Tharp's Thoughts Weekly Newsletter (View On-Line)
The Old Brokerage House Game
Trading Logs are Useless (Unless...) by D. R. Barton, Jr.
Forex Trade from Gabriel Grammatidis
Insights Objective and Subjective Beliefs
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The Old Brokerage House Game:
Fleecing the Public
When I look back at my early experiences trading, my perception is that I made every mistake that any of you have ever made and perhaps more. In fact, I have three early memories of market disasters. The first is my memory trading Poloron, which I’ve already written about. I’ve already talked about how everything I seemed to remember now seems as if it were a fabrication of the mind. (See Tharp’s Thoughts).
My second episode was in graduate school. My wife and I both had full scholarships. In addition, I managed some apartment units, so I had no housing costs. As a result, I managed to accumulate about $20,000 which I remember losing at the bottom of the 1974 bear market. My memory is that I lost money in 90-95% of the trades.
I also did it again in 1982 (another significant bear market bottom), only this time I discovered that you could go below zero — or at least that’s how I remember it (at this point, however, I don’t just trust the accuracy of my memory at all).
My assistant recently discovered an old journal of mine in which I had listed trades I’d made from 1971 through 1976. I actually traded during some great markets. 1971, for example, is the year in which we see the highest all time Market SQN® 100 scores in the S&P 500.
The most interesting aspect of the journal was some old brokerage execution statements that I found. I am including scans of two of them below. One was from an options trade and another was from just buying stock.
(Click here to view a larger version of this image.)
In the first trade, I bought 25 shares of Williams Companies for 65-1/4. So I paid $1,631.25 for my stock. Now look at the commissions — it was $34.33, 2.1% of the value of the stock. And this was consistent across positions. Whether I bought or sold, no matter what the price of the stock, my commissions to enter or exit a trade were a little over 2%. I also seem to remember that if you didn’t buy a round lot of 100 shares, they also charged an odd lot fee or perhaps another 1/4. So perhaps my actual cost was $65 per share and the firm added another 25 cents because I was buying an odd lot. However, there is no evidence for an odd lot fee or how much the bid-ask spread cost me in those days, so we’ll just ignore that part in this discussion.
Nevertheless, it should be enough that it cost me over 4% commission on every transaction (in and out) that I made. That means after 25 transactions I would have given Merrill Lynch 100% of the value of my account if my account has stayed at the same level. In other words, I would have doubled my account, but the actual value would have stayed the same and the brokerage company would have gotten the 100% gain.
Now look at the next trade, which represents an option trade.
(Click here to view a larger version of this image.)
Here I sold a call option for 100 shares of Louisiana Pacific Stock. I sold the call for $425. And my commissions and fees for doing that were $25.02. Now we are looking at a transaction fee of 5.89%. For a call option however, it was pretty much a flat fee of $25 plus change to execute the option. I only have the one call option statement, but my journal says that the cost to buy was also $25 plus change.
Let’s say that I bought the call of $850 and paid $25.30 in fees to do so. This would amount to a cost of approximately 3%. And the in and out fee would be 8.89%. So with an option trade, I’d have to make about 10% just to make a small profit.
I have two memories of the 1970’s trading. The first was that I lost on over 90% of my trades. According to my trading journal, that wasn’t true — I lost on 65% of them. The second was that my commissions totaled more than my losses. Well, that obviously was true. I closed out 31 trades and it cost me on average over 4% for stock trades and probably over 7.5% for option trades. There is no question where the money went. It really didn’t matter how sharp my trades were. How many of you clear over 10% on every option trade or over 5% on every stock trade?
When Market Wizards came out in the late 1980s, I made a statement that day trading was a losing game. Well, in the late 1980s the brokerage game had not changed much. Commissions actually made day trading a losing game. I’m not sure that the house odds for the brokerage companies were any better than the house odds at a Las Vegas casino. And at least in the mob-run casinos of the 1970s you got cheap rooms, meals and entertainment. Buy and hold almost had to be the stock market game in the 20th Century because of the house odds.
However, the brokerage house game of the 20th century was even more interesting. In the late 1980s I did some consulting with a Vice President at Dean Witter. At the time he told me that every month the company put out a list of stock recommendations to their clients. He said that the only reason a stock ever made it to that recommended list was because it was a stock that the firm wanted to sell. Thus, by recommending it to their customers, they made sure they had a ready market for the shares they wanted to unload.
My son once had a very active account at a full service broker, but because it was very active his fees were reduced to 1%. But that’s still 2% to get into and out of a stock. That means if your risk is 1%, your total risk in a position is actually 3% and you’d have to make 3% just to break even.
Charles Schwab became the first discount broker in 1975. I traded with them once, and I think the commissions were $25. However, a flat $25 if you were trading large size was still much cheaper than 4%. If you had a small account, it wasn’t much of a discount at all.
However, today we have eTrade, Ameritrade-Waterhouse, Scottrade, and Interactive Brokers. And the typical message is that of the eTrade Baby who says, “See, I just bought stock.”
I remember a quote from Daniel Drew in the 1860s. It went something like, “if you are not an insider, we will fleece you.” Well now that I’ve looked at the numbers from the primary brokerage houses of the 20th century, the same statement was also true. 2% to get in and 2% to get out is a “golden” fleece.
I thought I would look up some of the old brokerage companies of the 19th century just to see what happened to them. The table below gives a listing of many of them plus the slogan they presented to the public.
What Happened to Them
We’re Bullish on America
Bought out by Bank of America in the 2008 collapse.
Dean Witter Reynolds
Established in 1978 by merger of Dean Witter and Reynolds Company
We measure success one investor at a time.
Had over 9,000 account executives. Was bought out by Sears in 1981 and then by Morgan Stanley in 1997.
Established by Edward Shearson in 1902
If you want to know what’s going on in Wall Street, Ask Shearson Hammill.
Numerous mergers, including American Express (1981), Lehman Brothers (1984), and EF Hutton (1988). Became Smith Barney Shearson in 1993 (but was part of Citigroup).
When EF Hutton talks, People Listen
Acquired by Shearson Lehman in 1988.
Was indicted for money laundering for a prominent crime family one month before the 1987 crash.
Smith Barney Formed through a merger in 1938.
We make money the old fashioned way, we earn it. (with John Houseman’s voice)
75 year-old history, purchased by CITIbank and then by Morgan Stanley.
Goldman Sachs, Founded in 1869 Many Goldman CEOs tend to get prominent government positions
Our client’s interest always comes first
Usually involved in much bigger things than retail brokerage.
JP Morgan Chase
The right relationship is everything
“We have taken a long term approach to client solutions — providing committed, innovated and consistent advice and execution to our clients at all times” JP Morgan website.
Usually involved in much bigger things than retail brokerage.
JP Morgan Sr.’s history is a story by itself.
One client at a time.
“We’ve redefined the meaning of financial services” — Company web site
Was originally part of JP Morgan and had to divest itself in 1935.
Acquired both Dean Witter and Smith Barney.
The CITI never sleeps
Purchased Solomon Brothers in 1997 and as a result owned Smith Barney.
Spun off into Citi holdings and Citicorp in 2009.
Perhaps you can get some inkling of the tremendous money game that is played by these institutions. My suspicion is that charging 4% brokerage fees in the mid 1970s is very minor compared with some of the things that go on behind the scenes.
Anyway, the good news is that most of the things we now teach are possible with today’s discount brokerage community. For example, on Thursday June 12th, I purchased about $400,000 worth of stock and then sold it an hour later. Both transactions cost me $7.00 or about 0.002%. Now you might just purchase $2,000 worth of stock and it would still cost you $7, which is 0.35%, but that’s still a long way away from 2.1%. So today, short-term trading is a different game.
Are you a Discount Broker or an Analyst?
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Trading Logs are Useless
“I wanted a perfect ending. Now I've learned, the hard way, that some poems don't rhyme, and some stories don't have a clear beginning, middle, and end. Life is about not knowing, having to change, taking the moment and making the best of it, without knowing what's going to happen next. Delicious ambiguity.” ― Gilda Radner
I grew up watching NBC’s Saturday Night Live (SNL). I was old enough to be allowed to watch the first season (as long as I could still get up in time for Sunday School and church in the morning…) and I still believe the original cast was the best — okay the original cast plus Bill Murray (who joined in the second season).
I still remember many of those skits like they were yesterday. Gilda Radner was hilarious as a skit actress (Lisa Loopner of “The Nerds” skit was a favorite), but I remember her most vividly in the characters she created for cameos on Weekend Update — Roseanne Roseannadanna, the brash New Jerseyan, the hearing-impaired Miss Emily Litella, and the hilarious celebrity spoof, Baba Wawa. If you haven’t seen these, you owe yourself a trip to YouTube.
Ms. Radner was taken from us far too early at the age of 42, leaving a legacy of comedic genius and heightened awareness of the necessity for early detection in ovarian cancer.
With all that said, her brilliant quote at the top of this article shows a keen insight into life. And her take on uncertainty and embracing ambiguity makes me think that traders and investors could learn a thing or two from her as well…
One of Our Main Tools for Dealing with Uncertainty
There’s really no way to sugar coat it… uncertainty is a way of life for traders and investors. Some would go so far as to say that a trader’s ability to deal with uncertainty is directly correlated to success in the markets.
Since uncertainty is such a sure thing in traders’ lives (I get the irony), we need tools to deal with it as a concept and also in very concrete ways. Fortunately, Van has been giving the prescription for decades, and it’s just as effective today as it ever was.
Learning from each trade we make is critically important in our quest to handle the uncertainties of the market and improve as traders. The first step is to log our trades. And as the title of this article suggests, logging trades does little good by itself. Trade logs are only useful to the extent that they:
- Capture the important information about the trade (more on this below),
- Are done in a timely fashion so the information is accurate,
- Are used in some form of a daily debrief and subsequently a periodic review.
So the bottom line for trade logs is that they are like most kinds of data — useless until analyzed. Let’s look at what data to collect in the log and what to do with it once you have it.
Best Practices for Trading Log Data Collection
The Trading Log Basics for any time frame trading:
- For Trade Entry:
- Chronological basics — data and time of entry
- Symbol (and name, if you choose)
- Direction of trade (long / short; for options buy or sell to open)
- Price of entry
- Price of protective stop
- Number of shares or contracts
- Can add position sizing algorithm used if you use more than one.
- Slippage (price you intended vs. actual execution price — this might be zero.)
- Optional: proposed target (especially useful for counter-trend or target oriented trades; use this to make sure your reward vs. risk parameters are met.)
- Market type for instrument & time frame you’re trading
- Up, down or sideways
- Volatile or quiet
- Reason for entry
- This can be as simple as name of system signal or as complex as the contributing factors that combined to tell you to initiate the trade.
- Very short term traders (e.g. day traders) may want to use shorthand and then come back and fill in the details while the trade develops.
- Mental State during entry
- For Trade Exit
- Chronological basics — data and time of exit
- Price of exit
- Slippage (price you intended vs. actual execution price – this might be zero.)
- Reason for exit
- This can be as simple as stop or target hit or as complex as the contributing factors that combined to tell you to exit the trade.
- Again, very short term traders (e.g. day traders) may want to use shorthand and then come back and fill in the details during a lull in the action.
- Mental State during exit
Turing Trading Logs from Piles of Data into Something Useful
Your trading log data is only useful if you review it! A quick review at the end of the trade can be useful, but if you’re not in the right mental state for a productive review, it may not be very helpful.
Van’s “Tasks of Top Trading” from his Peak Performance Home Study Course contain the two most useful forms of review — the Daily Debriefing and the Periodic Review. The Peak Performance course contains pages of instruction on how to do these properly, and I won’t try to reproduce those here. (What? You don’t have a Peak Performance Course yet? For Pete’s sake, spend some – very little — of your moldy old money on, in my opinion, the most enduring and useful course on mastering yourself that’s out there).
Here’s the crux of the Daily Debrief concept:
- The Daily Debrief is where you look over your trading log for the day and ask yourself if you made any mistakes.
- A mistake is defined as not following your trading rules (if you don’t have a trading plan, then you have very little chance at trading consistently, so the daily debrief will be much less useful).
- If you did not make any mistakes, pat yourself on the back. If you didn’t make any mistakes and lost money, pat yourself twice; we generally learn more on losing trades than winning ones.
- The Daily Debrief is not a time for tweaking your trading plan — you SHOULD NOT make trading plan changes based on a daily debrief — that is only done during a more comprehensive periodic review.
- The purpose of the Daily Debrief is to identify and correct mistakes and to give you a point of accountability so that you don’t repeat mistakes.
The periodic review is a more in-depth process that is done when you’re away from the markets and can dedicate the time to making sure that your trading plan and systems are working as designed. Periodic reviews are best done every 30 to 75 trades (more frequently for new plans and systems and then more spread out for mature plans and systems).
Keeping track of your trades is a good practice for everyone in the markets. The data generated can be the foundation of your daily and periodic reviews which in turn will fuel your education and proficiency as a trader. Be sure to make them part of your trading routine.
As always, your thoughts and comments are always welcome — please send them to drbarton “at” vantharp.com
Forex Trading Video
In this short video, Gabriel Grammatidis provides an update to the JPY crossing opportunity, in particular the EURJPY pair, that he presented in his late May article. He identifies several important levels that have been established that provide possible entries and stops for short investments over the coming weeks/months — depending on how the price pattern develops..
Click here to watch the video.
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Matrix Insight: Objective and Subjective Beliefs
I’ve often wondered whether I am now, or ever was a typical reader of Van Tharp’s work on transformation, for I’ve spent my working life as (I thought) a super rational litigation lawyer, where success came from hard work and hard logic, and my inner self had little relevance. I’ve never had any interest in personal development, nor in any formal or informal religion nor in any relationship with any form of god. I, and others in the courtroom, might have come into work with pursed lips after some marital misunderstanding or might have uttered a few heartily felt expletives when the unforeseen happened, but that was about the size of my appreciation of the non rational, or of reactions to rational errors.
Some years ago, I became dissatisfied with the lawyer’s life and left it at age 50, believing that the same hard work and logic that had served me well there would be all that was needed when fashioning a new life, trading on my own. I’m no longer embarrassed to admit that I followed the path that many books recount — great good luck for a year, then great stupidity for the next. I ended up back where I’d started and was saved then, and since, by the only truly useful “luck” that I had — I instinctively position sized very small, and cut my losses. My problem was the hit rate and the inadequate profits, but that instinct kept me in the game while I learned more. I had been working hard all this time acquiring Technical Analysis and trade management skills and initially concluded that the problem must be my skill levels. Another year went by, and at the end of it I had not hit any of the modest trading targets set, but had established by comparison with colleagues that my TA skillset was as good as the best I knew. And certainly better than many who said they were doing better than I was.
Well the only rational response to that data was to conclude that something else wasn’t right. Assuming that it was true that some people made a good living trading technically, then if it wasn’t about the skill set it had to be about the guy who was (or was he?) applying the skills. At that stage I saw the question as being “why wasn’t I making good decisions”. A very difficult question to someone who had 25 years evidence of very good decision making in the law. So I set out down the road of studying the how’s and why’s of my subjective influence on what I saw as being an objective process. Of course I came to Van Tharp’s book Trade Your Way... quite quickly, and there I found enormous wisdom, quite eye-opening commentary and a huge amount to come to terms with. But I also found a bit of commentary that turned out to hold me up quite considerably in the months and years that followed. I found the resolution to that issue in the Matrix, and it is unquestionably the insight that has most impacted my life since reading the book.
I haven’t gone back to check the earlier commentary, but I remember it as being to the effect that Trading Systems were 30% logical and 70% psychological. In the context of that book and of my personal development at the time this seemed an utterly sensible belief to me, which I adopted immediately, and used many times to understand many issues. It became a little confused in my mind with the 80/20 rule widely known in other circles, which was very unhelpful, but anyway, my bottom line belief was that many processes were 20 or 30 % rational (objective) and 70 or 80 % psychological (subjective). I didn’t see the approach as limited to trading. My pastime is dancing, an activity requiring some skill, but it could be seen as within that 30-70% analysis. So can playing golf. Then with a bit of thought it became clear that it had much wider application. In other words, I adopted that belief hook line and sinker, and thought it must be right.
I wasn’t then thinking in terms of whether beliefs were useful, I was expecting them to be right or wrong But after some considerable time I came to know that it wasn’t useful. That belief allowed me to conclude that my lack of success was down to two issues — the logic of the trading system, and the psychology. I was finding dealing with the psychological issues to be extremely difficult. It’s the first step of actually identifying the issue that I found hard. Once it’s identified (which effectively means “admitted”) I found subsequent steps to be much easier. I’m good at discipline, but only when I understand what I have to be disciplined about. For example I realized quite easily that I was chasing the price as it went away from my entry signal, because once I started looking in the right place I could quite easily feel the emotions, indeed the compulsion, in my body as I did it. So that got cut. But it was about the only clear success. And of course my belief gave me a get out of jail card–if you can’t fix the psychology, then fix the trading system. So countless hours were effectively wasted improving my rational skillsets. I now see it as training to be an astronaut when I needed to learn how to ride a bike in balance. And if you’re spending countless hours doing the one thing, you’re definitely not doing the other.
Matrix sorted out that Gordian knot in no uncertain terms. 100% of trading is psychological. Period. Van Tharp’s earlier 30/70 split was misleading and not useful and he was changing it. Whoa, that was a shock. His earlier book had sounded right. What’s going on here? And what about all those skills I just learned. They’re all 100% rational, and many of them statistically proven in terms of probability. If trading is 100% psychological then what are the Stats doing? And would he now be saying, if asked, that Golf was 100% psychological?. It can’t be, can it?. Better clubs hit the ball better and further, don’t they? It’s that fitter, stronger and more agile men hit the ball longer and straighter than I do because they have those skills, isn’t it?... and so on. But it didn’t take long for the lightning bolt in his new belief to strike through my resistance to it.
It’s not just that the book powerfully explains Van Tharp’s thinking. It had already become increasingly clear to me before I read it that the 30/70 rule wasn’t working for me. It had became too vague to work with. Which bit is the logical and which bit is the psychological? If my logical bit is really super dooper can’t I think of it as 50/50? Indeed if I get it to 51% then I’ve got the edge … These thoughts were obviously unuseful when I had them, but they had still caused me to have lost grip on dealing with the real issue.
And when I started experimenting with the idea that trading was 100% psychological, and that by extension many other activities probably were too, a myriad of understandings started flooding through. The easiest analogies are sporting, but as I go through everyday life I see more and more clearly that the living of all aspects of life is essentially psychological, partly because our interface with life is essentially through the various interpretations of external data that our mind makes, and is not through that data itself, and partly because those interpretations are influenced by the very core of what we are, which isn’t to be found exclusively in any one part of our minds.
It’s profoundly affected my trading. I see the whole process in a completely different light, and have found it (i.e. the psychology underlying my trading performance) much easier to identify and come to terms with. Indeed the gratitude for my new success is, hopefully, expressed in the writing of this note, which I’ve not found easy.
But trading is not the half of it. Adopting this belief has transformed many of my relationships, as I get to understand that it’s psychology that partners are expressing, subjective interpretations influenced by a myriad of things. Not objective facts. My relationship with my son, conducted long distance half way round the world, has improved out of sight, as I can see much more clearly where he’s coming from when he says stuff I could have argued with before. My dancing has improved as I bring a new understanding to what dance is, and I suppose the real bottom line is that my relationship with myself has improved, too.
Editor's Note: This letter was sent to us in response to a contest we have been running in which we ask to hear about the one most profound insight that you got from reading Van's new book, Trading Beyond the Matrix, and how it has impacted your life. In the next few weeks, we will pick our favorite submissions and ask you to vote on them. The winner will receive a free workshop! Stay tuned for more information on this phase of the contest. If you haven't purchased Trading Beyond the Matrix yet, you can do so here.
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