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Feature
 Ten
Thousand Hours
by
Van K. Tharp, Ph.D.
A
common notion that many people have is �I�m just an average
investor.� This deeply
concerns me. That notion
implies two things:
1.
They probably have all of the biases that the average person has
about investing, which are killing them financially right now.
2.
They are not really committed to doing what it takes to be a good
investor.
The
average investor simply opens up an account at his/her brokerage
company and has no training in successful principles. Unfortunately,
he or she has probably read a few books filled with a lot of
misinformation and also listens to the talking heads on the
television give out more information.
Let�s contrast that with what Malcolm Gladwell says is
essential for real success in his new book, The
Outliers.
This
book is all about success. As
a modeler, I was drawn to it because he asks the question, �What
do hugely successful people have in common?�
However, he asks the question differently than I ever have.
I have always asked, �What do successful people do in
common, and for each of the common tasks, what are the three
ingredients?� I concluded that those three ingredients are
beliefs, mental states, and mental strategies.
Gladwell asks a different question: �What is common about
their background?� And
when you ask a different question, you get a different answer.
I�m
going to be addressing a few of these common elements in my next
articles in Tharp�s Thoughts,
and the first common element is absolutely fascinating.
It also fits into my pet peeve of people saying, �I�m
just an average investor.� It
turns out that really successful people seem to have a common
denominator of 10,000 hours of practice.
And Gladwell gives some really interesting examples.
In
the computer industry Bill Joy is a legend.
He almost single- handedly programmed the Internet.
But Bill had an opportunity that few others have.
In the late 1960s, he went to the University of Michigan.
The university center there was one of the first centers
to have a remote terminal where you could actually interact with the
computer and program online. In
graduate school in 1975, I didn�t have that opportunity; I had to
travel 30 miles to the computer center to turn in my punch cards and
then return the next day to see if there were any errors.
But Bill Joy had a terminal where he got immediate feedback
for anything he did. Furthermore,
Bill probably had more access to that terminal than anyone else.
He estimated that he�d spend about 10,000 hours programming
on that terminal. Thus,
when the opportunity was thrust upon him to start working on the
Internet, he was one of the few people in the world who was ready.
Gladwell
goes on to give several other examples in the computer industry,
including Bill Gates who had a similar access to a programming
terminal when he was about 13 and acquired his 10,000 hours when no
one else would be likely to compete.
Gates, of course, went on to found Microsoft and become one
of the world�s richest men.
Another
study cited was an examination of musicians coming out of a
major music institute. They
classified their musicians into three groups.
The first group consisted of the outstanding musicians who
could be soloists. The
second group consisted of good musicians who could earn a living
playing, but were not outstanding.
And the third group consisted of average musicians who would
probably end up being music teachers.
When they compared their background, one outstanding fact
stood out. And it seems
to go against the notion that some people are just purely talented.
Those who were great had put in 10,000+ hours of practice.
Those who were good had put in about 8,000 hours of practice.
And those who were at best average had put in about 4,000
hours of practice.
Gladwell
goes on to give several other music examples, including Mozart,
whose best compositions probably happened after he�d put in 10,000
hours. Mozart probably
had help from his father with his earliest compositions, which were
good but by no means his best.
Another
music example was the Beatles. The
Beatles were not just another band.
They had the Hamburg experience.
In Hamburg they got to play in the red light district, and
they were expected to play for 12 hours at a time.
At first, they weren�t very good, but they got lots and
lots of practice. So by
the time they suddenly burst on the scene in 1964, they had racked
up 10,000 hours of practice together�an experience that few bands
achieve even in a lifetime of playing together.
Gladwell
goes on to give other examples from other professions, but at this
point I was hooked. It
probably applies to the best traders and investors too.
My guess is that they all have about 10,000 hours of the
right sort of practice. While
I never explored this area in my initial modeling work, I know
enough about some of today�s great traders to realize that it
applies to them as well.
However,
there is a caveat here. I suspect that you need more than just
10,000 hours of trading to be really good.
You need 10,000 hours of the right sort of practice. If you
don�t get training in the right principles that will be the key to
your success, then much of the practice may be useless.
However, this doesn�t mean to say that the Beatles were
good when they first started playing in Hamburg or that Bill Joy was
that good when he first started programming on a live terminal.
But these people all had the practice plus feedback to
realize what was good and what wasn�t, so that they improved.
Let�s
look at Paul Tudor Jones as an example of an outstanding trader.
While I don�t know a lot about his early background, I do
know enough to make an educated guess.
Paul Tudor Jones started out as a clerk on various exchanges,
he was also a broker for E.F. Hutton, and he followed that by two
profitable years of trading on his own.
That�s a lot of practice and since he was profitable, it
was probably good practice. Jones
then mentored under Eli Tulis at the NY Cotton Exchange.
All of this occurred before he founded his own firm, Tudor
Investments. He also had
some exposure to Commodities Corp, which no longer exists but seemed
to be essential in the background of so many great traders�
futures. Is it likely
that Jones got his 10,000 hours in before he started Tudor
Investments? Absolutely!
And did he get the right sort of trading?
Well, he was profitable even before his tutelage under Tulis.
I
have several other examples of traders that also fit, but let�s
shift directions to a successful investor. Warren Buffett, the
world�s richest investor. There
is a lot of information on his early background, since a lot of
books have been written about him.
When Buffett was six he bought and sold bottles of Cola
making an easy 5 cent profit on each six pack. He worked paper
routes and saved $1,200. And
then he used that money to buy and rent out farmland when he was
around 16 years old. His
other childhood business ventures included pinball machines, horse
racing tip sheets, and buying and selling stock.
Thus, by the time he went to college, he was already a
successful investor. He
also did number crunching for his father who worked for an
investment firm.
Buffett
went to school at Columbia where Benjamin Graham was a professor.
He studied under Graham, and they became great friends.
Buffett then spent two years working for Graham, until Graham
retired. So did Buffett
get his 10,000 hours in? When
you ask Buffett what it takes to become successful, you get a clue
to how he may have put in his 10,000 hours.
He says that you should know every daily about every listed
stock. And if you were
to protest that there are over 7,000 listed stocks, he�d tell you
to start with the As.
Buffett�s
skill level is in understanding the fundamentals and cash flow of
companies. He
understands value, which he certainly learned in his apprenticeship
with Graham. You could
easily guess that he had 1,000 hours of exposure in business school
and another 4,000 plus hours working for Graham.
However, if Buffett used Graham�s methods to analyze every
listed stock, you have to assume that he spent at least an hour on
each stock, totaling another 5,000 or so hours.
His training was different from Paul Tudor Jones, but I have
no doubt that he put in his 10,000 hours and that those hours were
the right sort of training for what he does.
What
if you just went to work trading at a bank?
After about five years as a trader, wouldn�t you have
10,000 hours in place? Yes,
but those hours have to be practicing the right skills.
Bankers don�t understand position sizing, so you would have
zero hours at that skill. Most
of their trading is done by committee and you are expected to trade
each day whether you have good ideas or not.
Thus, their 10,000 hours does not involve understanding high
reward to risk ideas. And
it certainly has nothing to do with value investing, since most of
bank traders trades are closed out at the end of the day.
The key to the 10,000 hours has to be spending them doing
fruitful things and learning.
What
are the right things? Well,
for traders it amounts to the following:
- Accepting
personal responsibility, so that you can correct your mistakes.
- Understanding
and looking for high reward to risk trades.
This is why I emphasize the importance of R-multiples.
- Understanding
that position sizing is the key to meeting your objectives.
- Working
on yourself so that you can continually lessen the impact of
mistakes.
- Realizing
that high reward to risk trades are different under different
market conditions, so that you can adapt your thinking to
different conditions. In
my opinion, if all of your training is under one condition, you
are not likely to succeed.
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.
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Trading
Tip
 Volatility: The Real �Back Story� in Today�s
Market, Part II
by
D. R. Barton, Jr.
Last
week, we talked about the de facto investment standard for
volatility, called �beta.�
We looked at the pros and cons of that measurement.
The main problem with beta is that it covers five
years of monthly data, so it really tells us very little
about what�s happening today and is very slow to react.
So
today, we�ll look at a volatility measure that is much
more useful to traders and investors.
Specifically, we�ll look at Wilder�s Average
True Range (ATR). In
short, ATR tells us the average daily range of price,
taking into account gaps.
The default duration for this measurement is 14
bars (therefore, 14 days on a daily chart, 14 minutes on a
one minute bar chart, etc.).
Why ATR Is So Useful
ATR
helps us because it is very responsive to current
conditions. Take
a look at the S&P chart below to see the how ATR
reacted leading up to and during the market dive in
September.
Bear
in mind that the beta of stocks didn�t have a chance to
change during this time since it is only updated once per
month.
Let�s
now return to last week�s assignment where your great
aunt calls. She�d
like five low-risk stocks on the NASDAQ to add to her
portfolio, and wants you to give her five names to discuss
with her husband.
Remember
that we did a quick stock screen on the Internet.
You know that high volume stocks are best for your
great aunt, since they�ll have the liquidity to help her
get into and out of positions with no problem.
You screen for all stocks on the NASDAQ with volume
greater than two million shares per day and then rank them
from highest to lowest beta.
You
pick stocks with a low beta and with names that your great
aunt will recognize: JetBlue Airways, Direct TV,
Huntington Bancshares, Comcast and Staples.
That was easy.
You figure that by picking stocks from the bottom
of a list ranked according to beta, you�d be picking low
volatility, low risk stocks.
And
you�d be dead wrong.
Remember
how beta is interpreted.
Here�s the explanation found on almost every
financial dictionary site on the web:
The beta of a stock that exactly matches the
S&P 500 would be 1.0 while a stock that has 50% more
volatility than the S&P 500 would be 1.5.
A stock with a volatility of 50% less than the
S&P 500 would be 0.50.
Then
we looked at the stocks you chose and their current beta
measurements:
| Stock |
Beta |
| Comcast (CMCSA) |
0.81 |
| DirecTV (DTV) |
0.80 |
| Staples (SPLS) |
0.76 |
|
Huntington Bancshares (HBAN) |
0.24 |
| JetBlue Airways (JBLU) |
0.16 |
Based
on their beta measurements, this looks like a good low
risk list. The stocks are all below the volatility of the
S&P 500 (at least according to their beta measurements
and the traditional definition of Beta).
But as we shall see, beta doesn�t tell the whole
story. In fact
it can be very misleading, as is the case with the five
stocks that were chosen for your great aunt.
Stock
(Data from 12/1/08) |
Beta |
ATR |
Price |
ATR
as % of Price |
Range
vs S&P |
| Comcast
(CMCSA) |
0.81 |
1.36 |
15.45 |
8.80% |
147.70% |
| DirecTV
(DTV) |
0.8 |
1.8 |
19.39 |
9.28% |
155.80% |
| Staples
(SPLS) |
0.76 |
1.56 |
15.11 |
10.32% |
173.30% |
| Huntington
Bancshares (HBAN) |
0.24 |
0.86 |
6.6 |
13.03% |
218.70% |
| JetBlue
Airways (JBLU) |
0.16 |
0.63 |
4.76 |
13.24% |
222.10% |
| |
|
|
|
|
|
| S&P
500 Cash Index ($INX) |
1 |
51.88 |
870.74 |
5.96% |
100.00% |
Wow!
Five stocks with very low beta measurements.
They should all have volatilities below the
S&P, based on the traditional interpretation of Beta.
Yet all of them have 50% to 120% more volatility
than the daily volatility of the S&P 500. And this is
at a time when the S&P 500 has been around its highest
all time volatility. In
more normal times, a stock with a beta of 1.0 could have a
daily range volatility that is five times higher than the
S&P!
Obviously beta doesn�t
tell the whole story on volatility.
Use More Than One
Volatility Measuring Tool
The beta measurement has
two major flaws: it
looks at price movement only once per month, and it
compares everything to a fairly broad index that might not
be a good relative benchmark.
Let�s look at each of those issues and what we
can do to make better volatility calculations.
1.
Beta
uses five years of data, and only checks prices once per
month. Since
beta looks back through five years of data, it may contain
data that is not very relative to the stock�s current
performance. In
addition, beta only uses one data point each month; so it
doesn�t capture potentially wild gyrations that could
occur in between those month-end times!
Because of this, beta is really only useful for
people with very long term time horizons (those who hold
positions for many years).
For anyone who is going to hold a stock less than a
year, beta becomes a much less useful indicator.
Using ATR should prove to be a much better
volatility indicator for short and intermediate term
traders and investors (and even most long term investors,
if they use a longer ATR period).
And even for those people who hold stocks for
longer periods, beta can give misleading data, as we�ll
see in the next paragraph.
2.
Beta
is only useful for stocks that are highly correlated to
the S&P 500. If
a stock has a �best fit� line (as described last week)
that is very different from the S&P 500, then the
usefulness of the beta calculation degrades rapidly.
For beta to work well, the stock in question must
be correlated to the S&P 500.
For example, gold, pharmaceutical and biotech
stocks are usually very poorly correlated to the S&P
500. Because
of this, the betas for stocks in the those sector are not
useful in determining their volatility.
There are several ways to determine if stocks are
correlated to the S&P 500.
For those who want to dig into the math, one widely
used correlation measure is called �R-squared�.
It measures how much of the movement in a stock can
be explained by movements in a benchmark index (like the
S&P 500).
Next
week we�ll look at some other volatility measuring tools
that can help build our understanding of this
mega-important concept.
Until then�
Great
Trading,
D.
R.
About
D.R. Barton: 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 �iitm.com�.
D.R.
is presenting the upcoming How
to Develop a Winning Trading System That Fits You Workshop,
January '09.
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