Tharp's Thoughts Weekly Newsletter (View On-Line)

  • Article Paving Your Own Trading Path by R.J. Hixson
  • Trading Education Peak 203 is Filling Up Fast
  • TradingTip Phantom Revival in Residential Real Estate, Pt. 2 by D.R. Barton, Jr.

Peak Performance 101, August 24-26, with Van Tharp

Overcome self-sabotage and develop rock-solid discipline in your market performance. How do you answer these 6 questions?


RJProject Marathon Update:

Paving Your Own Trading Path

Some years back, I used to follow a particular market analyst very closely.  He was rather unorthodox in his approach and wrote richly detailed predictions with so much historical perspective and meticulous analysis that I was convinced he understood what the market was doing and where it was going. 

Recently, his company sent out a ridiculously low-priced trial subscription offer for his newsletter, so I decided to sign up and see what he was saying these days.  He’s been bearish since the late 1990s, and it turns out he’s still pretty bearish.  In fact, he just presented a long-term stock market log scale chart that looked something like this:

Chart1

Years ago, I would have looked at a chart like this one and believe that the red arrow was going to happen.  All those pages of analysis, historical research and a track record of correctly calling major turning points clearly proved that this guy knew!  All I needed to do was think about how big and how short I could get so that I could simply sit back and enjoy the long ride down.

When I consider now that I used to think and trade like that, I actually shake my head and shudder a little.  It amazes me how lucky I was that I never lost significant amounts of money doing things that way.

Still, when I first saw the above chart last month, the old feelings came flooding back. I felt the excitement I used to feel and thought about the huge gain I could reap from such a large move. But this time, I immediately started asking myself some questions.

1. Is the chart true? Is the drop going to happen?

I don’t know.  Before understanding Tharp Think principles, I used to believe that good traders had to know where the market was going in order to trade well.  Now, I believe that I don’t know what the market will do, and I don’t care that I don’t know.  In fact, not knowing can be quite liberating. Why?  Because the market could go down, or sideways, or up some more.  The market is going to do what it’s going to do, and it’s not my job to figure that out.  My job is to be ready with systems so that I can trade whatever type of market shows up (Byron Katie writes at length about the “don’t know” mind, but that’s another article in itself).

2. Could it happen?

I have my own big picture written out now, and a significant move down in the coming years fits with that picture, but I don’t try to predict the degree or the timing of that drop.  All I can say is that such a drop wouldn’t surprise me. I’m not willing to risk money on it, because I also wouldn’t be surprised if the market moved up a bit more or sideways for a long time. Central banks have more monetary engineering strategies left to try to buoy the markets, and some might actually work for a while.

3. Is a long-term short the best way to trade such a move?

I used to think so, but now that I have a number of trading systems at hand and a better understanding of my objectives, abilities and limitations, LEAP puts or a massive short would definitely not be the best way for me to trade such a move.  I believe I could earn a lot more and risk a lot less by trading shorter-term systems.  After all, there would still be plenty of strong up days, weeks and months during the years over which the move would play out.  Take a look at the DJIA chart from 1930 to 1932—down >80% in that period.  Within that decline, however, were numerous rallies of 10%-40%.  I’d like to benefit from bear market volatility in both directions rather than watch (sweat) a long-term short position expand and contract with lots of fluctuations.

After asking myself these questions, I came to the realization that I found the analyst’s predictions interesting, and that was all. They aren't particularly useful to me anymore.   

Traders Evolve, Trading Evolves

I’ve noticed a number of other changes in my thinking in recent months as well. 

Late last year, Van requested that I rework my business plan. I began the process by applying one of recently-deceased Stephen Covey’s seven habits—“to start with the end in mind.”

First, I revisited and revised my long-term objectives, which I really hadn’t looked at in a few years, even though a number of my personal circumstances had changed.  To that end, I built a multi-year cash-flow model of my trading business and personal financial situation.  After developing a long list of assumptions and calculations for the model, I discovered that financial freedom wasn’t some distant possibility, but something that was actually achievable—and long before I’d thought it would be.  That was more than heartening; it was thoroughly invigorating.  Just thinking about it now gets my heart going. 

Second, I built my objectives for the rest of 2012 in line with my longer-term objectives. 

Third, I rewrote a good chunk of my business plan. What’s come out of that process has proved very interesting, and I'm looking forward to trading in a very different manner for the rest of this year.  Before, my focus was on trading often and minimizing mistakes.  Now, it will be on flawless execution—on trading when and how the system rules dictate so that each system generates the results it “should” generate.  To help with this new focus, my business plan now reflects the following:

  • The number of trading systems I intend to actively trade at any one time is way down—by more than half.  Before, I was interested in taking lots of trades from lots of systems, but now, I’m more interested in taking a few trades and executing those trades flawlessly to achieve the expectancy of each system.
  • Also, the systems are different in nature.  One of the day trading systems would have seemed quite boring to me before; it has what I would have judged to be a low expectancy and a low win rate.  What it also has, however, is consistency and lots of setups.  Those factors give it a decent SQN score and a high expectunity.  Understanding the importance and power of position sizing strategies has dramatically changed how I think about trading systems and what kinds of systems I want to trade from now on. 
  • I’ve also invested much more time in the position sizing strategies themselves.  Given my objectives for the rest of the year, I created an independent position sizing strategy for each system. Why?  Because each system has very different performance characteristics, but they all need to help me reach my business goals. Each position sizing strategy will help each trading system accomplish that in different ways.

What Happens Now?

What happens when the predictions of an analyst you used to follow become nothing more than interesting to you, and you attempt flawless execution with effective position sizing strategies for a few systems? In all honesty, I don’t know yet, but I’ll share that with you sometime soon.

About the Author: RJ Hixson is a devoted husband and active father. At the Van Tharp Institute, he researches and develops new products and services that will help traders trade better. Among myriad aspirations, he dreams of moving dirt around his yard with a Bobcat and going for a sail on an America’s Cup yacht. He can be contacted at “rj” at “vantharp.com”.

 


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Trading Tip

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Phantom Revival in Residential Real Estate

Part 2


There’s an old Wall Street anecdote about a client who buys an illiquid small-cap stock.  As the stock goes up, the client calls his broker several times to buy more shares, and the broker happily complies each time. Unfortunately, bad news befalls the stock and the price plummets.  The client calls up the broker and screams, “Quick!  Sell all my stock!”  Exasperated, the broker replies, “to who?” (yes, the broker would not use proper English in this scenario).

Last week (click here), I cited the recent upturn in housing sales in many parts of the U.S. and how the continued rise in vacant houses and the ongoing drop in the velocity (circulation) of money in the U.S. bodes poorly for a lengthy continuation of that upturn.

Existing home sales figures for the month of June, which were released late last week, provide short-term confirmation for the weakness of this trend. According to those figures, sales dropped 5.4% month-over-month, and the percentage of first-time buyers dropped still further from 34% to 32%.

We also talked last week about a disturbing forecast that puts a true rebound in residential real estate, not just years, but decades away. This week, we'll explore that forecast by taking a much longer view than monthly or even yearly data can provide. Let’s start by focusing on the excess housing inventory out there and talk about who today's homeowners might sell their homes to in the future. The answer to that question will bring us back to our stock-broker anecdote.

Inventory, Inventory Everywhere

The number of houses that are available for sale or that need to be sold is mind boggling.  The official numbers released last week show that housing inventory is 2.34 million units, or a bit less than a 7-month supply.  But unless you still believe in the tooth fairy, you know that even a conservative look at the shadow inventory (unlisted houses) is at least two times that number—probably 4 times—and could be even higher, with an estimated 1.5 million option ARM (Adjustable Rate Mortgage) induced foreclosures also about to hit.  These option ARMs were written to allow little-to-no down payment and provide a low or negatively amortizing interest rate that would automatically reset in 5 years to a much higher rate.  A new wave of these resets is scheduled to happen in the coming months.

Existing Houses: Sell Them to Whom?

So, with lots of houses available (the full number isn’t official, but let’s just say it’s big), who will step up in the months and years to come and buy them once the speculators have cleared out the bargain bin?

American demographics give us some interesting insights.  Let me first say, though, that economic forecasts based solely on demographics can be way off, either in timing, magnitude or both.  Even seasoned demographers sometimes miss directional moves completely, and with great regularity.  Some demographic-based forecasts, however, pass the simple common sense test, and I believe this is one.

Let’s look at the demographics that were partly behind the real estate bubble build-up and inevitable pop.  There were 50 million folks in the U.S. who were part of the “Silent Generation”—those born in the 25 years before the end of World War II.  They were followed by the Baby Boomers—those born between the end of World War II and the early part of the 1960s.  Census numbers show us that 80 million people living in the U.S. were born in that particular time frame.  The Boomers bought houses from the Silent Generation as it retired, but because the Boomer generation was so much larger, there were never enough houses to go around, causing multiple decades of undersupply, steady home construction, and an accompanying rise in prices.

Now we're experiencing something like the reverse situation: 80 million Baby Boomers are retiring and downsizing and trying to foist their homes on a mere 65 million Generation-Xers.  And after two financial meltdowns in the last decade, the Boomers are making the situation even worse by holding onto jobs longer, thus denying promotions and in some cases even employment to younger generations.  How will Generation X afford all of those excess houses?  That’s certainly food for thought. 

But take heart:  The next generation, the "Millennials"—also referred to as "Generation Y"—exceeds the Generation X population by 5–10 million.  With their help, we should see housing demand improve—that is, after they find steady employment and move out of their parents’ houses.  That trend should start to kick in around 2025 or so.

Help This Decade?

There are some events, even in the near-term, that could keep demographics and market forces from holding down residential real estate sales volume and prices for the coming ten years. We’ll dig further into that topic next week.

Great Trading,
D. R.

About the Author: A passion for the systematic approach to the markets and a lifelong love of teaching and learning have propelled D.R. Barton, Jr. to the top of the investment and trading arena. He is a regularly featured guest on both Report on Business TV and WTOP News Radio in Washington, D.C., and has been a guest on Bloomberg Radio. His articles have appeared on SmartMoney.com and Financial Advisor magazine. You may contact D.R. at "drbarton" at "vantharp.com".

 

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July 25, 2012 - Issue 587

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