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Position Sizing Basics

Excerpt from Preface of Van Tharp�s new book, The Definitive Guide to Position Sizing

Perhaps the greatest secret to top trading and investing success is appropriate money management or what we now call position sizing.  I call it a �secret� because few people seem to understand it, including people who�ve written books on the topic. Some people call it risk control; others call it diversification. Money managers call it managing other people�s money and still others call it how to �wisely� invest or spend your money. However, the money management that is the key to top trading and investing simply refers to the algorithm that tells you �how much� with respect to any particular position in the market.  And because the topic of money management is so conflicting, I�ve coined the term position sizing.

I�ve written a new book to give you an overall understanding of the topic and show you various models of position sizing.  Mastering the concept of position sizing is potentially the most profitable journey you will ever take as a trader.  The material is quite complex, despite my attempt to make it simple.  However, you�ll find it well worth your while to go through all the examples until you have mastered it.

One of the fundamental concepts you can benefit from is that position sizing is the key to meeting your objectives as a trader.  Most people assume that there is just one objective to trading�their own�and thus their view is biased by their objective.  As a result, they never realize that the purpose of position sizing is to meet your trading objectives. 

There are many other key concepts that stem from this primary one. 

• There are probably an infinite number of objectives that you could have and thus, an infinite number of ways for you to use position sizing. 
• It is important for you to define your objectives before you develop a system and before you develop your position sizing routine.
• Although your system has very little to do with meeting your objectives, we have developed a method to quantify the quality of your system, which we call the System Quality Number^SM or SQN^SM for short.
• We�ve discovered that the higher your System Quality Number^SM, the easier it is to use position sizing to meet your objectives. 
• You might even think of position sizing as a separate system, overlaid upon your primary system, which is designed to meet your objectives. 

These key ideas are the foundation that you need to understand to make position sizing useful to you.

This book is one of the most important books you could ever read if you want to be a professional investor or trader.  The material provides the foundation for everything you do as a trader or investor. Only your personal psychological work is more important because you are the source of your trading success.  In fact, there are many psychological biases that keep people from practicing sound position sizing.  In addition, there are also practical considerations, such as not understanding position sizing or not having sufficient funds to practice sound position sizing.

Let�s look at the facts.  The entry price to being an investor or trader is fairly low.  All you have to do is have enough money to open an account.  Your brokerage company doesn�t care whether you understand expectancy.  Your brokerage company doesn�t care whether you know your objectives.  Your brokerage company doesn�t care whether or not you understand that position sizing is the key to meeting your objectives.  And your brokerage company certainly doesn�t care that you must have your personal psychology together in order for any of this to matter.  They simply don�t care.

Your brokerage company cares about three things: 1) that you have enough money to open an account, 2) that you don�t do things that might cause you to lose many times the value of your account so that you get your broker into trouble, and 3) that you generate a lot of commissions through your trading.  That�s it. You can make every mistake described in this book and it�s still okay with your brokerage for you to open an account.

This is not true of most professions.  You cannot become an engineer without understanding calculus.  And if you make too many mistakes, you can never be an engineer.  You cannot do brain surgery without going through medical school, doing an internship, and then going through residency.  You cannot hold a research job without a basic understanding of statistics.  You cannot practice law without attending law school and passing a rigorous bar examination.  To get a doctorate in finance, economics, or business, you must pass many exams.  But the material you must study is almost the antithesis of what it takes to be successful in the markets.  You even have to pass exams to become a broker, but there is absolutely nothing in that exam that tests your knowledge of material related to trading success�NOTHING. 

To be a trader or investor, you don�t have to know anything about what it takes to be �safe� as an investor and you certainly don�t have to know what it takes to be profitable as an investor.  All you need is enough money to open an account and to sign a statement that you understand the risks involved.  In fact, your brokerage company, when they make you sign that statement, probably doesn�t understand the fundamental basis behind that risk, which is the material in this book.  Furthermore, most people who open a brokerage account lose money.

Here�s the bottom line: if you want to safely master the art of trading or investing, you must thoroughly understand position sizing.  If it seems too complex, it doesn�t matter�it�s still core material you must master.  It is necessary if you want to be successful as a trader.  My new book contains a mini-test.  Answering all of the questions correctly doesn�t necessarily mean that you will apply this material because that means that you have mastered yourself as well, but it at least means that you have enough understanding to have a reasonable chance of success.

I�ve divided this book into four primary sections.  The first section is on understanding the golden rules of trading and how to evaluate the quality of your system.  The second section is on position sizing basics, including an introduction to basic position sizing models.  The third section is on how to use position sizing to meet your objectives.  And the last section is on miscellaneous topics related to position sizing, including what not to do, software, and information on putting it all together.  This book contains the most important technical information that you will ever be exposed to as an investor/trader and probably the least understood.  However, you must master this material if you want to meet your objectives as a trader/investor. 

To really master this concept first, have an open mind.  Second, make sure that you understand everything you read.  If you have questions about what some particular word means, go to the glossary of this book and look it up.  We also have a glossary at our web site, http://www.iitm.com/glossary.htm.  Third, be sure you can do all of the exercises in the book when they come up.  If you have problems, keep working until you have mastered the exercises.  Fourth, you must develop a plan to put all of this material together.  And finally, you must master yourself so that you can apply this material without making significant mistakes.

Trading isn�t about easy money and get rich schemes. It�s a profession worthy of quality training and a good solid education in what works and what does not work for successful results. 

About Van Tharp: Trading coach, and author, Dr. Van K. Tharp is widely recognized for his best-selling book Trade Your Way to Financial Freedom and his outstanding Peak Performance Home Study program - a highly regarded classic that is suitable for all levels of traders and investors. You can learn more about Van Tharp at www.iitm.com. 

Workshops

September Is Back-to-School Time, and Not Just for Kids

Understand Yourself

Understanding Your Core Issue

Part Two: An Amazing Twist to Van's Story

by
Van K. Tharp, Ph.D.

Last week I discussed my personal core issue of loneliness. As I said, everyone has a core issue inside of them; one issue that rules the subconscious more so than any other. I believe that most people have something similar to what I described with respect to core issues. In fact, A Course in Miracles says it is part of the human condition, part of the way we�ve created ourselves. However, we will learn this week that these core issues are merely beliefs that limit us, and I will show you first hand how getting rid of my core issue opened me up to a miracle. 

We basically all feel a deep sense of loneliness, emptiness, lack of wholeness, or something similar because we feel separated from God. Some people want to connect with a soul mate to feel complete, while others want the whole world to love them and approve of them to feel complete.

It�s this feeling of lack that is the basis for self-sabotage because it makes you think that you are much less than you are � that you are not worthwhile and that you cannot have abundance or success or joy or happiness. But that is only because you identify with the thoughts and feelings that pass through you that we call the ego.

Let me quote from A Course in Miracles:

What if you looked within and saw no sin? This �fearful� question is one the ego never asks. And you who ask it now are threatening the ego�s whole defensive system too seriously for it to bother to pretend it is your friend. Text, page 424.

But your thoughts, beliefs, feelings and subpersonalities are only you acting from what Eckhart Tolle calls object consciousness because you think you are them. And if that�s who you believe you are, then you�ll create a very limited world to live in and have your life experiences. But there is another way:

For on the voice you choose to hear, and on the sights you choose to see, depends entirely your whole belief in what you are. Text, page 425.

It�s interesting because I had been exposed to all of this material by the time I became a full time trading coach in 1986. However, I was still working on accepting concepts such as �I create everything that happens to me.� That was very hard for me to accept initially. When I�d read passages like the one above that I just quoted from A Course in Miracles, it made no sense at all. But that�s because I had not experienced it. I had not lived it.

I am NOT my thoughts and feelings. Instead, I am the awareness of my thoughts and feelings. It totally makes sense to me now because I have had an experience of the wholeness that comes from that realization. That realization is a part of me now, but I also realize I have a long way to go.

Several years ago, I could never have written these types of articles that I�ve written on my experience. First, I hadn�t had the experiences. But most importantly, I�d have been too concerned about your reactions to everything I�ve said.

However, I certainly know that I�m not your thoughts and reactions, just as I also know that I�m not my reactions to your thoughts and reactions and also that you are not those thoughts and reactions. My point is to help you realize that. When you do so you will have no limits to as what you can be, do, or have -- as a trader, as an investor, or as a human being.

Amazing Outcome

Remember the amazing twist I mentioned in last week�s article? After experiencing such a feeling of peace while working on my issues in Florida and remembering my experience with Mitzi, I had a strong urge to look at that letter from Mitzi�s husband again. I had not read it in many years. I had kept it in a family tree album. I pulled it out and reread it after all these years. This time, it seemed like a different letter when I read it and all the emotion was gone. I learned that Mitzi was just a nickname. Her full name was spelled out in the letter as well as her name after she married the American. It also mentioned her daughter, Diana, who was born in 1958.

I�d remembered her daughter and years ago had the urge to look her up. I didn�t because I assumed that it might be sad for both of us because we both probably would just have very distant memories of Mitzi � whom we both considered a mother. 

However, this time the Mitzi voice, which had become my internal guidance, said, �Look her up.� So I did. You can find almost anyone on the internet these days and I paid $2.95 for a people search. I got her name, address and phone number. But that report also had something else that blew me away. It had a list of Diana�s relatives and one of the relatives listed was Mitzi�s full married name, who it said was 80 years old. I immediately did another search and came up with her phone number and address. Mitzi is still alive!! The information about how she had died from a brain tumor wasn�t what happened. She did have a brain tumor but she did not die from it. She is alive and well, living on the west coast. 

I contacted her immediately and Mitzi was as excited to hear from me as I was to hear her voice. So as far as I�m concerned, I have a Mom who is still alive, which is a tremendous blessing. I arranged to visit with her upon my return from Fiji a few weeks ago, and it was wonderful reunion. 

I have much more to say about this and hope to share more with you later. 

I can�t imagine a much bigger miracle than finding out that a person I believed had passed away is still alive, and that I would have the opportunity to meet with her again after more than 50+ years apart. � Van Tharp

Melita's Inspirational Corner

The Bowl of Light

by
Melita Hunt

There is an ancient traditional story from Hawaii that the elders tell their children which I read many years ago and want to share with you today. I am writing this from memory so I trust that I will not do it a disservice or offend any Hawaiian friends if I don�t get it exactly right. It is the message of the story that remains the important thing.

The story says that at birth every child is represented by a bowl of beautiful light. The bowl represents the gift of spiritual light that they are born with, and all of this wondrous light and goodness shines forth from within them. 

As they journey through life, there will be things that happen that are not so good and for each one of these problems, a rock is put into the bowl and it blocks out some of their magnificent light. If they head down the wrong path or negative things happen to them, then eventually the bowl will be full of rocks and their light will seem as though it doesn�t exist anymore. The key is to recognize that the light is always there; it is just covered by the rocks, but if you look closely, you will see it shining through the cracks. To get back to their true self, all they need to do is turn the bowl over and let the rocks fall out.

We could say that that the light is joy, happiness, childlike innocence, love and all of the good things that we know that we are born with and then strive to feel throughout our lives. We know that we began with them because if they weren�t there, how would we know to strive for them? 

I believe that the rocks represent two things. They are the negative feelings, such as anger, hurt, jealousy, etc., that we allow to overtake us, and they are the problems and issues that we choose to hold on to. It could be from childhood, from divorce, illness, wherever we have felt bitterness or feel like we have been hard done by. We are, in effect, just picking up a rock and adding it to our bowl.

So how is your bowl doing? Are you weighed down with rocks, worrying about things that have happened in the past? Do you feel victimized in some way? Or is your bowl empty? Is the light from within you shining brightly and positively for all to see?

I believe that if you take a moment to go within and take a look at your own bowl, you will recognize whether the light is glowing or blocked.

The question is, can you let go of baggage if you need to? Can you throw away the rocks one by one?

Or better still, can you just turn over a new leaf, turn the bowl over and just let things go?

Either way, I guarantee that you will feel much lighter because a bowl of light is much easier to carry around than a bowl of rocks!

Melita Hunt is the CEO of the Van Tharp Institute. If you would like to keep up with Melita�s progress regarding her lung cancer (she is a never-smoker). Please feel free to read her blog at www.myleftlung.com. You can contact Melita at [email protected]

 

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