Top critical review
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Only just a beginning
on 25 August 2007
What this book discusses are futures and other highly leveraged financial products which are sum-zero games. This means that if you make a profit then someone, somewhere, makes a loss. It also means that the longer you play the game the more likely you are to run into a prolonged losing streak with serious financial consequences. To be able to stay in the game your trading strategy needs to be superior to the majority of other traders who are also playing. Many are professionals with access to considerable computing power and the ability to constantly analyse in depth such factors as entry and exit points and profit expectancy. The expertise of the other players means that the man in the street is likely to enter these markets with both hands tied behind his back and discover it is a very easy way to lose money!
Even the author of this book, Van Tharp, doesn't demonstrate that he is a successful trader. Consequently, it is not surprising there is no evidence that the ideas he puts forward actually currently work over a meaningful time scale. It is obvious that Van Tharp has researched the subject in depth and this is impressively reflected in the book which makes for interesting reading. However, it is important to realise that this book primarily reviews the work of others rather than calls on his own personal experience. One of the major drawbacks of that is trading strategies which have been successful in the past cease to be so once they are in the public domain and simply to repeat them is rarely a recipe for success. This is particularly true of the trend following techniques he advises.
To have any hope of achieving what the title of this book suggests depends on two ingredients. The first which is essential is the ability to select stocks that are more likely than not to move in your favour. It is here that the book is especially weak. More of that in a moment. The second which is highly desirable is to bet on these stocks in such a way as to maximise profit but at the same time to minimise risk. This second ingredient is bound up in what is known as position sizing which is a rabbit which Van Tharp pulls out of the hat with a great deal of panache. Clearly, from the number of 5 star ratings this book has achieved, both in the UK and US, readers are impressed and reflects how easily Van Tharp has been able to convince people who have little or no understanding or experience of these markets and who are not in a position to evaluate this book objectively.
What Van Tharp says about position sizing is fundamentally correct. However, it is important to realise that to work out the figures you must have a history of profitable trading. If you don't then this book will be of little practical help to you. Nor will it help you to make your trading profitable. If, however, you are already trading successfully then this book deals with the subject of position sizing at too superficial a level to be particularly useful. You will also need to look elsewhere. Van Tharp directs the reader to his own website, for which this book acts largely as a platform, where further information is available at significant cost. An alternative is the bibliography which is a little goldmine!
As far as the most important aspect of trading is concerned, that of stock selection, Van Tharp suggests it isn't possible to forecast how stocks will move and consequently it is largely pointless to try. He therefore attaches minimal importance to stock evaluation and selection. His advocates keeping control of a portfolio by using trend following techniques and stop losses which are well known strategies that weed out the losers while allowing the winners to advance. By their nature they produce a large number of small losses and a few large gains. In the right hands they can be sensible strategies but Van Tharp implies they are inherently capable of achieving a profit. Basically, all you have to do is to use any one of a variety of stock selection strategies, which one is not especially relevant, apply to it the stop loss principles and also the appropriate position sizing and maximise the profits. Wonderful - a free lunch. If only it was that easy!
Van Tharp gives examples of how position sizing affects profits. The models were back-tested using a trading strategy that involved breakouts and stop losses. The strategy was employed very successfully by a group of traders in the 1970's. His best model demonstrates a compound annualised profit of 23%. This appears to be attractive until you apply the strategy to different time frames and to different markets and realise that it is now just as likely to produce similar losses. Position sizing techniques haven't stopped working. What has happened is whereas in the past the strategy selected stocks that were more likely to advance than not, now it doesn't. Too many people are on the bandwagon and have eroded away the advantage.
The simple fact is it is impossible to trade these markets successfully without stock selection expertise, irrespective of how good the position sizing strategy might be. Position sizing, itself, will not produce profits. All it can do is to maximise an already profitable trading strategy. The bottom line is that this, in turn, depends on being able to select stocks that are more than likely to perform in your favour. There is no free lunch! The question of selection and bet size are comprehensively and authoritatively dealt with in the book "Commonsense Betting" by Dick Mitchell. Although written for the race-goer, the principles are the same and clearly explained by someone who, unlike Van Tharp, speaks from practical experience and success.