The Van Tharp Institute

April 19, 2006 — Issue #267

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In this Issue:

Teleconference

FREE TELECONFERENCE TOMORROW NIGHT

Feature Article

Tax Savings for Traders, By Jim Crimmins

Trading Education

People trade their beliefs about the market. 

Trading Tip

Managing Two Time Frames, by D. R. Barton, Jr.

Workshops

17 Steps to Becoming a Great Trader
Peak Performance 101 and 202

Listening In Measuring Your Own Trading Quality
Special Reports Reports by Van Tharp: Self Sabotage, Changing Markets

View this newsletter on-line, or read back issues

Free Teleconference

Turning Van's 17 Steps into a Viable Business Plan

Tomorrow, April 20th, 2006 at 8pm EST

Please join Van and one of his clients, Joe, on a teleconference this Thursday.  They will walk through Joe's trading business plan. The discussion will cover three key areas: 

  • Business Plan and Operations

  • Research and Development 

  • Self Work.

 

Learn More

Feature

Aaah...Another tax season is behind us and a new one is already underway. As a trader you have special considerations regarding your taxes and I have long believed in structuring yourself properly in order to get the best tax advantages. This should be a part of any trader's business plan and it's why you should run your trading as a business, not as a 'hobby.' I hope our colleague Jim Crimmins, can shed some light on the topic. — Van Tharp

Tax Savings for Traders

By Jim Crimmins

What is the Best Structure for Tax Savings for Traders? There are three options. One is to keep filing your Form 1040 (U.S. Individual Tax Return) year after year. That is the most expensive solution and unfortunately, that is what most people do.

Next, you could try to file as a "trader" and deduct your business expenses on Schedule C of your Form 1040. This is risky and does not offer you any income tax strategies, so we advise you to stay away from this option.

The third strategy is to place your trading capital in a legal entity. There are various entities that may be appropriate, depending on your situation. Your main choices are the c-corporation, the flow-thru entities such as the limited liability company (LLC) and the limited partnership, and a combination of a c-corporation and a flow-thru entity.

The following is an explanation of the corporation - LLC strategy for active traders. This strategy can allow you to legally write-off your computers, home office equipment, all educational expenses, and a large percentage of meals, entertainment and travel. You will learn how to run your investment activities as a qualified business, and how you can grant yourself all the legal perks, benefits, tax breaks, and tax deductions afforded to large companies.

The Limitations of Filing a 1040 Tax Return as an Investor

As you probably know, when you file your Form 1040 tax return, your ability to deduct expenses related to your investment activities is extremely limited. Certain expenses are deductible, but these itemized deductions are subject to the 2% of adjusted gross income limitation. Additionally, deductions for investment seminars and home offices are categorically disallowed.

Another limitation affecting more and more investors is the Wash Sale rule. This rule prevents you from realizing losses on securities sales if you are in basically the same financial position in a 61-day window of time. The goal of the IRS is to prevent you from selling a position simply to record the loss, and then immediately buying back the stock at a lower basis price. Unfortunately, with active trading being more the norm, individuals often find themselves moving in and out of the same stock within the same 61-day window.

One benefit of filing a Form 1040 tax return is the capital gain treatment of your long-term stock positions. If you hold your securities for 12 months or longer you can lower your capital gains tax bracket to as low as 10% or 20%.

In conclusion, if you work at a full-time job and are realizing capital gains in the stock market, you do not have any powerful methods for offsetting your tax liabilities. In fact, all of the expenses incurred in learning how to grow and manage your capital are almost entirely non-deductible. But what if there was a way to make your investment activities into a business? What if you became a qualified part-time money manager? Do you think that you might receive a preferential tax treatment by the IRS? Let's see:

Filing as a "Trader" on your Form 1040 Tax Return … tax breaks but very risky.

This tax strategy boils down to this: You convert your investment activities into a trading business. Once your investing is recognized as a business, you are able to deduct any ordinary and necessary business expenses. What does it take to form a trading business? The Internal Revenue Code is conspicuously quiet about how to qualify as a trading business. So, the burden has been placed on brave individuals who filed their 1040 tax returns and attempted to establish themselves as "traders" in order to write-off their business expenses.

Most of these individuals were slaughtered in the tax courts. In case after case, the individuals were rebuked by the courts. The net effect of the rulings is that it is nearly impossible to qualify as a trader. To qualify, you would most likely have to be trading full-time, hold your positions for less than a day, and trade a large amount almost every business day throughout the year. In essence, the court has said, "If you are not on the floor of the exchange, or holed up in a trading room, you do not qualify."

Some CPAs have been very active in promoting "trader status" filings. If you look at the actual text from the court cases, you will agree that attempting to establish your trading business as an individual trader on your personal Form 1040 tax return is a risky proposition and can lead to sleepless nights worrying about a possible audit. The bottom line is that while a very small portion of active traders can realize substantial tax savings by filing as a "trader", a majority of investors do not qualify and need an alternative strategy.

The Complete Solution: Placing Your Trading Capital in an Entity Structure

Instead of attempting the herculean task of qualifying as a "trader" on your personal return, there is a method of qualifying that is automatic, trouble-free, and positively overflowing with powerful tax benefits. This strategy is what business greats like Warren Buffet, Michael Dell, and Michael Bloomberg, along with tens on thousands of others, have chosen for their investment capital.

Advantages of Using a Corporation

One of the most exciting things about using a corporation is the sheer amount of tax deductions and perks that are available to corporate owners and company employees. Congress has created tax laws and special exemptions for corporations. It is the lobbyists of the major corporations that have paved the way for you. Now, you can own your own corporation and be able to write-off all "ordinary and necessary" business expenses, fully deduct the costs of attending board meetings that are held in vacation areas, write-off all medical expenses with no limitations, contribute up to $40,000 to your own pension plan, and much much more.

For individuals that are generating a large amount of excess revenue, the corporation structure allows you to start-up additional businesses with the expenses of the new business offsetting the income from the trading business. Another great benefit of the corporate entity is that it is a perpetual entity. Many individuals choose to retain the controlling interest in the corporation, and gift the non-controlling stock to their beneficiaries early in the growth of the business. That way, all future growth occurs in the estate of the beneficiaries, so that when you pass away, your beneficiaries do not need to sell off your business simply to pay the taxes. All they would be receiving is the small amount of controlling stock.

Taking Action

If you are a part-time trader, you have created a situation where you can take advantage of major tax strategies usually reserved for individuals with full-time businesses. It is simply a matter of getting started. We are the experts in this arena. We can look at your situation and show you how the entity structure would work in your situation.

About Jim Crimmins: Jim Crimmins is the founder and President of Traders Accounting. Jim worked with one of the largest and well-known educational organizations of the stock market where he became a master on entity structuring and developed a network of experts in the trading arena. 

Jim has become a nationally known speaker on tax strategies, entity structuring, and lifestyle change. He delivers over 30 talks a year throughout America as well as speaking in several chat rooms each month. 

 You can learn more at TradersAccounting.com.

Trading Education

Van Tharp's  Peak Performance Home Study Course

People do not trade the market. They trade their beliefs about the market. 

  • A guide to isolating and understanding your own belief systems in relation to trading.

  • Effective training for all levels of traders, from beginners to advanced.

  • A model that you can follow to emulate the success skills of profitable traders.

  • Discover your trading edge, set yourself apart from other traders.

  • Bring more discipline to your trading.

  • Learn self-confidence, overcome fear and eliminate self-sabotage.

These are just a few of the benefits of the Peak Performance Home Study Program.

Click Here to Learn More About the Course...

 

Trading Tip 

Trading Tip

The Power of Conviction, Part II

Managing Two Time Frames

by D. R. Barton, Jr.

“I will listen to anyone's convictions, but pray keep your doubts to yourself.”  — Johann Wolfgang von Goethe

                                                          

Last week we talked about convictions that I observed in Ken Long at his excellent “Exchange Traded Funds” workshop.

Ken’s convictions allow him to act decisively and effectively across two different time frames.  It’s actually quite rare to find someone who trades well in a long-term time frame (months long) as well on a short-term basis (a few days long).

Ken has built and traded systems that have performed well in real time in both time frames and continue to do so.

How does Ken pull off this difficult task?  He does it by building up a conviction so strong in himself across both time frames that not acting on his system’s signals would seem irresponsible to him – or even downright ludicrous.

Two Competing Thoughts:  Overcome by Personal Convictions

If you’ve never tried holding a long-term trend following position and then shorting a correlated stock, give it a whirl.  It’s a difficult gig!  I know several (actually many) excellent traders and investors that just can’t do it.

Ken is able to trade in the two time frames because of his strong convictions.  But what is interesting for us is how he developed those convictions.  Here is a short and far-from-comprehensive list of how I think Ken is able to trade two time frames so well:

1.      He is trading his beliefs.

2.      His beliefs about how long-term trades work and how short-term trades work are very different.

3.      He understands those differences very well.

4.      He keeps those time-frame oriented beliefs compartmentalized and doesn’t allow them to impinge on his beliefs for the other time frame.

5.      He is trading systems that he built from the ground up – he has taken ownership.

6.      He has tested the systems extensively.

7.      He has traded the systems in real time with real money.

Conviction is such a powerful force that it allows Ken to overcome hurdles that make other strong men and women crumple.  Next week, we’ll dig more into the efficacy of a systematic approach to strategy design.  Until then...

Great Trading!

D. R.

D. R. Barton, Jr. 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 Fin-ancial Fre-edom and co-creator and contributing author on Fin-ancial Fre-edom Through  Electronic Day Trading.

D.R. presents the IITM Swing Trading Workshop and Professional Tactics for Day Traders Workshop. Each workshop is only held once each year. 

 

Workshops 

The 17 Steps to Becoming a Great Trader Workshop

With Van Tharp and Ken Long

May 5-7, 2006, Raleigh, NC

$500 Early Enrollment Discount Expires Next Tuesday, April 25th.

Learn More...

 

Coming in June 2006
   
Peak Performance 101 Workshop 
June 3-5, 2006
Peak Performance 202 Workshop
June 7-9, 2006

 

Listening In...  
Measuring Your Own Trading Quality 
Author: level7 

I've being wondering lately how one knows if they are a good trader or not? How can you determine the quality of your trading? 

Someone might say how much % per year but this is really a statistical measure of nothing important at all in any particular year I think.

Someone might say by the cumulative money you have made trading, but this too is misleading since we all know millionaire traders who lost it all by not selling out in the bull market.

Someone might say by the strict money made versus the number of trades, but I think there is more to it than just this.

I remember thinking I might be pretty good by going through the IPI profile score I received. Does anyone have some input to help me out?


Reply To This Message 


Re: Measuring your own trading quality 
Author: PMK 

Level7,

I use 2 main criteria to determine how 'good' my trading is:

1) How closely my actual results match the objectives I set when I designed each system (risk/reward, maximum drawdown, annual return, average win compared to average loss size, average trade duration, trade frequency etc. etc. etc.)

2) How much my recent 'implementation errors' cost me (i.e deviations from my trading system as defined for whatever reasons) compared to the historical 'norm'.

If my trading is performing within normal operational parameters and I'm implementing it accurately and with discipline then I personally call that 'good' no matter what the actual results are.

Hope this helps

Paul King


Reply To This Message 


Re: Measuring your own trading quality 
Author: Terry 

I think the quality of one's trading is a function of adaptability. How well you adjust to the environment you are in will determine the quality and duration of consistency you are looking for.

Regards, Terry


Reply To This Message 


Re: Measuring your own trading quality 
Author: Chicken Little

Owning every aspect of your trading seems to me to be a good first step in improving the quality of your trading. On some level, level7, knowing if you are good or not doesn't matter. 'Everybody gets what they want.' If you are trading for some drama then that is good for you. If you are trading for life-fulfillment then that is good. Laboring in your bliss will bear the most fruit...just ask Johnny Appleseed. (;>

Here is something I saved from Van:

A critical difference between good traders and the average trader is that good traders thrive on simplicity and not knowing. They come from being and simply go with the flow of the markets. If the markets tell them, it’s time to go up, then they buy. They might be wrong 70% of the time, but that is part of the game. They’ll get out when the markets are no longer going up. They do this by simply observing what is happening, and are much more joyful because they are going with the flow. They allow themselves to let their profits run, because it’s okay to be in the market when it is going up. They also allow themselves to get out, because it’s okay to get out when the markets start to do something else.

What I’ve just described is pure trading. Its essence is simple. It doesn’t require a lot of time. Instead, it gives you lots of time to play. It also involves seeing all possibilities and being in the flow of what is happening right now. You cannot do this if you are preoccupied with being right, doing hard work, or having money or profits. You can only do this when your mind is pure and you can be at one with what is going on around you. 

I noticed you started your post with >>I've *being* wondering.

 Regards. 

Participate on Van's Trading Forum, a place for traders and investors to share ideas and learn from each other. To see more post on the segment featured above look for the heading: Measuring Your Own Trading Quality

Special Reports By Van Tharp

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

Self  Sabotage - Two Reports of Self Sabotage

Does Your System Still Work in Changing Markets?

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Copyright 2006 the International Institute of Trading Mastery, Inc.

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Quote of the Week:

"You must pay taxes. But there's no law that says you gotta leave a tip." 

~a Morgan Stanley ad

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A computerized version of Van's famous "marble game." 

It is designed to teach you the important principles of proper position sizing. 

Download the 1st three levels of the game for free. Register now. 

 

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2006 
Workshop Mini-Schedule

May 5-7 17 Steps
June 3-5 Peak 101
June 7-9 Peak 202
Jul 14-16 You, Your Money
Aug 25-27 Systems Development
Sept 16-18 Day Trading
Oct 27-29 Mutual Funds & ETFs

 More Info...

 

 

 

 

 

 

 

 

 

 

 

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