The group study program is our sharing of the market knowledge from the tested sources and eliminating the ones that do not work in the markets. We have a vast library of research resources worth over $50,000 accumulated over a long period of time.
Trading systems work or fail as a function of consistency and implementation. There is a serious lack of information available on implementation of a system. On the other hand there are thousands of places where systems are sold. They all promises to work. Will they work? We seriously doubt it. Why? You will find this out in the lines below.
The idea of this program is to allow you to understand market behavior and trading related behavior. This area is underserved. Most of the losses in the markets can be recognized to be from the emotions of fear, greed and/or hope. Of all three of them Hope is the destructive emotion in the markets. Hoping that riding a losing position will turn into a winner. Rule number one is not to ride the losing position for serving the emotion of hope. Fear is the second emotion what keeps us from entering the markets at the right time and holding on to the winning positions when the market temporarily moves against us. Greed is holding on to the winning positions when they should be closed out.
There are three basic rules when trading a tested system over a period of time.
1. Cut the losses short.
2. Run the profits.
3. Take trades in the direction of the signal.
We have discussed the first two problems related to the emotions. Third one is also very important to understand. You have too many inputs- news, commercials, news, more news, financial news, economic news, bad news, good news and all the news we hear represents the past and does not have any predictive value. This is the danger of information overload. We live in a world full of events and we have access to tons of it. The reality is that you can only focus on a limited number of things with your conscious mind. The conscious mind is only capable of handling 8bits/second of information. Any information more than that will be filtered. As an example, right now there are a lot of other things happening around you. Sounds, sights, smells but you are only focused on one at a time. Take this fact to your trading and if you mix your signals with news and other sources, you will not be trading any one them. So you need to focus on what you want to trade. In this case, you are paying us because we are your trading advisors. The choice is yours. There are things that you can do mentally if you focus with discipline to what you want to do. The bottom line is that too much data, opinions and inputs will divert you from your trading goals. What you need is discipline. These are the introductory reasons.
This one aspect of the multidimensional strategy towards the markets- YOU as a trader. The other reasons to consider are what you call systems and money management. All three are important while trading the markets.
Dimension number two is a system. To trade the markets you need a system which has positive expectancy. What is positive expectancy?
Expectancy = (Probability of Win * Average Win) - (Probability of Loss * Average Loss)
As an example let’s say that a trader has a system that produces winning trades 30% of the time. That trader’s average winning trade nets 10% while losing trades lose 3%. So if he were trading $10,000 positions his expectancy would be: (0.3 * $1,000) - (0.7 * $300) = $90. So even though that system produces losing trades 70% of the time the expectancy is still positive and thus the trader can make money over time. You can also see how you could have a system that produces winning trades the majority of the time but would have a negative expectancy if the average loss was larger than the average win: (0.6 * $400) - (0.4 * $650) = -$20. In fact, you could come up with any number of scenarios that would give you a positive, or negative, expectancy. The interesting thing is that most of us would feel better with a system that produced more winning trades than losers. The vast majority of people would have a lot of trouble with the first system above because of our natural tendency to want to be right all of the time. Yet we can see just by those two examples that the percentage of winning trades is not the most important factor in building a system. As Dr. Van K. Tharp points out-… your trading system should have a positive expectancy and you should understand what that means. The natural bias that most people have is to go for high probability systems with high reliability. We all are given this bias that you need to be right. We’re taught at school that 94 percent or better is an A and 70 or below is failure. Nothing below 70 is acceptable. Everyone is looking for high reliability entry systems, but its expectancy that is the key. And the real key to expectancy is how you get out of the markets not how you get in. How you take profits and how you get out of a bad position to protect your assets. The expectancy is really the amount you’ll make on the average per dollar risked. If you have a methodology that makes you 50 cents or better per dollar risked, that’s superb. Most people don’t. That means if you risk $1,000 that you’ll make on the average $500 for every trade - that’s averaging winners and losers together. In short, you need a system which have bigger average profits then losses. You need to trade a system that is tested over a period of time. Although there is no guarantee of profits with any system including ours, swing trading system we use gives us the edge in the markets.
The third and the most important dimension in the markets is your money management. How do you use your account size to calculate your position size in the markets? Look at the part of a snowball fight metaphor that Tharp uses in his book: Imagine that you are hiding behind a large wall of snow. Someone is throwing snowballs at your wall, and your objective is to keep your wall as large as possible for maximum protection. Thus, the metaphor immediately indicates that the size of the wall is a very significant variable. If the wall is too small, you couldn’t avoid getting hit. But if the wall is massive, then you are probably not going to get hit. The size of your initial equity is a little like the size of the wall. In fact, you might consider your starting capital to be a wall of money that protects you. The more money you have, assuming all the other variables (the components of expectancy listed above) are the same, the more protection you will have. Now imagine that the person throwing snowballs at you has two different kinds of snowballs — white snowballs and black snowballs. White snowballs are a little like winning trades. They simply stick to the wall of snow and increase its size…. Imagine that black snowballs dissolve snow and make a hole in the wall equivalent to their size. You might think of black snowballs as “antisnow.” Thus, if a lot of black snowballs were thrown at the wall, it would soon disappear or at least have a lot of holes in it. Black snowballs are a lot like losing trades — they chip away at your wall of security… Tharp continues walking the reader through different scenarios and possibilities. Like considering the relative sizes of the snowballs of each color. What happens to your wall after being hit by some black boulders of snow? Or considering how the rate at which snowballs are thrown affects the wall. You can see how important each aspect of expectancy is as well as the huge importance of both the amount of equity (the size of your wall) and position-sizing (which will determine the size of the snowballs). Expectancy, position-sizing and other aspects of money management are far more important than discovering the holy grail entry system or indicator(s). Unfortunately entry techniques are where the vast majority of books and talking heads focus their attention. You could have the greatest stock picking system in the world but unless you take these money management issue into consideration you may not have any money left to trade the system. Having a system that gives you a positive expectancy should be in the forefront of your mind when putting together a trading plan along with an excellent money management along with the psychology to trade both. This introduction is not complete without explaining the concept of R-Multiples. R is simply the dollar risk per trade. It’s nothing but a reward-to-risk ratio. Dr. Tharp reveals the great secret of trading: The golden rule of trading is to keep losses at a level of 1 R as often as possible and to make profits that are high-R multiples. You often hear (read) that traders should only look for trades with a risk/reward ratio of at least 2 or 3 to 1. Expressing your results in terms of how many times your risk allows you to easily see how well your trades measure up to such a standard. So when you look at your results in terms of multiples of R, you can easily tell how good or bad the trades were. We like to think of R-Multiples as telling us the efficiency of our system.
So why not just use dollars?
Expressing results in dollars would achieve the same result if always risked the same amount of money. But what if you triple the account and therefore trade larger positions compared to when started trading? Or what if hit a rough spot and decide to cut lot size down while ride out the storm? Then the dollar results won’t easily tell how trades from one period of time compared to another period of time. But if used, R makes such comparisons simple. Either trades pass the risk / reward ratio test or they don’t. The actual number of dollars at risk doesn’t matter, how many multiples of the dollars at risk does. Talking and thinking in terms of R-multiple when you discuss about profits is an excellent approach - that by itself makes you focus on risk and money management - the actual “grail” to successful trading. That is a very important point. Whenever you see people posting dollar returns, especially losses, that are all over the place the first thing ask yourself and wonder what the risk per trade is. It’s almost a certainty that those traders aren’t focusing on risk and as a result keep having huge losses. The mere fact that you have to define R and then place a stop to keep your loss to 1R is probably too constraining for those gamblers traders. Dr. Tharp says about determining your initial stop-loss point as soon as you enter a trade, which, by definition woud give you a 1 R loss: This principle is so important that if you cannot follow it, then you might as well give up the idea of electronic trading right away. It makes it easy for people to figure out what they could have made or lost on a trade with their own account size and risk per trade amount. If you see a trade that returned 3R all one has to do is plug in their dollar risk per trade to figure out what they could have made / lost.
Trader A thinks that R is just some made up number and could mean anything. He likes “real” numbers. While it may be fun to see that somebody made $10,000 on a trade that in and of itself doesn’t tell you how good that trade was. What if that person risked $30,000 to make that $10,000? Or what if they risked $1,000 to make that $10,000? Those are two very different trades. Sure they both made the same amount of money but isn’t the second trade a much more efficient use of capital? What if somebody is trading $500,000 lots to make $1,000 in profit? It may be nice to see somebody saying that they made $1,000 here and $1,000 there but damn(!) that’s an inefficient use of capital. So while R could mean anything in terms of dollars, what really matters is how many multiples of R were made or lost. That tells you the quality of a trade or system.
Trader A states that if he reported his trades in terms of R he could appear to be a good trader. Sorry to tell him that’s simply not the case. If you lost money that means your expectancy, which is just your average return expressed in R-Multiples, was negative.
Trader B said that “R values are subjective and don’t give you a true idea on how successful the trade was”. That is exactly wrong. R-multiples are the very thing that tells you exactly how successful a given trade was, if you choose to grade on a risk/reward basis. So how can we make the results clearer? Simple, express them in percentages. That way, regardless of how many shares were traded or the prices of the stocks traded the results can be equalized across all the trade. Looking at the percentages makes those kind of comparisons easier. R-Multiples do the same thing for traders. They can accurately compare their own trades and they can take another trader’s results expressed in R and easily relate them to their own system. For example risking 2% per trade is R and reward will be more than R.
Re read the Introduction to grasp the three dimensions of trading.
