Being Right and Making Money......Dr Tharp

#1
Nice article by Dr Tharp that must have already been read by many who have gone through his books.For those who haven't,something to go through....
Being Right and Making Money Are Not Equivalent by Dr Van Tharp

How important is it for you to be right? Let's say I could guarantee that you would make money by the end of the yearlots of moneybut you would probably lose money on 90% of your trades. Would you like that? Could you tolerate that? Would you accept that? Most people would probably answer "no" to all three questions. And if that is you, you probably are denying yourself the opportunity to make money simply because being right is more important than making money.

Some of you might be saying, "How could you be wrong 90% of the time and still make money?" The solution goes back to the golden rule of trading, "Cut your losses short and let your profits run." Let's say that 90% of your trades lose money and that your average loss is $100. On the year you make 100 trades so you end up losing 90 of them for a total loss of $9,000. However, let's also say that your average winning trade is a big R-multiple. It's an R-multiple of 100 or a $10,000 winner. You have ten of those in a year, so you end up making $100,000 on your winning trades. If you subtract your winnings from your losses, you'd end up with a profit of $91,000 at the end of the year. You make $91,000, yet 90% of your trades are losers.

My guess is that 99% of the trading population could not trade a system that would produce those kind of results. The reason is because they don't get to be right enough. They have too many losing streaks. They have losing streaks that are longer than five in a row. Most people cannot tolerate long losing streaks. When they occur, they totally abandon what they are doing. In such a system you could easily have 25 consecutive losses. At that point you become certain that your system is broken, and you try something else.

Let's look at the opposite end. Suppose you got to be right 90% of the time. Suppose your average win was $100 and that your average loss was $2,000. This means that you'd have a total of $9,000 in winnings and $20,000 in losses. You would lose $11,000. Would people trade that system? Yes, they would. They would probably trade it for a number of years until they went bankrupt. Why? Because they get to be right most of the time and that is very rewarding.

You might be saying, but how could people possibly tolerate losses of $11,000 after 100 trades? It is easy; they turn the losing trade into a long-term investment in their mind and say, "it's only a paper loss." For example, I've had workshop attendees who were probably way above average in terms of sophistication. However, I asked them to raise their hands if they had an investment in their portfolio that was only worth 50% or less of what they paid for it. Eleven people raised their handsover a fourth of the class. And my guess is that among the overall population of investors, most people are sitting on a number of big losers, hoping they will come back. Why? Because they cannot stand to be wrong on an investment and they are waiting to be right on those losing trades.

What is the cost of having losing investments in your portfolio? It's major. First, you are using valuable capital up with nonproductive investments. Second, you are missing many good opportunities.

Why Being Right Seems So Important
There are two primary reasons why we focus on being right. First, we are conditioned to be right by the school system. Second, everyone in the trading industry gives people what they wantways to be rightwhich tends to perpetuate the myth. Let's take a closer look at these two reasons.

First, we are conditioned by the school system to the importance of being right. In school you are taught that there are right answers and wrong answers. What is a right answer? If you learned how to survive in the system, you learned that a "right" answer is whatever the teacher wanted.

Your performance is measured periodically through tests in which you are asked to pick the right answer. If you cannot get more than 70% right on the test, you are labeled a failure and ostracized. Your humiliation might even be in public in front on all your friends. And if your humiliation isn't public, it certainly is semipublic. Your "poor" performance goes home in the form of a grade with a comment that "Johnny is a little slow or Johnny is bright, but he just doesn't try." Usually, at this point, the most important people in your young life get involvedyour parents.

Even if you understand the system and work hard to know the right answers, you still might be taught that your performance is not good enough. It usually takes 94% right to get an excellent grade. But how many children go home and show their 94% test to dad only to get the response, "Why didn't you get 100%?"

Thus, it is no wonder that traders want to be right all the time. And being right usually costs them dearly in terms of profits. Whether you've been through 20 years of schooling and have a graduate degree or less than 10 years of schooling, you still have the same conditioning about being right.

The second reason people want to be right is that service providers for traders and investors feed the bias to be right. First, software vendors tend to provide systems that can be highly optimized. Once you've optimized your trading, you can lay a line over the prices and see exactly where you should have bought and sold. It seems obvious. However, the same optimized system does very poorly when applied to the real world.

At investment conferences, the hottest speakers are those who provide information about high probability entry techniques. If you say, "Trade with the odds on your side" and show someone a technique that is right 75% of the time, you'll get a large audience. Yet most techniques of this nature usually have big losers and may not even have a positive expectancy. Nevertheless, being right 75% of the time is all is takes to get people to trade them.
All the best!
Saint
 

pkjha30

Well-Known Member
#2
HI

Sometimes, and may be most of the times being pragmatic is what is required.

One may be wrong and incurr loss. But accepting it as a wrong may not be possible as one may not know before it is too late.

But loss is visible and undesirable. Hence it is pragmatic to cut losses and let go.

It is a thought provoking article.

The forum has come alive with your presence.

Pankaj:)
 
#3
Hi Saint/Pankaj,
due to persistent pushing from u great guys,i have also started reading books:
Elder,Pring,Nison,Livermore,VanThrap,Jack,Edwards(and you guys were right , it changes way one approaches the market)
In continuation to Risk Management, I read on Net that there is a Trader who "Hates to win and Loves to Lose"
i.e have small profits and even smaller loses, thereby ensuring u are always in and never out of Market.
if u guys are interested will post the full article 2morrow.
regards
and Take care
 
#4
How important is it for you to be right? Let's say I could guarantee that you would make money by the end of the yearlots of moneybut you would probably lose money on 90% of your trades. Would you like that? Could you tolerate that? Would you accept that? Most people would probably answer "no" to all three questions. And if that is you, you probably are denying yourself the opportunity to make money simply because being right is more important than making money.
--Dr. Tharp
A very good article and good lesson. But the only problem is it fails to take into account the psychological effect on a trader if he looses 90% of the trades without seeing profits.

Ofcourse, I am not advocating sitting on losses.

Regards,
--Ashish
 

cooltetra

Active Member
#5
ragh_ash said:
In continuation to Risk Management, I read on Net that there is a Trader who "Hates to win and Loves to Lose"
i.e have small profits and even smaller loses, thereby ensuring u are always in and never out of Market.
if u guys are interested will post the full article 2morrow.
Hi Ragh
Waiting for your post.

And thanks Saint
A lovely read.

Best Regards
Coool.
 
#6
In continuation to Risk Management, I read on Net that there is a Trader who "Hates to win and Loves to Lose"
i.e have small profits and even smaller loses, thereby ensuring u are always in and never out of Market.
if u guys are interested will post the full article 2morrow.
Hi Ragh,

Always interested.........looking fwd to it whenever you get the time.

Saint
 
#9
hi Saint,here it is
""

How to Take a Loss

Brett N. Steenbarger, Ph.D.

www.brettsteenbarger.com


There are quite a few books written on how to make money in the market. Some of them are even written by people who have made money as traders! What you dont see often, however, are books or articles written on how to lose money. Cut your losers and let your winners run is commonsensical advice, but how do you determine when a position is a loser? Interestingly, most traders I have seen dont formulate an answer to this question when they put on a position. They focus on the entry, but then dont have a clear sense of exitespecially if that exit is going to put them into the red.

One of the real culprits, I have to believe, is in the difficulty traders have in separating the reality of a losing trade from the psychological sense of feeling like a loser. At some level, many traders equate losing with being a loser. This frustrates them, depresses them, makes them anxiousin short, it interferes with their future decision-making, because their P & L is a blank check written against their self-esteem. Once a trader is self-focused and not market focused, distortions in decision-making are inevitable.

A particularly valuable section of the classic book Reminiscences of a Stock Operator describes Livermores approach to buying stock. He would sell a quantity and see how the stock responded. Then he would do that again and again, testing the underlying demand for the issue. When his sales could not push the market down, then he would move aggressively to the buy side and make his money.

What I loved about this methodology is that Livermores losses were part of a grander plan. He wasnt just losing money; he was paying for information. If my maximum position size is ten contracts in the ES and I buy the highs of a range with a one-lot, expecting a breakout, I am testing the waters. While I am not potentially moving the market in the way that Livermore might have, I still have begun a test of my breakout hypothesis. I then watch carefully. How are the other averages behaving at the top ends of their range? How is the market absorbing the activity of sellers? Like any good scientist, I am gathering data to determine whether or not my hypothesis is supported.

Suppose the breakout does not materialize and the initial move above the range falls back into the range on some increased selling pressure. I take the loss on my one-lot, but then what happens from there?

The unsuccessful trader will respond with frustration: Why do I always get caught buying the highs? I cant believe they ran the market against me! This market is impossible to trade. Because of that frustrationand the associated self-focusthe unsuccessful trader does not take any information away from that trade.

In the Livermore mode, however, the successful trader will see the losing one-lot as part of a greater plan. Had the market broken nicely to the upside, he would have scaled into the long trade and likely made money. If the one-lot was a loser, he paid for the information that this is, at the very least, a range-bound market, and he might try to find a spot to reverse and go short in order to capitalize on a return to the bottom end of that range.

Look at it this way: If you put on a high probability trade and the trade fails to make you money, you have just paid for an important piece of information: The market is not behaving as it normally, historically does. If a robust piece of economic news that normally sends the dollar screaming higher fails to budge the currency and thwarts your purchase, you have just acquired a useful bit of information: There is an underlying lack of demand for dollars. That information might hold far more profit potential than the money lost in the initial trade.

I recently received a copy of an article from Futures Magazine on the retired trader Everett Klipp, who was dubbed the Babe Ruth of the CBOT. Klipp distinguished himself not only by his fifty-year track record of trading success on the floor, but also by his mentorship of over 100 traders. Speaking of his system of short-term trading, Klipp observed, You have to love to lose money and hate to make money to be successfulIts against human nature what I teach and practice. You have to overcome your humanness

Klipps system was quick to take profits (hence the idea of hating to make money), but even quicker to take losses (loving to lose money). Instead of viewing losses as a threat, Klipp treated them as an essential part of trading. Taking a small loss reinforces a traders sense of discipline and control, he believed. Losses are not failures.

So heres a question I propose to all those who enter a high-probability trade: What will tell me that my trade is wrong, and how could I use that information to subsequently profit? If youre trading well, there are no losing trades: only trades that make money and trades that give you the information to make money later.
""
 
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