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

• Article Being Passionate About Trading by D.R. Barton, Jr.
• Trading Education Peak Performance Home Study
• Trading Tip The Importance of Volatility by Ken Long
• Workshops Spring 2011 Workshop Schedule
• Mailbag Feedback from The Definitive Guide to Position Sizing

by D.R. Barton, Jr.

Every Monday, Wednesday and Friday, about a dozen guys make their way to the Western YMCA in Newark, Delaware to play basketball.  The first game starts at 5:45—that’s a.m.

Why in the world would level-headed people forsake the comfort of their Tempur-pedic mattress and drive to the gym in 12°F (-11°C) weather to run up and down a court?  The answer is simple: an undeniable passion for the game of basketball.

There’s something almost therapeutic about playing basketball, especially pick-up games at the local gym or playground.  (A pick-up game has no formal teams or referees.  People just show-up, choose sides and play.)   The game offers camaraderie, competition, and a psychological release.  On top of all that, it’s great exercise, too. Finding a good bunch of guys for a regular game is tough, so when you find such a group, you stick with them. 

This morning I was struck by the true passion these guys have.  Never are there any fights or long arguments; every shot is contested and every foul is called.  There are no easy baskets.  These people love to play; this shows not only in the high level of ball that we play, but more importantly, in their enjoyment of this early morning ritual.

I believe that it is much tougher to learn a complex skill, like basketball or trading if you don’t have passion for the sport—or the markets.  Competence makes no requirement for passion, although passion offers the shortest and most enjoyable path in the pursuit of excellence.

The Shortest Path to Success: Align With Your Passion

If you have a passion for something, spending the time required to master that subject will come more easily because it is so enjoyable. 

Let me say a word about the concept of passion.  The type of passion I’m referring to is an enjoyment to the point of absorption.  I don’t believe that we are born with this type of passion.  I believe that it grows in us as we become involved in an area and start to receive enjoyment from the experience.  This type of passion shows up in all walks of life.  I know passionate cooks, guitar players, gardeners, engineers, doctors, programmers and performers. And I don’t believe that any of them were necessarily born with that passion.

I have met traders and investors who I wouldn’t consider passionate.  Some were proficient, others competent, and a few were even successful.  When they spoke about the markets or trading, however, they lacked any spark for the topic.  Most likely they will not reach the top tiers of their field.

I have also met passionate people who eat, breathe and live the markets.  Most of them do it with some balance in their lives, but they love the markets.  They love the research.  They love to talk about what they’re doing in their trading and investing.  Many of these folks are at the top or headed in that direction.    

My best friend and trading and business partner will not go to bed without reading the Wall Street Journal.  He hasn’t missed a weekly Barron’s in 30 years.  He reads scores of market commentary emails every day.  He is a walking market encyclopedia.  When he talks about the markets, you can’t miss the gleam in his eye and the energy in his voice.  He has passion and is in the top tier of his field. 

You don’t have to have a passion for the markets to enjoy trading and investing or even to get good at it.  But if you find a part of the market experience where you really enjoy your time there—where you get lost in the moment—pay attention to that feeling!  It might be researching individual companies, system building, fundamental analysis of commodities or technical analysis of charts.  Find what you like about this great game of trading and investing and follow that passion.  That’s the quickest way to get good at something.

And as an aside, if you haven't tried exercising first thing in the morning, I highly recommend it for several reasons.  It’s a great way to get your day going!  If you are doing any mental activity (like trading or investing for example), the extra flow of blood to the brain through exercise has proven to raise performance in mental exercises.  And this doesn’t have to be a long run or playing full court basketball.  A good walk at a brisk pace will do the trick.  Get your blood moving and shift your mind to higher gear.

I’d love to hear your thoughts and feedback on this article or about trading and investing in general at drbarton “at” iitm.com.  Until next week…

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 "iitm.com".

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Trading Education

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Trading Tip

by Ken Long

Periods of great volatility are like thunderstorms: they get your attention. For short term traders, Friday, January 28 offered a reminder of what a big volatility day feels like. Longer term investors won’t soon forget the fourth quarter of 2008 or the first quarter of 2009.

Most investors look at volatility with fear and trepidation. That view deserves merit as wild swings in price are an indication of uncertainty about the fair value of the asset in question. This uncertainty plays havoc with your bottom line as someone earning money in the markets. It is a normal tradeoff consideration to give up the potential of out-sized gains in exchange for protection against downside volatility.

In one sense, volatility is a simple concept: the greater the price swings in the shorter periods of time, the greater the volatility. At the most fundamental level, volatility is the fluctuation in the price of an asset and is an absolute requirement for a trader to make money.

Based on scholarly studies, increases in volatility correlate strongly with declines in equity value. If you look at bear markets, you see volatility everywhere, which leads to tremendous gains on up days and tremendous losses on down days. This volatility is what drives longer term investors to the sidelines and creates the window of opportunity for longer term value players to establish excellent entry points for long term holdings in beaten down companies and sectors. This eagerness to buy value at a discount is why we see buying pressure even in the midst of the worst bear markets.

Traders who are looking to make their living off the buying and selling of inventory need the volatility of longer term position traders and short term scalpers to move price in swings that last long enough for them to realize their gains while offering the buyers and sellers from other time frames reasons to get in and out of these positions as well.

Because swing traders need no confirming fundamental beliefs in their positions, they can operate successfully in swing time frames during bear markets. Provided swing traders can manage their risk in the periods of higher volatility, they should be eager to trade on the most violent of days in the market. For a swing trader, the greater the intraday volatility, the easier it is to see opportunities and frame favorable trades in terms of reward to risk.

Carefully consider the effect of volatility on your strategy and choose a measure that best meets your analysis needs dependent on your timeframe. Here are a few ways to measure volatility.

Ways to Measure Volatility

There are several different ways that traders can measure and understand volatility. Depending on the typical length of time you plan to hold your positions, you may find one of these methods more suitable for you.

The bottom line is that the method you choose should be responsive to significant changes in the time period you favor, and be sensitive enough to give you actionable information. You should be prepared to spend some time trying out different parameter settings until you find the best tradeoff between smoothness and sensitivity.

By smoothness, I mean how well the parameter settings filter out or smooth over normal noise variation in the data, yet still making it clear that an important condition in the market’s volatility has just changed.

Long term traders can simply use beta, a comparison of the asset’s volatility to that of the market’s to find out if, in general, the asset is more or less noisy than the market. I recommend considering the correlation to the market to see how much in parallel the asset will move when the market moves.

As an example: if you intend to be an intermediate to long term trader, you may be well served by considering volatility as defined by “Annualized historical volatility.” This method describes volatility as measured by the standard deviation of price for the look back period, then annualizing it using normal statistical methods. This gives us a reasonable approximation of the kind of volatility we could see over longer periods.

Intermediate term traders to swing traders (holding from months to weeks) can get good information from the simple standard deviation of price over the holding period, without a need to annualize, because you don’t intend to hold that long.

Swing traders need something a little more sensitive and reliable than standard deviation, which loses its authority to describe volatility when sample size is less than 30 periods. A swing trader would have to look at hourly price data for standard deviation to be meaningful and sometimes that data is hard to get or unreliable.

Average True Range (ATR) is probably a better volatility measure for swing traders as it is more sensitive and accurate than standard deviation in shorter time frames. By going a step further and dividing ATR by price you have ATR%, which allows you to fairly compare an asset against itself through time or to compare different assets at the same time. Plotting a time series of ATR% gives a much better representation of volatility through time than straight ATR, whose line is skewed by changes in price.

Simple ATR time series actually disguise changes in volatility. If an asset goes up in price but has exactly the same relative volatility, the ATR time series will rise, which will usually be interpreted as increasing volatility when that is absolutely not the case. Choose your graphs wisely.

To conclude, I’ll offer an analogy: volatility is like electricity, it can be your best friend or your worst nightmare. As a trader you must learn to use the power of volatility responsibly and effectively. Stay grounded and respect the power for your own good.

About the Author: Ken Long is a retired Lieutenant Colonel in the U.S. Army with a Master's Degree in Systems Management. He is a  doctoral candidate researching the management of uncertainty and an active trader. Ken is the founder of Tortoise Capital Management, www.tortoisecapital.com, where he conducts market research and publishes a newsletter for his trading systems' signals.  He is a proud father of 3,  a husband, teacher, student and martial artist. The above article was reprinted from Ken's blog. Read more of Ken's essays at http://kansasreflections.wordpress.com.

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Workshop

2011 Spring Workshop Schedule

Note: Our Peak Performance 101 workshop for Sydney Australia, March 11-13 is sold out. We have a waiting list and sometimes we do get cancellations. Please click here and register for the workshop (at no charge) to get on the waiting list.

Peak Performance 203 has seats available to anyone who has already taken or is registered for Peak Performance 101.

Also, on March 10th Van will speak in Sydney for a special presentation on Inside the Traders Mind. Click here to register through our partner, Universal Solutions

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