Q: I have read and re-read (as you suggest) your book "Trade your way to financial freedom". It think it is great material, it is such a mind-opener.

However, I would like to clarify one point that it is yet not clear enough to me. It is about the Percent Volatility Method. If I use such Position Sizing Technique, then the Stop Loss is set by this position sizing method, I mean, the strategy must have a Stop Loss that is equal, for instance, to the 20-day SMA of ATR. If that is the stop loss, then the model is the same as the % of my equity.

I am getting confused. Let;s say that, prior to Position Sizing, my strategy has a Stop Loss that is 20-day SMA of ATR. Thus, the % of my equity and % volatility method are just the same. And if my strategy has no stop loss (let´ts say), if I use the Percent Volatility Method, it will be the method that will calculate the Stop Loss and place it 1ATR below the entry price.

A: Position sizing and the initial stop are two entirely different issues. The stop is NEVER set by the position sizing.
However, if the stop is 1 ATR, then percent risk and percent volatility are the same.

Posted by Van K Tharp at 04:53 PM | Permalink | Comments (0) | TrackBacks (0)

Q: Safe Strategies talks about bear mutual funds but recommends not to use the leveraged funds - why should one not use the leveraged funds and presumably can one use ETFs instead of a bear mutual fund?

A: That strategy specifically controlled the maximum exposure that you would have and the amount of risk you would have. If you used a leverage fund, then all the metrics no longer work and the risk is quite large.

Posted by Van K Tharp at 04:46 PM | Permalink | Comments (0) | TrackBacks (0)

Q: I'm a professional money manager running an open-ended mutual fund, with subscriptions and redemptions on a daily basis, which has a mandate to be at least 95% invested in stocks at all times.

How do you think about position sizing in a case like mine (which can obviously be applied to anyone with a portfolio whose assets are subject to inflows/outflows)? If I start off with USD 10M and invest it equally into say 50 stocks with a 2% position in each, what happens if after say 3 months the portfolio receives a USD 5M inflow. During those times the stocks have all moved, and some are trading below my 'in' price, others have done well. My feeling has always been that rather than add 50% more to each and every position, you add only to the 'winners'. The problem is that you then end up with a portfolio which is no longer equally-weighted, as you've maybe doubled the investment in say 25 winners and done nothing with the say 25 losers.

Sometimes I feel that unless you have a discreet pot of money where there are no inflows/outflows, the system breaks down because of things like this. What do you suggest?

A: You are in a big bind without your mandate to be 95% invested at all times and my guess is that many money managers with such a mandate will be out of business within the next ten years. What are you going to do when the baby boomers retire in a big way and you constantly have a net outflow of funds? And when that happens to all the fund managers, the major indices (that everyone is holding) will go down big time.

My big question to you is how can you get your mandate changed? It’s something you’ll have to do eventually and it's much better now than later.

Anyway, I have a specific solution for you in my new book The Definitive Guide to Position Sizing. Basically you have to buy the index that is your benchmark. Position sizing will be how much you under or overweight any stocks in the benchmark, with an underweight being a short position. Specific details are in the Definitive Guide (out soon) and it’s also in an article I did with a mutual fund manager (An Interview with Steven O’Keefe) which appeared in Market Mastery and back issues are currently available for sale through IITM.

Posted by Van K Tharp at 07:28 PM | Permalink | Comments (0) | TrackBacks (0)

Q: My question is about conflicting goals.
Goal number one is to cut losses and let profits run.
Goal two is make a certain dollar profit per week.

My conflict is that I have 2 profitable trades on. If I close them both, I will achieve my specific dollar profit for the week on Wednesday. But I want to let my profits run as well. One trade is weakening and I wouldn't put the trade on today using my entry signals. The second trade is still showing good entry signals and I would put the trade on today.

What I finally decided to do was close both trades. I felt good making my dollar profit goal, but I feel conflicted because I didn't let my profits run.

Which is the most correct course of action?

A: I think you need to do some conflict resolution. First, decide who you are? What are your beliefs about yourself? What part of you wants to let profits run and cut losses short and what part of you wants a certain profit goal each week?

Next you need to find the positive intention of each part and do a conflict resolution between the two parts. We do those sorts of exercises in the Peak Performance workshop and they are also in Volume 3 of the Peak Performance Home study course. When you sort out the conflict, then you will have the best answer for you.

Posted by Van K Tharp at 02:13 PM | Permalink | Comments (0) | TrackBacks (0)

Q: I have purchased your home study course, 2 of your latest books and your special report on position sizing. Position sizing has had the most impact on my trading. I still think I am missing something. I may be transferring a fear of letting my profits run into a position sizing scenario. If I can anchor my emotions and thoughts to a specific "rule of thumb, " I can trade much better.

When I place my 2nd entry after a profitable 1st entry, I always have a stop on the 2nd entry.

If the 2ntry stop is hit. What is a "rule of thumb" to do with the 1st entry? What are the parameters
for the trailing stop of the 1st position?

1) close it out at the same time as the 2nd entry stop loss.
2) close it out at break even point for both trades.
3) close it out at my 1st entry fill price ( a 1R loss + commissions)
4) close it out at original stop loss ( a 2R loss + commissions)
5) Do not close 2nd entry at regular stop price, close at breakeven point of trade.
6) Other

My guess is that it varies for different systems. But I am looking for some type of parameter.

A: I probably won’t directly answer your question, but will instead ask you more questions. Have you done the following? I’m asking them, because your question suggests that you have not done so.

1) Who are you? Determine your beliefs about yourself, your strengths and weakness, your edges, etc.

2) Once you’ve answered that question, you can determine your objectives. What are you trying to accomplish as a trader? Do you know that? The answer is 50% of system development.

3) What are your beliefs about the market? You can only trade your beliefs. Did those beliefs come from you? How do you know they are useful? Do they limit you in any way?

4) How good is your system and how does it perform in the 6 market types? My guess is that less than 0.001% of all traders have answered this question.

5) How can you use position sizing to meet your objectives? This is probably one of the most important questions you can ask yourself.

The answers you are asking for are basically “It depends…..!” But if you can answer the five questions I have given you, then you’ll probably also find the answers to the questions you have asked.

Posted by Van K Tharp at 09:26 PM | Permalink | Comments (0) | TrackBacks (0)

Q: I purchased both courses, and have a question about risk for Dr Tharp. I'm making my way through book 1 in Peak Performance, just re-read the chapter on Risk.

My question: Suppose I put on a stop order, so that I risk no more than 1% of capital on any single trade. The predicted risk is now 1%. E.g. 100,000.00 account, position size 10,000.00, set stop at 1000.00 (below for long, above for short).

But, the market could crash, and move through by stop, and it might take a long time to get filled (since the ʽbig boysʼ have good deals with the floor traders, if itʼs an exchange traded security). My actual risk might be much larger than 1%, but is usually going to be somewhat larger, due to fills and scalping.

Can you suggest a more formal way to estimate what the actual risk is, for a given type of security, beforehand i.e. knowing we canʼt always get our exact stop price, and sometimes it will be quite worse?

A: This is why a system is a distribution of R-multiples. Your goal is a loss of 1R or less (if you lose), but positions do go through stops and even gap through stops in a major way.

However, your example is huge and how did you get your position size at 10K? How about, 100K account, 1% risk = $1000. Stop equals $5. Position size = 200.

Posted by Van K Tharp at 01:54 PM | Permalink | Comments (0) | TrackBacks (0)

Q: I’ve read your book twice and it took some help from my wife to eventually implement expectancy and position sizing correctly.
My question regards analyzing my system. I don’t have R values for the past performances of my system so I averaged the losses to determine “R”. With one system the average loss over 135 trades came to -2.87%. So I determined this to be my “R” on each trade.
So, going forward with my system, does it make sense to use that number (2.87%) as my stop loss on each position (assuming that I never risk more than 1% of my portfolio on each trade)?

A: When I have said use your average loss to determine R, I mean the dollar amount not the percentage amount.
However, I’m going to answer your question as if you gave me an answer of my average loss is $2500. No it doesn’t make sense to use that as your stop. I would hope that your average loss (with trailing stops being hit) is less than 1R, so it doesn’t make sense at all.
Here are my recommendations. First, always have an exit when you enter into a trade that determines 1R for you. Second, you can then analyze that exit by looking at the Maximum Adverse Excursion of your winning trades in terms of R.

For example,
2R win, MAE -0.3R
5R win, MAE -0.12R
1.2R win, MAE 0.25R

This kind of data might suggest that you could tighten your stop, but you’d need a lot more than 3 examples.

Posted by Van K Tharp at 08:53 PM | Permalink | Comments (0) | TrackBacks (0)

Q: When comparing systems, I understand the concept of Expectancy, but I must have missed something related to selecting stock trading. It is this: the ratio of 1R to the price of the stock has to have a big impact on the profit of a trade. Let me explain.

Take two positions - traded by the same system/process.

1) Stock 1

Current Price $10. 1R = $1 with a system expectancy of 1.25R.
Using a position sizing model of 0.5% of asset base, let's say that was $5,000.
That means my risk is $5,000 - and if 1R = $1 I can buy 5,000 shares @ $10 each = $50,000 allocated in this position.
Now let us say that this particular trade resulted in a 2R gain (with a long term expectancy of 1.25R).
That is we sold the stock for $12 give us a gain of $2 x 5,000 = $10,000. We has allocated $50,000 on this position so our profit was 10,000/50,000 = 20%.

2) Stock 2

Current Price $4. 1R = $1 with a system expectancy of 1.25R.
Using a position sizing model of 0.5% of asset base, let's say that was $5,000.
That means my risk is $5,000 - and if 1R = $1 I can buy 5,000 shares @ $4 each = $20,000 allocated in this position.
Now let us say that this particular trade resulted in a 2R gain (with a long term expectancy of 1.25R).
That is we sold the stock for $6 give us a gain of $2 x 5,000 = $10,000. We has allocated $20,000 on this position so our profit was 10,000/40,000 = 50%.
Clearly 50% return is better than 20% return. Yet both have the same expectancy, the same R multiple distribution. But clearly the price of the stock related to the size of 1R is important.

I am missing something basic. What have I missed in your teachings? (Probably heaps because I am just a beginner!)

A: My account has $500,000 in it and I want to risk 1% or $5000.
In the first scenario with the $10 stock, you are up 2R or $10,000. 2R is a 2% gain.
In the second scenario with the $4 stock, you are up 2 R or $10,000. 2R is a 2% gain.
You were looking at the amount invested rather than the risk or the size of your portfolio. The amount invested has nothing do to with anything except to determine your worst case loss.

Posted by Van K Tharp at 04:07 PM | Permalink | Comments (0) | TrackBacks (0)

Q: I have been recently designing a trading system that uses a mixed bag of highly liquid ETFs. Doing any kind of testing on ETFs is becoming a challenge due to the lack of data. ETFs didn't really become popular until about 5 years ago, and some ETFs are newer than 5 years. Do you have any suggestions on trading system development with limited data? At this point I plan to test something on SPY, DIA, and QQQQ data and trade other ETFs with that system. Thoughts?

A:You can get a free historical download of all of those ETF you want to test, plus all of the test from YAHOO finance. Just go to Yahoo.com and the go to finance. Enter your symbol and then click historical data. You can download it to Excel. Or better yet you can get XLQ for free with a 30 day trail and it will get the data for you.

Posted by Van K Tharp at 02:03 PM | Permalink | Comments (0) | TrackBacks (0)

I’m struggling with the issue of entry. It seems like sometimes you make a strong case for “entry” not being important (a coin flip perhaps) and that risk management and exit strategies are all that matter. I want to believe this and in my trials it seems like giving any attention to entry is just a distraction because of the very reasons you outline you your books. In my mind, it always starts out with this great theory about how a particular entry signal should improve results but it seems to always get nullified after further analysis. But while this “entry doesn’t matter fact” seems like a great discovery, there seems to be many times that you write or make comments about entry strategies as if they make a difference. Can you clear this up for me? Just recently, in an answer to a blog question you seemed to imply that waiting for a trend to develop (whatever that means) will improve results.

I’m confused – can I ignore all conversation about entry? It sure would be nice. If it really just takes on the illusion of being significant then it seems like giving it any attention can only help to trigger the very emotions that I’m trying to suppress and keep me from focusing on what really matters (risk management and exit).

A: 90% of performance variation in your trading is due to position sizing. Position sizing is that part of your system that is designed to achieve your objectives. You can use position sizing to achieve your objectives with ANY system, but the higher the quality of the system, the easier it is to achieve your objectives. A high quality system has much more to do with your initial stop and your exits (i.e., cutting losses short and letting profits run) than entry.

Posted by Van K Tharp at 02:03 PM | Permalink | Comments (0) | TrackBacks (0)