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)