Tharp's Thoughts Weekly Newsletter (View On-Line)
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Workshops Blueprint for Trading Success and Peak Performance 101
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Article Insidious Stress by R.J. Hixson
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Trading Tip The Really LONG Term View (139 Years Worth) by D.R. Barton, Jr.
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Feature Article
Insidious Stress
by
RJ Hixson
Early one morning, I found setups for two swing trades; however, (and this was unusual) I felt uneasy about them. In the moment, it seemed like these setups were open to some interpretation—they didn’t exactly fit the setup criteria, but they sure looked good. I wanted to enter those trades as I had seen that same system previously trigger only a few setup signals but each had been nicely profitable in the recent market conditions. I am pretty disciplined about my initial stops, so I wasn’t too worried (only 1R per position would have been at risk, but even so I felt a little uneasy).
A little later, I went through the rest of my usual AM routine, which includes recording my overall rating before trading. I started this after learning about Van’s Top Tasks of Trading. After doing this exercise for more than a year, I found on the vast majority of mornings I rated a 4—right in the middle of Van’s suggested 7 point scale. Because I’m so often at a 4, I find the daily rating exercise kind of boring, but I do it out of discipline. That morning, however, I had to admit I felt like a 3, which was a noticeable breakout and an infrequent occurrence for me.
The 3 surprised me. It seemed as if my life had been pretty normal lately. Certainly none of the big life changes listed in my worst-case scenarios had happened that would cause me to stop trading: nobody had died, we weren’t moving, and there was no new baby in the house or anything like that. What was going on?
As I thought about it, I did remember that we were facing the potential for multiple families of relatives converging on our house in about a week. So yes, that was slightly stressful, especially if all of them did decide to make the trip. Oh yeah, that would be the same weekend that my daughter has an annual ballet recital—a busy weekend to begin with. Also, it occurred to me that the brand new daily swim practice routine had added stress to my entire family’s life as it overlapped the trailing end of my son’s busy sports season. So yes, that too was stressful. And then there were those two interpretable setups that were bugging me . . .
In and of themselves, each of the items mentioned would have made but a negligible blip on my stress gauge. However, that morning I became aware of the cumulative stress that had arisen insidiously. “What an insight,” I thought. No worries, though! One of my trading rules states that I am free to trade with a minimum overall rating of 3, so I was still OK to trade that day.
Besides my overall rating exercise, another morning routine is to obtain unanimous approval from my mental trading board. My board has six “people” on it who represent various parts of me and whose approval I require to trade. I’ll mention two of my board members and their responsibilities. My wife is the conservator of our money, and she ensures I do nothing highly risky (primarily like trading the way I used to). Also on the board is “Dude,” my beach bum part. He has no desire whatsoever to trade; he wants only to go sit on the beach—literally. He plays an important part in my trading because he serves notice that I’m close to burning out if I haven’t taken a break in awhile. So long as he’s had a break recently or is about to have a break, he’s OK that I do this trading thing.
Because of my overall rating that morning and feelings about those two setups, I altered my usual proposal to “trade normally” and decided to trade lighter for the day. Specifically for those two swing trade setups, I proposed to trade them at half my normal position size in recognition of my morning insights. I made the motion, it was seconded and with little other conversation on the matter, each member voted “Aye.” (I have found a lot more conversation with the board ensues when I make motions that haven’t been fully thought through—just like a real board!)
Checking my overall rating and getting trading approval from my board proved its worth that morning. If I didn’t do the rating process, the stress I was experiencing might have stayed unconscious and grown. If I didn’t have the board process, I might not have adjusted my position size. Can you see how being stressed, taking trades that maybe I shouldn’t and trading at full position size could have led to multi-R losses for the day? I believe those morning Top Tasks of trading have saved me from multi-R losses regularly. That’s a pretty good “trade” for what amounts to a few moments of quiet time each morning.
As a result of that morning’s insights, I made sure over the coming days that I slept enough and exercised daily to manage the physical aspects of my moderate stress. Also, I made certain that I honored the time I have built into my morning schedule for meditation. Practicing meditation has had a noticeable benefit to my overall rating and peace of mind since I started a few years ago.
So the story ends with lots of good news! Not all the relatives were able to travel here for that weekend—big relief! The sports season and ballet recital ended very well. My daily rating went back up to 4.
And those two trades? Good news there, too.
Over the following few days, both of those issues moved 5R+. Nice move but without me in them. I had entered and got stopped out on the first day with a fractional R loss on each position. It turns out I now am able to admit the less flattering explanation of my unease about those setups that morning: I did not have the setup/entry rules for the system down cold. In the moment that morning, of course, this point was completely absent from my thought process. Anyway, I was happy to pay the small tuition for the lesson of needing to relearn my setup and entry rules for that system. The great news is that the system works fine, and I can enjoy profits from it when the signals come again.
About R.J. Hixson: R.J. Hixson is a devoted husband and active father. He started trading again in late 2008 after completing Van Tharp’s Super Trader program and making a full recovery from his previous poor trading habits. He researches and develops new products and services at the Van Tharp Institute. He also has long held a desire to raise chickens and keep bees.
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Trading Tip
The Really LONG Term View (139 Years Worth)
by D. R. Barton, Jr.
I will admit that I’ve been smitten by some striking graphical representations lately. In particular, there was that nice one about bank loans from the Wall Street Journal a few weeks back (click here to take a look). And today, we’ll look at a visual that shows 139 years worth of market data, as well as some very compelling correlations.
But first, here’s a word on my recent visual fascination. Those who have studied Neuro-Linguistic Programming (NLP) know that the NLP world assesses people according to their main modalities—visual, auditory, or kinesthetic (and audio-digital in some schools). My main modality is auditory: I learn best by hearing and reading (which is oddly auditory, not visual—sub-vocalization, I guess).
This auditory bent makes me somewhat discerning on visual presentation of data and concepts. I pass by most visuals quickly but those that are particularly striking draw me in like a hound dog to a plate of bacon.
Visual Presentation in Its Highest Form
If you too have a bent for compelling visuals, you may have heard of Edward Tufte. He has distinguished himself as an authority on informational graphics.
Tufte calls Charles Joseph Minard’s graph of Napolean’s ill-fated Russian campaign of 1812 (shown below) “probably the best statistical graph ever drawn.” (click here for larger view of charts).
This graphic hits me on both visual and emotional levels—a beige river of a 600,000 strong fighting force evaporates as the army flows to Moscow. It returns to France a mere trickle as almost 98% of Napolean’s fighting force was consumed by Russian slash and burn tactics, weather, disease and the tangential attacks of Cossacks—always harassing, but never confronting.
If this shows how powerful graphics can be, then as traders and investors, we must celebrate when we find a compelling piece in our own field.
139 Years of Compelling Data
Bob Bronson of Bronson Capital Markets Research has put together the following graphic. The good folks there go into intimate detail about the meticulous way that they collected and massaged more than century of stock market data. Their extensive data collection and data cleaning is certainly the cornerstone of the research, but for me the resulting graphic is the real star. Let’s have a look. (Click here for larger view of charts.)
For the dataheads out there—to create this graphic, the Bronson folks spliced two databases: one maintained by Yale’s Robert Shiller going back to 1870 and a second called the Cowles Commission Database, which is a no-survivor-bias database. Further gory details can be referenced on their website but suffice it to say, I believe they have some pretty good data.
Let’s dissect what we’re looking at. The top part of the graph shows a capitalization weighted index of all U.S. common stocks—currently about 6,000 (excluding 4000 “non-common” stocks). This index has been inflation adjusted and includes the reinvestment of dividends. The bottom indicator (shown in blue) is a rolling16-year annualized return of the stocks in the database.
So What?
The revelations from this research range from interesting to striking and the graphic gives us several compelling ideas to contemplate:
- Most striking is that the price channel is decidedly clean as it extends back 13 decades. Yes, it is on a log scale so it’s not really linear, but it is extremely orderly. This shows us a 6.6% annualized growth in common stocks over 139 years.
- The second thing that jumps out is the consistency of the supercycles: 16 years +/- 4 years. This is shown beautifully by the alternating green and pink shading of the graph. Long-time readers of Van’s market comments can see that this is very consistent with his views.
- Another item of interest is how the bull supercycles all top at annualized returns of 15% +/- 1% and the bear cycles bottom at -1% +/- 1%. This tells us that, if past history holds, the current bearish supercycle hasn’t hit bottom yet and won’t until we fall a good bit more from our current earnings levels.
As we discussed last week, we can’t go out and start playing the short side with conviction until the market’s year-long sugar high runs its course. But most macro fundamental indications are that we have one more major down leg before this bear supercycle is over.
But for now, as long as the market continues to shake off bad news and trot to new 52-week highs, we can’t step in front of freight trains. We have had an impressive string of up days. At least one of the major indexes has closed higher for each of the last 13 days including yesterday (Tuesday). A short-term pullback is very near for this overstretched market, but as we discussed last week, that is just the normal rhythm of the market and won’t signal a broader drop until we break some key support areas.
If you have seen any compelling market data visuals lately, please share them with me! Send them or even just your thoughts to drbarton “at” iitm.com.
Great Trading,
D. R.
About D.R. Barton, Jr.: 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".
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Percent Risk Model Question
Q: Many of the experts say that 1% risk of your capital is fine to trade and it goes to max 5%. However, Van says there is a point at which 1R will give you a maximum return. How is that calculated to check its value, probably between 1 to 5%, if the percent risk position sizing model is used.
A: The answer to finding the max return position size requires trading system information and then some simulation work. You can find an optimal position size from a simulation based on your risk/reward parameters and your system's trading characteristics. In short, you would need to gather a statistically valid sample of trade results from your system and simulate those results using different position sizes. As part of the process, you need to define your upside targets and downside limits. Van provides guidance on this area in his book The Definitive Guide to Position Sizing.
I would add that the position size that earns you the maximum return is also the position size that will most often reach your drawdown limit.
To paraphrase Van, however, traders who are the most willing to sustain deep drawdowns are the ones most likely to achieve steep gains. Do you know where you stand in terms of ability to endure drawdowns? That is the more important question than what kind of gains you are trying to achieve.
Traders I have spoken with who have sustained deep drawdowns seem to agree that your drawdown tolerance is probably a lot less than what you might imagine. You might consider using our new position sizing game (v4.0 releases next week) in simulation mode to vary position sizes with your system results. This will let you see the effect of large position sizes on your equity and give you a feel for what drawdown percentage starts feeling uncomfortable. —R.J.
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