Alpha Trader is an incredible book for discretionary traders, utterly packed with insights, with a strong emphasis on the mindset aspect of trading. A huge portion of this game is building processes that prevent our worst system-one instincts from running amok. Donnelly puts it thus:

Every trader is a steaming hot bowl of bias stew and must maintain self-awareness and lucidity behind the screens as the trading day oscillates between boredom and terror.

He investigates, with reference both to his personal experiences and a study of the cognitive science literature, which psychological traits are most likely to lead to trading success – conscientiousness and rationality come out on top. The discussion of cognitive biases was surprisingly insightful. I say “surprisingly” because the topic comes up so often that I wasn’t expecting to learn many new things, but Donnelly expertly contextualises the cognitive biases, highlighting flavours of them that are specifically related to trading, For example, he describes the “chasing bias” (which I have noticed in myself) – the tendency for people to want to put on trades in the direction of the market (e.g. buy when it’s going up), which is sort of a combination of recency bias, system one FOMO, etc.

The second half of the book shifts the spotlight towards methodology (while still reiterating the importance of mindset). Donnelly explains how he thinks about narrative, sentiment, and portfolio management. The discussion is very pragmatic, taking into account not just individual human biases but organisational constraints. For example, Donnelly espouses the Mike Platt view (see his Hedge Fund Market Wizards interview) that trader profits should be structured like a call option, meaning that you increase your bet sizes as you make more PnL. There are many other valuable ideas here, so valuable in fact that I don’t feel it is appropriate to discuss them further here.

All said, I place this book in a similar category to Trader Construction Kit – ”required reading” for anyone on a trading desk – though Alpha Trader is slightly more focused on trading mindset and philosophy as opposed to TCK’s emphasis on the nuts-and-bolts practicalities, which though necessary, are sometimes dry. Alpha Trader is an unequivocal must-read for any aspiring discretionary trader.

Key ideas

These highlights are a very small fraction of the insights in the book!

• Important trader mistakes:
  • Overtrading: default position should be doing nothing
  • Confirmation bias: must actively consider alternate hypotheses and risks. Use premortems
  • Favourite vs longshot bias: humans overestimate the odds of low probability events and overbet positive skew payoffs
  • Round number bias: highs/lows are concentrated at round numbers so you should set limit orders accordingly.
  • Apophenia: we see patterns when none exist. Need scepticism and backtests to avoid.
  • Chasing bias: we want to enter trades in the direction of the market.
  • Grizzly bias: bias to be bearish/pessimistic.
• Anchoring:
  • We anchor on entry points. Need to learn to love small losses
  • We anchor on highs and lows
  • We anchor on PnL numbers: “If I can just get back to breakeven”
  • We anchor on prior economic data. This means that if economists forecast a miss, you should extremise the forecast.
• Market microstructure:
  • Types of participants: retail, corporates, real money, speculators, central banks
  • Liquidity: tx costs, gap risks
  • Intraday activity: volume profile
  • Volatility: daily vol profile, how it has evolved over time
• Technical analysis:
  • TA should be used for risk management and entry/exit timing, rather than for alpha forecasts.
  • Support and resistance reflect resting orders
  • Wedges: keep an eye out for narrowing of the wedge for countertrend views. Wait for a price close below the wedge then short with a stop loss above the wedge.
  • Doji: open and close price of candle is the same, so it looks like a + sign. This is a sign that trend is exhausted (daily or hourly timescale)
• Default mode network: where does your mind wander to by default – does it bias towards wanting to add/cut to a position?

Highlights

• Behavioural characteristics of alpha traders
• Self-improvement
• Cognitive biases
• Risk-taking and discipline
• Microstructure
• Narrative
• Sentiment and technical analysis
• Portfolio management
• Markets tidbits
• Trade idea generation
• Planning and journalling
• Reading recommendations