These Marbles Determine Your Success as a Trader
Editor's note: We still expect a big end to the year for stocks...
But with this year's bullish run, some folks might be concerned that stocks have gotten too far ahead of themselves.
That's why Pete Carmasino – chief market strategist for our corporate affiliate Chaikin Analytics – stresses you must put mechanisms in place to avoid taking on too much risk.
In today's Masters Series, originally from the November 21 issue of the Chaikin PowerFeed e-letter, Pete shares a method you can use to keep your risk tolerance in check...
These Marbles Determine Your Success as a Trader
Let's play a game that could change your life...
It's a trading game. Here's how it works...
Each player starts with $100,000 in fake money.
The game operator has a bag of marbles. Each marble represents a trade result. So the bag is filled with "winning" and "losing" marbles.
The game operator draws 50 marbles, one at a time. And players can bet any amount they want before he picks each marble.
The goal is to have the most money at the end of 50 rounds.
You just need to bet on the outcome of each marble draw. And here's the kicker...
The odds are in your favor.
You see, 60% of the marbles represent winning trades. The other 40% are losers.
Sounds easy, right?
You'd think that any decent trader would come out ahead in this scenario. And you'd think that some folks would end up with big profits on their fake money.
But after all 50 rounds, the game operator shares the results. They're shocking...
Only about a third of the players made a profit. The other two-thirds lost money. And of those losing players... half are completely broke.
Everyone followed the 50 marbles in the same order. But there was one big difference...
How they bet.
On any given trade, most people just bet an amount that "feels right."
Sometimes, betting what feels right works. Dumb luck can lead the trader to a winner.
But as this trading game shows, it could make you broke over the longer term.
Legendary trader Van K. Tharp popularized the "marble game" at his seminars...
Tharp earned a PhD in psychology from the University of Oklahoma Health Sciences Center in 1975. That became the foundation for his unique approach to trading.
In short, Tharp emphasized the importance of having a trading plan and sticking to it.
Related to that, the marble game is a classic lesson about position sizing.
Think about the jar of 50 marbles...
Tharp blindly pulled one marble out at a time. So the people playing the game might've needed to deal with two, three, or even more losing marbles in a row.
Imagine if they risked 10% or 20% of their fake money on each losing marble. A string of losses with that type of position sizing could spell ruin fast.
But what if they only risked 2% of the $100,000 on each trade?
That would allow these folks to endure three straight losses more easily.
The marble game proves that good money management can turn an OK system into a winner. And bad money management can ruin even the best system.
Tharp's marble game is a smart, hands-on way to learn about trading risk.
Ultimately, the correct position size for any trade is a personal decision. And two concepts help define the risk you take on...
One is the actual willingness to take on that risk. The other one is the capability to do it.
Of course, I don't know your specific risk tolerance...
So the best I can do is discuss position sizing with a hypothetical account size... such as the $100,000 I used earlier. Then, the next step is to add a hypothetical percentage of risk to take per trade – like the 2% figure I mentioned.
First, you need to decide how much cash you can comfortably risk on each trade. After that, you can determine the size of the position.
No matter what specific numbers you come up with, the key is to make sure your portfolio can withstand a few losses.
Even when the odds are in your favor, Tharp's game shows that it's possible to pull multiple losing marbles in a row... and keep on trading.
Good investing,
Pete Carmasino
Editor's note: Over the past month, investors have been distracted by President-elect Donald Trump's election victory and the market's bullish run. But Chaikin Analytics founder Marc Chaikin says a massive post-election surprise will result in a seismic market shift soon...
He believes your ability to do well with your investments in 2025 depends on one critical decision you must make before December 23. So he's going on camera on Tuesday, December 13, to reveal exactly what you can do to prepare. Learn more here...