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SUPER TRADERMAKE CONSISTENT PROFITS IN GOOD AND BAD MARKETS
By VAN K. THARP
McGraw-HillCopyright © 2011 Lake Lucerne LP
All right reserved.
Chapter OnePART 1 WORKING ON YOURSELF
The Components of Trading Well
I'm a neuro-linguistic programming (NLP) modeler and a coach for traders. As an NLP modeler, I encounter a number of people who excel in something, determine what they do in common, and then determine what beliefs, mental strategies, and mental states are required to perform each task. Once I have this information, I can teach those tasks to others and expect to get similar results. My job as a coach is to find talented people and make sure they learn and follow the fundamentals of my modeling work.
I remember doing a workshop with the Market Wizards Ed Seykota and Tom Basso around 1990. All three of us agreed that trading consists of three parts: personal psychology, money management (which I subsequently renamed "position sizing strategies" in my book Trade Your Way to Financial Freedom), and system development. We also agreed that trading psychology contributes about 60% to success, and position sizing strategy contributes another 30%, which leaves about 10% for system development. Furthermore, most traders ignore the first two areas and don't really have a trading system. That's why 90% of them fail.
After years of extensive modeling in all three areas, I now disagree slightly with our conclusions in 1990. First, I would argue that trading psychology accounts for 100% of success. Why? This conclusion is based on two findings. First, people generally are programmed to do everything the wrong way. They have internal biases that seem to lead them to do the exact opposite of what is required for success. For example, if you are the most important factor in your trading, you should spend the most time working on yourself, but the majority of people totally ignore the "you" factor in their success. Read over the checklists in this part that deal with good trading. If you've worked extensively in all the areas listed, you are probably very successful and are certainly a rarity.
Second, every task I model requires that I find the beliefs, mental states, and mental strategies that are involved. All three ingredients are purely psychological, so it's hard not to conclude that everything is psychological.
I now think that there are six components to trading well:
1. Developing and consistently maintaining a trading process. The trading process encompasses all the things you need to do on a day-to-day basis to be a good trader.
2. Understanding the wealth process. To trade successfully, you need to explore your relationship with money and why you do or do not have enough to trade with. For example, most people believe that they win the money game by having the most toys and that they can have it all right now if their monthly payments are low enough. This means that they save zero dollars and are over their heads in debt. If this is you, it also means that you don't have enough money to trade. Not understanding this process is one of the major reasons that individuals, corporations, and governments in the United States and around the world are in such deep debt.
3. Developing and maintaining a business plan to guide your trading. Trading is a business. The entry requirements are much easier than they are for other types of business because all you have to do is deposit money in an account, sign a few forms, and start trading. However, the entry requirements for successful trading require that you master all the areas listed here. That requires a lot of commitment, which most people do not have. Instead, they want trading to be easy, fast, and very profitable.
4. Developing a system. People often consider their system to be the magic secret for picking the right stocks or commodities. In reality, entry into the market is one of the least important aspects of good trading. The keys to a moneymaking system are elements such as determining your objectives and the way you exit a position.
5. Developing position sizing methods to meet your objectives. We've discovered through our simulation games that 100 people at the end of a set of 50 trades will have 100 different equities. (They will all get the same 100 trade results.) This extreme variability of performance can be attributed to only two factors: how much they risked on each trade (that is, their position sizing methods) and the personal psychology that determined their position sizing decision.
6. Avoiding mistakes. I've seen many short-term trading systems that would allow you to make 2R (twice your risk) per week or more. If you risked 1% of your equity on each trade, you would consistently make well over 100% each year. But most people cannot do this because they trade at about 70% efficiency or less. This means that they make three mistakes (meaning they don't follow their rules) every 10 trades. This will turn any winning system into a losing system.
Based on the six components of trading well, rate yourself by asking the following questions:
How well have I mastered the discipline of trading well each day? Do I do a daily self-analysis or a daily mental rehearsal to begin each day? If not, why not? I will give you a lot of ideas about how to improve in this area in the remainder of this book.
Do I really have enough money for trading to make sense? If you do not, you probably need to work on yourself and the wealth process.
Do I have a working business plan to guide my trading? If you don't, you are not alone. We estimate that only about 5% of traders have a written business plan. Then again, perhaps you've heard that only about 5% to 10% of all traders are really successful. Part 2 of this book will guide you toward developing this kind of working document.
Do I have a set of objectives thoroughly written out to guide my trading? Most people don't. How can you develop a system to meet your objectives without having objectives?
Have I paid attention to the how-much factor—that is, my position sizing strategy? Do I have a plan for using my position sizing method to meet my objectives? It is through position sizing strategies that you either meet or fail to meet your objectives.
How much time do I spend working on myself? You have to overcome your psychological issues and develop the discipline necessary to carry out the processes described above, which are necessary for success and for avoiding mistakes.
Most of the items described here could be the topic for an entire book. However, my intention is to give you an overview of what is required for successful trading, and my job as a coach is to find talented people and coach them on following the fundamentals I've described here.
Do an Honest Self-Appraisal
Peak performance traders are totally committed to being the best and doing whatever it takes to be the best. They feel totally responsible for whatever happens and thus can learn from mistakes. These people typically have a working business plan for trading because they treat trading as a business; that business plan gives them the confidence to do what they need to do to make large returns from the market and learn from the mistakes they make.
The first section of this book is not about some hot new investment. It's about how to be in the best possible condition mentally to trade at a peak level. My favorite cartoon character is Sam, the trading tiger, shown here looking inside himself. Sam will be guiding us through the process of successful trading/investing.
Getting Started: Some Concepts You Must Master as a Trader
First, you need a strong initial evaluation of yourself and what you need to do to improve your performance. Look at it this way. Suppose you are in the middle of the desert. There are no roads, but you have a map indicating where you are to go. However, what's missing from the map is an indication of where you are now. Remember that you are in the middle of the desert. How can you get where you want to go when you don't know where you are? Similarly, how can you work on yourself as a trader if you don't know much about yourself? That's the situation most people face. They think they know themselves well, but they really don't know anything about themselves. Have you, for example, made an inventory of your beliefs about yourself?
Second, if you want something, you must practice "being" it. Being comes before doing or having. In my opinion, most people want to trade well, but their primary concern is how to do it and have success. You must practice being a successful trader first. From that state of mind you will get information about what to do, and that will produce what you want to have. Many people also believe that they must struggle and work hard to get ahead. This is the antithesis of the statement above about "being" successful. If you believe you must struggle to become successful, you probably will struggle a lot.
Third, many traders have what I call the perfectionism-complexity complex. In other words, what you have is never quite good enough. It can always be improved in some way. There is always another exit or another entry that will make it better. What this means is that you always will be struggling with new ideas. Consequently, you never will get to the real issue of trading and just being a trader, doing trading. Instead, there is always one more thing to test—always one more thing to do—and never enough time to just relax and trade.
Give up complexity and move toward simplicity. The best traders are always those who practice simplicity. For example, at a recent seminar one trader remarked, "I just buy what's going up. If it goes against me, I get out immediately. If it goes in my favor, I let it run. I've made a lot of money doing that." That is simplicity, but you can do it only if your mind and spirit are pure and you are paying attention to what the market is doing. It's purity of spirit that makes the difference. This particular trader always asks for internal guidance before beginning the trading day. I tend to believe that makes a big difference.
Fourth, many traders—and people in general—have low self-esteem. If you don't believe you are worthwhile, that belief will tend to dominate everything else. You may believe, "If I can just make money trading, I'll feel better about myself." However, that belief actually is composed of two parts: low self- esteem and the belief that low self-esteem will be "fixed" by trading success. Unfortunately, that doesn't seem to be the case. Low self-esteem always seems to dominate and produce behaviors to justify itself unless, of course, you are aware of it and do the kind of self-work that will improve your self-esteem. If you think that life is a struggle, it's probably because of your low self- esteem.
The key to all these issues is to understand yourself and realize that you are the root cause of your results in trading. When you do that, you have started on the road to success.
Think about the last loss you had in your trading. What caused it? Who was responsible for it? If your response is anything other than yourself (for example, the market, my broker, bad advice), you are not taking responsibility for your results. You will repeat mistakes over and over until you understand this. In contrast, if you are willing to accept total responsibility for your investment results, you begin to understand all the mistakes you've made and are able to correct them. The market will become your financial university. Moreover, you will realize that you are the most important factor in your trading or investment success. If you understand that, you are way ahead of the crowd.
If you want to be good at something, you must design a method that fits you. That is possible only if you design the methodology to fit your beliefs, meet your objectives, and match who you are.
I once had a call from a gentleman in England who had been working through my peak performance home study material. He said, "I've been working through your course for over six months. It has helped me realize a lot about myself, but there is one thing it hasn't done. It hasn't given me a positive expectancy system." The ironic thing about that statement is that I had not attempted to provide a methodology in that course; it is about how to become a peak performance trader/investor so that you can design a method that fits who you are.
Psychology is far more important than methodology. In fact, psychology is part of methodology. For example, when we attempt to help people develop a reasonable method that works, they resist the process strongly because they have so many biases that keep them focused on the wrong aspects of trading—areas that have nothing to do with success. It is very difficult to show them the correct direction.
The best thing you can do to increase your income from the market is to determine how you are blocking yourself. This should be done at two levels. Whenever you develop a trading business plan, a large part of that plan should have to do with introspection. Take a look at all your beliefs. Are they useful beliefs, or do they hinder you in some way? What are your strengths and challenges? What about yourself can't you see clearly because you are part of it? You should consider doing this sort of assessment at least once each quarter.
The second self-appraisal you need to make is at the beginning of the day and perhaps even hourly throughout the day. What's going on in your life? Are you ready to face the markets? How are you feeling? Is some sort of self-sabotage surfacing in you? For example, are you starting to get too confident? Are you starting to get too greedy? Do you in any way want to override your system? The best traders and investors constantly do this sort of self-assessment. If you want to make more money in the market, perhaps you should start doing it too.
To help you with your self-assessment, I developed a quick 17-point questionnaire you can use to evaluate yourself. Take it and pass it on to your friends; I'm sure you'll all get some insights into your performance. Answer each question with true or false:
1. I have a written business plan to guide my trading/investing. _____
2. I understand the big picture about what the market is doing and what is affecting it. _____
3. I am totally responsible for my trading results, and as a result I can correct my mistakes continually. (If either part is false, all of this statement is false.) _____
4. I honestly can say that I do a good job of letting my profits run and cutting my losses short. _____
5. I have three trading strategies that I can use that fit the big picture. _____
6. For my first trading strategy, I have collected an R-multiple distribution of at least 50 trades (that is, from historical data or live trading). (If you don't know what an R-multiple distribution is, you haven't collected one, so answer false. The R-multiple distribution will be discussed later in this book.) _____
7. For my second trading strategy, I have collected an R-multiple distribution of at least 50 trades (that is, from historical data or live trading). _____
8. For my third trading strategy, I have collected an R-multiple distribution of at least 50 trades (that is, from historical data or live trading). _____
9. For each of my trading strategies, I know the expectancy and the standard deviation of the distribution. _____
10. For each of my trading strategies, I know the types of markets in which they work and in which they don't work. _____
11. I trade my strategies only when the current market type is one in which the strategies will work. _____
12. I have clear objectives for my trading. I know what I can tolerate in terms of drawdowns, and I know what I want to achieve this year. _____
13. I have a clear position sizing strategy to meet my objectives. _____
14. I totally understand that I am the most important factor in my trading, and I do more work on myself than on any other aspect of my trading/investing. _____
15. I totally understand my psychological issues and work on them regularly. _____
16. I do the top tasks of trading on a regular basis. _____
17. I consider myself very disciplined as a trader/investor. _____
Give yourself one point for each true answer. Be honest with yourself.
Fill in your score here: _____
Let's take a look at how you rate:
14 or more. You have the makings of a great trader/investor and probably do well in the markets.
10 to 13. You have a lot of potential but probably are making some major mistakes; for many of you, these may be psychological mistakes.
7 to 9. You are way above average but haven't graduated to the big leagues yet. You are like a high school football star trying to move to the NFL.
4 to 6. You are better than the average investor on the street but have a long way to go to hone your skills. You probably need to work on yourself, your discipline, and your trading strategies.
Excerpted from SUPER TRADER by VAN K. THARP Copyright © 2011 by Lake Lucerne LP. Excerpted by permission of McGraw-Hill. All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
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