Preserving Your Psychological Capital

This guide is rich in advice for the intangible influences on trading success.
Author:
Publish date:

R.E. McMaster, The Art of the Trade: Mastering the Analytic and Intuitive Elements of Successful Trading, McGraw-Hill, 1999, 201 pages, $34.95

Another trading book? Yuk, you may think, having sampled at least some of the trading-book deluge pumped out by the American publishing industry in the last 12 months. But unlike so many of these that pander to the desire to become rich through trading, R.E. McMaster's

The Art of the Trade

is time and money well spent.

McMaster is editor and publisher of

The Reaper

, a respected bimonthly investment newsletter begun in 1978. It covers the international spectrum of trading -- everything from stocks, bonds and currencies to energy, grains, meats and others. It also describes fundamental conditions that affect all of these markets, including psychology.

The book's main thesis is that while market opportunities are unlimited, a trader's time, energy, financial and above all, psychological capital are very limited. In 10 chapters, McMaster tells about the similarities and differences between trading and gambling -- the biggest difference being very different kinds of risk -- managing risk with money management; treating trading as a business; the methodology, consistency, mentality and emotions of trades; self mastery; and in the last chapter, McMaster puts it all together. His explanations are clear and easy to follow.

How and how not to pyramid is a good example this book's value. While most traders pyramid shares or contracts -- meaning they increase their position in a winning trade before the trade is completed -- McMaster argues that traders should increase the equity at risk in subsequent trades instead. There's a good reason why: "If the market has already moved in your favor, the odds are greater that the market will move against you -- at the same time you are betting on the market continuing its current trend. A small correction can wipe out your hard-earned profits."

It is better, says McMaster, to take the winnings from one trade, and increase the equity at risk in the next trade by using 50% of the cumulative winnings, so as "to be more aggressive without violating your money management system."

McMaster advises traders to plot trading tactics the night before a trading session so that they can sleep on it to "allow your right-brain intuition to identify signals that your left-brain logical analysis might have missed." This is extraordinarily sound. Why? Because, he advises, "it reduces the fear, the greed and the uncertainty that can cause traders to stumble and burn up their psychological and financial capital."

While offering advice about preserving psychological capital, McMaster presents several of his own poems as inspiration. Those weaned on

John Keats

and raised on

T.S. Eliot

will be horrified: These poems are prime examples of bad doggerel. But don't dismiss them out of hand, because it's not their form but their content that counts.

Note also that McMaster is a devout Christian. While the reader is never importuned, the very brief parallels he draws between religion and trading are apt. Like the religious, traders "walk by faith, not by sight." They have to believe that the market always tells the truth and that even though they can't always see this truth, being faithful to sound principles lets them pursue it successfully.

Overall,

The Art of the Trade

is well worth reading carefully. It will go a long way in helping traders preserve their psychological capital -- which R.E McMaster argues convincingly is

the

key to successful trading.

We'd like to hear what you think. Which kind of book reviews would you like to see more of on TheStreet.com?

I want to learn more about trading -- stick to the how-to books, please.

I want to understand more about the effects that economics and politics have on my investments. More big-picture books, please.

By Friday, I've heard enough about trading. On the weekend, I'd rather hear about good history, biography, mysteries or thrillers.

I like all of the above -- keep the variety coming.

Here's a sampling of some books just out. Which ones would you like us to review?

Patterns in the Dark,

by Edgar Peters -- understanding investing risk and financial crisis using complexity theory by the chief strategist of PanAgora Asset Management.

Devil Take the Hindmost,

by Edward Chancellor -- a history of financial speculation.

A Traitor to His Class,

by Hilary Rosenberg -- a biography of Robert Monks, founder of Institutional Shareholder Services and America's most successful corporate activist.

Defying the Market,

by Stephen & Donna Leeb -- profiting in what Leeb thinks is the turbulent post-technology boom.

Building Wealth,

by Lester Thurow -- the noted MIT economist shares the new rules for individuals, companies and nations in a knowledge-based economy.

Desmond MacRae is a New York-based freelance journalist specializing in banking, finance and investments. He is a regular contributor to Managed Account Reports, Global Investment and Plan Sponsor, and can be reached at

desmondmacrae@worldnet.att.net. TheStreet.com has a revenue--sharing relationship with Amazon.com under which it receives a portion of the revenue from Amazon purchases by customers directed there from TheStreet.com.