Eight Edges You Must Have

Your Written Trading Plan

Van K. Tharp

• Publisher: Wiley
• Year: 2013
• Print ISBN: 9781118556801
• eBook ISBN: 9781118556894
• Edition: 1
• Topic: Business
• Subtopic: Investments & Securities
• Index: Business

Why investors lose money and how NOT to

Wall Street makes it easy to jump into the game of trading. After all, they love taking your money. Trading without proper preparation could be a windfall for your broker, but fatal for your account. In this e-book, bestselling financial writer and trading expert Van K. Tharp shares eight essential rules that will help you NOT lose your shirt and even make a profit in the world of trading.

In Eight Edges You Must Have: Your Written Trading Plan, Van K. Tharp explains that success in the markets takes the same amount of—perhaps even more—work, study, and commitment that any other profession requires. For those people who are committed to learn how to trade properly, who do the obligatory work and possess the necessary talents, it is quite possible to make a lot of money in the market in the long run. To that end, he outlines the eight key reasons why people lose money in their trading and investing and shows how to avoid them.

• Lists the eight essential reasons people fail at trading—from the fact that you're playing Wall Street's game to the common misconception that trading is technical when in fact, it's 100% psychological
• Written by recognized trading expert Van K. Tharp, bestselling author of Trade Your Way to Financial Freedom
• Reveals the secrets of trading psychology that can give traders a significant advantage

Utilizing charts and solid data throughout the book, Tharp arms traders with eight essential rules to follow to protect themselves from falling into the traps awaiting the poorly prepared and to maximize their potential for coming out winners in the game of the trade.

Edge 1

Big Money Wins No Matter What: So Don’t Play by Their Rules

If trading and investing were easy, it would be very hard for you to become a trader or investor. In fact, big money would strictly control the entrance fee to becoming a trader, and it would be almost impossible for you to trade. Why? So big money could control the industry and make most of the money and not have a lot of competition.

In fact, banks already seem to have a strange rule that says to be an investment banker you need to graduate from an Ivy League school with a 4.0 grade point average. Now, big banks know very little about good trading, nor do Ivy League graduates. Banks do make markets and manage client money and they make a lot of money doing that. So they make it difficult to become a trader for a bank. It’s that simple.

However, it is not easy for the average person to make money in the markets once he or she opens an account. In fact, big money controls trading and investing income by making money in some way other than trading income. And there are many examples of this besides the previous example of big banks.

• First, the brokerage industry is paid when you enter and exit the market. The brokers really don’t care if you make money, because they get paid no matter what your performance is. You get charged a commission no matter what. Charles Schwab, and Thomas Peterffy of Interactive Brokers, didn’t get to be in the Forbes 400 because their commissions were cheap—just relatively cheap. In fact, the brokerage industry considers it to be unethical for brokers to participate in your success (i.e., make money only when you make money).
• Second, the mutual fund industry gets paid by convincing you to buy and hold. The funds then get paid a percentage of the money that you keep with them. And they get paid whether they make you money or not. In addition, many funds charge you a fee when you buy shares in the fund. Thus, you need to make 1 to 3 percent or more off the top before you even break even on the year.
• Third, the better funds (hedge funds and commodity trading funds) get paid both for keeping your money (and sometimes you are forced to stay with them for a certain period of time) and also a percentage of profits. The percentage fee is big enough that a good hedge fund manager could eventually find that most of the money he is managing (because of performance fees) eventually belongs to him, and at that point the fund may close to new money. Most hedge funds, in fact, as they get successful enough, end up giving back all of their client money and just trade proprietary money. Twenty-seven members of the Forbes 400 got to their position on that list through a hedge fund.
• Fourth, many of the bigger investment companies get paid by (1) market making (having the advantage of getting the bid/ask spread on their side), (2) developing new products that they sell you and for which they get a fee, or (3) putting together investment offerings such as an initial public offering or helping other companies merge.
• And fifth, although this has been discouraged over the years, company insiders (and this doesn’t mean employees) generally make most of the money that a company generates through appreciation. It used to be easy for insiders to give themselves free stock. However, that became illegal, so now the insiders issue stock options, which allows them to buy the stock at a cheap price. It still dilutes the price of the stock for everyone else, but for some reason this is considered more honest. In addition, insiders are likely to sell if they know the company is not doing well, and they are likely to buy if they believe that the company will do well. Now insider trading is also illegal, but insiders still trade (more long term) on knowledge that you and I don’t have.

One of my first consulting clients in the mid-1980s was a vice president of PaineWebber. PaineWebber is long gone, so it’s easy for me to tell you what they were doing. My client told me that PaineWebber would regularly publish its list of recommended stocks to buy. And these were always stocks that the company owned and wanted to get rid of. So if you followed the brokerage company recommendations, they won and you lost.

• Wall Street over the years has been filled with robber barons—John D. Rockefeller, J. P. Morgan, Andrew Carnegie, Commodore Vanderbilt, and Jay Gould are just a few names that come to mind. And while some of the games they played (cornering the market) became illegal, there are still plenty of games that get played in today’s market that are not illegal or that get played despite being illegal. For example, Michael Milken spent many years in jail for what he did in the markets, but he is still worth $2.3 billion according to Forbes.
• The Nobel Prize in economics is often granted to an economist who does research to support some of the big money myths.
• And last, what you might learn about trading at a university or college is usually the antithesis of what’s essential for good trading, as Jack Schwager points out in his new book, Market Sense and Nonsense.

That’s how big money developed the game of investing and trading. They make the rules, and those rules determine how they win. And they win if they can convince you simply to participate in their game. Also you have all sorts of hidden costs that make it less likely that you will win. In fact, big money doesn’t care if you win. That’s why entry into trading/investing is so easy. You just go down to your brokerage company and open up an account, sign a few documents, and then start trading. And big money wants you to believe that making money is as easy as just picking the right stock. If the E*Trade baby can do it, then you can do it. “See,” the baby says, “I just bought stock.”

So given that background, do you think it’s likely that most people will make money in the market? No, not at all! Yet it’s quite possible for someone with talent, a clear psychology, and the right knowledge to make a lot of money in the market. But you won’t make money paying attention to what big money wants you to know and think. Furthermore, it takes a lot of work and study to get to the point where making good money is easy. And most people don’t know what’s involved in success at all. In fact, it takes the same amount of work, study, and commitment that any other profession requires—perhaps even more because you need a very clear mind to trade well.

Imagine walking into a hospital with no training whatsoever and deciding to perform open-heart surgery on someone. The person would probably have very little chance of surviving. And the same goes for your account when you deposit money with your broker for trading without adequate training to become a professional. It’s probably fatal for your account, but good for your broker, at least while you are trading, so he’s happy to allow it.

Thus, the number one reason you lose is that big money encourages you to play the game of investing/trading with little or no education. They want you to play their game. After all, isn’t it just about picking the right stock? Well, no, it isn’t, but that’s part of why you are likely to lose and why most of your money will be turned over to those who have the appropriate knowledge and training.

However, for those people who are committed to learn how to trade properly and to do the necessary work and who have the talent necessary (as is required of any field), it’s possible to become quite successful.

For more information about why the average trader/investor is likely to lose, see my YouTube video below:

Building Your Edge

I’m a neuro-linguistic programming (NLP) modeler. And in my 25 years as a trading coach, I’ve modeled every aspect of trading success. To model any process, you need to find a number of people who do it well, find out what they do in common, and then determine the three ingredients of each of the common tasks. Those three ingredients are the beliefs, mental states, and mental strategies necessary to do the task. I’ve modeled the trading process, the system development process, the process of achieving your objectives through position sizing™ strategies, and the wealth process.

And overall I call the models we’ve developed for traders Tharp Think. The principles in those models are general success principles, but I call them Tharp Think because I believe we are the only company to have put together this specific list of principles necessary for success.

Tharp Think consists of about 40 commonsense rules plus another 20 psychological rules. If you adopt them, you have a good chance for success. If you don’t, then you probably have little chance for success.

Let’s go through six key parts of Tharp Think. I’ll briefly describe some useful beliefs in each area.

Part 1: Learning to Trade Is Hard Work, But It Can Be Taught

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1. Successful trading can be modeled and taught to other people.

2. Learning to trade well requires as much work and education as any other profession.

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In a sense this is the first key problem of why people lose. They think trading should be easy, and they don’t want to do the work. They think they should just be able to go into a trading office (for stocks, commodities, or forex), open up an account, and trade. Opening up an account is that easy, and the E*Trade baby would have you believe that success is just pressing the right button. However, making that account stay even or grow is not that easy. This is what we have talked about in Edge 1.

Part 2: Knowing Yourself

A key to successful trading is knowing yourself. Only by knowing yourself can you develop objectives and trading systems that fit you. In other words:

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1. You need to find a trading system that fits you.

2. In order to accomplish that, you must know yourself:

Your values

Your strengths

Your weaknesses

Your parts as described in Edge 3, Step 1

Significant beliefs (spiritual, self, market, system)

Trading edges

Trading weaknesses

3. You can trade only your beliefs about the markets, not the markets themselves. Thus, you should know and understand your beliefs and whether they are useful.

4. System develo...

Table of contents

• Cover
• Contents
• Title
• Copyright
• Dedication
• Acknowledgments
• Preface
• Edge 1: Big Money Wins No Matter What: So Don’t Play By Their Rules
• Edge 2: Realize That Trading Is 100 Percent Psychological
• Edge 3: Being Right is Trading Mistake-Free
• Edge 4: Understand Your Trading Systems
• Edge 5: Knowing There Are Different Market Types That Must Be Treated Differently
• Edge 6: Understand That You Achieve Your Objectives through Your Position Sizing Strategies
• Edge 7: Treat Trading Like a Business
• Edge 8: Develop the Talent, Temperament, and Commitment to Be a Successful Trader
• Special Offer
• About the Author
• Appendix: The Market Types for the Past 14 Years
• Index