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Monday, June 16, 2014

3 Core Principles of an Enlightened Trader


Since I became a full time trading coach almost thirty years ago, my mission has been transformation through a financial metaphor. My staff thrives on the comments that we receive on almost a daily basis: “You have changed my whole life for the better, thank you” Or “I want to thank you for your materials that have helped me become so much more confident and optimistic.”

Several years ago, my staff agreed at a meeting that along with the fundamental trading principles we teach, we should also really promote our mission of transformation. Being open about our passion for transformation would help answer people who occasionally ask, “If Van Tharp knows so much about trading, then why doesn’t he just trade?” Well, that question presupposes that money from trading is “the be-all and end-all” of life. It’s not for me. My mission is transformation. I find much greater joy when people say, “Dr. Tharp, you’ve not only improved my trading but every aspect of my life.” than from any of the money I have made from trading.

In the last few years, I’ve actually come to discover that we help people with transformations on three individual levels.

Transformation One:  Adopt the Core Trading Principles that Work

At the first level, we help traders transform their core beliefs about the markets and trading to those beliefs that coincide with top traders. In my research, I have modeled many of the top traders in the world to discover what they have or do in common with each other. Once you understand how they think and what they do, others can learn their processes. I’ve never seen anyone else put all of this material together so we call it Tharp Think.  There are about 50 core principles to Tharp Think.  However, many people can’t just adopt those principles. Instead they have to transform themselves so some degree before they can internalize these core principles.

Let me give you an example. Larry Connors did some research on how repeated market behaviors can give traders an edge. For example, in his book How Markets Really Work he suggested that a stock would tend to have a nice upward move after it had gone down for at least five consecutive days. One of our instructors, Ken Long, developed a full trading system around that tendency that he teaches in one of our workshops.

1) You have five or more down days followed by an inside day.  The inside day tells you “it’s stopped going down.”  This is shown in the figure below.
2) This setup works if it produces a potential reward-to-risk ratio of at least 3 to 1.
If you are looking for high probability trading, you’ll want to read this new research in High Probability Trading with Multiple Up & Down Days.
Risk (1R) is the difference between the high of the inside day and the low of the last down day. Reward is the potential move from the high of the inside day to the old swing high, assuming this to be a target. In the figure the risk is the distance between the two bottom horizontal lines. The reward is the distance between the two top horizontal lines. It’s about 3 to 1 in this example.

Entry:  Enter the next day if the price moves just above the high of the inside day.

Protective Stop:  Just below the low of the last down day.

Ken Long Entry Setup Chart

Figure 1:  Five Down Days Trade

Target Exit:   At the old swing high.  However, in this trade you’d probably exit at the close of the green bar that exceeds the old high.

Trailing Stop:  You’d at least bring your stop to break even once you had a 1R profit locked in (i.e., a profit as big as your initial risk).

While this is a simplified version of Ken’s rules, it illustrates the parts of a full trading system very well and it also illustrates several of core Tharp Think principles.
  • Always have a predetermined risk (1R).
  • Never take a trade unless the reward to risk ratio is at least 3 to 1.
  • Which means cut your losses short and let your profits run
How does the system work?  During 2008-9 bear market, Ken traded GM long only using these rules all the way to GM’s bankruptcy.  In other words, as GM went from its highs in 2007 down to zero, Ken made a big profit trading it by going long. Could you do that?

Most people probably couldn’t because this system clashes with many of their beliefs, such as-
  • How can you go long in a bear market?
  • How can you go long a stock that is crashing?
  • The trend is down, why don’t you follow the trend?
  • Etc, etc. etc.
Transformation Two:  Transform Yourself  Enough to Adopt the Core Principles That Work.

Some traders are able to adopt core trading principles as soon as they hear and understand them.  Most traders, however, need to go to the second level of personal transformation so they can adopt the core trading principles that work.  For example, there really is a Matrix, like that of the movie. You create your own matrix with your beliefs and your beliefs program you into behaving like a robot – you act consistently with what you believe.  Once you understand Tharp Think, watch CNBC for a while.

Here’s a quick example of how beliefs affect two groups of traders – those who watch CNBC and those that understand Tharp Think

CNBC says it’s all about picking the right stocks.

Tharp Think says it’s all about trades with 3:1 reward to risk ratios or better.

CNBC says that diversification and asset allocation are all important but never mentions position sizing.

Tharp Think says position-sizing is the most important non-psychological factor in your trading.  It’s how you achieve your trading objectives.

Can you see the contrasts in these beliefs? Can you see how believing one set or the other would lead you to different actions and trades?  If you don’t understand the powerful role of beliefs in your trading, you are caught in the matrix and don’t even know it.

In order to transform yourself, you must

  • Really look at your beliefs to determine if they are useful.
  • Identify non-useful beliefs and transform them.   This is easy to do once you decide the belief is not useful unless the belief is locked in place with an emotional charge.
  • If the belief is locked in place with a charge, then you must do some sort of feeling release work to release the charge. Once that’s done then you can replace the old belief with a more useful one.
  • These are just a few of the techniques we teach to help you through your transformation. Others include various forms of conflict resolution, developing a strong internal guidance, etc.
Transformation Three:  Change Your Level of Consciousness

The late David Hawkins was one of the most successful psychiatrists in the world. He had a very high level of consciousness and performed miracle cures on his patients. In his book, Power vs. Force, Hawkins describes human consciousness using a log scale from 1 to 1,000, with 1,000 being the highest level of consciousness achievable by a human being. Hawkins postulated that only a few (e.g., Jesus, Buddha, Krishna, etc.) ever achieved the 1,000 level. He goes on to say that, for much of the past 5,000 years, human consciousness as a whole has been just below 200—the level that separates the positive from the negative. According to Hawkins, Gandhi had a consciousness of 700 and was able to defeat the British Army, whose collective consciousness was 175. That’s the power of the log scale difference between power (high consciousness) and force.

Raising your level of consciousness doesn’t just help Gandhi; it can help you as a trader. If you are trading at a low level of consciousness, you are probably trading out of fear, greed, or desperation. Now imagine how that would change if you were to trade from a level of acceptance or peacefulness. The difference would be enormous. While I’m not sure how theoretically valuable the scale might be, it is very useful. It should be quite obvious that you don’t trade well from the negative lower levels such as anger, guilt, fear, or greed. You probably are all aware of what happens when you trade from those mental states. The results are not pretty. This can be explained by your level of consciousness. Both fear and greed are very destructive states of consciousness. You can move higher on the scale, however, at least to neutrality (300) and acceptance (350), or even higher to the levels of love (500) or enlightenment (600), and then you will be a much more effective, successful trader. Now imagine how that would change if you were to trade from a level of acceptance or peacefulness. The difference would be enormous.

The following table from my new book, Trading Beyond the Matrix, shows levels of consciousness from Hawkins and two other sources.

Level of Consciousness Chart

My finding from numerous clients is that doing a lot of personal transformation work will tend to raise your level of consciousness. For example, if you change enough beliefs to raise your consciousness to the level of acceptance (about 350 on Hawkins scale), then your results would be vastly improved. What if you could trade from “an enlightened state” in which there was no internal chatter and you just see the market for what it is? The young woman who wrote Chapter 16 in Trading Beyond the Matrix, trades from such a mental state and generates truly phenomenal results.

You might think about the transformations you have experienced in your trading.  If you can’t think of any, maybe just start by doing what I ask my Super Traders do – write down a hundred beliefs you have about the market and then ask yourself a few simple questions.

 Where did that belief come from?
What does that belief get me into?
What does it get me out of?
Is it useful? (Does it help me reach my goals?)

This tends to be a challenging and enlightening exercise.  Then you can do the same exercise about yourself.  This tends to be more challenging, more enlightening and opens to door to level 2 and level 3 transformations.  Good luck.

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