An Update On Efficient Stocks
By
Van K. Tharp, Ph.D.
A number of you have been making comments on efficient stocks lately. And to me, most of the comments show how careful I need to be even just talking about it. Let me give you some examples, although these are not exact quotes.
- Can anyone tell me what I need to know to follow Van�s strategy for the efficient scans?
- Is a 25% trailing stop the only exit strategy (as mentioned in Safe Strategies for Financial Freedom)? And with that exit, what�s the expectancy?
- I am unable to test the strategy with my analytical software. What changes have you made to it since you wrote Safe Strategy for Financial Freedom because you seem to be making good money with it?
- I don�t understand how Van trades negative efficiency stocks. Can you help?
And though the following client wrote to say thanks for the information, you'll be surprised when I explain below how this information is not designed to be USED as recommendations.
- On November 2nd, you indicated that ENG is a negative efficiency stock. I had just bought it and was up over the round turn commission. With this information, I sold it and was glad I did. ENG has been retreating ever since. Thank you.
First, let me talk about the strategy. Safe Strategies for Financial Freedom was written with the idea of giving you a framework to develop strategies that you could use within in the current big picture (i.e., a secular bear market). One of key statements made in that book was �use the efficient market strategy (as described) only when we are in green light mode or yellow light mode.� In fact, by mid 2002 at the end of the last major downleg of the secular bear, I could not find a single stock that would pass my efficiency screen. There were no stocks that scored above +10 and the hundreds of stocks that scored below -10 had such low prices that it wasn�t worth shorting them. With that information as a guideline, remember that we�ve been in red light mode since July 2004.
I also didn�t talk about shorting negative efficiency stocks in Safe Strategies for Financial Freedom. We recommended several criteria for shorting stocks, but negative efficiency was not one of them.
Secondly, one of the key principles that I�ve always advocated is that to be a good trader, you need to develop strategies that fit you and your personality. This is what the whole book, Trade Your Way to Financial Freedom is about. Many of you have decided that because I�m trading efficient stocks, you should be doing so as well. That doesn�t mean that you should not do it, but it does mean that if you do use this type of strategy, then you should adapt the strategy to fit you using the techniques we talk about in our systems course and workshop.
Third, the efficient stock strategy given in Safe Strategies for Financial Freedom was a simple strategy that was meant to be a substitute for buy and hold. It gets you in when stocks are going up (i.e., they are efficient). Furthermore, rather than buying and holding the stock, it protects from a downfall by having a 25% trailing stop. And the strategy has built in risk control in that you should not take more than 1% risk in each position. However, I want to stress again that this strategy was designed for you to use in a bull market (such as most of 1982 through 1999) or in a major up move (i.e., a correction) in a secular bear market, such as the one we had in 2003. It was not designed for the conditions we are in now. Again, we�ve been in red light mode since April 2004.
Yes, I currently trade efficient stocks on both the long and short side. However, I have not taught my strategy in any of my books. I�ve briefly mentioned it in the last systems workshop just to give people an idea of how I constructed the system from my beliefs � not to suggest that they trade that way. Let me again stress the message given in How to Develop a System that Fits You (both the workshop and the home study course) and in Trade Your Way to Financial Freedom:
|
If you want success in the market, don�t trade someone else�s system. Instead, you must develop a system that FITS YOU. |
As a result, even though I trade efficient stocks, if you decide that the idea of efficient stocks is right for you, then you must develop your own version of it. Otherwise, you just will not be able to trade it successfully. You must develop your own rules instead of saying, �How does Van trade it?�
In addition, if I were to give you all the specific details of how I trade it, then you�d want to test it thoroughly and then compare your results with my results. �What expectancy did you get, Dr. Tharp? I only got 1.49 and you got 1.89. What did I do wrong?� Why did you use this efficiency rating and not that one?� As a result, I�d be spending a lot of my time on things that were not that productive for me. (By the way, those expectancy numbers were just PFA � plucked from air.)
The bottom line is that I like my system. It fits me and my beliefs. I make nice profits trading it. But the way I�ve developed it, it is right for me! I like trading it because it fits me. At the same time, it�s probably not right for you. And even if you like the concept, you�d probably feel much more comfortable trading it differently than I do.
Lastly, my trading with efficient stocks � both positive and negative � is very discretionary. Many of the stocks my scans show me as being efficient are really junky looking stocks. The efficiency scans just make it so that I only have to look through about 100 stocks to find the nice charts that reflect the stocks that I like. However, I still have to sort through the junk. I�ve tried to filter them out, but I haven�t been able to do so. As a result, the system has to be quite discretionary if I am to use it.
So why do I report on some of the most and least efficient stocks in my monthly market commentary in Tharp�s Thoughts? Well, first of all I found it very useful to look at the percentage of positive and negative efficiency stocks as a market barometer. And the results have been quite wild.
- At the end of September the market was about 60% positive and making money wasn�t too difficult on the long side.
- By the end of October, the market was about 60% negative and it was much easier to make money on the short side.
- And already, by mid November, the market has turned back to nearly 60% positive.
Second, I like to point out some efficient stocks just so that you�ll see EXAMPLES of what is out there in the market. For example, I first discovered MOVI as a negative efficiency stock in September and it was just under $18 per share � down from a high of $33.54. The dark line going up is a trending that was broken. It was moving straight down. In two and a half months MOVI has lost about 75% of its value (since I pointed it out) and is now selling below $5 where it is dropped from my negative efficiency screens. It�s been a very profitable ride down and I still have a short position on it because my feeling is this one could go to $1 or $2. However, I �ll be out quickly if it reverses. Chart One.
Also it�s important to me that you understand that positive efficiency stocks can exist in bear markets. For example, Deluxe Checking was a smooth line up throughout most of 2001. It was easy to make money from that stock even though the overall market was down. And I recently found a stock that�s been going up steadily since 2000 and accelerated into 2005 which is why it started showing up on my scans. That stock was INGR. It�s only gone up about 30 points during that five year period, but that�s still a 300% gain.
I make two strong cautions in each market commentary of Tharp�s Thoughts and I�d like to repeat them here.
- The first is that if you happen to like any of the stocks I mention (or dislike some for that matter) that you should still do your own due diligence on them before you take action. Ask yourself, �Does this action make sense to me and fit within my rules?� Tharp�s Thoughts is a FREE educational service, it�s not meant to be a recommendation of stocks you should buy, sell, or short.
- The second comment is that we occasionally have typos in the newsletter.
When Mr. X mentioned that he�d sold ENG because I reported it to be a negative efficiency stock, I was happy that it saved him money, but also a bit shocked that he�d used it like a recommendation. I then looked up ENG and found that it had an efficiency rating of about +6 (not good enough for me to buy it, but certainly not a good shorting stock). The chart below on the left shows ENG.
Ironically, it wasn�t what I remember as a classic negative efficiency stock at all. The stock I remembered had been at about $60 a share and had had a significant drop. I also believe that I sold that stock short and bought it back rather quickly because it wasn�t behaving properly. And it didn�t look like the chart of ENG. Now here�s the irony.
I went back through my scans and discovered that ENG was NOT the stock I had intended to give as a good negative efficiency example. Yes, it was a classic typo � and the kind of typo that none my staff would be likely to catch. The stock that was a great example of a negative efficiency stock was ENR shown in the chart on the right. Notice the difference between the stocks. ENR is at about $46 with plenty of room to fall. While ENG is already at 6, just looks choppy, and it is certainly in a downtrend.
It�s somewhat ironic that I probably would have sold ENG (had I owned it) as well. It�s a terrible looking stock, despite having a positive efficiency. However, it hasn�t been in a downturn long enough for me to call it a negative efficiency stock like MOVI.
This example ( charts two and three) perfectly illustrates my point of why it is important to DO YOUR OWN DUE DILIGENCE if you decide to do anything with any of the stocks I happen to mention as examples. Just think, we might have even made a typo when we gave you the symbol � they do happen.
About Van Tharp: World�renowned trading coach, author and psychologist Dr. Van K Tharp, is widely recognized for his best-selling book Trade Your Way to Financial Fre-edom and his outstanding Peak Performance Home Study program - a highly regarded classic that is suitable for all levels of traders and investors.
Van
Tharp Didn�t Invent Risk Control�
He Just Perfected it.
The Psychology of Trading Small While Learning
by D. R. Barton, Jr.
Trade small while you�re learning.
I wrote that again in an e-mail last night. And as usual, I was defending that sage bit of advice. One of the interesting benefits of teaching seminars with Van and others is that I get to hear feedback on the items that we teach.
I have given the recommendation from today�s title to literally thousands of people in person and to hundreds of thousands in print. Trade small while you�re learning. A simple message.
Yet, I have never once had a person come up to me and say, �You know, I started that new account (system, strategy, or whatever) and because I was trading such small size, your advice has ruined my life.�
But on many occasions I have had people tell me that trading small while starting out has �saved their bacon�. This isn�t rocket science. But trading small is very hard to do from a psychological standpoint. Here are a few reasons why:
� Excitement is at its highest when we are just starting something new. It really doesn�t matter if it�s a new trading system, a new hobby or a new relationship. Our natural response is excitement. And part of that excitement stems from the profit potential of our new strategy. So when the rational parts of our thought process chime in with �trade small while you�re learning� � it dampens the excitement and enthusiasm. Many people choose to cling to the excitement and give away thousands or tens of thousands of dollars in losses when they could have limited those losses to hundreds of dollars and gotten the same experience and education just by trading smaller sizes.
� We get caught up in trading expenses � especially commissions. The most frequent comment I hear about trading small is �I�ll never be able to cover my commissions if I only trade 10 shares (or 100 shares). There are two ways to overcome this problem. Start out trading a broker who charges �per share� commissions (or low per contract commissions for futures traders). There are plenty of reputable brokers like Interactive Brokers, TradeStation and CyberTrader who charge very low �per share� commissions. But if you like your a broker who is charging �per transaction� fees, then re-frame your commission costs. Set up a mental or real �tuition account� that you will use to pay for commissions until you can prove to yourself that you can trade a new strategy profitably over time. Then you can evaluate the system and your ability to execute it properly based on trading results exclusive of commission costs. Once you can trade properly then you can ramp up your size per trade (not jump up in one big step!).
� What if I miss the �big trade�? This is another of the more frequent reasons given for not trading small when starting, �I might hit that big trade but just have a few shares, and will have lost all of that potential profit�. That could happen, but 99% of the time the opposite happens. Through an execution error or a psychological misstep, you find yourself in a big losing trade when starting out. Or a string of them. And if you do that while trading big size, you�ll get crushed, both financially and psychologically. It�s much better to make a modest profit on one or two nice trades, than it is to lose half or more of your account while you figure out your trading psychology and whether a system fits you or not.
Trade small while you�re learning: useful instruction for new traders and also for experienced traders learning new strategies or systems. I hope you will choose to learn your new strategy while paying the minimum tuition instead of the maximum!
Great Trading!
D. R. Barton, Jr. is the Chief Operating Officer and Risk Manager for the Directional Research and Trading hedge fund group. D. R. has been actively involved in trading, researching, and teaching in the markets since 1986. D. R. has taught extensively in many investment areas including intra-day trading, swing trading, and cutting edge risk management techniques.
His writing credits include co-authoring Safe Strategies for Fin-ancial Fre-edom and co-creator and contributing author on Fin-ancial Fre-edom Through Electronic Day Trading.
Home Study Course vs.
Books
Author: Robin
Date: 11-17-05 07:06
I have bought and read Van's books and am contemplating whether I should take
IITM's home study course. I wonder what more I can learn from the course that cannot be learnt from the books.
I am sure that there are a lot of folks here who have taken the course and read the books. Any comment?
Reply To This Message
Re: Home Study Course vs. books
Author: PMK
Date: 11-17-05 08:14
Robin,
If you are really serious about becoming a better trader or investor I would suggest you get the course. Van's book are excellent, but a book can never give you the same depth of information as a complete
interactive/exercise-filled course (or a workshop for that matter).
I have used almost every written/audio product Van has produced, and recommend them without reservation on my website
pmkingtrading.com.
Although it is generally impossible to pinpoint exactly which products made me a competent trader, all of Van's would have to be on the list.
PMK
Reply To This Message
Re: Home Study Course vs. books
Author: Level 7
Date: 11-17-05 11:53
I took the home study course and have read a couple of his books. I was already a skilled trader yet I found it very useful.
As you know, trading is not about one area. There are several (at least 4
in my opinion) strategic areas to understand and master with several (unknown how many) tactical areas as well. For the area (psychology) that the home study course deals with, it is excellent. The book works on a second area of (system). It is still in my top 5 (of over 100) books that I have read on investing. The two deal with different strategic areas.
Psychology is the most important strategic area in my opinion and even though I knew that before I took the course, like most, I still didn't really appreciate how important it was to me. If you are not willing to learn more about trading, then as PMK says, you are not serious.
Most useful for me than both was the skills inventory [profile] though. I would definitely take this before (and possibly again after to measure your progress). My learnings from that were best of all. I learned that psychology is not my weak strategic area, I don't take enough risks, and why that is so, and finally that I was already a pretty good trader.
I have no affiliation with Van at all in any way. My suggestion is to order the course if your are serious and save your money if you are not since it will not help you.
Reply To This Message
Re: Home Study Course vs. books
Author: Mark
Date: 11-19-05 09:05
I assume here that we are talking about the Peak Performance Home Study course. The big difference I have found between reading the books and working through the PP Home study is that the Home Study course requires action on the part of the reader. Reading books is much more passive.
If you take the time to actually do the exercises in the home study course you will get much more out of it than you would reading a book that covers the psychology of trading that requires no other commitment from you.
- Mark
Ed Note:As Always...read the complete and unedited thread at the link below.
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