Dr. Van K. Tharp has written a complete guide on how to trade commodity futures and stocks successfully in Trade Your Way To Financial Freedom, Second Edition. He begins with the reasons why many investors and traders lose money in this business and then he progresses to the areas where traders should focus their attention. Van Tharp is a trader and he has spoken with and coached many professional traders in his career, which gives him an excellent insight into what it takes to become a successful trader.
Entries are not The Holy Grail of Trading
Most traders and investors concentrate on when and where to buy, which Van Tharp points out is not the most important part of trading commodities. In fact, you could almost use a random entry and make money as long as you
manage your risk properly. Most books on trading commodities mainly focus on the entry price and show example after example of how you would have made piles of money by using a specific entry technique.
I have to commend Van Tharp for shedding light on this issue. Most investors and traders don’t realize this, but it is absolutely true. I once had the same problem trading commodities years ago where I would have excellent entry points, but I would cut my profits short or I would take a few large losses. I didn’t become a successful trader until I learned to focus on my exits and controlling my risk.
Exits and Risk Control
In Trade Your Way To Financial Freedom, Van Tharp extensively covers how you should focus your attention on when to exit a position and reward-to-risk ratios. He defines the amount you are willing to risk on a trade as
R. For example, if you risk $500 on a trade, then R would equal $500. You normally want a multiple of
R as your profit objective – 2
R, 3
R, etc.
When you do your research and develop a trading system, R will give you a good expectancy of your future results. You cannot expect to make money in the future if your average win equals 1.2 R and your average loss equals 1.1R, while only 40 percent of your trades are profitable. And there will be the inevitable mistakes that you will make, which will lower your expected results.
Position Sizing in Trading
Van Tharp also puts a great deal of emphasis on position sizing. This tells you the size of a position you should take, relative to the size of your account. This is where many commodity and stock traders get into trouble. They over-leverage their accounts and it is only a matter of time before they get wiped-out. You want to find a good balance between drawdowns in your trading account and overall returns. Tharp presents several strategies you can implement for position sizing.
Putting It All Together
Trade Your Way To Financial Freedom, Second Edition dispels some myths of trading commodities and stocks that have distorted the thinking of many aspiring traders. Van Tharp tries to put traders in the right frame of mind to trade successfully and then he presents several examples of how to do it. This book should be an excellent read for new and struggling traders. Those who are already successful traders may find a couple interesting points here and it may serve as a good refresher.
