#868 December 13, 2017
  • Feature: A New Super Trader Edge, by Van K. Tharp, Ph.D.
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  • Tips: U.S. Markets — Sector Rotation and What it Tells Us, by D.R. Barton, Jr.
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Feature Article

A New Super Trader Edge
by Van K. Tharp, Ph.D.
Van Tharp
The best traders and investors in the world become that way because they have rich internal maps that allow them to see and capture a huge edge in the market. Let me give you three examples of famous traders/investors who captured such an edge.

First, Ed Seykota is probably one of the best of the traders in the original Market Wizards book. When I was visiting Ed about 20 years ago, his then wife told me that his trading dominated/controlled two different brokerage companies. But how did Ed get into that position? First, he was a computerized trend follower — at a time when there were almost none. And he wrote his systems in assembly language. Second, he really understood position sizing strategies and risk control. And third, he used those two unique advantages during a time of huge inflationary commodity markets. That’s a formula for greatness. Today, my Super Traders easily learn the first two principles and everyone has access to this edge.

Second, let’s look at Sir John Templeton after he had stepped down from managing the Templeton Fund. In 1999, Templeton used his entire fortune to short dot com stocks. At the time, some of those stocks were fluctuating about 20% per day. Templeton rode the highly volatile market watching huge drops in his equity but he stuck to his guns through 1999 and early 2000. The market as a whole really started going down in about March of 2000 and Templeton ended up making a fortune that is almost legendary today. He was at the right place at the right time with a huge edge understanding how overvalued those stocks were.

Third, let’s look at John Paulson. In the mid-2000s, Paulson suspected that the housing market and the value of subprime mortgages were grossly inflated and were headed for a major fall. Paulson began to bet heavily against risky mortgages and against financial companies heavily exposed to those mortgages. Paulson's positions originally lost millions as financials continued to soar in 2006-2007. Instead of backing down, he bet more and put both his hedge fund and his reputation totally on the edge of the abyss. Markets began to implode late in the summer of 2007 but big banks and the government were trying to save financial companies which put Paulson’s shorts at even more risk. Eventually, Paulson made $15 billion dollars for his fund even though others with the same idea got crushed.

By the way, notice that the position sizing strategy of Templeton and Paulson was terrible. They were convinced about an idea and they went all in on it but somehow, they survived and flourished. Today they are thought of as financial legends because they pulled it off.

We believe a huge new edge has emerged similar in scale to the one that the three traders mentioned had. We are going to make that edge available to our Super Traders in two new courses (one will be for Super Traders only) at some point in 2018. I’m not going to talk about it yet because before we start teaching it, I want to uncover all the risky areas that could cause people to crash and burn. Actually, it’s still possible that I will decide that this area is too risky and is not an edge. If so, I will not to teach it to anyone. Should I decide to make it known, however, I believe that our Super Traders could use the edge to recoup their Super Trader tuition — long before they ever complete the program. It’s that good.

I don’t want to talk about where I think the edge is yet. You’ll know soon enough if we announce new courses for 2018. What I can do, is to use a metaphor that gives you some of the issues involved in the edge. As I discuss it, think to yourself, would you take this trade? And if so, under what circumstances?

Here is the metaphor: (THIS IS A METAPHOR. IT IS NOT TRUE.)

Let's say a physicist developed a theory that time travel is possible using a newly-found material called PNT. Most of his academic peers accept this theory so it’s more than just a fantasy. PNT is a substance found at an ancient meteor crash site and the supply is very limited. A company has begun the process of building a time travel machine based on the physicist's theory and they expect the machine to generate enormous revenues. As a result, the PNT material has gone from a price of $150 per ounce to almost $7,500 per ounce in less than a year.

Here is your opportunity: you can invest $100,000 in the only mine for PNT in the world - but there are several catches -

  • You have to invest $100,000. You can invest the whole amount up front or invest a smaller initial amount but then you have to reinvest all of the profits until you reach a total of $100,000 invested in the venture.
  • You will not get any of your original investment in the mine back because it will go for labor and equipment. Once you have invested that money, it’s gone forever. Thus, your profits from the venture over the next year must be enough to return your original investment and earn enough profit to compensate you for the risk.
  • The cost of mining the PNT is $1,000/oz. right now but that cost continues to rise as PNT becomes more and more difficult to extract.
  • PNT is expected to continue to rise in price. It could get as high as $100,000 per oz. or perhaps even $1M per ounce.
  • There is only enough PNT material at the site to mine for the next year. At the end of this year, the supply will be totally gone.
  • You can hold on to your daily allocation of PNT mined hoping for the million-dollar per ounce price. Your other option would be to have the mining company pay you returns on a daily basis. If you choose to receive daily returns, then you must pay income taxes on the dollar value you receive each day as if you had actually received that income.
  • PNT’s price can fluctuate as much as 25% a day depending upon the rumors about the time machine’s development. The price can be manipulated easily by false rumors as well. For example, a rumor that the president of the time machine company had died sent the price of PNT plunging almost 30% but it recovered quickly when he was confirmed still alive.
  • While nearly everyone accepts that time travel is now possible with PNT (remember this is a metaphor), no one has yet built a working machine. It’s possible but engineers are still not sure whether they will be able to do it and how long it would take to build a functioning version. Furthermore, once time travel has been accomplished, the huge projected revenue will still have to materialize in order to justify the staggering prices of PNT. So, despite the scarcity of PNT, several scenarios still make it quite possible that its price could also drop far below its current price or below the mining cost within the next year.

So here are some questions to ask yourself —
  1. How much money would you have to be worth in order to be willing to risk $100,000 in the PNT venture? (Your $100K goes in either all up front or partially up front with profits committed to the investment until the total equals $100K.) This is equivalent to asking, “What percent of your net worth would you be willing to risk on this venture?”
    • None — it’s too risky even though the potential returns are great.
    • A small percentage because I can turn 1-2% into 100%; or
    • Risk it all and hope for a huge return (to be like Templeton and Paulson).

  2. What daily percent return would you want to earn in order to invest in this sort of deal?
  • For example, a 0.5% return per day would give you a yearly return of 182.5%. At a price of $7,500/oz, you would get your money back in 200 days and make an 82.5% return the rest of the year. This is the return at a constant price and cashing out daily. It says nothing about the additional potential price appreciation of PNT.
  • As another example, you could initially commit $50,000 and then reinvest all of the profits until you had $100,000 invested. Let’s say it takes about 200 days to reach $100,000 after which you have another 165 days at ½% return per day. You would make 165% on your $50,000 investment – but you risk something adverse happening with the time machine or to the price of PNT before your first 200 days are up. If something like that happens, you’d lose everything.
Would either of these possibilities attract you? Remember that at any time the time travel company could announce that the machine was impossible to build or instead, that they would need 50 years to construct it. Both scenarios would send the price of PNT below the mining costs — and possibly to $0. In those cases, you will lose your initial investment and you will make no money.

On the other hand, you could accumulate your allocations and hold your PNT until the end of the year. And let’s say PNT went up to $100,000. Now your investment, be it $50,000 plus $50,000 reinvested or $100,000 up front, expands from $82,500 to $825,000. And remember if the time machine could be built by the end of the year, PNT might go as high as $1M per ounce at which point your investment would be $8.25 million.

How would you decide what to do? To make it easy, let’s estimate some scenarios along with probabilities — which were plucked from air (best we can do). At least this gives you something to help you make decisions.

  • Chance of PNT going to zero is 1%.
  • Chance of PNT going below your mining costs is 14%.
  • Chance of PNT fluctuating between $1,000 and $25,000 is 60%.
  • Chance of PNT going between $25,001 and $100,000 is 15%
  • Chance of PNT going between $100,001 and up to a million is 9%
  • Chance of PNT going above a million is 1%.

Would these odds change your mind about the investment? Remember that Templeton and Paulson both invested their entire fortune in ideas that were probably more risky that the PNT example and I personally would not recommend doing that at all. Risking something like 10% of your net worth on such a venture, however, might be worth it.

Finally, there is one more unknown factor involved in PNT — how will the government treat it? Of course, the government stance toward taxing PNT will influence its profit potential.
How might they tax your PNT profits?
  • Scenario A: You can write off a large percentage of your initial investment against your everyday income, much the same way you can with oil and gas drilling investments today. You will be taxed on your profits from the venture, but only when you actually sell the PNT.
  • Scenario B: You will get no write off and you will be taxed on the PNT profits as ordinary income at the current daily rate of conversion as soon as it is removed from the mine. So, if you mine 0.3 oz today at $10,000/oz then you will have to pay income tax on $3,000 for today’s profits — even though you haven’t sold the PNT. Assume that this is the case when you invest, but realize it might change.
  • Scenario C: There is a loophole where you can avoid being taxed on any PNT profits at all. You don’t know if this loophole is entirely legal or not.
  • And lastly, the government could decide that time travel belongs to them and they could take over the time travel company and the mining operations. At best, you might get your $100,000 investment back under this scenario.
Although the PNT example is just a metaphor and an exercise for you to think about how you would behave in these scenarios, it is an important exercise. Furthermore, the edge I am talking about has many similarities to the PNT metaphor and it faces similar issues as well. There is probably some risk of losing the whole initial investment and making nothing. There is a pretty good chance, however, the edge could help Super Traders easily pay for their entire tuition within a year or two. I won’t announce this edge, however, unless I fully believe in it.

The Super Trader program is all about transformation and being able to spot and capture low risk ideas. So given all the scenarios that I described, under what conditions is a PNT investment of $100,000 a low risk idea?

Whether or not we decide to offer new courses about this edge, the price of the Super Trader program is going up to $22,500 per year on Feb 1, 2018 and then it’s going up to $25,000 per year on August 1, 2018.

These increases are coming for the following reasons —
  • We are returning to the yearly price of our original Super Trader program in the 1990s of $25,000 per year.
  • Van’s time is becoming more valuable.
  • The program is getting full so we are capping enrollment at 75 slots permanently. With this cap, 10 slots at most will open up each year.

If you have been considering joining Super Trader program or if you received a Super Trader application at a recent Peak Performance 101 workshop, now is the time to apply and avoid the February 1st price hike. There are no more qualifying workshops before the price increase but if we have any vacant slots after February 1st, we may allow Peak 101 workshop attendees at the February workshop to fill those slots at the current rate.
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Trading Tip

U.S. Markets — Sector Rotation and What it Tells Us
by D.R. Barton, Jr.
Van Tharp
One of the intermediate-term indicators that I always keep an eye on is sector rotation. I believe that seeing where money is flowing can help us understand some of the positioning patterns of investors and traders. And right now, the changes that are taking place give us a very good clue about market health. To get there, let’s look at the long-term and the short-term performance of the nine major S&P Sector Exchange Traded Funds (ETFs).

First, The Long-Term Picture.

In the chart below, we see the performance of the nine ETFs relative to the S&P 500 from January 1st through November 28th:
DR Tip Chart 1
Here we see that Tech far outperformed, the Energy and Consumer Staples sectors significantly underperformed, and all of the other sectors were within 4% of the S&P 500’s returns. I’m guessing that outcome is not too surprising to anyone.

In The Shorter Term…

Since the Thanksgiving break, the markets have shown a unique pattern. Market leading tech stocks have had two significant down days. By itself, this development could be troubling but the breather in the tech onslaught has been met by a resurgence in three sectors: financial, consumer staples and industrial.

We see this sector rotation since the end of November in this chart showing the percent change in the nine major S&P Sector ETFs:
DR Tip Chart 2
In the chart above, the number “1” shows that Tech has been lagging as profit taking has hit the sector. You can see this as the lime green line is near the bottom of the page. We also see at number “2” the top line on the graph — Financials — shows strong outperformance. Significantly, number “3” highlights outperformance currently from the two worst long-term performers for 2017 — Consumer Staples and Energy. Meanwhile, Tech and Utilities take a dive.

All of this is actually a very healthy occurrence. Investors have been taking money out of the strongest sector for the year — technology. Instead of heading that cash to the sidelines, however, investors are rotating it into other sectors that needed to catch up (consumer staples and energy) or that have the most promising prospects (financials and industrial). At the moment, financials are strong due to tax reform plus reduced regulation and industrials are strong due to the growing economy and prospective infrastructure spending.

The bottom line? The market refuses to give us very many reasons to doubt the grinding bull market's ability to grind on into the end of the year — and beyond.

I’ve talked with several traders who are looking for a market pullback in the near term. A 3% - 5% drop would be quite normal and unsurprising. Without any pending outside trigger event like geopolitical unrest occurring, I think the probabilities for such a pullback in December are less than the probabilities for one happening in the New Year.

As always, your thoughts and comments are always welcome - please send them to drbarton “at” vantharp.com

Great Trading,
D. R.

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Use coupon code SALE.
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April 2018 - US
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