The Van Tharp Institute

March 29, 2006 — Issue #264

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In this Issue:

Workshop 17 Steps to Becoming a Great Trader
Feature Article

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

Back-to-Back

Systems Development and Mutual Funds/Exchange Traded Funds Workshops, Final discount and chance to register expire today.

Trading Tip

Emerging Markets in the Middle East, by D. R. Barton, Jr.

Trading Education

People Don't Trade the Markets, They Trade Their Beliefs About the Markets.

Listening In Money Management System
Special Reports Reports by Van Tharp: Self Sabotage, Changing Markets

View this newsletter on-line, or read back issues

 

Workshop 

The 17 Steps to Becoming a Great Trader Workshop

May 5-7, 2006, Raleigh, NC

"This is the best conference I have ever attended. This is the hardest conference I have ever attended. I had to ask myself some of the most difficult questions I've asked in a long time...Van and Mel are not just great trading coaches, they are great people. You are a breath of fresh air in a industry full of hucksters." — S.W., Rancho Mirage, CA, Past Attendee

Are you confused about all of the information that is thrown at you in the trading arena? Set-ups, exits, R-Multiples, expectancy, position sizing, business planning (to name just a few). How do they all fit together and which piece is the most important? What do you do first?

The 17 Steps workshop will help you to answer all of these questions and more.   

This workshop has been designed to take you through a step-by-step process of everything that you need to know to become a great trader. Dr Tharp will work with you through a series of intense questions and exercises, to get you thinking about (and designing) your own trading business plan, your strategy development and the best ways to work on yourself to maximize your success.

If you want to take your trading from A to Z, then this course will take you there step by step…

Learn More...

Plus, Download the Teleconference, How to Become a Great Trader...

Feature

An Interview with Ken Long

By Van K. Tharp, Ph.D.

Part Four

This is my final installment of our four part interview series with Ken Long, founder of the Tortoise Method for mutual fund switching and my lead instructor for my Mutual Fund and Exchange Traded Funds Workshop.

Through this series of interviews with Ken Long ( Parts One  Part Two Part Three), we have discussed many aspects involved with system development through discussions that stemmed from Ken’s strategies participating in trading simulation exercises in the How to Develop a Winning Trading System workshop. 

So far we have discussed the importance of defining your objectives, how the steps one follows in the decision making process makes a big difference in the outcome of the system and how market conditions change and the trader must keep pace with changing markets.

We finish this discussion, starting with multiple systems.—V.T.

Van: Sometimes the task at hand may require that multiple systems go into play.  For example, in a trading management business you have systems such as the trading system, the back office system, the position sizing system, the research system, and perhaps many others.  How do you decide when multiple systems are required?  And how do you separate them?

Ken: I like the golf metaphor for developing a set of trading systems.  You want a certain amount of specialized tools that let you get the best results from your effort (your swing), but you can take it too far and have too many systems (clubs) that they become unmanageable.  At the same time, too few clubs and you are accepting too many compromises.  Pick a club, master it, add it to the bag and then go after the next one.  Keep it up until you feel a sense of equilibrium and you are meeting your investment objectives with the tools at hand.  In this metaphor, simulation represents a hitting a bucket of balls at the range to groove your swing or optimize your system, before you take it on the course.

A good place to start in determining if multiple systems are needed is a process called functional analysis, where you brainstorm to develop as many tasks as you can imagine.  Once you've done that, you group those tasks into logical sets to see if you can gain efficiencies.  Normally tasks cluster together and you can begin to see where a business center or functions center is developing. 

And what do you do with that?

The next step might be to take each of these subsystems and consider them by themselves. Determine the objectives and measures of effectiveness for each subsystem, and how that subsystem can affect the other subsystems it must work with.

Modern systems studies of the supply chain have introduced the “Input-Process-Output” model to 1) help understand where each system gets raw materials (or information) from suppliers, 2) act upon these raw materials to add value, and then 3) output something of greater value for downstream customers.  Mapping these information and/or production flows in detail helps the systems designer engineer the process to improve communication and timing among all the subsystems.

A major consideration is to ensure that efforts to optimize a subsystem do not sub-optimize the overall system performance.  Awareness of the importance of the interconnectedness of subsystems has led to keen interest lately in business process modeling and simulations in many industries.

That’s interesting.

Another way to skin the cat is to benchmark, where you find the best of breed performer of a particular function and map that system and performance. This is important if you intend to manage other people’s money.  It’s important to know where your unique competency is, where you have an edge.  For all other areas you’ll find that’s its better to benchmark best practices that are already out there working than trying to invent a better way to do everything yourself. 

In developing a trading system, this approach might lead you to hire existing researchers, marketers, coaches, accountants, administrative and clerical support organizations so that you can focus your energy on fully developing, testing and then operating your particular trading strategy.

So what are some of the issues involved with multiple systems?

We’ll I can think of a few off the top of my head: compromises and tradeoffs; linear thinking vs. spiral thinking; mission statements; coaching/mentoring; and role playing points of view.

Okay, let’s take them in that order—first, let’s talk about compromises and tradeoffs.

Inevitably you discover that overall system performance is improved when you let your subsystem components contribute their strengths and get their weaknesses covered by other systems.  For example, you can design a trading system that moves money among members of a mutual fund family that has a higher rate of return at the end of the year than the single best performing fund in the family. So, pay attention to the power of teamwork and the way your system components can work together to be more than the sum of their parts.

How about linear versus spiral thinking?

Remember that systems in nature develop in cycles;  it is not a linear process.  It is useful to think of system development as a spiral, where you rapidly develop the subsystems together.  In doing so, you must pay attention to interfaces and interactions along the way, and moving to subsequently greater levels of detail when it seems like all the pieces are fitting together.  In a linear approach you can get too far down in the weeds of detail on one system component, only to discover later that it doesn’t fit in well with the other components and you have to start over.  Rapid prototyping, experiments and testing along the way, and keeping details to the required minimum will keep the ball rolling and save time, money and energy.

Okay, how about mission statements.

I try to express the mission or purpose of each system component and the system itself in a simple declarative statement that states its task, purpose and end state.  “Task” states “what to do”, “Purpose” states “why we are doing it” and “End state” tells us “what success looks like”.  If you find it hard to do that for a part of your system, it probably means you are asking it to do too much and you may need to break out the conflicting purposes and functions into separate systems.

And role-playing—how does that come into play?

Take on the role of different members of your system, and of customers, suppliers, competitors, allies, the media, the public, the government, your friends and family.  Imagine what your system looks like to them through their eyes and ears and give voice to their reactions.  Watch your feelings and reactions to what they say and see how your system might adjust to account for their points of view.

Tom Basso used to say that he’d always explore what it was like to take the opposite side of the position from his system before he’d run a system.  I guess that’s a trading equivalent to role-playing.

Yes. Your opponent is your greatest teacher, because he will show you where you are weak.

I’m a big believer in the next one — having a coach/mentor.

I recommend having a coach or mentor who is not deeply immersed in a project who can stand back and provide a strategic assessment and an experienced perspective on your efforts.  There is a cottage industry of senior executive consultants, “the gray beards”, advising systems developers and entrepreneurs.  Take advantage of the experience that is out there, while protecting the energy and vision that drives you to create your own system.

And lastly, what about remaining true to your vision?

Consider carefully the feedback you get from the environment, but run it through your judgment and weigh its value. Accommodate and adjust to the feedback you get, but keep the bright light of your vision and goal out there to help you get through the rough times.  Let it pull you forward, gaining wisdom along the way.

How important is it to simulate any sort of system before you put it into practice?  Can you give us an example with something you’ve encountered in the “real” world?

In the past 10 years the Army has completely reinvented itself from a forward based force with stockpiles in place, to a continental US- based force projection force that has to bring its soldiers and materiel to the theater of operations.  At the same time, we’ve tripled our overseas commitments while cutting the force in half.  We’ve done this successfully without standing down from our daily commitments worldwide.  In that process we’ve reinvented our supply system and made major organizational changes throughout all our formations.  Extensive modeling and simulations to determine if the proposed changes would present unforeseen second and third order risks years in the future have supported each of the steps along the way. Even today, mainframes in the Pentagon work 24 hours a day, seven days a week to determine where our risks are in meeting the timelines for deployment and operations that support the national strategy. 

At the smallest of tactical levels (squads and platoons) we employ a lot of simulations before we ever get out in the field and try ideas out with soldiers and equipment. Done correctly, simulations are a simple, low-cost, cost-effective and objective way of testing new ideas. Our military’s great success in Desert Storm and Desert Shield can be traced directly to the innovative use of simulations as part of our training and deployment strategy.  We used it to train our soldiers as well as to model and improve our strategic deployment systems.

When developing a trading system, simulating and testing it with historical data and probabilities is a great way to see if the system you have designed on paper and you, the operator, are robust enough to handle the real world with its surprises, time constraints and stress.  Simulation never guarantees success in the real world, but it goes a long way towards reducing the time and expense of trying out marginal systems in the market.

Okay, let attempt to summarize this, Ken.

If I had to sum up my experiences with both the theory and practice of systems development I would have to at least include these rules of thumb:

1.                  Know yourself, the members of your team, your objectives and your opponents

2.                  Study your market and the environment in which you will operate.

3.                  Keep the system simple and flexible.

4.                  Make the system robust, so that it can be used in a variety of conditions.  (Don’t overspecialize).

5.                  Use imagination to anticipate options, events, issues, and conflicts during planning.

6.                  Rehearse your responses to as many events as you can imagine.

7.                  Act quickly and decisively, thereby allowing yourself time and space to make adjustments.  A good decision in time always beats the perfect, but too late, decision. Replace assumptions with facts as they occur, but don’t wait for certainty to act.

8.                  Check your oil often.  Know what and when you are checking and why.

9.                  Keep your mind open, and question your assumptions.

10.             Be humble, generous in spirit, and young enough to learn from the wonder and marvel of it all.

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.

If you'd like to learn more about Ken Long and his Tortoise Method, please visit his website: www.tortoisecapital.com

 

Back-to-Back Workshops

Last Chance to Register...

Develop a Winning Trading System That Fits You

April 1-3, 2006 Raleigh, NC

How to Trade Mutual and Exchange Traded Funds

April 5-7, 2006 Raleigh, NC

 Register for Either 
Register for both

 

Trading Tip 

Trading Tip

Emerging Markets in the Middle East 

by D. R. Barton, Jr.

Take a region with monster amounts of free cash flow.  Add in traditionally authoritarian governments.  Stir in some free market limitations and sprinkle in a history of civil unrest…

And you get a recipe for a potential stock market disaster.

That’s what we see kicking up its heels in the  Middle East.  Last week, reliable analyst Dennis Gartman alerted his readers about the potential issues in the equities markets of the  Middle East.  In Monday’s (March 27) Wall Street Journal, we read about the potential political and economic unrest in the region due to the drop in the stock markets there.

The news site Middle East Online dubbed Tuesday (3/21) “Black Tuesday” as the Dubai stock market’s Dubai Financial Market Index dropped 11.7% in one day.  Broader market indices in the region were dropped 4% or more on the day.  These massive drops got little-to-no media exposure in the west.

But the drops were enough to send protestors to the streets demanding government intervention. 

Persistently higher oil prices have provided a cash glut in the region and citizens are turning to the equities markets to invest their new-found wealth.  As an example of the investing frenzy, an astounding 40% of the adult Saudi population placed orders for an initial public offering in an issue listed on their exchange.

So why should traders and investors worry about these frothy markets and the civil unrest that market drops are causing?  There are two good reasons:

1.     The regional unrest is adding risk premium to the price of oil, and could add more if it gets worse.

2.     Problems in these highly provincial emerging markets could spill over and dampen or squash interest in other, more open and available emerging markets.

There is not a strong reason to start reducing your emerging market portfolio just yet.  But for the next couple of months the prudent trader and investor should keep an eye on the Middle Eastern markets to make sure that it is not a starting off point for a domino effect that impacts other regions – and your portfolio.

Great Trading!

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

Van Tharp's  Peak Performance Home Study Course

People do not trade the market. They trade their beliefs about the market. 

  • A guide to isolating and understanding your own belief systems in relation to trading.

  • Effective training for all levels of traders, from beginners to advanced.

  • A model that you can follow to emulate the success skills of profitable traders.

  • Discover your trading edge, set yourself apart from other traders.

  • Bring more discipline to your trading.

  • Learn self-confidence, overcome fear and eliminate self-sabotage.

These are just a few of the benefits of the Peak Performance Home Study Program.

Click Here to Learn More...

 

Listening In...  

 

Money Management System 
Author: Dan06
Money Management System

I am thinking of implementing the following Money Management System:

1) Sell half amount of stocks when price rallies to a price where the reward = initial risk level 
2) Move initial stop to break even and tail the rest of the half with tailing stops onwards

I am using trend following strategies. 

One advantage of the above system is that it able to capture half of profit fast and conservative but it relies on the rest of half to make significant profit. Also the ability to generate more profit is reduced compared to system like selling all units with trailing stop or at 1.5 pof initial risk. 

Can anyone pls provide some opinions about this system and how can it be improved without forgoing much of the conservative (Risk protecting) part?

Dan

Reply To This Message 


Re: Money Management System 
Author: PMK 

Dan,

Here is my opinion on this. Both of your exit strategies I would consider 'psychologically pleasant' in that you 1) take profits early on half of the winning position, and 2) have a 'free ride' on the other half.

Unfortunately, pleasant strategies are rarely a good idea in trading since you will not be alone in their application. This will lead to a bunching of stops at your exit points and a much more likely chance they will be hit (even if you don't put them in the market or with your broker - enough traders will to provide a 'market target').

The upshot of this is that for your winning trades you will first realize a (capped) 0.5 R win and then often breakeven on the other half of the trade as the market moves to where all the stops are. Also, there will be lots of selling at both your exit points (for a long position) which will cause increased slippage.

The practical consequences of this are: 

1) You feel comfortable in your winning positions while they are on
2) You push your winners towards 0.5R (but your losers stay at -1R)

If these are your desired objectives then fine, but I have a feeling that is not what you intended to design.

Hope this helps

Paul King

Re: Money Management System 
Author: Andrew


My understanding of trend following strategies is that you enter the trade when you receive your entry signal, and then follow the market as far as it goes with your trailing stop. 

By definition you should follow the market and not anticipate where and when the trend will end; however, by employing a profit target equal to the initial risk level, anticipating is exactly what you are doing. 

Effectively, on those trades that go on to be big winners, you are cutting you profits short, whilst on the risk side nothing is gained as any trade that never reaches the 1R profit level will still be a realized 1R loss. By implementing the 1R profit taking strategy, you may be trying to increase your winning % by capturing some 1R profits from trades that otherwise would end up as losing trades, because it feels more comfortable to trade a higher % winning system. If this is the case, maybe a trend following strategy is not suitable for you. 


Participate on Van's Trading Forum, a place for traders and investors to share ideas and learn from each otherFor the more on the above posts, look for the title, Money Management System.

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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Copyright 2006 the International Institute of Trading Mastery, Inc.

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Quote of the Week

"The words 'I am' are potent words; be careful what you hitch them to. The thing you're claiming has a way of reaching back and claiming you." ~A.L. Kitselman

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Free Trading Simulation Game

A computerized version of Van's famous "marble game." 

It is designed to teach you the important principles of proper position sizing. 

Download the 1st three levels of the game for free. Register now. 

 

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Featured Book:

The Why Cafe

by John Strelecky

A book about your Purpose for Living...

John has been a guest speaker at several of my workshops and his book has been an inspiration for me and for my staff. 

It's now sold in 14 countries and has been translated into 13 languages. If you don't already own it, it's a quick, uplifting read and has just been released in hardcover.

Buy Now

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2006 
Workshop Mini-Schedule

April 1-3 Systems
April 5-7 ETF/Mutual Funds
May 5-7 17 Steps
May 19-21 Swing
June 3-5 Peak 101
June 7-9 Peak 202
Jul 14-16 You, Your Money

 More Info...

 

 

 

 

 

 

 

 

 

 

 

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