the unique arena of professional trading coaches and consultants,
Trading Psychology Expert,
Van K. Tharp stands out as an
international leader in the industry.
Most people are not successful
when it comes to trading. Why?
I can answer that question on a number of levels. At the most basic
level, people must trade by processing information. Unfortunately,
we're not very efficient information processors. We have a lot of
biases that enter into trading decisions. I've documented 25 of
them in my home study program. However, I think most of those biases
can be summarized by realizing that trading/investing are very
simple processes and we human beings try to make it into something
much more complex. Those biases are all about adding complexity to
Is it really that simple?
Consider the trading rules that work: 1) follow the trend; 2) let
your profits run; 3) cut your losses short; and 4) manage your money (i.e. risk)
so you can stay in the game. If you design something around
following those rules, you'll make a lot of money. But when a great
trader says, "That's what I do," the average person
responds, "Yes, but tell me what your real secret is."
This all about Trading Psychology.
The markets are not random in that we have very large abnormal price
moves. On a normal distribution curve, these amount to abnormally
large tails. For example, in the past, we have seen a one-day move
of 500 points in the Dow Jones and a very short-term move of crude
oil from the mid-teens to the $40 level and back to the mid-teens.
We might expect those moves by chance, perhaps once in a 1000 years,
but not several times in a decade. But we've seen those moves in the
last decade. Consequently, what most traders need to do to be
successful is to participate in those moves in some way and not lose
too much money when we're wrong. Unfortunately, we have all sorts of
biases in our thinking which keep us from doing so.
What are some of those biases?
First, we have a bias to understand things such as "Why is the market
acting like it is?" Most traders make money with systems that are
right less than fifty percent of the time. What makes them money is
that they make a lot more, on average, than they lose. Executing a
system based on probabilities doesn't require an understanding of
how the market works, it requires position sizing strategies. sm Nevertheless,
people want to treat the world as if they could predict and
understand everything. As a result, they tend to seek patterns where
none exist and to invent the existence of unjustified, causal
relationships. Traders don't want to trade probabilities. Yet
trading is a probability and money management game.
Another bias that most people have is called the law of small
numbers. This means that we don't need a lot of information in order
to find the patterns or causal relationships that produce our
understanding—it only takes a few examples. People also have a bias
in that we tend to imagine that what we see or expect to see is
typical of what can and will occur. Thus, if you observe a pattern
in the market, you expect it to occur. If you develop some concept
about the market, you will look for data to support that concept in
the market, and you will probably find it whether it exists or not.
Add to those another bias called the conservatism bias. This means
that once we find a pattern or causal relationship, we tend to
ignore contradictory evidence no matter how pervasive it is. There
are many more biases. Hopefully, you get the picture. We tend to
create a reality that's much more complex than what really
try to add complexity rather than employ sound money management.
There is one more important bias, called the ego bias. The ego bias
amounts to the fact that most of us make the following statement:
"Yes, I understand that most people have these biases, but none
of them apply to me."
Are there any biases around risk management?
Yes, there are several. The most notable is called the gambler's
fallacy. People tend to assume that after a string of losses, a win
is much more likely and vice versa. Thus, after a losing streak they
are likely to risk a lot because they believe a win is more likely.
Or after a winning streak they are likely to bet less because they
believe a loss will occur soon. However, in reality a win or loss
depends upon the probabilities levels in your type of trading, not
what has happened in the past. Professional gamblers know that you
bet small during a string of losses and bet big during a winning
streak. This is the reason most professional traders use some sort
of money management in which they risk a percentage of equity. Your
equity increases during a winning streak and decreases during a
Most good traders would agree that risking less than 1% of equity in
a trade (where 1% is the amount you would lose if your stop loss was
hit) is a prudent risk. Risking between 1% and 3% gets into the gun-slinging
range. Risking any more than 3% is usually financial
suicide, and the average trader commits financial suicide all the
time without knowing it.
Your definition of 1% risk is important!
Most people don't understand risk at all—including a lot of
professionals. Risk often is equated with the probability of losing.
Thus, for some people, futures trading is considered to be risky.
Others equate risk with the amount invested or with margin. But
that's not it at all. Risk is the amount of money you are willing to
lose if you are wrong about the market. When you define risk that
way it changes a lot.
Let me give you an example. An equity trader might say, "I risk
10% on each trade." For him, that might mean that if he has
$100,000 he wouldn't invest more than 10% in each stock or $10,000.
That's not the same thing. According to his definition, he could
only buy 50 shares of a $200 stock. But let's say that he bought a
stock at $200 and that he would admit to being wrong if his stock
dropped to $198 and sell it—that's a $2 stop. If he is willing to
risk 10% of equity it means that he could buy 5000 shares of the
stock. Those 5000 shares would cost him a million dollars and no
brokerage house would allow him to buy that much with a $100,000
account. Risk must be thought of as the percent of equity you are
willing to lose on a trade if you are wrong. And when you do it that
way, anything over 3% is extremely risky, especially if you have 10
to 15 positions on at one time.
What's really interesting is that once you understand risk and
portfolio management, you can design a trading system with almost
any level of performance. For example, you can design a system to
trade for clients that would make about 30% per year with only 10%
drawdowns. On the other hand, if you want to trade your own account
and be a little more risky, you can design a system that will
produce a triple digit rate of return-as long as you have enough
money to do so and are willing to tolerate tremendous drawdowns.
I have written a text book on this subjuct as there are so many possible strategies that one can devise to manage their capital. I coined the term Position Sizing to describe it because the term money managment and or risk management means so many different things to people. My book is called The Definitive Guide to Position Sizing Strategies.sm
you describe yourself a modeler. What is a modeler?
I've had a lot of training in NeuroLinguistic Programming (NLP), and
I consider NLP to be the science of modeling. That means if you can
find several people who do something well, then you can determine
how they do it. You need several people because if you try to model
one person you tend to find that person's idiosyncrasies rather than
what makes that person a super-performer. For example, I know one
"Market Wizard" caliber trader who has actually hired
people to model him. However, they've all failed because they were
only trying to model one person and that just doesn't work. They'd
just find out what he thinks he's doing and that's not it at all.
Most of what he thinks is important are his idiosyncrasies.
Anyway, once you get the common tasks that produce excellent
behavior, you need to get the ingredients of those tasks. Those
ingredients include the beliefs, mental resources, and mental
strategies necessary to carry out those tasks. Once you have that,
then you can teach the same skill to others and have them perform
well. And when you can duplicate success in others, which we have
been able to do in most aspects of trading, then you know you have a
What is a coach for traders?
A coach is someone who takes raw talent and brings out top
performance. People sometimes forget that trading is human
performance—measurable human performance. Changes in equity reflect
the performance of the trader much more than what happens in the
market. A good trader can make money in the long run no matter what
the market is doing. In contrast, a poor trader is unlikely to make
money, regardless of what the market is doing.
A coach is someone who attracts talented people and then teaches
them the fundamentals of good performance. At the Yankees spring
training camp, Casey Stengle, who coached such baseball greats as
Mickey Mantle and Roger Marris, used to hold up a baseball to his
entire staff and begin the season with the statement, "This is
a baseball." Even the best players need to be reminded of the
But just what are the fundamentals of trading?
To me, trading fundamentals include the ten tasks of trading.
Traders need to be reminded of that and to eliminate any
self-sabotage that keeps them from following those tasks. That's
what I do and I am very effective at doing it.
Van, what is a low-risk idea?
A low-risk idea is a trading strategy or concept with a long-term
positive expectancy for profit, which allows for the worst
possible result in the short term. It still allows the trader to
remain in the game to obtain the long-term rewards.
Why did you decide to do modeling and coaching with traders, Van?
My mission in life is to help people understand how they think and how they
can change their lives and this planet by changing their thinking.
Traditional occupations do not do that. If I can influence just one
more person by creating great models, I'm eager to do so. People
need to realize that they can wish upon a star and get their wish.
What they really want is happiness. Happiness does not come from
wealth or money or achievement. People get happiness from deep down
inside of themselves. And they realize they have it by giving it
away. I guess that's what I'm about—giving away happiness. I sell
financial success, but what I'm attempting to do is give away
happiness in the process.
You said there were
other levels at which we could talk about why people lose in the
Yes, at another level, people get exactly what they want out of the
markets. Most people are afraid of either success or failure (or both). As a result,
they tend to resist change and continue to follow their natural
biases and lose in the markets. When you get rid of the fear, you
tend to get rid of the biases.
I guess the classic question is "Can a losing trader transform
I believe that if one person can do something, then you can model it
and teach it to others. And we've developed all sorts of trading
models that work. In fact, we've had great success teaching the
models to other traders.
Yet transformation is only something that winners do. I've found
over the years that most of the people who come to me are
above-average traders and investors. In fact, when my clients have
tried to talk others into using my service, they don't want it. I
can remember one client telling a friend that if my course didn't
help him (both his life and his trading) that he (my client) would
pay for it. The friend still refused to buy it. Eventually, the
friend lost so much money that he no longer trades. Yet he never
called me. I hear stories like that all the time. The best way to
describe the phenomenon is to say that losers don't want to
What role does discipline play?
Discipline to me means being able to control one's mental state
where mental state is like the emotional context that one brings to
a task. Every task has some state of mind that's important for
optimal performance. For example, in answering these questions I'd
describe my state as being relaxed, confident and focused. I just
let the answers flow. If I were in any other state, I think it would
be a lot harder to come up with the answers.
Well, the same thing holds for trading—there's some optimal state
that is necessary for carrying out each of the tasks of trading.
Overall, you need a background state of confidence, of knowing that
you'll make money in the long run. If you don't have that context,
then trading is quite difficult. And, each trading task requires a
different sort of state.
Can you give us an example?
The first task of trading, self-analysis, requires that you be
introspective, dissociated, objective, curious, and willing to trust
messages that come from your unconscious mind. If you don't have a
mental state like that, then it's hard to do self-analysis properly.
And the same goes for any of the other nine tasks that are important
to successful trading.
Can one change their mental state?
Yes. We teach about 15 methods for changing one's state. One that
everyone reading this interview can use immediately has to do with
what we do with our bodies. Our posture, our breathing, and the muscle
tension in our bodies all have a profound affect on our mental
state. There's a profound statement credited to the native American
Indians: "Before you judge someone, walk a mile in their
moccasins." So try it; only imitate their walk rather than
actually wear their shoes. Try on four or five different walks.
That also leads to a profound way of changing yourself when you are
not in a resourceful state. Change what you are doing with your
body. Change your posture! Notice your posture and change it. Notice
the muscle tension in your body (especially your face) and change
it. And notice your breathing. Sometimes when people panic, for
example, they completely stop breathing. That's not very useful, so
change your breathing.
What are mental strategies?
Essentially, mental strategies refer to another of the three
ingredients of success. It refers to the sequencing of our
thoughts—most of which is unconscious. For example, most people make
decisions based upon specific details of their mental images.
Traders usually have a mental image of a trade that works. If the
image is in the correct location and has a sharp figure-to-ground
distinction (e.g., the last bar stands out), then people get a
strong feeling to act. Now, that's not the same for everyone, but
it's the most common pattern. Everything else we do in terms of
manipulating the environment or changing our own thinking is just to
set up an image like that which causes us to act.
Are there different mental strategies for different types of
Floor traders, for example, tend to be more auditory than
off-the-floor traders. That's one reason floor traders have trouble
making the transition to an off-the-floor job. Their decisions
usually relate to the volume, pitch, and location of the sounds they
hear in their mind. When they are off-the-floor and don't have that
input, they feel lost. In our courses I usually can suggest some
strategy work with them to help them make the transition to being a
What other kinds of strategies are there?
We have strategies that distinguish confusion from understanding,
successful versus unsuccessful decisions to act, what is
easy-to-remember from what is hard-to-remember, and even what's
"real" from what's made up. People are really amazed when
I teach them that!
What's the difference between system development and trading?
System development is different than trading. For a beginner, it's
learning how to trade. For a seasoned trader or investor, it is
ongoing research. But in either case, it is different from the
actual tasks of trading.
I have continually asked top traders how they learned to trade and
there are a lot of commonalities. As a result, I have incorporated
many aspects of systems development into my work. It started with
the material in How to Develop a Winning Trading System that Fits
You workshops and has evolved into detailed information about position
sizing and expectancy. Jack Schwager says in his New Market Wizards that the most important characteristic that all market wizards have
is that they've adopted a trading system to fit their personality.
Well, that's the concept that I've seen work over and over again, and
it's what I've built my system development work upon.
What can you share with us about system development?
First, there are a number of trading psychology issues involved in
system development. That topic covers a lot of ground. It's too much
to cover in this interview, but I've written a newsletter on the
Issues in Trading System Development and it's only $19.95.
Second, trading systems tend to have various components. Those
components include selecting the market, the entry, the initial
stop, the exit, and the money management overlay. Everyone
concentrates upon entry, which is the least important component. In
fact, technical analysis, which is popular among investors and
traders, focuses primarily upon market timing, which implies entry.
I've conduced a study in which you can use a coin flip for entry and
still make money if you use the other components effectively.
Incidentally, the most important part of the equation is the position sizing overlay that I've already talked about. Yet, if you
bought a software package to develop a trading system, you could not
apply any of these position sizing stategies. Isn't that
interesting? All of the software packages give people what they want
and thus focus on the least important areas of system
development—how to use various indicators for entry.
What about a trading business plan? What role does that play in
I think the statistics indicate that 90 to 95% of all new businesses
fail and the reason they fail is that they do not plan adequately.
Most fail because they lack an adequate business plan. Well, trading
is just like a business. Traders need more than just a system—they
need a business plan. And that business plan should include several
systems that generate low-risk trading ideas, a psychological
management plan, a money management plan, and a worst case
The psychological management plan has to do with managing oneself.
Trading is human performance and the main determiner of the
performance is the trader. For example, most people spend all their
time analyzing the market and trying to predict what is going on,
which has very little to do with successful trading. As a result,
I recommend that people develop a full psychological management
plan. This involves analyzing themselves regularly and spending time
on anything that would improve their own performance. This would
include such things as proper diet, regular exercise, regular
relaxation or meditation, goals, planning, and avoiding anything
that would get one's life out of balance, etc. This kind of mental
rehearsal will go a long way toward improving performance.
But perhaps the worst case contingency planning is even more
important. It amounts to brainstorming about what could go wrong.
That doesn't mean that I'm advocating that one expect disasters,
just that one plan for them so that it's easy to weather the storm.
Once you've brainstormed what could go wrong, then I recommend that
your plan include three or four ways of dealing with each potential
Once I got a phone call from Tom Basso wondering what I had called
about the previous day. He said, "We had a disaster yesterday,
and I wasn't able to answer the phone." I said that I hoped
everything was okay and Tom responded, "It was a planned
disaster." They had planned and run-through dress rehearsal of a
disaster in which all of their computers and phone systems were
down. Thus, they were assuming that they had to run the office on
Tom's home computer and home phone line. Could they do it? What
would the problems be? And how would they overcome problems they
hadn't predicted? I think every trader should do that kind of
Do you advocate a mechanical approach to trading for most people?
That's generally true. Most people have better things to do with
their time than sit around watching a monitor all day, which is
usually necessary if your trading is not mechanical. Also a lot of
problems tend to develop in discretionary traders that system
traders can easily avoid. Consequently, I advocate system trading
for most people.
But I also think that discretionary trading can be terrific once
someone has had a mental clearing and knows what he or she is doing.
What other component is important to trading and investing?
Belief systems. Beliefs are grounded in the universe. Everything
I've said in this interview reflects my beliefs. Beliefs are
filters. You see and experience what you expect because your beliefs
are filters to reality that allow you to find information and
evidence to confirm them. Beliefs are concepts that help you
understand things in this universe.
For example, people once believed that the earth was flat and that
everything in the universe revolved around the earth. People's lives
were shaped by that belief. We then believed in Newtonian physics
where everything was mechanical and lawful and most of the universe
was thought to be outside of us. And today we've moved into quantum
physics in which everything is relative and the observer has an
effect on the observation because he is part of it. The laws of
physics (which are really just beliefs) shape our concepts,
inventions, and progress. Probably at a level beyond all of that (of
course, this is a belief) is that once you give up all of your
beliefs, you have an experience of the universe as it really
is—which tends to be a very profound spiritual experience, the
kind that some of my clients have after an emotional clearing.
Beliefs are one of the ingredients of success. They tend to form a
hierarchy with spiritual beliefs and self-concept beliefs being the
most significant. I've written extensively on this topic in my home
study program. Most significantly, I have developed my advanced
workshop, Peak Performance 202, to maximize a person's understanding
of belief systems and how they affect not only our trading and
performance, but our daily lives. It's powerful material.
About the Author: Trading
Coach Dr. Van K. Tharp, is widely recognized for his best-selling
book Trade Your Way to Financial Freedom and his classic Peak
Performance Home Study Course for traders and investors. Visit
him at www.vantharp.com for a FREE
trading game or to sign up for his free weekly newsletter.