Five Steps to Consistent
Van K. Tharp, Ph.D.
The goal of my Super Trader program is to help people develop a full time trading business that produces consistent, above average profits under various market conditions. This means that you can perform profitably in up markets (both quiet and volatile), in down markets (both quiet and volatile), and sideways markets (both quiet and volatile). And to help
traders reach this goal, I’ve designed a five step approach. If you are reading this, then you probably would like that sort of performance, even though you may not be part of the Super Trader program. My objective here is to familiarize you with the five
1. Work on yourself and your personal issues so that they don’t get in the way of your trading. This step must be accomplished first; otherwise, it would interfere with each of the other
2. Develop a business plan as a working document to guide your trading. This business plan is not to raise money, which is the purpose
of many business plans. Instead, it’s designed to be a continual work-in-progress to guide you throughout your trading career. The business plan actually helps you with all five of the steps. The plan also includes an overview of the big picture influencing the markets you will be trading and a method for keeping on top of those factors so that you will know when you are wrong. My view of the big picture is updated in the first issue each month of
3. Develop several strategies that fit your view of the big picture and understand how each of these strategies will perform under various
market types. The ultimate goal of this step is to develop something that will work well under every possible market condition. It’s actually not that hard to develop a good strategy for any particular market condition (including quiet, sideways). What’s difficult is to develop one strategy that works well under all market conditions—which is what most people attempt to
4. Thoroughly understand your objectives and develop a position
sizingSM strategy to meet those objectives. Probably less than 10% of all traders and investors understand how important position
sizing is to trading performance and even fewer understand that it is through position sizing that you meet your objectives. Thus, the fourth step is to develop position sizing strategies for each system that will help you meet your
5. Monitor yourself constantly and minimize the number of mistakes that you make. I define a mistake as not following your rules. Thus, for many people who have no written rules, everything they do is a mistake. But if you have followed the first four steps, then you will have rules to guide your trading and you can define a mistake as not following those rules. And, of course, when you repeat the same mistake over and over again, then that is self sabotage. However, by monitoring your mistakes and continuing to work on yourself, you can minimize the impact of such mistakes.
People who do this, in my opinion, will tend to produce consistent, above average
Part I: Working On Yourself
This part of the program is so important
because everything you do is shaped by your beliefs – in fact, your reality is basically shaped by your beliefs. What’s a belief? Every sentence I’ve written (including this one) reflects my beliefs. Every sentence that comes out of your mouth reflects your beliefs. And your beliefs shape your reality. Who you think you are is shaped by your beliefs.
Let me give you an illustration of how that works. My niece from Malaysia came to live with us when she was 19 years old
(my wife and I were putting her through college in the United
States). After she’d been with us for a year, one day she said to me, “Uncle, in my next lifetime, I would like to be born beautiful and talented.” Let’s see, she is very artistic. My wife has become a professional painter, but my niece actually completed the initial art course faster than my wife did – she was so good. In addition, she sings like an angel.
Also, coming from a liberal arts background she got a degree in biomedical engineering, graduating cum laude. I think she passes the talent criteria with flying colors.
As far as beauty, I’d describe her as one of the most stunningly beautiful women I’ve ever seen.
And everyone that meets her comments on how beautiful she is. Here was an incredibly beautiful and talented woman, who because of her beliefs, didn’t think she had those qualities at all. Your reality is shaped by your beliefs. By the way, I’ve been working on those beliefs of hers since she’s been living here, and she’s finally coming
So who you are is basically shaped by your beliefs about yourself. In addition, you do not trade the markets. Instead, you trade your beliefs about the market. So one of the key aspects of working on yourself is to examine most of your beliefs to determine if they are useful. And if they are not useful, then find beliefs that are more useful. This is one of the key aspects to working on yourself.
You probably will never be free of limiting beliefs and some aspects of self-sabotage during your lifetime, but I consider this step to be complete when you transform about five very limiting aspects of your life and you feel very different about each. Once you’ve accomplished five such transformations, then I consider you capable of generally overcoming future roadblocks that might come up in your
Part II: Developing a Working Business Plan
The business plan part of trading includes step one. In fact, a good business plan includes a thorough examination of the person who is doing the trading – beliefs, issues, strengths, weaknesses, goals – everything you can possibly think of about yourself should be included in this
However, the plan should also include many other important things:
Your assessment of the big picture and how you’ll keep up with it. For example, I wrote about the possibility of a huge secular bear market in 2001 when I first started working on
Safe Strategies for Financial Freedom. I decided that the big picture should include a) a general assessment of the stock market in the U.S. and world wide; b) a general assessment of the strongest and weakest areas of the world for investments; c) a general assessment of the strength of the dollar (or your home currency if you are not using the U.S. dollar); and d) a general assessment of inflation or deflation potential in the future. I also developed ways to measure each of these and my way of keeping up with them is to write a market update on the first Wednesday of each month.
Other strategies, such as how you will do research, monitor your data, market yourself (to your family or clients), monitor yourself, manage your cash flow, keep track of your trades and your performance. Basically, running a trading business involves many systems other than trading systems. And to have a successful trading business you’ll need to master those others systems.
You’ll need several strategies that fit the big picture and that work when conditions change. For example, strategies that work in volatile bear markets
(e.g., 2008) are quite different than those that work in quiet bull markets
A worst-case contingency plan so that you’ll be prepared for anything major that could upset your trading business. This sort of planning often takes as long as six months to
Part III: Develop Trading Strategies That Work Under Various
In 1999, everyone in America seemed to be a stock market expert. For example, we were giving a stock market workshop at the Embassy Suites at Cary and one of the bartenders said to the other, “Perhaps we should take Dr. Tharp’s Stock Market Workshop.” The other one responded, “No, I don’t need that. I could teach a workshop like that.” Similarly, a waiter in a high class steak restaurant informed us that he was really a trader, but that he just works as a restaurant part time at night. He’d already made over $400,000 trading and he considered himself to be an expert trader. However, my guess is that those people didn’t survive 2000-2002 much less the market we’ve been through in 2008. Why? They are different markets, and a strategy of buying and holding high tech stocks, which worked in 1999, had mixed to horrible results in the years since
1999. However, a strategy of buying inverse index funds as soon as the market signaled a clear bear market in 2007 has worked wonders in 2008. The basic idea is that you have to know what kind of market we are in:·
Up volatile (11%)
Up quiet (19%)
Sideways volatile (20%)
Sideways quiet (38%)
Down volatile (10%)
Down quiet (2%)
These are the six market types and the percentage of time we’ve been in them (rolling 13 week windows) since about 1950. Down quiet markets very seldom occur (about 2% of the time), but the other five market types do occur often enough that you need to be able to find something that works profitably when it does
Typically, most people attempt to develop one strategy that works in all kinds of markets. The waiters and bartenders, and most others for that matter, usually fail. However, there is good news. It’s not that hard to develop a strategy that will work well in each kind of market. What’s difficult is to find one that will work well under all conditions. However, you don’t have to do that if you simply monitor the market
Part IV: Develop a Position Sizing Strategy to Meet Your
In our workshops we typically play a marble game. Marbles are placed into a bag to represent a trading system. For example, a trading system might include 20% 10R winners, meaning that when one of those marbles is drawn, you make 10 times what you risk. The system might also include 70% 1R losers, meaning that when one of those marbles is drawn you lose whatever you risk. And lastly, the system might also include 10% 5R losers, meaning when those marbles are drawn, you lose five times what you risk. By the way, the marbles are always replaced after they are drawn so that your odds remain the same after each
Now some of you might be thinking, "But you’ll lose 80% of the time. How can you possibly make money?" Let’s say there are 100 marbles in the bag. If you total the R value of all the marbles in the bag, you’ll find that they total to +80R. That means that on the average you’ll make 0.8R per pull over many, many marble draws. Thus, the expectancy of the system is 0.8R (after 100 trades, you’ll probably be up about 80R). And if you risked about 1% on each marble pull, then after 100 pulls you’d probably be up more than 80%. Perhaps now the system doesn’t seem so
However, when I play the game I usually provide the audience with different incentives. For example, I might say that if you go bankrupt, you are out of the game and have to pay a fine of $10. I might also say that if you end the game down 50%, you have to pay a fine of $5. I could also say that if you lose money by the end of the game, it will cost you
$2. On the positive side, I might say that if you make money, you’ll win $2. If you make 50%, you’ll win $5. And I might also say, if you make the most money, you’ll win whatever is left in the pot – let’s say
$100. Notice how my incentives set up a number of objectives for the game. For example, here are three possible
To win the game at all costs, including risking bankruptcy. The person who wins the game will usually have this
To win at least $2 and to make sure that you don’t lose more than $2. Notice how this is an entirely different
To win the game, but to make sure that you don’t go bankrupt. Again, this is an entirely different objective from the first
When I tell people how to strategize about the game, I suggest that they answer the following questions:
Who are you?
What are your objectives?
What is your position
sizing strategy to reach your objectives?
Under what conditions might you be willing to change your position sizing
If 100 people play the game (starting with $100,000) and they all get the same trades (i.e., the same marble pulls randomly done and replaced), then chances are
there will be 100 different equities at the end of the game. You will also be able to group people according to their objectives. For example, those who are trying to make money and have minimal losses will have a minimal fluctuation of equity around a 5-10% gain. However, those trying to win the game will have huge equity fluctuations ranging from bankruptcy to making
My point here is that the game illustrates what is really important to trading success – the “how much” variable of position sizing. Thus, a key step for anyone wanting consistent profits is to develop a strategy with a positive expectancy and then develop a position sizing strategy that maximizes the probability of meeting your objectives. This hugely important step
is largely ignored by most traders and investors, including most
Part V: Taking Steps to Minimize Your
What happens when you don’t follow your rules? You make a trade when your system didn’t tell you to trade. You are supposed to get out when your stop is hit, but you don’t get out. Your position sizing is way too big on one particular trade. Those are all mistakes. And mistakes can be very
We’ve done some preliminary research on the cost of mistakes and results suggest that for leveraged traders, mistakes can run as high as 4R per mistake. If that person makes ten mistakes in a year, then that person could find his or her profits dropping by about 40R. That means that if he or she made 50% on the year – they could have made nearly 100%. If he or she lost 20%, then mistake free trading could have made that person
For long term investors with wide stops, mistakes probably cost about 0.4R per mistake. The total cost per year is about 4R. However, the average investor is lucky to make 20% per year so 10 mistakes could easily cost them 20% of their
The final step that you must concentrate on is to minimize the impact of mistakes on your trading. This amounts to developing a disciplined routine in your trading and continuing step one – working on yourself.
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.
Oil Climbs up the Stairs and Jumps out the Window, Part II
D. R. Barton, Jr.
home from the airport yesterday, I paid $1.84 for a gallon
of gas. I felt
like I was in a time warp.
These are gas prices from back when the Yankees had
a good baseball team…
a few short months ago (during the summer), gas prices
were shaping up to be THE defining issue of the
Then the credit markets crashed and the health of
the broader financial system quickly pushed crude oil and
gas prices down and pushed news about the cost of filling a
gas tank off the front page.
drop has been amazing – here is a chart that I really
source of the data is the Department of Energy weekly
survey. Take note of the time scale for the graph; it is
very compressed and shows over 40 years of data.
This is important because you’ll see that the
incredible gains that took many years to get us up above
$4 per gallon were erased in a matter of a few months.
sure very few people are overly sad about the drop in gas
prices (and now heating oil prices).
In fact, this huge drop has helped ease the pain of
the financial woes brought on by the credit crisis.
oil prices continue to drift lower, with crude oil futures
trading as low as $53.66 per barrel – down more than 65%
from the July highs.
week, we talked about the part that weakening demand and
the strengthening dollar have played in the drop in oil
few people have talked about the bubble-like ascent of
a was an oil bubble and its end was like that of any
other bubble. Technical
and sentiment indicators were screaming, “Overbought!
Overbought!” right up to the top.
yes, demand and dollar valuations did help drop oil prices
– but they only account for a part of the fall.
Most of the fall can be explained in this way –
when bubbles burst, buyers flee.
And prices drop harder and farther than could ever
be expected. Next
week, we’ll look at some of the technical analysis and
sentiment indicators that signaled a bubble.
for now, the crude oil market is getting very oversold –
the pendulum has swung the other way.
Here’s a chart that illustrates the point:
notes in the chart highlight the key points:
Momentum indicators are divergent at current price
levels, including my favorite Chaikin Oscillator, which shows that money is not flowing out of this
instrument as fast as it was a couple of weeks ago.
In addition, we’re staying way oversold on the
stochastic and volatility is clearly decreasing.
these things lined up, it’s a tough bet to say there’s
a lot of downside left in crude oil in the near to
intermediate term time frames.
A rounded bottom or a fairly violent spike up would
seem quite likely from here.
in next week as we revisit the bubble months.
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
You may contact D.R. at
“drbarton” at “iitm.com”.
is presenting the upcoming How
to Develop a Winning Trading System That Fits You Workshop,