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

• Article Trade Like a Wildland Firefighter by Dr. Ken Long
• Trading Education Many workshops are selling out. Reserve your seat now.
• Trading Tip The Cyprus Deposit Levy and the Markets by D. R. Barton Jr.
• Ken's Class Dog of the DOW to Prime Trading Target by Dr. Ken Long

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Feature

Trade Like a Wildland Firefighter

By Dr. Ken Long

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We know from scholarly and popular literature that 90 percent of new businesses fail within the first five years and 90 percent of the survivors fail in the next five years.  Then there are organizations that succeed remarkably operating in the most difficult circumstances. In these environments, failure is typically catastrophic and you would expect it to be the norm, yet certain organizations thrive in conditions of high risk and  high uncertainty.  Collectively, they are known as high reliability organizations (HRO). Scholars have taken a number of different approaches to the subject of the HRO role in literature approaching it from various disciplines: neuropsychology, civil engineering, organizational psychology, sociology, naval aviation and nuclear propulsion.  
           
My own research on decision-making under conditions of uncertainty led me to the scholarly literature on HROs through the approach of social psychology.  The two most influential writers in this discipline are Weick and Sutcliffe from the University of Michigan. Their research has identified five qualities of HRO roles that lead to exceptional out-performance and the development of organizational resiliency. Resiliency is an important topic for traders because it describes strategies and resources that help them endure emotionally challenging and draining times. Because traders operate under high stress and uncertain conditions all the time, it occurred to me that perhaps the principles of HRO might have some value for traders. I was happy to find important connections that can benefit traders in developing robust trading plans and emotional resilience.

Weick and Sutcliffe categorize five qualities of HRO's which distinguish them from traditional organizations. Traders might seek to develop these in their own trading plans:

1. Preoccupation with failure: To avoid failure one must look for it and be sensitive to early signs of failure; not in order to lay blame but to ensure the plan does not further unravel.
2. Reluctance to simplify: Labels and clichés can stop one from looking further into the events; consider the evidence for your beliefs carefully and don't oversimplify.
3. Sensitivity to operations: Systems, by nature, are dynamic and nonlinear; it can be hard to know how the different pieces fit together and how quickly things may change.
4. Commitment to resilience: one must be able to perform during periods of high stress. This means having the ability to absorb strain, recover from difficult situations, and then learn and grow from previous episodes.
5. Deference to expertise: This means respecting the evidence of the results and having confidence in the quality of your justified conclusions. These are more important than platitudes and conventional wisdom.

A wilderness firefighting units is an example of an HRO in practice.  The National Wildfire Coordinating Group (NWCG) has developed a set of 10 Standard Fire Orders which are a logically organized set of rules that have been keeping firefighters alive and successful in their mission since 1957.

Would it surprise you to discover that traders could learn a lot from wildland firefighters?  I believe that the firefighters’ 10 Standard Fire Orders apply equally well to trading the markets.  Here are my adaptations of their code for traders: 

(Adapted from the NWCG: http://www.nifc.gov/safety/safety_10ord_18sit.html )

Professional Trader Behavior:

Market Behavior
1. Keep informed on market conditions and forecasts.
2. Know what your market and target are doing at all times.
3. Base all actions on current and expected behavior of the market and target.

Market Safety
4. Identify escape routes and safety zones and make them known.
5. Post lookouts when there is possible danger.
6. Be alert. Keep calm. Think clearly. Act decisively.

Organizational Control
7. Maintain prompt communications with your brokers and other partners in the market.
8. Give clear instructions and insure they are understood.
9. Maintain control of your trades, orders and decisions at all times.

If 1-9 are considered, then...
10. Trade the market aggressively, having provided for safety first.

The 10 Standard Orders are firm. We don't break them; we don't bend them. All traders have the right to a safe environment. 

The NWCG has also identified 18 “Watch Out” situations that represent known conditions of especially high risk. This list is more specific and cautionary than the 10 Standard Fire Orders.   Below are my adaptations for traders of the 18 Watch Out Situations:

The Trader’s 18 Watch Out Situations:

1.   The market and your targets are not scouted and sized up. 
2.   You haven't planned for or rehearsed this situation. 
3.   Safety zones and escape routes (protective stops) are not identified. 
4.   Unfamiliarity with market and sector factors influencing price behavior. 
5.   Being uninformed on strategy, tactics, and hazards. 
6.   Instructions and assignments are not clear. 
7.   No communication link between traders, brokers and partners.
8.   Entering trades without predetermined exit points. 
9.   Trading without stops. 
10. Chasing a runaway breakout.
11. Not being aware of critical states in the market or in a position.
12. Not being aware of the broader market condition. 
13. Not being aware of potential market turning points.
14. Price range begins to expand in short term time frame. 
15. Change in broad market volatility. 
16. Ignoring signals of changing market conditions. 
17. Difficulty judging where to place safety stop. 
18. Feelings of physical, mental or emotional fatigue.

Note that these are my interpretations; yours may vary.

Just like much of the risk involved in fighting wildfires can be reduced through the use of safety-first principles, the risks of trading can be reduced by following a similar set of guidelines.  The exercise in translating the firefighter’s perspective to a trader’s is definitely worth doing on your own. Give it a try!

About the Author: Ken Long retired from the Army as a Lieutenant Colonel and now teaches at the U.S. Army Staff College. He recently earned a D.M. in Organizational Behavior. He is a proud father of three, a husband, teacher, student, martial artist and active trader. Ken also instructs dynamic trading workshops for the Van Tharp Institute.

Trading Education

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We always have our Super Trader Summit in December.

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Trading Tip

How Important Is the Cyprus Deposit Levy to the Markets?

by D.R. Barton, Jr.

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The financial industry is abuzz over the news coming out about Cyprus.  The story begins with Cyprus finding itself as the latest country in need of a bailout.  European regulators decided that it would be a good idea to have Cypriot bank depositors help pay for that bailout.  The subsequent plan to levy all bank deposits raised a furor among not only the Cyprus natives, but also Cypriot leaders, German legislators — and even the Kremlin (because of the large amounts of Russian deposits in Cyprus). So much of a furor in fact, that the all-powerful regulators have been scrambling to revise the bailout plan even before it started.

So for traders and investors, the questions come fast and furiously:  What does this mean in the short and intermediate term for the grinding bull market?  Will we finally get a pullback?  And in a broader view – how much does this news of the Cyprus bailout matter overall?

The last question is probably the best place to start — how much does the Cyprus bailout matter?  From there we’ll look at some support and resistance levels to keep our eyes on if a pullback does materialize so that we can measure its severity.  Let’s dig in…

How Much Does the Cyprus News Really Matter to Traders and Investors?

Let me start by telling you what I concluded and then we’ll look at some supporting data.  On Monday, the markets gave us our first response that the news out of Cyprus didn’t matter that much.  The markets dropped a bit in the morning, but, as many observers pointed out, in a way that did not indicate any panic.   Then in the U.S. markets, prices spent the rest of the day recovering to close with a very unassuming, modestly down day.

Here’s why: financially, Cyprus is tiny, financially.  In fact, Cyprus is so small that it makes Greece look like a giant.   To give some perspective, if you look at the Gross Domestic Product (GDP) of the 50 states in the U.S., the most recent data shows that Vermont is ranked number 50 (lowest) with a GDP of $26.4 Billion.  The GDP of Cyprus is only $25 Billion!  That’s more than 11 times smaller than Greece.   So in one sense, the markets are telling us that this action is like taking a bucket of water out of the Pacific — while there may be some yelling about how the bucket was used to remove the water, in the final financial analysis, no one notices that anything has changed.

But before we dismiss the incident completely, I believe that there are bigger ramifications to the European regulator’s actions — ramifications that far outweigh any immediate financial math.  By confiscating bank deposits, major notions have been violated — the concept of private property rights, the notion of insured deposits not losing principal, and the broader notion that banks in general are a safe place to store your savings.  Everyone chuckles at the fictional uncle Ernie who buries his savings in a coffee can in the back yard or stuffs them under the mattress.  Now, no one is laughing at the people who used “non-traditional” savings methods in Cyprus and may therefore get to keep all of their money. 

Next, let’s turn our attention to what happens if the EU’s attempted methods to solve the most recent bailout in Cyprus outweigh the amounts involved.   How do we know that this is more than a minor blip? What if this is just the first domino that starts toppling other dominoes? The chart below of the S&P 500 ETF (symbol: SPY) is self-explanatory as we look for sign posts that could point to deeper retracements:

It’s important to note that, so far, (as of the close on Monday) the markets have once again absorbed bad news (this time about the EU and Cyprus) and held their ground.  The next couple of days will tell if there are runs on banks outside of Cyprus and if this is more than a minor blip on the proverbial financial radar screen.

As always, I’d love to hear your comments and feedback.  Send them to drbarton “at” vantharp.com.

Great Trading,

D. R.

About the Author: A passion for the systematic approach to the markets and 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".

Disclaimer

Ken's Class

How a dog of the DOW in 2012 has become a relative strength leader and a prime trading target. 

In this 17 minute video, Ken narrates a set of trades from last Friday, March 15 and then gives a longer term lesson in relative strength and interpreting how his regressions lines help him identify very tradeable targets.  He finishes the video with his intraday trading screen and how that helps him understand what’s happening in the market and where he can find long and short opportunities. 

Click Here to Watch the Video

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