Van Tharp Back-To-Basics Series

What Does Van Tharp Mean When He Says:

"We Only Trade our Beliefs About the Markets"?

If you are a regular student of Van Tharp's work or reader of this newsletter you hear this a lot: You can't trade the markets, you can only trade your beliefs about the market. Let's explore what this really means.

As a long time modeler of what makes great traders great, Van understands that to model effectively you have to find out what highly accomplished people do in common. Once you get the common tasks that produce excellent behavior, you need to get the ingredients of those tasks. Those ingredients include the beliefs, the mental states, and the mental strategies necessary to carry out those tasks.

Let's look at some statements and see what you believe about them:

• The market is a dangerous place to invest. (You are right.)
• The market is a safe place to invest. (You are right.)
• Wall Street controls the markets and it's hard for the little guy. (You are right.)
• You can easily make money in the markets. (You are right.)
• It's hard to make money in the markets. (You are right.)
• You need to have lots of information before you can trade profitably. (You are right.)

Do you notice the theme?

You are right about every one of these beliefs (whether you said yes or no to any of them). If you don't believe in any of these statements, what do you believe instead? You are right about that too! However, there is no real right/wrong answer. Some people will have the same beliefs and agree with you and others won't.

Therefore, whatever your beliefs about the markets are, they will direct your thinking and your subsequent actions.

What is a Belief?

Beliefs are a primary way to filter information from the world. Beliefs are judgments, categorizations, meanings or comparisons. They determine how we perceive reality and relationships in reality. What you expect (i.e. your reality) depends upon your beliefs and they are largely unconscious. Every sentence in this document represents one or two beliefs, including this one.

One of the beliefs that is most productive for good trading is the belief that you are totally responsible for your own results as a trader. When you adopt this belief, then you can learn from your mistakes. However, if you tend to blame someone else (your broker, your spouse, the person giving you tips) or even the market for the results that you get, then you will tend to repeat the same mistakes over and over again.

When traders "own their problems" and assume responsibility for the results produced, then they discover that their results come from some sort of mental state that either allowed them to 1) follow their rules, 2) not follow their rules, or 3) trade without having any rules.

When traders take the time to write down all their beliefs (about themselves, the markets, money, etc.), then they can establish a much better idea of what they want to trade, and how they want to trade. They can also see flaws in their thinking much easier. It is valuable to know which beliefs support you as a trader, and which ones hinder your progress.

What is a Mental State?

Every task has an optimal mental state that will allow you to accomplish it effortlessly. For example, to execute a trade you benefit from courage and total commitment. Fear, in contrast, is a big disadvantage as a mental state for executing trades.

Mental states are primarily what most people call discipline or emotional control. Examples include: being impatient with the markets, being afraid of the markets or being too optimistic about the markets.

Controlling your mental states is just part of the answer, but when you can see that you are the creator of your own results as a trader, then you can really make progress.

What is a Mental Strategy?

To understand mental strategies, you have to understand how people think. People think in their five sensory modalities (that is, in terms of visual images, sounds, feelings, taste and smell).

A mental strategy is the step by step way in which you use these modalities; it is the specific sequence of your thinking. For example, the most effective strategy for the action step of executing a trade is to 1) see the signal, 2) recognize internally that this is the signal you decided you should take, 3) feel good about it, and 4) take action. If you do anything else, you probably won't be able to take action or it will be very slow.

The Psychology of Trading

Once you have a clear understanding of which beliefs, mental states and mental strategies are the core factors in top trading performance, you can then teach the same skills to others and have them perform well too. And when you can see this success duplicated in others, which we have been able to do in most aspects of trading, then you know you have a workable model.

The key psychological traits of top traders are

1. Personal Responsibility
2. Commitment
3. Their psychological "profile"
4. Working on personal issues (e.g., self sabotage)

Trading fundamentals include the Ten Tasks of Trading.

1. Self Analysis
2. Mental Rehearsal
3. Low-Risk Idea Development
4. Stalking
5. Action
6. Monitoring
7. Abort
8. Take Profits
9. Daily Debriefing
10. Periodic Review

Traders need to be reminded of these tasks and to eliminate any self-sabotage that keeps them from following the tasks. Van teaches all of these steps in detail in his various products and workshops.

Van Tharp believes that everything revolves around your beliefs, mental states and mental strategies, so with that in mind, everything about trading is 100% psychological, including why and how you trade and which system you will follow or build.

Many traders have a hard time "believing" this and it is almost the antithesis of what people learn in academic finance. So only you can decide whether it is worth the time to learn more about yourself and the psychological aspects of trading.

People get exactly what they want out of the markets. Most people are afraid of success or failure. As a result, they tend to resist change and continue to follow their natural biases and lose in the markets. When you get rid of the fear, you tend to get rid of the biases ~ Van K. Tharp, Ph.D.

Know When to Fold 'Em

One of my hobbies is playing poker and I can do it for free online. When I visit a casino and play poker, I usually make money. However, when I started to play online with play money, I had tremendous difficulty making money. And that didn't make sense to me because I knew that most of the people I was playing against were terrible. Why couldn't I make money?

However, one day I read a poker book by a professional who said that he had the same experience in low-limit games in Las Vegas. He said that when he had a good hand, he typically had five or six bad players staying with him. One of them would typically make a very lucky draw and he would be beaten.

Once he figured out what was happening, however, he rarely lost again. And his secret was knowing when to fold 'em. In Texas Hold'em, every player is dealt two cards face down. These are your unique cards that you must use, although with five common cards that are dealt face up, to make the best five card poker hand. You typically bet your hand after you see your two "pocket cards;" after the fist three common cards (called the flop); and after the fourth and fifth cards respectively.

Bad players typically play most starting hands they are dealt, but if there are enough bad players, then one of them will get a good draw that will beat most people. So the solution to beating them is to only play the outstanding starting hands - the hands that will typically win the pot 30% of the time or better. That means that you must FOLD 80% of the hands you are dealt. You never play them and in most cases, it doesn't cost you anything not to play a bad hand.

One of the advantages we have as traders is that we do not have to trade. And it costs nothing to not trade. So the common solution is to only take a position in outstanding trades. And these are usually either trades that are moving strongly in your favor before you enter or trades that are so highly undervalued that you are getting an investment at a small fraction of what it is worth.

One of the highest starting hands in poker is an Ace-King of the same suit. In a ten person game, this starting hand will typically win 68.6% of the time. But it usually does require some help to win. Suppose you are dealt an Ace-King of hearts which you bet so you can see some more cards. However, the next three cards are a 3 of clubs, a jack of diamonds, and a 7 of spades. Those three cards didn't help you at all. You don't even have a pair in your hand and you only have two more cards to see. Now the odds don't look good that this will be one of the 68.6% of the hands that an Ace King of the same suit will win. You should fold that hand, especially if other people are betting heavily. And again, it won't cost you much money at this stage to fold - just the amount of your initial bet.

The same occurs when you invest in a stock. You buy the stock because it is going up. However, once you buy it, it starts to slowly go down. After several weeks, it's down about 5%. At this point it's like the bad poker hand - you should walk away from it. The odds, right now, don't seem to be in your favor.

Bad players will typically play bad hands to begin with and they'll stay with good hands that don't get supported as more cards are revealed. If you become more conservative with the odds, only playing the best hands, you'll probably win most of them and lose very little money.

One of the golden rules of trading is to cut your losses short and this means get out of trades that don't seem to be working in your favor. Next, week we'll talk about the opposite situation, when the poker hand or the trade starts to look really good.

Do What You Love

I have a pretty good taste in art, I think. At least, I can go into most art galleries, find the piece that I like the best, and it is usually one of the most expensive pieces in the gallery. I can do that except for abstract art. I remember one gallery in Paris that we went into. This artist had a very expressionist style and I liked most of the work in the gallery, but it was all very expensive.

With that introduction, I'd like to mention that I've watched my wife learn art and go from beginning artist to a fantastic artist in a period of about 5-10 years. Many of her pieces might now be the type of work that I'd tend to gravitate to in a gallery.

And I think her art turned the corner as a result of two things she did. First, she went to an Avatar workshop in Ireland. She didn't think that she got that much out of the workshop, but her painting took a leap forward after that workshop. She said that somehow it freed her creative expressive.

The second thing she did was to start a program in a book called The Artists Way by Julie Cameron. As she worked through the program I noticed that her art was getting better and better. She painted her first painting in the style of the artist we both admired in Paris and my feeling was that it was as good as his work.

At this point, what I noticed was that Kala was really loving her work. She actually opened up a web site called www.kalatharp.com to sell her painting. She painting two pieces for her brother in Singapore and he thought that they were pieces that she had bought. And our friend DR Barton actually commissioned her to paint something for his study. And the work was fabulous.

So what does this have to do with trading and success? I've noticed that the people who are really successful in many, many fields start some sort of program of self improvement. I have mentioned many of those in past tips and the Artists Way is one of them. They move into what they love to do and as they commit to it (because they love it) all sorts of things happen to make it work for them

And one day my wife announced to me, “No one has more self-sabotage than me,” as she was going through her program. I was delighted to hear her say that, not because it is true, but because when people begin to think that, then I know they've come a long way in their self-work program. In fact, just saying that told me that she was way ahead of most people who are so numb to their self-sabotage that they are not even aware of it. It shows in her art and it shows in her way of being. I'm very proud of her.

In our Super Trader program, I have most of the people in there spend at least six months (or perhaps a year) of their two years doing psychological work. And as they begin to get insights of how much self-sabotage they really do have, and also get the desire to move through it all, then I know they'll make it.