Van Tharp Paradox....

Discussion in 'Strategy Development' started by ikkyu, Mar 17, 2006.

  1. ikkyu


    Greetings everyone,

    Long time lurker with his first post...

    I am front testing (i.e. paper/simulated trading) a very simple system that is based primarily on volatility for setups, position sizing, and so forth. Right now I am working with mostly the ER2 and the EUR/JPN.

    I am a big fan of Dr. Van Tharp, but I have seen a paradox in his book "trade your way to financial freedom." He interviews Tom Basso and he states that he wants to enter the market as near the reversal as possible to gain the highest risk-reward ratio possible. However, Tharp himself states says that the market must confirm the move before you enter. He often recommends a volatility breakout as confirmation.

    For example, last thursday I got an relative extreme volatility reading that suggested a reversal in ER2. Price was right at the bottom of a channel. The 80% ATR volitility breakout came the next day. However, using this as an entry signal (in an overall low price vol. environment) the move seemed to be almost half over upon entry. If I had used the volatility extreme as an entry instead of a setup, the trade could have made almost 100% in five days.

    It would take nerves of steel to enter before confirmation, but like Basso states, that is really the ideal entry point.

    Any thoughts on this situation? Is this a fundamental differnce between short term trend following and high probablilty speculations?

    The same problem seems to exist in Connors's VIX reversals.

    Kind regards from England,

    john (ikkyu)
  2. danielc1


    Two different persons explaining there different trade ideas can be a paradox if you compare them.
  3. fconyer


    Basso and Van Tharpe have two fundamentally different ideas about trading.
    Van Tharpe wants to trade with the crowd, Basso wants to trade against it.
    In my opinion Basso is correct. It simply comes down to this: You want to buy when EVERYONE is selling. Your theoretical results from the trade you mentioned are a perfect example. If you wait for confirmation half the move is over.
    If you enter a trade, for a good pre-defined reason with adequate risk control and position sizing, when 999 out of 1000 people be doing the opposite thing, then you have a good trade on your hands. If and when the initial signal is confirmed, you can than add to the initial position with the conviction to press the trade the trade for all it is worth.
    You do not need nerves of steel to trade this way. You needed a plan, which it sounds like you have the beginning of one, and you need to find a way to quantify your risk and become comfortable with it. You can be wrong 80% of the time and still make good money. The hard part is truly accepting that and be satisfied being wrong 8 times out of 10.
  4. Nothing wrong with what anyone on this thread has said really.

    The good thing about the markets are that there are lots of different ways to win or lose money. If u take your "with the volatility" strategy the key is to have enough expected win for the average loss - and a high enough win ratio.

    Whereas the last poster might pick the end and be right 20% of the time but win a lot vs lose a little I tend to the middle of the thrust approach. I win 70% of the time but my average win isnt much bigger than my average loss.

    Just a choice. Find what fits you and provides a return. Realise that every strategy has a form of pain (losing 8 times in a row for the last poster, letting lots of profit go before I get in or after I get out for me). Work it out for yourself. In a few years you will know if you got it right :)
  5. fconyer


    I apologize for my for my poor grammar. I failed to proof-read my previous post.

    kiwi-trader said, "the key is to have enough expected win for the average loss - and a high enough win ratio."

    Statistically this is referred to as "positive expectancy."

    kiwi_trader is correct, one can be profitable with a low gain/loss ratio and a high win/loss ratio. However, it is nearly impossible to produce stellar returns, say 50%/year unless you hit a couple of home runs. My year is always made on just a handful of trades.
    The rest of the time I am just protecting capital.
  6. "Conventional Wisdom" always says to wait for confirmation. But ...

    To be better than the crowd, you can't think like the crowd. Accordingly, I agree with Basso and basically that's how I trade as well. Except in cases where I think the market is breaking out for a major move in which case I will buy after the move has started, I buy weakness and sell strength before the move is apparent. The only "confirmation" I get is my indicators/system indicate that suggest that the trade is a high probability / low-risk trade.

    I struggled with this for a long time because I wasn't "trading by the book" -- you know, "picking tops and bottoms is a loser's game" type of stuff. However, my system is based on that and the backtesting and results going forward have been proving the validity of my system.

    The point of all of this is you have to trade based on your personality and design a system and risk management that accomodates that. Don't take what everyone says, including me, too literally. It's all about being consistently profitable and managing risk. If your system does that, trade it.

    Good luck!
  7. John,

    I have never been a fan of Van Tharpe mostly because I think NLP is stupid and he uses it to much BUT to address your question on volatility extremes I agree that you should WAIT for confirmation before entry and this was an isolated case that you need to just forget about.

    You will be better off 7 out of 10 times if you wait. imo :)
  8. ikkyu


    Great discussion, folks.

    I really appreciate the well thought out responses.

    The system I am shooting for would trade a minimum number of times a year. My ballpark now would be less then 10 trades. Along those lines, I am really fishing for the few bigger winners, as I believe fconyer is.

    Perhaps a compromise would be to enter with something like 1/4 ATR confirmation in the direction of the anticipated reversal.

    Looking forward to more great posts....

  9. ikkyu



    What is NLP?