Interview with Van Tharp - StockTickr Blog 09.04.

2019, 23*20

Interview with Van Tharp

For the seventh interview in the StockTickr Interview Series, I sat down
with Dr. Van Tharp, a trading coach and author of several books on
trading, most notably Trade Your Way to Financial Freedom and Safe
Strategies for Financial Freedom. Van was also featured in the bestselling
book Market Wizards : Interviews with Top Traders. Vanʼs coaching
services can be found on his web site.

Dr. Van Tharpʼs explanation of money management in chapter 12 of Trade

Your Way to Financial Freedom is what inspired me to create StockTickr. I
wanted a tool that let me easily calculate the number of shares of a stock
to buy given my account size and then track my progress and long term
expectancy of my system. The StockTickr Trading Journal does this and
has proved to be a valuable tool in my own trading.

Dr. Van Tharp has donated signed copies of Trade Your Way to Financial
Freedom and Safe Strategies for Financial Freedom that weʼll be giving
away to new StockTickr Pro subscribers. Sign up now to get your free
signed copy (while supplies last).

Read on to learn why Van thinks you should never enter a position
without knowing exactly where youʼll get out, how itʼs theoretically
possible to use random entry points and still make money using strict
money management principles and a trading journal, and how trading
really isnʼt that hard.

StockTickr: Tell us a little about yourself.

Van: Okay, I have a Ph.D. in psychology. I think that gave me enough

sense to decide after several episodes of losing a lot of money in the
markets that the losses might have something to do with me. As a result,
in 1982, I began a research project to determine what qualities great

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traders had (that I lacked).

That same year, the Investment Psychology Inventory was born. Over the
years more than 5000 people have taken that test. It does a great job at
predicting investment success based upon “where you are now.” But, of
course, nothing is set in stone. Iʼve seen people who rank in the bottom
10% totally transform themselves.

Anyway, initially about 700 traders took the test and they started asking
me, “How can I do better?” I really didnʼt know, but I knew how to find
out. I became an NLP modeler and started modeling some of the best
traders in the world to find out what they did. And over the course of the
next five years, I wrote a five volume course on peak performance
trading. That course has been the corner stone of our business. Iʼve been
coaching traders for about 25 years now. Iʼve modeled all aspects of
trading from discipline, system development, position sizing, and even
the wealth process. And we teach it all. There are many, many people
that Iʼve coached now who have made millions trading the markets.

StockTickr: When did you first start trading stocks and how long
have you been involved with it full time?

Van: My first trade was in 1962. I bought 100 shares of a stock at $8. I
watched it go to $20 and then down to zero. And on the way down at
$4/share and at $2/share, I bought more. I broke every rule that I teach in
that one trade. But there are some people who just say I picked the
wrong stock. However, I am not a full time trader. I do manage my
companyʼs retirement funds and we do very well. But Iʼm a full time coach
for traders and there is a big difference. If I were a full time trader, thatʼs
all Iʼd be doing.

StockTickr: Is there a simple trading system you like for the “holy
grail” seekers in the crowd?

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Van: Let me say this, the system has at most 10% of what it takes to be
successful and there are many, many, many systems that work. But with
that said, Iʼll answer your question. I personally like the efficient stock
method that I described in Safe Strategies for Financial Freedom. Itʼs
really simple. You find stocks that are going up in as close to a smooth,
straight line as possible. When you find them you buy them. And when
they stop going up, you sell them. Itʼs that simple; and good trading really
is that simple.

I also find it very interesting because when I describe my efficiency

algorithm, everyone wants to know all the details as though it is “the
secret to my success.” No, itʼs not. The efficiency algorithm is simply
designed to show me a list of stocks. I look over the list to find stocks to
meet the criteria I just described – going up in a straight line. Most
people, however, wonʼt accept that and they want to know all the details.
However, even if I described all the details I wouldnʼt help anyone,
because one of the keys to success is that you must find a system that
fits you.

StockTickr: Do you ever trade options?

Van: Yes, but options are probably the most dangerous instrument out
there. I know more people who lose money trading options than any
other area. But option guruʼs say it is a way to limit your risk….Yes it is.
Your loss is limited to 100%.

StockTickr: Most traders do fine with entry points, but many

struggle in exiting both winning and losing positions. What are your
suggestions for taking profits (and losses)?

Van: One of the keys to trading is to never enter a position without

knowing exactly when youʼll get out of that position to preserve your
capital. And if you donʼt have a clue where to get out, then you could just
use a 25% drop in price for stocks or a 3 times volatility stop for futures.

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And any system you have needs to have exits. But again, if you donʼt
have a clue, you could trail the 25% stop (recalculating it every time your
stock makes a new high) or trail a 3 times volatility stop.
Basically, Iʼd suggest that you write down all your beliefs about exits and
then design your exit strategy around your belief. Thatʼs part of the
secret of designing a system that fits you.

StockTickr: Do you find that most traders take positions that are too
large? Small? What advice can you offer for money management and
position sizing?

Van: First you need objectives for your trading system. Most people donʼt
think about that when they design a system, but itʼs probably 50% of
system design. The goal of your system is then to find one that gives you
a great expectancy and lots of opportunity. Once you have that, then the
purpose of position sizing is to meet your objectives. I really canʼt make
any suggestions about position sizing, because the purpose of position
sizing is to meet your objectives. Different objectives require different
position sizing algorithms.

However, if you donʼt know anything about position sizing, then just risk
½% of your equity per position if you are a beginner or 1% if you know
you are making money. But “risk” should not be confused with the actual
amount that you are “investing” in the position.

So hereʼs an example:
Letʼs say you have a $50,000. That means you donʼt want to risk more
than 1% of that or $500 on any given position. Letʼs say you buy a $40
stock. You decide that if it drops 25% to $30, youʼll get out. Your risk per
share is thus $10. If you divide $10 into your total risk, youʼll get 50. That
means you can buy 50 shares of stock. Thus, you invest $2000 in buying
50 shares of the $40 stock. If it drops to $30, youʼd get out and your
total loss would be $500 or 1% of your account.

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StockTickr: What is a reasonable R value to use when trading? i.e.

What % of your portfolio should traders have at risk with each trade?

Van: I define R as the risk per position. In the example, about a 1R risk
was $10. However, the exact value of R per position will depend upon
your system and your beliefs about how you should limit your risk in your
system.

If you are using a percent risk position sizing algorithm, then 1R also
becomes the percentage of your portfolio that you are willing to risk. I
already gave an example of 1%. However, let me repeat myself, your
position sizing algorithm is designed to meet your objectives, so what Iʼd
recommend will depend upon your objectives.
And objectives are simply - what are your goals? What are you trying to
achieve as a trader? Most people say “I want to make a lot of money” but
the more specific you can be about your objectives, then the more
efficient you can be about creating the right trading system for you and
finding the most effective position sizing strategies to meet those
goals/objectives.

StockTickr: Can a winning system be created using completely

random entry points if you have a strict money management plan?

Van: You can make money with random entry, but I wouldnʼt recommend
trading it. I described this in Trade Your Way to Financial Freedom just to
make the point that entry was not that significant. But hereʼs the logic
behind my thought.

The rule with random entry is that you are always in the market, either
long or short based on a coin flip. And when you get stopped out, you flip
a coin and get back in. This means that you have to have a stop that will
keep you in the market as long as possible so that you can potentially
catch a trend. What seemed to work was the 3 times volatility trailing
stop. Combine that with a simple position sizing algorithm like risking 1%

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per position and you generally will make money. However, you need a lot
of money to trade this sort of method. In the futures markets, it required
over a million dollars to trade it.

And whatʼs the point? You can at least say Iʼll go long in nice up trending
markets and go short nice down trending markets and stay away from flat
markets. Thatʼs basically what I do with my efficiency trading method.

StockTickr: It seems like a lot of traders make things too

complicated: fancy technical indicators, complex trading systems,
etc. Do you think traders would be better served to simplify there
trading? How?

Van: Buy whatʼs going up. Sell whatʼs going down. Risk about 1% per
position. Itʼs not that hard.
However, you have to have a system that fits you. So write down all your
beliefs about the markets — all your beliefs about setups, entry, worst
case exits, profit taking exits, position sizing, etc. When you have all the
beliefs written down, then design a system that fits you and makes
sense. And if you donʼt know enough to do that, then it just tells you
about your knowledge level. Go read Trade Your Way to Financial
Freedom (perhaps several times) and that should give you the knowledge
level you need.

StockTickr: Do most failing traders use flawed systems, or do they

simply lose faith and deviate from a workable trading system?

Van: They donʼt understand what a trading system really is, so in that
sense they donʼt really have a trading system. And if thatʼs the case itʼs
probably a flawed system. In my early days as a coach, most trading
systems equated to a set of set-up conditions for entry. For example,
people thought CANSLIM (William OʼNeilʼs set up conditions) was his
trading system. And he still doesnʼt spend much effort talking about
position sizing in that book.

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So most people never get a reasonable system. If they do get a

reasonable system, then they probably donʼt understand position sizing.
And if they understand position sizing, then the probably make a lot of
mistakes.

Let me explain it this way. Expectancy is the mean R-value of your trading
system. Thus, if you have a trading system with an expectancy of 0.75
that gives you 100 trades per year, then youʼd probably make 75R on the
average per year. Thatʼs a pretty reasonable system. Now, if you risked
1% per trade, then youʼd probably make 75% per year trading that
system…maybe even 100% with compounding.

However, letʼs say that you make one mistake each week. And letʼs say
that every mistake you make costs you 2R. That means that over the
course of a year youʼve cost yourself 104R in mistakes. And your system
produces an average profit of 75R per year. That means that the net
result is a loss of 29R. Iʼd say that probably describes what happens with
most traders that have a reasonable system.

They continue to make mistakes and donʼt learn from them.

StockTickr: How do you think the stock market has changed over the
last several years? How do you recommend traders adapt to longer
term market shifts?

Van: I think weʼre in a secular bear market that will last another 15 years.
This doesnʼt say anything about what the stock market will do in say
2006. It really doesnʼt even predict prices. Rather a secular bear market
means that I expect PE ratios to decline over the next 15 years. Secular
bear markets usually end with single digit PE ratios.

Now since 2000, when this started, weʼve only had one good up year,
2003. In 2003, the S&P 500 finished up 25%. However, during 2003 the
dollar lost 40% versus the Euro and almost every stock market in the

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world outperformed the U.S. stock market. That, I think, describes what
typically happens in a secular bear market.

I think crisis means opportunity. You can go short the market when it
goes in prolonged down periods. And thereʼs lots of opportunity because
there are now ETFs that represent most aspects of the market, including
most foreign stock markets. So thereʼs lots of opportunity. However, the
most dangerous place to be, in my opinion, is in a lot of mutual funds. My
guess is that 75% of them will be out of business by the time the secular
bear market is over.

StockTickr: What is the most common, but easily corrected fault you
see in traders?

Van: There are many but Iʼll give you one that is the root of everything
else. Make the assumption that you totally create your investment
results. That way, if you are not meeting your objectives, you will look to
yourself as the source of the problem and not something outside of
yourself …like the market or your broker.

StockTickr: What advice do you give investors who are just starting
out?

Van: Probably the advice I just gave is perfect for the beginner. Know
that you are responsible for the results that you create in the markets.
And, the markets will give you plenty of lessons about yourself – so be
willing to learn about yourself and then you can fix your mistakes.

StockTickr: In addition to your own, which 2-3 books do you

recommend traders read?

Van: My three:

Peak Performance Course for Traders & Investors (Van Tharp)

Trade Your Way to Financial Freedom (Van Tharp)

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Safe Strategies for Financial Freedom (Van Tharp)

Others:

Market Wizards : Interviews with Top Traders (Jack Schwager)

The New Market Wizards (Jack Schwager)
Unexpected Returns: Understanding Secular Stock Market Cycles by Ed
Easterling

StockTickr: What mistakes do you see commonly made in

backtesting?

Van: For many people doing backtesting might be a mistake. People do

backtesting because they think that computers can tell them if their
system works. However:

1) I guess that almost all the software youʼll use has a 10% error rate in
the outcome.
2) Data that you might use is frequently flawed.
3) People cannot test the same way theyʼd trade, with multiple positions
on making decisions time frame by time frame. Thus, most backtesting is
not realistic of how youʼd trade.
4) If 1-3 were perfect, what would happen is that youʼd get a set of R-
multiples. However, thatʼs just a sample of what you can expect. What
happens when it comes in a different order? What happens if you havenʼt
seen your biggest R loser? What happens if your sample does not
accurately represent what really happens with your system?

What we teach is that you can only trade a system that you are
comfortable with. This means:

1) Knowing yourself
2) Knowing your objectives
3) Knowing your beliefs about the market and each aspect of your

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system.
4) Understanding how it all works. Tom Basso used to say the more you
understood how your system works, the less testing is necessary. How
will your system perform in all kinds of market conditions?
5) And what criteria do you need beside those Iʼve just mentioned to feel
comfortable trading your system? Perhaps backtesting is one, but if so,
then realize all the limitations Iʼve just mentioned. You could also trade
your system with very small position size and generate a realistic set of
R-multiples. That might be a better way to test it.

StockTickr: What do you like best about stock trading?

Van: I guess trading teaches me about myself. Thus, Iʼm one of those
who can use trading as a benchmark of my personal growth and
evolution.

StockTickr: Thanks, Van!

Sign up for StockTickr Pro to receive an autographed copy of one of

Vanʼs books while supplies last.

Stay tuned - there are several interviews on the way. You can subscribe
to these interviews via RSS feed.

Previous interviews in the StockTickr Interview Series (RSS feed):

Brett Steenbarger
Eyal Maoz
Gary B. Smith, the Chartman
Nusair Bawla (alibawla on StockTickr)
Dave Landry, Swing Trader
Jeff White, the Stock Bandit

Do you have suggestions for other traders youʼd like to see an interview
with? Let us know!

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Related Posts:

Van K. Tharpʼs Smart Trader Blog

Most Popular Interviews of 2006
Updated Edition of Trade Your Way to Financial Freedom

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