This was originally published at The on June 1, 2005 — so this is a 5 year anniversary of sorts.

Feedback appreciated


So far the Apprenticed Investor series has discussed a lot of don’ts. Don’t do this, don’t do that; avoid talking to these kinds of traders; don’t say or think these kinds of things.

Well, it’s time to shift gears, and since trading is an active enterprise, I’ll discuss some things you should do. I plan to expand on these ideas significantly in future episodes.

Taken together, the following 10 rules will not only help you with the philosophical grounding necessary for thoughtful — and successful — investing, they will help you avoid some of the more common mistakes made by investors and traders early in their careers.

This is the “Zen of Trading;” It is more than an overview — it’s an investment philosophy that can help you develop an investing framework of your own.

1. Have a Comprehensive Plan: Whether you are an investor or active trader, you must have a plan. Too many investors have no strategy at all — they merely react to each twitch of the market on the fly. If you fail to plan, goes the saying, then you plan to fail.
Consider how Roger Clemens approaches a game. He studies his opponent, constructs his game plan and goes to work.

Investors should write up a business plan, as if they were asking a Venture Capitalist for start-up money; just because you are the angel investor doesn’t mean you should skip the planning stages.

2. Expect to Be Wrong: We’ve discussed this previously, but it is such a key aspect of successful investing that it bears repeating. You will be wrong, you will be wrong often and, occasionally, you will be spectacularly wrong.
Michael Jordan has a fabulous perspective on the subject: “I’ve missed more than 9,000 shots in my career. I’ve lost almost 300 games. Twenty six times, I’ve been trusted to take the game-winning shot and missed. I’ve failed over and over and over again in my life. And that is why I succeed.”

Jordan was the greatest ball player of all time, and not only because of his superb physical skills: He understood the nature and importance of failure, and placed it appropriately within a larger framework of the game.

The best investors have no ego tied up in a trade. Those who refuse to recognize the simple truism of “being wrong often” end up giving away unacceptable amounts of capital. Stubborn pride and lack of risk management allow egotists to stay in stocks down 30%, 40% or 50% — or worse.

3. Predetermine Stops Before Opening Any Position: Sign a “prenuptial agreement” with every stock you participate in: When it hits some point you have determined before you purchased it, that’s it, you’re out, end of story. Once you have come to understand that you will be frequently wrong, it becomes much easier to use stop-losses and sell targets.
This is true regardless of your methodology: It may be below support or beneath a moving average, or perhaps you prefer a specific percentage amount. Some people use the prior month’s low. But whatever your stop-loss method is, stick to it religiously. Why? The prenup means you are making the exit decision before you are in a trade — while you are still neutral and objective.

4. Follow Discipline Religiously: The greatest rules in the world are worthless if you do not have the personal discipline to see them through. I can recall every single time I broke a trading rule of my own, and it invariably cost me money.
RealMoney’s Chartman, Gary B. Smith, slavishly follows his discipline, and he notes that every time some hedge fund — chock full of Nobel Laureates and Ivy League whiz kids — blows up, the mea culpa is the same: If only we hadn’t overrode the system.

In Jack Schwager’s seminal book Market Wizards, the single most important theme repeated by each of the wizards was the importance of discipline.

5. Keep Your Emotion In Check: Emotion is the enemy of investors, and that’s why you must have a methodology that relies on objective data points, and not gut instinct. The purpose of Rules 1, 2 and 3 is to eliminate the impact of the natural human response to stress — fear and panic — and to avoid the flip side of the coin — greed.
Remember, we, as a species, were never “hard-wired” for the capital markets. Our instinctive “fight or flight response” did not evolve to deal with crossing moving averages or CEOs resigning or restated earnings.

This evolutionary emotional baggage is why we want to sell at the bottom and chase stocks at the top. The money-making trade — buying when there’s blood in the streets, and selling when everyone else is clamoring to buy — goes against every instinct you have. It requires a detached objectivity simply not possible when trading on emotion.

6. Take Responsibility: Many folks believe “the game is fixed.” To them, I say: get over it. Stop whining and take the proper responsibility for your trades, your losses and yourself.
Your knowledge of the game-rigging gives you an edge. So use your hard-won knowledge to make money.

We have a national culture of blame-passing, and it infected investing long ago. Enron did not cause your losses, and neither did stock-touting analysts, or talking heads on CNBC. You did, and the sooner you accept this, the better off you will be.

A Chinese proverb is particularly insightful as applied to trading: “He who blames others has a long way to go on his journey. He who blames himself is halfway there. He who blames no one has arrived.”

7. Constantly Improve: Investing is so competitive that you cannot afford to stand still. Investors should constantly seek to raise their skill level by learning as much as possible about the markets, the economy, trading technologies and various schools of investing thought. But whatever you read, you must do so with a keenly skeptical eye, while retaining an open mind (‘taint easy to do).
One way to constantly improve is to find something for which you have a peculiar natural proclivity for and develop that gift. It may be moving averages, or position sizing, or MACD, or Bollinger Bands or the Arms index. Perhaps you have an expertise in some aspect of technology, or a particular sector.

This is essential because a developed expertise yields ancillary benefits. It bleeds over into everything else, with net positive results. The specific area of expertise you own does not matter as much as having one. Those of you who have been trading for a while will know exactly what I am referring to.

8. Change Is Constant: Heraclitus was a Greek philosopher best known for his “Doctrine of Flux”: “The only constant is change.”
That doctrine is especially true in the markets. Therefore, as you constantly upgrade your skills, you must remain supple enough to adapt to an ever-changing field of play.

Human nature — especially in herds — is unchanging. But these behaviors must be contemplated within their larger context. Add a new element — PCs, lower trading costs, the Internet, vast amounts of cheap data, even CNBC — and you introduce a new factor that impacts all the players on the field.

As conditions change, you must decipher how they impact your strategy, your emotions and your trading — and adjust accordingly.

9. Learn to Short/Hedge Stocks: Short is not a four-letter word. Successful traders learn to play both sides of the fence. That’s less controversial today than it was as the market was first falling apart, but it is no less true.
When a particular strategy isn’t working, the market is telling you something. Thoughtful traders must consider whether there are bigger issues than their own trading mechanics when they enter a losing streak.

In Law School, students learn they have to be ready to argue either side of a case. You never truly knew a case until you could argue both for and against it. Only when you were able to see its warts could you truly appreciate the beauty.

The trading corollary is that you should never own a stock unless you know what makes it an attractive short. Each buy and sell decision should be an argument pro and con.

The market is cyclical; count on a bear market every four years or so. Unless you plan on sitting out for 18 to 24 months once or twice each decade — as much as four years out of 10 — you better learn to either short stocks or hedge long positions.

10. Understand Sector Strength and Market Trend: This rule generates the most “pushback” of any on the list, because it’s so counter-intuitive: Stock selection matters less than you think.
Studies have convincingly demonstrated that about 30% of a stock’s progress is determined by the company itself; a stock’s sector is equal to at least another 30% (if not more). The overall direction of the market is an even bigger factor, counting for some 40%.

If you own the best company in the wrong sector, or buy the greatest stock when the broader market is going the other way — both positions are likely to be losers. But if you see a strong sector, the market trend will help out even the weakest stock in the bunch.

So that’s the 10 rules I call the “Zen of Trading.”

Investing skills are worthless without a broader framework in which to practice them. The above rules will provide you with that frame of reference. They were as true 100 years ago as they will be true 100 years from now. Those who develop a plan and an investment philosophy are on the path to achieving trading success.

Originally published at The
Apprenticed Investor: The Zen of Trading
Barry Ritholtz
06/01/05 – 11:37 AM EDT

Category: Apprenticed Investor

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

21 Responses to “The Zen of Trading”

  1. chicagosean says:

    Barry -

    I wholeheartedly agree that one must trade with a written comprehensive plan (your rule #1). I have used this rule to great effect in the past and recently.

    One area, though, that I could use some guidance in is how to put together a comprehensive plan when you intend to make discretionary trading decisions? The way the market is positioned at the moment, I’m having a hard time putting together “a plan” to capitalize on its wild gyrations. I’m finding that I’m coming across many great trading ideas, but they change weekly, sometimes even daily. I put a plan together, and it is either immediately successful (faster than I expected), or conditions change and I need to immediately shift gears.

    Any thoughts on this would be greatly appreciated.

    -Sean in Chicago.

  2. Sign a “prenuptial agreement”

    That’s an interesting way to put it. Many people say you shouldn’t fall in love with a stock so I guess you should marry for money, not for love :)


    In Law School, students learn they have to be ready to argue either side of a case. You never truly knew a case until you could argue both for and against it.

    Probably why so many people hate lawyers :)


    The trading corollary is that you should never own a stock unless you know what makes it an attractive short. Each buy and sell decision should be an argument pro and con.

    That was one good thing the Yahoo message boards were for in their heydays. As much as I hated the shorts coming on and slamming a stock I always tried to read what they had to say (when they were reasonable in their arguments) because it challenged your subjectivity. Like you have stated, the buyer always falls in love with their purchase. That happens in stock also and that is a deadly trading error. Especially when you get in and information comes to you that changes the picture


    I found that early in my trading when I was looking at stocks based on fundamental valuation that I also became a value shopper. Trading allowed me to respect the value of a dollar. Thus I began buying everything based on what practical value it had and the quality of a product relative to price. I also began to ask myself, “Do I really want to work X amount of hours for this?”

    Learning the value of money taught me the value of money


    I would add know your own temperaments. Once you learn your trading style (what lets you sleep at night) you can build a trading plan around that. Are you a day trader, a short term trader, a long term investor? Do you trade stocks or short them? Do you trade option or futures? bonds or currency?

    I started out in futures but couldn’t handle (or afford) the extreme trading. It did lead me to futures options which then led me to stock options and stocks. That is where I found my comfort zone


    Keep Your Emotion In Check

    I always tell people that if they want to learn about themselves then trade stocks. They will meet the monster of both fear and greed and it will rise from their own heart. I think that is why many people dislike trading because it very much is a well lit mirror that shows all the minor flaws in our character

  3. peterpeter says:

    > Some people use the prior month’s low. But whatever your stop-loss method is, stick to it religiously

    Barry, I’m begging you to please elaborate that you don’t mean stop loss market orders (which I believe is what most retail investors think of when they hear “stop loss”)… and if that is what you did mean, then please rethink.

    Stop loss market orders are the most likely cause of the May 6th meltdown, and any “Zen of Trading” should avoid causing more of them to be placed. They are dangerous not only to the investor, but to the markets at large.

    I think it is interesting that your “Zen of Trading” lacks the word “price” in it. This is the single most important element in trading IMO, and it translates into what I believe should be the cardinal rule of order placement – namely, only trade with limit orders at the prices you are willing to execute your trades (which in turn means never ever setup a stop loss market order).

  4. surferbuoy says:

    “9. Learn to Short/Hedge Stocks: Short is not a four-letter word. ”

    In German, I believe that it is.

  5. Sanjay Bigglesworth says:

    Barry – in point #10, you mention the 30/30/40 split with equity performance. I was wondering if you could cite the research for this comment. It would be an interesting read. Thanks.

  6. aquaterra says:

    Barry, This is one of your best artciles and it should be put on the blog as a sticky so that most readers could have access to it. The nature of the blog is that old article are replaced by new articles. I do appreciate the time and effort you have put into the website and I should rate it among the top for both its content and variety.

  7. lalaland says:

    Bernanke deflates
    turkeys puff in the roses
    Maxine on her way!

  8. Chris says:


    Unfortunately there is no way around stop loss market orders. It is not the task of an investor beginners guide to set up the reader for complete losses just to prevent a market meltdown (that’s what we have analysts and politicans for). If you have no stop loss market order the next black swan will kill your depot.

    So that leaves thge question how to be profitable. If you stop losten to the propaganda of the analysts (trend following blah) the answer is simple. Have cash 99% of the time and wait for the crash to buy. At least that’s been my trading strategy for intraday trading (I am sure it also works on a longer time-scale). The hard part of this strategy is not buying into a crash, you can prepare mentally for that. The hard part is not to buy when everybody else is. Boredom is the enemy, discipline the friend.

  9. Chris says:

    Edit: I guess it is more clear to write: “The easy part is buying into a crash, you can prepare mentally for that.”

  10. Chris says:

    Another note: I consider “learning the value of money as counterproductive”. I find it more useful to think of my trading money as completely virtuell. You must be able to shrug off a loss of $5000 in 10 minutes, and then go out and save $1 on your grocery shoppings. This is in my opinion absolutely fundamental to get out of losing positions quickly.

  11. [...] Barry Ritholtz goes back to find a “zen philosophy of trading.”  (Big Picture) [...]

  12. TheUnrepentantGunner says:

    my only complaint about the article is you reference Roger Clemens as having a plan.

    In light of the Mitchell report, it’s clear that he obviously studied and did all the right things, but he would also be the trading equivalent of “make sure you get some juicy insider information as well”

    or in his case “make sure you have some juice you can have a teammate inject into you”

  13. I’m assuming that the “Zen” aspect in this post is similar to your idea that “the crowd is right most of the time.” In this regard, your philosophy might be considered a balance of passive and active, which may be considered partially “Zen.”

    My idea of Zen, with regard to investing, is that it is almost completely passive, which would connote heavy index and ETF sector funds, as well as a long-term, patient approach.

    “Slow down and the thing you are chasing will come around and catch you.” ~ Zen saying

    “Those who have knowledge, don’t predict. Those who predict, don’t have knowledge.” ~ Lao Tzu

  14. @Chris

    So that leaves thge question how to be profitable. If you stop losten to the propaganda of the analysts (trend following blah) the answer is simple. Have cash 99% of the time and wait for the crash to buy.

    My vanilla stock strategy is to buy your stock based on low debt but more importantly sustainable yield. If you buy for the cash flow of the dividend and you set it up to drip then when the market goes down you will be buying more shares.

    Another reason this strategy works is because higher yield stocks tend to draw in value buyers in the time of crisis and thus are better supported.

    If you check out INTC during the panic in the fall of 2008 you’ll see that once INTC got to a certain level its yield made it a screaming buy (I think the yield peaked out at 5% at the time)

  15. engineerd1 says:

    to the chicagoean:

    If your plans are blowing up before you can execute them you need to develop plans with a longer time horizon. I wouldn’t have a clue how to profit on the market tomorrow….But I have a clear idea of what I will do over the next 3 months, and what the triggers will be.

  16. chomen says:

    It’s wrong to use the term “Zen” when clearly you’ve never practiced Zen Buddhist sitting meditation. First, sit — then you can talk about Zen, not false Zen.

  17. Sanjay Bigglesworth says:

    “Consider how Roger Clemens approaches a game. He studies his opponent, constructs his game plan and goes to work.”

    You may want to update that one.

  18. lalaland says:

    @chomen – you’d get smacked with a stick if you said that out loud in certain places….

  19. jmay says:

    Just to be clear, Michael Jordon “said” that in a commercial, but it was most certainly written for him by a clever copywriter.

  20. Bokolis says:

    Most of us are, as you’ve put it, picking up nickels in front of a steamroller. The whole piece funnels into reconciling what it states on number 6. It’s savage, but I wonder if the prevailing sentiment was something akin to, yeah, yeah, yeah.

    Refereeing basketball games is highly subjective. That ad was some canned BS. Jordan was as great as he was because it became a crime to touch him and Pippen started getting all the calls Jordan was getting (those two would get further without putting the ball on the ground than some running backs)…sounds like Goldman rules to me. Jordan was a hell of a preparer, but played his sickest ball before he ever won a title (that commercial of his older self playing his young self should have more accurately had a referee giving the older Jordan all the calls) and it is his coach who is called the zen master. Hell, if they went the other way and legalized left hooks to the ribs (my preferred form of insider trading), even Bokolis could take out MJ (if the Pistons didn’t beat me to it).

    You were closer on Clemens. Clemens was another master preparer, with a just.didn’t.give.a.fcuk attitude on the mound (5?) and knew, by how the batter would set up and what kind of swings he was taking, what the batter could do against him (#10?) and adjusted accordingly (#8?). That really only applies to his post-steroids renaissance (he was merely an exceptional gunslinging cowboy before that), but we can discount the steroids because most of them were doing it.

  21. [...] Barry Ritholtz goes back to find a “zen philosophy of trading.”  (Big Picture) [...]