(Originally Appeared in Equities Magazine)

Bernie Madoff went from being a relatively unknown name with the public to a highly recognized one in just a matter of months. And, of course, for all the wrong reasons.

But, what most people don’t understand about Madoff is that he made a great deal of his wealth not through his investments, but through his market maker firm. Avid traders knew his company as MADF on their Level II screens.

If you’re not familiar with market makers or their roles, these companies are registered to act as dealers in a stock. They buy, sell, and accumulate shares in a stock on behalf of their clients or for their own accounts. They fill both market and limit orders, and provide much-needed liquidity to maintain at least some level of stability in the stocks they feature.

So, how did Madoff’s firm – as well as other market makers – make so much money?

They do so in four basic ways. Market makers capture the spread between the bid and the ask price on orders, receive commissions from large institutional clients (such as mutual funds), get order flow from brokers, and trade for their own accounts. (Madoff was instrumental in developing the order flow aspect, in which market makers would pay brokers, such as E*Trade or Schwab, to funnel customer orders to them.)

All of this adds up – to a fortune – due to the sheer amount of trades processed each day. And, with the wild volatility and big movements we’ve seen over the past year or so, market makers are really making money.

It’s fascinating to watch market makers at work. You need a Level II screen to do this, and unless you know what to look for, most of the action will escape you. But, if you have a deep understanding of what’s going on, you’ll marvel at how adept market makers are at their craft, as well as how many tricks they employ on unsuspecting market participants to create even more profits for their firms.

While you may never be a market maker like Madoff or accumulate the amount of money he once had, you can see how a market maker operates by watching me in action it my classes. Trust me: It will be an eye-opener.

Bernie Madoff. Goldman Sachs.
Those two names don’t seem like they’d have a lot in common, do they?
Madoff is a despised figure, while Goldman Sachs is a revered firm on Wall Street. Madoff just received a 150-year jail sentence, while Goldman just recorded the biggest quarterly profit in its history as a public company.
So, what do they have in common, and what can you learn from them?
Most people don’t realize this, but Madoff made a large chunk of his money over the years not through his investments but by his market making activities. For those unfamiliar with market makers, these firms maintain a market in a particular stock by buying and selling shares in it, and filling orders accordingly. Madoff’s firm was known to traders under the symbol MADF.
So, Madoff accumulated much of his fortune through trading-related activities. Meanwhile, Goldman Sachs operates in a similar manner.
You might assume that a firm that won’t even considering taking you on as a client unless you have at least $5 million to invest would make most of its money through its investments.
But, you’d be wrong.
Roughly 70% of Goldman’s revenues comes from trading-related activities; namely, through its role as a market maker and through its trading desk.
The takeaway here is that there’s far more money to be made by trading, not investing. Why else would Maddoff and Goldman be so heavily involved with trading? This is particularly true during chaotic, tumultuous times like those that we’ve experienced over the past few years.
As a trader today, you have far more advanced tools at your disposal than you did years ago. The opportunities are there for you. It’s up to you to use them as wisely as possible, and get the most profits out of your trading.
Granted, successful trading isn’t easy. But, I can teach you how to do so.
As Maddoff and Goldman Sachs showed, there’s a ton of money to be made through trading. So, why not grab your little slice of the pie?

This post originally appeared on Equities Magazine's Blog Does this sound like you? You buy 1000 shares of a stock at $20. It promptly drops to $18. You’re now sitting on a paper loss of $2000. And, you’re not happy. But, you’re sitting on a lot of cash. You figure if you just buy another 1000 shares at $18, the stock only needs to rebound to $19 and you’ve erased your loss. That’s only a single point. Even better, if the stock merely goes back to $20 – your initial buying spot – you’ll be up $2000. And then if it climbs like you anticipated it would in the first place, you can have a healthy gain. Seems like a sound plan, right? Wrong. Completely wrong. If what I just described seems like something you would do, please follow what I’m about to tell you: Stop doing it. Why? It’s a dangerous game. Sure, sometimes this strategy works just fine. Too many other times, though, it doesn’t. And, that capital you worked so hard to build can quickly evaporate.

Follow up:

Now, I can’t blame you for falling into this mental trap. It’s human nature to delay or avoid pain for as long as possible. And, taking a loss – even a minor one like this – can be painful. But, honestly, if you’re not emotionally and mentally ready to accept losses on a regular basis, you’re not meant to be a trader. To make matters worse, some financial pundits and stockbrokers favor this exact sort of an approach. Hey, they say, if you liked the stock at $20, you gotta love it at $18, right? Wrong again. To begin, these groups are often selling this pitch to value investors who have long time horizons. But, you’re not an investor. You’re a trader with a short timeframe. You shouldn’t be listening to anything that has to do with investing. Beyond that, these sorts of moves are dangerous even for investors, as they face the same risk as traders in terms of endangering their capital. Let’s look at Citigroup. A year ago, the stock was around $50. Now, it’s less than a tenth of that. How many investors gladly bought all the way down, thinking they were getting a great buy? As a trader, how do you know that the stock mentioned in my hypothetical example won’t fall to $16? Or $14? Or $10? Will you keep averaging down all the way? If not, when will you get out? And, by then, how much of a hit will your portfolio have taken? As I teach in my classes, you must learn to be comfortable taking small losses. And, you must stick to your game plan, and not try to create plans on the fly. Actually, all of this relates to the most important characteristic of successful traders: discipline. As I’ve said time after time, you can have the best trading methodology, instincts, and equipment, but if you don’t follow your rules and maintain your discipline, you’ll get washed out of the market. It’s not a question of if, but when. So, the next time you’re in a situation like this and that inner voice tells you to stick with the stock and average down, just ignore it. Instead, take your loss, move on, and stay in the game.

Whenever I’m with a group of new day traders, it isn’t long before the conversation turns to trading vehicles – the mixture of computer hardware and software used to trade.  And just like tastes in motor vehicles, there is a wide variety of tastes in trading vehicles.

Some traders opt for the “luxury model” trading system.  They must have all of the latest and greatest gizmos and gadgets.  They outfit their systems with several monitors and all of the software bells and whistles you can imagine.  In fact, if you didn’t know better, you’d think these people were single-handedly landing the Space Shuttle. To the other extreme, you find the trader who insists on buying the “economy class” system.  They equip themselves with the bare minimum – a low-end computer, an acceptable internet connection and the least expensively priced trading tools.  They figure that it doesn’t matter how you look when you roll onto Easy Street, just so long as you get there.

Of course, in day trading, as in life, the best course of action is somewhere in the middle.  However, if you must veer towards any extreme, I urge you to steer clear of trying to enter into financial race in an economy vehicle.  After all, would you attempt to win the Indianapolis 500 driving a 1973 Ford Pinto?  Of course not.  Well, the same principle applies in the market.  The few dollars you save will pale in comparison to the fortune you squander by settling for inferior functionality.  At a minimum, your trading vehicle must have the following features:

A Top of the Line Computer By “top of the line”, I mean that your computer should have an excess of CPU speed and RAM.  If your computer is just powerful enough to run your trading software, then it’s performance is going to be sluggish.  And trust me, there is nothing more frustrating (or expensive) as being locked out of money-making opportunities because your computer has frozen up.

High Speed Internet Access This really should go without saying.  If you try to travel the information superhighway via dial up, you’re going to find yourself being run into a ditch.  This is particularly true in the market where millions of shares trade hands every second.  You must invest in the fastest (and most reliable) Internet connection available to you.

Level II Access Just as your access to the Internet must be timely, your access to current market information must be timely as well.  And while stock market information abounds on the Internet, it isn’t always timely.  For example, stock quotes posted on a web portal may be delayed by as much as 20 minutes.  Trying to day trade by relying on outdated information is like trying to drive a car by looking solely through the rear view mirror, it’s a recipe for disaster.

Of course, even having current information isn’t enough if the information isn’t also complete.  And by complete, I mean that the information must go beyond just the Level I information, such as the last bid and ask.  You want to be able to see how the market makers are positioning themselves with respect to the stock.  You need Level II information.

And don’t fall into the trap of trying to save a few bucks by getting “Level 1 ¾” access.  Some providers have begun selling access that lets you see the ECNs, but not the market makers.  Remember, you want to be able to play follow the leader and not follow the follower.  You need to know what the real experts are doing in the market, not the Ordinary Joes like you and me.

Bells and Whistles Ideally, your Level II execution system should be linked to your charting tools.  You don’t want to spend valuable time searching for current stock charts.  You want to be able to type in the symbol and have your charts pop up.  Also, you should be able to customize which charts are displayed.  I like to be able to see the 1-minute chart, intraday chart and 1-year chart at a glance.  You also want to have immediate access to the top gainers and losers of the day to alert you to lucrative trading opportunities.  When looking at these lists, I like to set my system to sort them by percentages and not just overall dollar amounts.

Of course, you should be careful to avoid cluttering your screen with too much information.  You don’t want to miss a good trading opportunity because the pertinent information was hidden behind a useless chart or graph on the screen.

Double Vision One solution to the problem of hidden information is to invest in a computer capable of displaying on two monitors at once.  That way, you can see twice as much information as you could view on one screen.  Of course, you don’t want to take this idea to the extreme.  Ten monitors won’t allow you to view ten times as much information.  From my experience, I’ve found that two screens are probably all you can watch at one time anyway.  If you try to watch any more than two, you usually end up not watch any.

That being said, you don’t want to scrimp on your trading vehicle.  That’s simply being penny wise and fortune foolish.  In fact, if the price of a solid trading system is a problem for you, then you’re probably like the person in the Mercedes dealership asking about the car’s gas mileage.  If you can’t afford the gas, then you certainly can’t afford the car.  Likewise, if you can’t afford an adequate trading platform, then you’re probably trying to perform on the wrong stage.

Fausto Pugliese. President and Founder of Cyber Trading University.

In a very familiar old joke, one gentleman asks another, “How do you get to Carnegie Hall?”  The second gentleman responds, “Practice.”  I believe the same advice applies to the person who asks how to become a successful day trader. The simple truth of the matter is that most day trading systems (at least the good ones) are not terribly complex.  For instance, my system is built on the simple premise of follow the (market) leader.  It isn’t rocket science.  After all, if it was, I wouldn’t be able to follow it.  Yet, all too often, my day trading students let the simplicity of the system lull them into a false sense of security.

The truth of the matter is that most things in life are simple.  It’s simple to swim, drive a car or hit the perfect golf shot.  It’s only a matter of taking very simple actions and putting them together in a specific order so that you produce the desired result.  Yet, very often, the ability to put these steps together requires practice and plenty of it.

Think about it.  If you had the good fortune of taking a private golf lesson from Tiger Woods, would you then immediately quit your job and try out for the PGA tour?  Of course not.  But why not?  After all, if Tiger told you everything that it took to be a PGA champion, then why can’t you just follow his advice and start raking in the big bucks yourself?  It works for him.  It should work for you, right?  Wrong!  The reason it works for Tiger Woods is because he has spent more than 20 years practicing his craft.

The same is true when you read a book or article on day trading or attend a live training.  Trying to translate that knowledge into day trading profits without practice would be like trying to learn to swim by merely reading a book.  It won’t work.  You can get an understanding of the basic techniques from a book but in order to really learn to swim, you must get in the water and splash around a bit.  Well, the same thing is true for day trading.  You must get into the water (in this case, the market) and splash around some.  In other words, you must practice what you learn.

Needless to say, when you first start out, you’re not going to be a master day trader.  You’re going to swallow some water.  For that reason, I always recommend that my students refrain from doing any live trading for at least the first 30 days after taking my course.  During this time, I ask them to set their trading software to training mode and simply practice what they’ve learned.  Only after they are consistently making a profit should they even consider “going live.”  If you’re new to day trading, I recommend the same thing for you.  Practice what you’ve learned until you can carry out the actions that will make you consistent profits.

In my experience, this is where many of my students stumble.  They can’t resist the temptation of getting in the game.  After all, it isn’t much fun to brag to your friends that you are making a killing in the market on paper.  And you certainly can’t use your paper profits to put a down payment on a new car or take your family on vacation.  Yet, paper profits are much better than the alternative – real losses.  After all, if you think your family will look at you funny when you tell them that you just made $7,500 in paper profits, then just imagine the looks you will receive when you have to admit that you are $7,500 behind in real money because you jumped headlong into the deep end of the market without first learning to stay afloat.

As I see it, if you’re going to make mistakes (and you will), it’s best to make those mistakes for free.  Over the years, I’ve met many day traders who didn’t heed this advice.  They were so anxious to try out their newfound skills that they ended up exposing themselves to significant financial losses.  As a result, they spent their first few years of day trading trying to recoup the losses they incurred in the first few months.

To demonstrate how devastating these early losses can be, let’s suppose you belly flop into day trading by losing half of your initial investment in the first few months.  With half the capital to work with, you will need to be twice as good as the average trader just to make the same amount.  Of course, you won’t be twice as good as the average trader because you’re just starting out.  Yet, the need for spectacular returns will force you into making spectacular blunders and before long, you will be dead broke or very close to it.

Trust me on this one.  I’ve seen it more times than I care to remember.  Yet, each time, it is equally frustrating because it is 100% preventable by just taking the time to practice the system you’ve been taught.

And how long should you stay in training mode?  Until you can consistently make money on paper.  A .333 batting average is great for a baseball player but it is disastrous for a day trader.  Therefore, you shouldn’t even think about lacing up your cleats and getting into the day trading game until you are able to make paper profits at least four out of five days.

I realize that this may seem like a lot of time spent on the sidelines.  Yet, if you ask me, “How do I get to Easy Street?”  My answer will be “Practice!”

Fausto Pugliese. President and Founder of Cyber Trading University.

Perhaps, the biggest misconception about day trading is that success can be measured in spectacular profits.  Yet, just the opposite is true.  The key to successful day trading (and successful living in general) is in avoiding major losses.  And while every trader loses money from time to time, the key is to minimize those losses.  After all, one or two really bad days can wipe out the profits of 3-4 weeks of good trading.

Furthermore, major losses keep you from making money in the future.  The less capital you have to work with, the less you will have available for trading.  Therefore, one of the keys to success is to preserve your capital base. How do you avoid major losses?  Some people would suggest that you set a stop loss order on every trade.  In other words, whenever you buy a stock, you place a sell order for those shares if the stock reaches a certain point (say a loss of $0.10 per share).  However, the problem with setting stop losses is that you very often will get “stopped out” in potentially profitable situations.

For example, if you set a $0.10 stop loss, you will often have times when you buy the stock at $10.00 and it immediately falls to $9.90, only to rebound within minutes to $10.50.  In this case, even though the stock rises $0.50 in a matter of minutes, you don’t make any money.  Instead, you lose money when your position is stopped out at $9.90.  This kind of thing happens all of the time to people who set stop losses.

So what’s the alternative?  Stay at your post. Yes, it’s that simple.  Instead of relying on an automatic computer trade, you want to constantly assess and re-assess the situation.  Have the support and resistance levels changed?  What are the market makers doing?  What major news has been released about the company?  This is the only reliable way to determine if a drop in price is a normal fluctuation or the beginning of a major downward shift in the direction of the stock.

Now, am I suggesting that you glue yourself in front of your computer never taking any time to stretch your legs, eat a meal or go to the restroom?  YES; at least when you have money on the line.  When you have an open position, you should watch it like a hawk.  After all, you can do these other things during the vast majority of the day when you don’t have an open position.

If you are like most traders, you will do most of your trading during the first 1½ hours of the morning and the last 1 hour of the day.  That leaves 4 hours when the market is relatively slow; not to mention the rest of the entire day.  Given that you only have money on the line for a small amount of time, why would you use this time to do anything else but watch over it carefully?

After all, you wouldn’t want to be riding on a bus with a driver who decided to get up and, say, go for a bathroom break in the middle of left turn, would you?  Likewise, you wouldn’t want to have your hair cut by a stylist who was busy wolfing down a cheeseburger and talking on her cell phone while simultaneously cutting your hair, would you?  Well, shouldn’t your hard-earned money get the same consideration.  While you have it in the market, your first priority should be to shepherd it, guide it and bring it home safely.

That being said, there are going to be times when situations arise that will take your attention away from the market.  For instance, let’s say that you get a call from your child’s school telling you that she has come down with a stomach ache.  In that case, I don’t expect you to tell your child, “Suck it up, Mommy’s trading!”

Obviously, in that case, you must shift your focus to what’s really important.  However, I am suggesting that before you head off to the school, you close out any open positions, even if you have to take a small loss to do so.

Now, I know you’re thinking that I’m being overcautious.  After all, it’s just a ten-minute roundtrip to your child’s school.  Why take a loss on a trade that looks so promising?  Because the risk simply isn’t worth the reward.

If you close out your position, the worst thing that can happen is that you lose out on the opportunity to earn a modest profit.  Alternatively, if you leave the position open while you pick up your child, chat with the nurse, and then run into the pharmacy for some Pepto Bismol, you run the risk of catastrophic losses.  In that case, your child’s stomach ache is going to pale in comparison to your “wallet ache.”

You simply can’t afford to leave your post during the heat of battle.  Therefore, whenever you have money in the market, be vigilant.  And when you can’t be vigilant, don’t have money in the market.  It’s just not worth the risk.

Fausto Pugliese. President and Founder of Cyber Trading University.

People often ask me, “What is the single most important personality trait of a day trader?”  Almost as often, they are surprised by my one-word answer – discipline.  In my experience of teaching thousands of individuals to day trade, I’ve found that the ultimate determining factor in success is not education, analytical ability, risk tolerance or the like.  The determining factor in 99.9% of the cases is discipline – the discipline to follow the rules of day trading, the most important of which is NO OVERNIGHTS!
It is called day trading for a reason.  And, by the way, that reason isn’t because we make our trades during daytime hours.  Just about every investor makes his or her trades during the day.  The reason it is called “day trading” is because we open and close all positions during the same trading day.  In other words, a true day trader starts each day with no open positions, make trades during the course of that day, and ends each day like he started it – with no open positions and with no exceptions.

Of course, this is a pretty easy rule to follow when you’re making money.  If your trade is showing a positive return, you’ll have no problem cashing out the position by the end of the day and taking your profits.  That’s only logical.
However, it becomes more difficult to follow this rule if it means cashing out a losing position.  For example, let’s say that you bought a stock late in the day at its support level, expecting to sell it as it bounced back up near its resistance level sometime before the closing bell.  Yet, for some reason, the stock broke through its support level and now, you’re looking at, say, a $1,000 loss on the trade as the closing looms.
In this case, it will be tempting to hold onto the stock with the hope that it resumes its normal trading pattern at the opening bell, getting you back near even.  A voice inside your head will say, “Hey, why close out a losing position that might turn into a winning position if I just wait an extra day?”  Ignore that voice!  It is the voice of potential financial ruin.

And if you think I’m being overly dramatic, I’m not.  I’ve seen the results of what happens to day traders who head this voice.  A friend of mine was down about $1,500 in a particular stock one day, which was an unusually large loss on a single stock for him.  However, rather than taking his medicine at the end of the trading day, he thought, “Why not hold it overnight and see what happens on the morning bell?  It couldn’t get much worse, right?”  Wrong!
After the bell, the company reported catastrophic news; accounting fraud, insider trading, you name it.  This news caused the price of the stock to drop $50 per share at the market open on the next day.  My friend, who was holding 1,000 shares, had seen his original loss of $1,500 balloon into a $50,000 shortfall.
Now, I’d like to say that this is the sad end to the story but it isn’t.  Desperate to recoup at least some of his investment, my friend then dumped the rest of his funds into the stock at the reduced price with the hope that just a small increase in the stock would make up for his original loss.  Over the next few weeks, the stock fell another 80% in value.  My friend was completely ruined.  And why?   Because he decided to keep a stock overnight to avoid a small loss.
Now, don’t get me wrong.  This type of devastation won’t happen every time you overnight a stock.  The problem is that it doesn’t have to happen every time, just once is enough to wipe out your entire life savings.  This is why discipline is so important in day trading.  The discipline to avoid the temptation of waiting “just one more day” can make all the difference.
Fausto Pugliese. President and Founder of Cyber Trading University.