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Article Why You Should Not Believe Everything You See on TV
by Van K. Tharp, Ph.D.
Trading Tip Did One Trade Crash the System?
by D.R. Barton, Jr.
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Why You Should Not Believe
Everything You See on TV
For some time now I have had a rather low regard for the financial TV media in the United States. In my opinion, they were puppets of the brokerage and mutual fund industries. Although I don’t get requests for TV interviews often, usually I turn them down because these journalists have no use for someone who encourages real financial education. During my trip to India last month, I granted an interview with a financial channel. That experience prompted me to change my opinion about the financial media—and not for the better. I now believe that many, if not most, of the financial television reporters are worse than puppets. What they cover has nothing to do with brokerages or the mutual fund industry. (I don't feel the same about most of the print media journalist as tend to be open to pursuing the true story and asking pertinent questions.)
I took my first trip to India in September and stayed with the parents of my niece’s best friend. My niece’s friend’s father just happens to be the Director and founder of one of India’s largest brokerage companies. He has read a couple of my books and has been a subscriber to Tharp’s Thoughts for some time. He asked if I could speak to a group of people in Mumbai and perhaps do a television interview. I was happy to do both.
On September 12th, I gave a three hour talk to about 100 Indian investors and traders in Mumbai. The next day, I went to a local television station to tape an interview that was to last about 30-minutes.
The reporter and I sat down to review her planned questions before the actual taping. I don’t remember the exact wording of her questions, but her list looked something like this:
- Where do you expect the Indian Markets to go from here?
- What’s your opinion about the U.S. markets?
- Are there any other Asian/Middle Eastern Regions you like and why?
- What do you think about oil?
- There is a trend for hedge fund money right now to be flowing into ________. (I don’t remember exactly where she thought the fund money was going). What’s your opinion of this trend and what are the implications?
I was horrified. These were typical financial channel talking head questions. I wasn’t about to become a talking head if I could help it. Keep in mind that the brokerage company had sent her a thorough brief of my background, the books I have written, and what I do.
My first reaction to these questions was to ask the reporter if she had earned a degree in journalism and she had. I said, “So you’ve had at least six years worth of training to help you do your job well. That’s the way it is with most professions. But anyone, with no training whatsoever, can open up a brokerage account and trade. The only education they might get is listening to people like you ask questions like that. Answers to those kinds of questions will not help anyone trade well or make money in the markets. My job as an investment educator is to turn things around and provide education to investors. Perhaps instead, we can talk about what Indian investors/traders really need to do to be consistently profitable.”
The reporter looked at me and then in interview mode said, “That’s interesting, but what do you expect the Indian markets to do?”
I had actually looked at some charts of the Indian market, so I said, “Well, the market is in an uptrend and there probably isn’t any reason to expect that that uptrend won’t continue—at least until it reaches the old highs. However, saying that won’t help any Indian investors learn how to make intelligent investment decisions. They need to know more important things like understanding reward-to-risk ratios, how to get out of the market, and how to control their emotions.”
Her response was, “Well, that’s very interesting, but what’s a good strategy for Indian investors to use?”
So I tried to explain, “People don’t really trade the markets; they trade their beliefs about the market. Thus, you need a strategy that combines certain principles with your beliefs so that you have something that fits you. There is really no strategy that fits all Indian investors, but there are many good strategies that Indian investors can use that might fit their particular beliefs. That’s what they need to find.”
“But you didn’t answer my question,” she responded, “What sort of strategies can Indians use in these market conditions?”
I replied, “People only trade their beliefs about the markets. Thus, they can only trade a strategy that fits their beliefs. There is no one strategy for Indian investors. Instead, there are probably hundreds of strategies that would work—perhaps as many strategies as there are Indian investors.”
She didn’t seem happy with that, so she went on to ask me about U.S. markets, deviating from her questions a bit.
Perhaps I should have held back my two cents, but I did not. I said,
“The U.S. is in a secular bear market that started in 2000 and could last as long as 20 years. That means valuations, long term, meaning price to earnings ratios, will go down. It doesn’t necessarily mean that prices will go down. And there are lots of things fueling that: the massive implosion of wealth worldwide because of the subprime crisis, the fact that many multiples of the world’s wealth still exist in the form of derivative products, the fact that banks don’t understand risk because they think it has to do with the volatility of the products they sell (so they could package subprime loans as being low risk because they didn’t fluctuate much in price), and the fact that the baby boomers will retire soon and pull massive amounts of cash out of the markets. That being said, the overall trend in the market has nothing to do with whether or not people make money. Educated traders can make a lot of money under these conditions.”
She didn’t seem to like that answer at all and responded something like, “So how can Indian investors profit if you are right?”
I said, “This trend has been going on already for 10 years now. Short-term trading strategies have nothing to do with long-term market trends, so there are plenty of opportunities. You just have to understand things like reward to risk or position sizing strategies.
And do you think she followed up by asking me to clarify what I meant by that? Not at all. Instead, her response was, “What do you think other Asian markets are going to do?”
At this point, I grew a little frustrated, “You are asking the wrong questions.” I told her,
“Making money has nothing to do with predicting what the markets are going to do. It has everything to do with making sure that when you are right you make a lot more money than when you are wrong. Last night at my talk we played a game in which people were only right 20% of the time, but almost everyone made money. Why? Because they made 10 times their risk when they were right and only lost what they risked when they were wrong. And if your total risk per position is small enough to tolerate long losing streaks, you can capitalize on the long term expectancy of the market.”
Of course, she glazed over my comments and went on to her next question, “What do you think oil will do?”
I said, “I have no idea, but I can probably make money in the oil market whether it goes up or down, so I don’t care.”
Undaunted, she continued with her planned list, “Foreign hedge fund managers are putting a lot of money in _________. (I think it was in some sector of the Indian market). What do you think of this move? Is it smart? What do you think Indian investors should do?”
I said, “I don’t have any opinion about that. I wasn’t aware that it was happening.”
She then said, “So what markets do you like?”
I responded, “Well, I assume that question means what markets are going up?” So I said, “The best long-term trend out there is the gold market, and I recently heard that about 40% of the supply for the market right now is people who are melting down their junk gold. That trend will dry up soon, and then gold will go up much more. However, that really doesn’t tell anyone how to make money from the gold market. You need a strategy tied to it or you’d just buy and watch it go up and then watch it go down.”
Again, she didn’t ask a related follow-up question. Instead, she just looked down at her list and asked, “What other Asian markets do you like?”
I said, “You are pretty tied up into your list of questions. Would you like me to write some useful questions that will make our interview more productive?”
She looked horrified and said “No.”
At this point, the two gentlemen from the brokerage company who accompanied me stepped in. One had organized my presentation the day earlier and the other was head of institutional trading at the brokerage. Both had become supporters after learning some “Tharp Think” the day prior and they tried to explain my role as an investment educator. They offered some ideas for better interview material and even pointed out that we could talk about the Trade Your Way to Financial Freedom book that I had brought with me.
She listened and then said, “Perhaps we should get onto the taping?”
I said fine and we went next door into the taping room with the cameras. We sat down and the camera man began recording.
She started, “What do you think about the Indian stock market?”
I think she expected me to be more “cooperative” with the camera going. I wasn’t. I answered her just as I had a few minutes before so the interview went almost the same as the rehearsal. The intended 30 minute interview lasted only about 15 minutes, which was good because I really didn’t want to answer these questions.
While I didn’t think the interview had gone well, I realized something later. If she edited the material down to about 5 minutes, she could have had a nice controversial piece based on my market predictions. If the interview actually aired on Indian TV in Mumbai, I’m sure that’s what she did.
As a result of that whole experience, I feel compelled to make a couple of apologies. First, I apologize to anyone who saw that interview if the reporter touted me as a typical financial news “talking-head guest.” As you know, I am not and I would not have agreed to do the interview if I’d expected anything like I got in the interview. I would like also to apologize to brokerage companies and mutual funds everywhere. For a long time, I thought financial journalists were your puppets. However, you can’t possibly have so much control over journalists to turn them into people like the reporter who interviewed me last month. She was like a wind-up toy.
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The Flash Crash Revisited Part 2:
Did One Trade Crash the System?
“A good scapegoat is nearly as welcome as a solution to the problem.” — Anonymous
Flash Crash Dog Pile
Back in my grade school days, we developed a fun playground ritual. If someone stayed on the ground a little too long, one kid would scream, “Dog pile!” and then everyone would jump on top of the kid on the ground.
It was always done in fun. The person at the bottom of the pile was rarely hurt and usually came out with some added respect for having survived. And everyone jumping onto the pile had fun screaming and jumping in.
The now infamous “flash crash report” that I wrote about two weeks ago has been the subject of a not so collegial dog pile ritual. It seems that every article, blog or comment written about it recently has been negative and dismissive. The main point of contention: the 104 page report issued jointly by the Securities and Exchange Commission (SEC) and the Commodities Futures Trading Commission (CFTC) named one trade by the mutual fund firm Waddell & Reed Financial as the “key contributing factor” to the flash crash.
One Trade or a Scapegoat?
A brief scan of the report’s conclusions made it clear that the report was making a classic example of finding a scapegoat for the flash crash.
The term scapegoat comes from an Old Testament biblical reference. On the Day of Atonement, a goat was to carry the sins of the people of Israel out of the community and then perish—along with all the sins of the people. Since the goat itself was innocent, the term scapegoat has come to symbolize a single entity, often innocent or only tangentially involved, that is blamed for the problems, errors or suffering of others.
Our quote for today's article fits the report’s conclusion perfectly! The SEC/CFTC did real research, significant hard work, and investigation for the purposes of their report. Regardless, the conclusion that a single Waddell & Reed order caused the flash crash is almost laughable.
Test One—Fishy Smell
In my last article on the topic, I said that the report’s conclusion failed the “smell test.” Here’s what I wrote:
Let’s look at the smell test first. In this test we ask, “Does something smell fishy?” That is to say, does it seem that the report is drawing a simplified conclusion as a way of defending the status quo?
The answer to this question is a resounding, “Yes!” Every article that I have read on this report had either an implicit or explicit reference to the feeling that the report justifies the regulations and oversights in place, and that it was just one ill-timed trade and some subsequent reduction in high-frequency trading that caused this monster market anomaly.
This begs the question, “If one fairly large trade really can destabilize the system, is all really well?”
Test Two—Absence of Common Sense
Does a sell order of 75,000 S&P e-mini futures contracts over a 20-minute time frame pass the common sense test as an order size that triggered something close to financial Armageddon on a global scale?
When I looked at a price/volume chart from May 6th, I knew in about 15 seconds that the report’s conclusion was ludicrous. Decide for yourself by looking at the following chart. The burgundy arrows and numbers show the number of contracts traded during each five minute bar of the flash crash.
A quick common sense look will tell you that a 75,000 lot split up over any four of those high volume bars had no chance of causing such a massive selloff. On top of that, Waddell did not issue a single order to sell at the market 75,000 contracts but instead used an algorithm-driven computer trade that divided the position into multiple orders spread out over 20 minutes.
Want more confirmation of common sense reasons to scoff at the report’s conclusion?
- An article in Barron’s last week confirmed that the algorithm broke up the trade into smaller blocks so that it could execute no more than nine trades out of every 100. In addition, only half of the order had been entered as the market fell!
- Several traders acknowledged that trades of this size routinely trade on heavy volume days.
- And lastly, the CME Group, owners of the exchange where the contracts traded, confirmed that Waddell’s trade was consistent with market practices.
In short, the now infamous report found a scapegoat, and the rest of world knows full well that the report’s conclusion is wrong.
What will be done? My guess is nothing for now. And because no one is doing anything to find out and deal with what really happened at the foundational level, sometime in the not too distant future, we’ll get another flash crash (or flash blow-off top). As a result, that may lead to another, perhaps more serious investigation.
In the meantime, consider how another flash crash type event could affect your trading.
I’d love to hear your thoughts and feedback on this topic or about trading and investing in general at drbarton “at” iitm.com.
One final request: If you know who said or wrote the great scapegoat quote under the headline, please send me an email! I could not find its origin.
Until next week…
Planning the "Perfect" Trade
Q: My mindset is always on planning the “perfect" trade. I apply this concept to each of the elements within my planning process, and I am achieving a very high rate of satisfaction in the results I receive.
I think at this point my goal of making money is conflicting with my goal of planning the “perfect" trade as I sometimes exit a trade to increase my account balance to find that the price goes to my planned exit and at other times I exit early and take a loss to find that the position goes in my favor.
How do I align my requirements for “perfect" trading with high returns so that they support/supplement and enrich each other and I achieve the exceptional results that I know I am able to achieve?
A: I'll respond to your question in two parts.
First, be sure you have well-thought-out objectives. Right now, your perfect objective as stated is probably not going to be very helpful in the long run. For a more useful objective, you might ask yourself what kind of drawdown would you want to avoid at all costs? Then, what drawdown could you tolerate with a 50% probability?
Second there is no such thing as a "perfect" trade. You could, however, trade with 100% efficiency meaning that you always follow your rules and you actually achieve your system expectancy. You can only do this if you have written out your trading rules.
Trading is a process that can be described statistically and, if well-researched, with known probabilities. Thus, to trade perfectly is to achieve with expected probabilities your system’s R-multiple distribution. —Van
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