Understanding the New Rules for the Trading Game

[vc_row css=”.vc_custom_1548052909912{margin-right: 20px !important;margin-left: 20px !important;}”][vc_column width=”3/4″][vc_custom_heading text=”Don’t play by the old rules” use_theme_fonts=”yes”][vc_column_text]The first transformation a trader must make is to recognize the new rules of the trading game. These new rules consist of the Tharp Think concepts I require everyone in my Super Trader program to know and understand as the cornerstone of their training. To being with, consider what happens if you read a few books on how to trade/invest and watch the financial media talk about investing for a significant period of time. Most people who do this come to believe certain rules such as the following.[/vc_column_text][vc_separator el_width=”50″][vc_custom_heading text=”Exercise: Evaluate the old rules.” use_theme_fonts=”yes”][vc_column_text]Look through these rules and ask yourself the same question for each one:

Does this rule make me believe investing is easier or harder?

Selecting the right investment (i.e., picking the right stock) is the most important task.

  • When you find the right investment, you should buy and hold if for a long time.
  • The best investors possess the best method for picking the right investment.
  • The best method is like a Holy Grail. It will work all the time.
  • The best investors, like Warren Buffett, for example, possess the holy grail investment picking method.
  • If you follow the best investors you will be successful.
  • The market will determine whether you make money.
  • You are at the mercy of the market in the short term, but if you hold on, you will prevail.
  • The market eventually goes up, so stocks are a good long-term investment.
  • If you do lose more money than you like, it’s probably not your fault.
  • If you lose all your money, you can probably blame your broker, and a good lawyer can help you sue them.
  • The market is efficient and that is important.
  • Diversification is also very important.
  • Asset allocation is also very important as well.
  • Investors can accept that some rules are simply important and not need to learn more about them.

If you look closely at these rules, you will see that they facilitate the illusion that investing is easy. There might be a trick to it, but if you quickly learn the trick, good money is yours. What would be the outcome of believing that investing was easy and that losing money was not likely to be your fault? One possibility is that it would lower your fear of investing. Can you see that the financial industry has a fair amount of incentive to perpetuate rules and beliefs that reduce the fear of investing?

Van Tharp writes, “My experience indicates that these rules cause most people to be net losers in the markets. To overcome being a net loser in the market, you must understand that trading profitably and consistently is not easy. Big Money wants you to think trading is easy. They want you to believe that you need only turn on some financial program and listen to the stock picks. But trading with no preparation can be as fatal to your account as an untrained surgeon would be to a patient.”[/vc_column_text][vc_separator el_width=”50″][vc_custom_heading text=”The New Rules that Can Help You Succeed” use_theme_fonts=”yes”][vc_column_text]

The New Rules that can help you succeed

No surprise. The new rules will make investing appear to be harder than you previously thought. You might even think you don’t want to do it. But as you read these new rules, ask yourself this question: Does this rule make it easier for me to believe that, eventually, I can determine my investing and trading returns, as opposed to trusting markets I don’t really understand?

Rule #1: Trading is as much a profession as any other.

Rule #2: Trading reflects human performance just as much as any top athletic endeavor.

Rule #3: You must define your individual investing objectives.

Rule #4: Trading and investing consists of the study of probability and reward-to-risk ratios under specific market conditions.

In addition to the four primary rules, consider two more rules that are tactical in nature.

Rule #5: A Trader should never enter into a position in the market without knowing how to determine when they are wrong and where they should get out of the position.

Rule #6: Never enter a position in the market unless you have a potential reward that is at least three times the size of your initial risk.

With these rules comes a new way of thinking. These rules are tools that allow you to think, measure and evaluate your own behavior and performance. These rules transform the trading game from focusing on something you can’t control, the markets, to something you can control: your self.[/vc_column_text][vc_separator el_width=”50″][vc_custom_heading text=”Exercise: Explore what the new rules mean.” use_theme_fonts=”yes”][vc_column_text]Each of these new rules has a big insight behind it. Review each of the following and think about how they apply to your situation.

#1. Insight from the first rule: If trading is a profession, you realize that to do it well, you must learn the profession well. You will expect to devote significant time working on your skills as a trader if you hope to be successful at it. In turn, this places your focus not on the markets, but on you and the decisions you make. This naturally leads you to comprehend what comes next…

#2. Insight from the second rule:  Because trading reflects human performance just as much as any top athletic endeavor, it follows that you are responsible for the results you get.

#3a. Insight from the third rule: The third new rule, that objectives are important, implies that you have to think through what your objectives are in terms of performance expectations and risk tolerance (meaning how much you could allow yourself to lose). This is a big insight because the average trader doesn’t even think about their objectives, let alone to articulate them. Instead, they simply assume that it is good enough just want to make a lot of money. It isn’t good enough. Without articulating your objectives, you will have no idea how to make a lot of money trading.

#3b. A bigger insight from the third rule: Once you have articulated your objectives, you can achieve them through position sizing™ strategies. This is the KEY insight that is purely unknown to the average trader. In fact, most traders simply don’t believe this is true, or that if it is true, it is barely relevant. You can control the results you get by controlling the position size you employ on each trade. This is very powerful concept and the foundation of your success as a trader.

#3c. Still another insight from the third rule: It is possible to measure the quality of your system, and that will tell you how easy it will be to use position sizing strategies to achieve your objectives. This is a more advanced concept covered in later lessons.

#4. Insight from the fourth rule: Because investing is all about probability and so forth, you can use statistics to predict some boundaries for your performance. While you cannot predict the future, you can get a good idea what your performance will be through statistics and proper sampling under the different possible market conditions. As you begin to understand this, you’ll be amazed at the changes that occur in your thinking. These changes will help you refine your expectations and objectives and immediately begin helping you become a better than average trader.

The four primary rules above have many parts and other rules that are required to implement them. Together, they form what I’ve been calling Tharp Think. When traders join my Super Trader program, the first thing I require is that they thoroughly understand all of the Tharp Think rules. There are many more of them, but for this lesson we introduce just two more to you.

#5a. Insight from the fifth rule: The fifth new rule is to never enter into a position in the market without knowing when you are wrong and how you should get out. This implies that you will need to have a stop exit at that point. The key insight that this rule creates is that you can now very concretely quantify your risk in the trade. That is a powerful point of control that the average trader and investor simply never has.

#5b. Tharp Think Concept from the fifth rule: The difference between your entry into a position and your predetermined exit is your initial risk in the trade. This initial risk is what we will call 1R for short. R for risk, and 1 meaning a multiple of 1. This simple concept is a major building block for helping you unlock more powerful insights into your trading.

#6. Insight from the sixth rule: If you won’t enter into a position unless you have a potential reward that is at least three times the size of your initial risk, you can quantify the outcome of your trades in the following way: -1R represents a loss and +3R represents your average gain.

Now let’s see what the sixth rules give us. Imagine that your system makes money 40% of the time and it follows these rules. Yes, you lose more often than you win, but remember that when you win your goal is to make +3R. In ten trades you might lose six times at an average loss of -1R each time and a total loss of  -6R. But you’d also win four times with an average gain of +3R each time. Your total gains would be +12R and your total loss would be -6R. The net gain over ten trades, despite being wrong 40% of the time, would be +6R. That sounds pretty good, but how can well tell if it is truly worthwhile performance?[/vc_column_text][vc_separator el_width=”50″][vc_custom_heading text=”Thinking like a Super Trader” use_theme_fonts=”yes”][vc_column_text]Recall that rule #3 tells us we need a position sizing strategy to meet our objectives. A position sizing strategy tells you how much to risk throughout the course of a trade.  So let’s add a position-size strategy to the hypothetical outcomes we assigned to rule #6. Let’s say your strategy is to risk exactly 1% of your equity on every trade. If you have a $50,000 account, then you’d risk 1% of that or $500. So in this case -1R equals $500.

Now suppose you want to buy a $40 stock, and because of rule #5, you have predetermined that you will get out if the stock drops 10%. So you place a stop $4 away from the entry at $36. Your risk per unit is $4.

To make sure that the risk on this trade does not exceed -1R, you must determine the correct number of shares to buy. It is simple to calculate: your total risk of $500 is divided by $4, and it tells you that you can purchase no more than 125 shares.

Note that even though buying 125 shares at $40 per share will cost you $5,000, you should keep in mind that your initial risk is only 10% of that or $500. (This also assumes no slippage from unfavorable gaps. Though this is rare, it does happen).

Let’s assume that we make 10 trades per month. Since -1R represents 1% or your portfolio and we are up +6R, that means you’ll make 6% per month. At that rate, it also means that you’ll make 72% per year (more if you consider the monthly compounding as 1% gets bigger each month). Making 72% per year or more is far better performance than the average trader. All of a sudden it seems easy to think about trading this way. So why don’t most traders think about their trading like this? Why do most traders end up net losers?[/vc_column_text][vc_btn title=”Take Quiz Now” style=”flat” color=”primary” size=”lg” align=”center” link=”url:https%3A%2F%2Fwebsitesvaluator.com%2Fquizzes%2Ftransformation-of-the-trading-game%2F|||”][/vc_column][vc_column width=”1/4″][vc_widget_sidebar sidebar_id=”flash_right_sidebar”][/vc_column][/vc_row]

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