Super Trader. Make Consistent Profits in Good and Bad Markets

256 Pages·2009·2.09 MB·English

by  Van Tharp

S U P E R
T R A D E R
MAKE CONSISTENT PROFITS IN
GOOD AND BAD MARKETS
Van K. Tharp, Ph.D.
I J C
WITH LLUSTRATIONS BY ILLIAN OMPHEL
New York Chicago San Francisco Lisbon
London Madrid Mexico City Milan New Delhi
San Juan Seoul Singapore Sydney Toronto
This book is dedicated to three very special people in my life.
My wife, Kalavathi Tharp, provides a very special spark in
my life. Without that spark and her tremendous love, this
book would not be possible. My son, Robert Tharp, is one of
the real joys in my life. He’s a trader, and he’s worked very
hard to understand these concepts. I’m very proud of him.
And my niece, Nanthini Arumugam, has in my mind become
the daughter that I always wished I would have. I am very
blessed to have all of you in my life.
Copyright © 2009 by Lake Lucerne LP. All rights reserved. Except as permitted under the United States
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Contents
Acknowledgments........................ vi
Preface: The Fate of
the “Average” Investor.................. vii
INTRODUCTION The Five Steps to Consistent Profits......... 1
PART 1 Working on Yourself: The Critical Component
That Makes It All Work.................. 11
The Components of Trading Well ............. 12
Do an Honest Self-Appraisal ................. 16
What’s Your Trading Type? .................. 22
Commitment.............................. 25
Do What You Love......................... 31
Personal Responsibility ..................... 33
What Are Your Excuses? .................... 36
Empower Yourself ......................... 39
Write Down Your Beliefs.................... 41
Enjoy Your Obstacles....................... 45
Trade through “Mindfulness”................. 48
Make Friends with Your Inner Interpreter ....... 54
Learn to “Dissociate”....................... 58
Achieve Balance in Your Trading/Investing ..... 61
Overcoming a Stuck State of Mind ............ 63
Does Failure Motivate You?.................. 66
No Requirements to Be Happy................ 69
Vitamins for Your Soul to Improve
Your Trading............................ 74
Discipline in Meeting Your Goals ............. 87
Removing Stored Charge.................... 90
How Do You Know When You’ve Done Enough
Self-Work? ............................. 94
iii
iv Contents
PART 2 Developing a Business Plan: Your Working
Guide to Success in the Markets......... 97
Have a Plan for Your Trading/Investing......... 98
Having a Mission Statement behind Your Trading
Is Critical toYour Success as a Trader........ 101
What Are Your Goals andObjectives?.......... 106
Market Beliefs ............................ 108
Understanding the Big Picture................ 113
What Are Your Tactical Trading Strategies? ..... 119
How Will You Achieve YourObjectives through
PositionSizing? ......................... 120
Dealing with Your Challenges ................ 121
What Are Your Daily Procedures?............. 123
What Is Your Education Plan? ................ 125
Worst-Case Contingency Planning............. 126
Mentally Rehearse Your Disaster Plan.......... 129
Systems Other Than Trading Systems .......... 131
The Four Quadrants ........................ 134
PART 3 Develop a Trading System That Fits
Each Market Type You Plan to Trade...... 139
Designing a Trading System That Fits You ...... 140
Trading Concepts . . . . . . . . . . . . . . . . . . . . . . . . . . 143
Setups Are Not as Important asYou Think ...... 146
Entering the Market ........................ 148
The Source of the Myth of Stock Selection...... 151
Exits Are the Key to Making Money . . . . . . . . . . . 153
Exiting a Trade beyond the Initial Stop ......... 156
Start Thinking in Terms ofReward and Risk..... 158
One of Your Most Important Tasks: Keep Up
with the R-Multiples of Your Trades ......... 161
Six Keys to a Great Trading System ........... 167
Common Elements of Success................ 169
The “It Didn’t Work” Mentality............... 171
Trading Reality Check ...................... 174
What It Takes To Have Confidence ............ 176
Contents v
PART 4 Understanding the Importance of
Position Sizing ........................ 179
System Quality and Position Sizing............ 180
Position Sizing Is More Important Than
You Think.............................. 184
Three Components ofPositionSizing .......... 189
THE CPR Model for PositionSizing........... 191
Position Sizing Basics ...................... 194
Types of Equity Models..................... 197
Different Position Sizing Models.............. 200
The Purpose of Position Sizing ............... 202
One Way to Use Position Sizing to Meet
Your Objectives: Simulation ............... 204
The Problems of the R-Multiple Simulator ...... 207
Getting Around the Problems ofSimulation ..... 209
PART 5 More Ideas for Producing Optimal Trading
Performance........................... 211
Keep It Simple ............................ 212
Understanding theHolyGrailofTrading ....... 214
Miscellaneous Ways to Make Money in
a Trading Business....................... 217
Avoid Making Predictions in the Market........ 220
Mistakes and Self-Sabotage.................. 222
How to Prevent Mistakes.................... 224
How Not to Repeat Mistakes . . . . . . . . . . . . . . . . . 226
You Cannot Ignore theFundamentals .......... 227
The Answers.............................. 229
A Personal Invitation from Van K. Tharp ..... 232
Glossary................................. 233
Index.................................... 239
Acknowledgments
So many people contributed to the content of this book, and
although I cannot recognize each of you individually, to all of
you, let me just say thank you. Some of you may have just
asked a question that stimulated me to think in a certain way.
Some of you may have made a suggestion that started me in a
new direction. However, certain people deserve a special
acknowledgment because their contribution was enormous.
In particular, I’d like to thank Jillian Comphel for her
wonderful illustrations for the book. Jillian is a member of my
staff, and I was delighted to find that she was so talented.
I’d like to thank Becky McKay for her work in proofing and
editing, and for being an all-round jack-of-all-trades for this
book. Thanks, Becky.
I’d also like to thank Cathy Hasty and Melita Hunt for
everything they do for me because what they do makes it
possible for me to write a book like this. Thanks to both of you.
Melita, who used to be the CEO of my company, passed away
in early 2009. She was a joy and she will be greatly missed.
Thank you all for your incredible contributions, as well as
all of you who contributed in a small way that I’ve not
mentioned directly.
Van K. Tharp, Ph.D.
vi
Preface:
The Fate of the
“Average” Investor
Countless times people call me up asking for help; however,
their plea usually comes with the condition “I don’t want to
spend a lot of time or do a lot of work because I’m just an
average investor.” Is that you? Well, Joe Smith considered
himself an average investor.
Joe retired in 2003. He had done well during his working
years and had a retirement income of $6,500 per month,
including Social Security. He had saved about $623,000 as a
nest egg for emergencies in his retirement. He still owed about
$350,000 on his house. Joe and his wife debated a lot about
whether they should pay off the mortgage with their cash. The
house payment was nearly $2,000 per month, and if they paid it
off, they’d have plenty of money to spend each month and little
to worry about.
Joe had lost about 30 percent of his retirement nest egg
during the market crash from 2000 to 2003. However, in 2003
the market was going up. Joe figured the worst was over and he
probably could make 10 percent per year on his money. That
would give them an additional $5,000 per month for spending,
which more than covered his mortgage payment. Joe had an
advanced degree in civil engineering, and as far as he was
concerned, investing wasn’t rocket science. He’d do well in the
market because he was a smart guy. Chances are, he thought,
he could be better than average and get his account back up to
a million dollars (the way it was before the 2000 crash).
Joe made a mistake that many people make. He’d spent
nearly eight years learning his profession and much of his
lifestaying on top of it. He thought he was smart enough to
vii
viii Preface: The Fate of the “Average” Investor
outperform the market professionals and make 10 percent or
more each year as an investor in his retirement. After all, it just
amounted to picking the right stocks, and he could do that.
Joe was now 68 years old. His total education in the market
consisted of reading three or four books on how to pick the
right stocks plus a book about Warren Buffett written by
someone other than Warren Buffett. He also watched the
financial news regularly, and so he was sure he could make his
fortune. He also read several financial newspapers each day,
and so he felt informed.
For a while, Joe was right. He made about $120,000 with his
investment from 2003 through 2005, and he and his wife spent
about half of that. Thus, Joe’s account at the beginning of 2008
was worth about $683,000. However, Joe was not ready for the
second leg of the secular bear market. On September 30, 2008,
the stock market was down over 40 percent for the year, and
Joe’s account was down 29 percent—it was now worth about
$484,000. If he paid off his house now, it would take most of his
assets. When the bailout bill passed, he watched the market fall
by hundred-point increments each day. Joe was really worried as
his account balance approached $400,000.
The CNBC gurus Suze Orman and Jim Cramer said stocks
would soon be a bargain: "Don’t sell unless you need the
money." Didn't they realize that by the standard of just investing
and holding, he was down nearly 60 percent from his equity
high in 2000? In fact, Joe now needed to make 70 percent on his
money just to break even on the year, and he was struggling to
make 10 percent per year.
What’s the bottom line here? Joe spent eight years getting
his education to become a good engineer, yet he treats the
investing process as if anyone could do it. It’s similar to
building a bridge without any training. You can’t work like that
in the real world, but it’s easy to do in the market. In the real
world, it could mean a collapsed bridge; when you do it in the
market, it means the death of your account.
What does it take to trade successfully, especially in this
market? Chances are that we’re in a long-term bear market that
could last another 10 years. The United States as a country is
bankrupt, and no one seems to realize it because we spend
money like crazy.1 Seven hundred billion to bail out troubled
debt is just a drop in the bucket. It could get much, much worse.
1research.stlouisfed.org/publications/review/06/07/Kotlikoff.pdf.
Preface: The Fate of the “Average” Investor ix
What happens when the baby boomers really need cash for
retirement and there is a net flow out of the stock market? There
will be a giant sucking sound coming out of the market! Are you
prepared for that?
Ask yourself the following questions:
1. Do I treat my trading/investing like a business? Have
Iprepared for it the way I would for a business?
2. Do I have a business plan—a working document to
guide my trading business?
3. Do I make mistakes regularly (a mistake means not
following my rules)?
4. Am I following a regular procedure to prevent mistakes?
5. Do I have a tested system?
6. Do I know how that system will perform in different
kinds of markets?
7. Do I know what kind of market we are in now and know
what to expect from my system in such a market?
8. If I don’t, have I gotten out?
9. Do I have exit points preplanned for every position
Icurrently have in the market?
10. Have I developed specific objectives for my trading?
11. Do I understand that I achieve my objectives through
aposition sizingalgorithm? Have I developed a specific
position sizing algorithm to meet my objectives?
12. Do I understand the importance of the points above?
13. Do I understand that I create my own investment results
through my thinking and beliefs?
14. Do I accept responsibility for that creation?
15. Do I regularly work on myself to make sure that I follow
the points above?
Circle all the responses that are true for you. If you haven’t
circled at least 10 of the 15, you are not taking your trading
seriously. Your financial health is in danger.
Here is what you need to do: Don’t accept the notion that
you are just an average investor and there is nothing you can do.
You create your own results, and your results right now come
from playing a game with no training.