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Tharp's Thoughts Weekly Newsletter

August 29, 2007 — Issue #336
  
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Article

The State of Day Trading – Plus a Market Update by D.R. Barton, Jr.

September Workshops $500 Discount Expires Next Week on Day Trading Workshop
Trading Tip

The Easiest Lesson of Successful Investing, by Dr. Steve Sjuggerud

Melita's Corner

Changing Beliefs, by Melita Hunt

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Feature

The State of Day Trading – Plus a Market Update

by D.R. Barton, Jr.

At the end of the summer, many more folks are thinking about that last vacation fling rather than the markets.  And so August is usually a boring, range compressed time for traders.

But this year, the market forgot to follow the script!  By the time August had started – BAM!!  Volatility had hit the market like a handful of spices slamming into Emeril’s meatloaf.

This volatility thundered in on the heels of the first true correction (a drop of 10%) that the S&P 500 cash index has seen since March of 2003.

Volatility has started regressing toward the mean over the past week (starting Tuesday 8/21), but it has not left us yet (as witnessed by yesterday’s range of 34+ points on the S&P cash index).

I’ll only say a brief word about the “why” and then let’s concentrate on the “what to do” part!  It’s clear that the credit contraction has damaged the market both financially and psychologically.  This is a serious problem – and by most accounts we have not seen the worst of it yet.  The number of questionable loans that were made but have not yet reached “hard decision points” far outweighs the smaller number of loans that have already caused problems. Add to this the fact that lenders have done the “predictable corporate over-reaction thing” and swung the pendulum from “money is available to anyone with a pulse” all the way to “King Midas can’t qualify for a loan” and you have problems that can’t be overcome by one 50 point Fed rate drop.

BUT… The financial markets are multi-faceted and sophisticated.  Central banks can keep the wolf from the door for long periods of time by injecting more and more liquidity into the markets (as they have been doing).  Because of cash infusion, it’s almost impossible to make reasonable long-term analysis of the markets.  They could resume their upward climb, bloated by central bank paper, for months (or longer).  But make no mistake, the credit contraction will extract its pound of flesh from the market.  As my good friend Christopher Castroviejo reminded me, “Loans are always repaid – sometimes by the borrower, sometimes by the lender”. 

My concern is that the market drop, when it comes, will be harder and longer because of the “propping up” actions that have been taken.  But that’s a story for another day…

For now, what does all this mean for traders and investors?  Well, it’s a mixed bag.

Day traders love the volatility!  Directional players are largely getting eaten alive as the market dashes one way, stops on a dime and reverses for an explosive run in the opposite direction.  Really long- term investors have seen some sizeable drawdowns and stop outs.  Intermediate and swing traders either have systems that adjust dynamically to the volatility or are “dying the death of a thousand cuts” as they get stopped out time and time again. 

For today let’s talk about what’s going on in the day trading world, which has been eating up this nice volatility.  Day trading strategies are working really well because the extra volatility brings a greater number of opportunities per day with bigger per trade payoffs.

Let’s take a look at some of the advantages that day trading brings us as well as some of the downside aspects of trading in that time frame.

Advantages of  Day Trading

Reduced Risk.  First and foremost, intraday trading eliminates “overnight gap risk”.  This is so significant that brokerages give any customer who opens a stock day trading account twice as much leverage for day trading as for overnight trading.  And because we don’t have to factor in overnight gap risk, day traders can use more aggressive position sizing techniques.  And the fact that positions are closed at the end of the day leads to my next point.

Sleeping Easy at Night.  Day traders don’t have to worry if some news is going to hit after the market closes that blows up a position.  I’m sure folks out there have had the misfortune of being on the wrong side of overnight news.  People who got short on the big down day (August 16) only to wake up and find the Fed cutting rates by 50 basis points, gives us a poignant reminder of this danger.

Leverage.  The reduced risk of day trading allows traders to use 4-to-1 leverage on their trading accounts.  By SEC rules, traders must maintain a $25,000 account size to get this leverage rate.

No Margin Interest.  Because the extra leverage, or margin, is only used for less than one trading day, no interest is charged for using this extra leverage.  Just another added perk for day traders!

Trading Styles for Everyone.  One of the things that surprises many people is that most day traders do not trade like they’re playing a video game!  Many people comment that when Brad Martin trades live during our day trading workshop that he’s calm and takes only a select number of trades.  Sure there are profitable scalping methods for quicker paced traders.  But most of the useable day trading strategies are much more about patience than speed!

The Down Side of Day Trading

There are also some issues to counter balance all of the positives offered by day trading:

Leverage – the Other Side of the Sword.  Great leverage can bring great reward.  But it also brings greater risk.  Our logical mind will quickly tell us that if we can trade four times the value of our account, we can get bigger gains – but also bigger losses.  Proper position sizing is a MUST for day traders.

Overtrading.  There is a definite tendency for day traders to take too many trades.  Because today’s trading platforms have made it so easy to execute trades, many traders fall into the trap of taking too many low quality trades.  The development of a good trading plan and the use of high- quality strategies (along with a little discipline) can mitigate this problem area.

Trading Psychology.  Because there is the opportunity to trade more often and with higher leverage than in other trading time frames, day trading tests the trader’s psychology exponentially more than any other trading style.  As the old saying goes (credited to George Goodman), “If you don’t know who you are, the stock market is an expensive place to find out.”

Trading psychology is so important for day traders that the upcoming course that I teach with Brad Martin has a brand new section on trading psychology that has been developed specifically for day traders.  We’d love to have you join us there in just over two weeks.  For more information click here.

About D. R. Barton: 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.

September Workshops


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"Day trading has one huge and undeniable advantage over every other trading time frame: Reduced Risk".

 

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September 18

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Trading Tip

The Easiest Lesson of Successful Investing

by Dr. Steve Sjuggerud

B.P. – a subscriber of ours – just got burned in the markets...

In just one stock, "I have lost almost $13,000," he told us via e-mail. "I have now been stung, and I learned my lesson."

The reality is, he already knew the lesson. He just didn't apply it.

He knew he wasn't following "the rules." He knew a loss of that size was his own mistake. He told us in his e-mail that his loss "validates your constant reminder to [follow the easiest lesson of successful investing]."

Losing $13,000 in one stock did it for B.P. He told us the easiest lesson of successful investing "is now burned in my brain, and I will always be careful."

Today, I'll share with you the lesson that B.P. chose to ignore...

I've got to warn you though, for some reason, the easiest lesson of successful investing seems to be the hardest to apply...

There's a funny thing about it. When I share it with someone who has never invested before, they understand it immediately. It makes total sense.

But when someone is emotionally connected to his investments, he often fights it. He can't seem to follow through. And then he loses money. Sometimes, he loses a lot of money before he finally "burns it in his brain," as B.P. said. Some people are so stubborn; they keep on losing money.

Mark Twain's famous quote applies here... "If at first you don't succeed, try, try again... But then give up. There's no sense in being a damn fool about it."

The easiest lesson is incredibly simple: Keep your losers smaller than your winners.

Most people sell their winning positions once they see a small profit – maybe 20%. But most people don't sell their losers, meaning their downside risk is 100%. Therefore, most people invest with 20% upside potential and 100% downside risk. Those are not good odds!

Said another way, their "reward-to-risk ratio" is 1 to 5. You've got to turn this around. You need to get your reward-to-risk ratio up to around 3 to 1. So how do you do it?

Well, first you need to limit your downside risk... Tell yourself you won't lose more than 25% on any stock, for example. There's nothing magical or special about 25%... it's having a plan and the discipline to stick to it that counts.

If you want to have a reward-to-risk ratio of 3-to-1, like I recommend, then you can't invest in anything that can't make you at least 75%.

So the second thing you need to do is let your winners run... Quit "cutting" your winners as soon as you see a 20% profit. Instead, change your mindset entirely... let your winners run!

For example, right now, subscribers to my letter Sjuggerud Confidential are sitting on gains of 700% in Seabridge Gold. Look, you make your big money in stocks by having a few really big winners like this. If you had "cut" this winner as soon as you'd made 20%, you would have missed out on all those profits!

Think of it like poker: Poker is not about the card; it's about managing your bets. You have to fold a lot in poker – you have to lose a lot – to win in the long run. But you're managing your money... you're cutting your losses early.

B.P. knew these rules. He knew that the way to make money is to limit your losers and let your winners ride. But he didn't do it. He told us "I lost almost $13,000 on American Home Mortgage... because I did not sell when I reached my 25% stop loss. I have now been stung and I learned my lesson. This validates your constant reminder to set a stop loss and apply it."

Don't worry B.P. I'm sorry to hear about your loss. What you just did was simply "pay your tuition." Often, we have to have a painful experience before we really hold onto this kind of stuff. You never know what your tuition fee will be in advance, before you finally take the lesson to heart.

Good investing,

Steve

P.S. In addition to getting out there and making a few mistakes, reading about the world's greatest investors is one of the quickest ways to becoming a successful investor. You can learn about several of my favorite books here.

"Reprinted with permission from DailyWealth. Written by Dr. Steve Sjuggerud and Tom Dyson, DailyWealth is a free daily e-letter focusing on the world's best contrarian investment opportunities. We write with a simple belief in mind: You don't have to take big risks to make big money with your investments. Click here for a free subscription."

Melita's Inspirational Corner

Changing Beliefs

by Melita Hunt

I remember being at a workshop many years ago and hearing about “changing beliefs” for the very first time.  I also remember just how reluctant and resistant I was to even consider working on my beliefs. I was adamant that I wasn’t at that workshop to hear or learn about beliefs. I was darn well “right” and no-one was going to use hocus pocus or hypnosis or any other thing to convince me to change who I was (or believed I was). I liked my beliefs and who I was. I thought that I was pretty cool chick and the thought of changing  was pushing far too many buttons and bringing up a plethora of fearful thoughts about who I might become if I start messing around with my beliefs. Murky waters…

After all, wasn’t it my beliefs that had gotten me to where I was at that moment? I was happy, with a great job, family and friends. I traveled often and was excited and enthusiastic about life. I didn’t want to change my friends, my lifestyle or my job. I just wanted to improve it. Life was good.

But then again, why was I at the workshop?

Well that particular workshop was all about investing in real estate, and I wanted to learn what to do and find out how I could become a guru real estate investor. What I didn’t realize at the time was that it wasn’t just the knowledge that I needed (the techniques) but more importantly, I required the belief system that I could actually be, do and have what it was that I was seeking. I knew there was something more, but I wasn’t ready to change who I was to get it. I just wanted information about real estate investing.  

When I look back at that time in my life, I realize that the thought of changing too much was terrifying to me. I had “made up” that I would lose friends, family, security, credibility, etc… "What if the 'new beliefs' that I adopted really screwed me up?" After all, my comfort zone was pretty comfortable.

In hindsight, I was fearful and just uninformed because at that time, I had the “belief” that someone else may be able to control my thoughts, or  that others could convince me and coerce me into beliefs that I didn’t want and my whole life would subsequently fall apart if I wasn’t careful.

How naïve I was because the exact opposite was true. And it took me many years to finally get the “aha” moment that I am in control of my own belief system (if I choose to be).

Here are some things I didn’t know at that time:

1. Other people had already been controlling my beliefs because I had unconsciously adopted their beliefs without question. Those of my parents, friends, the media, school, etc.

2. Beliefs guide my behaviors whether I am aware of them or not.

3. Many are useful and I can continue to believe them if I want to.

4. Many are limiting and keep me stuck in my comfort zone and these are the ones that I can get rid of, change or replace.

5. Questioning and changing my beliefs will certainly alter aspects of my life, but most of my fears were completely unfounded.

6. I’m in the driver’s seat, and I can always change direction.

7. There are many ways to change beliefs if I am willing to do so.

So let’s take a look at how to change them. There are simple techniques and there are advanced techniques. 

First you need to identify your beliefs, which we have spoken about previously. It doesn’t all have to be done in one sitting because it is an ongoing journey and actually becomes a way of life if you want it to be. Perhaps you are ready to spend considerable time journaling your thoughts, writing down things that you believe in each area of your life (self, faith, friends, family, finances, fitness, fun, etc...) or you may just want to concentrate on one particular subject. What do you say, how do you act, what are you writing about? Notice notice notice!! Becoming conscious of your beliefs is ALWAYS the first step.

Second, question the belief. How has it been useful? Is it still useful? And where does it limit me? Is there a more effective belief that I can use?

Here is an easy example:  Last week I received conflicting information from two clients about the exact same thing, and I found myself shrugging and saying “Well you can’t please all of the people all of the time.”  I identified it as soon as I thought it, so I looked at where that belief came from, questioned it and asked myself if it was useful and how it had  limited me.

It was a long held belief that I have heard my whole life, so I am not sure where it came from. I don’t like the word “can’t” so I questioned it and thought “Could I please all of the people all of the time?” That didn’t seem very useful either.

How has the first belief been useful? It has protected me from criticism and allows me to be nonchalant about the people that I haven’t “pleased.”

On the flipside, how has it limited me? Well for the exact same reasons, I notice that I shrug and become nonchalant (which is not how I want to be) and I notice that I can use it as an excuse rather than hearing criticism objectively.

All in all, I still regard part of it as a useful belief; however, I have chosen to add to it as follows:  I accept that I may not please all of the people all of the time, and will learn from each experience. In addition, I will also look at why I am feeling the need to please all people.

This is simply known as a re-frame.

Now if the first belief ever “pops up” again, guess what will come into my head in future? And it may change again and again as I learn and grow.

So beliefs can be very easy to change (unless you want to believe that it is hard work), but keep in mind that if there are any emotions or feelings attached, and reactions occur or buttons are pushed, then there is more work to do! We’ll get into that next week when we talk about noticing feelings.

There are books, workshops, classes, ways to stretch yourself, to leave your comfort zone, to do the seemingly impossible, releasing techniques, exercises, therapy, etc… The list of ways to change your beliefs is endless if you really want to.

So this week’s exercise is to notice some of the “sayings” that you have operated under throughout your life and do a re-frame on them. If you aren’t sure of any, ask someone that knows you well or listen to what others are saying and where you nod in agreement, you may just be surprised.

Feel free to send them to me, too.

About Melita Hunt: Melita is CEO of the Van Tharp Institute. She has had a diverse career working in the fields of telecommunications, accounting, marketing and sales, real estate investing, and ultimately speaking, coaching and writing; which are her passions. Her energy and enthusiasm is the cornerstone of her writing and speaking success and she has a special interest in inspiring people to be the best they can be. She has an innate ability to simplify complex subjects and enjoys traveling the world and sharing her experiences. She has worked throughout Australia, in London and is currently working in the USA. You can contact Melita at mel@iitm.com.

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