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Tharp's Thoughts Weekly Newsletter

August 06, 2008 — Issue #384  
  
Workshops

September Workshop Schedule - Reserve Your Seat Now!

Article

Implications of a Secular Bear Market Part II by Van K. Tharp, Ph.D.

Trading Tip

Online Trading Platforms Part I: The Tools of the Trade by D.R. Barton

You're Invited

Dinner with Dr. Tharp

Melita's Corner

Time to Dream by Melita Hunt

Coming Soon

September Workshops

September 20-21-22 Peak Performance 101 with Van K. Tharp

Free yourself from internal conflicts that keep you from performing at a peak level.

Learn more...

September 24-25-26 Advanced Peak Performance 202 with Van K. Tharp

Dr. Tharp's ultimate psychological workshop. 

Learn more...

 

Feature

Implications of a Secular Bear Market 
Part II:
Van's Response to a Reader

by
Van K. Tharp, Ph.D.

The following article is in response to an email from one of our Tharp's Thoughts readers regarding the article Implications of a Secular Bear Market published two weeks ago. Click here to read the original article.

I have decided to spend some time responding to his/her comments in case other people have misinterpreted or focused on the wrong things in my article. I hope this helps to reiterate what's important in my article. His/her email is in italics and my responses are in regular type. 

The opening paragraph of Tharp’s Thoughts on the Secular Bear Market is pure dribble. Your credibility is at stake writing stuff like this: “By the end of 2000, I said to everyone that we were in a secular bear market that would last 15 - 20 years. When the bull market of 2003 happened, the media announced (and many people believed) that the bear market was over and a new major bull market had begun.”

The Dow rose over 30% since your call of a 15 - 20 year secular market. Hardly a bear market! 

In my opinion, the 30 Dow stocks do not represent the U.S. stock market. But since the end of July 2000, the DOW has risen from 10511 to 13397 (with about 300 pts of that in the last two days). That’s a 30% rise, but it amounts to a compounded annual growth rate of 2.46%. And during that time the dollar has dropped from 100.82 to 70.84. That’s a drop of 30%, so that pretty much cancels out the 30% gain.

In addition, inflation over the last 8 years in the U.S. is shown in the following chart from www.shadowstats.com. The red line marks the start of the secular bear market. The government CPI figures, which have been manipulated since 1983, show inflation at about 3% per year. The old CPI figures show inflation averaging about 10% per year since 2000. I don’t see how anyone can be happy with a 30% gain in the DOW over the last 8 years. 

As a systems educator you know that there are far too many variables at play in the markets to make such a prediction, especially such a long term one. May I suggest that you examine your own biases especially when you announce your purpose as such?

I agree with you. You don’t make money through predictions. However, I do believe that trading systems should fit your beliefs about the big picture. My beliefs say we are in a secular bear market and I post results every month in Tharp’s Thoughts as a update. I’ve been doing that since Safe Strategies for Financial Freedom came out just to see if I needed to say, "Okay, I was wrong and things are different.” But even during the bull market of 2003, I didn’t see anything to change my mind, especially since the dollar went down 40% while the S&P 500 went up 30% in 2003.

My purpose in writing the article was because so many people tell us, “I don’t want to learn anything complicated because I’m just an average investor.” Well, NO ONE can afford to be an average investor in a secular bear market.

Furthermore, my definition of a secular bear market comes from the rather amazing work of both Ed Easterling and Michael Alexander. Ed’s bookm, Unexpected Returns: Understanding the Secular Bear Market, was published in 2005, but I’d seen his work many years earlier. Ed perfectly explains why secular bear markets occur and why they have nothing to do with the economy. I don’t want to get into his logic here because this is to be a short article, but I suggest you read his book. Ed also showed great curves predicting what the market might do over the next 10 years beginning in 2000 on his web site, www.crestmontresearch.com. Furthermore, Ed has published, for many years, great charts showing returns over many years on his website – just to show that during secular bear markets you cannot buy and hold. 

Michael Alexander’s book was actually published in 2000 in which he also predicted the beginning of a huge bear market. His book, Stock Cycles: Why Stocks Won’t Beat Money Markets Over the next 20 Years, is also excellent reading.

Lastly, I’ve written 3-4 articles on the secular bear market in Tharp’s Thoughts over the years. The secular bear market is one of valuations, not prices. Now in an inflationary bear market (which is what we are in), we could see the dollar deflate to a value of 10 cents while the DOW goes up to 50,000. So the dollar loses 90% while the Dow goes up 4 times. A terrible trade off, but that's what you might get in a secular bear market.

Such bear markets last until PE ratios go to single digits and that’s a long way away for the S&P 500 from where it is now. It could easily drop another 50% or more. The drop in valuations that happen during a secular bear market is one reason I’ve stopped using the 1-2-3 model that we presented in Safe Strategies. PE ratios have declined to the point where that model will start to turn bullish. However, I don’t expect the secular bear to stop until the PE ratios get into the single digits like they did in 1982 and 1949 – the end of the prior secular bear market.

Taking a 10 year period as you have in the quoted paragraph below and ignoring what has happened in between is spin doctoring to suit your current marketing bias. C’mon, get real. And get objective, just like a systems trader should be.

“On July 20, 1998 the S&P 500 stood at 1140.80. Ten years later on July 16, 2008 the S&P 500 stands at 1245.36. That amounts to a 10-year gain of 104.56 points or 9.1% in ten years. That’s a compounded annual growth rate of 0.88%. That’s what I’d expect from a secular bear market, and it could get much worse.”

Okay, since the secular bear market started in 2000, the real return on the S&P 500 has been a minus 13% or a CAGR of minus 1.2%. I thought I was being rather fair by including the last two years of the secular bull market. The buy and hold people usually quote the returns over a ten year period and that’s what I was doing.

But remember my purpose in the article was to respond to the many people who say, “I’m just an average investor. I don’t want to do anything complicated.” My purpose was to say that you cannot afford to be an average investor. YOU CANNOT AFFORD TO BUY AND HOLD IN THIS TYPE OF MARKET.

And then continuing in your article quoting the media…... As a trading systems educator you are supposed to teach objectivity through using a system that emanates from the market and here you are joining the “noise” brigade.

I don’t know how many people on our database consider themselves to be average investors as opposed to professional traders, but it’s probably quite a few. The media is basically controlled by its advertising and they want you to think the following:

  • You should buy and hold to make money.

  • You cannot time the market.

  • Making money is all about picking stocks.

  • If something goes wrong, you picked the wrong stock.

  • If Warren Buffett holds on through 50% drops because then things really are a bargain, then you should do so as well.

  • Now that the market is down, it’s especially attractive and you should buy all you can and just hold it.

As I said in the article, this is very, very dangerous for the average person. It’s pretty much like trying to build a bridge or managing a computing system or operating on someone all without any training. You could NOT do those things in your respective occupations – instead, you get many years of training. But you can do that in the market. And the result is financial suicide. Only day trading systems and swing systems are working in today’s environment, so position traders should probably be 100% cash – although that position might change next month and I’d say that in my monthly update.

So what are you trying to accomplish? ( I added this question just to complete this article because I want to reiterate what was important in my previous article rather than emphasize my opinion about the state of the market which is what the reader was reacting to.)

I actually thought that the article on the secular bear market was one of the more important articles I’ve written. And part of the reason for that was my message to people. The comments pretty much ignored that message. Let me repeat that I think people who develop systems need to be aware of the big picture. They need to develop systems that fit the big picture. And they need to be ready with other systems when the big picture changes.

These were the important points in that article:

  • Trading is 100% psychology so you must master yourself.  However, everything is psychology, so that’s why I can make that statement.  You can only trade your beliefs (which are psychological filters to reality).  Even the act of executing a trade involves the mental strategy of 1) seeing the signal; 2) recognizing that this is the signal you should take; 3) feeling good about it; and then 4) acting.

  • Given that everything is psychological, success in the markets is 60% discipline, 30% position sizing, and 10% system.  You can have a great system that will be destroyed by mistakes created by a lack of discipline.

  • You should never enter into a position without having a worst case exit, which I call 1R (R stands for risk).  You also need profit taking exits.  The bottom line is that you should always be looking at cutting your losses short (making them 1R or less) and letting your profits run (making them much bigger than 1R).

  • You need to develop a business plan that includes (but there is a lot more) the big picture, at least three non-correlated (totally different concepts) systems, and a worst case contingency plan.

  • Your system must fit your beliefs about the market or you will not be able to trade it properly.

  • You need to know how your system will perform in various types of markets.  And my definition of market type (based upon the S&P 500) is published monthly in Tharp’s Thoughts.  When you have a market type in which your system does not perform well, you shouldn’t be trading a system that works in that type of market.

  • 90% of performance variability is due to position sizingSM and few people understand that concept.

  • If you don’t know yourself, then you cannot determine what you really want from the markets.

  • Your system has nothing to do with meeting your objectives.  You meet your objectives through position sizingSM.  Few people understand this, even those who understand the impact of position sizingSM.

You can make money under these conditions, and you can do so without doing a lot of work (perhaps trading a few hours a day). For example, we have systems that I would define as Holy Grail systems. Some of them are even fairly long term, but you must know when to apply them. And most of you, right now, would make so many mistakes trading them that you would destroy them – at least until you have done the necessary preparation work. 

Furthermore, let me repeat. You meet your objectives through position sizingSM. A Holy Grail trading system would only make it easy to do.

But to get to the point where you can do that easily requires some work. And please don’t use the excuse, “I’m just an average investor!” Did you start in your regular profession without any training, saying “I’m just an average doctor or engineer or IT professional?” No, you didn’t. You prepared yourself. What most of you are doing as “average investors,” trading in today’s market conditions without adequate preparation, is equivalent to operating on someone’s brain without any training or building a bridge without any training! If you did so, the person you were operating on would probably die and the bridge would probably collapse. Investing in today’s secular bear market without thoroughly understanding all of the above principles means that your financial nest egg will probably die. Many of you did that in 2000-2002. Please don’t keep doing it. Educate yourself.

About Van Tharp: Trading coach, and author, Dr. Van K. Tharp is widely recognized for his best-selling book Trade Your Way to Financial Freedom and his outstanding Peak Performance Home Study program - a highly regarded classic that is suitable for all levels of traders and investors. You can learn more about Van Tharp at www.iitm.com.

 

Workshops

Dinner at Dr. Tharp's 

All Peak 101 and 202 attendees are invited for dinner with Dr. Tharp, Monday September 22, 2008.

September 20-21-22 Peak Performance 101
September 24-25-26 Advanced Peak Performance 202

Click here for pictures of our April 2008 dinner.

 

Trading Tip

Online Trading Platforms
Part I:
The Tools of the Trade

by
D.R. Barton

It’s not the floor, it’s the dancer. --Workshop attendee lamenting to debate on trading platforms

I was in the grill at the golf course last week and overheard a group of players discussing golf clubs. Okay, since they were loudly discussing the merits of different brands and generally raising a ruckus, I wasn’t actually “overhearing” their conversation – I was being subjected to it against my will. But the cheese steak sandwich was quite good, so I listened and munched.

As the debate raged on, I noticed a very peculiar development; amid the flourishes about Ping irons and Calloway drivers, I never heard anyone talk about their swings. Just about their equipment.

As you all know, there is a trading and investing analogy that relates directly to the golfers enjoying a cold beverage in the grill at the 19th hole. There are a couple of them, actually. One could center on trading indicators and technical tools. (Fodder for another series.) But for today, let’s dig into another trading tool where passions run deep.

Any time a group of traders get together, the easiest way to start a lively conversation is to start talking about trading platforms.

Some folks have very strong convictions – even bordering on fanaticism. And since our discussion of low and no-cost internet tools for traders and investors was so well received in the spring of 2007, I thought we might kick off a lively debate on the pros and cons of various trading platforms, and their component parts.

The Trader's and Investor’s Software Toolbox

Every trader and investor needs a window into the financial markets. For some, the daily newspaper or a Saturday copy of Barron’s and a phone to call in an order is all they need. But for the vast majority of traders and investors today, online charting and order entry are a way of life. Let’s take a look at these tools and the roles they play for the modern day trader.

The trading platform has a few component parts. Some people prefer to use an integrated solution that ties them all together, while others prefer an “a la carte” approach. Here are the basic components that make up most trading platforms:

  • Charting Package. This is the dashboard – the window to the world. In the most basic form, this would include charts and a selection of indicators to put on the charts. Some basic charting software stops there. Online charting sites like stockcharts.com have very useful functionality for no cost (with premium packages for users to add bells and whistles).

  • Other Charting Package Functionality. Some graphical packages include other items like quote boards (lists of stocks that have various information like daily high, low, net changes, volume, etc.), Time and Sales windows (a listing that shows every trade or tick with the time and number of shares or contracts exchanged), Level II windows (that show the depth of the bids and offers at different prices for a particular instrument), and options chains (windows that show the bid and ask for various option strike prices and expiration months for puts and calls of a particular instrument).

  • Order Entry Platform. This is where you enter your orders to buy and sell. This component can be integrated with the charting platform, or be a stand-alone product. They range from very plain versions with basic capabilities to highly sophisticated automated tools with every imaginable bell and whistle. Of course, this is the component that has commission rate structures associated.

  • Data Streams. Many packages come with their own data supply. Others require you to purchase or access data, so this becomes another area where attention must be paid.

Next week we’ll look at some popular platforms and start digging into the pros and cons of the various options available.

Until then keep those comments coming to drbarton “at” iitm.com and let me know your favorite trading platforms and why you like them (or the ones you tried that didn’t pan out)!

Great Trading!
D. R.

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.  He is a regularly featured guest on both Report on Business TV, and WTOP News Radio in Washington, D.C., and has been a guest on Bloomberg Radio. His articles have appeared on SmartMoney.com and Financial Advisor magazine. You may contact D.R. at  “drbarton” at “iitm.com”. 

 

Melita's Inspirational Corner

Time to Dream

by
Melita Hunt

This week I am going to share a simple exercise with you that I did about ten years ago. I hope that you will take the time to do it because I actually found it very beneficial. It really gave me a snapshot of where I wanted to head, what my subconscious wanted and where I was actually situated at that particular time.

I still look back at the answers now and am able to see where I have changed, where I am stuck (and haven’t changed), and what I need to do to head towards my goals. It’s amazing that something so simple can be so helpful.

It will take you about 20 minutes to complete it if you do it properly and do not ponder or think too much about your answers. The best answers are spontaneous and written down quickly. So you will have a time limit and cannot go back and change any answers. 

There are 12 questions and you are going to answer the same questions 6 times (using 6 different time frames). Therefore, you will need to project yourself into the future and think of how you will answer the question at the age that you are at that particular time. For example, if you are 40 years of age now and the projected time frame is 25 years, you will answer the questions based on what you believe the answers will be in the year 2033, when you are 65 years old.

So, to get started you will need 6 pieces of paper, or you can work directly on your computer using a new page for each time frame. 

The time frames are as follows: 

  • 2033 – 25 years from now

  • 2023 – 15 years from now

  • 2015 – 7 years from now

  • 2010 – 2 years from now

  • February 2009 – 6 months from now

  • August 2008 – Today

You will be starting with the furthest time frame (25 years) and working back from there; therefore, the answers for “today” will be the last ones that you answer. You have 3 minutes to answer all twelve questions in each time frame. Do not go back and change your answers. If you run out of time and have not completed all questions, leave them blank and move onto the next page and time frame anyway. 

Each time you work through the set of questions, your answers should reflect that period of your life; subsequently, they should change. However, it is perfectly okay if they stay the same. You'll be covering a 25 year period, starting 25 years from now and ending with the answers that are relevant today.

Remember, the whole idea of this exercise is to dream and project yourself into future time frames. Imagine yourself at whatever age you are on that particular date and just “make up” the answers and jot them down as quickly as you can, then move onto the next one. There are no right or wrong answers and of course you do not know if your thoughts will ever come to fruition, but it is a great exercise to see where your brain is at this given moment. You may just surprise yourself. 

The truth is, how do we know if we have 6 months, 7 years or even 25 years left to live? The goal of this exercise is to see whether the things that you are doing today are in alignment with what you say you would like to experience 25 years from now. Are your current actions moving you towards or away from your projected future life? 

Have some fun with it and see what you find out. 

Here are the 12 questions (don’t read them until you are ready to get started). Be as specific as you can with your answers in the 3 minutes that you have:

  1. Where do I live and what is my standard of living?

  2. Who am I surrounded by and who do I spend most of my time with?

  3. Where do I work and what do I do? 

  4. What are the three main things that I do with my time?

  5. How much money do I have? What do I do with my money?

  6. What is the best vacation or trip I have ever taken?

  7. What is my biggest accomplishment in life so far?

  8. What awards or recognition have I received?

  9. What do I still want to accomplish in my life?

  10. What type of health am I in? How do I stay healthy?

  11. What do people say about me? 

  12. What do I say and think about myself?

Melita Hunt is the CEO of the Van Tharp Institute. If you would like to keep up with Melita’s progress regarding her recently diagnosed lung cancer (she is a never-smoker). Please feel free to read her blog at www.myleftlung.com. You can contact Melita at mel@iitm.com

 

Feedback

Feedback to Dr. Tharp and the Van Tharp Institute

Everything that we do here at the Van Tharp Institute is to help you improve as a trader and investor. Therefore, we love to get your feedback, both positive and negative!

Feel free to click below to leave us any comments so that we can serve you better.

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Copyright 2008 the International Institute of Trading Mastery, Inc.

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Tharp Concepts Explained...

 

- Psychology of Trading

- System Development

- Risk and R-Multiples

- Position Sizing

- Expectancy

- Business Planning

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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.

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