People often ask me what I mean by “trading defensively“. That is a very simple question with a huge base of answers of which some are really common sense stuff that we do in our every day lives. So starting this weekend, I will be delivering a series of five lessons on what I do as a Defensive Trader and why I choose to trade this way.
DEFENSIVE TRADING – LESSON 1
When I first started trading, I had picked up all the wrong things that I thought trading was about. A fair amount of stuff were from books and gurus. And almost all the things I picked up were based on the American Trader’s way of doing things – gung ho. They were all attacked minded stuff meant to hype you up and drive you into the market head-first and with guns blazing. Maybe it was the way they taught, maybe it was the way I perceived it or maybe it was true. Whatever it was, one thing was certain – it wasn’t working for me.
To cut a long story short, I looked east instead to find another way of doing this. And I found Japan. I had no idea at that time how deeply steeped Japan was in the culture of trading. And to cut that long story short, it came down to one man who made all the difference in the way I trade today. His name is Homma Munehisa.
Homma Munehisa (Honma Munehisa, 1724-1803) was a rice trader around 260 years ago in Sakata, Japan during the Tokugawa Shogunate (Tokugawa jidai) in the Edo Era (Edo jidai). He traded at the Ojima Rice market in Osaka and is widely accepted as the father of the candlestick charting analysis. He was a legendary trader with many accolades to his name including being honored as an Honorary Samurai for his trading prowess and for his contributions to the advancement of the art of trading.
In 1755, he wrote San-en Kinsen Hiroku, The Fountain of Gold – The Three Monkey Record of Money. This is one of the earliest books in history that discusses Trading Psychology as an important aspect of market behavior. He mentioned that a Trader’s Psychology is critical to trading success and that the Traders’ emotions have a significant influence on price movements.
Munehisa was also arguably the first to give us the two types of markets; Yang (a bull market), and Yin (a bear market).
It wasn’t Warren Buffet who first said,
Be fearful when others are greedy.
And greedy when others are fearful.
It was Munehisa who first gave us,
When all are bearish, there is cause for prices to rise.
When all are bullish, there is cause for prices to fall.
I am sure you have heard about Buying The Rumor & Selling The News. Munehisa wrote that if you get news about something that could make a profit for you, wait three days and if it still looks good, it should be a profitable trade. This was based on the extensive Sakata Method discussion from his second book, Sakata Senjyutsu Syokai – A Full Commentary on the Sakata Strategy. A lot of this methodology employs the number Three as its basis; Three Crows (Bearish Reversal), Three Soldiers (Bullish Reversal), Three Methods (Continuation), Three Buddhas (Head & Shoulders), Three Mountains (Triple Top), Three Rivers (Triple Bottom) and Three Gaps.
A lot of what we read today have their roots in the books that Munehisa wrote.
In his third book, Homma Sokyu Soba Zanmai Den, written as Honma Sokyu – Tales of a Life Immersed in the Market, Munehisa shares his methods and techniques that made him a legend. His conservative manner and the defensive attitude he took into the market made him the finest trader to have walked the earth. His humility and the respect he gave the market made him one of the most profitable traders of all time.
But the beauty in the way he wrote it all was lost in translation when the west got hold of his philosophies and turned it into something more aggressive and offensive. And it was this rubbish that was taught to me and this nonsense that I was reading off books.
Having discovered this 250 year old approach to trading has made all the difference in the way I trade, teach and live.
I found that the Japanese way of trading suited me better as an Asian who is conservative and defensive by nature, by upbringing and by education. It was easier to grasp the concepts and methods as they were more natural to me rather than the gung-ho style that had been forced down my throat. The Japanese style of trading employs Three Choices rather than the do-or-die choices that the west teaches.
In the west, we learn,
Buy Low, Sell High
That is pretty much a do-or-die choice without any room for much else. Munehisa advocates that you should;
Never Buy The High.
And Never Sell The Low.
That allows you two out of three choices;
Never Buy The High tells you that you can sell if the price is at a high or you can hold if the price is high but you should never buy because the price is high. This gives your psychology a chance to choose and greatly reduces your risk of doing the wrong thing. And the wrong thing is buying things when the price is high – don’t we always look for discounts when we shop?
Never Sell The Low tells you that you can buy if the price is at a low or you can hold if the price is low but you should never sell or short-sell because the price is already at a low. The wrong thing to do is to sell when the price is low – don’t we always look for the highest bidder when we sell? (think property.)
That was just the tip of the Defensive iceberg.
In the next four lessons, I will share more defensive ways to go about your business and help you to stop losing money to the market as a result of doing stupid things that are not natural. Many of your beliefs and dependencies are going to go up in smoke or blow up in your face when you realize the simplicity, efficiency and beauty of the Japanese Defensive Methodology that I employ today.
Till next week, have a good weekend and Happy Hunting Always.