Reproduced with thanks to Dr. Van Tharp – www.vantharp.com
This is a FREE newsletter that Van Tharp.com produces to subscribers, often there are articles that are extremely educational to traders/Investors and that is when I repost them.
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An Interview with Frank Eaves:
Hit in the Head with a Marble Bag
Conducted by RJ Hixson
Last week, one of Van’s research assistants, Frank Eaves, sent an interesting email to Van and a few of the staff here. In his note, Frank quoted this selection from Volume 5 of the Peak Performance Home Study Course:
“Most people cannot, and do not, trade with Bill’s simple strategy because it is not an efficient decision making strategy. It neither generates options nor effectively evaluates them. But, because your trading system should make decisions for you, it is an excellent action strategy.”
In a subsequent conversation, Frank related how he had realized a number of insights from those few sentences. He explained his insights in plain terms and his ideas seemed to hold a lot of potential value for our clients. I asked Frank if he’d be willing to be interviewed for an article. He agreed and here’s how it went:
First, that passage mentions Bill’s strategy. Who is Bill and what is his strategy?
Van was talking about two traders. One, named Jack, looked at a chart, considered which directions price might go and considered what could go wrong with each scenario. The other trader, Bill, used a simple mental strategy to make a trade. He would see the pattern, recognize it, feel good about it, and place the order.
Why isn’t Bill’s strategy an effective decision making strategy?
He’s not thinking about all of the options, what could happen, or what the best choice is at this point. His process is more automatic.
So that’s why it’s an excellent action strategy?
Yes, exactly. Bill’s not there to consider all of the options — he’s there to follow his system’s rules.
Your email made it sound like some idea in that quote really hit you. What was so remarkable?
Bill’s process makes the key connection between a mental strategy and a trading system. Your trading system has a set of rules for you to follow that generate an R-multiple distribution. It’s the system’s job to make decisions, not the trader’s. This is a very big piece of the puzzle to being a successful trader and it really brings me back to the foundation of successful trading — myself.
What do you mean by that?
It’s all psychology. If you don’t follow Bill’s strategy, you can’t execute a system to get a valid R multiple distribution for it. Without a valid R multiple distribution, you don’t have a meaningful marble bag to craft position sizing strategies to meet your objectives. Without being able to craft effective position sizing strategies, you can’t meet your objectives. This leads to a cycle of fail, trigger, operate, test, exit, fail, then start over, which probably means looking for a new system. It can become an endless loop and it’s a rat race — you are looking externally for what’s wrong when really it’s all inside — your psychology.
What do you mean by a “meaningful marble bag”?
Van uses a bag of marbles at his workshops to represent a trading system. The marbles in the bag have different colors which represent different R multiple trade results. Pulling out multiple marbles from the bag is just like executing trades — it gets you a set of R multiple results. The bag makes a great metaphor for understanding how to look at a system. Viewing your system as a marble bag simplifies trading so you can use Bill’s mental strategy and forget about being “right” or worry about losing on any given trade. The marble bag brings a trading system into the domain of statistics and probability and mathematics. Once you get to that domain, making trades has a lot less emotional charge. 2+2=4 does not have a lot of charge, it just is, and that’s how you should look at your system.
You think traders don’t view their system this way?
A lot of people seem to believe that the trading system is the most important factor in trading success. That’s where the Holy Grail analogy comes from, but that really shows a lack of awareness that the system is just a set of beliefs. It’s a way to help you generate a set of results consistent with a particular set of rules. How often though do traders bend the rules when they trade a system? You may get “good” results from bending the rules but those results are not the results of the system, they are something else. Actually, that’s a different marble bag than the system’s marble bag.
Why do you think following a system’s rules can be so hard to do?
There are probably lots of reasons but let me just talk about following the rules for a new system. When you trade a system that’s new for you, you have to adopt the beliefs behind the system and they may not match yours. It’s kind of like clothes. You are comfortable in your clothes. If you come to a technical workshop to learn a system, though, you have to take your clothes off and try on the clothes of the trader who teaches the system. Those clothes may or may not “fit” you — figuratively speaking. If, however, you keep your clothes on and try to put the instructor’s clothes over yours for whatever reason, you are definitely going to be uncomfortable. Which items will you remove first in that case? Not your clothes, you’ve been wearing them a long time and they are comfortable. So when trading that new system, you’ll do what feels comfortable which probably means doing something other than “wearing uncomfortable clothes” or following uncomfortable rules.
Systems are just beliefs; they aren’t magic. Sometimes at our technical workshops, though, I have heard people ask, “Am I allowed do ‘this’ instead of ‘that’?” as if “this” would ruin the magic. Again, there is no magic. Adjusting the rules on a positive expectancy system to match your beliefs is going to happen. Those adjustments may keep it profitable or turn it into a negative expectancy system. Once you know that, however, you can identify specific beliefs, choose to let go of them and adopt new ones.
I have seen some traders whose beliefs match closely with the instructor’s and they are able to trade a system well with very few modifications. Nearly everyone, however, needs to make some modifications to the system’s rules based on their own beliefs. Sometimes these modifications work but other times, they generate a negative expectancy. Sometimes people believe that the poor performance comes from a faulty system, but really, it can come down to a new set of clothes that didn’t fit. A system is 100% beliefs so if someone else’s beliefs don’t work for you, figure out ways to use your beliefs to develop a system. Again — all psychology.
Then what advice do you give people about systems?
I encourage people to find any positive expectancy system with a decent SQN score, use the position sizing game to enter a trading system’s R multiple distribution, and trade that — a lot. Once you have your marble bag, you can see how position sizing strategies are what truly help you meet your objectives — not the trading system. Try risking 1% of equity, try more, try less, try the other strategies discussed in The Definitive Guide to Position Sizing Strategies, like market’s money. Get a feel for how the position sizing strategy works together with the system results and what one will work best for you. That said, the limitations of multiple open positions and portfolio heat still matter. I think you could use multiple bags to overcome this limitation of a single marble bag simulation, but regardless, the gains from understanding the idea far outweigh the limitations.
After someone understands the marble bag idea and how position sizing strategies really work, following Bill’s strategy comes a lot easier. And by the way, Bill’s automatic strategy also applies to positions sizing strategies.
How so?
Your position sizing strategy is the engine that will take you where you want to go and helps you avoid where you don’t want to go. Once you set it though, executing it needs to be a matter of following its rules. Say you created a position sizing strategy for a system that helps you meet your objectives. The strategy requires you to take the profit from your last trade and risk it on your next trade. If you are unable to follow Bill’s model with the risk amount, however, then you aren’t executing your position sizing strategy. The system rules, the marble bag results, your objectives, the position sizing strategy — they all work together, but here, none of that matters. So where are you going? What are you doing?
How about you, what are you doing? I’m trying to increase my awareness of my mental processes through the Peak Performance Home Study, Van’s workshops and a lot of self-study. I want to be able to follow Bill’s model and trade really well. In that process, I keep seeing different ways that trading always comes back to psychology.
Great. Thank you very much and good luck.
About Frank: Frank Eaves is one of the research assistants for the Van Tharp Institute and has been with the company for about two years. He is a key contributor to software development initiatives and has a current focus on our newest trading simulator. He prides himself in keeping the rest of the office on its toes with his frank and sarcastic sense of humor
The HOVIS Trader 