The Van Tharp Institute

June 21, 2006 — Issue #276

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In this Issue:

Trading Education

20 Percent Off STOCK CLEARANCE SALE, Ends Next Week.

Feature Article

Business Planning, An Important Consideration for Traders

Workshops

Upcoming Workshops in 2006. Some include dinners with Van Tharp!

Trading Tip

A Review of Market Models: Momentum Indictors for Overbought / Oversold Conditions,  by D. R. Barton, Jr.

Listening In...

Changing Market Conditions, How Best to Handle Them?

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Stock Clearance Sale

Save 20% on these items before we do our year-end inventory counts

Offer ends next week

Items include:

  • Peak Performance Home Study Program

  • How to Develop a Winning Trading System

  • Make Money Work for You

  • Infinite Wealth Home Study CDs

  • Trading Simulation Game: Full Version

  • Position Sizing DVDs

  • Market Mastery Archive Collection and Single Issues

  • Seven Tips for Peak Performance Trading CD

  • Business Planning for Traders CDs

  • Psychology of Trading CDs

  • Van Tharp's Books

  • Books and products by other colleagues

To See the Items on Sale, Click Here

 

 

Feature

Van Tharp's Back-To-Basics Series

This week we turn our attention again to the back-to-the-basics series, which some of you may have seen in our new site map.

Whether this is the first time or the twentieth time that you have read this core information, it may just give you new insight or could be a timely reminder. Both are useful. 

Business Planning

When people choose to trade the markets, they always want to rush in and get started straight away. They foolishly think that are going to miss the next “big wave.” But the market doesn’t know when you get in or when you get out. So don’t be foolish, take the time to plan. ~Mel

The entry price to being a trader or investor is fairly low. All you need is enough money to open an account. Your broker doesn’t care whether you understand expectancy or objectives. Your broker doesn’t care whether you understand that position sizing is the key to meeting your objectives. And your broker certainly doesn’t care that you must have your personal psychology in order for any of the other to matter.

Your broker cares about two things:

1. That you have enough money to open an account, and,

2. That you don’t lose many times the value of your account so that the broker gets in trouble.

That’s it!

You can easily open an account without knowing the first thing about trading.

Is this true of other professions? Can you become an engineer without understanding calculus? Can you become a doctor without going to medical school? Can you be an attorney without passing the bar? Of course not.

Similarly, could you play golf against a pro the first time you stepped on a golf course? Would you put yourself in a chess tournament against a master player if you’d never played before? If so, the worst you could do is lose a few games or your pride.

But what do people lose in the markets? Anything from a few dollars to their life savings; yet there are no rules about who should or shouldn’t be in the markets.  

Day in, day out, people jump into the markets recklessly: without experience, without training and most definitely, without any type of formal plan. In fact, your broker may not even know the real nuances and fundamentals of safe and profitable trading themselves. And more often than not, people who open a brokerage account will lose money.

If you are serious about being a good trader, then you need to approach the practice of trading with the same level of rigor in which you would approach any high level endeavor.  The market does not owe you or anyone great riches.  The market does, however, occasionally tease a large number of people with seemingly easy gains (during bubbles and other manias) only to take them away again.

Trading is a business. It’s a profession. It’s a skill to learn.

Most businesses fail because they fail to plan.

Business planning is the backbone to success.  It shows you where you’re coming from and helps you to organize your thoughts and your objectives, and come up with a plan to keep you trading successfully and in the markets for the long term.

Therefore Van recommends that every trader or investor develops a thorough business plan to guide your trading.  And even if you are trading well, he still recommends developing a planning tool.  Those who are doing well will just have a little less work to do.

Your business plan should cover all of the following areas:

  • Your vision.
  • Your purpose.
  • Your objectives.
  • A thorough self-assessment of your strengths and weakness based upon real trading logs that you collect (if you haven’t done so already).
  • A thorough assessment of the big picture and the fundamentals that might be behind any trend.
  • A complete understanding of your beliefs about the market.
  • Procedures for getting empowering beliefs and mental states behind you.
  • A documentation of your research procedure for developing new systems and determining how to analyze their effectiveness.
  • Your procedures for developing and maintaining discipline.
  • Your budget and cash flow systems.
  • Other necessary systems such as marketing, back office record keeping, etc.
  • Your worst-case contingency plan.
  • System 1—which is compatible with the big picture.
  • System 2—which is also compatible with the big picture.
  • System 3—which might come into play should the big picture change.

If you have all of those things, then you have a chance of doing well.  But your business plan becomes a tool for you to continually use to improve yourself and your trading. 

How to Handle Hot Tips:

What happens when someone gives you a tip or idea about the market?  Do you get very excited about it and want to act?  In some cases, you probably do act.  Or, do you become skeptical and suddenly distrust the person giving you the tip?  Or do you notice if the tip fits into your game plan?  If it fits your plan, you need to do more evaluation according to the criteria that you use in your plan.  If it does not fit, then you simply discard it, saying that’s not something I know much about.

The only correct response to any “hot tip” is to integrate it into your game plan for trading to see if it fits and you can evaluate it.  An improper response is to go out and buy some closed end Thai mutual fund just because “Van recommended it."

Van discusses mental rehearsal as one of the ten tasks of trading. The point of mental rehearsal is to determine what could go wrong with your trading plan and determine how to deal with it in your mind.  That way, when it does occur under the heat of battle, you are ready to deal with any distractions that might come up.  Think of the tip you received as a possible distraction.  How did you react?

This tip is a test in several ways.  First and foremost it is a test of whether or not you even have a game plan.

Do you have a plan that helps you deal with learning of a “new sure-fire can’t lose” investment you’ve heard about?  If not, then it’s time you developed one. Just do whatever it takes to develop a thorough business plan to cover your trading or investing.

Having a plan of this nature is so important that Van ranks it among his top requirements for traders.

Every outcome is preceded by a process. You will not make money trading unless you follow a predetermined plan and continually stick to that plan. That’s why you should pat yourself on the back every day if you can honestly say that you totally followed your rules throughout the day. Every "Market Wizard" arrives at that stature by taking one trade at a time. The primary difference between that person and the average trader is that the Market Wizard probably continued to follow his plan every single day. ~Van Tharp

 

About Van Tharp: Trading coach, and author Dr. Van K Tharp, is widely recognized for his best-selling book Trade Your Way to Financial Fre-edom and his outstanding Peak Performance Home Study program - a highly regarded classic that is suitable for all levels of traders and investors.

Workshops:

Make your plans now for upcoming workshops. 

Back to Back workshops are color coded below

How to Develop A Winning Trading System
Aug 25-27
Raleigh, NC
Day Trading
Sept 16-18
Raleigh, NC
Peak Performance 101
Sept 23-25
SYDNEY, AUSTRALIA
How to Develop A Winning Trading System
Sept 27-29
SYDNEY, AUSTRALIA
17 Steps To Become A Great Trader
Oct 23-25

Includes a networking dinner at Van Tharp's home, October 25th

Raleigh, NC
Mutual Funds & ETFs
Oct 27-29

Includes a networking dinner at Van Tharp's home, October 25th

Raleigh, NC
Peak Performance 101
Nov 3-5

Includes a networking dinner at Van Tharp's home, November 5th.

Raleigh, NC
Peak Performance 202
Nov 7-9

Includes a networking dinner at Van Tharp's home, November 5th.

Raleigh, NC

 More Info...

 

Trading Tip 

Trading Tip

A Review of Market Models:  Momentum Indictors for Overbought / Oversold Conditions

by D. R. Barton, Jr.

In the real world, kids learn what momentum is in two ways.  They learn about it in the classroom somewhere around sixth grade.  And they learn about it on the playground as soon as they’re big enough to walk.

The lesson learned on the playground when a bigger kid runs over a smaller one is usually remembered long after the academic lesson is forgotten.

In the trading world, we find the same thing; people remember the effects of momentum on their charts and in their account equity long after the formula for MACD is forgotten.

Momentum indicators are certainly pervasive in the technical trading literature.  But are they any good?

Momentum Indicators:  Misnamed, But Still Useful

Every sixth grade science student can tell you that momentum is calculated by the mass of an object times its speed.

But in technical analysis, when someone talks about momentum, they mean the rate of acceleration of a stock or commodity’s price.  Therefore, momentum in trading terms is really a “rate of change” indicator, that has been misnamed as momentum.  But the designation is universally accepted, so we’re stuck with it.

What if “rate of change” or “rate of acceleration” doesn’t mean much to you?  Momentum is really much easier to understand on the playground – or the traders’ playground – known as a price chart.

In simple terms, momentum is all about the slope of the bars on the chart.  Steeper bars, either up or down, equals more momentum.  Flatter bars, means lower momentum.

There are loads of momentum indicators out there.  Some of the more popular ones are MACD, Stochastics, RSI, and Williams %R.  All are used in two distinct ways:

1.      To determine overbought or oversold conditions in the market.

2.      To show divergence between price moves and rate of change.

Today we’ll talk about the first use and cover the second use next week.

Is it theoretically credible?  Yes – very much so.  Most momentum indicators are built as oscillators that move within a prescribed range. At the top of the range, price has moved up far enough that a correction is likely.  At the bottom of the range the opposite is true.

Who’s it most useful for?  Folks looking for a tool to predict short or long-term market turns.

How Fanatic are the fans?  Pretty modest.  As with most standard technical tools, little cheerleading is needed to convince people where momentum indicators are effective.

Is it being used by real-life traders?  Yes.  Almost every trader that I know looks at one or more of these momentum indictors on a regular basis.  Few use them as their primary tool, but almost everyone uses them as support tools.

Next week we’ll continue our series with using momentum indicators to spot market divergences.  Until then…

Great Trading!

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. 

 

Listening in...  

From the Van Tharp Mastermind Forum:

Changing Market Conditions, How best to handle them?
Author: TyphoonTycoon
Date: 06-13-06 04:29

I've been playing around and experimenting with various trading systems for a while now on various financial instruments (mostly Forex) and from my own understanding, there appears to be two broad types of Market conditions, trending and ranging.

I've only ever succeeded in designs systems (or a suite of different trading systems) around one of those market conditions, but never both...

1. Trend based systems (e.g Moving Average based systems) work well in trending markets, but drawdowns come thick and fast in a ranging market as you get whipsawed in and out.

2. Ranging systems (e.g the grid scalping type systems, which rely on the market to come back OR oscillator based systems) are lucrative in range bound markets, but once the market begins to trend strongly, they too result in quite severe draw downs.

The main angst is that I've never been able to sufficiently detect in a timely manner (before profits get significantly eaten into), when market conditions for a particular system, (the system is not fit for current market conditions) change and when I should stay out

and vice versa...

I've always had trouble detecting in a timely manner (before a significant opportunity to profit is lost) when market conditions are now ripe and when I should get back in.

The question I wish to ask the panel is...
Does anyone have a concrete set of rules to determine when to either stay out -or- when to dive into your tool box and grab another system more suited for current market conditions to trade?

Reply To This Message 

Re: Changing Market Conditions, How best to handle them? 
Author: PMK
Date: 06-13-06 07:18

First, I believe that the volatility in a market is also a factor in its classification (low, normal, high) as well as trend, so that should be added to your consideration.

Second, I also believe it is impossible to predict when a market will change volatility or trend, so attempting to 'turn a system off or on' based on market classification is generally counter-productive since one runs the risk of missing a large winning trade when conditions do change (this is obviously more of a problem for a long-term system that depends on a small number of big winners for the positive expectancy, rather than a short-term pattern system (for example) that relies on the repeated application of a small edge).

Therefore I suggest you develop a suite of non-correlated systems that work in different timeframes, markets, trends, and volatilities. In this way (assuming systems are designed to lose as little as possible when conditions are not favorable) your trading should adapt to different market conditions and still be profitable overall.

Hope this helps.

Paul King

Reply To This Message 

Re: Changing Market Conditions, How best to handle them? 
Author: Terry
Date: 06-13-06 17:52

Heng,

Market conditions have a tendency to be so fleeting, that by the time you are aware of the change, your opportunity has vanished.

I also view market conditions in terms of being range-bound or trending but I realize these are basically descriptions after the fact. In between those conditions are a million different variations which suggests that to take advantage of those variations, you need to adapt rapidly.

Instead of looking for a new tool to describe what is going on, maybe a different way to think about what the market is doing is to view it in the context of the tools you presently use. Let me give you an example.

I should first preface my example with the fact that I use a couple indicators...a volatility channel and moving averages for support and resistance. If my volatility channel is above my moving averages I'm thinking long....below it, short.

Last Friday(9jun06), the S&P e-mini mkt. opened up about 5 pts. higher than the preceding days close. Thursday(8jun06) was a wild day with a range of 26.25 pts. ....trended down all morning hitting its low just before 12:00, went sideways with a slight upward bias for about an hour and a half, and then proceeded to climb the rest of the day to reach a new high before the end of the day. It closed off its high by about 6.5 pts. What a roller coaster. That was the setup for Fridays open!

After watching Fridays open and looking at the action for the first hour and a half, a couple of things were apparent. First the market seemed to be catching its breath and the volatility was much more subdued....price was moving sideways and even though my volatility channel was above my moving averages (I'm normally looking to buy), this market looked spent. Volatility shrunk, trade facilitation to the upside seemed to be cutoff, and there was no follow through. At this point it is a little after 11:00 and the high for the day was 1274.25 just after 10:30. With no new buying coming in I am thinking of selling this market. If the high of 1274.25 isn't taken out and I can find a good location to enter, I'm going to go short. Right around 11:30 price broke through my volatility channel to the upside and I got short at 1272 even. The risk seemed reasonable considering the information the market presented to me and as it was the trade worked out very well (5pts.)

I never change my indicators... I just use them to guide me in how I view information the market is giving me. I create an idea of what seems reasonable in relation to how well the market is facilitating trade and then put it on. If it works fine...if it doesn't, then I cut my losses and move on to the next idea. If you can jump on your idea early, you have a decided advantage.

I hope this is somewhat useful for you. This is how I look at markets.

Good trading to you!

Regards Terry

Participate on Van's Trading Forum, 
a place for traders and investors to share ideas and learn from each other

 

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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Cool Trivia:

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Free Trading Simulation Game

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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