The Van Tharp Institute

August 31, 2005 — Issue #235

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In this Issue:

Feature Article

How Competent Are You As A Trader? By Van K. Tharp, Ph.D.

News

American Red Cross Can Use Our Help

Trading Tip

Keeping Stops and Pension Funding – Unlikely Allies, By D.R. Barton, Jr.

Special Report Reports by Van Tharp: Self Sabotage Re-examined, Part One and Two 
Listening In What Is An Error? 

View this newsletter on-line, or read back issues

Feature

How Competent Are You As A Trader?

By Van K. Tharp, Ph.D.

How good are you as a trader?  Do you make money every year?  Do you make money at all?  Can you live off your trading?  Do you make money, but probably not enough to cover all your trading expenses?  Or perhaps you made a lot of money once, lost it all and then some, and now you are just trying to get it all back.  Is that you?

So, considering all of the questions I just asked, rate your competence as a trader on a one through ten scale.  

Let’s say that “one” is terrible, you lose on a regular basis.  “Five” is neutral – you don’t make or lose money.  And “ten” is very good – you make a living trading and your earnings are probably in the top 1% of all Americans.  So what kind of rating would you give yourself?

<- Poor 1 - 2 - 3 - 4 - 5 - 6 - 7 - 8 - 9 - 10 Very Good- >

            Rate Yourself Now _____________

Now, rate your feeling about your competence on the same scale.  This feeling refers to how successful you think you’ll be in the next year or in the next five years.

            Rate Yourself Now ______________

Guess what?  You’ve just given yourself a predictor of your success.  Competence at trading starts with feeling competent.  It starts with being competent.  So if your average rating on the two scores above was less than 6, you’ve got some serious work to do.

This all gets into some key psychological issues about trading.  Most people think that trading success comes from finding some magic secret of success and, once you have that, you just apply it.  And once you’ve applied it, then you BECOME a successful trader.

But that’s not the way it works at all.  Success comes from the inside first.  You must BE a successful trader.  That means you must come from the persona that successful traders have.  What is their nature?  What is their beingness? 

When you first step into the BEINGNESS of a trader, you will start to do what successful traders do, and then you will start to have what successful traders have.  You’ll start having success and profits.

In the Peak Performance Course for Traders and Investors, I wrote about a floor trader who was very successful.  He made millions in the market.  However, one day, because of poor position sizing and perhaps a little too much cockiness, he lost it all.  Well, not quite everything, because he’d put $30,000 away just in case something like this might happen.  He still had a $30,000 cash reserve to sustain him as a trader.  (And this was ten years ago when $30,000 meant a little more than it does today.)

But only having $30,000 really got to him.  He felt like he couldn’t spend any money.

He felt like he had to be particularly careful with everything he did. In fact, he said he used to go into bars at happy hour, buy one drink, and then eat all the free food – and that was his dinner.

So how did this trader do in making a comeback?  What would you predict?  He didn’t have the beingness of a successful trader!  He was very concerned about losing.  And he was living at a lifestyle that was way below the lifestyle he had when he was successful.

If you guess that he wasn’t trading well, then you guessed correctly.  Within a few months, his $30,000 was down to about $10,000.  And how do you think he felt then?

At this point, he had a sudden realization.  He suddenly understood that he was totally different from the person who had made millions in the market.  He said to himself, “What the heck, I only have $10,000 left, so I’ll just going to go back to the type of person I used to be.”  And as he did that, he resumed his old lifestyle, which meant that he probably had enough money to last one to two weeks.

At the same time he made the decision to resume his old lifestyle, everything else shifted inside of him.  Suddenly, he could also trade well.  Suddenly, he was making a lot more money than he was spending.  He was now BEING a good trader.  And the net result was that within a few years, he was a millionaire trader again.

So What’s the Moral for YOU?

Does this mean that you should just assume that you are a competent trader, spend money like you were going to make millions in the market this year, and just charge forward?  No, it doesn’t mean that at all!!!!!

Here’s what it means.  You need to study what good traders are like and get into their psychology.  You could go out and be around good traders and try to get inside their heads, but I’ve already done that for you in the Peak Performance Course, so why not save yourself a lot of time and money and do that instead?  Study what good traders are like and then become like them.

It also means that you need to develop a business plan and some systems that work.  Because almost every good trader I know of works hard at these things.  We have the products to help you do these tasks as well.  And the main reason to do all of this is so that you’ll have the confidence to trade well. When you have a great business plan and some great systems in place that you’ve proven will work through your testing and simulation, then it is easy to assume the BEINGNESS of a good trader.

The Market Wizard Exercise

And lastly, I’d like to talk about one of the exercises we'll do in the Peak Performance Workshop next month.  I call it the Market Wizard exercise. (The term Market Wizard is derived from Jack Schwager's famous book in which he interviews the worlds top traders. It's still an essential book for all traders*.).  

To do the Market Wizard exercise, imagine yourself in a situation in which you are not doing well at all in trading.  Now, get up and walk away.  Look at what you looked like trading poorly.  Notice what you were doing with your body. That’s part one of the exercise and you’ll probably notice that you were slumped over, tense, and not breathing very well.

The second part of the exercise is to imagine a Market Wizard sitting in that same situation in which you were having so much trouble.  What is that person doing?  How are they handling that situation?  The amazing thing about this exercise is that everyone can do it – even beginning traders who have never seen a great trader in action.  Nevertheless, they know exactly how that trader is BEING.  And typically they are relaxed, very upright, breathing well, and behaving totally differently from the way you were.

And the third part of the exercise is to just go over to your chair and become that Market Wizard.  And this is a perfect illustration of how you must BE a great trader to DO what they do, and HAVE their results.

So what do you need to do?  Study, work hard, and develop a plan that you have confidence in.  Understand the psychology of top traders and investors and then adopt it.  Develop confidence in your future success and then when you are ready, just BE a great trader.  The results will follow.

This is your trading coach, Van Tharp, until next week.

* Here's a link to the Market Wizards Book on Amazon if you want to learn more about it. Market Wizards

American Red Cross Can Use Our Help

by

Van Tharp

My son, Robert, was in New Orleans this past weekend, preparing to conduct a seminar, when Hurricane Katrina was forecast to blow through the city with devastating force. Like thousands of other visitors, his flight was canceled. All the rental cars were quickly in use and unavailable.

My son is very resourceful and good fortune was on his side. He and his colleague were able to share a limo with some others that took them from New Orleans to Houston, TX. It was not cheap, but it was a way out.

As we are hearing on the news, thousands of others could not leave and still hundreds of thousands of others in the whole region are in need.

Red Cross can use all of our donations to help out and I’ve supplied an easy link below if you want to donate.

Here’s what my good friend and colleague, Chris Anderson, told me. He lives in the Florida Panhandle (the northwestern corner of the state on the Gulf of Mexico). 

“Having gone through the aftermath of hurricanes myself, but on a much smaller scale, I am just awestruck at the devastation that is coming out of the area.  What most people don't know is that when something like this occurs, 100,000's of people will have their lives turned upside down for months on end.  This is definitely not a 'sweep up the mess and in a week you are back to business as normal' situation.

“Just basic needs such as food, ice, shelter, gas, medical supplies, etc that we take for granted become a major daily struggle.  Also on a first hand basis, I have seen the impact of the American Red cross and what it can do for a devastated area such as Alabama, Mississippi, and Louisiana.  The role they are going to be playing in this disaster relief will be huge. 

“In addition, the locations impacted are not just where the rich people have lost their condo on the beach.  Instead, this has struck areas where the majority of the people are low income and barely making ends meet before they lost everything.

"Right now, the best way people can assist our Southern neighbors is with a donation to the Red Cross."

If you are inclined to help, then it is very simple: 

Go to: https://www.redcross.org

For those that don't like to do this on-line, they also provide a phone number. 

Thank You,

Van K. Tharp

 

Trading Tip: 

Trading Tip

Keeping Stops and Pension Funding – Unlikely Allies

by  D. R. Barton, Jr.

There are many reasons why people have difficulty keeping stops. Many of the reasons can be summed up as the “need to be right.”

And it is this “need to be right” that leads to the main logistical reason that stops are not kept: a failure to commit to the stop level.  The trader will make the stop a vague intention rather than a firm line in the sand.  And from that point of mental ambiguity, it neither gets written down nor entered as a hard stop electronically.

But whatever that reason, we know that most people tend to keep stops when they are placed in the market.  This is perhaps because of an added level of commitment, combined with the inconvenience of having to move or cancel the stop once it is entered.

Interestingly, an article in The Economist this week deals with the behavioral finance of personal retirement funding, and it has some substantiation for the practice of placing your stops “automatically.”

For clarification, behavioral finance is a branch of economics that uses both experiments and psychology to explain the workings of the financial world.

According to the behavioral finance folks, individual retirement savings are lower than one could rationally explain because individuals place a higher value on short-term savings or money use than do on long-term savings.  Said another way, people would rather have cash and the stuff cash can buy instead of a nest egg or more stuff later on. (Individuals keep a mental yield curve that is always inverted!  Their short-term discount rate is higher than their longer-term rate.)

This explains why saving, especially for retirement, is low despite government incentives such as tax breaks designed to encourage individual pension funding activities.

Some experiments have shown how future pensioners might be “persuaded” to save more (or at all) for their retirement.  Currently, people are given an option to enroll in retirement plans such as a 401K.  This is an “OPT-in” strategy.  One study cited by The Economist shows that simply by changing the default status of employees to “enrolled” with an option to “OPT-out” increased the number of participants from 49% to 86%. It may be quite some time before we see this “OPT-out” style program as the norm (though New Zealand is enacting a nation-wide “OPT-out” plan in 2007), but we can learn from this finding in our trading.

Making “my stop is in the market” your default action immediately after your entry has been filled will go a long way toward helping you honor your stop loss levels.

 

D. R. Barton, Jr. will be teaching the September 2005 How To Develop A Winning Trading System That Fits You Workshop. 

He is the Chief Operating Officer and Risk Manager for the Directional Research and Trading hedge fund group. D. R. has been actively involved in trading, researching, and teaching in the markets since 1986.  D. R. has taught extensively in many investment areas including intra-day trading, swing trading, and cutting edge risk management techniques. 

His writing credits include co-authoring Safe Strategies for Financial Freedom and co-creator and contributing author on Financial Freedom Through  Electronic Day Trading.

 

Special Report

Self  Sabotage - Two Reports of Self Sabotage

Click here to read page one of each report, or to order. 

Listening In... 

What Is An Error? 
Author: PMK
Date: 08-25-05 13:18

I think that most traders would agree that spotting mistakes and putting things in place to prevent them from happening again is one of the key paths to improving your trading.

In fact, making the same mistake twice and expecting different results is one of the definitions of stupidity, and we all know successful traders are not stupid, right?  :-)

The question I have been struggling with in a previous thread is:

If you are a discretionary trader, how do you define a trading error, and how do you differentiate it from 'good' trading?

For mechanical/systematic traders, an error would be any deviation from your trading system/rules/plan (or the incompleteness of your plan or method)?

Are there any experienced discretionary traders out there that participate in this forum that can shed some light on this issue?

Paul


Reply To This Message 


What Is An Error? 
Author: Terry
Date: 08-26-05 23:15

PMK, 


Discretionary traders also have trading plans. I think there is a general misconception that a discretionary trader is nothing more than a gun-slinging, shoot-from-the-hip cowboy who has less than a precise and qualitative approach to the markets. Perhaps in some instances that is accurate, but certainly is not in my case.

I view discretion (my definition) as the flexibility to read the market in real time. In addition, it is discretion within a structured context. I use technical indicators like anyone else to give me the edge that I need based on my personal experiences. Some people might look at the way I trade as some kind of mystical intuitiveness, but I view it as a probability statement based on my personal interactions with the markets through the years.

My personal beliefs are that trading is 95% psychological and my definition of what constitutes a trading "error" is probably not much different from yours. I've made an "error" when I push a trade that should not have been made in the first place. I've made an "error" when I get mentally sloppy. I've made an "error" when I don't adhere to the trading rules that I've made for myself. As I create a list of trading "errors," I realize they are all psychologically based. Losing money on a trade means nothing as long as I have executed properly. Good trading is executing properly and most importantly, being in control of oneself.

Being mentally in control has always been the most difficult aspect for me, but I seem to get better at it through the years. But it is something I am constantly addressing on a daily basis.

I don't think there are too many traders who are purely discretional or perfectly systematic. I think most traders blend the two approaches to various degrees. I certainly am structured in my approach but I also realize the artwork involved in creating opportunity the market presents

I hope I have been able to "shed some light" on your question.
Terry


Reply To This Message 


Re: What is an error? 
Author: PMK
Date: 08-27-05 11:18

Terry,

Thanks for your informative answer. I agree with you that most traders will not be at the very extremes of the systematic-discretionary continuum.

I started out with the belief and objective that 100% mechanical was the way to go, but have moved slowly towards the discretional end as each year has passed. I am approximately 95% mechanical right now, and I see as my trading evolves that this percentage will continue to drop slowly as my 'feel' for trading increases based on the gradually increasing number of trades in my past.

I can envision a time in the future where my systems become a 'framework' for my trading, with a larger proportion of discretion. I think this is only natural as we evolve from novices (where discretion has a negative effect on performance) to experts (where experience can improve the performance, and make up for the caveats of a purely systematic approach)

Regards

Paul 


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The Van Tharp Institute will be closed Monday, September 5th in observance of the Labor Day Holiday.

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Quote of the Week

It's not who you are that holds you back, it's who you think you're not. ~Author Unknown

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Van Tharp's Market Update for Period Ending July 29, 2005

Look for a new update September 7, 2005

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