The Van Tharp Institute

February 28, 2007 — Issue #311

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In this Issue:

Workshop

Exchange Traded Funds Workshop, Discount Expires Next Week

Feature Article

Five Things We Can Learn About Trading From One Of Our Greatest Fighter Pilots, by Ken Long

Workshop

Professional E-Mini Futures Tactics

Trading Tip

China Coughs and the World Catches a Cold, By D.R. Barton, Jr.

Recommendation

Tax Time for Traders, Here's a Resource You Can Use

Melita's Corner

That Sinkin’ Feelin’, by Melita Hunt

Van Out and About

Van Tharp is Speaking at Investment University, Phoenix, March 15-16

View this newsletter on-line, or read back issues

 

Coming Soon

ETF and Mutual Fund Techniques Taught by a Master

March 16-18, 2007

Raleigh, NC 

Presented by Ken Long

"You may have heard of Ken because of his Tortoise system for switching between mutual funds. That system made over 100% trading real money in an IRA in 1999.  And its generally made pretty good money even during the bear market or you may have heard about  the many systems that he has developed with high system quality numbers. 

LTC Ken Long is one of the few people I know of, who has a graduate major in systems design.  Because of his training, Ken can spot ideas that most people never think of.  For example, when Ken attended our systems workshop and learned about the complex training game we were playing he developed a procedure for strategizing about the game that I now teach in that workshop.  He’s that good."--Van Tharp

Click Here to Learn What Ken Can Teach You...

 

Feature

Five Things We Can Learn About Trading From One Of Our Greatest Fighter Pilots

By Ken Long, Tortoise Capital Management

COL John Boyd , USAF was a national treasure.  One of the most gifted and effective fighter pilots of all time, he went on to revolutionize the way the armed services thought about command, control and combat effectiveness on the modern chaotic battlefield. He was instrumental in reforming the process by which the Department of Defense designed and procured platforms for all services.  The intellectual and visceral contribution he made to the art of war for which he is most often remembered is the “OODA Loop”, and the implications of this theory have reached every corner of our current military doctrine. I believe the insights he developed for fighter combat, and the doctrine of warfighting have an even broader applicability to the world of business and specifically to the art and science of trading.  There is already quite a cottage industry that adapts his insights to the business world. I want to briefly examine a few of his ideas and their implications for traders.

Briefly, the OODA Loop is an acronym that stands for “Observe-Orient-Decide-Act”. In his now famous diagram of this iterative feedback process, Boyd describes a “decision cycle”, a process set in motion by the recognition of a meaningful input (observe) that triggers the selection of a mental model or mindset appropriate for processing this input (orientation). The mental model and thought process generate a decision to act that steers you to a more desirable state (decide), and then this decision is put into action (Act).  There is nothing particularly novel about this sequence; it is intuitively compelling and natural.  Boyd’s genius lays in his examination of the many avenues of feedback  between each of these steps, and the implications for improving the cycle time to get from observation into action.

There may not be a combat environment that requires more precision, split- second timing, and effective decision- making than fighter to fighter combat, where the consequences of failure are so catastrophic and the margin for error so slim. This laboratory of human decision making under stress was where Boyd forged the insights that make the OODA loop a powerful combat multiplier in the air. Its applicability to all forms of competitive interaction make his story and insights so compelling. His story is well told in  Boyd: The Fighter Pilot Who Changed the Art of War by Robert Coram.

Why do you care? You might find his insights make you a better trader.  Here are a few direct applications of his insights for traders.

  1. Orientation drives the train or “Believing is seeing”:  Boyd described orientation as the integrated whole of our personal analysis and synthesis of our experience, culture, new information, and genetic heritage. In other words, it’s our paradigm, or the paradigm we are currently using if we have more than one to choose from.  It’s the context you use to frame a problem, which identifies the values you will use to evaluate courses of action, and provides the foundations of your motivation to act and compete. It feeds forward all of these elements into the Decision loop, but perhaps even more importantly it establishes the framework and sensory apparatus to seek the new observations that will trigger a new decision cycle.  Your world view, your mental model, and your paradigm act as a filter for you to sense the world and to make sense of the input you can gather.  These beliefs operate at the unconscious level to define what is knowable and what is observable.  These paradigms have evolved because they are generally a very effective way of organizing a chaotic world into a manageable entity that permits planning, goal setting and achieving. It describes our sense of cause and effect.  The pervasiveness of paradigms are such that when we experience things outside of that paradox, it can seem like the world has just come apart and we are stunned by the unexpected, the unforeseen.  It’s the experience that makes you say in surprise “Man! I never saw that coming”.  This line of reasoning suggests that we are well- served by examining our paradigms, assumptions and beliefs with care and attention, to define environments in which a given paradigm is likely to be effective, and the boundary conditions that define the limits of its utility.  Some of Van Tharp’s most powerful teachings are precisely in this area of paradigms and beliefs.
  2. Construct your dashboard wisely:  Using an older simpler and performance- inferior aircraft, Boyd routinely out-flew hot shot fighter jocks piloting the Air Force’s most sophisticated fighters,  because he was able to apply the advantage of simplicity. He flew the aircraft as an extension of his own body and will.  He had internalized to an instinctive and personal level the capabilities and limitations of his jet, and its simple, barebones dashboard layout supported rapid observation. His opponents struggled consciously to make sense of the complicated instrument panels before them that flooded them with too much information, which made them take their eyes off of Boyd while they tried to figure out what was going on. It was in that moment of sensory overload that they would routinely discover Boyd on their tail in the dominant, decisive position.  We should remember the differences between need to know and nice to know, and that newer isn’t better; better is better. As a trader, I must give careful consideration to the amount, the format and timing of my information feeds to ensure they are supporting my decision making and not getting in the way.
  3. Perfect practice makes perfect: Boyd embodied the warrior spirit and spent his life in pursuit of refining his approach to and his understanding of air-to-air tactics. He invented impossible maneuvers, and refined their execution with physical models, computer models and actual practice.  He over-trained his critical skills so that in the moment of decision there would be no hesitation and he could execute maneuvers on a dime. This insight pertains to both orientation (warrior spirit or trading identity) and decision. The payoff was performance to a high standard in the shortest possible time.
  4. Operate inside your opponents decision cycle:  This is often interpreted as simply acting more quickly, but Boyd’s insight was to add in the factor of doing the unexpected.  The unexpected is what creates confusion in your opponents mind and causes them to slow down or stop to figure out what is wrong with their paradigm.  When you multiply reduced decision cycle time AND doing the unexpected, you get tremendous payoffs.  As a trader, you have to recognize that if you do what everyone else does, you will get what everyone else gets.  And if your execution time is slow because of equipment limitations you are unnecessarily harming your performance, and if you are waiting to get too much redundant confirmation of your signals, you may be missing the opportunity in your search for certainty. Finally, this insight suggests that by looking at the market in new and different ways, you have the possibility of uncovering unique insights and fresh opportunities to get better than average results.
  5. Always wear a parachute and know the location of the ejection lever:  When you are operating in a risk filled environment, where consequences of failure have serious implications, it’s important to know when to eject, and have the opportunity to live to trade again.  Honor your stops and know the limitations as well as the capabilities of your system (which includes you).  Know your envelope of performance!

These are a few of the highlights of Boyd’s insights as applied to the world of the trader.  I hope this essay has given you some things to think about before you get into the cockpit for your next trading mission.

Cheers!

Ken

Ken Long, a retired Lieutenant Colonel in the U.S. Army with a Masters Degree in System Development, is currently a professor of tactics and logistics at the Army's Command and General Staff College. He has developed the Tortoise Method of mutual fund switching, a trading system which takes about five minutes each week with a goal of outperforming the S&P 500 Index. 

Ken is the featured speaker at next month's Highly Effective ETF and Mutual Fund Techniques workshop, Raleigh, NC.

He is a trader, writes a daily and weekly market assessment for mutual funds and exchange traded funds. He is a proud husband, dad, and a ju jitsu practitioner. 

 

Workshop

This weekend,

Professional E-Mini Futures Tactics Workshop

March 3-5, 2007 - Raleigh, NC

Presented by D.R. Barton, Jr. and Christopher Castroviejo

Call now to register for one of the few remaining seats

Learn More ...

Trading Tip 

China Coughs and the World Catches a Cold

By D.R. Barton, Jr.

Yesterday (Tuesday, 2/27/2007) was a truly extraordinary day in the equity markets.

Here’s how unusual this drop was: it's only the fifth time in 100 years that the DJIA has gone from trading above its 50-day moving average on one day to dropping below the lows of the past 50 days the next.  In other words, it was higher than the average price over the prior 50 days, and all of the sudden it wiped out all the gains from those days in just one single day (thanks to Jason Goepfert’s excellent work for the statistics).

Here’s another way to look at yesterday’s trading – in one day, the market wiped out almost four months of bull run, dating back to the beginning of last November (in the futures).  This was no ordinary move.

But even with all of the extremes presented by the market’s activity, we have to keep some perspective. The market was only down 3.47% yesterday (for the S&P 500 cash index).  And to be considered a “correction” (which is generally considered to be a 10% pullback), we would need to travel another 6% from here, all the way down to 1315.41 to move 10% from the highs.

Today’s trading (as of 2:00) has given us an inside day (the highs of today are lower and lows of today are higher than yesterday’s trading).  But we are trading in the bottom third of yesterday’s range.

While the market could do many things from here, the extreme overbought levels that peaked late last week have only been partially relieved.  A very likely scenario is that Tuesday’s huge drop was the trigger for a larger-scale pullback.  In that scenario, Wednesday’s trading has predictably slower trading while the market catches it’s breath.

A close below yesterday’s low (1389.42 on the S&P 500 cash index) should make everyone take notice that this round of selling is not over.  But until that time, the bulls can rest a bit easier.

Great Trading!

D. R.

 

D. R. Barton, Jr. will be teaching our New Professional E-Mini Futures Tactics Workshop, March 3-5, Raleigh NC.  He will be joined by ace trader Christopher Castroviejo. To see what D.R. says about Christopher, click here.

A passion for the systematic approach to the markets and lifelong love of teaching and learning have propelled D.R. Barton, Jr. to the top of the investment and trading arena where he is one of the most widely read and followed traders and analysts in the world. 

He is a regularly featured guest analyst on both Report on Business TV,  and WTOP News Radio in Washington, D. C., and has been a guest analyst on Bloomberg Radio.  His articles have appeared on SmartMoney.com and Financial Advisor magazine.

 

Recommendation

It is Tax Time Again...

We often get emails and calls from our clients concerning their taxes.  As all of you know, Van is not an accountant or tax guy and we can’t really answer all of your questions. The best advice that we can give you is to refer you to one company that has specifically been in the business of helping traders with their taxes for close to ten years - Traders Accounting.  

As an active trader, if you are having problems understanding what forms to use and how to file them and if you are interested in finding someone who will get your taxes done correctly and keep you out of trouble with the IRS, then please take the time to visit them and see what they have to offer. 

www.tradersaccounting.com/2006tax  

 

Melita’s Inspirational Corner

That Sinkin’ Feelin’

by Melita Hunt

 

With a touch of a cold, a funeral to attend and meetings with attorneys and accountants to prepare for, I’m just not feeling particularly inspirational today. So I’m really glad that I have an inspirational piece to write, because I’m sure that there are a few of you out there who might be feeling a bit flat as well, especially after yesterday’s market drop.

So how do we turn it all around?

Self Care comes first. I always make it okay to feel a bit flat sometimes because I know that it is just the ebb and flow of life and brightness always returns.  Second, I take a look at how many of my woes are external and environmental and things that I just can’t change, which is just acceptance of what is. Third, I look at how and why I created these things in my life at this time and what are the lessons that I can learn? This is simply being personally responsible and the creator of my own life. 

And finally, I make decisions about how I am going to deal with each thing in a beneficial way so that I feel nurtured, especially while my energy is low – which is making the right choices in this moment.

So how does this relate to the markets? Well if you were fearful, nervous, scared or even negative in the last day or so – it really is okay. But take a look at how much of your woes were external or environmental. Are you focusing too much on what others are saying and doing? What can’t you change after the fact? Allow things to be as they are. 

Third, did you even notice that your feelings played a part? Do you get over confident sometimes and down in the dumps too? Or are you adamant that you can remain calm and focused in all market environments? (What? Not even a twinge?) What lessons can be learned either way?

Finally, what are the right choices for you to make right now in this moment in regards to your trading so that you can remain a consistent trader for the long term? 

I do not really think through each of these steps consciously because it has just become a way of life for me due to the self improvement work that I have done both with Van and others. And even if this sounds too “right brain” for some of you, I must say, I’m feeling much better already. 

You can contact Melita at mel@iitm.com

Van Out and About

Van Tharp Will Be Speaking in Phoenix, AZ,  March 14-17, 2007

Van Tharp will be a speaker on the "Dream Team" of experts at
The 9th Annual Investment University

Presented by the Oxford Club
March 14-17, 2007

Learn More...

Join in the discussions on our blog and forum

www.smarttraderblog.com and MasterMind Trader Forum

 

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