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Tharp's Thoughts Weekly Newsletter

December 17, 2008 — Issue #403
  
Trading Education

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Article

The Right Circumstances and Trading Success by Van K. Tharp

Workshops

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Trading Tip

Bonds and Gold: Talk of Bubbles and Bugs by D.R. Barton, Jr.

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Feature

The Right Circumstances and Trading Success

by 
Van K. Tharp, Ph.D.

In my last update, I discussed Malcolm Gladwell’s new book Outliers.  In that book Malcolm discusses what might be involved in being a hugely successful person.  Malcolm asks different questions in his quest for success than I do as a modeler.  As a modeler, I look for what successful people do in common.  Gladwell, in contrast, looks for what is common about their background.  Since our questions are different, we tend to come to different conclusions.

Gladwell generally concludes that successful people are influenced by the following factors:

1)     The amount of practice they give to their craft.  In particular, those who achieve 10,000 hours of practice (especially if it is the right kind of practice) are the ones with outstanding success.

2)     When they were born. For example, children who were born so as to have the most maturity before a particular cutoff date have a huge advantage.  The oldest children are typically the most mature and thus excel and get more opportunities and training. For example, almost all NHL hockey players are born in the first three months of the year. When the tryouts occur they are the most mature so they have a huge advantage. And those who are the most mature, get into the accelerated programs.

3)     What kind of values their family had. For instance, middle and upper class children get training from their families about success that poor children just do not have.

4)     Being born at the right age and time to take advantage of some particular change in society.

5)     Their cultural legacy, which might include hard work (e.g., the rice farmer legacy), or the need to defend yourself from any insult (e.g., the legacy of honor). However, the latter is seldom an edge for success.

One of these, in my opinion, has no relationship to trading success and that is one’s birth date.  There is no advantage, in my opinion, to being born on any particular month for trading success.  I cannot imagine any circumstance in which that currently applies to trading.

However, there are definitely big changes in society that occur and being at the right place at the right time to take advantage of that can be a huge advantage.  I can think of one trader in particular for whom that was true.  When I interviewed him as part of my modeling work, I promised him that I would not mention his name, so we’ll just call him the Mechanical Trader.

The Mechanical Trader, in my opinion, has several huge edges that amount to being at the right place at the right time with the right skills and knowledge.  Isn’t that what Gladwell talks about extensively in his book?

First, the Mechanical Trader went to one of the top engineering schools in the world—one that does financial modeling.  As part of his early training, he became a programming expert way before most people even knew about computers in the mid-1960s.  He spent six months testing trend-following systems on a big main-frame computer with punch cards.  When I was at his house in 1990, all of his trading programs on his personal computer were written in assembly language.

Second, the Mechanical Trader was exposed to some of the early geniuses of trend following, especially Richard Donchian.  Thus, he was one of the first, if not the first, computerized trend follower.  That was a huge edge, in my opinion.  I’m not sure what his system was, but it was probably as simple as a moving average crossover, such as those advocated by Donchian.  You might have trouble using one of those today, but they were much easier when few people used them.

Third, the Mechanical Trader thoroughly understood the power of position sizing.  More importantly, he had developed an algorithm to use position sizing to go for goals that most people would consider impossible.  In addition, he began by trading commodities before the field was dominated by huge CTAs. 

So let’s look at the combination of edges that he had.  First, he was one of the very first computerized trend followers.  This alone was a huge advantage at a time when no one else had it.  Second, he traded in a highly leveraged market that was full of trends and he understood how to use position sizing to make huge amounts of money.  He was probably the only person around who had that combination of edges.

Lastly, he understood that the golden rule of trading was to cut your losses short and let your profits run through a trend-following model.  And most importantly, he understood that if he had trouble doing that, he needed to work on the source of the problem—his self.

Imagine the edge of being the first computerized trend follower in a highly leveraged area, knowing both the power of using position sizing to achieve huge returns and understanding the importance of working on yourself to be sure that you do not make mistakes.

I think there are probably others who have had huge edges in trading by being at the right place at the right time, but none stand out to me as much as the Mechanical Trader. 

Presently, we have the ability to give people a huge edge in trading and that edge could take a number of forms.  Here are some of the edges that you could be able to take advantage of right now.

First, I tend to doubt that there are any particular computer advantages these days.  But I think very few people realize that it is possible to easily develop a Holy Grail system that fits any one kind of market.  The real secret is to understand that it is only a Holy Grail System for that one kind of market and when you try to make it fit all types of markets, you will have major problems.  I don’t know how long this will be a major edge, but it is certainly is an edge now.

Second, many people are starting to understand the importance of position sizing, but few people understand that the purpose of position sizing is to meet your objectives.  And I think that very few people understand that it is only through position sizing that you meet your objectives.  The purpose of a good system is just to make it easier to meet your objectives.

Lastly, many people still have not understood that all of this is impossible if you don’t know yourself.  For example, how can you have objectives if you don’t understand who you are?  And even more importantly, how can you reach your objectives if you don’t have enough control over yourself to keep from making mistakes?  So gaining self-control is also a huge edge.

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.

 

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Trading Tip

Bonds and Gold: Talk of Bubbles and Bugs

by
D. R. Barton, Jr. 

We’re going to take a break from our volatility series to take a closer look at two markets: bonds and gold.

One has reached bubble proportions— with bonds attaining unsustainable price levels. And in the other one, the gold bugs are starting to whisper quite loudly, “I told you so,” perhaps a bit prematurely.

With the FOMC announcing a monstrous rate cut to unchartered levels, the financial markets have entered yet another era of completely unprecedented existence. While the Fed hasn’t shot its last bullet, it certainly needs a microscope to find its remaining ammo.

And with the Fed Funds rate all but disappearing below single digits, bond prices have absolutely exploded. By any measure, they have made an asymptotic move.

Markets can remain overbought for longer than we expect, but the correction in bonds will most certainly be a violent one when it comes.

Gold on a Run, But It’s Far from a Bull

Meanwhile, gold has been on a short-term tear, gaining $100 per ounce in just two trading weeks. While gold’s relationship to the dollar has improved quite a bit over the short run, its climb relative to crude oil has been absolutely dizzying.

A mere six months ago, an ounce of gold would buy a scant 6.6 barrels of crude oil. With oil’s recent plunge and gold’s strengthening price, that ratio has almost tripled! An ounce of gold currently buys 18 barrels of oil – the highest level since early 1999!

So gold’s strength relative to other weakening commodity prices is impressive. And yes, massive amounts of paper money have been printed and more will have to be printed to make good on the non-stop promises made by (most notably) the U.S. government, as well as others around the globe. Fundamentally, gold certainly wins the “most likely to appreciate to new highs never seen before” award. The gold bugs shout it from every blog. But just when it will reach those lofty heights is far from certain. There is one inescapable fact standing in the way of gold’s coronation – gold is decidedly in a bear market! Before you call for my head on a platter, let’s look at the facts (as represented by price).



The classic and purest definition of a downtrend is a market that is making lower highs and lower lows. And clearly gold’s movement fits that definition to a tee over the past nine months.

There are no fewer than three obstacles in the way of gold moving from “having a nice up move in a bear market” to “bullish shiny metal”:

1. It has to make a few closes above the 200 day moving average for the first time since July. The descending 200 MA is not very far away.
2. It needs to break the downtrend line that is currently at ~900.
3. It needs to make a higher high, above the last one set at 938.50.

When we get all of that done, then we can talk about $2,000 gold. Until then, it’s just another bear market with loads of potential.

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”. 

D.R. is presenting the upcoming How to Develop a Winning Trading System That Fits You Workshop, January '09.

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