The last post dealt with overconfidence, so today I am going to provide you with a simple set of guidelines to keep in mind while you are trading.

Being right has little to do with making profits. Good traders make winning trades less than 50% of the time and they hit “home runs” occasionally. If their losses are small, then profits can be tremendous.

Successful trading requires that you know when you are wrong. Before you enter the market, always know what signs the market will give you to prove you are wrong. If you don’t know when you are wrong before you get in a trade, then you do not have a workable trading method.

Make sure you have a set of rules that you use to guide your behavior. These rules should fully detail the conditions under which you will open a position and take profits, and they should include information about how to know when you are wrong. Trade only when you meet all the conditions set forth in your rules!

A mistake means not following your rules. You can make money and still make a mistake by violating your rules. This is dangerous because it encourages the trader to repeat those mistakes. In contrast, you may follow your rules exactly and still lose money. This is a normal part of trading and occurs frequently. But you should still pat yourself on the back for following your rules.

Posted by Van K Tharp at 03:11 PM | Permalink | Comments (1) | TrackBacks (0)

Most of us have a tendency to overestimate how right we are. This tendency does not depend upon intelligence. Nor does overconfidence in our positions depend upon our expertise in a given subject.

Experts may be more knowledgeable about their subject matter than others are, but they are still not very accurate in estimating how much they know. Expertise in technical analysis, for example, has little to do with making money in the markets.

The more information to which one is exposed, the more one tends to be overconfident about his or her positions. Thus, if you are exposed to a great deal of information in order to make a decision about the market, you will be more adamant about your position once you make up your mind.

Unfortunately, most information—especially financial information—has little correlation with price movements. Thus, exposure to a lot of data will probably make a trader much more confident in a position but have little bearing on whether he is correct about the direction of the market movement.

Posted by Van K Tharp at 01:52 PM | Permalink | Comments (5) | TrackBacks (0)

Have you ever wondered why you can paper trade successfully, but fail miserably when real money is at stake? The reason is simple: the trader who concentrates on profits will have difficulty winning, as will the investor who concentrates on losses.

When investors concentrate on the rewards of what they are doing, their behavior becomes rigid and less accurate. They become results oriented rather than solution oriented, which means they are more active and more careless.

In fact, many traders, when reflecting on their previous trading activity, realize they would have become better traders sooner without the hindrance of early success. Early profits teach bad habits that are extremely difficult to unlearn.

The solution? Concentrate on doing your best, not on your immediate profit and loss. Have a set of rules to guide you in the market and concentrate on following those rules.

Posted by Van K Tharp at 07:17 PM | Permalink | Comments (4) | TrackBacks (0)

I've been in Northern New Zealand for about four days now, having a wonderful time. It reminds me a lot of Hawaii except that its a lot colder. Kala and I have been in the most northern part visiting the Bay of Islands and seeing much of the history. We took a trip to the very tip (Cape Reinga) which included a bus trip along a deserted beach. I was amazed at the number of cars that venture onto the beach and then get stuck (destroyed by the ocean) and they are not insure on the beach. And there's no way off. The exit is through a stream and you'd never figure that out by yourself (plus you'd think it would damage your car to travel in the stream and it will).

Also did my first experience sliding down a large sand dune. I did it and my wife refused. But the hard part wasn't going down, it was climbing the sand dune. 10 steps felt like I just climbed a mountain.

Not much to comment on market wise but down under is a lot better place for Americans to visit. You still get a reasonable rate for the dollar.

Posted by Van K Tharp at 11:00 PM | Permalink | Comments (2) | TrackBacks (0)

Just to let everyone know that Van has left for Australia and New Zealand today. He is on a whirlwind tour and has a number of workshops, speaking engagements and interviews and thankfully a brief vacation squeezed in. He will be back on line in mid-October.

In the meantime, the staff here at the Van Tharp Institute will periodically post segments of Van's work, comments, tips and give any updates on his travels. If there is anything specific that our blog readers would like, feel free to email becky@iitm.com

Thanks for your patronage and understanding

Kind regards
Melita Hunt
CEO
Van Tharp Institute

Posted by Van K Tharp at 08:00 PM | Permalink | Comments (0) | TrackBacks (0)

I read an interview today in which the person being interviewed commented on effient markets. Although some people can consistently beat the market, 90% cannot. And what's always cited is the Morningstar data that 90% of the mutual funds cannot outperform the market averages so that you are better off with an index fund.

Okay, but let's look at how they define performance. Satisfactory performance is outperforming some benchmark like the S&P 500. And if you cannot outperform it, then staying close is okay. But let's look at the rules: 1) a mutual fund has to remain about 95-98% invested; they cannot go to cash because they don't like the market conditions; 2) the best way to stay close to the benchmark is to own the benchmark -- so they do. So let's say during the year, as a mutual fund, you are about 90% invested in the S&P 500. You give yourself about 3-5% leaway to try to outperform it. However, you also have 1-2% fees that your charge the public. What are the chances of you beating the market. Almost zero!

Thus, the evidence that people support for market efficiency is ridiculous.

Also with trillions of dollars, its very difficult to move in and out of things without moving the market. So big funds, by nature, should have a difficult time beating the market.

However, my belief is that anyone with a million or less could easily double their money each year. It doesn't take real genius to develop a system that could make 100 trades with an 0.8R expectancy, thus giving you about 80R per year in returns. The real genius is being able to be efficient as a human being and actually achieve that return without making mistakes. And if you want to know about mistakes, see my other posts (I still want to call them blogs because I make the rules on this one).

Posted by Van K Tharp at 06:14 PM | Permalink | Comments (4) | TrackBacks (0)

I just got asked an interesting question that I've never had before or even thought about. It was, "Could you please explain some position sizing errors of the U.S. government."

To the best of my knowledge, the government doesn't trade. If it did, it would be in trouble because I'm sure it doesn't understand position sizing.

But I think you might say that most of the errors that our government makes in terms of the budget and debt might be a position sizing error. (HERE I'M REALLY STRETCHING THINGS). For example, instead of making changes to reduce risk, it makes changes that makes the risk bigger but less obvious. And I'll give a few examples.

To hide the debt, the government got social security to buy the debt. So social security looks like a big fund that holds t-bonds. But instead, its just a way to account for about half of our debt (oh, it's in social security).

Each president looks for ways to make himself look better. Clinton's big coup was the Roth IRA. They came up with an idea that wasn't tax deferred, but everything you earned once you establish it was tax free. That was more attractive that the current way, so massive amounts of money were transferred from regular IRAs into Roth IRAs. The government got a huge windfall of money and Clinton looked like a genius for balancing the budget. Instead, he got current revenue at the expense of future revenue. And it all continues to make the overall situation worse and worse.

Best I can do on a complex subject.

Posted by Van K Tharp at 05:26 PM | Permalink | Comments (3) | TrackBacks (0)

In late 1979, the Hunt brothers controlled over 200 million oz of silver, half the world's supply. The Hunts had future contracts but they were always taking delivery. Major interests in the world had short positions, including many members of the CBOT. And when major interest get cornered and have a financial problem, they CHANGE THE RULES FOR HOW THE GAME IS PLAYED. And here's what happened.

1) The CBOT changed the rules and said no individual could hold more than 3 million oz of silver. Simultaneously, they raised the margin requirements.
2) The COMEX changed their rules and said no individual could hold more than 10 million oz of silver. The COMEX has always been a very suspicious exchange. The COMEX than susupeded silver trading. You could liquidate silver positions but you could not buy silver.
3) Lastly, the Federal Reserve stepped in and Volker raised interest rates. This means that the rates the Hunt Brothers paid for their siver went up dramatically.

The net result was that the Hunt brothers could not afford the margin costs of their positions. And they were forced to liquidate. In a period of several months, with all these rule changes, silver went from over 50/oz to under 10/oz. The Federal Reserve actually had to organized a billion dollar bailout of the Hunts to prevent a financial collapse.

Could it happen again? Of course, people who have money make the rules about money.

What's the next big rule change that will affect lots of people. I think I know, but I don't want to say here.

Posted by Van K Tharp at 09:07 AM | Permalink | Comments (3) | TrackBacks (0)

Obviously, if you make a mistake and it turns into a winner, you'll count that too. It's a positive R value, rather than a negative one. But these are the most deadly because they make you think it's okay to make a mistake. And even when you count winners in your mistakes, I still think you'll find that the average mistake is worth 2-4R against you.

It's a little like poker. Let's say I'm betting with an AK in my hand and an AK on the board. Someone is better against me with pocket sixes. (This actually happened). I raise their bets and they still call. Their bet is absolute ridiculous. First, they might think I'm bluffing, but if they paid any attention to me they'd know I'm a conserative player and I usually have something if I'm betting. Thus, they have to know they are behind in the hand.
Secondly, there are only two cards left in the deck (two sixes) that will beat me. They have a about a one in 20 chance of beating me but they are still calling my bets. Really dumb. But what happens. On the river another six comes up and they win a huge pot. I'm a little upset because an idiot with a lot of luck beat me. But they are reinforced to do the same thing over and over again to win a big pot. However, THEY WILL LOSE 19 out of 20 times.

That's what happens in the markets when you make a mistake and you make money. You are reinforced to do it again. And that's why its so important to keep track of your mistakes.

As for the person who said this is not a useful exercize.... we'll my job as a coach is to teach people what works. Typically, people who don't do what the coach says are kicked off the team. However, free coaching, when you are not on a team, usually isn't valued. I once told a firm that if they kept doing what they were doing they'd go bankrupt. They disagreed and went under ($11 million lost) in about six months. Perhaps if they'd paid me a million for the adivce they'd still be in business.

Posted by Van K Tharp at 08:43 PM | Permalink | Comments (1) | TrackBacks (0)

Keep track of your R-multiples on every trade. If your initial risk was $200 and you make $600, then you have a 3R winner. If your initial risk was $200 and you have a $400 loss then you have a 2R loser.

Now a "mistake" is not following your trading rules.

SO here are some examples.

1) You take a trade that's not part of your trading rules - you trade it just on a whim. You lose $200 on it on a $200 risk. That's a 1R mistake.

2) You take a trade and you don't keep your stop. Let's say your stop was to get out of the trade if it fell 10% and let's say that your initial risk was $200.

The stock falls 50% and you lose $1000 before you get out. Your mistake cost you 5R.

Now does that make sense?

However, if you don't have a set of written trading rules to totally guide your behavior and trading, then you shouldn't be trading and everything you do is a mistake.

Posted by Van K Tharp at 02:21 AM | Permalink | Comments (3) | TrackBacks (0)

To trade well you need to overcome the emotional hurdles that tend to get in the way. This means having a business plan, having systems with well documented rules that are tested, and then having the discipline to follow those rules. When you have this, then you have a chance to follow the discipline that will lead to success.

However, everyone has emotions that tend to get in the way of following your rules. This comes up occasionally in long term trading. It's comes up much more in swing trading. And it's very noticeable in day trading. And then when you really notice it -- or at least I do -- is in playing poker. You have a few seconds to make a decision but you are still getting over your feelings from when someone else made a stupid bet against you and was rewarded on the last card with an exceptional stroke of luck. You did everything right and that person was rewarded.

That's a lot like following your system...overall, you'll make money. But sometimes the trade just goes against you. However, in the short term it just feels like that other guy did something stupid and was rewarded and it's not fair. But they key here is to make sure that you don't do anything stupid while you're feeling emotional to ruin the next hand. And this is one of the main challenges of poker and of good trading.

Posted by Van K Tharp at 04:43 PM | Permalink | Comments (1) | TrackBacks (0)

When we have inflation, it means the value of the dollar is less. I expect this for two reasons: 1) the dollar keeps getting weaker because of our debt and 2) the government has to inflate the debt. Inflating the debt
means that the dollar and thus the debt is worth less. Deflation, in contrast, would mean that our money is worth more and the debt would be worth more.

Okay, so that's the basic logic behind thinking that inflation is the only possibility. It's well documented, I think, in Safe Strategies for Financial Freedom.

So if we have inflation, it means that things will be worth more compared with money. Here's an example, my late mother was born in 1904. She saw the early silent movies and the first sound movies that came out. She said
that she could remember when it cost 5 cents to go to the movies. Me, I'm not nearly that old, but I can remember when a hamburger was 15 cents and you could see a double feature movie for 50 cents. Now a single movie cost
$8 to $10 and you'll spend that much or more for a snack at the movies. That's inflation.

When I lived in California, I lived in a house that cost $4000 new when it was built in the 1940s. I paid $120,000 for it in 1982. When I divorced and moved away, that house was worth over $500,000 and now it's probably
close to a million. While some of that is people wanting to live in the LA area, some it is also due to inflation. Today, a house that might have cost $4000 in the 1940s will probably cost $120,000 someplace in the Midwest
like Memphis. And that's basically all inflation.

Thus, if we have say 10% inflation....your house will be worth more simple because the dollar is worth less. Everything will cost more and owning things, like commodities will be where the profit lies.

Posted by Van K Tharp at 04:15 PM | Permalink | Comments (1) | TrackBacks (0)