Smart Trader

Q: In setting up your own simulation, it asks for an input on margin, but it doesn’t seem to use it when you run a simulation. Since I’m only trading FX and the Aussie 200 Index, which have 100 to 200% leverage, that is a problem. Also, you mention version 4.0, but when I talked to one of your customer service people they didn’t know when it might be available – I asked for some sort of a guess and got six months. Any suggestions on Monte Carlo simulators (free or up to around $100, eg Excel plug ins) in the meantime?

Re leverage, while there is some discussion, I don’t feel like I have a good feel for how leverage might impact many of the points/specific suggestions in the book. One of the areas where it is covered more than in passing is Table 9.3. However, I don’t understand the rationale behind the suggested reductions in portfolio heat. Also, if you have a SQN of 4 (I wish) how much do you suggest reducing portfolio heat if your leverage is 100% and how much if 200%? If your SQN is 1.7 to 2.5, why don’t you reduce maximum portfolio heat if leveraged?

A: 1% risk is 1% risk and it doesn’t matter if you are 100% leveraged or 1000% leverage. That’s critical. Now leverage increases the possibility of ruin with large gaps that go through your stop, but it doesn’t change your risk if you have a stop. Margin doesn’t enter into the game except that you cannot buy more shares of stock than you have cash. Simulators are discussed extensively in the Definitive Guide to Position Sizing.

Q: I have saved some money and am looking to invest about $10,000. I just finished reading Trade Your Way to Financial Freedom and I am wondering what my best options are. Because my account size would be very small and my time somewhat limited I figured something long term would be best to keep transaction costs low. Do you think I should use a percentage based position sizing model. Should I be more aggressive than 1%? I also want to use a value based portfolio filter and would like your suggestions a good book to read on valuation. Thanks for your great book!

A: First, I wouldn't do any investing until
1) You have developed a business plan as a working document to guide your trading. That plan should have a description of the big picture and how you
are going to monitor it. I do this once each month in Tharp's thoughts in
case you do want to do it yourself.
2) Your plan should also have a worse case contingency plan.. and this can take quite a while to develop if you do it from scratch.
3) It should have three systems that fit the big picture.
4) For each system you should know the system quality number (TM) under six different market conditions
1) up volatile
2) up quiet
3) down volatile
4) down quiet
5) sideways volatile
6) sideways quiet
And you should only trade the system in the market conditions under which it performs well.
5) You should thoroughly understand that you are the primary driver of your performance and that if you do not regularly work on yourself, then your performance will suffer.
6) You must have objectives that you have thoroughly researched and that fit you.
And 7) You must understand that it is through position sizing that you meet your objectives.

I recommend that you read 1) My Definitive Guide to Position Sizing; 2) that you take my free Tharp Trader test;
3) that you thoroughly study the Peak Performance Course for Traders and Investors; and 3) that you possibly take my Blueprint for Success workshop.
Now those three suggestions will cost about 25% of your capital... but how
much did you just invest in your education. And do you think you can
really trade well without a reasonable investment in your trading education?