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January 10, 2007 � Issue #304 | |
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Trading Education $700 off the Systems Workshop and 20% off Van Tharp's Core Material
Feature Article The Problem with Recommendations, by Van K. Tharp
Workshop NEW WORKSHOP Professional E-Mini Futures Tactics
Trading Tip Trading and Christmas Presents Part IV, by D.R. Barton, Jr.
Melita's Inspirational Corner Patience by Melita Hunt
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20% Off Sale Expires Next Week Did you know that you could get 20% off our core products? This is just one of the special bonuses that you would have received when you ordered the updated and fully revised edition of Trade Your Way to Financial Freedom. You can still buy the book now and take advantage of this great offer. Hurry because it expires next week, Wednesday, January 17th. If you've purchased the book already and don't have your list of bonuses, email [email protected]. |
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Feature
The Problem with Recommendations By Van K. Tharp, Ph.D. Many of you probably get newsletters that make specific trading recommendations. Most recommendations are usually made within a specific time frame with specific conditions attached. And when that time frame elapses or the conditions change, then the recommendation is no longer any good. However, people who get the recommendation may not know that. Noticing the specific conditions of a recommendation probably applies to almost all recommendations: 1) a stock recommendation, 2) an employee recommendation, 3) a recommendation of a colleague, 4) a recommendation of a product, etc. For example, suppose I tell you about a computer that I think is the best computer on the market. At the time I make the recommendation, it might be the best computer on the market. But suppose you don�t read the recommendation for at least a year. With today�s advances in technology, any computer is out of date within a year. Or suppose I have the computer for three months and I love it, so I recommend it to you. You go and purchase one on my recommendation. But right after I recommend it, my computer crashes three times in one a week. I might still like it after one crash. But by the time the second crash happens, I�m beginning to have my doubts. And after multiple crashes, I�m not going to recommend it to anyone. But that still doesn�t negate the fact that I recommended it when I liked it and that someone bought it on my recommendation. �Okay, Van,� you might be saying, �what�s the point?� I�ve always recommended personal responsibility in your actions, no matter what happens. If you elect to take someone else's recommendations for an investment, then you are turning some of your responsibility over to them. But that�s okay as long as you are assuming responsibility for your results. That�s certainly one point that I want to make. However, my second point is to talk about my new book, the second edition of Trade Your Way to Financial Freedom. It�s now nearly 500 pages and I�m especially proud of all of the new sections. And in one of the new sections I elected to treat newsletters like systems and evaluate some of them in terms of win rate, expectancy, expectunity (i.e., expectancy times opportunity), and the overall quality of the system described by the recommendations. One of the newsletters that came out on top, Extreme Value, was a strong value-oriented newsletter. As of September 2006, it had the best win rate and the best overall system quality. And because of the track record, I am happy to be able to share that with others. However, a system often depends upon whether it was evaluated in a suitable environment. If the market is right, then certain systems will shine. But when the market isn�t right, those systems could do very poorly. Well, when you think of a newsletter as a system, then there is another significant variable � the newsletter writer. What if that person changes his mind or beliefs? When that happens, the newsletter could change completely . I know of one newsletter that changed to a new editor and right after that it seemed to deteriorate, but I'm not mentioning them by name in this article. Extreme Value was my highest rated newsletter in the book. It ranked highest in two of four possible categories. That newsletter was doing very well because the author was doing a lot of homework and finding stocks selling at pennies on the dollar in terms of what they were really worth. Some of the stocks had highly discounted land prices. Some had other things that just made the stock exceptional, but you had to look under the covers. One of the things I didn�t like about this newsletter is, like most value players, he didn�t put stops on his recommendations. And to be fair to the editor, most value players don�t use stops. They want to hold the investment as long as they consider it undervalued. As a result, I had to assume that a 25% drop was 1R. And if something dropped to zero (and nothing has even dropped close to that) it would be a 4R loss. Overall, I still like the newsletter, but something changed that caused me concern. The editor doesn�t talk about position sizing at all. And indeed value players like Warren Buffett make statements such as �diversification is a substitute for ignorance,� so it is easy to understand why. However, in the January edition of Extreme Value the editor suggests that you could (and perhaps, should) put all of your money into just four stocks (and they are all big, well-known names). And you should keep your money there for a long time. And if you did so, he believes you would be set for life. Well, I�m sorry, but anyone who puts out a recommendation like that is going overboard. And I feel it is my duty to warn you. Do your own due diligence on any stock recommendation and always be careful (and understand your risk) if you ignore any position sizing or risk control rules that we normally teach. Never put all your money in just four stocks � especially with the idea of just holding onto them forever. With time, the biggest companies still just fade away and you never know if that will be sooner or later. Go to �EpcotCenter� at Disney World in Orlando. Notice the big companies that sponsored everything in the 1960s. Those companies were the darlings of Wall Street. And where are they today? Where is Xerox? Where is Eastman Kodak? And where is GE since Jack Welsh retired? We plan to update the newsletter recommendations every 6-12 month and will likely make it available as a special report. We�ll probably update our list again at the end of June and it wouldn�t surprise me if Extreme Value is still way up there because the editor has made so many good recommendations in the past. But that makes the assumption that you risk about 1% of your portfolio on each recommendation. If you pick certain investments, bet the ranch, so to speak, on them, and hold them forever, then your results might be stellar or to they might be disastrous. I�d like to suggest to anyone who follows newsletter recommendations to remember two core fundamentals of great investing. Always remember to have a worst-case stop loss. And always remember to practice wise position sizing. And if someone says an investment is so good that you don�t have to pay attention to either of those two core investing principles, then run for the hills. Incidentally, if you know of a newsletter that you would like to compare with the other newsletters that we evaluate, then send us a set of R-multiples for the closed trades made by the newsletter and we�ll determine its system quality number and consider including it in our revised June report and we�ll send you that report for free. The format for the R-multiples should be set up as we recommend in the second edition of Trade Your Way to Financial Freedom.
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Workshop
NEW WORKSHOP THIS FEBRUARY Professional E-Mini Futures Tactics Presented by D.R. Barton, Jr.
Learn how pro traders take consistent profits from the e-mini markets. Don't become one of those traders who tries futures trading and loses a bundle by trading like the herd. Discover the tools and tactics that top traders use to gain a huge edge in these volatile and profitable markets. |
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Trading and Christmas Presents (Part IV) by D.R. Barton, Jr. " 'Tis silence all, and pleasing expectation."
We�ve had a month-long look into the issue that comes about when we �open up� a trading or investing idea. Some of these ideas are in the form of �canned� systems that we purchase; others are strategies that we have developed ourselves. Whatever the case, digging into a new trading idea is a bit like opening a wrapped Christmas present � glorious expectation can quickly turn into jaded cynicism (For more on this topic, see Part I of this series by clicking here.) The problem with a fall from the lofty heights of high hope is this: sometimes the disappointment is justified by a weak or poorly developed system or idea. BUT, often the disappointment is purely emotional. This emotional disappointment comes when we find that the new strategy has ANY faults at all. And it usually only takes one or two negatives to burst the bubble of idealism that we built in anticipation of �opening up the present.� So, how can we tell whether we�re feeling disappointed with the system just because it�s less than perfect or if we�re disappointed because the system really stinks? Try asking yourself this question before you toss a strategy aside! Last week, we talked about working on our trading goals before digging into a prospective system or strategy. And this is the first place to start in our quest to determine if our trading strategy is really worth looking into. In assessing your trading objectives, you will find the characteristics that are most important to you in your trading. And if you follow the guidelines that Van has established (I mentioned a good checklist in last week�s article that can be found in Chapter 3 of Van�s excellent book � now in the second edition - Trade Your Way to Financial Fre-edom), then you will have weighed the trade-offs between areas like maximum return and maximum draw down. And with a good set of trading goals in hand, you can dig into the characteristics of your prospective strategy with your eyes wide open and a reduced chance that you�ll throw out a useful system for emotional reasons. What are the first things to look for when you�re evaluating a new system or idea? First of all, I have to assume that you have some sort of track record available to look at for this evaluation, whether from back testing or generated in real time. The first and most important question (which you hopefully asked before you bought the system or invested much time developing the idea) is: �Does it fit my beliefs about the market?� While this is really a goal setting / self-evaluation type of question, it is absolutely the most important one for evaluating the system at hand. I�ve stressed this point over and over again in workshops: If you don�t believe in the REASONS why a system works, over time you will find a way to lose money with that system (note the voice of experience leaking through�). With a good grip on why the strategy works, you next need to look at the major tradeoffs that the system makes. Simply put, no system does everything well. An old axiom comes into play here: �If it looks too good to be true, it probably is.� Our job at this point is to weigh the trade-offs your particular system makes and see if those trade-offs are a fit with our trading objectives. Here are some things to consider: � Take a hard look at the strategy�s winning percentage. A very high winning percentage usually means that other sacrifices were made to achieve the high number. Pay special attention to these trade-off areas: o What is the ratio of the average win to the average loss? Ideally this should be 1.5 or higher. Longer-term systems (anything you hold longer than a month) should be greater than 2.0. Any number below 1.0 is a definite red flag. o What types of market conditions were used to develop the track record? Ideally, you�d like the record to be based on many years of data covering markets moving up, down and sideways, with each of those three markets going through periods of high and low volatility. It is easy to get a high winning percentage by testing the system only in market for which it is ideally suited! o What is the frequency of trade? Too many signals and you may not be able to take all of them. Too few and the track record may be meaningless. A broad rule of thumb is that 30 trades are required for each market type to validate the track record. � What is the ratio of annual return percent to maximum drawdown (as a percent of equity)? Anything that is lower than 2:1 is a red flag. Good systems should be significantly higher. � How long does it take the system to recover from its worse draw down? Good day trading and swing trading systems should take weeks not months and good position trading systems should take months not years. Hopefully, this will be a starting point that will get your creative juices flowing so that you can develop a set of criteria that are most important for you and your objectives. Next week we�ll look at some more detailed performance criteria to consider when reviewing a trading strategy. Great trading, D. R.
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Patience by Melita Hunt When I arrived home from the gym last night, I was absolutely starving. However, I had also promised myself that I would cook up some chicken in a particular recipe, and that meant at least a 40-minute wait until the finished product was ready. So was it worth the wait? You bet it was. And it got me thinking about being patient. What if something isn�t meant to be rushed and to get it just right we are just supposed to have patience and wait for the finished product to unfold? It�s glaringly obvious in nature, isn�t it? We can�t make a plant grow any faster, or an egg hatch until it�s ready. Yet we force and push for things to happen every day, getting stressed and frustrated; rather than just letting things unfold at the pace that they are meant to, or giving ourselves a little break along the way. Most things aren�t life threatening, yet we act as though nearly everything is. I have been talking about writing my adult parable/book for a long time now, and although I finished it once (rushed and didn�t like the end product so I scrapped that version), I had promised it to so many people that I just thought I �had to do it� and was extremely disappointed in myself, which led to thoughts of self-doubt, un-kept promises, that I was slack etc� which simply isn�t true. So this year, I�ve chosen to give myself a break on this subject. I�m going to be patient with myself, not promise anything to anyone and when the book is ready to appear, I trust that it will. And I�ll like the finished product. I hear the same thing in the trading world every day. People have made promises to themselves and others, they are searching and needing a quick fix. Things should have been done by yesterday or results aren�t showing up quickly enough. This leads to frustration and the invariable �put-downs� of their own characters as though they are letting everyone down including themselves and that they will never succeed as a trader. Folks, it�s time to give yourself a break! Author of Power of One Bryce Courtenay says that of the 20,000 words that we speak and direct towards ourselves daily, most of them are said within a negative context. So if that rings true for you, then maybe it�s time to be patient with yourself and just allow certain things to unfold in their own good time.
You can contact Melita at [email protected]
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Stocks and
Commodities Magazine, January 2007 Issue by Van K. Tharp,
Ph.D. |
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