The Van Tharp Institute

March 08, 2006 — Issue #261

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In this Issue:

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Systems Development and Mutual Funds / Exchange Traded Funds Workshop

Feature Article

Interview with Systems Expert, Ken Long, Part One, By Van K. Tharp, Ph.D.

New Teleconference

Free, Peak Performance Trader Teleconference MP3 File is ready for download.

Workshop

Coming March 11-13 to Ft. Lauderdale, Florida

Trading Tip

Is Short Selling Unpatriotic (or Unethical)? by D. R. Barton, Jr.

Trading Education

Special Reports on Money Management and Expectancy

Listening In Starting Over 
Special Reports Reports by Van Tharp: Self Sabotage, Changing Markets

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Feature

An Interview with Ken Long

By Van K. Tharp, Ph.D.

Part One

With my upcoming back-to-back workshops (Systems Development and How to Trade ETF/Mutual Funds); now seems like a great time to share an interview that I conducted with Ken Long, one of my instructors and an expert in systems development. 

Following this interview, Ken developed a mutual fund switching system for the busy professional that takes only a few minutes a week, called the Tortoise Method. After perfecting that system, he mastered the somewhat new trading area of exchange traded funds. 

Through this series of interviews with Ken Long it is my objective to highlight important points about trading system development.--VT

I met Ken Long at one of my systems development workshops in 1999.  I was quite impressed with him because I do not believe there are too many military officers who have had great success trading the market.  However, Ken is one of them.  In addition, Ken is the only person I’ve ever met who has a Masters degree in systems development.  He says that he spends his time helping ease the transition so that civilians can run many of today’s Army functions.  In addition, he must also continually work with systems that seem optimal on paper or in the computer, but just don’t work when the human element of a soldier becomes factored into the equation.  As a result, Ken is one of the true experts in the world on system development.

During the IITM trading system development workshops we play a very complex trading simulation game, involving two bags of marbles.  Ken’s group seemed to have the situation well in its grasp by the beginning of the first day.  When I talked to him about it, I discovered that he had completely laid out all of the steps that his group needed to do the night before.  That is a huge advantage to anyone.  Ken outlined those same steps to me and I couldn’t agree more.  In fact, I thought they would apply to many of the situations facing my students who are budding traders and have no idea where to go next.  As a result, this interview will highlight some of Ken’s thinking in order to help you simplify the tasks involved in system development.

VT: Ken, the first thing you talked about was defining who you were in the game.  You decided to assume that you were mutual fund managers in the game.  Why is that important to do?  And how does that apply to the situation of developing any type of system?

KL: Before you conduct any planning or system design, you must have a thorough understanding of who you are and what your objectives are.  In the game, we were able to establish a realistic and consistent framework for decision making for ourselves by giving some thought to the roles we were playing.  Individual investors, private hedge fund managers, public mutual fund managers, trust managers: these groups will have different dynamics, time frames, and risk profiles. This relates to system design in that the final product must fit the circumstances and dynamics of the group or individual.  If you jump into system design without considering these basics, you will sow the seeds of future problems.  How many horror stories have you heard where groups tore each other apart because they neglected these basics? Even in the game we played, these intra-group misunderstandings caused many fine systems to fail through frustration and miscommunication.

The next step seemed to be to define what it is that you want to accomplish in the game.  Can you elaborate why that’s important?  For example, I’ve always said that objectives are 50% of system development.  Would you agree?

I couldn’t agree more.  The first step in problem solving is to define the problem.  In trading system design, the problem is to define what you want the system to accomplish.  With as many ideas, events, circumstances and adjustments that occur in system development, you have to have your objectives crystal clear in your mind.  If you don’t know where you are going, then any old road will do.

Objectives give you the basis for making choices and prioritizing actions.  This is not to say that objectives are static.  In fact, they can change as you discover either unexpected limitations or advantages in your system as it matures.  But before you start you must have an initial set of goals and objectives to guide you. 

How do you really know you’ve done it?

After the system is deployed and operational, part of the process of calibrating the system is checking to see if the objectives still fit the person or organization that you have become.  That’s a very exciting part of system design.  I can’t tell you how often I’ve been part of a design team that started with a limited set of objectives and discovered in the “imagineering” phase that by adjusting our sights we were able to accomplish far more for much less. But, you have to start somewhere.  If you don’t start with objectives, you are spinning your wheels.

In the game, the step you went through was to determine your decision making process.  How would the group make decisions and when would those decisions be made?  Is this important in most systems?

If you don’t work out how your group will make decisions ahead of time, then you will certainly have to sort it out at the time of the first difficult decision.  If you make decisions on the spot, with no guidelines, you have two problems: 1) figuring out what to do and 2) how to do it.  And, these problems must be faced under great stress and limited time.  It’s better to calmly sort out the decision making process ahead of time so that the decision mechanism is agreed to before hand.

In our group, for example we had four people.  We agreed that all decisions would be by majority rule, with the elected leader breaking ties, and that any group member could ask for a vote.  That seemed fair, and once we agreed on how we would make decisions we could devote our attention to the specific details of particular decisions.  This may not seem that important, but in multi-person systems, like partnerships and boards of directors, it’s vitally important.  If you look at our US Constitution, it spends more time on how to make decisions than on the specific matters of policy.

I found it interesting that you chose to determine your strategies ahead of time, so that when you did make a decision it was only a matter of which strategy to adopt.  Talk about this in the general format of system development.  Why is it important and can you give us some specific examples?

In the Army, no plan usually survives the first contact with the enemy, and so our goal in planning is to develop a range of alternatives that can apply to a number of scenarios.  Through rehearsal and analysis, we know which strategy works best for a given set of conditions.  The goal of strategy development is to provide the decision-maker with a menu of choices, which are robust enough to cover a wide range of contingencies. 

In general system development then, we look for robust, simple plans that can cover a wide range of conditions.  When you preplan like this, you don’t try to force the world to adapt to your plan.  If you fall in love with a strategy and become emotionally invested in making it work no matter what the market or the world says, you lose the ability to adapt and learn. 

Give me an example.

A simple example might have to do with choosing a strategy based on the nearness of the next FOMC interest rate announcement when you have systems investing in instruments sensitive to interest rates.  We might choose strategy A with a higher risk when the next Fed announcement was two months away and Strategy B with tighter stops as the announcement approached.  Or we might have a model that varied our portfolio allocations among non-correlated markets that responded to signals from the environment.

So how did that work for you in the game?

Each of the strategies in the game represented a clear, distinct and reasonable course of action.  They were broad enough to help us meet our objectives because we had analyzed and carefully planned a set of choices that covered the game’s contingencies.

When you are developing a set of choices, you have to make sure that each of the courses of action is suitable, feasible and acceptable.  I’ve seen plans where the team invested a lot of time in effort in their preferred course of action and then tossed in a few poorly considered alternatives that weren’t realistic and viable.  They basically were paying lip service to alternatives because they consciously or unconsciously really only wanted their first choice.  This kind of delusion is worse than putting all your eggs in one basket because you might believe you have choices when you really don’t.

Next week in Part Two we’ll continue with the topic of decision making…

About Van Tharp: Trading coach, and author 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.

 

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Trading Tip 

Trading Tip

  Is Short Selling Unpatriotic (or Unethical)?

Short Selling  (Part II)

by D. R. Barton, Jr.

Short selling has always been portrayed as the “dark side” of trading.  It has been vilified by everyone from the Finance Minister of Malaysia (who recommended caning for convicted short sellers!) to U.S. Congress members to beleaguered CEOs.  But if you dig deeply into the rhetoric, you find lots of emotion, and few facts.  

CEOs motives against short selling are pretty easy to see.  They usually get lots of their compensation in the form of stock and options in the company they run.  So they have a vested interest in keeping people from taking the other side of their investment.  Also, short sale analysis digs deeply into the performance of company management; this is added scrutiny that CEOs don’t want.  In fact, the Enron and Tyco scandals were broken by analysts who were looking at the companies as shorting opportunities.

Congress members have a little different incentive to keep short sellers out of the market.  They believe that short sellers drive the market down (which is not true, as we shall see next week when we dig into some good research done on the effects – or lack thereof – of short selling).  Congress members want one thing – happy constituents.  And when the stock market falls, they want to look like they’re doing something to protect those voters.  So they blame short sellers for the problems.  This was seen after the Crash in 1929 and as recently as the post-internet bubble.

Is short selling unpatriotic?  Only to people who don’t understand the markets, capitalism or the real effects of short selling.  To address whether short selling is unpatriotic, we need to know if it is ethical and if it hurts the country’s well-being.  There is no compelling evidence that short selling hurts the markets, let alone the country.  In fact the opposite is thought – that short selling HELPS the markets. Next week I’ll share with you the results on some studies on short selling that show it has little effect on the markets (except that it helps to keep extremes in check).

But is there any ethical difference in buying a stock or selling it short?  With all the tired rhetoric aside, the answer is no.  Both the buyer and the short seller want the same thing: to make a profit.  The buyer is neither ethically nor morally superior to the short seller.  They just have different expectations for the direction of the stock, based on their individual analysis.

Of course, there are unethical ways to buy or short sell – rumor mongering, pump-and-dump and other tactics are used.  But for someone who is acting on the basis of fundamental or technical analysis, buying and short selling are ethically equivalent.  Both are at the heart of true capitalism.  What could be patriotic than that?

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.

 

Trading Education

Special Reports on Money Management and Expectancy

 $79.95 each. Click below to learn more

 

Special Report on Money Management

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Special Report on Expectancy

Downloadable format! Learn More...

 

Listening In...  

Starting Over 
Author: Steve737
Date: 02-16-06 16:46

Just finished [Van's] three books, "Trade Your Way", "Financial Freedom Through EDT", and "Safe Strategies". All are excellent; I have recommended them to several traders. I now need to implement my new way of thinking about trading, learned from your books, but I still hold several "lousy" positions that are examples of all the errors and wrong ways to do things from my past. I can point to each one as an example for what not to do.

Do I just liquidate them to start over (as many "industry experts / brokers" seem to advise), or have you thought about a technique or system that might help in this situation? Obviously, I have made dumb decisions to get in this position, and if there is a smarter way to address the errors, I would like to hear about it. 

I take full responsibility for the mistakes but I have no problem in asking for help. 

Steve

Reply To This Message 


Re: Starting Over 
Author: Terry 
Date: 02-16-06 21:31

Liquidate with a fresh , clean slate and reward yourself for taking the "responsibility" for learning "what not to do".

Terry


Reply To This Message 

Re: Starting Over 
Author: PMK
Date: 02-17-06 08:45

One of the few trading truisms: If in doubt just get out.

Paul King


Reply To This Message 


Re: Starting Over 
Author: bruce
Date: 02-17-06 21:17

I agree with Terry. If you've started new beliefs about how you want to trade in the future, I think you'll need to get rid of any previous baggage (including your current positions) to start anew. Your current positions are not how you want to trade anymore. I would get back to all cash and then start trading the new methods.


Participate on Van's Trading Forum, a place for traders and investors to share ideas and learn from each other. For more on the above posts, look for the title, "Starting Over."

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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