I have included a link to his site that offers a free 35 question test that will help you see what kind of trader you may be. Tharp breaks out traders into many categories and offers some insights to each specific type. Take the test and see where you stand.  

www.tharptradertest.com

Tweet This Post

In his book The Art of Happiness, the Dalai Lama notes a Greek fable on perspective. 

Once there was a disciple of a Greek Philosopher who was commanded by his master for three years to give money to everyone who insulted him. When this period of trial was over the master said to him, “Now you can go to Athens and learn wisdom.” 

When the disciple was entering Athens, he met a certain wise man who sat at the gate insulting everybody who came and went. He also insulted the disciple, who burst out laughing. 

“Why do you laugh when I insult you,” said the wise man. 

“Because,” said the disciple, “for three years I have been paying for this kind of thing and now you give it to me for nothing.” 

“Enter the city,” said the wise man, “it is all yours.” 

If we want to own the city, we have to learn how to change our outlook at will. The ability to change our perspective, viewing our problems from different angles, requires that we keep an open, compliant mind. It also takes practice. 

The Dali Lama said, “Generally speaking, once you’re in a difficult situation, it isn’t possible to change your attitude simply by adopting a particular thought once or twice. Rather it’s a process of learning, training, and getting used to new viewpoints that enables you to deal with the difficulty.” 

If you are in a trading slump it pays to look at the situation from different angles. You have to train yourself to focus on the positive aspects through knowledge and practice. For example, by being educated about the previous magnitudes and durations of your draw downs you could conclude “Hey, I should be looking forward to a prosperous period soon,” instead of, “Boy I can’t do anything right.” 

In a trading world that is characterized by unexpected events, we will see volatility and sloppy periods of trading. So, let’s expect that. Let’s swallow that fact and not be surprised when it happens. We know no one trades without draw down periods, so let’s educate ourselves to what these periods have looked like in the past. By adopting the process of changing perspective we will be in better shape to maintain our composure in the stormy times, and stay focused on the long term.

Tweet This Post

It is tough to make predictions, especially about the future. - YOGI BERRA

I keep CNBC on all day while I work. Perhaps I think I will miss something, or maybe it’s the background noise that’s appealing. In any event, what I always find amazing is the parade of experts making one prediction after another. I think I would fall out of my chair if I heard one of them say “Well, to tell you the truth Mark, I have no idea”.

What’s most surprising is the arrogance in which these forecasts are made. The forecaster always seems convinced he is right. I think the world is far more complicated than we think, yet we always seem to place way more value in what we know over what we don’t know. If you are an auto mechanic, you most likely know more about fixing cars than you don’t know about fixing cars. Also, errors are easily rectified. In this light, a good mechanic is an expert.

If you are a psychologist or an economist, I don’t think so. In fact, it’s practically impossible that your knowledge of the human condition would exceed your lack of knowledge of the human condition. Not to mention that mistakes can be catastrophic in these “big system” type professions. Plumbers don’t kill people but doctors do. Mistakes when predicting the weather, the economy, or the financial markets can and do ruin our lives. Nothing is as potentially dangerous as a rational prediction in an irrational world. So, are there really experts in these professions or are they just the one-eyed men in the land of the blind? I Guess Yogi Berra, the great baseball player/coach had it nailed when he said “It is tough to make predictions, especially about the future.”

I think we love predictions because if we make predictions, and/or concoct explanations for those events we predicted wrong, then we won’t feel like victims of randomness. We feel more in control. But are we more in control or just intoxicated by some illusion of control?

In his book “The Black Swan” Nassim Taleb says, “We have seen how good we are at narrating backwards, at inventing stories that convince us we understand the past. In spite of the empirical record we continue to project into the future as if we were good at it, using tools and methods that exclude the rare events.” Funny isn’t it, since the big, rare, unpredictable events are precisely what shape the world. Events like the automobile and the World Wars, the internet and the Beatles.

I think it’s ironic that by accepting we have little control over most things, actually gives us greater control over what might happen. By realizing our lack of control we may be able to minimize the more negative events. If we realize anything can happen when trading commodities, then we are more likely to actively manage our exposures to big loss and potential ruin.

Tweet This Post

I shared with him some of the concepts that we discuss on this blog. How we buy/sell commodities and how we cut the losses when they are not working and how we take profits on those that are working.

So then he said, “How do you know you’re right?”

“I don’t know for sure,” I said, “that’s why we protect ourselves by getting out when we’re wrong”. 

“You must be right a lot” he then said.

“Not really, we’re right about 40 out of every 100 trades or so.”

“So you lose more? Doesn’t that make you a loser?”

I went on to explain that in some professions it sure would. What if you were an airline pilot? You can’t be wrong at all so to speak. The accountant or the auto mechanic have a little more room for error, but not much before they would be fired. A baseball player on the other hand gets in the hall of fame if he consistently bats 300 or so, which is- statistically speaking – a loser. A team that wins half their games most likely will be in the playoffs.

Mel Fisher, the famous treasure hunter, brought up an estimated 450 million when he found the 1622 wreck of the Spanish galleon Nuestra Senora de Atocha. I guess you don’t have to be right much in that profession to succeed. It looks like once might do the trick.

So, the airline pilot can’t make any big mistakes and the treasure hunter only has to be right once. I guess losing is greatly defined by your profession. We happen to be in one of those professions where losing is part of the process of winning.

Kevin liked the treasure hunt example and I thought I had won him over until we went home that night. Exercising his great sense of humor, I heard him say as we came through the door “Hey Aunt Kim, did you know Uncle Charles is a loser at work?”

Tweet This Post

If you don’t know who you are, the stock market is an expensive place to find out.  – ADAM SMITH, The Money Game

According to Ori and Rom Brafman in their book “Sway” the National Institutes of Health (NIH) conducted a rather interesting experiment. They gathered participants and placed them in a MRI like machine and gave them a computer monitor and a joystick. Then they played a game.

Every time a circle showed on the screen, and they zapped it, they would make money. They would earn $1 for a circle with a line through it, $5 for one with two lines through it etc. If squares appeared, they also had to be zapped, or otherwise they would lose a certain amount of money. Just like the circles made money, different type squares erased different amounts of money if not zapped. Finally triangles appeared, but they had no monetary consequence. The participants were shown a running tab of their earnings as they played. 

What was interesting is that every time a circle or square appeared (money made or lost), a region of the brain called the nucleus accumbens lit up. When the triangles appeared however, the region stayed quiet. This nucleus accumbens is the region of the brain that is associated with what scientist call the “pleasure center”.

Watching the Phillies win the World Series, opening up a Porsche on a winding road, or throwing dice in Vegas are a few things that stir up the pleasure center. On the other hand, a shot of tequila, or a line of cocaine will stir up the pleasure center.

The authors go on to say that the MRI studies surprised the researchers “because it revealed that the pleasure center is also where we react to financial compensation. And the more money there is on the line, the more the pleasure center lights up. A monetary reward is– biologically speaking- like a tiny line of cocaine”.

The moral of the story is to keep ourselves in check. Trade for dollar bills and not thrills….. or you may have a very expensive habit on your hands.

Tweet This Post

Also successful traders share similar attitudes toward expectation for reward. They, for the most part, believe there is a risk premium over the hedger that is available to the speculator. They are also well aware that they are not entitled to it, only that it is available. Second, they believe that the rate of return is tied to the cost of money. Finally, they view their jobs to be a long term process to obtain that return without risking a drawdown beyond what they can handle, or the random risk of ruin. The failures tend to think there are returns consistently available at the higher levels of 50% and 60%. Unfortunately they find out the hard way that they must be more realistic to survive.

There is nothing magical that I can share with our readers. The reality is that trading is one of the most challenging endeavors that you will ever undertake. Get a precise logical plan. The logic behind the method you choose is critical. It is impossible to trust the interpretation of past data where logic is absent. Then proceed with realistic expectations, understanding that you will encounter more obstacles than you might imagine. Accept the real risk. Previous draw downs are simply a statistical guideline to potential risk and not the true risk. True acceptance of risk means you know you can lose your money. The good news is that this freedom should allow you now to think in probabilities as opposed to being driven by emotion. Also seek help. Get smart people around you. Get aligned with other traders or a firm that can help you work on these concepts.

Tweet This Post

It all starts with the 4 possibilities. Once you put on a trade only four things can happen:

1- You can win big

2- You can win a little

3- You can lose big

4- You can lose a little

The goal is to eliminate number 3. What do we do?

Number #1- First form a hypothesis.

Your hypothesis can be as simple as this.

1- You (or your system) think the stock or future is going up.

2- You (or your system) think the stock or future is going down.

How you arrive at this conclusion may be based on your analysis of fundamental indicators, technical indicators or a trading system. You might even be in agreement with someone else’s analysis. For example, you might agree with Morgan Stanley’s opinion that crude oil is going much higher.

However, what you do next is extremely important.

You need to determine how much money you are going to risk on this particular trade. The easiest way to do this is to use a percentage of your account value. For example, if your account value is $100,000 and you are going to risk 1% of this value, you are going to risk $1000. You do this because your hypothesis might be wrong or you might be just early. By defining and accepting your risk, you hopefully eliminate the possibility of the big loss.

Number #2-The trend should confirm your hypothesis

This is done for two reasons:

1- If you are trading against the trend, you may not be in sync with your hypothesis and you either going to get stopped out often or suffer a big loss.

2- If you are trading with the trend, you know anything can happen. You are positioning yourself for the possibility of winning big.

Winning big is what will eventually make you a successful trader.

Number #3-You think in probabilities for two reasons:

1- It is unreasonable to believe that every individual trade is going to be profitable. It is equally unreasonable to believe that you will be able to identify only the successful trades. However, each trade has a probability of being profitable. The way to determine how your trading is doing is by evaluating a series of trades over time.

2- Evaluating your trading over a series of trades will also confirm or not confirm your hypothesis. If after a series of trades you are losing money it might be time to review your hypothesis.

Tweet This Post