You Don’t Trade the Markets: You Trade Your Beliefs About the Markets By, Van K. Tharp, Ph.D.

In the last few months, I’ve observed one person trade a system that he’d already proven not to work because he thought it might work if he had more trades. I’ve seen another person say that cryptoassets had no intrinsic value and subsequently delete all newsletters related to cryptos. That sounds a bit like Warren Buffet saying Bitcoin is “rat poison squared” and about fifty percent of all institutional traders were agreeing with him.

On the other hand, I’ve watched people in their twenties get excited about crypto “Shitcoins” such as DOGE and SHIBA INU because of Tweets by Elon Musk. However, they are called Shitcoins because there is no business model supporting them.

In the past, I’ve seen hedge fund managers, who don’t understand 1) systems; or 2) position sizing to meet your objectives; or 3) R-multiples and risk control; or 4) all three, trade differently because of their beliefs. Some of that sounds like the person who takes a trade just because it’s exciting. But all of it boils down to traders taking positions without understanding that a mistake is not following your rules and that repeating the same mistake over and over again is self-sabotage.

Mistakes and Missing Out

Some people stay on the sidelines throughout a huge bull market because they thought a bear market would start any time – and that belief may have persisted throughout years of bull markets. In fact, I moved a small retirement fund from stock to real estate when the 1987 crash occurred. That fund had a restricted exit, so it took ten years to get out of. That’s a lot of money left on the table not being in the market from 1987 through 1999. I’m out of the fund now, but I missed three major bull markets because of that mistake. But don’t feel sorry for me, I owe a lot in income taxes this year because I’ve made so much money trading.

Over the last two years, one of my favorite systems is a Richard Donchian type system – both for the entry and the exit. But I also have a belief about low-risk trades which conflicts with this system. Namely, my belief is when you’ve had a big decline, followed by a flat period that goes up a little over 2-3 months, then you have a low-risk trade. I didn’t take the trade because I waited for my system entry. However, in that trade, I had an experience in which I saw a really low-risk trade that I didn’t take because it wasn’t part of my system. The trade I took produced a 3.3R winner. The trade I was tempted to take produced a 7R winner.

Even more recently, I had a position that went within $1,000 of my stop even though it was going up. I didn’t take it because it wasn’t part of my system. But that was a 40R winner, whereas my current trade (with the same profit) is only a 4R winner.

Bottom line is people don’t trade the market, they trade their strongest beliefs about the market.

Belief: Trade/Invest in Value

One belief that many traders/investors have is that you should only trade value. However, is their definition of value even sound? Let’s look at a few such definitions.

Intrinsic Value: In my opinion, only living things have intrinsic value, and that value only occurs in their natural environment. Non-living things just have the value that human beings give them. Let’s take the example of an acre of trees. A timber company just sees the value of the timber in those trees, less the cost of converting the trees into lumber.

However, growing in the ground, among other trees, those trees have an intrinsic value.

First, have you ever stood in a forest of big, majestic trees – such as Giant Sequoias? There is a strong energy there that you cannot feel anywhere else. Those trees have lived for thousands of years and accumulated something special. When you’re there, you can just feel it.

Second, trees have intrinsic value in their natural environment. They take in carbon dioxide and breath out oxygen. Living trees are essential for all oxygen-breathing life forms. They also store carbon in their trunks. Trees living in forests as part of an ecosystem tend to live longer than trees in urban environments. Trees also have a complex communication through their roots. And it was found that when a fir tree was covered to prevent photosynthesis (the natural method for obtaining nutrients) nearby birch trees would send them sugars through their roots.

Third, trees have a symbiotic relationship with lots of other animals, including bacteria and fungi in the soil. Fungi can cover a large surface area of the forest by developing white threads called mycelium. These spread over the tree roots by taking up sugars from the tree, but at the same time, they provide essential minerals such as nitrogen and phosphorus.

Fourth, trees provide shelter for birds, squirrels, insects, and probably many species that I don’t know about. These trees also provide food (in the form of nuts, etc.) for many of those same animals plus other animals such as termites. Animals, of course, return the favor by moving enough of the nuts/seeds to favorable locations so that the trees can germinate and reproduce.

I owned my last home for about 30 years. It was on a wooded lot with some of the largest trees in the neighborhood – about 40 of them. I loved those trees. Among them, I had a favorite tree located near my home office that I would occasionally hug, and from it, get a huge sense of energy. In 2018, we sold that house, and the new owner cut down all the trees within three months of buying it. I felt devasted, as if I had betrayed my trees by not vetting the buyer a little better. My only consolation is that in my new house, I’m the custodian of about 150 trees and I have thousands of trees within 2,000 feet of where I sleep.

This is what I really mean by systems thinking because there is a whole independent network that develops out of living things interacting with one another. And, it’s a good reason to believe that consciousness (God) is the basis for all of it. Non-living things have much less of this type of relationship, if any.

Value in Stocks

I think there are two kinds of value in stocks: real value and “funny-mental” value. Both are derived from human belief systems but real value is much more useful than “funny-mental” value. Of course, this is just my belief.

Real Value: One of my favorite systems at the bottom of bear markets is called NCAV (Net Current Asset Value). We teach this system in the Bear Market Strategies Home Study Course. NCAV takes the total value of the company, if you were to attempt to liquidate it within one year, then subtract the value of both the long-term and the short-term debt. If NCAV is greater than the price of the stock, then you have real value. For example, if NCAV is $2, while the price of the stock is about a dollar, then you have a dollar of real value.

Another way to look at value in a stock is, if a company has 100,000 acres of land on its books valued at $100 per acre when the land is really worth $5,000 an acre, then you also have real value. However, this form of real value is less likely to be translated into an increase in stock price than the aforementioned NCAV form.

Fundamental “Funny-Mental” Value: This is a form of value created by analysts to determine future stock prices. Here they look at what new products the company is producing, what they are doing with their old products, and then attempt to look at the future growth in earnings. If they think the growth is substantial, like 20% or more, then they might estimate that the stock will have a Price to Earnings Ratio (PER) of perhaps 20. If the PER is only 12, they might say the price is undervalued. However, if they predict little or no growth, then they would predict a relatively modest PER of say 8-10.

While a lot of people might believe these sorts of mental manipulations – giving them some utility – over time they are not that useful. But again, that’s just Van’s belief.

Technical “Funny-Mental” Value: There is even a funnier form of “funny-mental” value that I classify as technically-based. Technicians have developed oscillators, such as RSI and Stochastics. They look at the values of those oscillators and say that if it is above a certain number, it is overbought (meaning it’s overvalued and it will probably go down) and if it is below a certain number it is oversold (meaning that it is undervalued and it will probably go up). Can you see the ridiculousness of these sorts of beliefs? However, if enough people believe them, then they can be useful while they are believed.

False Intrinsic Value

False intrinsic value is where people believe that some commodity or some other non-living substance has some extrinsic value[1]. Two examples come to mind – gold and fiat currencies, that most people consider to be money.

Gold was first developed as a store for value by King Croesus of Lydia (now part of Turkey) around 550 BC. By the Renaissance and the discovery of the New World, gold was the king of value. South America, in particular, was pillaged by the Spanish in search of gold. By the late 19th century, many of the world’s major currencies were fixed to gold at a set price per ounce. This standard, called the “Gold Standard” persisted for about 100 years.

According to the World Gold Council, there were three major periods for gold:

  1. 1660-1819 which is called the rise of the Gold Standard.
  2. 1820-1930 which is called the heyday of the Gold Standard. Gold coins circulated along with paper money that was backed by gold.
  3. 1931 to the present which is after the Gold Standard.

During the Gold Standard, almost everyone wanted gold, believed it had real value, and its price was fixed for stability. But let’s look at the “after the Gold Standard” period when fiat (not backed by anything except perhaps the debt of the nation) currencies tended to dominate. These dates primarily apply to the US States but the US was quickly followed by many other countries.

  • The Federal Reserve was established on December 23, 1913. Here, a privately owned central bank was established by Congress to regulate the money supply. Those in power knew that if you controlled the money supply you controlled the country.
  • The Gold Reserve Act of 1934 made it illegal for American people to hold gold with the exception of jewelry and collectors’ coins.
  • In 1944, a conference took place with all allies of World War II at Bretton Woods, New Hampshire. Here, countries promised that their central banks would maintain fixed exchange rates between their currencies and the US Dollar. That is, the US Dollar became the new gold standard. However, the US Dollar was fixed to the price of gold at $35/ounce.
  • Richard Nixon, in August 1971, announced the temporary suspension of the US Dollar’s convertibility into gold. This marked the breakdown of the system and the price of gold started to soar.

There have been several reasons for the drop in the Gold Standard.

1) If people hoard gold, then it is impossible for a Gold Standard economy to grow.

2) The richest people in the world have found a way to manipulate the money supply and thus grow and contract money when they wish to do either.

  • Growing money makes their assets grow and they get a larger supply of the world’s wealth.
  • Shrinking the money supply makes economies shrink and assets go down in value. If they are in cash (because they are manipulating the money supply) they get to then accumulate assets at rock bottom prices. And then they can grow the prices of those assets again.

3) Those who don’t realize the game being played get poorer and poorer.

Fiat currencies basically have been what existed since 1971 with most currencies tied to the US Dollar. In the chart below, we see what has happened to those currencies since 2001.

https://www.goldavenue.com/en/blog/newsletter-precious-metals-spotlight/gold-vs-fiat-money

The decrease in the value of the US Dollar depends upon one’s source. If you look at something like Shadowstats.com which uses the US Inflation Index established in 1980, then being down 80% is not unreasonable. If you look at official statistics (remember there are lies, damned lies, and government statistics), then the depreciation is much less. Obviously, the government doesn’t want you to know what I’m writing about, but the information here is publicly available.

Once again, I’d like to state a major point. There is no intrinsic value for non-living things. Those values are set only by human beliefs and their knowledge of how values are being manipulated by those who make up the rules of the game that everyone seems to agree to play.

Value Changes Over the Last 10 Years

Let’s look at the value of what most of us consider to be assets over the last 10 years. We will start with the US Dollar. By the way, all the other measurements are against the US Dollar so unless they have made more than 6% per year, you are losing money.

  • The US Dollar has deflated by about 80% or about minus 6% per year.
  • US cash invested in the bank has earned an average of 0.5% per year.
  • While it’s only a recent development with the advent of Decentralized Financing, if you purchase and “stake” a stable crypto that is based upon the US Dollar such as USDC, then over the last 12 months you have earned 5.13% per month. Here you are almost at breakeven.
  • Most other fiat currency has earnings about the same as the US Dollar.
  • How about commodities as measured by the ETF, DBC? These usually go up when inflation goes up. However, DBC, since 2001, has lost a total of minus 4.1% per year. Did you once believe that commodities were an inflation hedge?
  • How about gold, the standard against which fiat currencies are measured and the so-called ultimate inflation or crisis hedge? Well, since 2001 the average return on gold has been 1.5% per year.
  • Now let’s look at TIPS, inflation-protected bonds. These have earned an average of 3.4% per year.
  • How about investment-grade bonds? They have earned about 5.3% per year. With them you are almost at breakeven. Junk bonds (high yield) have done just a little better at 5.4% per year.
  • How about long-term Treasury bonds? Now, we have 6.4% per year so you are a little ahead here.
  • Now let’s look at a few of the better investments. The first one is REITs. Here you are up an average of 9.7% per year. You are starting to make a little money.
  • What about equities based upon capitalization?
        • US small caps (IMW) are up an average of 12.9% per year.
        • US large caps (SPY) are up an average of 14% per year.
        • And, the NASDAQ (QQQ) is up an average of 20% a year – the clear winner despite huge losses in 2001-2001 (or perhaps because of it depending upon when they started collecting data used here) plus more huge losses in 2007-08.
  • But what’s the big winner? It’s Bitcoin, BTC is up an average of 230.6% per year.

To be fair, very few people were in BTC the first five years of the last decade. So let’s just look at it for the last five years. The trend was obvious for anyone in 2017. If you jump on trends, the opportunity was staring you in the face and was all over the news. If you missed it, it’s because you believed that BTC didn’t have any value, or you lacked the know-how to invest.

Let me look at one other investment—which I refer to as a Shitcoin. DOGE is a Shitcoin because it has no business model and it’s being supported by Elon Musk tweets and the enthusiasm of the 20-somethings crowd.

In 2021 DOGE is up by 4,545.66%. That means that $1,000 invested in Doge on January 1st this year would be worth $45,546.60 today. If you have a clear exit, does it matter that the coin will eventually be worthless? And perhaps that won’t happen for several years if enough people believe in it. If you only invest what you can afford to lose, and you watch for a clear exit signal, then you’ll probably make a lot of money.

Recap

Let me summarize my major points here.

  • Only living things have intrinsic value and that cannot be measured in terms of wealth or power. Intrinsic value is the value of the relationship of living things in the system.
  • The value of anything else, including the things you tend to invest in, is all based upon beliefs. The more people who believe in it, the more useful the belief and the more likely you are to make money from them.
  • Even stuff you hate can go up by huge amounts. For example, I would not hang a Paul Klee painting in my house because they look awful to me, but his paintings all sell in the millions. There is a service where you can buy a piece of what’s considered a master work that sells for over a million. I have invested in two, but I won’t invest in anymore unless I’d want to hang them in my house.
  • When you die, everything that is solid in this world will be valueless to you.
  • In this world, look at what beliefs are making things go up and consider those to be useful.
  • If you are not making a large amount of money in today’s market, it is because you have limiting beliefs such as:
        • A major crash is going to happen soon. The signs will be there, get out when you are sure it is happening (i.e., the market type changes to bear).
        • I’m not worthy of making money, or I don’t know how, or it’s impossible for me to do so. All of these beliefs will stop you cold, but you can change them.
        • I don’t care if it’s going up, it has no real value, so I won’t invest in it. I realized I had a little of this belief with the Shitcoin, SHIBA INU. So, I bought $600 worth and two weeks later it’s worth $1,700. When it starts going down, I’ll be out.

It’s as simple as that.

 

[1] One intrinsic value might be the value that employees give to a company that they have worked at for many years. For example, if someone bought the company inexpensively and then tore it apart of the value of its pieces, then they would probably say that the “extrinsic” value of the company is much more than the intrinsic value. However, this still supports my belief that intrinsic value comes from the whole – from the relationship with other living things.

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