable outcomes can produce consistent results, if you can get the odds in your favor and there is a large enough sample size. The best traders treat trading like a numbers game, similar to the way in which casinos and professional gamblers approach gambling.

To illustrate, let’s look at the game of blackjack. In blackjack, the casinos have approximately a 4.5-percent edge over the player, based on the rules they require players to adhere to. This means that, over a large enough sample size (number of hands played), the casino will generate net profits of four and a half cents on every dollar wagered on the game. This average of four and a half cents takes into account all the players who walked away big winners (including all winning streaks), all the players who walked away big losers, and everybody in between. At the end of the day, week, month, or year, the casino always ends up with approximately 4.5 percent of the total amount wagered.

That 4.5 percent might not sound like a lot, but let’s put it in perspective. Suppose a total of $100 million dollars is wagered collectively at all of a casino’s blackjack tables over the ...

What casino owners and professional gamblers understand about the nature of probabilities is that each individual hand played is statistically independent of every other hand. This means that each individual hand is a unique event, where the outcome is random relative to the last hand played or the next hand played. If you focus on each hand individually, there will be a random, unpredictable distribution between winning and losing hands. But on a collective basis, just the opposite is true. If a large...

Here’s what makes thinking in probabilities so difficult. It requires two layers of beliefs that on the surface seem to contradict each other. We...

The second layer is the macro level. At this level, you have to believe that the outcome over a series of hands played is relatively certain and predictable. The degree of certainty is based on the fixed or constant variables that are known in advance and specifically designed to give an advantage (edge) to one side or the other. The constant variables I am referring to are the rules of the game. So, even though you don’t or couldn’t know in advance (unless you are psychic) the sequence of wins to losses, you can be relatively certain that if enough hands are played, whoever has the edge will end up with more wins than losses.

The degree of certainty is a function of how good the edge is.

It’s the ability to believe in the unpredictability of the game at the micro level and simultaneously believe in the predictability of the game at the macro level that makes the casino and the professi...

Their belief in the uniqueness of each hand prevents them from engaging in the pointless endeavor of trying to predict the outcome of each individual hand. They have learned and completely accepted the fact that they don’t know what’s going to happen next. More i...

Because they don’t have to know what’s going to happen next, they don’t place any special significance, emotional or otherwise, on each individual hand, spin of the wheel, or roll of the dice. In other words, they’re not encumbered by unrealistic expectations about what is going to happen, nor are their egos involved in a way that makes them have to be right. As a result, it’s easier to stay focused on keeping the odds in their favor and executing flawlessly, which in turn makes them less susceptible to making costly mistakes. They stay relaxed because they are committed and willing to let the probabilities (t...

First, the trader, the gambler, and the casino are all dealing with both known and unknown variables that affect the outcome of each trade or gambling event.

Market analysis finds behavior patterns in the collective actions of everyone participating in a market.

The set of criteria and the boundaries identified are the trader’s known market variables. They are to the individual trader what the rules of the game are to the casino and gambler.

Trading also involves a number of unknown variables that act on the outcome of any particular behavior pattern a trader may identify and use as his edge.

In trading, the unknown variables are all other traders who have the potential to come into the market to put on or take off a trade. Each trade contributes to the market’s position at any given moment, which means that each trader, acting on a belief about what is high and what is low, contributes to the collective behavior pattern that is displayed at that moment.

The fact is, the outcome of every (legal) trade that anyone decides to make is affected in some way by the subsequent behavior of other traders participating in that market, making the outcome of all trades uncertain.

Since all trades have an uncertain outcome, then like gambling, each trade has to be statistically independent of the next trade, the last trade, or any trades in the future, even though the trader may use the same set of known variables to identify his edge for each trade.

Furthermore, if the outcome of each individual trade is statistically independent of every other trade, there must also be a random distribution between wins and losses in any given string or set of trades, even though the odds of s...

Casino operators have learned that all they have to do is keep the odds in their favor and have a large enough sample size of events so that their edges have ample opportunity to work.

TRADING IN THE MOMENT

Traders who have learned to think in probabilities approach the markets from virtually the same perspective. At the micro level, they bel...

For any particular pattern to be exactly the same now as it was in some previous moment would require that every trader who participated in that previous moment be present.

It is extremely important that you understand this phenomenon because the psychological implications for your trading couldn’t be more important.

It takes only one trader, somewhere in the world, with a different belief about the future to change the outcome of any particular market pattern and negate the edge that pattern represents.

The most fundamental characteristic of the market’s behavior is that each “now moment” market situation, each “now moment” behavior pattern, and each “now moment” edge is always a unique occurrence with its own outcome, independent of all others. Uniqueness implies that anything can happen, either what we know (expect or anticipate), or what we don’t know (or can’t know, unless we had extraordinary perceptual abilities). A constant flow of both known and unknown variables creates a probabilistic environment where we don’t know for certain what will happen next.

This means that unless we train our minds to perceive the uniqueness of each moment, that uniqueness will automatically be filtered out of our perception. We will perceive only what we know, minus any information that is blocked by our fears; everything else will remain invisible.

When you’ve trained your mind to think in probabilities, it means you have fully accepted all the possibilities (with no internal resistance or conflict) and you always do something to take the unknown forces into account.

In fact, the degree by which you think you know, assume you know, or in any way need to know what is going to happen next, is equal to the degree to which you will fail as a trader.

Traders who have learned to think in probabilities are confident of their overall success, because they commit themselves to taking every trade that conforms to their definition of an edge.

They don’t attempt to pick and choose the edges they think, assume, or believe are going to work and act on those; nor do they avoid the edges that for whatever reason they think, assume, or believe aren’t going to work. If they did either of those things, they would be contradicting their belief that the “now” moment situation is always un...

When you achieve complete acceptance of the uncertainty of each edge and the uniqueness of each moment, your frustration with trading will end.

In light of the fact that anything can happen, wouldn’t it make perfect sense to decide before executing a trade what the market has to look, sound, or feel like to tell you your edge isn’t working? So why doesn’t the typical trader decide to do it or do it every single time?

For the traders who have learned to think in probabilities, there is no dilemma. Predefining the risk doesn’t pose a problem for these traders because they don’t trade from a right or wrong perspective. They have learned that trading doesn’t have anything to do with being right or wrong on any individual trade. As a result, they don’t perceive the risks of trading in the same way the typical trader does.

Any of the best traders (the probability thinkers) could have just as much negative energy surrounding what it means to be wrong as the typical trader. But as long as they legitimately define trading as a probability game, their emotional responses to the outcome of any particular trade are equivalent to how the typical trader would feel about flipping a coin, calling heads, and seeing the coin come up tails. A wrong call, but for most people being wrong about predicting the flip of a coin would not tap them into the accumulated pain of every other time in their lives they had been wrong.

If you believe the outcome is random, then you naturally expect a random outcome. Randomness implies at least some degree of uncertainty. So when we believe in a random outcome, there is an implied acceptance that we don’t know what that outcome will be. When we accept in advance of an event that we don’t know how it will turn out, that acceptance has the effect of keeping our expectations neutral and open-ended.

Any expectation about the market’s behavior that is specific, well-defined, or rigid—instead of being neutral and open-ended-is unrealistic and potentially damaging.