Tuesday, November 3, 2009

Super Trader

The book Super Trader: Make Consistent Profits in Good and Bad Markets by Van K. Tharp is definitely not what I expected. I thought the aim would be to show me how to make consistent trading profits. Instead it assumes the reader already knows how to profit by trading and needs help sticking to a proven system.

Tharp paints a picture where profitable trading strategies are a dime a dozen, but the discipline to follow a system is the real key to success. A lack of discipline can certainly be harmful to investors’ returns, but Tharp offers no evidence that the consistently profitable trading strategies that he repeatedly refers to actually exist.

The book anticipates this criticism by ridiculing a “gentleman from England” who took one of Tharp’s courses and complained that it didn’t give him a profitable trading strategy. Tharp’s reply is that the course wasn’t designed to give a methodology; “it is about how to become a peak performance trader/investor,” and “psychology is far more important than methodology.” I’m with the English gentleman on this one.

Any failure to make 25%, 50%, or 100% return each year can be traced back to investor error, according to the author. This could easily be self-fulfilling; unless a trading strategy is described extremely precisely, a trader could look over the losing trades for a year and decide that many of them were mistakes.

God

Some of the subject matter of this book seems more suitable for athletes. Maintaining a positive attitude is good in most endeavours and feeling confident may help with tennis, but I’m not sure how it helps much with trading. Tharp takes this a step further by saying “it is time to open up the spiritual basis of trading.” Does this mean that we should pray for our stocks to go up?

More along these lines: “The opposite of joy is not necessarily sorrow; it’s unbelief in the true nature of your soul or the essence of God.” Thanks. Now my next trade is sure to be profitable.

Einstein

The author attempts to link his ideas to Einstein a couple of times. Apparently, the techniques for looking at things from multiple perspectives are “part of how he [Einstein] formed his great ideas about relativity.” I guess the idea is that disagreeing with the author is like disagreeing with Einstein.

Defusing More Potential Criticism

It’s simple math that the average trader gets the same returns as buy-and-hold investors, except that they pay more in trading costs. For very active traders these trading costs can be substantial. Tharp attempts to defuse this criticism of trading with a little story and a reader exercise:

Bill’s wife says “Trading is nothing but gambling. It’s a waste of time and has no redeeming value.” Bill then uses one of Tharp’s techniques aimed at solving the problem. It begins with Bill writing down some “statements” including “I married the wrong woman” and “She’s an idiot.” Of course, the real substance of the criticism is left unaddressed.

Investment Advice

“I’d recommend a good hedge fund over T-bills because you can get a much better rate of return.” You can also get a much worse rate of return as we’ve seen from recent hedge fund implosions.

Fantastic Returns

“I’ve known people with systems that can easily net 100% or more each year.” That’s great. A 30-year old starting with $10,000 could build it up to $10 billion by age 60 and $1 trillion by age 67. If the existence of such a system sounds implausible to you, you’re not alone. This book is filled with references to systems with incredible returns without giving any hint of how they work or any proof that they actually exist.

Advice for Prospective Hedge Fund Managers

“To have large amounts of money under management, you need to produce above-average returns with very little risk.” Most promises of high returns with little risk are scams as we’ve seen with the flurry of exposed Ponzi schemes.

Half-Way There

“Deciding on your objectives is about 50% of developing a trading system.” This reminds me of a joke about a clueless CEO. One day he announces that he has a great new idea: the company needs to double revenue while keeping expenses constant. This sounds great to the underlings, and one of them asks “that’s fantastic, what’s the idea?” The CEO stares back blankly and says “I just told you the idea.”

It takes 10 seconds to choose an objective of making at least, say, 40% return each year risk-free. The idea that the work toward meeting this goal is now half done is laughable.

Random Trading is Profitable

Tharp claims that choosing the right equity to trade isn’t important – what matters is the right exit. To prove this he devised a random trading scheme as follows. For each of 10 commodities toss a coin to decide whether to go long or short. Choose an exit point to cut losses equal to 3 times the trading range over the last 20 days. Otherwise, ride profits indefinitely.

After a trade is exited, flip a coin again to start a new position in that commodity. Tharp claims that this strategy made money consistently over a 10-year period. I’ll leave it to others to examine this more closely, but I’ll need a lot of evidence to believe that random trading can be more profitable than buy-and-hold.

An Example Trading System

“Let me present a simple trading system.” This got my attention. Maybe this is finally the part where the reader learns the secret to profitable trading! Sadly, the description doesn’t reveal how the system works. It just describes each trade’s results in terms of a dollar amount R:

– 20% of the time it makes 10R
– 70% of the time it loses 1R
– 10% of the time it loses 5R

On average, each trade makes 0.8R, although there is considerable volatility. The system is assumed to make 80 trades per year. Tharp claims that such a system is “not unrealistic” and that he’s “seen much better systems.” Let’s examine this a little.

If we set R to be 2% of our portfolio, then on each trade the portfolio makes 20%, loses 2%, or loses 10% with varying probabilities (see above). After 80 trades (one year), the average compound return is 156%! At this pace it would take only 20 years to turn $10,000 into over a trillion dollars.

Volatility is a factor here, and so I decided to run some Monte Carlo simulations. Out of a million simulations the starting $10,000 grew to at least $1 million 99.99% of the time.

If Tharp has seen trading systems with this kind of phenomenal potential, why is he wasting time writing books?

A Few Good Parts

There isn’t much I can recommend about this book, but there were a few good points. Tharp criticizes come-ons for trading saying they are designed “so that other people can take your money in fees and commissions.” There is no comment on the irony that this criticism can apply to this book as well.

There is extensive discussion of position sizing which more or less means controlling the size of trades to avoid doing significant damage to your portfolio if a trade works out badly. Tharp gives examples of profitable trading systems that can become money losers if the bets are too big. However the real value of this advice is that it will allow the typical trader with a money-losing strategy to lose money more slowly.

The best part of the book is the third of three biggest lies a cowboy tells:

1. The truck is paid for.
2. I won this belt buckle at the rodeo.
3. I was just helping that sheep over the fence.

Conclusion

Much of this book is self-help advice and exercises that have little to do with trading. For the parts that are related to trading, there is no evidence that they will help anyone trade profitably. This book definitely does not live up to its title.

12 comments:

  1. I'm wondering what possessed you even to read this book. :-)

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  2. Patrick: I can't find out if I'm wrong about something unless I give the other side a proper hearing. Also I had seen references to Tharp before where he was portrayed in a positive light.

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  3. Michael James, the Super Money Myth Buster, strikes again! Good job on the "steak" part of the review and some "sizzle", aka fun read, to boot.

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  4. Canadian Investor: Thanks. I actually edited out a lot of sarcasm. It was difficult to remain fair in the face of some of the book's content.

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  5. I'm glad I declined a review copy of this book. Speaking of trading, PBS Money Track ran a segment on many of the "trading system" informercials misrepresent their returns. For example, they'll count just their winning trades. Perhaps they took Tharp's advice and count their losses as "mistakes". What a joke!

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  6. CC: I think I found the video you spoke about. It is video #302 at http://moneytrack.org/videos-2/scam-alerts/. A com man says that he made over $100,000 in a year. Then an FBI agent says that the con man failed to mention that he also lost that amount for the same clients. Priceless.

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  7. This book sounds like complete junk. Your review was hilarious.

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  8. Anonymous: Thanks. I aim to entertain as well as inform.

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  9. Hi, no offense to the author of this article. If you thought you were going to buy a book with a magical holy grail strategy that would be your fault not Tharp's fault.

    Even if you were gave a good strategy you probably still would not be profitable in the markets until you understood how and why the strategy was profitable.

    If you are new to the game you should be learning the basics through many free sites here on the web. Such as investopedia or many others.

    basically the concept of position sizing is the most important part of the game. Yeah maybe you will lose money slowly but this allows you to stay in the game long enough to persevere with a successful strategy. Also more importantly minimizes your draw down with a successful strategy.

    Now lets assume you have found a successful strategy and your only fault would be executing improperly
    this is where this book would be helpful. Now position sizing as i explained minimizes your draw down with a successful system. (if you lose 50%of your account you have to make 100% to make your money back.)This is not fun, thus the reason risking only 1% to 3% per trade minimizes this effect with a probable trading system.

    Now heres the kicker. You may think how am i going to get rich only risking a small portion of my account each time. Like Einstein had mentioned compounding is the eighth wonder of the world. If you came up with a system where you banked 1% per day compounded you would have an annual compounded return of 938% per year.Approximate estimate.
    So in a nutshell position sizing profitable strategy and compounding will pave the way to supertrader status.

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  10. @Anonymous: I didn't expect Tharp to provide a "magical holy grail strategy". I expected there to be some discussion of the author's idea of successful trading strategies, but there wasn't any.

    I don't think anyone needs a whole book to read the message to not put too many eggs in one basket.

    "Now lets assume you have found a successful strategy and your only fault would be executing improperly
    this is where this book would be helpful." This is a little like providing useful advice for how to best use a perpetual motion machine.

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  11. @Michael James: Trading strategy which fit you , you should find in yourself, not in a book. I suppose that you still didn't pass your way to successful trading. Once when you come near success, you will see that you will be sorry why you didn't take this book more seriously. But you are still in a phase that you are looking for strategies, looking for a Holly Grail, like previous Anonymous said :)

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    1. @Anonymous: I've found my strategy, thank you. I did take this book seriously and found it wanting.

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