The Van Tharp Institute

January 25, 2006 — Issue #255

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In this Issue:

Workshop Special

Van Tharp's Signature Workshop, Peak Performance 101

Feature Article

The  Psychological Side of Expectancy by Van Tharp

Trading Education

Special Reports on Money Management and Expectancy

Trading Tip

The Bright Side of  Forex, by D. R. Barton, Jr.

Listening In Success Percentages 
Special Reports Reports by Van Tharp: Self Sabotage, Changing Markets

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Workshop Special

Van Tharp's Signature Workshop for Traders and Investors

Peak Performance 101

March 11-13, 2006

Fort Lauderdale, Florida

"My self confidence is soaring off the meter! My trading performance has improved. There is a sense of serenity that I learned to create (as a mental state) around my self whether I'm winning or losing. I'm much more calm watching the markets whipsaw. This mental state control has in turn improved my overall technical edge. I can focus better on the programming tasks."  Past Workshop Attendee

Learn More...

Feature

The  Psychological Side of Expectancy

By

Van K. Tharp, Ph.D.

In the real world of investing or trading, expectancy tells you the net profit or loss that you can expect over a large number of single unit trades (One share of stock or one futures contract would be a single unit).  If the total amount of money in the losing trades is greater than the total amount of money in the winning trades, then you are a net loser and have a negative expectancy.  If the total amount of money in the winning trades is greater than the total amount of money in the losing trades, then you are a net winner and have a positive expectancy.

However, there is another side to expectancy—the psychological side.  Indeed, the psychological side may be much more powerful than the side that involves determining the historical expectancy of one’s system.  The psychological side revolves around one of the laws of the mind—whatever you expect to happen does.

The psychological role of expectancy is paramount.  If you make two lists—what you value the most and what you most want to avoid—you’ll find that the combination of the two lists perfectly describes your experiences in life.   For example, if the most important values in your life include family, success, fun, honesty, and friendships, you’ll probably have all of those things in your life.  If money and success are not among the top five, however, you may not be bringing them into your life.

You also bring into your life the things you most want to avoid.  For example, if you have a list of things to avoid that includes not being taken advantage of, avoiding rejection, avoiding change, avoiding confrontation, and avoiding anything risky, then you probably also have a lot of those qualities in your life.  Why?  If you dwell on what you want to avoid, you give it energy and that’s what you get.  As a result, your life will be a direct combination of the things you value and the emotions you want to avoid, depending upon how much time you dwell upon each of them.

Whatever you put into your mind, whatever you expect—whether positive or negative—you tend to draw into your life.  Consequently, you are much more the architect of your own life than you probably ever thought.

Your reaction to what I’ve stated might be “If that’s true, why should I do any research in the market?  Why should I do historical testing to determine the expectancy of my system?  If what you say is correct, then I should just think good thoughts, enter into a trade, and reap the reward of my good thoughts.” Unfortunately, it’s not that simple!

Wishing or hoping will not make you a lot of money in the market.  Indeed, there’s a great deal of difference between expecting to win and hoping to win.

When I say that you get what you expect, it doesn’t mean that you can forget to do any research or preparation and just expect to be a winner.  Perhaps you could do that if you were totally clear psychologically, but very few people, if any, reach that condition.  We all have issues in our unconscious mind that we tend to play out in real life over and over again.  My guess is that the people who have done enough psychological work to be fairly clear will be eager to do the research to be sure (have the confidence and the positive expectancy) that they will trade well.

What I would suggest is that you make sure you have a mathematical positive expectancy in your trading.  But in addition to the mathematical positive expectancy add some psychological expectancy.

About Van Tharp: World–renowned trading coach, author and psychologist Dr. Van K Tharp, is widely recognized for his best-selling book Trade Your Way to Financial Fre-edom and his outstanding Peak Performance Home Study program - a highly regarded classic that is suitable for all levels of traders and investors.

The above article is excerpted from Van Tharp's Special Report on Expectancy.

 

Trading Education

Special Reports on Money Management and Expectancy

Van's next book The Definitive Guide to Position Sizing is still a work in progress and we don't expect publication until later in 2006.

However his Special Report on Money Management and Special Report on Expectancy are still available and great resources for understanding the critical role these concepts play in your system development and trading profits. $79.95 each. Click below to learn more.

Special Report on Money Management

Learn More...

Special Report on Expectancy

Downloadable format! Learn More...

Trading Tip 

Trading Tip

Foreign Exchange Markets Part Three

The Bright Side of Forex

by D. R. Barton, Jr.

In last week’s article, we looked at some of the negatives of the forex market (remembering that all markets have some negative points).

I’m sure lots of folks were asking why so many new retail investors are jumping into the forex markets if there are so many potential potholes.  The answer is simple – forex brokers are making big margins on each trade because of the high transaction costs (mostly hidden) that retail traders and investors are paying.  But because of these high operating margins, brokers are willing (and able thanks to the lax regulatory atmosphere of forex) to give some nice added perks and advantages to traders.  (And they can also mount some pretty good marketing campaigns.)

Let’s look at some of the positives offered by the forex markets.

·        Low starting equity requirement.  For many people, day trading stocks is not a viable option.  Regulations require a minimum account size of $25,000 and most brokerages require $30,000 to open a day trading account for stocks.

But for forex accounts, I have seen starting equity requirements as low as $200.  And many brokerages will take credit cards to open an account.  So the cash barrier to entry is exceedingly low for the forex markets.  However, like the next item (big leverage), low starting equity is a double edged sword that can hurt or help the trader.

How can this hurt?  First of all, it can lure people in who do not have the training or the financial ability to take speculative risks.  It can also encourage people to enter the markets who have a very low level of commitment to trading well and are therefore highly likely to fail.  And lastly, very small amounts of account equity last only a short time in the hands of beginners. Running out of cash makes it difficult to learn.

On the positive side, more people can participate in the markets with low entry levels, so one could argue that this is really quite democratic.  Low minimums also give traders an opportunity to set up an “educational” account and learn while risking no more than the amount deposited.  (A note of explanation is required: with many forex brokers that offer low account minimums, they limit your risk – and theirs – by including built-in liquidation stop losses in their software.)

·        High leverage.  I would bet there are higher leverage rates out there, but I have seen 400:1 leverage offered.  Talk about a double-edged sword!

Very high leverage can help you build up a small account in a hurry or burn through it all equally fast.  Some common sense is called for when using leverage.  Concentrating on the size of your risk on each trade rather than the amount of currency you’re controlling is a good place to start.

Most forex brokers that provide very high leverage do this on sliding scale. Highest leverage (say 400:1) is provided to the very smallest accounts (say $200 - $1000).  Once an account gets bigger than the prescribed margin thresholds, the margin drops to 200:1 then 100:1 to 50:1.  This reduced leverage limits the broker’s exposure as accounts grow, but clearly show us that the generous margin provisions are done to attract small accounts, not to reward sensible traders.

·        Most brokers have very good trade execution software.   There are only a handful of stock brokers that have execution platforms that offer order-cancels-order type controls and other contingent orders.  I’ve looked at several forex-based platforms, and forex brokers place a premium on putting high levels of functionality into traders’ hands.  This makes business sense – if you find it easier to execute your strategy, you’re likely to trade more often.  This is one area where the equities world could learn a thing or two from their forex counterparts.

·        Liquid markets round-the clock.  Sunday evening through Friday afternoon, forex offers highly liquid markets, especially in the most popular currency pairs.  Traders can also minimize “overnight gap” risk, since forex markets trade in a liquid fashion almost around the clock.  (Forex traders can attest that there are some “low activity” periods, however.)   News can still cause fast markets and slippage, but stops that are placed and ready for execution in brokerage software can still take some of the sting out of bad news hitting your position while you’re sound asleep at 3 a.m. in the morning.

·        Trending nature of currencies.  Major currencies are still dominated by central banks, national financial policies and macro trends.  This means that currency traders enjoy markets that have a greater tendency to trend than most markets.  I have seen some compelling data on this trending characteristic of the currency markets.  (Special note – if anyone has seen recent data on the trending nature of currencies, please let me know at drbarton@iitm.com.  Most of the research I have is a few years old.) 

Until next week – great trading!

D. R. Barton, Jr.

 

D. R. Barton, Jr. is the Chief Operating Officer and Risk Manager for the Directional Research and Trading hedge fund group. D. R. has been actively involved in trading, researching, and teaching in the markets since 1986.  D. R. has taught extensively in many investment areas including intra-day trading, swing trading, and cutting edge risk management techniques. 

His writing credits include co-authoring Safe Strategies for Fin-ancial Fre-edom and co-creator and contributing author on Fin-ancial Fre-edom Through  Electronic Day Trading.

 

Listening In...  

From Van Tharp's Mastermind Forum

Success Percentages 
Author: Scott 

In any endeavor/game, there seems to be a theoretical limit on the success rate of the participants. Consider the following:

Major League Baseball: The 50 highest career batting averages range from .317 to .366

NBA: The 30 highest career field goal percentages range from .523 to .599

NFL: The 3 highest career passing completion percentages range from .643 to .659

All of the above record holders would be considered very successful in that not only did they have great success percentages, but they also had positive expectancies over very long careers.

Does anyone have any thoughts on the win percentages of a large group of successful traders (with positive expectancies)? I realize the success rate of long term trend followers will be lower than other traders, but it seems to me that there is probably a theoretical limit on a trader's winning percentage just like there seems to be in other games.


Reply To This Message 


Re: Success Percentages 
Author: Pumpernickel 

For those who have a daily track record encompassing more than 1000 data points (~4 years), I recommend calculating the following statistic:

PERCENTAGE OF DAYS MAKING NEW ALL-TIME HIGHS IN ACCOUNT EQUITY

Any day whose total account equity value is higher than all previous values, gets counted as +1. Otherwise zero. Tally them up and express as a percentage of all days.

A few of the more excellent mechanical-systems software packages do this calculation automatically. It's a fairly sobering result: the best of the best of the best systems, produce an equity curve in which about ten percent of days are making new equity highs (!).

In other words, ninety percent of days are not making equity highs. Ninety percent of the time, your account is in a drawdown, below a previous equity high. And this is from the best of the best of the best. Ouch!


Reply To This Message 


Re: Success Percentages 
Author: PMK 

In cases like this it is useful to think about how the market functions rather than about how traders trade.

In a casino, there are only negative expectancy games, this does not mean you can't have a high win%, just that the amount you win when you're right is going to be less than the amount you lose when you're wrong (over all punters).

In a market, the market makers make money by earning the spread on each transaction, so for them to survive and prosper it must be a negative expectancy environment (for the market participants) overall.

If you take 'random' as the normal win% then anything above that would be considered 'good' in terms of win% alone. In reality the win% is a bit of a red herring - being a successful trader is not about being right, it is about making money. Therefore you can be excellent if you lose 1R 90% of the time and make 20R 10% of the time, or lose 0.75R 50% of the time and win 1R 50% of the time.

Conversely you can have terrible results if you win 1R 99% of the time but lose 1000R 1% of the time (think LTCM).

Personally, my win % is usually about 55%, but has gone through periods of months where it was as low as 30% (and that's where the drawdowns come from because the size of my my average winner and loser is pretty constant).

Paul

P.S. in addition I don't have any real control over my win% - I just know that I have designed positive expectancy trading systems that should make money overall as long as they are not broken regardless of how many trades turn out to be winners versus losers. 

Editors Note: As Always...read the complete and unedited thread  at the link below. Look for the title Success Percentages, to read many more posts on this topic.

Participate on Van's Trading Forum, a place for traders and investors to share ideas and learn from each other.

Special Reports By Van Tharp

Click below to read page one of each report, or to order. 

Self  Sabotage - Two Reports of Self Sabotage

Does Your System Still Work in Changing Markets?

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The markets are not a problem to be solved but rather a behavior to be understood. --D.R. Barton

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