Enjoy Bumping Into Walls

This is a new section featuring Peak Performance Trading Tips. These won't be tips on some hot new investment. Instead, they'll be tips on how you get yourself in the best possible condition mentally to perform at a peak level. We'll be doing one new tip each month. You may have heard some of them in one form or another before, but you can never apply them enough. As a result, these tips should become second nature to you.

In any endeavor in life, you have up and down periods. Dealing with the market has many such up and down periods. In order to profit from the up periods, you have to tolerate or even “enjoy” the down periods.

I'm an NLP modeler. That means if someone does something well, I can figure out the essence of what they are doing by understanding their thinking. Thus, when such a person goes from A to B easily and effortlessly, I can determine how they do it and teach that skill to other people.

It turns out that one of the major problems people have in going from their current location to their desired goal is all of the walls or obstacles they continually run into each day. There is a common solution to these obstacles — make them okay. Don't worry about getting from point A to B, just enjoy bumping into the walls.

If you're in the market, one of biggest obstacles you'll face is the wall of losses. It's fairly difficult dealing with the markets if you are not willing to lose. It's almost impossible. It's like wanting to be alive, but always wanting to breathe in and not willing to breathe out.

When you want to be right, you're not dealing with the obstacles. Instead, you're forcing things. When you want to make a profit out of today's trade, even though it's a big loser, then you're not dealing with today's obstacle. Enjoy the obstacle — embrace it — and be willing to accept it. If the market tells you it's time to get out at a loss, then do so.

Quite often traders take the relationship they are having with the market, and transmute it by developing a different system or trading with a professional money manager. Now, the old struggle they used to have with the market—of not accepting what the market gives them—becomes a similar struggle they are having with their system or with their new advisor.

Instead of giving up on the market after a string of losses, just in time to miss the really big move, they avoid their system until it is doing really well. When it is showing tremendous profits, they jump on board — only to be blown away by the market. And the same thing happens when they invest with money managers. This desire to be “right” motivates them to jump to the top money manager when he's hot, only to go through a big string of losses. It's all the same thing.

Psychologically, if you don't come to grips with your obstacles and embrace them, you will simply find another way to repeat them. Realize that the walls occur because they are there for you to bump into. When you accept this fact and embrace it, you'll accept bumping into walls. And strangely enough, you hardly even notice that the walls are there. The result will be a new level of success in the markets.

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.

When To Quit Your Day Job

I have had many readers through the years--most of whom were less-experienced traders--tell me that at some point in the future they planned to quit their day jobs and trade futures full-time. While their optimism was certainly positive from the standpoint of eagerness to learn about a truly fascinating business, it is also probably unrealistic that they will ever make a good living as a full-time futures trader. At the end of this feature I have a few questions that may help determine if you are ready to attempt to join the elusive rank of "full-time" trader. But first, I want to present you with some straight facts.

I have been in this business nearly 20 years. I have read stacks of trading books and have voraciously studied markets and market behavior. I have worked right on the trading floors of all the major futures exchanges. As a journalist, I have conducted countless interviews with the very best traders and analysts in the world. But I still cannot specifically predict what a given market will do in the future.

Now, at this point a few of you may be thinking, "This is not very encouraging news. Maybe I should listen to some of those other guys that say I can have immediate trading success by learning their 'secrets' or adopting their 'proven' system or strategies?" While I hope this is not the case with you, I am very proud of the fact that I have made my reputation in this industry by refusing to be marketed and promoted (hyped) as something I am not, nor can ever be.

It's very important to realize the fact that neither I nor anyone else--not even the most powerful computer trading systems--can predict what the markets will do in the future. Markets will never be tamed. I've said many times that my profession is not a business of market predictions, but one of exploring market probabilities, based upon fundamental and technical analysis--and human behavior. By exploring and understanding market probabilities, and human nature, one can achieve trading success.

Many traders are lured by fast-talkers or fancy wording into thinking that someone or some firm has a sure-fire trading "secret" or system that beats the markets on a consistent basis--and racks up big trading profits in the process. But the truth is, most of these claims are half-truths at best and downright lies at worst--and come from people who are out to take your money. I tell my readers right up front that I have no "trading secrets" and that achieving futures trading success is not easy and takes hard work. And even hard work does not guarantee futures trading success. Unfortunately for many traders, it takes the pain of losing substantial amounts of money early on before they finally realize what I stress to my readers right away.

Okay, enough preaching from me.

What are some clues that you could be one of the fortunate few that actually could succeed at being a full-time trader? I'll get some questions for you shortly, but first I want to address an issue about which you may be pondering right now. That is: Jim, why don't you only trade futures full-time if you are so knowledgeable?

I have never attempted to be a full-time futures trader. By "full-time" I mean focusing only on trading futures and using the realized profits for my living expenses. In my case, that would mean no analytical service, no custom consulting, no educational writing--all of which I'm doing now. Since I have never tried to make a living only by trading futures, I cannot tell you whether I would be successful or not. The reason I have never attempted to trade futures full-time is because I truly enjoy the communications aspect of being a market analyst and a trading educator and mentor. I hope that those of you who have talked with me or emailed me would agree that I do really enjoy discussing markets with other traders. I do know that if I were to attempt to be a "full-time" futures trader, the task would not be easy, even though I do have much experience and knowledge.

Now, on to a few questions to ask yourself if you think you might be ready to trade futures full-time:

Are you a successful part-time trader? You'll need to be successful at trading futures on a part-time basis before you think about moving into the full-time trader ranks. Don't be fooled into thinking that trading futures on a full-time basis will allow you to spend more time to cure your part-time trading ailments. In other words, don't say to yourself: "If only I could spend more time trading markets, I could have more success than I've had just trading 'one-lots' here and there."

Do you have enough money available to live on when (yes when, not if) you hit a streak of losing trades? A losing streak will inevitably occur--and probably sooner rather than later. And I don't mean a losing streak of two weeks, but more like a stretch of poor performance of up to six months, or longer.

Do you have the psychological stamina to be a full-time futures trader? Quite frankly, most people do not. Can your psyche (not to mention your pocket book) handle six months of mostly losing trades?

Will your immediate family members support you--even during a prolonged rough stretch of trading? Believe it or not, this is a very, very important question. For example, if your spouse does not support your decision to trade full-time, then you are likely doomed to failure. The pressure of having to produce winning trades and knowing that your spouse is skeptical of your efforts is almost insurmountable.

And on your part, will you be able to uphold your family or other important responsibilities even during a rough trading stretch? Or, will you brood and kick the dog when he happens to cross your path?

I think you'll agree with me that those are tough questions to answer.

One more thing: I do have many readers that are "full-time traders" but who do fall into a different category than what I described above. These are people who do have enough money to trade futures on a full-time basis--even if their trading profits alone will not support their lifestyles. These are individuals who already have significant amounts of money derived from means other than trading futures. Also, I have many readers who are now full-time traders, and that have retired from another profession and want to spend the "autumn of their lives" not in a rocking chair, but in a field that is challenging to them.

Finding the Best Traders In The World

I was recently approached by a top hedge fund about profiling the best traders in the world. Profiling really refers to finding those psychological characteristics that will best predict success. And I believe that I'm one of the world's experts in that area since we have a huge database of psychological profiles of traders. I've been testing traders since 1982 to help them discover their strengths and weaknesses. The instrument that I've developed, The Investment Psychology Inventory, does an excellent job of that.

However, if you were to numerically rank the best traders in the world, they are probably people who can take $100 million dollars or more and make 20% per year on that money consistently. There are probably only about 20-30 such traders in the world, so how do you profile those traders? And even if you could get a thorough profile of all such traders, their numbers are so small that your data might not be that meaningful. Such are the issues of profiling.

After spending some time thinking about the whole issue, I now believe that my company has developed everything possible to do the task. However, it involves a lot more than just a psychological profile. In fact, it involves a number of assessments.

First, you need their psychological profile. I would expect traders who can make 20% per year or more on large amounts of money to generally fall in the top 10% of our database on all the skills we measure.

Second, I would look for their trader type. We now believe that there are approximately 15 trader types, but that most top traders would fall into only five or six specific categories. As a result, I'd want to look at their trader type.

Third, I'd want to look at accountability. All top traders must believe that they are personally responsible for the results that they get. This leads to certainly qualities. Either 1) they have tremendous discipline to do what needs to be done to be a top trader or 2) they have a strong desire to constantly work on themselves to improve. They are constantly working to maintain an optimal mental state for top performance and they are constantly looking at their beliefs to see if they are useful.

Fourth, we can now quantitatively measure systems and determine how good they are, regardless of the type of trading that people do. I call this the System Quality Number or SQN ™ for short. For example, someone who has a system with an SQN of 5 definitely has a much better trading system than someone who has a SQN of 3. I would expect most of the world's top traders to have systems with SQNs of 5 or better. And the exciting thing about the SQN, is that we can measure it for various market types.

Fifth, one of the big secrets (that most people don't understand) is that position sizing (the variable that controls how much throughout the course of a trade) is the key to meeting your objectives. I expect that most top traders understand this concept at some level. However, this can be taught and can be used to improve performance dramatically. And the higher the SQN, the easier it will be to use position sizing to meet your objectives. Thus, if your SQN was only 3.5, you still could be one of the best traders in the world if 1) you had thorough control over your personal psychology; 2) totally understood how to use position sizing to meet your objectives; and 3) have mastered the sixth quality which is the ability to minimize the impact of mistakes upon your trading.

Sixth, the next secret of the top traders is that they know how to minimize the impact of mistakes. I've talked about this in prior tips, but let's say that the expectancy of your system is 1.2R. You make 100 trades per year, so you should be able to make about 120R per year. However, let's say that every month you make one mistake. That mistake costs you 5R. So in one year, you'll make about 60R worth of mistakes, and your total return is now only 60R. Your mistakes will have cost you half of your potential returns. Top performing traders know how to negate the impact of mistakes.

Lastly, there are certain fundamental skills that all top traders will have such as 1) how to get the information you need; 2) how to execute orders; 3) how to organize yourself; etc. I'd expect all top traders to have these specific qualities.

Using the "ADM" Method to Deal with Losing Trades

A main tenet of success in futures trading is the ability to accept losing trades as part of the overall trading process. This is not an easy undertaking--especially since many futures traders tend to be of a more competitive nature in the first place. Traders certainly don't have to enjoy losing trades, but they must accept the fact and move on. Those who can't accept the fact that losing trades are a part of futures trading usually don't stay in the business very long.

My wife is a school teacher, and one of her favorite acronyms--ADM--can be applied to losing futures trades. "Accept" it. "Deal" with it. "Move" on. (This is a part of the important psychological aspect of trading, and deserves much more discussion than I can provide in this feature.)

I had lunch with one of my trading mentors a while back. We discussed losing trades. I asked my mentor how many losing trades in a row he has had to endure during his long and successful trading career. His reply was 13 in a row. I asked him how he coped with that. He said that while it was certainly not easy, he knew that losing trades are a part of the business and that he was in the business "for the long haul," and that his trading methodology was sound. He added, "Ninety-percent of futures trading profits are made on 10% of the trades, which means most of the other trades are either small losers or break-even-type trades." This is an important fact for all traders to keep in mind.

My lunch meeting with my mentor was good for me because, even though we made no "break­through" discoveries on the path to increased futures trading success, we did reaffirm our own philosophies on trading and markets. My passion for trading and market analysis is fed immensely every time I talk with people in my profession, or attend the quality trading seminars.

For many of you, the futures trading arena can be more fulfilling (and more fun) if you have someone, or some support group, with which to share your thoughts and strategies. If you are passionate about futures trading and markets, finding someone who shares that passion is a great trading tool within itself!