Trader Self-Evaluation
by Van K. Tharp, Ph.D.

I believe the most significant work that anyone can do to increase market returns is self- work. Really understanding yourself and how you think can give you an edge that others in the market don't have. 

As part of my training, I give a long questionnaire to each trader to do an evaluation of themselves.  Some of the feedback that I get is that taking the test is like doing a Ph.D. program!  It's that involved.  

I consider the ten questions that I give my Super Traders to be the essence of this self-evaluation process—a minimum starting point for this type of work.

We'll start with just one of the points. My advice to spend at least an hour on each question—a day is even better. These questions are meant for you to really dig deep and come up with responses from your core belief structure. 

What are seven key psychological areas that you need to work on or are currently working on?

Don’t say “none” because that answer really suggests that you are totally unaware of what is going on with you.

We basically live in a society in which we are programmed to feel separate and alone from everyone else, programmed to follow the rules of the games that others invent for us to play.  The net result is most people do the exact opposite of what is necessary for success.  As you become aware of this, you’ll also become aware of all your patterns, beliefs, and emotions that you need to work on or clear out to become more successful as a trader.

 Here are some examples that might fit some of you:

• I really have a fear problem that enters into my trading.  I want to make trades but I’m afraid to pull the trigger.  And that fear seems to come up in other areas too; I guess I’m really afraid of failure.
  
  
• I have some internal conflict when it comes to working on myself.  On one hand I want to, but on the other hand, I’d rather do other things.  Working on myself feels like having a tooth pulled.  For some reason, I just don’t want to do it.
  
  
• I don’t have any discipline.  Sometimes I just decide to trade.  I make almost random trades or take recommendations that I’ve been given, but just certain select ones appeal to me.  And the net result is that those trades never seem to work out.  (Note: this is also an incomplete answer.  What is the selection process?  What happens to those trades?  Do you cut losses and let profits run?  Are you compelled by some emotion to trade?)
  
  
• My mother continually criticizes me.  My mother gave me everything when I was growing up, and I’m very grateful to her.  But she’s always telling me what I do wrong.  In fact, it upsets me to be around her.  Yet at the same time, I feel that I must support her.  I need to find out why her criticism bothers me so much and what I can do about it.
  
  
• I really don’t like to be alone.  When I do things that are important to trading success, like psychological work, I have to go inside and search and that really disturbs me.  Also when I try to meditate, things come up that cause me to be afraid.  (And, of course, if you had this response, I’d want you to at least find out what’s trying to come up that is causing this).

Those five statements are just examples of what might come up for you.  But whatever you find…look thoroughly.  What’s really going on?  What are the emotions you don’t want to feel?  What are the hidden beliefs?  What is the internal conflict where part of you wants certain things and another part wants something else?

What are your key beliefs about the markets?

It is important for you to remember that you can only trade your beliefs about the market.  So what are the key beliefs that are guiding you?

To really understand what’s guiding your trading, you should list at least fifty beliefs.  However, at least ten is a good starting point. 

To help you get started, I’ve listed 12 of my most important beliefs about the market.  Some of these are core principles that I teach everyone and some of them are just things that fit me.  Also I just came up with these twelve off the top of my head.  Like I mentioned, you’ll probably need to discover at least fifty beliefs to thoroughly cover the key principles that guide your trading.

1. Cut your losses short and let your profits run!!!!!!!
   
   
2. Risk, as it relates to how much you can lose in a trade, is much more important than risk as it related to how much volatility you can have.  Both are related though.
   
   
3. You must understand the R-multiple distribution of your trading system and the average R it produces (expectancy) and the variability of that distribution (i.e., how volatile it is).
   
   
4. You must know the objectives you wish to accomplish.  What would you like to accomplish and what can you tolerate in terms of drawdowns?  In my case, I’d like to make 10% per month in my trading.  
   
   
5. To achieve your objectives, you must understand and use position sizing to your advantage. 
   
   
6. Fill your portfolio with a core position that you might adjust weekly or monthly.  However, then find efficient stocks and use leverage with those stocks to achieve peak performance.  (Again, remember that these are my beliefs and they might not fit you.)
   
   
7. When I have a large down day, thoroughly investigate what happened and how I might have caused it or made any mistakes.
   
   
8. Keep a trading diary on every trade.
   
   
9. Follow the ten tasks of trading.
   
   
10. When I cannot be actively trading, remove all speculative positions.
    
    
11. Understand the risk reward of each trade before you enter it.  For example, your potential reward should be at least three times your potential risk.
    
    
12. Keep stop loss levels with my core positions and actively monitor the market for my speculative positions.  (Again, this one is my personal preference.)

I want to caution you again that these 12 beliefs are my personal beliefs.  Your beliefs might be different.  However, certain beliefs are universal for good trading.  These include beliefs 1- 4 (knowing your objectives), and 8-11.  These are just ideas to get you going. 

So be honest with yourself, and start to look at what you truly believe about the markets. You may surprise yourself.

 

Selling Options: The Real Story
by Jim Wyckoff, Senior Analyst

There are old sayings in the futures industry that go something like this: “Eighty percent of all options on futures expire worthless.” And, “The only way to make money trading options on futures is to sell them--not buy them.”  Neither one of these statements is accurate. This educational feature will focus on the advantages and disadvantages of selling (also called “writing”) options on futures.

But before I discuss writing options on futures, let me first elaborate on the first “old saying” that 80% of options on futures expire worthless. While I have heard the saying many times through the years, I have never seen credible statistics on the percentage of futures options “that expire worthless.” Maybe it’s because such a statistic cannot be compiled. Consider this: If a trader hedges his straight futures positions with options purchases, and those options do perform their function of limiting risk for a period of time, then those options have performed their intended function--even though they may expire “worthless.” Also, most speculative options buyers who make profits on trades do sell their options before they ever expire. Thus, I expect it would be very difficult, if not impossible, to have any accurate statistics on the number of futures options that are bought and sold that did not successfully fulfill their intended purpose.

A major appealing factor for speculative traders to sell (or write) options, as opposed to purchasing options, is that the odds are more favorable for producing a winning trade. Reason: If a trader is writing options, generally the market can move “against” the trader by a certain amount before the trader sees his option’s strike price hit and he starts to lose money. Also, the option writer has “time decay” working in his favor—meaning that the day the option is sold, its time premium starts to decay as the option moves toward expiration.
Now you might be thinking this options-writing stuff all sounds pretty easy, huh? Well, hold on just a minute! Remember that there are trade-offs in every aspect of trading futures. Here’s the “rub” with selling options: 

--First, the premium traders collect for writing options is generally not nearly as much as the profits a trader would collect on a straight futures trade or a winning options purchase trade. For example, if a trader sells a call option on corn futures for 10 cents, that is his profit. But then he has to wait (or “squirm” might be a better way to put it) until the option expires to secure his profit. For many traders, pocketing just 10 cents profit on one corn contract is not much, so they may sell several contracts to make a bigger overall profit. Read on…

--Second, when writing options (just like in straight futures trading) you cannot absolutely limit your risk of loss. Margin money is required by the broker.

-- Finally, there is one more “old saying” regarding writing options on futures. It goes something like this: “A trader will make money and make money and make money writing options…until that one time when an option sale will go against the seller. And that one options sale will then take back all the profits that were made on the previous winning options sales—and then some.”

I do want to be clear on one point. There are very good and successful traders who do employ options-writing strategies. I have another “old saying” that I use frequently when discussing a trader’s methodology. “If it ain’t broke, don’t fix it.” If there are options writers reading this educational feature and you are having and have had consistent success—more power to you! The main point I want to make in this feature is that there is generally more risk and generally less reward involved in writing options than in purchasing options on futures. The one big advantage of buying options on futures is that the price you pay for the option is the most you will ever lose on that trade. Also, there is no margin required. That’s very good money management.

Currency/Commodities Markets
by Kevin Klombies

The point was the near-0% U.S. TBill yields suggest that the U.S. may have replaced Japan as the provider of free credit. The idea was that this could still lead to a sharp rally over the next 12 to 18 months.

We have argued from time to time that one wants to be long those sectors that are pushing interest rates higher and NOT long those sectors that are pulling interest rates lower. If housing prices are so weak that interest rates are declining then don’t by the home builders. If tech and telecom is doing the damage then forget about Intel and Cisco. If it is commodity price weakness then obviously avoid the commodity cyclicals.

The point? The most positive thing that we can think of with respect to biotech is that it is not ‘the problem’ these days. In the current situation not being ‘the problem’ is a fairly serious positive.

In any event below we show 10-year Treasury yields (TNX), the share price of Coca Cola (KO), and the ratio between the CRB Index and the S&P 500 Index (CRB/SPX). Yields, consumer stocks, and the commodity/equity ratio.

We would like to see 10-year yields decline below 3.6% and expect that they will continue down through 3.2% and quite possibly towards 2.5%. Coca Cola above 48 would be something of a positive for our views.

Quickly... we know the autos are a large part of the problem so our most recent comment was that this is a group that we can like from an intermarket stand point but won’t think seriously about until January. The chart below shows that GM peaked in price a number of months AFTER the CRB Index/crude oil ratio topped out in late 1998. The thought is that the autos- if they are going to survive- should bottom some time AFTER the CRB Index/crude oil ratio turns higher. Given that the ratio has been on the rise since the autumn early in 2009 seems somewhat appropriate.

Short-term Views

Our view is that slowly- very slowly- the markets are starting to unclench. To explain we have stacked a comparison between 1-month LIBOR futures, Anheuser Busch (BUD), and Johnson and Johnson (JNJ) at right.

First the Fed cut the funds rate. Second, LIBOR yields stopped rising and began to decline. Every so gradually long-term Treasury yields started to move lower. Third previously committed to deals such as InBev’s offer for BUD began to firm up somewhat. Eventually the markets will start to lift the share prices of those financial assets that have not been specifically hurt by the credit crisis. In other words our thesis is that the process will begin once JNJ’s share price starts to work back towards 70.

Obviously the process is in the early stages but seeing BUD rise back towards the cash offer price of 70 is encouraging because it suggests that progress is being made. We would also like to see something other than the energy and basic materials sectors lead to the upside when the equity markets show strength.

Let’s see if we can explain what we mean by this. Below are two chart comparisons of the S&P 500 Index, crude oil futures, and the ratio between the Amex Oil Index (XOI) and SPX. The chart below right is from 1990- 91 while the chart directly below is from 2008.

The argument has been that the SPX should recover as the XOI/SPX ratio declines. The problem since the first half of October has been that even with crude oil prices tumbling from 90 down 55 the oils were relatively strong. In other words the markets appeared to be saying that for as bad as things were for the oil producers they are worse for everything else and that is NOT the sort of back drop that leads to a sustainable stock market rally.

 

U.S. Stock Market Update
by Robert W. Colby

Weekly Currency Wrap-up for Week Ending November 14, 2008
by Darrell Jobman, Editor-in-Chief

Conditions within global economies and financial markets continued to dominate for much of the week as volatility levels remained high. There were increasing fears over the outlook for all the major economic areas as the economic data continued to deteriorate while the US financial rescue plans also came into increasing focus.

Initial US jobless claims rose to 516,000 in the latest week from a revised 484,000 the previous week and this was the highest figure since 2001. Continuing claims also increased further and reached the highest level for over 25 years.  The latest retail surveys continued to suggest that spending had weakened during October and the official data recorded a 2.8% fall for the month as underlying sales fell 2.2%.

The trade deficit narrowed to US$56.5bn for September from US$59.1bn the previous month. There was a decline in exports and imports for the month. There were market concerns over the implications of declining trade volumes. The monthly budget deficit for October was also a record US$237.2bn as spending rose sharply while revenue fell 7.5% over the year which illustrated the negative impact of a weaker economy.

Treasury Secretary Paulson announced that the focus of the TARP rescue plan would be shifted away from buying bad loans from the banking sector. Instead, there would be increased support for bank capital levels with a greater emphasis on supporting consumer-orientated sectors. There was additional pressure for assistance to the main US auto-makers which continued to face severe financial stresses.

The German preliminary third-quarter GDP data was weaker than expected with a decline of 0.5% after a revised 0.4% drop previously. The French data offered some slight respite, but the Italian data was weak with a 0.5% contraction.

The German ZEW business confidence index recorded a slight recovery to -53.5 in the November reading from -63.0 with the decline in energy prices sparking some improvement, although there were still major concerns over the outlook.

The ECB monthly report stated that the outlook for price stability had improved further. The comments from ECB officials continued to suggest that the bank would be willing to cut interest rates again as growth fears have increased with markets confidently expecting another cut by the central bank in December.

The dollar retained a firm bias for much of the week, notably against Sterling, but was unable to hold the best levels near 1.24 against the Euro. Although fears over the global economy provided support, there were increasing doubts over the US fundamentals as the week progressed.

Source: VantagePoint Intermarket Analysis Software

Japanese Finance Minister Nakagawa stated that there was a need to avoid rapid exchange rate moves at all costs and this reinforced speculation over possible action to stabilise currencies at the weekend G20 meetings.

The Japanese currency tested levels below 95.0 against the dollar and 120 against the Euro as equity markets were subjected to heavy selling pressure. A rally on Wall Street triggered a dollar recovery to 98 while the Euro also recovered against the yen, but rallies quickly attracted selling pressure. The dollar pushed to fresh 2008 highs against the Swiss franc during the week with a challenge on the 1.20 level as confidence in the economy weakened.

The UK labour-market data recorded a further 36,500 increase in unemployment for the month following a revised 36,300 increase the previous month. This put the unemployment total at the highest level for over 10 years.

In the quarterly inflation report, the Bank of England downgraded its growth forecasts sharply from the August report and suggested that there would be a relatively severe recession with GDP set to record an annual decline of around 2.0% during the course of 2009. Bank Governor King also warned over the risks of a deep recession.

Source: VantagePoint Intermarket Analysis Software

There was also a sharp downgrading of inflation forecast with the bank forecasting that inflation would be slightly below the 2.0% target level in two years time assuming interest rates at current levels. The report suggested that interest rates would be cut further despite warnings over the impact of Sterling weakness on import prices.

Bank of England MPC member Sentance stated that it would take time for the interest rate cuts to take effect and that the bank would consider at the next meeting whether a further cut is required.

Sterling came under heavy selling pressure as economic fears intensified and marts digested the huge interest rate cut seen last week. The UK currency weakened to record lows beyond 0.86 against the Euro and a six-year low below 1.46 against the dollar as the trade-weighted index dipped sharply to a 12-year trough.

 

Darrell Jobman is Editor-in-Chief of www.tradingeducation.com, which provides free daily and weekly commentaries for traders as well as complimentary trading tutorials, and eBooks. He is an acknowledged authority on the financial markets and has been writing about them for more than 35 years. 

Why You Win And Why You Lose: Trading Traps And How To Get Out Of Them
by Janice Dorn, M.D., Ph.D.

Trading Trap #1: Failure to Preserve Financial and
Neuropsychiatric Capital

Estimates are that 75-95% of all traders lose all their trading capital in the first year, and only about 5-10% of those that get into trading are able to stay profitable on a consistent basis after 5 years. This is not encouraging.   However, since the majority of people tend to be overconfident, most believe that they are not going to be among the casualties.

What is behind this overconfidence?

Some of the most highly educated professionals such as doctors, lawyers and engineers who are used to being first in their class--the best of breed in whatever they do-- fail miserably as traders and investors. The reason is that the process of trading and investing is completely different from activities and ways of thinking that bring success outside of the markets.   Trading is a counterintuitive to what we are taught growing up. As we grow and develop, we acquire levels of control. We learn to control our bodies, movements, environments, who we chose as friends, lovers and mates, our educational goals, where and how we live. We get cozy and comfortable in our little worlds where we make the rules, and live out

our lives in accord with them. Yes, there is a lot going on in the world, but it really doesn't mean all that much unless it affects us directly.  When external challenges face us in our personal lives, we take control, problem solve, and get done what needs to be done.

In the markets things are quite different. There is no way to control the market forces. Markets are larger than life, yet they are life. Millions of people from every part of the world are there making decisions that affect you in either a positive or a negative fashion. Millions of nameless and faceless people are trying to take your money before you take theirs. There is no situation in the life of most people that compares with this. That is why successful trading and investing requires one to adopt an entirely new brain-set.

The majority of people are simply not neurologically flexible enough adapt to this new environment. They insist on adapting the markets to their own worldview, and they fail—sometimes miserably so.

It is anathema for many highly educated and extremely intelligent people to hear that they might be programmed to lose , are sabotaging themselves or might have a subconscious desire to lose.  We know differently because we see it all day every day.

We have learned that the markets speak to us and tell us many things about ourselves.  They expose every single aspect of our personality, whether we like it or not. If we open ourselves to receive the messages from the markets, we will understand ourselves as never before. If we remain rigid, stuck in linear or closed-minded thinking, then we are well-served to keep our day jobs and stay out of the markets. If we are willing to be flexible and adopt a non-linear mindset and become comfortable with uncertainty, we have a good chance to be successful.

In our time and culture, the battlefield of life is money. Instead of horses and chariots, guns and fortresses, there are banks, credit cards, mortgages, salaries and tax authorities. But the inner enemies remain the same now as they were in ancient India or feudal Japan: fear, self-deception, vanity, egoism, wishful thinking, tension and violence…
- Jacob Needleman

The greatest source of failure in trading and investing is loss of capital. Lose it and you are out of the game. If you lose your money, you have to go out and find more money to put into your trading account. That may or may not be throwing good money after bad. If you lose your emotional stability, you have to go out and find ways (we are talking money here because therapy is not cheap and neither are psychiatric meds) to get it back. In either case, you will need to leave the markets for a while and get your financial and emotional act together. This takes a toll, gets you out of the market flow and inflicts damage to you in ways that may not be immediately obvious. Faced with large drawdowns or wipeouts, many people become both emotionally and physically ill-- and this carries over to their families and loved ones. What begins as a financial loss turns into actual biochemical changes in the brain.  Losing money causes sadness, despair and anxiety.  This leads to stress (sometimes called allostatic load) that causes buildup of inflammatory substances in your body. Systemic toxicity and sickness develop because your immune system is overloaded and cannot defend you from pathogens.  It also leads to a variety of symptoms including those in the Diagram of Stress 101 to the right:

We have all heard heroic stories of traders that have gone through complete disaster, only to come back stronger than ever.  Those who can be believed (caveat emptor!) are few in number. These are the true comeback kids. The rest are not so lucky, and just go quietly (or kicking and screaming) into the night, buried in shame and guilt and vowing never to return. (You might be surprised at how many come back only to fail again and again.  Insanity is doing the same thing over and over and expecting different results).

Small losses almost always become larger and larger losses, leading to every manner of emotional distress as you are holding and hoping, or in complete denial that the position could possibly turn against you. Holding and hoping leads to larger losses and more emotional carnage until you are a financial and neuropsychiatric basket case and you just want out at any cost. Desperation, anxiety or depression set in and remind you of every time in your life you were told that you were not good enough, that you would never amount to anything or that you didn't deserve to win or be successful.  You are now in a state where both financial and psychological capital are depleted--all because you didn't take a small loss.

How do you preserve your financial and psychological capital? You learn to embrace risk by using rigorous risk management techniques. The most important of these are position sizing, stops and money management. You take small losses. You take small losses! You let winning positions run and take profits and trail stops as they are running. Please memorize this until it is burned into the connections in your brain: The single biggest reason for failure as a trader or investor is the inability to take small losses and letting them grow into larger losses.

A few words about stress:

It is important to understand that some stress is good for you. It evolved as a survival mechanism. You get a rush of adrenaline and other chemicals when faced with a sudden life- threatening situation. You react faster, often without even thinking. Your strength can suddenly double for an instant.  This flight or fight reaction is a basic survival mechanism hard wired into your brain from the days of the caveman. Get Your Trading Brain Out Of The Cave in our store.

Now that we’re civilized (at least technologically) we seldom face life threatening events. However, modern day life puts other pressures on us. Instead of being attacked by a wild animal, escaping and then relaxing for a week, we get stressed by the multiple processes of living in a complex world where technology is accelerating logarithmically and communication is almost instantaneous.   Stressful situations can stay with us for days, weeks and even years, or they come to us in rapid succession such that we feel overwhelmed and helpless. Sometimes we feel that our lives are spinning out of control and we can’t take it anymore.  This chronic stress is what kills us instead of saving us.

We have written and spoken for years about how to manage chronic stress without dropping out and meditating in a cave on a mountaintop.

All you need to do is stop and get off the horse once in a while. Relaxation is not only fun and easy to do, but it will extend your life and help keep you from getting sick. Focus and intentional practice are much more effective than passive relaxation. You might try meditation, yoga, prayer, self-hypnosis, deep breathing exercises, creative visualization, biofeedback or tai chi.  Stress management can measurably reverse much of your stress-induced damage very quickly. You can restore your depleted immune system in ninety days or less. Best of all, your benefits accumulate. The longer you practice stress management techniques, the healthier you become.

In the coming weeks, I will show you two simple stress-busting techniques that work like a charm with almost no time or effort. Plus, they are fun! They’ll take you—in a manner of minutes-- from a dysfunctional, tied-up-in-a bundle-of-knots to the relaxed, happy and productive person you are meant. Until then, a picture might be worth a thousand words:

Until Next Time,
Good Trading and Brain On!

Doctor Janice

Janice Dorn, MD, PhD - Neuropsychological Trading Coach - Financial Neurobehaviorist
www.thetradingdoctor.com

Janice Dorn, M.D., Ph.D. holds and M.D. in Psychiatry. She is certified by the American Board of Psychiatry and Neurology in General Psychiatry and Addiction Psychiatry. She also holds a Ph.D. in Brain Anatomy. Dr. Dorn has been a full times futures traders since 1994, focusing on the precious metals markets. A graduate of Coach University, she has coached over 600 traders world-wide. She is the author of over 500 articles on Trading Neuropsychology and Behavioral Neurofinance.