The Best

THE BEST
CONVERSATIONS
hy Pict
-M. GORDON PUBLISHING GROUP
Have you ever wanted to spend time learning the strategies of
some of the very best traders and hedge fund managers in the
world? With The Best: TradingMarkets.com Conversations With
Top Traders you will read, learn, and absorb how these individuals
reached the pinnacle of trading excellence.
Among the things you will learn in this book:
Gil Morales & Christian Kacher Ph.D. — Over an 18-month
period, Gil Morales tallied a return of over 3200% in his personal
account. Christian Kacher Ph.D. amassed a mind-boggling return
of over 70,000% over a 4 % year period. In their joint interview,
these William O'Neil (founder of Investors Business Daily)
disciples share with you the tools of their trade, what they
consider their most profitable chart patterns, and when they
decide to nail down profits in their funds for you to apply in your
own trading.
Kevin Haggerty — As Senior Vice President and manager of
Equity Trading at Fidelity Capital Markets, Kevin controlled how
Fidelity Capital Markets moved its considerable assets into and
out of stocks. Now, he reveals to you his strategy for reading and
reacting to the actions of institutions, specialists, program traders
and other market players that shape price action. Kevin also gives
you what he considers to be his most important lesson after 25
years of trading and his best advice for traders just starting out.
Lewis Borsellino — Ever make $1.3 million on one trade? Lewis
Borsellino has. The fabled Merc trader and S&P futures pit shark
shares with you the 10 commandments of trading that have made
him one of the biggest and best traders in the world. Borsellino
also shares his strategy for reading Fed interest rate moves with
you and then he tells you how he applies that information to his
S&P Futures trading. Additionally, he provides you with-his exit
strategy, trading philosophy, and tips for beginners. Finally, see if
you pass his litmus test for defining what it takes to become a
successful trader.
Jon Najarian — After 19 years of experience in options trading,
the other “Dr. J", Jon Najarian, comes clean and tells you about
his journey from unpaid clerk to manager of two hedge funds
worth over $8 million. After retiring from over a decade and a half
in the pits, Najarian has moved out of the pits to the “upstairs”
and has graciously detailed for you the advantages and
disadvantages of trading on the floor and off. Specifically, he
covers the distinct advantages that pit traders have over retail
options customers and recommends to you the best trading
strategies for off-floor traders to use to nullify those
disadvantages. For beginners, he reveals a basic, high-probability
strategy that can help make you a consistently more profitable
trader. .
As you can see, whether you trade stocks, futures, options, short-
term, are a daytraderorlong-term fundamental investor, this book
contains effective, straight-forward advice to help you improve
your trading results. Capture for yourself the best insights and
most successful strategies from some of the best traders in: the
world.
445 S. Figueroa Street, Suite 2930

Los Angeles, California 90071
213.955.5777 Fax: 213.955.4242
Become An Even Better Trader www.mgordonpub.com
THE BEST:
MARRES
CONVERSATIONS WITH TOP TRADERS
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THE BEST:
CONVERSATIONS WITH TOP TRADERS
Kevin N. Marder
Marc Dupée
04. GORDON P hese SHING GHROUOr

Los Angeles, California
Copyright © 2000, TradingMarkets.com
ALL RIGHTS RESERVED. No part ofthis publication may be reproduced, stored in a retrieval sys-
tem, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or
otherwise, without the prior written permission of the publisher and the authors.
This publication is designed to provide accurate and authoritative information in regard to the subject
matter covered. It is sold with the understanding that the authors and the publisher are not engaged in
rendering legal, accounting, or other professional service.
Authorization to photocopy items for internal or personal use, or for the internal or personal use of spe-
cific clients, is granted by M. Gordon Publishing Group, Inc., provided that the U.S. $7.00 per page
fee is paid directly to M. Gordon Publishing Group, Inc., 1-213-955-5777.
ISBN 1-893756-08-4
Printed in the United States of America
Cover design by Conrad Kalil using an image from Bryan Reinhard/Masterfile. The book was typeset
in Garmond by Judy Brown.
10 my parents, who gave
me all that mattered.
Kevin N. Marder
lo Barbara Dupée, my mother,

for her enduring enthusiasm
and gentle encouragement.
Marc Dupée
Digitized by the Internet Archive
In 2021 with funding from
Kahle/Austin Foundation
htips://archive.org/details/besttradingmarke0000mard
CONTENTS
FOREWORD XI
ACKNOWLEDGMENTS XV
THE INTERVIEWS
GiL MORALES AND DR. CHRISTIAN KACHER
THE DISCIPLES 1
KEVIN HAGGERTY
TRADING WITH THE GENERALS 33

CEDD Moses
© 63
MarK BOUCHER
THE MIDAS TOUCH 89
LEWIS BORSELLINO
BIG ITALY 107
vill @ CONTENTS
(OAR ea aN a RTI Ol cE iG ON I TIN Ty RE OI SER NO ENT eit SRE
DAVID RYAN
THE TRAIL BLAZER 133

JEFF COOPER
HIT AND RUN 145

WILLIAM GREENSPAN
PIT MECHANIC 161

JON NAJARIAN
MERCURY RISING 189

GREG KUHN
PASSIONATE PLAYER 209

DAVID KUANG
THE COMEBACK KID 231
ON THE CUS
DAVID BAKER ©
THE WHIZ KID 253
MANUEL OCHOA
STEALTH 271
JIM WHITNER
ONLY THE HUMBLE SURVIVE 291
TEEN 5 ETE SCRA POE EERE SET UL SLEPT TTL TE A I SS UTS TS

CONTENTS @ ix
ia Re PPE a RR IE Pre a ee EE RDN BE RMI i OE Sa 7EIT ing! 75dt
FINAL THOUGHTS 305

ABOUT THE AUTHORS 315
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FOREWORD
his book is all about great traders. How they started, how they took their
hard knocks, and how they arrived at a strategy to conquer the markets. In
“short, how they became great traders.
Consider this: One trader’s personal account appreciated 70,000 percent in
the 4 1/2-year period ended June 30, 2000.
Another grew his account by 3,270 percent in the 18 months ended June
30, 2000.
Another was the former head of trading at Fidelity Capital Markets from
1990 to 1997. He had 94 traders reporting to him each day.
Another, after losing 90 percent of his account in the 1973-1974 bear mar-
ket, turned his career around enough to be ranked by Nelson’s Best Money Man-
agers as the No. | hedge fund manager in the world for global macro strategy in
the five-year periods ended 1997 and 1998.
Another was the biggest S&P 500 futures trader, a man that all other trad-
ers in the S&P futures pit feared so much that they felt compelled to keep an eye
on him at all times.
Another, after a calamitous start that included a $20,000 loss in his first
nine days as well as his boss’ comment that he was “redefining the definition of
XI
xil_ @ FOREWORD
Re I ET IRS I De RE PEEA TENOR FE ES GT TE EIEN IESEETS cP RT ARES
bad luck,” earned $1.8 million in only his second full year of daytrading, exceed-
ing the seven-figure threshold in each of the next two years.
Another won the U.S. Investing Championship three times before opening
up his own hedge fund.
Another set a record return for the U.S. Investing Championship, then pro-
ceeded to catapult his hedge fund into the top 1 percent of all hedge funds for
the three years ended May 2000.
When I began my trading career in 1986, there was no one to turn to for
advice, no Internet, and precious few books that were written from the perspec-
tive of some of the world’s top traders. Today, most traders find our era's infor-
mation overload downright overwhelming. In 1986, however, if you were an
aspiring trader, you ached for it.
In any of life's pursuits, whether it be playing tennis, cooking, or playing a
musical instrument, the quickest route to success is to learn from someone better
than you. Of course, the absolute best way is to learn from the very best in a
particular field. In the case of trading, though, how often do you get a close-up
peek at what goes on in the minds of some of the world’s top traders? Spe-
cifically, how often do you learn how some of the world’s top traders enter a po-
sition, sell a position, or add to a position?
If you're like most people, the answer is probably “not very often.”
For unless a trader is fortunate enough to have a top trader in his or her cir-
cle of friends or acquaintances, the chances are slim that he or she will come in
contact with one. Even then, it’s sometimes difficult to know exactly who the top
traders are. Many of them deliberately shun the public eye, preferring to lead a
low-profile existence. After all, what do they have to prove?
This book, then, presents an opportunity for traders, both aspiring and pro-
fessional, to benefit from the experiences—both good and bad—of some of the
top traders in the world. Some of the interviews represent the first time a trader
has consented to a full-length interview detailing his strategy of consistently pull-
ing money out of the market.
I learned a lot from interviewing the traders in this book—indeed, far more
than I'd imagined when I began putting it together with Marc Dupée. Although
I’ve read scores upon scores of books since I began trading in 1986, ! walked
SE STE EA I ELE HE SANE ENG ST ED

FOREWORD @ xiii
SE RS PAS TET AT SS ANS PE RAT TE FLEE EERE EAE
away from each and every chapter of this book with something I can integrate
into my own plan of attacking the markets.
My hope is that you will, too.
Kevin N. Marder
July 10, 2000
| Pe with the best. There is nothing that has helped me more in the finan-
cial markets than learning directly from experienced traders: how they think,
what they do, and how they trade.
When I began trading, I had trouble finding successful traders who would
share details of how they traded. The few books that were available on the sub-
ject, I felt, fell short of adequately describing the specifics of what successful trad-
ers did and how they traded. By compiling these interviews, I believe we have
provided to traders of all stripes a source that allows readers to get inside the
minds of victorious traders: traders who are down in the trenches taking money
out of the markets almost every day.
Differing ideas, approaches, and techniques are what make a market. We
have assembled a cross-section of top traders, who, despite their differing ap-
proaches to the market, have experienced unusual success. And herein lies one of
the enduring benefits of this book. Whatever your temperament, time frame, or
experience level, there is something from the conversations that you can take and
immediately apply to make you a better trader.
In short, we have sought to create a manuscript that mentors. My hope is
that the combination of technique and candor shared by the traders in this book
will help you achieve greater success in the trading markets.
Marc Dupée
July 9, 2000
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ACKNOWLEDGMENTS
hanks to Toni and Jim Kaplan for being my first believers and for making it
all possible. Thanks to Larry Connors, a trader’s trader if ever there was
one. Thanks to Bill O’Neil for changing my entire life. Marc Dupée and Eddie
Kwong, friends and colleagues, thanks for your help in making this book a real-
ity. Greg Kuhn, thanks for the inspiration. Jeff Cooper, thanks for the vote of
confidence. David Ryan, thanks for all of your encouragement. Gil Morales and
Christian Kacher, thanks for all of your sharing. Danilo Torres and Marianne
Winfield, thanks for all of the behind-the-scenes work. Cedd Moses, thanks for
setting the example early on. Dave Baker, thanks for the zeal.
Long live the California Momentum School.
Kevin N. Marder
XV
xvi @ ACKNOWLEDGMENTS
Bos are collaborative efforts and I would like to extend my gratitude to ev-
eryone involved. I would also like to give a special thank you to the follow-
ing:
To the traders interviewed, for sharing their knowledge. To Larry Connors,
whose vision and drive bring to life projects such as these. To Kevin Marder, for
his friendship, insight, and editorial judgment. To Suzie Stubbs, for her patience
and understanding. To Mark Etzkorn, for his contribution to the Manuel Ochoa,
Kevin Haggerty, and William Greenspan interviews. To Eddie Kwong and
Marianne Winfield, for their levity and assistance with charts and the manu-
script. To the TradingMarkets.com team, for their support and dedication
throughout.
Marc Dupée
GIL MORALES
AND
DR. CHRISTIAN KACHER
THE DISCIPLES
a By Kevin N. Marder
Y would be hard-pressed to find a trader with a more outstanding track re-

cord than either Gil Morales or Dr. Christian Kacher. Simply, these guys are
monsters. Gil took a personal account of his and grew it by 3,270 percent in the
18 months ended June 30, 2000. Not to be outdone, Chris’s personal account
swelled by 70,472 percent in the 4 1/2 years ended June 30, 2000. I verified
both sets of results with brokerage account statements.
Gil and Chris are portfolio managers for William O'Neil + Co., managing
the company’s internal investment account. Gil also runs the institutional services
division of the company, which provides research for institutional investors. I first
met Gil and Chris in November 1999 through my friend Greg Kuhn, who intro-
duced us at an O’Neil investment seminar.
2 @ THE DISCIPLES
(EMILE atesags) oo TTB gl eR SC PR LET,
Some top traders don’t like to share their secrets and findings with others.
Gil and Chris, on the other hand, couldn't be more different, as you will see in
the following conversation which took place in December 1999, January 2000,
and July 2000.
Kevin N. Marder: Gil, how did you get started in the stock market?
Gil Morales: I first became interested in the financial arena at Stanford where |
majored in economics and took some courses in investment analysis. Ironically,
absolutely none of what I learned about investments in college do I use today.
Right after I graduated from Stanford I received a job offer from Caterpillar
Tractor in Peoria. Instead of taking the job, I took the advice of my advisor, John
Cogan. He thought I should do something crazy, so I decided to publish in book
form a collection of comic strips titled “Dupie” that I had drawn for The Stan-
ford Daily while I was in school. That sold fairly well and then Ballantine Books
in New York came along and asked me to do a second book. They got me a
publicist and were billing me as “the next Doonesbury.” I was doing interviews
on talk shows, CNN, CBS News Radio, etc. to promote the book, and the Los
Angeles Times Syndicate was looking at picking up the strip for distribution. So
here I was, right out of college and I was a professional cartoonist with a Stan-
ford economics degree. I spent the next several years as a cartoonist, illustrator
and graphic designer, which was about as far away from the stock market as you
could be.
The big turn occurred in 1987, when I moved to Maui, Hawaii to start my
own graphics firm. That failed miserably, and I limped back to Palo Alto, Califor-
nia in October 1987. Since I was broke, I was staying with one of my best friends,
David Schneider. Dave was in the market pretty heavily at the time and he asked
me what I thought of the market. I just kind of blurted out, “Sell everything!”
Well, the truth is, I didn’t have a clue what I was talking about. But Dave followed
my advice which ended up saving him a lot of money, since the market crashed a
few days later. From that point on he became a constant influence, telling me J
should become a broker and that he thought I was smarter than his broker, etc. So
Dave planted that seed in my head.
(SEES TERS ES, STAR AE Pe PS RAD

Gil Morales and Dr. Christian Kacher # 3
SA
TS EIT Nd
One thing led to another, and I found myself back in Los Angeles in 1991.
I took a temp job at a Dean Witter office in San Marino, a suburb of Los An-
geles. After a while, the manager, Scott Hennington, suggested that | apply for a
broker position with Dean Witter. So I took this test that you had to pass to be-
come a Dean Witter broker, and failed it! Incidentally, Bill O’Neil took the same
test when he was first looking for a job as a stockbroker, and he failed it as well.
Well, Dean Witter wasn't going to hire me because I failed their test, so I got
mad and finally ended up walking into Merrill Lynch in Beverly Hills where |
landed a broker trainee position.
Anyway, I started reading everything I could get my hands on, but nothing
really got me excited. Finally I came across Bill’s book, How to Make Money in
Stocks, and a light went on in a big way.
| can relate. When | first read Bill's book in 1990, | got to page 70 or so, and a
giant light bulb went on in my head. | was so excited that I'd finally come
across a book that made it all come together! And | remember putting the
bgok down at that point, pacing the living room floor, getting very excited.
I made all kinds of notes in the book and carried it around with me wherever I
went. One day the book is sitting on my desk and this little old guy, a senior
broker at Merrill by the name of Harry Wayne, comes waddling by, points at the
book on my desk with Bill’s picture on it, and says, “I hired that guy.” As it
turned out, Harry was Bill O’Neil’s first boss and the guy who hired Bill into the
business when he was first looking for a job. So Harry and I became good friends
and I would give him stock ideas which he would do some nice business with.
Harry introduced me to Bill, and I had several opportunities to talk with Bill at
investor meetings for Bill’s old New USA Fund, Harry’s birthday parties, etc.
In 1994 I left Merrill and went to PaineWebber, where I began to focus en-
tirely on catering to investors who were interested in Bill’s methodology,
CANSLIM. So I chucked my entire Merrill Lynch client base, which consisted of
mutual funds, wrap accounts, insurance, and financial planning . . . all that bor-
ing financial consultant baloney. My wife Linda thought I was crazy throwing
away the client base I had spent the last three years building in order to try this
4 @ THE DISCIPLES
{ec i emp ee TR I PRET AEP I NO TT IS LE OTE,
new idea. Anyway, Harry told Bill about my plan, and I remember my first day
at PaineWebber. Bill called me up and gave me a little pep talk which helped al-
lay my nervousness about starting at a new firm with this crazy idea of only
managing CANSLIM accounts. As it turned out, my crazy plan ended up blos-
soming nicely as my business shot up to over $1 million in commissions a year
and I became one of the quickest million-dollar producers ever at Paine Webber.
Bill had been casually following my progress through Harry, who had re-
tired and then become a client of mine. In September of 1997 I went out to
lunch with Kathy Sherman, the head of communications and public relations at
Investors Business Daily, and a couple of her friends who wanted to open accounts
with me. After lunch, Kathy told me that Bill asked if Iwouldn't mind stopping
by their offices to chat with him. So I stopped by and talked with Bill for a
while, where he sprung this whole idea of recruiting me to run his Institutional
Services group and manage internal money for him. Needless to say, it was an of-
fer I couldn't refuse, because here I am.
And, Chris, how did you first become involved in the stock market?
Dr. Christian Kacher: I think it’s always been in my blood. When I was in ele-
mentary school, I was interested in stamps and coins. I collected them as tools of
speculation, not because they looked pretty, like most kids would. At a young
age, I think I had an innate sense of the ability for things to appreciate in value.
I attempted to actually make money in stamps in elementary school. This was
back when the price of stamps was surging. I mean every three months these
things would go higher and higher in price. Then when I was 11, I began to
track price movements of precious metals. My mom was a top-grossing broker
for Merrill Lynch and she received a Bill O’Neil product, Daily Graphs, as well as
The Wall Street Journal in the mail. I would clip the listings of precious metals’
spot prices from The Wall Street Journal each day and paste them in a notebook.
This was in ‘79 and ‘80 when gold and silver were making huge moves. This was
very fascinating for me.
And then at age 12, I bought my first stock, which was Apple Computer. It
just started to gain momentum . . . the whole concept of how stocks seemed to
BESIDES SLE RSLS RES Oe TS TE ET SS

A SRE NO Sa AR A A EI ER Es IE OE ESAs) 2TM es
be the ultimate vehicle for being able to buy and sell and make money off price
movements. | would say my interest in stocks really took off after reading Bill’s
book. That really made me understand that it was actually possible to consis-
tently score big gains in the market. I started devouring Daily Graphs each week
in college. I would scrutinize each of the charts in Daily Graphs on the weekends.
I began to carry a copy of the latest issue of Daily Graphs with me wherever |
went so I would always have a chance to look at charts. At that point, my trad-
ing started to work. Prior to that point, I was just dabbling and I would carry a
position for years. I wasn’t really a trader. I had an interest in the market but I
wasnt really making much headway.
After reading Bill’s book, I started reading a number of other books on the
market that were also helpful in trading. I remember telling my mom once that
you cant beat the markets because they're all fairly efficient. I bought that school
of reasoning. But Bill’s book kind of broke through the ice and really made me
understand that the markets are not purely efficient and that there is rhyme and
reason to these chart patterns.
Once you got out of college, was the O'Neil Co. job your first gig in the
business, or were you somewhere else before you came to O'Neil?
Kacher: I finished my BS degree in chemistry at Berkeley and I went right into

the graduate program at Berkeley. It was the Ph.D. program in nuclear chemistry.
At that point, I didn’t feel that I had a real trading methodology. My interest in
the market was definitely building. But I didn’t feel confident that I could strike
out and go right to a job as a professional trader or a market maker or anything
like that. I had very strong ties to chemistry, so it was a natural progression to go
from chemistry in undergrad to nuclear chemistry in grad school. In graduate
school, my interest just completely took off. At the end of my first year in grad
school, I finally understood what a base breakout was, that it wasn’t just arbitrary,
that there was some sense to it. I just totally immersed myself in the business li-
brary, where we had archived copies of Daily Graphs and many other publica-
tions. I started to devise all of these econometric models in my attempts to time
the market. I came up with these crazy models with Excel spreadsheets and I fi-
6 @ THE DISCIPLES
ERTS ARTETA YL I TN ET TI ATER TEED
nally came full circle and realized that none of those models really worked. I
came back to the basics of just looking at chart patterns and using those chart
patterns to anticipate moves in the market.
About halfway through grad school I almost quit because my interest in the
market was so great. I just wanted to quit and go trade the market. I would have
taken a junior analyst position anywhere just to get my foot in the door in this
field. But I realized quickly that most places weren't going to hire me in that situ-
ation. I didn’t have any formal training or experience in economics or business or
any of that. So I decided to stick it out and finish the degree and then decide,
figuring that the degree would open-a lot of doors for me, which it did. So it was
the right decision.
In my third year of grad school, I started a Web site called The Virtues of
Selfish Investing. It was designed to help investors pick good stocks using the
CANSLIM method. I started investing successfully in 1991, and by the time |
put the site up in 1995 I had a nice little track record. I was beating the market
every year. I put all of my trades up on the site just for the record. It was a sub-
scription-based service and, lo and behold, the $90 checks started coming in on a
daily basis. All of a sudden I found that I was making some pretty good cash for
a graduate student, just setting up a Web site that cost me absolutely nothing
and giving people advice on what my stock picks were.
At the same time, I was prospecting for a job in the field, knowing that |
wasnt going to go into nuclear chemistry as a career. A year and a half before |
was going to graduate, I knew what the odds were of getting into this field—they
were pretty slim. I was frantically cold-calling money managers across the U.S. I
must have called 300 of them. I went into an informational interview with a guy
in L.A. who was one of the big fund managers for Trust Company Of The West.
We had our nice little interview and he gave me some friendly advice. We parted,
and two weeks later he called me at Berkeley and said, “I want to try something
new that we've never done in the long history of Trust Company of the West.
We're going to hire you while you're still in grad school. And youre going to ad-
vise me on which stocks I should play. You're going to be one of my advisors.” I
signed something like a million different forms and I became an employee of
Trust Company of the West while still a grad student. They paid me this nice
(STEUNSITE TRESS PSE LDN AT STS

ae ESE SAR 2
salary and I was an advisor to Charlie Larson, who | would say really gave me
my start in the business. I worked for him for about a year, advising him on my
picks.
This was in 1995 when we were in a great market. | happened to hit some
pretty big ones. He was very open to giving me any kind of letter of recommen-
dation I needed and helping me along once I graduated so that I could get a per-
manent job in the field. He knew what my whole strategy was and he said that I,
without question, should apply to William O’Neil + Co. He thought that would
be the perfect fit for me and pushed me into that direction. I interviewed with
the O’Neil company and they made me an offer, which I accepted. As far as all
of the other job offers that were pending, I didn’t even want to hear about what
they were going to offer me dollar-wise. I knew that this was the place for me.
Money was not an issue. I just wanted to be able to work here.
What did you start doing for the company?
Kacher: They started me off in data research, which is kind of like the bottom
rung in the organization. I came to work here with this incredible passion. I’d
have to say that since I started working here Jan. 22, 1996, there hasn’t been one
day that I’ve gotten up in the morning and not wanted to come to work.
Whereas in grad school there were many, many days when I just didn’t want to
get up and go into the lab. It was like night and day. My whole life just took a
dramatic turn for the better by coming here and being in the environment that
I’m supposed to be in.
I met some fascinating people. In three months of being here, I met one of
the traders who worked for Bill, Dan Morris, who later retired at the age of 33.
He had that same passion for the markets that I had. We used to talk long into
the evenings and sometimes we'd have these nine-hour marathon talks about the
market. It was pretty intense. I knew this was the place for me. I traded my own
account, hoping that Bill would notice eventually. After working for three
months, they gave me a promotion to sell WONDAs, an O’Neil database prod-
uct. So I had the opportunity to fly around the country and talk to money man-
agers about this product that I used to make money in the market. So it was
8 @ THE DISCIPLES
RATESHEET IE NO FID ET PO IE IONE LIRR GEIS
something I totally believed in. In the process of flying around the country, I had
several job offers thrown at me. Of course I didn’t take any of them.
One of the fascinating people I met was Ed Seykota, who's interviewed in
one of the Market Wizards books. He’s always been one of my favorite interviews
because he’s so intense on the psychological aspects of trading. I spent an entire
day with him and it was a day I'll never forget. I constantly refer to that day be-
cause we basically talked for the whole day. There’s so much that I learned just in
that one day sitting with him and talking with him. He had such an impact on
me because he wanted to psychologically analyze me. He said he could judge
how effective people would be at trading the markets by just sitting and talking
with them and picking their brains. He asked my permission first and said it
could get very intense, which it did. He’s a very strong personality and was very
probing in his questions about my early life experiences and things. I found the
whole process fascinating and at the end of the day he said he didn’t really see
any impediments to me becoming a world class trader. That meant the world to
me, the fact that he would give me that kind of validation. At that point, I really
didn't know Bill very well and had only talked with him once. So this was the
first real validation I got from someone Id truly respected.
A few months later, I ended up getting a job offer in San Diego. This com-
pany basically said it was going to roll the red carpet out for me. They said, “we'll
give you whatever you want, come trade for us, you have a great track record.”
Nineteen ninety-five was the first year I scored a triple-digit gain in the market. In
1996, I scored a triple-digit gain of 218 percent. And in 1997, when I was still
selling WONDAs, I had already run my account up over 100 percent. Dan Mor-
ris, who was still at O’Neil + Co. at the time, said, “it'd be a shame for the firm to
lose you because you trade just like Bill trades.” And on the day that I was packing
my stuff up, getting ready to leave, he went to talk to Bill on my behalf. Bill called
me into his office and made a counteroffer, something that I couldn’t refuse. Natu-
rally, I knew this was the place.
Then I started trading money for him two weeks before the market topped
out in October 1997. So I had just enough time to get on full margin when the
market absolutely topped and I had to completely reverse my positions! Fortu-
nately, I finished that segment from October through the end of the year off a
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couple percent. Nineteen ninety-eight was really the first year that I traded for Bill.
I was up 140 percent that year. And then 1999 was really the great year, being up
566 percent.
That's not your personal account, but the account that you manage for the
company?
Kacher: Right. Its much larger than my personal account. What was interesting
was that even though I traded different stocks for each account during the year,
the percentages were very close, since my personal account was up 584 percent.
That comes back to what Ed Seykota said, that everyone gets what they want out
of the market. I had wanted to get over 500 percent in both of my accounts.
And that’s pretty much what happened.
That's phenomenal!
Kacher: Thanks, Kevin.
a
Let's say your account is 100 percent long. How many positions will you
typically have open with that much of an invested position?
Kacher: If it’s 100 percent long, that means we're either starting a rally or we're
coming off a peak. That means I would probably have about six positions,
maybe seven.
And if you're 200 percent long?
Kacher: I'll typically have anywhere between 10 and 15.
When you initially open a position, is your goal to start off with 10 to 12
percent of your account in that position?
Kacher: Something like that. It depends on the stock, too. If the stock is very
liquid and it’s a top-quality name—an institutional name—and it’s got a perfect
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10 @ THE DISCIPLES
SSIS PRGA oR aR a RZ I PS
breakout, then I will try to ramp into that thing pretty fast . . . you know, be-
cause it poses very little downside risk. But if I’m playing something a little thin-
ner than that, I don’t want to get stuck in the position, so maybe my maximum
size is only going to be 12 percent of my account.
Whereas the first example of the more-liquid, institutional-quality name

would be, what, up to 20 percent?
Kacher: I'd say usually up to 25 percent. My thinking is that if Ihave 25 percent
in top-quality names, then I'll have eight positions at 200 percent invested. And
that’s where I’m always trying to get my account to—eight positions. But in real-
ity, | always find that I’m playing more than eight. Because what happens is I'll
land into a stock and I'll go 25 percent in that stock and realize it’s deficient or
maybe it’s slower. And since I want to get as much juice out of the market when
it is trending, I'll quickly cut that position back. I want to make room for some-
thing else that is just breaking out, especially if ’'m 200 percent margined. So
what I'll do is Pll cut that position back. Maybe I'll go from 25 percent and re-
duce it to 15 percent and then use that extra buying power to initiate a new po-
sition in a new stock that’s breaking out. So when all is said and done, I don't
have eight positions. I have 12 or 13 or 15.
How about you, Gil? If your account is 100 percent long, how many positions
will you have open at that point?
Morales: Anywhere from five to 10. And maybe as few as three to four. As we
progress through a market cycle, I whittle things down.
So you might have up to 35 percent or so in one position if you really feel

good about it?
Morales: Yeah. And that’s how you make your big money. I did that in ‘98 when
my big money was heavily into Schwab. In ‘99, I was heavily into VerticalNet,
Verisign, Ariba, Oracle, and Sun.
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What were your results in 1999?
Morales: I ended up 518 percent and Chris Kacher was up 566 percent.
You two guys hit the ball out of the park as well as anybody in the entire U.S.
stock market in 1999. Can you touch on the basics of what you look for in
your trading strategy?
Kacher: We use tools like WONDA (William O’Neil Direct Access, a Wil-
liam O'Neil + Co. research product) to screen out stocks with certain charac-
teristics. We look for stocks that are in leading groups that are near new price
highs that have high relative strength that have either a really solid, accelerat-
ing earnings track record, or a sales track record. A lot of these new compa-
nies don't have earnings and some of them are not going to be earning money
for maybe another year or so. But their sales are ramping up very nicely, with
high, triple-digit, quarter-over-quarter sales growth. So we look for one or the
other.
What percentage weighting do you place on your fundamental analysis

versus your technical analysis of a particular stock?
Kacher: That's a great question. The way we approach it is we don't buy stock
just on a technical basis. It’s got to have good, solid fundamentals. We want to
buy stocks that are going to lead their space. So we look first for those stocks
that have the strongest fundamentals. And then from there we look at those
stocks that are close to their old highs and are forming sound bases.
Morales: I ask myself a very simple question whenever I’m going to buy a
stock: If it's got the technical formation and the earnings or sales that we're look-
ing for, does this company dominate its industry or does it have the potential to
dominate its industry? And that requires a little bit of putzing around on the
company’s Web site, maybe looking at some other analyst reports, assessing an
industry. And right now, that’s quite a challenge because you have a lot of emerg-
ing industries, what with e-commerce and all.
10 @ THE DISCIPLES
ee
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breakout, then I will try to ramp into that thing pretty fast . . . you know, be-
cause it poses very little downside risk. But if I’m playing something a little thin-
ner than that, I don’t want to get stuck in the position, so maybe my maximum
size is only going to be 12 percent of my account.
Whereas the first example of the more-liquid, institutional-quality name

would be, what, up to 20 percent?
Kacher: I'd say usually up to 25 percent. My thinking is that if Ihave 25 percent
in top-quality names, then I'll have eight positions at 200 percent invested. And
that’s where I’m always trying to get my account to—eight positions. But in real-
ity, I always find that I’m playing more than eight. Because what happens is I'll
land into a stock and I'll go 25 percent in that stock and realize it’s deficient or
maybe it’s slower. And since I want to get as much juice out of the market when
it is trending, I'll quickly cut that position back. I want to make room for some-
thing else that is just breaking out, especially if ’m 200 percent margined. So
what Ill do is I'll cut that position back. Maybe I'll go from 25 percent and re-
duce it to 15 percent and then use that extra buying power to initiate a new po-
sition in a new stock that’s breaking out. So when all is said and done, I don't
have eight positions. I have 12 or 13 or 15.
How about you, Gil? If your account is 100 percent long, how many positions
will you have open at that point?
Morales: Anywhere from five to 10. And maybe as few as three to four. As we
progress through a market cycle, I whittle things down.
So you might have up to 35 percent or so in one position if you really feel

good about it?
Morales: Yeah. And that’s how you make your big money. I did that in ‘98 when
my big money was heavily into Schwab. In ‘99, I was heavily into VerticalNet,
Verisign, Ariba, Oracle, and Sun.
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What were your results in 1999?
Morales: I ended up 518 percent and Chris Kacher was up 566 percent.
You two guys hit the ball out of the park as well as anybody in the entire U.S.
stock market in 1999. Can you touch on the basics of what you look for in
your trading strategy?
Kacher: We use tools like WONDA (William O’Neil Direct Access, a Wil-
liam O'Neil + Co. research product) to screen out stocks with certain charac-
teristics. We look for stocks that are in leading groups that are near new price
highs that have high relative strength that have either a really solid, accelerat-
ing earnings track record, or a sales track record. A lot of these new compa-
nies don't have earnings and some of them are not going to be earning money
for maybe another year or so. But their sales are ramping up very nicely, with
high, triple-digit, quarter-over-quarter sales growth. So we look for one or the
other.
a
What percentage weighting do you place on your fundamental analysis

versus your technical analysis of a particular stock?
Kacher: That's a great question. The way we approach it is we don't buy stock
just on a technical basis. It’s got to have good, solid fundamentals. We want to
buy stocks that are going to lead their space. So we look first for those stocks
that have the strongest fundamentals. And then from there we look at those
stocks that are close to their old highs and are forming sound bases.
Morales: I ask myself a very simple question whenever I’m going to buy a
stock: If it’s got the technical formation and the earnings or sales that we're look-
ing for, does this company dominate its industry or does it have the potential to
dominate its industry? And that requires a little bit of putzing around on the
company’s Web site, maybe looking at some other analyst reports, assessing an
industry. And right now, that’s quite a challenge because you have a lot of emerg-
ing industries, what with e-commerce and all.
12 @ THE DISCIPLES
[SSP a WA en me IE APCS PO TE ES BEI SL I TA ITE
But I am asking myself that question because we do. know that, with the
biggest winning stocks, probably the No. 1 characteristic is that they dominate
their industry. Cisco, Microsoft, Dell, Home Depot, Wal-Mart, you can go down
the line. And that’s really what we're looking for. You don't find very many of
those. But by asking that question we do position ourselves in the right stocks.
And we have the potential to maybe have one or two of these massive winners. I
made more money in the six weeks ended Dec. 7, 1999 percentage-wise than I’ve
ever made in any other period in the market since I started in this business in
19 be
Kacher: I would have to say the same thing. It’s been phenomenal.
Morales: The real question for us now is whether we are looking at com-
pressed time frames. In 1999, stocks were going up in six weeks as much as they
normally would move up in six to eight to 12 months. We're wondering if this is
a sign of power or a sign that we're in these compressed time frames, and maybe
wed better start looking at taking some off the table here. That’s a question we're
grappling with right now. We don’t really have an answer for that. But as long as
the trend is our friend, we're going to stay with it.
Kacher: This is a very exciting time. Actually, it’s the most exciting time I
can remember to be in the market because there’s all these new, emerging tech-
nologies like storage area networking, business-to-business, e-commerce, and fiber
optics. We're trying to figure out what the next big name is going to be in each
of these areas and we use a lot of fundamental analysis to figure those things out.
Morales: We're just trying to answer the question of “who is the next Cisco
or Home Depot?” We think that we own a couple of them. We're not sure yet
which ones they are, since you would know it all only in hindsight. But at the
time, that is what we're trying to do. That really drives the fundamental side of
our stock selection.
Gil, just getting back to the earnings side of things, a lot of these Internet
companies have not earned any money yet. Would that turn you away from
buying a stock even though the potential is there and it could be the leader in
its space?
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Morales: Initially, it was very difficult for us to get a handle on the whole
Internet thing and to assess it. At the outset, we weren't putting a lot of the
names, like Yahoo and AOL, on our buy list because they didn’t have earnings.
But we had to think about this more from a fundamental aspect. And also, we
had to consider that the stock market is really just a big pricing mechanism—you
have the cumulative mind of the stock market representing all of these people
that are participating, their opinions and their knowledge about where they're go-
ing to put their money.
So I see the market as a pricing mechanism. No. 1, it recognized that there
is definitely a significant economic development going on in the Internet. Then
the problem became why some of these had no earnings. But the market sensed
or could tell that this was going to be big. And so now, the market being a pric-
ing mechanism, it has to grasp onto some way to price it. And since there were
no earnings, the next best thing, as far as we could tell, was top-line sales growth.
We've studied these models now, since we've got a lot of recent models of these
types of big-winning, Internet stocks. We know that the primary characteristic,
$r the characteristic that’s replaced earnings, is a huge sales ramp-up. So we're
looking now for companies in these spaces that have huge sales ramp-ups. And
the market is using the sales growth as a way to gauge these companies and func-
tion as a pricing mechanism to put a value on these companies.
I also think that the market is trying to assess the overall value of the
Internet as a whole. Sometimes what happens is you get some companies that
have no earnings and maybe in the long run they don’t have great potential. But
right here, right now, they become representative of a new emerging industry.
And so the market grasps onto these companies as well, to try and assess the
value and put a price on everything. Our job is to find out what the market's
keying on, and what we've discovered is that it is the huge sales ramp-ups. And |
mean significant ramp-ups. Not $200,000 this quarter and then $500,000 next
quarter, which looks like 150 percent. We're looking for $10 million last quarter
and now $26 million this quarter. That's the type of ramp-up we want to
see—significant, big sales.
Kacher: It’s interesting because the market does function like a pricing
mechanism. You can find these things either by looking for high sales rates, high
16 @ THE DISCIPLES
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each situation a little bit differently depending on how the general market is
acting?
Morales: I use a 5 percent stop loss. I know Bill O’Neil says 7 or 8 percent, but
at this stage in the development of my career, I should be good at picking stocks
at the right point. So I should be up right away with a position.
Right away, meaning the first day?

Morales: Within the first hour or the first couple of days. My stops are generally
5 percent. I don’t let them get too much further than that . . . 8 percent at the
most. But when it’s down 5 percent, I’m looking at just getting rid of it. Chris
might do something different.
Kacher: I would say that if a stock is not behaving right, yeah, I generally
cut the position within 5 percent. A lot of my sells are actually 2 or 3 percent
losses. Probably the majority of them are like that. Because we trade size, it’s im-
portant not to get stuck in a stock that’s a little thin. So when youre trying to
get out of it, sometimes we're going to be selling it at an average of 8 to 10 per-
cent off where we bought it if its not working out. We're pretty quick to see
when a stock’s not working out, so we immediately try to sell at that point.
How do you add to a winner on the way up? Do you double down at a certain
point?
Morales: I use a simple rule. Let’s say I have $1 million that I want to allocate to
this one stock, and it’s a $100 stock. So if the stock breaks out, I put one-half
the money in it and I buy 5,000 shares. If it goes up 2 percent from my buy
point, I put in another $250,000. And then if it goes up another 2 percent from
there, I put in the next $125,000. And then the last bit I kind of use at my dis-
cretion as to where I want to add to the position. But that’s how I pyramid a po-
sition right away and get my full position. If it moves up like that, I'll be in right
away and get my full position. I'll be in right away and I'll be in deep, heavy.
That's how I do it. Now Chris might have a different way.
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Kacher: What I do is, when you get to the pivot point and if the volume’s
there, I'll buy one-half of a full position outright on the breakout. Say that very
same day the stock closes at the top end of its range. As long as it’s not too ex-
tended from the base and did not run up excessively that day, I will buy another
one-quarter position at the end of the day. So now I’ve got three-quarters of my
full position intact at the end of that first breakout day. Now as a stock runs up,
I’m not going to touch it. But what often happens is, after breaking out, these
things will come back on lower volume for a few days before running up again. |
will go ahead and sometimes add another one-quarter and get my full position
that way.
Another way to do it is, let’s say the stock came back a little bit, everything
looked good, I bought that last quarter, and now I’ve got my full position. If the
stock then runs up another 50 percent, what happens during a one-month mar-
ket setback is that these stocks will sometimes come back to the 50-day moving
average line. If they're institutional quality, what I find is that a lot of mutual
funds that own the stock will come in and support the stock at the 50-day movy-
ing average. You can actually use the 50-day as another pyramid point. That's as-
suming, though, that you already have a lot of cushion in the stock. If it comes
all the way back down to the 50-day, and if you’re up appreciably in the stock,
then there's very little risk to you to add to your position at that level.
So a lot of institutions are really watching that 50-day, then.
Kacher: Yes. You can see that with companies like Qualcomm. Every time
Qualcomm hits the 50-day it tends to bounce. Sometimes it'll go below the
50-day, but it’s very quick to bounce above it, usually within a day or two. And
JDS Uniphase, remarkably, every time it hit the 50 it bounced. It’s also an insti-
tutional quality stock.
Chris, what would be one or two of the things you'd be looking for that would
first give some sort of indication that the market is putting in some sort of
intermediate-term top?
18 @ THE DISCIPLES
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Kacher: When we get these nice long trends, and we're seeing a lot of these tech
stocks go up dramatically, often the last day of the run is accompanied by huge
climax buying, where a lot of stocks go through the roof. A lot of the leaders like
Exodus, Verisign, or Qualcomm, will run up huge. This is what happened in the
April 14, 1999 top. That was the day when companies like NetBank, AOL,
Schwab, and all of those leading names went up huge that last final day . . . and
then we went into a correction. So we do look for that. There’s no way to tell
how long the correction is going to be, but that is an indication that you do have
some sort of correction on the way.
Morales: It’s pretty much like an across-the-board ebullience. You look at all
of the leading names and they'll all be running all at the same time.
Kacher: Also, in addition to the percentage move, since in this market some
stocks will move 100 to 200 percent in a few weeks, what we look at is a time
frame. When a stock breaks out of a base and runs up 150 percent over the next
six or seven weeks, that doesn’t mean it’s topped. Usually, a stock will make its fi-
nal topping action three months to four months down the line after the break-
out, if it’s going to top at all.
To me, the toughest decision is the sell-to-nail-down-a-profit decision. The

sell-to-cut-a-loss decision is much simpler, while | think the buy decision
might be somewhere in between. What would your advice be to
intermediate-term traders to better time their exit points?
Morales: Basically, there are three ways a stock will top. First, you will either be
making new highs on less and less volume, which we call wedging. Or you will
have a climax, blow-off type of move where the stock has its biggest one-day
range from the time the market turned—in other words, from the day that you
had the follow-through in the big averages. The stock will have gone on a tear
and at the very end of it you're gapping up on huge volume and you've got the
widest spread, almost as if there's a rush to get into the stock. At that point, it’s
almost capitulation on the buy side. We're looking for that, a climax type move.
And you had that in a number of the leaders recently. For instance, you saw Sun
when it got up above 80, it was up 7 1/2 points in one day which was the biggest
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one-day point rise throughout the move. So we kind of got a signal there to start
losing some of the position.
Kacher: Not only that, but after it made that huge, 7-point move, it came
in and then started to wedge over the next few weeks.
Morales: Right. In other words, you rallied from that low at 70 1/2 up to-
ward 80 and your volume was declining pretty much daily. And so that’s giving
you some signs. In the case of a stock like Sun, it’s an institutional-quality com-
pany. They're a key to the build-out of the Internet infrastructure. It’s possible
the stock will have to go through a period of base-building. But in any case, we
think the stock has topped for now.
20 THE DISCIPLES
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Kacher: Our whole take is this: Why have your money in a stock that at
best is going to go sideways and base-build for a number of weeks?
| know that Bill O'Neil likes to say that big gains need a lot of time to build.
Now when you say that you don't particularly want to sit in a stock that's
forming a base, does that mean you would exit the position now and then if it
rebuilds and maybe breaks above 80 you might get back in?
Kacher: I wouldn't exit here. It’s easy to sell early—it’s hard to sell late. Early
would have been to sell—
Morales: —into the climax move at about 80 and into the wedge.
Kacher: Or you could easily have sold into the wedge in the
mid-to-high-70s. Now, it’s right at the 50-day. So I wouldn't be selling right here
because you're at support and it might bounce. If it bounces up into the
low-to-mid-70s, I'd probably be selling off the rest of my position.
How would you have handled JDS Uniphase?

Morales: JDSU came out of a narrow base and broke out at about 135, ran up
very rapidly, and then you finally had one last day where you had the biggest
one-day point move since the breakout. That’s sort of like capitulation buying. So
its kind of like it works in reverse for selling. And then the stock picked up vol-
ume for three days in a row. And that stock, in our view, has topped. Now that
doesn't mean it’s dead and it’s going to collapse to 40 or something like that. What
it means is at best it’s going to have to build a whole new base and set up again.
At worst, it has topped and could go into a long-term decline, the severity of
which you cant really gauge and we're not even going to try to.
Realizing that you do not own the stock, let's hypothetically say you did and
let's say you bought it coming out of that October breakout there, around 68 or
69. Now let's just say you held onto the position and it formed that base in
November and early-December and then it broke out again a couple of weeks
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ago. Right now would you be tempted to just hang on to the thing and hope
that it forms a base with say 150 or so as the low?
Morales: It depends on my cost basis.
Let's say you got in at around 69 or so and you have a pretty good profit.
Morales: At 69? You might try to hold it. Let’s say I have a position at 69 on the
breakout and I've ridden that thing all the way up. I would probably sell half of
the position here, and then let the market tell me what to do with the rest of it.
If it starts to come under severe distribution, and there’s no rally, then maybe I'd
lose it all. There’s nothing wrong with making money. And that means nailing
down profits. People shouldn't feel that they have to sit with everything forever.
Now we know people who've owned Home Depot and Cisco for 10 years and of
course they've had to sit through all of this. But they've been fortunate that they
have a low cost basis. Buying right when the market turns and not hesitating on
at O'Neil follow-through day (following a market sell-off of at least 10 percent,
a session in which one or more of the big averages rises at least 1 percent on in-
creased volume, and occurs on the fourth through tenth day of rally) is key be-
cause you have a low cost basis in most of your stocks and you can afford to
maybe sit and watch a little bit here.
Kacher: Whether to hold is a very personal decision and has to do with
your time frame. Some people like to have a very long-term orientation with the
market and ride through these little corrections that we experience. With some-
thing like JDSU, it’s had a series of little corrections all the way up from 20. So
some fund managers might have gotten in very, very early and have held it the
entire way and they're not going to be selling it here because they've got much
longer horizons, and the company is a leader in its space. Other traders might
have a little shorter-term orientation. Personally, had I bought it at 65 or 70, I
would have already sold at least one-half of the position because the tone of the
market has changed. We were in a nice up trend on the Nasdaq. The Nasdaq has
broken that trend to the downside. That tells me the color of the market is dif-
22 @ THE DISCIPLES
(RESERV RS DOES EY OS
ferent now. I don’t want to have all my money on the table. I'd be taking at least
half of it off, if not all of it.
Was there one particular day on the Nasdaq in January 2000 that you thought
was the turning point?
Kacher: Tuesday, Jan. 4, 2000. If you looked at the S&P, the Dow, the Nasdaq,
and the Internet index, they were all down huge. That’s one of the signals. On
April 13 or 14, 1999, the Nasdaq: and the Internet indices got clobbered after
these huge run-ups. I was looking for that kind of sign in this market. And Jan.
4’s sell-off was that sign.
Morales: And on Jan. 4, the other thing you saw was a number of the big
leaders get clipped. Oracle was down 10 and Sun was down something like that.
A lot of coincidental factors all occurring together kind of gave us a sign that we
had to start selling. It doesn’t necessarily mean that you run to cash right away.
But you do start cutting back and you nail down some profits. We've been very
fortunate and we sat through those questionable days when people were nervous
in November and we got those powerful moves through December. When I look
at where I stand right now, I’m pretty much back to where I was a week before
the end of the year even after taking it on the chin just a little bit as I’m selling
out of my positions here.
That's pretty significant, then.

Morales: For us, it is.
You're saying two or three days of losses took away a couple weeks of gains,
then?
Morales: Yeah, but you were getting tremendous gains.

Kacher: The nice thing about this style is that you can rum your account up
a few hundred percent in a good market and then give back maybe 10 percent of
all those gains you've made. Basically, if you're quick to exit, you can hold on to
SESE TT RSE RSG OR TEHDI LT. SS TL a NTS a

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the majority of your gains and just sit. Actually, the best thing right now—and
this is what takes a lot of discipline on my part, which is what I fail to adhere to
time and time again—is to stay out of the market. The tone has changed. The
best thing I can do is to not trade until the market sets up again. But I can tell
you right now I’m going to get my feet wet, put my toe in the water here and
there, just because I like to feel that I’m still playing the market. But at least I
will play it with very small positions. That way, if Iam wrong, and I probably
will be wrong in this topsy-turvy, choppy market we're going to be in, I won't get
my head handed to me.
So that means that you might extend yourself up to 30 to 40 percent long

instead of 100 to 200 percent long?
Kacher: Or I might go more like 10 percent long and 10 percent short, just kind
of dabbling here and there. If I see something that looks good and I feel like I
can scalp some profits, | might do that. It’s really meaningless. I never make a
Killing when the market gets choppy like I feel it’s going to. I find it’s tough for
me to short and make real money on the short side. That’s not my forte by any
means. So I try not to play hard.
Meanwhile, back at the ranch, Gil never finished his discussion on the three
ways a stock can top.
Morales: I gave you an example of a climax top, which can be thought of like
capitulation selling or capitulation buying. And that will be the final move in a
stock. The other one is where you get wedging activity. In other words, the
stock continues to move higher but your volume is declining. An example is
Verity, which I bought on the breakout in September at around 26. It ran all
the way up pretty rapidly to 60 or so. But you'll notice that as the stock was
going to the 48 level up into that last final move up to 60, you had no volume.
That stock is actually wedging up. I sold into that move up. I didn’t get out at
the top, but I saw that wedging and that was danger. And then of course the
stock breaks once and makes one final attempt to rally to new highs which
24 @ THE DISCIPLES
Wedging Top: Verity (VRTY), Daily
Verity Inc-Daily .1214/1999 C=49.090 -5.000 G=55.063 H=55.063 |
~ Created withSuperCharts byOmega Research © 1997
youll often see, and then it just blows apart and comes out with poor earnings
and that’s the end of it.
The third way stocks will top is a failed, late-stage breakout. A good example
is Razorfish from December 2000. Here’s a stock that broke out down around 20,
ran up and then tried to set up again, and tried to break out again. It was very
choppy and you'll even notice that the failed breakout occurred as the stock
wedged up toward 50 late in December. There was no volume there. Once that
thing starts to come back into its base it should be sold. So those are the three
ways stocks will top and that’s what we're looking for. It’s tricky and I think people
Failed Breakout: Razorfish (RAZF), Daily
Razorfish Inc-Daily 01/07/2000 C=39.500 +3.969 O=38.000
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should study Bill’s book, How to Make Money in Stocks, where he goes over every
single one of his sell rules. I think his new book is a much more succinct and sim-
pler explanation of how these things top. It’s a good starting place.
And the new book is called what, Gil?
Morales: The new one is called 24 Essential Lessons for Investment Success.
Actually, | have it right here on my desk.

26 @ THE DISCIPLES
RR RSTA ge OU NS RI IY A RC AI I TE IE
Morales: A lot of people make the mistake of giving up on the market when in
fact this is your time to be culling through and finding out where the new
strength lies. To us, that’s the beauty of corrections or bear markets—
Kacher: —to weed out the weaklings, essentially. Right now you can look at
it as forming the left-hand side of cup-shaped bases. We're right in that process.
The strongest stocks will form the left-hand side of that cup, but their cups aren't
going to be quite so deep. They're going to be resistant to selling off and they're
going to form these pretty-nice cups and it’s going to be pretty obvious who the
next leaders are going to be when the market turns back around.
When you say we're forming the left side of the cup, Chris, are you talking
about looking at the Nasdaq Composite, in general?
Kacher: You can take a look at the market indices or individual stocks. A lot of
these stocks have corrected 20 to 30 percent off their peaks. That is the left-hand
side of the cup. Now we don’t know how deep this cup is going to go. Some of
the weaker names are going to be off more than that, especially if the market co-
mes off more than it has already.
Morales: And right now you don't know for sure if in fact those are left
sides of cups. They still have to form the right side. Some of those will just go
into down trends.
Kacher: Right. Some of these stocks will not form cups at all. It’s over for
the real weak ones.
Let's talk about the short side for a second. What's interesting to me is how
many people think shorting stocks is just as easy as going long. All you do,
according to them, is just switch the parameters that you're looking for
technically. My take on that is that shorting is many times more difficult
because you're dealing with the emotion of fear, which is a much more
extreme human emotion than, say, greed or hope. This means your timing on
a short sale must be more precise.
18 RRS Ri ET RE IRAE A OS SII Ce SNE TIN NY AE RETIRE SAA! BOSE BE PS ae
Kacher: That's a good point, actually. Interestingly, you can see that to some de-
gree on the chart. If you look at a chart right-side up and you look at the up
trend, a lot of these up trends are pretty nice and have a normal rhythm to them.
It doesn’t take a whole lot to be able to sit in a position on these up trends. If
you take a stock that’s breaking down and you turn its chart over, you will actu-
ally see a cup as well, but it will be a lot more choppy. The volatility on a declin-
ing stock is much, much greater than the volatility of a stock that’s in an up
trend. That’s kind ofa general rule that you can actually see on the charts.
So wouldn't that make the timing of a short sale so much more critical, then,
as opposed to the long side?
Kacher: Exactly. And you can also get whipped out of your position that much
more easily. Because on the short side, when a stock drops, it will violently lurch
back up, shaking you out of your position.
Morales: Our studies show that the optimal time to be shorting is three to
foyr months after a stock has topped. This is precisely what Chris is talking
about. If you take a stock that’s gone into a decline, and you flip the chart upside
down so that now it’s like you're looking at the chart in reverse, a lot of times
these things make these upside-down, cup-and-handle patterns. It may take three
to four months to form that whole pattern. And that’s generally when the opti-
mal time to short is. Generally, the type of pattern we look for is a stock that has
topped, based on the three criteria that I mentioned earlier. Once a stock has
topped, it will go through the 50-day moving average on huge volume, and then
youll get kind of a wedging rally, in other words a rally where the volume is de-
clining on the way up, back up to or through the 50-day moving average. Then
when that stock goes back through the 50-day moving average on vol-
ume... that’s your shorting point.
So that’s the way we would short. But the market goes up a lot more than it
goes down. I’ve never made much money shorting and neither has Bill O'Neil.
And he’s been in the market 45 years. Bill will tell you he’s never made big
money shorting for the simple reason that it’s easy to get run in. And it’s much
28 @ THE DISCIPLES
(EST ME TAG A a I aN RT ITE GN A ITE EEE OEARSE APES TE
more violent to the downside. The trends are more violent and volatile and you
can get shaken out. You can study any stock that’s been in a prolonged down-
trend: You get these violent rallies and they'll run the stock right up your nose
and you've got to be covered.
If you look at Razorfish, it gave us all the topping signs we look for, up in
the 45-50 area. Then the stock broke the 50-day, down to 35, goes through 35,
finds support, then rallies back up to the 50-day, then reverses on huge volume.
So as soon as that stock reversed back to the 50-day today, you could have
shorted that stock. That’s a good example of how shorting should be done. But,
again, I don’t really recommend it as a way to try and make big money in the
market because it’s just too difficult.
Kacher: There’s another problem with shorting some of these stocks, espe-
cially some of the thinner ones like Razorfish. Let’s say you try to get on board a
short position at 42 when it was topping. Well, because of the uptick rule,
whereby you can only short on an uptick, you might not get that uptick until
39, 3 points from where you initially saw it. Often when a stock does uptick, it'll
run 2 or 3 points beyond where you've shorted it. Now youre 2 or 3 points in
the hole and that can scare you right out of the position. So in five minutes you
can already be down a few percent and get scared out. In fact, some of my short-
est plays in the market have been on short positions.
Morales: Some of my biggest and fastest losses have been on the short side!
I don’t think I’ve ever lost big money faster than when I tried to short CNET
back in April 1999. I remember that. I shorted the stock, walked away from my
desk, came back 20 minutes later, and the thing was 22 points up on me.
Whoaaa.
Morales: So that’s what can happen.

Kacher: There might be some people out there that are really good on the
short side. I’m sure there are people that are consistently good. But shorting is a
totally different animal. I think that when you're playing the markets your per-
sonality is oriented a certain way—toward either being really good on the long
side or really good on the short side or playing the market on a short-term level
EH SARS LD EL I LS SU ES ETS SISTENT

AEE De YR TEE EE ORS ET TS EOD RR IE EE ET SI a EVEL RAS LSE EE TO IB
or a long-term level. It all has to do with your personality. To be able to change

your personality is like trying to change the color of your eyes—it’s a very diffi-
cult thing to do. So to be able to switch gears from going long to all of asudden
going short . . . unless you're a really short-term trader and youre doing all of
these daytrades, | think it’s pretty tough to do for most people.
Morales: Even then, it’s not very much and it’s not worth the trouble. You
go through 50 bottles of Tums and Rolaids, and what’s the point? For 10 or 20
percent? I'd rather go to cash, study my mistakes from the previous up cycle, and
be ready to go when that market turns.
Generally, when we get an important intermediate bottom, such as we saw in

October 1999, and a powerful advance follows with great leadership and
potent volume, the first pullback is a pullback that can be bought, though this
shouldn't be done blindly, of course. Is that the way you see this?
Morales: If you have a stock that’s acting well and has strong fundamentals and
has pulled back to what looks like a logical point and it’s not undergoing huge
distribution, maybe you could add to your position, say on a move down to the
50-day. In general, when we get this type of action, we just have to become very
defensive. Especially, when people make as much money as they've made, you
want to keep that. So that’s primarily what we're concerned about at this point,
keeping what we've made.
Kacher: Again, we're seeing a lot of leaders coming down very fast from
their peaks. Whenever we see that kind of action across the board in top-quality
names, that’s a serious caution flag. You had better be at least off margin in this
kind of market environment otherwise you can get your head handed to you. A
lot of these big leaders are already 15 to 20 percent off their highs. So if you're
on margin, you double that loss off your peak, which is devastating. You don't
want to get into that position. If you run your account up quite a bit, you have a
lot more cushion. But the whole idea is to give back as little as possible.
Morales: Your question is related to duration. In other words, we're only
about 12 weeks out from the follow-through day. You're saying is this about the
right duration to go through an initial short- or intermediate-term correction? In
30 @ THE DISCIPLES
PBIB Gna! TE Re GIRS SS LD i SEE AL RE SN FS SNE OT ESTE TTI,
most cases, yes. Right now, all we can say is that we're certain we're in a short- to
intermediate-term correction. It could be a broader top, but—
Kacher: —the markets are actually a lot faster today than they've ever been
before. So the cycles are compressed.
Morales: Right. And maybe they are. And given the fact that they could be
compressed, you can’t get into the business of telling the market what to do.
Kacher: You've just got to look at the averages and the leaders and they're
going to tell you what to do—when to get out and when to get back in.
Morales: Also, if you've been in the market for a period of time, you can get
a sense of what the market’s going to give you, going from bull market to bull
market. How much can these things go up? One way that we can gauge a move in
a stock is to look at the P/E ratio expansion. Our studies show that the average
P/E expansion is 120 to 130 percent. So we're looking at the P/E ratios of the
leaders when the big averages staged their most recent follow-through, in this case
on Oct. 28, 1999. What were those ratios and what have they expanded to today?
Some of them are even greater than 130 percent—200 percent, 250 percent, and
more. But once we're at that number, we're starting to ask ourselves how much fur-
ther can this really go. Also, we're mindful of the fact that our objective is to make
money and keep it.
And again, Bill will tell you this: There’s nothing wrong with taking profits.
You're either going to sell too early or too late. Accept that. You're not going to
get everything the market gives you, but you can get a good chunk of that and
you should be grateful for that. We certainly are.
Kacher: Trading the markets is very Zen activity. Gil and I always talk
about that, just in having the right mental balance that will give you the right
balance on when to sell and when to buy. The whole thing is you don’t want to
sell too early in the run-up and you don’t want to sell too late after the market
has peaked. It’s like walking a tightrope. And you've got to have a lot of concen-
tration and focus and you don’t want to let your emotions get involved because
then youre not focused anymore. These markets are so sharp and so much more
volatile than they've ever been, that timing and your window of opportunity to
get in or get out of the market is so much shorter than it’s ever been.
Se
ET VOTE
The optimal window of opportunity to get out of this market was about a
day, maybe a couple of days. You can catch the bounces if you don’t get out on
the first day; the market will rally back and there will be some more exit points.
But if you wait, say a week, your account could be devastated. This was exempli-
fied by April 1999, when in one week the averages came unglued by 20 percent
or something. If you were in some of the highflying Internet stocks, some of
those things were off 40 percent from their peak—in one week.
So it’s really critical that you've got day-to-day focus on the market and you
dont get carried away by your profits. Ego is another problem. Ego can be devas-
tating. I firmly believe that if you have an ego when youre trading the markets,
you will potentially give back what you've made. Ego will keep you in when you're
supposed to get out.
Morales: Make sure youre operating with a system that has a set of rules.
You operate on that so that youre outside of your own head and outside of your
own emotions. I saw a lot of people get very ebullient in the last week or so go-
ing into the end of 1999. There was a lot of euphoria. Everybody was talking
about quitting their jobs. In fact I went to the doctor on Jan. 3 and he even told
me he was thinking about urteiite his practice and daytrading. And I thought
“Oh boy, we're in trouble now.” And sure enough, the next day was the top.
When you feel like you're God and you can print money on demand, that's
probably the time to be selling.
It's been real. Thanks for your time.

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KEVIN HAGGERTY
TRADING WITH THE GENERALS

By Laurence A. Connors
YX Then the evening news tells you why the big rally or drop occurred in the
stock market today, that’s one thing. When trader Kevin Haggerty tells
you, that’s another thing altogether.
As senior vice president and manager of equity trading at Fidelity Capital
Markets (a division of Fidelity Investments) from 1990 to 1997, Haggerty had a
close-up view of how things really work on Wall Street. In charge of U.S. institu-
tional equity trading, he oversaw trading operations and accounted for a signifi-
cant percentage of the company’s volume on the New York Stock Exchange on a
given day.
His unique insight on trading is the direct product of this quarter-century
career on the institutional side of the stock market, through which he gained a
subtle understanding of the way institutional traders, specialists, program traders,
and other market forces shape price action.
One of the most interesting aspects of his story is that he has used his un-
derstanding of longer-term position trading strategies as the basis of a short-term
stock trading approach he now uses to manage his own money.
33
34 @ TRADING WITH THE GENERALS
EDO ea Ra RR ATTIRE I ST TE,
Haggerty got into trading as a stockbroker in the early 1970s after a short
stint in banking. He began hanging out in his firm’s trading department, where
he was exposed to various hedging techniques—long convertible bonds and short
stock, long warrants and short stock, etc.—designed to make money regardless of
whether the market was up or down.
Such a multi-dimensional approach made sense to Haggerty, who began using
these techniques with a great deal of success. They were especially appealing when
the stock market was bottoming in 1974. He moved on to a number of other eq-
uity and convertible trading positions on the Street, as well as exchange board posi-
tions and his successful stint at Fidelity, the fund colossus of the 1990s.
One of the greatest advantages of his career path was that he was exposed to
a wide variety of ideas and was able to become intimately familiar with the strat-
egies and tactics of institutional portfolio managers and traders—how they put
trades on and took them off, common patterns they reacted to, and the kinds of
opportunities they looked to exploit in the markets—information that would
prove invaluable when he began developing and trading shorter-term strategies.
Beyond all of this, he is also the father of two sons who have played in the
National Hockey League.
Haggerty trades fast and talks even faster. His enthusiasm for the market is
obvious, and there isn’t an aspect of his profession that he doesn’t seem familiar
with or hold an opinion on.
Larry Connors: How would you describe your general approach to short-term
stock trading?
Kevin Haggerty: You develop your skills over the years. I started looking at
short-term techniques from day one. I’ve been a position trader my whole life,
working large orders on the institutional level. You get to see what a multitude of
accounts are doing, how they do it, and you get the opportunity to try these
things yourself. It soon becomes apparent that in order to be successful, you have
to understand short-term trading techniques to be able to maneuver in and out
of the market.
KEVIN HAGGERTY @ 35
nn
I like to work from the long side, for the most part, although I have strate-
gies to play the short side, mostly using options. I stay in the most active
names . . . it doesn’t matter if they're big-cap or small-cap. I just want to make
sure I’m in an area | know the institutions are going to be interested in.
I also pay close attention to volume. In stocks, you'll definitely see volume
precede price. I want to see a trade break out with no news rather than news. I
want the breakout to occur, then have news follow . . . that’s the better trade. If a
stock has been going down, then stops, and volume builds up, I'll put it on my
watch list. The stock may have reached a tradeable level.
I trade a lot of pullbacks off the opening move, or any other intraday pat-
terns—congestion patterns, and so forth—that give me low-risk entry points
when I see market dynamics pointing in a certain direction.
How did your short-term trading approach grow out of your institutional
background?
The edge I’ve gotten from being in the institutional side of the business for so
long is to understand the dynamics of individual stocks and recognize what’s
“real” buying or selling and what's not . . . when a price move has something
backing it up and when it doesn't.
There are a lot of practical things that average investors don't understand
about institutional trading. For example, the institutions won't admit it, but they
are very technical and many are momentum-oriented. They'll try to break stocks
out of patterns and accelerate the stock to higher levels. They're not supposed to
be “traders,” but sometimes it’s part of the overall process to beat the S&P
500... or it might simply be the style of a particular money manager. The spe-
cialists and floor traders are aware of technical levels and patterns, too.
Another example is when analysts at big firms put out recommendations on
stocks based on technical developments. If a traditionally popular stock has been
in a slump for a while, but has recently made a move back above, say, its 50-day
moving average, an analyst might put out a “buy” on it. It’s a good gamble for
them to take, because if the market does run up at that point they look like ge-
ORAS er iN gO RSS RTE SOROS GG WR eS RGR NE REET EE SB PEI EI SEG CS LE AOA GPE FATES
niuses, and the fact that it’s a big-name stock that institutions traditionally like to
hold puts the odds in their favor, too.
How do you try to take advantage of this kind of behavior?
It’s a matter of aligning yourself with what the major market forces are doing and
finding a pattern that gets you in with a defined risk. Big institutions cant
hide—you can always hear an elephant coming—and what they do results in
some fairly easy-to-spot patterns.
Say a stock only opens down slightly on a big, down opening and holds its
ground in the face of heavy selling in the overall market. There’s a reason for
this—somebody has to be holding up this stock. So I'll go long when the stock
gives an indication it’s ready to take off to the upside . . . when it makes a move
back above the opening, for example. Those can be great trades.
Another example is if a market-leading stock opens up much lower, but on
very light volume . . . what I like to call a “trap door” scenario. The light volume
tips you off that the selling isn’t for real. Institutions often look at this as an op-
portunity to pick up shares at a lower price or run up a stock, and the turn-
arounds in these situations can be explosive.
It's apparent there's a strong discretionary element to your trading. If you're

trading a pullback situation, for example, where do you look to enter your
trade?
I don't have set points or rules. Pll take a shot at any point in the pullback if I
see the dynamics pointing in my direction—larger bids and a series of new highs,
for example. If a strong stock pulls back, I don’t care if it’s a four-day move or a
one-day move . . . when the dynamics change and that stock moves above its
previous high, I want to be there. The specific pattern, or entry point for that
matter, isn't important, as long as it indicates a shift in the stock. The only thing
I won’ touch is a strong gap move.
KEVIN HAGGERTY @ 37
A RRS ESOS DS el
What's the most important lesson you've taken out of the markets in the last
25 years?
Without question, risk management. It doesn’t matter if your other trading skills
are great or so-so. If you don’t manage your positions correctly, you'll never make
it. Everybody talks about risk management, but sometimes it’s difficult to know
exactly where they're coming from.
In my case, it’s simple: I shoot for a 2:1 reward/risk ratio on every trade and
I never take a position home overnight unless I’m protected by options. I almost
always limit my risk to three-eighths of a point or less on an intraday trade.
Why don't you like to hold positions overnight?
There is too much manipulation in the market these days to go home na-
ked . . . too many out-of-proportion responses to news items. There’s no advan-
tage to exposing yourself to the kinds of two- or three-day swings that are
common now. It’s unnecessary.
- I learned my lesson a long time ago: You never know what's going to hap-
pen overnight. Early in my career I was short a stock that kept rising even
though the rest of the stocks in its group were going down. I held it one day af
ter another, and it kept gapping up until I finally covered with a significant loss.
To make a long story short, the reason the stock was rising was because of a
stock-loan fraud case involving a buy-in. But it didn’t matter that the reason for
the move wasn’t legitimate. I still lost money. From then on, price action alone
was my idol.
How do you reconcile your recognition of the high degree of volatility in the
market with the tight stops you use?
A big part of my strategy is being able to take many trades on a given day and
get in and out of positions quickly. Getting stopped out doesn’t bother me. I can
get right back in when the market moves through that stop level again in the op-
a ge Ra
posite direction. I’ll still have two or three more chances to trade throughout the
day.
The point is to not let the losers be the big trades. If I get a quick
half-point or 5/8-point gain on a trade, I'll take profits on half my position and
follow up on the rest of the position with a trailing stop.
But I'll get out of a trade almost immediately if it doesn’t go in my direc-
tion right away and the dynamics of the market change. If I’m long and a bid
disappears or a size offer comes in, I get out . . . sometimes I can break even on
the trade.
Basically, you like to stress that you cannot be successful without money
management. Can we talk a little about that?
Sure, this is key, especially with the volatility in the marketplace. Regardless of
how long you've been trading, it’s very difficult to adhere to that discipline of
cutting your losses short. You try to do it, and a stock looks like it’s only going
to tick down 1/8. All of a sudden, it’s off of there and you miss your stops.
To avoid that, I put my sell stops in at the levels that equate to the volatility
of the stock, and go from there. But I also do not wait for the stop to get hit. I
let the market dynamics take me out of a trade. Say I’ve got a 3/8 stop in a
$50-$60 stock, and that stock has done nothing in a short period of time. All of
a sudden it becomes offered, and if I see some down ticks on the NYSE ticks,
and it looks like the up volume/down volume and the overall market dynamics
are starting to fade a little bit, I'll scratch that trade, down 1/8 or maybe flat if
I’m lucky. But I will not wait. I'll cancel my order and cancel my stop if I see the
market dynamics change.
So you're being proactive throughout the trade?

I am, because if I go in saying that the market has to prove me right, then I have
to really stick to that discipline on the way out. As soon as that trade turns on
me, why should I give the market 3/8 or 1/2 or 1/4? That’s my feeling on it.
KEVIN HAGGERTY # 39
a Re ET TD TNE II Ry Aa MER ty DI Se
Now one of the things we were talking about recently was that you got a
chance to see people who are new to trading make the same mistakes over
and over again. And that is where they are maybe risking 2 to 3 points on a
trade or maybe are just afraid to pull the trigger to get out of a trade when it
goes against them.
Good point. That is the most common thing. I run a trading office, so I
have a dynamic updating on everyone's trades that come through as each trade is
taken. I’ve learned more about trading just by watching the results and how peo-
ple buy and sell and how they actually enter and exit the trades. And what I see
happen with a lot of new traders is they really don't get in and trade certain pat-
terns or inflection points, or trade with discipline.
A lot of them will get in when they see something up 2 to 3
points . . . theyll jump in and try to play that trade. And of course, as happens
often, you see the momentum, and all ofa sudden it’s not there anymore. Unfor-
tunately a lot of the time the new traders are in over-the-counter
stocks . . . Internet stocks or something similar. These are situations where there
is no depth on the bid or the offer, depending on whether they are long or short.
0 there might be an inside bid of, say 1/8, and below that there may be a 3/8 or
a 1-point spread market. So by the time they are able to hit that button and get
out, they’re already down 1/2 or 5/8 just based on their original trade. Coupled
with a little momentum, youre down 1 point or 3/4 of a point before you even
react. I just think those are the wrong stocks for beginners, or for any kind of
trader.
You have to define your losses based on the amount of money that you've de-
cided that you can risk in the business. Let's say I’m working with a new trader
who has $50,000 in capital. I like to tell the trader something like this: “Okay,
make the commitment. What have you committed to buy this business that you're
willing to lose should that happen?” And they might say, “I’m willing to lose 20
percent of that.” A reasonably new trader, learning what they should be doing once
they get live, is saying, “Look, I need at least 50 or 60 trades.” Well, I'll say, “Are
you going to lose 50 in a row?” They'll say, “No way, based on what I’ve done in
40 TRADING WITH THE GENERALS
TRS
SSE Se TE I OO ET
my pre-trading plans, paper trading, and trading with a small amount of shares.”
They say, “No, my ratio is good.”
So I tell them fine, we don’t know how the loss trigger is going to work, but
at least their stock picking has reached a reasonable level. So what you do is di-
vide 50 trades into the $10,000 that they've committed to the business. That
tells you they can lose $200 per trade, or whatever the number happens to be.
And then they decide whether they are going to trade 200 shares and risk 1
point or trade 400 shares and risk 1/2 point. |
So any way you combine it, it still comes down in my mind to a money
stop. But the commitment has to be there to say “I am going to invest this
amount of money in this business.” It doesn’t mean you have to lose it. And
that’s not the $50,000 capital or whatever capital you put up to support the
trades. But you do have to make a financial commitment and you have to be
willing over time to trade that. That’s risk-taking, and that’s one of the reasons
why Goldman Sachs is one of the best traders in the business. There are going to
be peaks and troughs, but over time, their risk-taking is going to make money.
So, you know, trading runs in cycles and you want to be consistent with
your money management and the volatility in the stocks that you choose. And
there’s nothing wrong with choosing a volatile stock, in conjunction with how
much you've committed to the business versus your total capital . . .
You just have to trade fewer shares of a more volatile stock.

Exactly right.
One of the popular money-management theories, at least in the futures

markets—and you don't see this in the stock market and I'm going to ask you
why—is where you risk 1 to 2 percent per trade. For instance, you'll see
someone with a $100,000 account risk $1,000 per trade or maybe $2,000 per
trade. But you don't see this method of risk management as much in the
equity markets.
KEVIN HAGGERTY @ 41
EA SS PT REE DE 1 SSCs. IEa UM ed
No, you don’t. You know I think, Larry, part of it has to do with the fact that
you don't want to risk $1,000 per trade, 2 percent of your $50,000 in capital. 1
don’t know that that makes a whole lot of sense. But I think people have to ad-
just their size according to their experience, which is really a better way to do it.
| think in the equities business everyone gravitates toward money stops and then
adjusts the size according to the amount of money and the amount of shares,
versus how much money you can lose.
One of your beliefs about successful trading is that you have to be inside the
mind of a large money manager and that you want to be trading in the same
direction as the large money managers. One of the things that you use to
guide you in your trading is the moving average—the 200-day and the 50-day
moving averages. Why are those so important for traders to focus on?
First of all, there have been many tests psychologically and historically that have
proven that the 200-day and the 50-day moving averages are two of the best things
out there. The institutions are very cognizant of the 200-day and 50-day, especially
when they add to positions. What usually happens is that when a stock pulls back
#to its 200-day, usually it's a stock that has had a good run and the 200-day is a
30-to-40-percent retracement of the run. For some reason the institutions will
come in and add to positions at these levels. These are also the levels where the
brokerage firms and analysts like to come in and say, “this is a reasonable support
level.” Then if a stock starts to base a little bit, it's a good point for them to come
in and reinvent the wheel and re-recommend the stock. You know, somebody co-
mes in and makes the comment that they’re going to make a new widget, or what-
ever. And the 200-day or 50-day moving average is a good level for it.
Let's talk about the ways that you use the 200-day moving average. You've
talked about it when a stock is pulling back to the average. What if it is
crossing the 200-day moving average after a sustained downturn?
I call it a cross and a re-cross. The trade I like is when a stock comes from down
below the 200-day moving average. Usually, it will back off, go back down below
\ERTESRTRST SITY PL 2 A SNE I I SE I
it, then re-cross again. But what usually happens is you get a base period. And
the breakout from that base period just at, or above or below, the 200-day is usu-
ally a very powerful move.
So far we've discussed tight money management, that you want to have a
limited amount of money you're willing to risk on a per-trade basis. We've
also discussed that you want to be trading in the direction of the trend. Do
you like to see the stock trading above both the 200-day and the 50-day
average?
Absolutely, because I think you have a much better edge by staying in strongly
trending stocks with high relative strength and where the +DMI component of the
ADX indicator is above the -DMI component.
How does volume play into this whole thing?

Volume gives away the buyers. It gives away how aggressive they are. There are
also many good trades where you can get in without monster volume coming in,
usually out of consolidation. Sometimes they start that way without breaking out
of a wide-range bar or a thrust or a runaway move. They'll sneak out of there for
a couple days and give you entry.
Another noticeable thing about volume is when you get some narrow-range
bars and the stock is not going down. The volume is increasing and you see the
thrusts getting smaller and smaller, the bars getting narrower. Volume increases and
usually that portends a change in direction. The same thing happens on the upside.
Someone recently mentioned that they mostly hear me talk about longs. Well, you
know, in a bull market you don’t run around in shorts. But the reality is you can
short these things every day when you get a change. Usually volume will precede
price on both ends.
You're not advocating that people avoid shorting stocks. You're saying ina
bull market you want to try to be more long than short.
FERRET ETE RN TO ER ET REE LET EE TETRIS

KEVIN HAGGERTY @ 43
aa Sana MNAMSEDR EN
Absolutely. The motors . . . let me give you some examples. Recently, General
Motors and Ford both broke down below their 200-day moving averages, looked
awful, and were excellent shorts—declining 200-day, declining 50-day. But lo
and behold, they've turned around, they've run right back up over the 200-day
again, and are no longer great shorts. So you've got to be very careful in a bull
market. There are a lot of institutions, hedge funds, and momentum players that
spend a lot of money studying liquidity factors of sectors to squeeze. From a
daytrading standpoint, you don’t have a problem. From an overnight standpoint,
a naked short on a stock, regardless of how bad it looks in a bull market, can be
difficult, obviously.
Do you find that most of your intraday trades are above or below the highs of
the day, or do you feel that it doesn't make a difference? Do you want to enter
above yesterday's high on the long side?
Good question. On the long side, if you've selected a trade from the prior day’s
daily charts, most of those entries are above the prior day’s high. Or if it is a gap
opening—-say, for instance, yesterday’s high was 50 and today the stock opened at
* 50 3/4, pulls back and holds at the 50 level or somewhere just above it—that’s
good entry above the prior day’s high at 50. And also if the stock opens the other
way around, if it opens below 50 but trades back up through 50, you're going to
enter 1/8 above the prior night's close. That’s assuming it’s a daily chart, trad-
ing-plan entry.
And that's not much different than what Jeff Cooper has discussed in his
books. | know that (TradingMarkets.com Director of Research) Dave Landry is
also looking for a stock to take out the prior day's high for longs or prior day's
low for shorts.
Absolutely. On the daily bars for sure. I’m always looking for early entry, but
there are also a lot of head fakes—especially with this volatility—similar to the
search-and-destroy missions futures traders run on the opening range. So you see
2 er ee UI eR A AE EG ADGA PES EB PIE ISR SET EI,
a lot of head fakes early in the morning in stocks above their prior night's close,
high, and low.
So the second entries above those highs and lows usually prove to be the
best entries. I love the pullback trade because you don’t have as much competi-
tion: This is where it opens above, pulls back down, and then comes back up. Or
else you get in, you get stopped out down 3/8, a 1/4, whatever your number is,
and you re-enter the second time. Then the head fake is out of the way, at least
in the listed stocks, and you have a very, very good probability on the second en-
try, assuming the dynamics on both the market and the stock are good.
After doing your nightly chart work with your relative strength screens,
explosion lists, pullback lists, etc., how many names will you ultimately
focus on as target stocks for the following day? It would appear that you're
looking at 150-plus charts a night. Also do you set alarms on those stocks
throughout the day or do you just continually scroll your five-minute charts?
How many trades will you average on any given day and how many positions
will you carry at one time, intraday?
Well, in answer to the question on the number of positions, on a strongly trending

day you want to take advantage of as many of the entries as you can get and that
you can handle from a capital standpoint. Youre right; I'll look at more than 150
charts. I segregate the charts and pre-screen them according to volume and take
those that have traded the most volume. Then I'll take those stocks that closed
above the mid-point or in the top of the range. I'll go through each chart individ-
ually and take the ones that have the best setups. And then I relate those to relative
strength and to what their group is. And after you start going through them every
night, you know exactly which are the strong groups and which aren‘.
One of the things you and | were talking about yesterday was getting familiar
with a stock. You tend to trade the same names over and over. | know
General Electric is one of your favorites. Talk about that. It's getting to know
the personality of a stock.
KEVIN HAGGERTY @# 45
OS
REDBET SERRA St AD A a a ere
It is. | think one way you can trade, especially starting out, is to pick four or five
stocks in the different industries, like GE, a multi-industry stock. And pick a
bank, pick a tech, pick a financial, and what have you, and get to know the char-
acter of those stocks, because certain specialists will trade certain stocks in certain
ways.
One quick aside, EMC happens to be a stock that is not as much fun now
that it has split . . . they never are. An EMC specialist likes to open that stock as
the last possible stock on the New York Stock Exchange. He takes advantage of
every little bit of information that he can get . . . you know, on the tape,
whether the S&P is really up or whether it’s going to fade. What you'll see with
EMC is that the S&P 500 and the futures are up, and all of a sudden they start
to fade. And then EMC suddenly pops up and it opens up 2 points. Well that
stock will never see above that opening level again because I just happen to know
how that specific specialist trades EMC. So I’m very comfortable when I get an
indication or get word that it is going to be opened up, to fade EMC on the
opening. In other words, if that stock gaps up, Ill sell stock if I see the market
deteriorating right in front of me. If it gaps down, I'll buy stock ifI see the mar-
ket improving. That’s the character of the stock.
e And General Electric, it’s a classic trader. If anybody is into geometric, or
Fibonacci or 50 percent retracements, the stock is a classic stock that trades by
the numbers. And the good thing about it is that it’s got a good range, you know
3 to 4 points a day. But it is also a $100 stock that can explode when they want
to mark it up and the programs kick in. Yet it trades at a teeny (1/16) or
1/8-point spread. Sensational stock.
The only way to get to know the personality of a stock, though, is to trade it
over and over and over again. And on the other side, I'm sure you have stocks
that—we all do—that you're just not going to trade. There's just no way
you're going to make money in those stocks. They just don't trade the way
that they should, or at least the way that you think they should.
(Chuckles) ve got a few of those.

RC
(EAS LT eee aa a eG
So it's about becoming comfortable with those stocks that have been good to
you and just staying with those stocks until proven otherwise.
That’s correct.
This question comes into the TradingMarkets.com office a lot. | don't know if
there is a right answer to this but let's try to attack it.What is the best time to
purchase stock at the opening? Should orders be placed prior to the opening?
As long as I’ve been in the institutional business, and trading now, and in differ-
ent ways, I’ve never made money before the opening or at the opening. There's
always an exception, but I very rarely do it. I don't think I’ve made three trades
in the last two years outside of regular trading hours.
So you don't have a resting order to be there on the opening. Is that correct?
That’s correct. Unless I have a position-trade in and I’m trying to get out of it for
some reason.
So even if stocks are going up, you'd still advise to let these stocks open up
and see where they settle before you enter.
Absolutely, because you'll have lots of choices. Stocks all come back sooner or
later, but there are always other choices . . . you always have another selection.
The only time [ll put it in at the opening is if Iwant to fade the opening. I have
a Trac Data quote machine. So on Trac Data I hit a certain thing and it tells me
all the stocks that are being indicated opening up above the limits or with an or-
der imbalance on one side, either the buy side or the sell side. So then I can
make a decision whether I want to sell stock on the opening—fade that open-
ing—or buy stock if it looks like it’s going to be a real down opening. Those are
the umes that I will trade the opening to fade it. And you have to put a market
order in to sell short at the market or buy at the market because you're not enti-
tled to stock with a limit order on the openings.
DENCE ESSE SRT NS TPG TER Ra TAR SS So

KEVIN HAGGERTY @ 47
CRT See ce et a A oR ee I SE REAR Sabet hsA TESS SER
But you're fading the opening moves. If it indicates 5 points higher, you're not
looking to buy it, you're looking to short that stock.
Absolutely. If it’s a big gap down opening I want to buy it and vice versa.
What do you use intraday to keep you in the trend? And what do you do to
recognize that there has been a change in the trend and that you need to get
out?
I keep a little, simple market table and I update it every 15 or 20 minutes—or

less, if in fact it’s a real dead day and nothing is really changing.
What market table are you referring to?
The market table is just a little tool that takes a look at the futures, the S&P 500
cash and the New York Stock Exchange ticks, which is the difference between the
number of stocks advancing and the number of stocks declining—the up ticks
minus the down ticks. And then I’m looking at the up volume and the down
~ Volume to see how that changes.
Up volume/down volume can be especially helpful when used with the
NYSE ticks. For instance, say the NYSE ticks suddenly go from plus 200 to mi-
nus 400, and I see that up volume stays the same while down volume changes by
10 million. And then all of a sudden those stocks are rallying back and I know
what the premium was—the difference between the futures and the S&P 500
cash—because I have that right on the screen. Well now I know where the pro-
grams are or where somebody is operating at a certain level, and that helps me
for the rest of the day!
I’m also looking at the difference between advancers and declines, and I’m
looking at the sectors. In other words, if I’ve got the averages up and I just see
the futures moving and the S&P 500 cash is really not moving and most of the
sectors are red (down) on the screen, that tells me that this is just some funny
money out there playing games in the futures trying to get something going or
maybe some of the allocation programs doing something.
(Rg apr te pn eR 8 a INTIS ORD SES PE CEE EE ET OTE EINATE,
But really your best long trades are in up markets and vice versa. So there-
fore, when you look at the dynamics, those are the times where you are going to
get stocks that explode out of patterns, especially going back above the opening
or out of a consolidation. Everything on full-bore together is what makes a good
trade.
On neutral days, nontrending days, those are days that can get you into
trouble and you have to cut your profit parameters in half. On these days, stocks
just take out the highs and the lows in a narrow range. But those are also the
days where you really get to do well in a stock like GE or some stock that you
really understand. You understand how it reacts to programs and how it moves
when certain buyers and sellers are.in there.
Looking at a bar chart, a higher low would be when the current bar's low is
higher than the previous bar's low. A lower high would be when the current
bar's high is lower than the previous bar's high. What do you think of playing
off higher lows for longs and lower highs for shorts as the main criteria for a
play, both daily and intraday? Do you use that as a criterion?
Oh, absolutely. Price bars relate to each other. The strongest thing that can hap-
pen is that on the first day a stock closes in the top end of the range after open-
ing in the bottom. And then the second day is another up day with a higher low
and a higher high and also the low is above the high of the prior day on increas-
ing volume. That’s the strongest thing that can happen in any market when you
are looking at a bar and then from there it goes to a little different level.
Let’s also reverse it and say you had the higher high and the higher low and
then it closed below the open. Well that wouldn't tell me a whole lot. That does-
nt confirm anything. I always want to see the close above the open in addition
to having the higher high and higher low, and vice versa for sells.
And you'd like to see some increasing volume with the higher high?
Most of the time . . . we're assuming reasonably liquid stocks now. It’s a different
game when you get into the mid-cap and the small-cap stocks that don’t trade.
EERSTE AEE ETE BMP SEF TSAR SS TT DES SATE OTH ES. AT SRR I BS a GG
KEVIN HAGGERTY @ 49
|S SD A i SAR CREE IEE SRE ES URS EERE Oa
But institutions—and you can trust me on this’ one—they’re not going to reach
in price unless they can get volume. Sometimes there is someone out
there—some momentum player or what have you—that is trying to get the stock
to a level to see how far they can take it. But in the normal course of business,
when the mutual funds and the money managers are buying, they won't reach for
size unless they can get volume. So volume becomes paramount when I look at
expansion of range.
Is it more bullish if the bid size is larger than the ask size over the course of
a day? And conversely, while in a short, would a larger ask size over bid size
be more profitable?
Definitely. If I’m short, I want to see a larger ask size. If I’m the person that’s
long, I want to see a larger bid size. Absolutely. Where the stock is trading is also
important. If you are a buyer or if youre looking to buy, it’s very bullish when a
stock trades at the mid-point and on the offered side if that is where most of the
volume is. And vice versa on the sell side—that stock is weak if it is trading be-
low the mid-point and on the bid side. And if you are watching these, you're go-
*ing to see that dynamics change right in front of you immediately, as soon as it
happens. Because what does happen is an institution can scale down if they are
the only player in the game. If the market is a little weak and the institution is a
buyer, you wont see that institution. They'll be down there doing what they call
a volume weighted average price, scaling down a little bit at each price, a little bit
every 15, 20 minutes—and nobody really sees them. And vice versa going the
other direction.
But if the market firms up a little bit and things are looking pretty good
and everyone’s getting a little excited, other buyers show up and now they've
got to compete with each other and they can’t scale down. Now they're getting
aggressive, they're telling their brokers on the floor, I have to be there, I have to
be part of that volume, you better protect me on the book. And all of a sudden
the broker has to put a bid for 10, 15, 20, 50,000 on there because he’s in
competition with other buyers. Those are the stocks that weve looking for be-
cause that’s when we notice that the Generals (large institutional investors) are
an a A Be NEE I IE SN SI PEE DS IETS
there. And we want stocks where buyers are competing with each other—or
vice versa, sellers are competing. And if that’s the case and the programs and
the accelerators such as the front-runners and the hedge funds and all of the
rest that try to get in there in front of size kick in, those are the stocks that
make the best moves.
So tying this together, you have a strongly trending stock and all of a sudden
you're seeing that the bid has been increasing throughout the day. You also
see that volume is beginning to pick up and that the stock is beginning to
uptick. It's probably a safe bet that there is a pretty low-risk trade there. You
put your stop in there right under the bid and see where they take it.
Absolutely. We have several traders I know at our firm who, before they split the
eighth, would do that with the program traders. And I know one or two of them
that were extremely successful with it, you know reading, anticipating the tape,
good overall market, good buyers in there, the futures moving, knowing full well
the buy programs would kick in, who just made a living scalping—trading
eighths and quarters—which is a very difficult way to do it. They were very good
at it. But you can't do it now that youre able to split the eighth—with the mar-
ket a teenie spread it is very difficult, and that’s not the way that I suggest that
one should trade. . .
No, no...
But those are the dynamics they are looking at. It’s very difficult to do.
There is a daytrading book out there that a hedge fund manager wrote that
basically discusses his trading for sixteenths and eighths and things like that.
It is a tough way to make a living.
You cant last for too long doing it. If you last for two weeks, you're lucky.
{SEAT SR SP RE ET SN AE ATE CY NEE RAE EN AS SERS HN
| won't mention the name of the book, but the reviews from the readers of the
book on Amazon.com just shredded this guy. | mean people were getting hurt
pretty badly by it. It takes a while, but you get chewed up.
You know Larry, my answer to that is that it is very difficult to scalp when you
compete with the people on the floor. You trade futures.
Yes and you hear a lot about the guys who were successful floor traders in
the futures who can't make a living when they come off the floor or they just
don't do as well.
Same thing I think in the equities. There are floor brokers down there and there
are registered traders on the floor with open wires and hand-held devices. So if
youre a regular daytrader sitting upstairs, utilizing the normal tools—Trac Datas
and Signal and everything else—you don’t have that flow, you're not looking into
the specialists’ eyes. You don’t know whether it is a double-yellow ticket. A dou-
ble-yellow ticket on the floor of the stock exchange means the specialist is buying
or selling it. You're not looking into the eyes of four or five floor brokers and see-
gng they are all anxiously waiting to buy or sell stock. Unless you are talking di-
rectly to the floor and have that communication line open, you can't make those
kinds of trades.
But sitting up top, it’s very nice to sit back and be able to look at it and just
get on board when something’s going through an inflection point with buying
pressure if you are buying . . . or vice versa if you are selling and the direction
has switched. And you can recognize that and you don't have to be on the floor.
Now, that can change dramatically in a second—somebody walks into a crowd
with a new order—but you know, that’s the game, that’s trading. And I try to re-
serve all the trades for those types of situations. I want to be able to look at it
and say, yes, that has changed direction. Or maybe it’s made three or four higher
lows or a pullback with closes all between the mid-point and the high. Each time
I would sit there and say “okay, I don’t care what they do, as soon as it trades
over the high of the low day, that’s it, I’m in, dynamics all being equal.”
SSI ECA a rR SG SAN EEL ACUED GD CE A TE SE SA TT
One of the other things | wanted to talk with you about is program trading.
How do you use program numbers and fair value? How does program trading
apply to daytrading?
Program trading or fair value numbers are different because a lot of different
firms have different costs of money. One good site to look at is, of course, the
Chicago Mercantile Exchange, at www.cme.com. They have information there on
what program trading is and how it affects the market. The levels that we use are
at the mid-point of people that pay commissions and people that dont pay com-
missions, and are based on the cost of money. So our numbers are right in the
middle. And what I do with them is I look at them with NYSE ticks—I’m al-
ways looking at the NYSE ticks—and that gives away the program trading. I’m
also looking at the up volume/down volume.
There is nothing you can do to apply program trading to your daytrading,
specifically. But what I do is, let’s say, for instance, a sell program comes in. How
do I know? The NYSE tick will all of a sudden go negative or drop dramatically.
It will fall real quick by 300, 400, 500 ticks, depending on the size of the pro-
gram. Now when I see the ticks starting to go negative, relative to what they
were, I immediately look at the S&P 500 cash index. Because if it’s just a pro-
gram and the buyers are real strong out there, and the S&P cash doesn’t really go
down that much and doesn’ really move or follow it, I know it’s just a program.
If it is a $10 million program or a $15 million program—somewhere be-
tween $10 and $20 million—stocks like GE will all drop 3/8, 1/4, 1/2, real
quick. If I look at the sectors and see that they're mostly green, I make the deter-
mination that the overall market is strong
If I make the determination that the overall market is strong because I’m
looking at the sectors, and they're mostly green—in other words, everything else
is there, it's just a program—that’s when I try to buy stock. I try to fade the pro-
grams: If it is a sell program I'll buy stock on a pullback. And vice versa, if there
is a buy program and a tape that is not so good, I'll try to sell some stock—un-
der the guidelines of what my trading plans looked at and if I was trying to get a
short off. And that’s how I'll utilize it.
SO I IEEE ETE TIE PEW SAREE ISS SLES ROTI
And what will happen is every day the programs will come in at different
numbers. Sometimes when the brokerage firms are doing programs, they can do
it at much different numbers than what you see posted anywhere or what you
will see on TV, because they basically have a very low cost of money. So you can’t
do anything in advance, you can just react. But what I do is as soon as I see
things start to change, I just write down on a piece of paper—hey, the spread
was 2 points, and all of a sudden sell programs were coming in. The spread was
4 points or 3 1/2... that’s where things picked up. And usually what will hap-
pen is those numbers will stay consistent for the rest of the day because program
traders will try to outdo each other and everybody is trying to get in and get
their program off and they give up a little to do it each time. So each day you
kind of watch, and it will happen early in the morning . . . say the first half hour
or hour, you'll see the programs start to go.
Kevin, let's talk about this because you said something that is the opposite of
what | would have expected. | would have thought that you were going to
say, “Okay. | see a buy program is going to hit. |want to come in immediately
shere and buy General Electric.” But that is not what you want to do here. You
want to wait for a se// program to hit, see if the market holds well and then
come in and buy GE.
Yes, I do because it’s easy to get price. That means I’m buying it on the bid or
down because everybody steps aside. I'd rather buy a stock that’s pulling back in
an up trend. I’m talking about a stock that’s above its open, that has rallied up
and now it pulls back due to program selling. I'd rather do that because it’s a
much stronger situation.
Got you. It's almost opposite thinking, but it is obviously the correct
way... you've got things moving in your favor.
Well, it is. I know one rule that works on the pullbacks and also when you sell
short. I don’t know if it’s a rule, but it’s one guideline that works. You buy pull-
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backs on stocks that are trending above their open and you sell short stocks that
are trending down below their open. Very rarely do you make a ton by coun-
ter-shorting a stock that’s uptrending above its open and trying to catch both
moves, the long and the short.
How do you prepare yourself for each trading day? What do you read and
what do you look at? Assuming an up trend, how do you pare down the
number of stocks to track? How many stocks can you track at any given
time? What technical software do you find useful?
I don’t use any technical software. f just use a stock scanner that searches for RS
(relative strength) value and ADX. I use several Web sites that give you some
data on volume and whether the stock finished in the top of the range. The soft-
ware I use is strictly Trac Data and a couple of Internet sites. I’m just looking at
the market in general—at the tape—and just watching things change direction.
And that’s strictly just bar charts, volume, price, time, and range expan-
sions . . . very simple, basic stuff. But I won't jump in, in the middle of the day
and say, “Gee, that looks good,” and just start to trade something to get a feel for
it. I have a pre-defined entry point based on the charts from the night before.
And I have pre-defined patterns that I'll look at on the intraday, five-minute
charts.
And then just by utilizing two or three patterns—like pull backs or consoli-
dations off the daily charts—I find I have too many stocks. At that point, I try to
narrow those down to the ones that finished with the most volume up or the
ones that finished the highest in their ranges so that I don't have that far to go.
And then I'll couple these with the volatility factor of the stock. [ll look for
stocks with high relative strength values combined with high earnings and great
momentum. And then I look for stocks that have pulled back—but not below
their 10- or 20-day moving averages—two to five days at most before making a
go again. Those are the stocks that I’m going to lean toward at all times.
So you want things that are really flying in runaway mode, as I know Mark
Boucher likes. But even on a daytrading basis, you want the kind of stocks that
RE USES Un PE ERT SR AE EP A AF PERO SI
can give you range. You want the highest volatility stocks with the best liquidity
that have the strongest pattern. That’s how I try to eliminate them. If it’s a
choice between a VISX or a CAT tractor, it’s going to be VISX. So you elimi-
nate . . . you go through that process.
And then you also want to stick with those stocks where you have some li-
quidity. If its an over-the-counter stock, you really want to see four or five mar-
ket makers down a good 3/8- to 1/2-point. This is so that if you buy it on the
offered side or at the mid-point and you make a mistake and the inside bid dis-
appears, you can approximate where you will get out. On the listed stocks, I stay
primarily with the over-the-counter stocks, the NDX 100, and those special
Internet stocks that look like they are trading with a little reality . . . and then
the highly liquid, big-cap stocks.
Let's jump ahead here. Explain what a Slim Jim is.

The primary Slim Jim that you are going to see is a long, narrow consolidation.
Its either near the highs of the day or the lows of the day or it’s either below the
high or above the low. And you usually see a minimum of six to eight bars, as-
#suming a five-minute bar chart. The longer the consolidation, the tighter it is,
the better the move. And youre looking at the Slim Jim in two ways. The first is
to go long, if it hasn’t had two or three breakouts already. If it is consolidating at
the high but it hasn't really got a good run relative to its range, youre looking to
take it to the upside.
It sounds pretty straightforward.

It is, but trading isn’t just about looking at chart patterns, it's about what's going
on around them. This kind of approach works because you've got all the players
in the market working for you. There will be institutional buyers and program
buyers pushing the market up. Also, the specialist might be long, and if he is,
you can bet the stock will accelerate to the upside. Hedge funds will be trying to
front-run the institutions, and so on. And there will also be the normal technical
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buying by retail investors. It’s a pile-on effect that can make these turn out to be
“moon shot’-type trades... 1 1/2 to 2 points in a day.
The other way to trade it is if it’s at the high of its day and it’s still in a
Slim Jim after two or three consolidating-breakouts to the upside. If momentum
swings in the marketplace, you may very well be able to short that for a quick
daytrade on the downside, even though it’s been a strong stock. You can do this
because it might be up 3 or 4 points and beyond the move of its normal range.
And the other type of Slim Jim that you'll see is with a stock that is down 4
or 5 points and has consolidated at the bottom of the range. This stock could go
either way. But it was already down beyond a standard deviation, down 3 or 4
points. Then the market turns and just explodes to the upside. So you can catch
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KEVIN HAGGERTY @# 5/7
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them at the bottom of the day for a rally back if they are down big and they go
the other way.
One thing about Slim Jims is that you can load up 75 to 100 stocks on
five-minute charts and put them on a list. And what I do is I just have a little down
arrow button and | go through the whole works from A to Z. And I just keep hit-
ting it all day long to see what's setting up.
So that’s the primary Slim Jim: a long, horizontal, narrow consolidation.
The narrower it is, the more compression you have. And you want to know
what? The best trade you can ever get long-term is a five-year-or-more, horizon-
tal trading range that’s been down for a long, long while and get an explosion
out of that. Take a look at Dell or any other stock . . . that’s how they all ex-
ploded. So the same thing works on five-minute charts as it does on long-term
charts. And, Larry, you can certainly attest to that with the commodities.
Yes, very true. In a sense, low volatility precedes the move.

For sure. But Slim Jims also take the form of dynamite-triangles. These are little
consolidations that you see during the day that you relate to the prior day’s con-
*solidation. So the whole process is relating something to something else, whether
it be today’s bar with yesterday’s bar, today’s bar with five bars ago, daily to
weekly or weekly to monthly. You can get some explosive moves with the Slim
Jims. Slim Jims work because institutions get new money in and have to put it to
work. The market might be running a little bit, and they don’t want to run in
and pay up for the stocks. So what they do is they go buy futures. They give an
order to a major firm like Morgan Stanley or Goldman Sachs or some big futures
players to buy futures at fair value, if they can. And these are S&P 500 stocks. So
in the meantime throughout the course of the day, the firm buys the S&P fu-
tures at fair value. Somewhere around 2:00 p.m., 2:30 p.m., they can’t buy any
more futures at fair value since the market is a little too strong. They have to
come to market and give those orders to buy the underlying stock, the underly-
ing cash. And what will happen is you will see these explosions at 3:00 p.m.,
2:30 p.m., and 3:30 p.m. on the S&P stocks. And the S&P average explodes.
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You will get orders coming down to the floor—for instance on Chevron, a
$95 stock, to buy 400,000, with a half-hour to go—that must be done. I used to
see them all the time when I had 94 brokers. And they'll say, “Can you help? I’ve
got to buy in size, I have to get done.” Well, what happens is no one is going to
sell that. Now as that stock starts to move up and up, the specialist is probably
going to short most of it, but he’s going to darn well short it at much higher
prices. Those are the explosions that come out of the Slim Jims. So I’m always
conscious of that, knowing that that can happen.
If the market is pretty strong and you see those consolidations, especially
when they haven't had three or four of them during the day, the first breakout is
always the best. And then it kind of diminishes as it goes because you run out of
KEVIN HAGGERTY @ 59
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range in price of the stock. But that’s what happens and that’s why you see those
explosions that make such powerful moves: they come right out of Slim Jims.
Let me ask another Slim Jim question. Is it better to enter when it passes that
day's high or just play it when it breaks out of its Slim Jim even though it is
below the day’s high? It always seems intimidating to play the
low ... there's a high looming over you.
Again, if it’s the first intraday high that pulls back and forms a consolidation,
then I'd play it going back to the upside. If it’s a stock that’s already run up a
couple of levels and it’s up there and it’s made a high, it’s like a spike and ledge
and then you play it to the short side.
A strong stock may retrace one-half or one-third of the move. But it will
form something as it consolidates to decide whether it’s going to make a run to
new highs or not. It will do something there. It will form a reversal pattern or it
will go into a little trading range such as a little triangle. If it’s above the open-
ing, the market dynamics are good, I don’t see any real sellers or anything show-
ing up on the offer side, and it’s just moving back and forth in a consolidation,
“I'd play it breaking out again. I would do this even though it’s below the high
and even though it’s probably not sitting the same way as it was sitting at the
high in the consolidation.
What would you say is enough volume to indicate that institutions are most
likely accumulating stock?
Well, you can look at it a couple ways. I have 50-day average daily volume and
30-day average daily volume indicators, and I also like to look at volume relative to
the day before and to the prior five days. There are two other things that you can
use. One is to have a service such as Bloomberg’s that lets you see how much vol-
ume traded on the bid side, how much volume traded on the offered side, and
how much volume traded on the mid-point. And you can go back “x” number of
days. That to me is the best way to determine what volume is doing. If a big-cap
stock doesn’t trade lots of volume, but it all traded on the bid side and it was 20 to
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30 percent less than its 50-day average daily volume, and all of a sudden I see all
that volume on one side or the other or a bias with a midpoint down or a mid-
point up, that also tells me something. You also can look at the volume-weighted,
average price.
The volume-weighed average price is just an average at each price the stock
traded at relative to volume during the day. This is an interesting number because
if institutions are competing to buy stock, what will usually happen is the stock
will close above the volume-weighted average price. And that’s very, very positive.
If the institutions are having their way and they can scale down, the selling
pressure is greater, and the stock will keep closing below the average—they usually
close below the volume-weighted-average-price because the institution is able to
scale down. That's very, very helpful in conjunction with the absolute volume
that youre talking about.
Kevin, do you advocate that stock traders just starting out keep a very small
position of 100 to 200 shares even though flat commissions are eating into any
gains? Or is it better for them to paper trade and then jump right into
500-share lots?
I think there are two things you should do. Paper trading with no money is not
going to help you from the standpoint of managing the trade from a profit
standpoint, reading the dynamics, and also pushing the button to get out of a
trade that goes against you. You have to trade real-time to do that.
Having said that, I think paper trading is great, and we shouldn't call it pa-
per trading. You should select stocks to see how your selection of stocks does, to
see whether those stocks gain anything the next day. You should look to see what
the profit range was above the high, what the range about your entry point was
on the stocks traded. Was it a second entry? Was it a first entry? And you should
start to get a feel of that part of the trader’s equation and not sit down and say,
“Pve made this much money or whatever,” but look at the dynamics of what
those stocks did. And then say, “look, ’'m running 50 to 60 percent.” Well, in
the real world, if you're running 60 percent on paper, when emotions get in-
volved and it’s real money and you can do 40 to 50 percent, you're probably go-
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ing to be okay in a reasonable amount of timé when you get some experience.
That's the only reason I advocate paper trading. It’s very good in the beginning
for stock selection and for getting the feel and idea of trading.
But the other thing about trading small size and a small amount of shares
gets back to money management. And you say, “Well, gee, the most I can lose is
$100.” Obviously, that’s the point on 100 shares. So you're not going to get hurt
and your capital is not going to get hit. But if you lose too many trades and
youre approaching that number—whatever number you give yourself, 50 trades
in a row or whatever—youre not going to let yourself get there. You're going to
see that your stock selection is not good at this point in time and after six or
seven straight losses, you're going to bail out and say, “What am I doing wrong?”
And I think that’s the way to go about it.
During the break-in period you should also go to a firm and say, “I want to
be in this business. Can I do 100 shares and get a reasonable amount or rate for
some break-in period?” Most firms will work something out with you where you
can do that. And I strongly advocate that.
Yes. Paper trading is good to a point and you should certainly do it. But it
will never replicate the psychology of trading, which is when you've got a posi-
* tion moving against you and youve got to react to that. Because you're on paper
and there’s no money on the line, the reality is you're not going to react the same
way if you're all of a sudden getting hit real hard.
No question about it.

If you're in a position and it’s running in your favor, either in your favor or
against you, you still have to pull the trigger. You have to get used to the type of
stress that’s involved. And you just can’t know how your mind is going to react
when you are just doing it on paper.
Another thing in line with what you are just saying is that it’s very hard to
get a feel for the kind of noise that you can get on your entries. Many times, you
get what looks like a good entry, but you get stopped out really quickly and then
the stock runs back up again. You may even get stopped again, if that’s the case.
But it’s very hard to know how you will react unless you are trading real money.
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It's better to do it with 100 shares than to do it on paper.

Absolutely, with 100, 200 shares, depending on the stock involved.
What's the best advice you have for aspiring short-term traders?
Other than risk control, I'd tell traders to ignore most inane market news and
opinions. They should look at relationships between price bars, highs and lows,
opens and closes, and volume from day to day. These are what tip you off to
market dynamics. Are the buyers more aggressive than the sellers or vice versa? A
series of higher closes and higher highs coming out of a pullback situation on in-
creasing volume tells me a story—I don’t need to listen to the news. When you
combine this with the institutional side of the story, it gives you a pretty good
perspective on the market.
When someone asks me, “Why are you buying that stock?” I tell them, “Be-
cause it’s going up, and the stocks in the group and the larger market are up,
too.” I don’t try to pick bottoms or tops; I pick my points—if they turn out to
be tops or bottoms, so be it. If you're picking your points based on market dy-
namics, youll pick a lot of tops and bottoms anyway.
A pattern is a pattern—it’s where it occurs that’s important. What are the
players doing that will push the market one way or the other? Look for trading
ranges, triangles, and other congestion areas that get you into the market with
little risk, and let the institutions do the work. I get on board when pieces are in
place and the market is going in the direction I want it to go. If the institutions
are interested, I’m interested.
Thank you, Kevin.
Good to be here!
CEDD MOSES
©
By Kevin N. Marder
he name Cedd Moses has a certain ring to it. Surely, it’s not a name that
one stumbles across very often in life. I first came across it in the early 90s
when I saw performance rankings for the U.S. Investing Championship. Moses
finished first in one of the USIC’s equity divisions in 1991. Right around the
same time, I noticed that Moses regularly finished among the top performers of
Money Manager's Verified Ratings, a service designed to track portfolio perfor-
mance. I'd see the same handful of names consistently dominate the MMVR
rankings, and Moses seemed to always be near the top. It’s one thing for a trader
to have a good year, but something entirely different to consistently shoot out
the lights as Moses had done.
And then it was in 1992, I believe, that I again came across Moses, this
time in an interview in Barrons. A few years prior to that, I had begun adopting
Bill O’Neil’s philosophy of buying aggressive growth stocks sporting high relative
price strength. As I learned in the Barron’ piece, Moses’ big influence was none
other than Bill O’Neil. Here was a guy not only putting up big numbers, but
running big money as a hedge fund manager to boot.
63
64
4 ©
Whereas some of the biggest hedge fund managers have called it quits over
the past couple of years, Moses has been able to achieve returns of 137 percent in
1998 and 81 percent in 1999 (this is net of all fees). Managed Account Reports
ranked Moses’ hedge fund in the top 1 percent of all hedge funds for the
three-year period ended May 2000. In addition, Nelson’s Worlds Best Money
Managers ranked his fund in the top 1 percent of all U.S. equity products for the
three-year period ended March 2000.
Kevin N. Marder: Did you have a love of the market from a young age, like so
many other top traders?
Cedd L. Moses: Yes. When I was 12 years old, my grandmother set up a custo-
dial account and gave me a few shares of stock. Right away I went to the library
to see whether or not I should hold the stock or sell it. At that time it was just
pretty generic, fundamental information, but at least it piqued my interest. Then
later, as a teenager, I started getting O’Neil’s Daily Graphs and following those. I
also started going to his bookstore in West L.A. and began getting to know him
and getting a feel for his CANSLIM strategy of investing. He did a back test of
about a 37-year time period and he looked at every stock that doubled within a
year, as well as the characteristics that a lot of those had before they doubled.
This was even before he called it “CANSLIM”?
Exactly.
So this was what, 1980-ish?
Yeah. Way back then. And I started looking for those factors, flipping through
chart books myself, looking for the ideal cup-and-handle patterns and companies
with accelerating earnings and sales growth, etc. But I would do it manually.
With the help of Daily Graphs?

Right. Exactly.
CEDD MOSES @ 65
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Since O'Neil had not written How To Make Money In Stocks at that time, how
did you learn his approach? Were there other books that you read?
Oh yeah. I read a lot of them. I was basically reading everything I could. An-
other influence was a book by Nicolas Darvas. . .
How | Made Two Million Dollars in the Stock Marke?
Yes.
That's one of my five favorite books.
That and things like Gerald Loeb’s Battle For Investment Survival. | mean | basi-
cally read everything that I could get my hands on. Market Logic had an impact
on me. That was written by Norman Fosback, who had an approach where he
would look at a series of indicators and back tested them to see if they had any
kind of accuracy. That was the beginning of my building an econometric model
to give me a feeling for market risk. What other books did I read? There was a
e ton that I read. Reminiscences of a Stock Operator influenced me.
And now again, this was when you were in high school?
High school and college. I did a lot of trading in college. I studied mechanical
engineering—computer science—and by the time I graduated school I had offers
to go to work for defense companies and so forth. But I wasn’t really interested
in that. I wanted to go directly into the stock market, so I started working in the
brokerage industry right out of college.
What company was that?

It was a small firm. Baraban Securities. I don’t know if you remember them,
Kevin.
66
# ©
Oh yeah, sure. Are they still around?
They are, but they got swallowed up by another company.
| think | remember reading about that. And were you a broker there, then?
Yeah. I was a broker and I was also heading up their trading desk. I learned a lot
sitting on the trading desk.
Were you trading just for the firm's account or...
No, I was entering trades for the other brokers.
What would you say the big learning lesson was when you sat on that
trading desk at Baraban? Was there one big thing that you learned that made
the thing—
—because I dealt a lot with the other brokers’ orders and orders they were get-
ting from the public, I got to realize that the public, a lot of times, was wrong at
key turning points in the market. I would see the sell orders pouring in at the
market bottoms and I would see the buy orders pouring in at the market tops. I
would see people making typical mistakes, psychological mistakes, like trying to
buy beaten-down stocks, broken stocks, and selling their winners after a small
gain and holding onto the losers, and buying losing stocks and falling into that
trap, losing money.
That's interesting.
When I was a teenager, I learned the hard way one time when I rode a stock
way, way down. It just kept going down every day. I didn’t know anything about
using benchmarks at the time, so I learned the hard way. When O’Neil’s ap-
proach came to me, it made a lot of sense. You've got to know where to get out
and cut your losses. And that’s still a key part of everything I do. I define my risk
on every trade before I enter it.
ERSETSESTO STATS EST NG TS RL RL RE eR SS RD EG,

CEDD MOSES @ 67
a
Do you do that based on a straight percentage basis? Or do you look at a

chart and say, okay, here’s some support, so if it breaks that support level, I'll
have to sell?
It depends on which security it is. If it’s a futures trade to hedge my portfolio, |

have a specific benchmark and use a momentum oscillator to get me out. But I'll
have a maximum risk that I'll take on a trade. And then on each individual
stock, my decision depends on how much upside I feel the stock’s got based on
my screens. If a stock has the potential to double, based on my main quantitative
screen—which consists of 22 different screens—I tend to give those a little more
room. My benchmark is then based on an absolute bench off the stock’s high
since I've owned it, as well as a relative bench.
Okay. We'll come back to the when-to-sell criteria a little bit later. You were
at Baraban for a number of years. You went straight from there into your own
money management company?
Basically, yeah. After a few years, I turned into the top broker at Baraban even
e though I'd never made a cold call. This was because I had already developed my
stock selection process to a point where everybody recognized that I knew how to
make money trading. So the firm actually changed their whole scope toward
something called co-brokering, which I developed, where I was basically manag-
ing money. The other brokers would raise money for me and wed basically split
the commission. They would have the contact with the clients. And then eventu-
ally I broke off on my own and for a little while tried to start up my own bro-
kerage firm.
I was already trading for clients as if Iwas a money manager, so I decided
to move on and start up my own money management firm. That was back in
1989. And it’s been successful ever since. I was basically trying to do it in an-
other form within the brokerage industry from 1983 to 1988. I couldn't advertise
a track record because I was in the brokerage industry and they were sensitive to
the fact that your clients can call up and sell their stock at any price they want,
affecting your track record.
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I'd heard that you'd started off as a daytrader. Is that correct?

I used to do a lot more trading intraday based on sentiment indicators, momen-
tum indicators, and relative strength.
Were you holding positions for less than a day or taking them home
overnight?
I traded options and I would trade positions in stocks on margin and I took on
large positions that were a large percentage of my portfolio. I'd only hold them
overnight if the trade was working. I would not hold a losing position overnight.
So you would maybe sell the winners within three, four, five days or so?
If they were still working, I would stick with them. The whole philosophy was to
let your winners run. As soon as the market would start to turn against me or a
stock would lose momentum on the upside, then I would get out. I had indica-
tors to track the momentum. Sometimes I would hold stocks that had powerful
upside momentum for a long time. Like in the ’80s I held Wal-Mart for a long
time... and also Home Depot.
Was it in 1991 that you won the U.S. Investing Championship?

eGo
What was your return for that?
I’m trying to remember. Actually, it was such a huge number that we decided not
to talk to clients about it because we didn't want their expectations to be too
high. We could just talk about triple-digit performance. It beat the previous re-
cords that were out there at that time. By the time I started my own money
management firm, I had my technique refined in terms of using more diversifica-
tion. When you manage a pool of money, you have to widen up your
benchmarks a little bit and use a little more diversification to help control volatil-
ity and try for longer-term gains for your clients.
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Let's get into your basic strategy, then. What are the things that you look for
in your buy candidates?
I have three specific screens. Two of them bring out my buy candidates. Instead
of flipping through chart books, I went back a few years quantifying the factors
that | would look for when I would flip through the chart books. That allowed
my system to become much more objective, instead of having to look through a
chart book and say “oh, this one looks good, this one looks bad.”
| can sure relate to that.
I was able to quantify the things that I would look for and I was able to
back-test them to see what kind of results they would have generated in past pe-
riods. | kept refining it and adding more and more characteristics that I would
look for and did more back-testing of other new factors and new ideas that I
had. I continue to do that, but right now I am up to 22 characteristics that I
screen for in my primary fundamental screen.
Do you still use your Five Market Principles model?

Yes, that’s incorporated into how I control risk. They are incorporated into my
three layers of risk control.
Can you go into some of the specific things you screen for on the buy
candidates?
Yeah. There are two screens that bring up my candidates. One is the fundamen-
tal screen. That’s where 70 percent of my names come through on the buy side.
There are fundamental characteristics, liquidity characteristics, and technical
characteristics that I look for. On the fundamental side, companies have to be ex-
hibiting strong current earnings-per-share and sales growth, and have a history of
at least four quarters of strong sales and earnings growth. I also have a valuation
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screen where I look at P/E relative to the growth rate of the company. There’s a
screen based on that. The actual numbers are kind of proprietary . . .
Sure.
I use this to make sure I’m not paying too much for a stock relative to its growth
rate.
Is this like a forward P/E-to-growth ratio, then?

Yes;
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Again, this could be proprietary, but you would take today’s price and divide
it by the forward four quarters earnings forecast by the Street—or the next
fiscal year earnings forecast—and divide that by the expected growth rate in
the next fiscal year. Ils that the way you do it?
That's kind of a simplified version. Actually, it's the weighted moving average of
the forecast for the next year, two years out, and the past year. The heaviest
weighting is on this coming year.
The first year.
Exactly. It's a weighting of those. Again, in testing, I’ve been able to find a factor
that works the best by quantifying it. It’s something that’s hard to do yourself,
mentally, by just looking at a chart. And the amount that I’m willing to pay in
terms of valuation is also a factor of a couple of other fundamental factors: earn-
ings surprise consistency is one.
For example, a company that consistently has beaten earnings estimates by a
certain percentage . . . those are companies that are much more well-managed in
“terms of Street expectations . . . managing their own company’s growth. For those
companies, I’m willing to pay a larger premium for the growth there, if there's a lot
of consistency and visibility going forward. Also, companies have to be exhibiting
positive earnings drift in order to make it through the screens. That's the other
fundamental factor which is something I developed internally, too. That's a factor
that’s only been available in the last five years or so. At the time, O'Neil didn’t
have it. A lot of people didn’t have it, because companies like First Call and Zacks,
for example, didn’t have their earnings estimate data available on a real-time basis
like they do now where you can screen for it on a real-time basis.
Again, this could be proprietary, but do you look at drift over the last 30 days
or 45 days?
It’s the 45 days going into the earnings number. I’ve found a high correlation be-
tween positive earnings drift and positive earnings surprises. To sum it up, the fun-
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damental factors I’m looking for are companies that 1) are growing strongly, 2) are
still selling at a reasonable price relative to their growth, 3) consistently beat their
numbers, and 4) have a high probability of beating the number. that quarter.
The whole screen is broken into three different categories: fundamental, li-
quidity, and technical. The liquidity factors that I look for make sure that I can
get in and out of a stock in one day. I tend to trade between small- and
large-cap. But because of the size of my fund, they have:to be at least $250 mil-
lion in market capitalization. They have to be exhibiting a certain amount of av-
erage daily dollar volume. They also have to have a tight, bid-ask spread. And all
that’s done through the screen, so that eliminates names that aren't liquid enough
for me.
And then I have the technical factors that I screen for. First, our stocks have
to be above major moving averages that the market's above. For example, if the
market's above its 200-day, then the stocks have to be above their 200-day. If the
market's above its 50-day, the stocks have to be above their 50-day. They have to
be outperforming 80 percent of all stocks, and I measure this through relative
strength. I have two different relative strength measures: short term and long
term. The long-term measure is very similar to O’Neil’s measure of relative
strength. And last, they have to be exhibiting positive up-to-down volume. They
have to exhibit all these technical factors in order to come through the screen.
Oh, okay, so special situations is—

—a whole different, separate screen. It brings up all different buy candidates.
Right.
The fundamental screen brings up a couple of names a day, usually, except in a
weak market when there are a lot of stocks breaking down with poor technicals.
Then no new names tend to come through.
And what about the special situations screen?
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The special situations screen isn’t as tight in terms of fundamental factors as the
fundamental screen. The most important fundamental factor that I am screening
for there is just a positive earnings drift, so that there is a high probability that
the company is going to beat earnings expectations that quarter.
Okay.
So the company can still be losing money. Like the Internet names came through
this screen in the mid- to late-’90s. Even though they were losing money, they
were beating earnings expectations and the earnings estimates were rising, espe-
cially going into the numbers. They were coming through that screen. Then they
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have to be exhibiting the same liquidity and technical factors as my fundamental

screen, so it’s a larger pool. Then they're ranked, based on their relative strength.
Now, as far as looking at a chart goes, how do you integrate that with the
screens that you've just spoken about?
Well, once they’ve come through the screens, that tends ‘to bring up a couple of
new names a day. Then I look at the chart pattern. Assuming the stock’s in a bas-
ing pattern, I wait for either the relative strength or the price to break out of that
basing pattern before initiating a position in the stock.
Do you build a position before the actual breakout occurs?

If the relative strength is breaking out.
Otherwise, you'll actually be buying on the day of the breakout, then?
Right.
And do you insist on the volume being pretty big on that breakout day? For
example, O'Neil likes to see volume increase 40 to 50 percent above the
average on that breakout day.
I like to see that, too. And if it increases more than that, then I take a bigger po-
sition. The size of the position is dependent on how much strength is in that
breakout as well as the liquidity of the stock.
Do you have any set amount or set percentage that would be your opening
position?
About | percent.
And this is, did you say, with a $350 million fund?
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The fund’s about $300 million now.
And then how do you add on to positions when you're right? Do you like to
pyramid up as the thing moves higher?
Yeah. With about 10 percent of my positions, I feel comfortable taking a larger

position in a good market. In that situation, I pyramid up, if the stock is very
powerful coming out of a base, to between 1.5 and 2.0 percent. I'll go up to 3
percent on a stock that bases again and breaks out real powerfully again. That's
rare.
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Moving it up from 1.5 to 3 percent, would that be all one buy or would you
make successive buys?
I would go from 2.0 to 2.5 percent if it breaks out again, but if it breaks out re-
ally powerfully, then it would go to 3 percent. Usually there would be some ap-
preciation between then, too, if it’s a really powerful stock and it naturally just
becomes a larger percentage of the fund. So it might already be up over 2 percent
by the time I start adding to it, moving it to 2.5 percent or to 3 percent.
I dont take larger than a 3 percent initial position on a stock right now be-
cause of the size of my fund and diversification. But I’ll let them appreciate.
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When your fund was, say, $20 million, $30 million, $40 million in size, was the
size of your positions larger at that point?
Yeah. I would go up to 5 percent on a stock.
With the opening position, you mean?

No, the opening position was between 1.5 and 2.5 percent.
And then you would go up as much as 5 percent if it was one of those add-on
types.
Real leaders.
Does that pretty much cover what you look for in buys, then?
Pretty much, yeah. The important thing is the screen that’s got more fundamen-
tal factors in it. Those are the ones we think have more upside. We have tighter
*benchmarks on the special situations than we do on the fundamental screen. Spe-
cial situations help us get more diversification because it brings up names that
might be companies that aren't making money yet, companies that are turning
around . . . like it brought up the oil service names . . . it brought up a lot of
Internet names early on. It gives us more diversification and allows us to get into
some companies early on.
Otherwise, though, apart from your special situations screen, are you trying to
pick stocks in the best-acting groups?
Yes. That’s basically it. With the fundamental screen, we'll basically buy any
name that comes through there that’s acting good in terms of the chart. So it will
naturally get us over-weighted in the sectors and groups that are leading the mar-
ket. That does tend to happen . . . like during the ’80s, a lot of healthcare and
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retail, and during the 90s, a lot of technology. But the special situations screen
brings us more diversification and gets us into other groups that might be start-
ing to emerge . . . like Internet stocks and biotechs. These groups started moving
before they had earnings.
And what about shorting?
A lot of people that focus on the buy side have trouble on the short side. Since
I’ve been able to quantify a lot of my stock selection process and back-test it, I
can keep my head clear enough so that I can also focus on short-selling candi-
dates as long as they're coming through screens. I don’t believe in shorting stocks
just because they’re overvalued. That’s a mistake that a lot of people have made.
Yeah, hordes of folks got killed shorting Internet stocks.
Yes. Our goal is shorting stocks before the company misses the number that
quarter . . . because we all know what happens to those stocks when they miss
numbers. So the best factor that we've found is negative earnings drift because it
has a high correlation with negative earnings surprises.
That makes sense.
If there’s a dropping of earnings drift by a certain percentage in the 45 days be-

fore their number, there’s a high probability that they're going to miss their num-
ber. They also have to be liquid and exhibiting negative technicals, such as
breaking moving averages that the market’s above.
Would you also want to see a stock break some support on a chart?
Exactly. That’s part of the short screen. We've quantified breakdowns in charts
through weak relative strength and breaking moving averages, and a high amount
of down volume relative to up volume. There’s new names that come through
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the screen every day and I'll look at the chart patterns and double-check it and
then put the position on. In certain market environments, if there’s a lot of risk
in the market or if the market's acting poor, Ill offset long positions that we have
with short positions so that it cuts our overall risk in the market. It allows us to
hold onto some of our big winners as long as they're acting good, but at the
same time offset them with short positions in a lot of losing stocks.
So those are our three screens.
Moving over to your sell decision, can you give me the factors that you look
at? | guess we should split this up. If you're wrong on a stock and it drops
right after you buy it, where would you consider cutting the loss and moving
on?
Well, on special situations I set a benchmark based on the price action and a
support level. I try and buy the stock just coming out of a basing pattern, and |
put a price benchmark just below that base.
“Below the top of the base or the bottom of the base?

It really depends on the relative strength. If the stock breaks the top end of the
base independently of the market—let’s say in a strong stock market—then that’s
a really bad sign. But if it breaks the top end of that base, and at the same time
the market’s in a major correction, then the stock still might be okay. So then I
bench it off the bottom of the base. That’s how we handle special situations.
Then on every stock that goes in, we put on an absolute bench off the high
since we owned it, and a relative bench, relative to the market. So for example,
with a fairly liquid stock, the maximum bench we take is 20 percent relative to
the market. So if the market goes up 10 percent and that stock drops 10 percent
off its high, then it would be sold. The maximum risk on a volatile stock we'll
take is 30 percent.
That's something we went back and back-tested. I don’t hear many people
talking about relative benches.
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I've never heard anybody talk about it. Your research reminds me of the
research that Mark Boucher does . . very painstaking, thorough,
nothing-but-the-facts-ma‘am type of stuff.
Yes, the relative bench is something that’s been incredibly useful. I mean if you
think about it, one thing that it does is get you out of stocks just before the mar-
ket goes into a major correction. So it takes you out if they start dropping relative
to the market. Ahead of a big correction, youre just taken out of the most vulnera-
ble stocks through that relative bench. It helps protect you. For example, going
into the 1998 correction we were actually only 30 percent long and we had a big
short position on before the correction really began in the third quarter. The same
with the March-May 2000 correction. We were out of a lot of stocks before the
market correction began, especially the weakest groups that were starting to really
break down. That relative benchmark has been really useful.
And then the other thing that we bench off of is related to earnings esti-
mates, which we monitor real-time. We have a fundamental benchmark, so if es-
timates drop by a certain percentage in the 45 days going into the number, that
would also take us out of a name because there’s a possibility of a negative earn-
ings surprise.
Those are our sell disciplines.
That includes selling to cut a loss as well as selling to nail down a profit, then?
Yes. Sometimes a stock will go up 300 or 400 percent and then it will drop a
certain percentage relative to the market and that takes us out of it. As long as
the stock keeps outperforming the market and making new highs, then we tend
to stay with the position.
Do you ever take a specific set percentage and say, “Okay, the stock just
dropped, say, 20 percent off its high, I'm going to sell the stock here”?
Oh yeah, we have a set relative bench and an absolute. We have an absolute
bench as a protection, too. It helps us in real bear market conditions or correc-
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tions. But the relative bench has protected us before those corrections and bear
markets have begun and keeps us in the leading stocks.
As far as the absolute bench goes, does that vary from stock to stock, then?
Yes, it’s dependent on the stock’s volatility.
How much does this amount to?
It's between 20 and 30 percent off the stock’s high, maximum.
How do you handle a climax blow-off, where a stock runs, say, 80 percent,
something ridiculous, in a week or two? Do you sell into that or do you want
to see the stock put in some kind of peak and then come down 10 or 20
percent?
If a stock’s running up big, selling it can be kind of a subjective decision. Some

of the Internet stocks did that in a short period of time and then they double
and triple again in a short period of time. I’m sure you've seen that, too, Kevin.
Its kind of a subjective decision when a stock’s going straight up, whether or not
that’s a blow-off or that’s the beginning of another huge explosion in the stock.
So I try not to make that decision myself. I let the stock’s action after that dictate
what's going on. But if the stock appreciates that much—like doubles quickly—a
lot of times it will become too large a percentage of my portfolio. So then the
stock would be cut back. We would trim the position at least. And if the stock
started dramatically underperforming the market from that point forward, then
the stock would be sold.
As far as your general market indicators go, | know you used to have 15
different ones. How many do you have now?
Twenty-five.
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Could you talk about some of your more important ones?

Sure. The 25 break into five categories: momentum, sentiment, smart money,
valuation, and monetary. It gives risk ratings on the market from a short-, inter-
mediate-, and long-term perspective. In the short term, the best predictive tools
on the market are sentiment and momentum indicators. For sentiment indica-
tors, very valuable ones are the VIX, which I know you guys use over at your
shop, and the put-to-call ratios on both the CBOE and OEX. The good thing 1s
now you can follow those intraday through the CBOE’s Web site.
Yes. In the old days, | used to call them up every 60 minutes or so, but—
—yeah, we would do the same thing! But now it comes up live on the Web site
so you can just keep that on your computer screen.
And besides sentiment, you also said market momentum?
Yes, market momentum. The best situation for a short-term market top is when
sentiment is extremely positive on put-to-call ratios among speculators and then
market momentum turns down. Often that’s a sign of a short-term top when
momentum has confirmed that a short-term top is in place at the same time as
there’s excess optimism.
What are some of the momentum indicators that you use?
I use the MACD, which I use for different time periods.
Different time periods?
Yeah, different time periods depending on the index that I’m looking at. And
also the McClellan Oscillator and Summation Index . . . we've used those pretty
successfully. Those are some of the best tools. And then price action in the mar-
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ket is something I also watch. For example, accumulation and distribution days
in the major averages . . . if they’re breaking on higher volume or lower volume
than the previous day.
That's a favorite of mine as well.
If you see the MACD confirming a top at the same time you see the market vol-
ume picking up on the downside and too much optimism, you've got to be real
concerned, at least in the short run.
With the MACD, if you were looking at the histogram, would you use more of
a move from positive to negative territory? Do you think that's more important,
or for example when the thing peaks and the histogram bars get, you know,
shorter and shorter?
The perfect situation for a top is when you have a non-confirmation. The market
makes a higher high but the histogram makes a lower high. And then the histo-
egtam moves from positive to negative . . . so a non-confirmation in terms of the
level of momentum on the histogram. Those are the best sell signals—using the
MACD—when you have a lower high break from positive to negative. That's
when you have the sharpest short-term sell-offs.
So those are the most important factors in the very short-term. But on the
intermediate- and longer-term basis, monetary policy is the highest weighting in
my model. I use indicators on monetary policy that I’ve developed. Ned Davis
has developed some that are good, too. Indicators of smart money trades have
nailed the market tops and bottoms in the last two decades really well. One mea-
sures what the members of the NYSE off the floor of the exchange are doing ver-
sus the members that are on the floor.
| actually first learned that from you in your Barron’s article of ‘92 or so.
Oh yeah?
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Yeah. | never knew anything about that and started following it after that.
Back then, | think you had pointed out something like when the long
positions are in excess of 20 million or 25 million shares a week ... when
we start seeing a few weeks of that, that's very bullish. Am | correct in
saying that?
The numbers relate to buying relative to selling. Right.
Is that still the case today?
Yes. Over a 10-week period of time, if you see it averaging over 10 million shares
a week, that’s pretty significant. But it can get up to as high as 20 million shares.
And conversely, on the sell side, when you see more than 10 million a week be-
ing sold. For example, ahead of the 1998 correction and ahead of the
March-May 2000 correction, we saw heavy member selling and you also saw a
pick-up in specialist shorting vs. the public. You also saw a pick-up in corporate
insider selling. Typically, there’s about a 2-to-1 ratio of corporate insider selling
relative to buying. But when it gets up to 3-to-1, that’s a warning signal. And
when it gets down to 1-to-1, that’s a positive signal.
And then another thing that called this correction really well at the beginning
of this year was the smart money flow, which is the change in action between the
first hour and last hour of trading accumulated over time. I’m sure youre probably
aware of it that the smart money is known for trading more in the last hour of the
day and the more emotional money invests during the first hour. So if you see a
day when the market's up big in the first hour but down big in the last hour, that’s
a sign of distribution in the market. And if you take the price change in the mar-
ket in the last hour minus the first hour, and accumulate that over time, you can
see divergences between that and the chart of the market itself.
I've also looked at this, once again courtesy of your Barron’s article.
It called the ’87 crash . . . like nailed it. . . the 90 correction, the ’98 correction,
and the March—-May 2000 correction. The smart money flow was collapsing at
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the beginning of this year, so you could see a lot of distribution going on. So
that’s a pretty good tool, too. I kind of mix all five of the areas in intermediate-
and long-term signals. But I use a little bit different indicators for momentum
and contrary sentiment for long-term confirmations. And then I also use funda-
mental valuation tools that aren't strictly based on P/E, but factors that are based
more on valuations relative to interest rates and also the supply and demand of
stock in the marketplace. Say, if there’s a period of a lot of stock offerings, that’s a
negative in terms of valuation of that principle versus a lot of stock being taken
off the market—that would be a positive for supply and demand.
So all those tools go into the five market principles and give me an overall
assessment of market risk on a short-to-long-term basis. And when long-term risk
and intermediate-term risk are high, and there’s potential for a correction or a
bear market, and it starts to be confirmed based on the price action, then I take
my risk off the table and have an equal percentage of longs in my portfolio as
shorts.
Its worked out that my longs tend to outperform my shorts, so I can make
money in that environment and that’s why I’ve been able to be non-correlated in
significant down markets. In a tough market environment like 1998 or early
2000, I can make money.
What will be the highest cash position you raise during the course of a year
as a percent of your total portfolio?
Hypothetically, it could go to 100 percent ifIdon’t have any long positions and
there are no attractive short positions coming in. But that’s extremely rare.
Usually, looking more at the net exposure—I try to go to about a 0 percent net
exposure unless I have confirmation of a bear market which has to come through
those five different principles, too. In that situation, I would take a net short po-
sition. That’s rare . . . the last time I had a signal for that was before the ‘87
crash.
Otherwise, I don’t really believe in being net short the market . . . pretty
tough.
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Right. | haven't really been a short-seller myself. You know, O'Neil said in
that book of his that he'd only made money in something like two of the prior
nine bear markets. When | read that | thought, well, you know if it's not good
enough for him, maybe it's not good enough for me. So I've only rarely
shorted. And that was about it.
If they're small enough bears, you can just get out of all your long positions and
wait out the bear market.
Exactly.
We try and get out of our long positions, but sometimes there’s some stocks that
are still working up in bear markets and we try and stick with those and try and
offset the risk of those positions with short positions. That’s kind of the philoso-
phy.
Obviously your strategy has changed over the years because you're running
much more money now. If you were running a smaller account, say, $500,000
or $1 million or so, would you be trading the way you did in the beginning
days when you relied more on chart patterns and momentum?
No, I don’t think so. One thing the quantitative screens have allowed me to do is
to select stocks that dramatically outperform the market. And I don't have to
thumb through chart patterns every day.
Right, right.
My current strategy also is able to give me stocks that have a lot more upside po-
tential. Sometimes I'd be buying stocks just based on their chart patterns and
they'd do pretty well for me. But in the meantime I'd maybe miss another one
that exploded. Looking at the screens . . . it helps me find the stocks that have
the biggest upside potential and focus directly on those just before they break
CEDD MOSES @ 87
out. Otherwise, you're looking at a 7,000-stock universe. This way, I can focus
on just about 400 stocks and watch those much more closely. If Iwas just han-
dling that small amount of money, I probably would be taking larger positions as
a percentage of the portfolio. But that’s only if the client was willing to take a lit-
tle more volatility.
| mean if it was your own account, let's just say, would you take position
sizes of 10 percent or something like that?
No. I don’t think so. Now I feel pretty comfortable being more diversified and
not having to put up with that much volatility. Five percent, potentially.
Interesting.
But that’s just where I am.
What have we left out here?
We've been able to achieve our objective of being a high alpha fund. Our average
alpha is 4 percent a month. This means we add 4 percent on average to the S&P
per month. At the same time, we haven't had to sacrifice in terms of diversifica-
tion. You know, we've been able to be extremely diversified and have low volatil-
ity in down markets and actually make money in significant down markets. Four
percent alpha is considered big enough in the business that we're in. We're add-
ing 4 percent a month.
That's while you own the stock, you're adding 4 percent? Or before you buy
the stock, you're buying stocks with...
No, no, just our average monthly performance versus the S&P. We add 4.06 per-
cent per month. That’s been the average on our portfolio. Our objective is
outperformance and not having to sweat down periods in the market.
88
¢ ©
You've been most generous, Cedd, in sharing so many of the specifics

associated with your strategy.
It’s been my pleasure, Kevin.

MARK BOUCHER
THE MIDAS TOUCH

By Kevin N. Marder
w people must know as much about the ups and downs of being a trader
than Mark Boucher. Before he was ranked the top hedge fund manager in
the world over a couple of five-year periods in the 1990s, he experienced the
harsh reality of watching his account collapse by 90 percent during the
1973-1974 bear market.
This latter experience impressed upon Boucher the absolute necessity of de-
vising a rigid money management plan. Boucher took the task to heart, emerging
from this near-calamitous event to log a well-deserved reputation as “the man
with the Midas touch,” a reference not only to his hedge fund of the same name,
but also to his record of consistently potent returns with one of the lowest levels
of volatility of any hedge fund manager in the world.
Much of Boucher’s thinking is detailed in his book, The Hedge Fund Edge. |
always have a lot of respect for a trader who decides to start from scratch and fig-
ure out “what works” in the market. Boucher took this approach to the nth de-
gree early in his career, spending years and thousands of hours doing the
painstaking research needed to cull the wheat from the chaff among the heap of
89
90 # THE MIDAS TOUCH
a a gE AR hg Ar aT IA LT I EEL PET
indicators and data available. What he emerged with, and how he got there, is
the subject of our interview.
Kevin N. Marder: Mark, when did you first get interested in the stock market?
Mark Boucher: I started trading when I was in high school. My father died of
cancer when I was nine years old. In 1972, he started a trust fund for me for my
college education because he knew he was sick. He put $100,000 into it, which
was pretty much most of his savings that wasn’t depleted by his illness. By the
time I got to college in the early-1980s, that account was worth about $10,000.
What had happened was that the bank in charge of the trust had put it in
high-flying Nifty Fifty stock mutual funds and kept it there the entire time. So it
lost 90 percent of its value. In between the time that he died and the time that I
needed it for college, we went through a major secular bear market and we pretty
much caught it near the bottom by the time I needed the money.
That experience had a major impact on me because it was my first real expo-
sure to investments. It taught me the importance of not buying and holding, par-
ticularly with the high-flyers, and the risk involved in investing money. Like in any
bull market, when you get to have a number of years—five or 10 years—where the
market's done very well, people start saying, well, you know, all you really need to
do to make money on a long-term basis for any type of college planning or any-
thing like that, is to just have a disciplined plan to stay invested in the market.
And I learned that that really wasn’t necessarily the truth.
So your first exposure to the market was a rude awakening.

Yes. When I was in high school, I knew that that account was down somewhere
between 70 and 90 percent and that it wasn’t enough to pay for my college edu-
cation. So in addition to trying very hard to get a water polo scholarship, which
I did, I also saved up all of my money from working in the summers and I
started investing it. When I started in the late--70s—it was quite a different envi-
ronment than in 2000—gold stocks were particularly strong at the time.
Through some recommendations and some research I had done, I invested most
TEL EL LS EE RS SS RR
MARK BOUCHER @ 91
EE ES Se BR Sy eT eR
of my life’s savings in some long, nine-month options on gold stocks. I ended up

turning $3,000 I had saved up into about $50,000. And that was still when |
was in high school. Then I went ahead and lost about half of it before I figured
out I'd been very fortunate to have gotten involved in that big, secular move and
that I really didn’t know what I was doing and wasn’t the genius that I'd thought
I was.
And so I began to change my investment strategy and I dove into every
book and everything I could to try and learn. This is because after I'd lost half of
that, I still barely had enough to go to school with my scholarship. I knew I was
going to have to make that money last quite well.
Where did you go to college?
I went to University of California, Berkeley.
Did you continue to invest and trade in college?
* Yes, I traded my way through school with the trust fund money and the money
that I had made.
What was your initial strategy in those early college days?
I was much less risk-averse than I finally became. So I had some very, very wild
swings. Because of my experience in gold after I made all of that money in gold
stocks, I began to delve more into commodities. I went through a period in Jan-
uary 1980—just before gold went limit down—when I was a millionaire on pa-
per for a couple of days in a row. When the limit down period stopped after Fed
Chairman Paul Volcker made margin requirements retroactively higher in the
gold market, I ended up with something like a $20,000 profit. I was throwing a
millionaire’s party and then a few days later I wasn’t even a hundred-
thousandaire!
Another trade that was similar happened within a year. I had a very strong
pyramid move shorting orange juice futures. I promptly had a profit of over
92 @ THE MIDAS TOUCH
PTET Ae CS eR A iS LS A SP I I AT A CES TEI
$100,000. Over the weekend there was a freeze and the contract went limit up
each day for over a week. That just about wiped me out.
Whoa.
So after going through some pretty extreme ups and downs, I began to under-
stand risk more and also learn that some of the best money managers weren't the
ones that had the highest returns. They were the ones that had the most consis-
tent returns and had very low drawdowns. The real trick to managing money ef-
fectively is to make the most money on the least drawdown, not necessarily to
make the most money, period.
Can you define drawdown?
Drawdown is basically the maximum drop in your equity value. It's the worst
percentage drop from any equity high. If you hold a stock, and it goes from 10
to 100 and it makes up half of your portfolio, and then it drops down to 80,
that’s going to be at least a 10 percent drop in your whole portfolio from the eq-
uity high. Even though it’s all profit, that’s part of drawdown. And especially for
a money manager that has new money coming in all of the time, it becomes
much more important what your drops from equity peaks are. That's the risk
that people really are measuring.
So you traded your way through college. Was your degree in business?
It was in economics.
When you got out of college, where did you end up?
I didn’t end up anywhere. I basically traded on my own for about a year and a
half. I had a couple hundred thousand dollars in the bank, and at that time that
seemed like a lot of money. However, I began to get sort of lonely and bored
with just trading on my own, just sitting there with a screen and no employees.
SEE Ea SS TA RS SEI HT TT TT RCT

MARK BOUCHER @# 93
A RRS SE TERRA DSR EY RECS a SEAR AERTS RY ROO ae CHSTARR GE
Not having people to have contact with was a lot more psychologically difficult
than I had imagined. So I began to write some papers and do some things to try
and get involved with different groups that were giving seminars. I got involved
with CompulTrac software, which at the time was the premier technical analysis
software package . . . probably the only one. And actually CompuTrac software
got me involved in using computers to do analysis. That’s how long ago that was.
| remember CompuTrac. They were early.

Right. They were early and they just didn’t keep their lead, unfortunately. When
they were bought out by Teletrac, they were still in the lead and they just let it
die. Tim Slater, who originally started CompuTrac, invited me to speak at one of
the conferences. I was doing quite a lot of stock trading and also a lot of seasonal
commodity spread trading, which was fairly low risk but offered decent returns. I
did a talk on that at the CompuTrac conference. After my speech, Tom Johnson,
a Stanford Ph.D. and professor, and a graduate student named Paul Sutin, came
up and talked with me. I was trying to find something to disprove the Efficient
Market hypothesis. It seemed like the returns that I was talking about with these
seasonal commodity spreads were way out of line with the risk that was being
taken and so he thought that might be a way of disproving it.
We got together and I helped Paul do research and I also assisted him in writ-
ing a thesis on that. In the process, I got involved with Tom and decided we
would spend about three years doing a major research project. We had about six
different graduate students and Tom and myself, and we had all of the research fa-
cilities from Stanford, Berkeley, and the University of Chicago at our disposal. We
did this huge project looking at the common criteria of the stocks that did well
versus those that didn’t. We looked at currencies, interest rates, different commod-
ity futures, different foreign exchange movements, a lot of macroeconomic vari-
ables, a lot of advanced statistical analysis to do correlations, and other things. And
we came up with a very large group of models that we used as a background to
guide us in the different markets.
After we had gotten done with a big phase of the research, Paul got his Ph.D.
and went to Switzerland to begin working for Chemical Bank as a trader. We had
94 THE MIDAS TOUCH
REGAL NA RE OR Wh I PT RI IR AR NS I GO ETO
written up some of our work in various trade magazines and for the Stanford Re-
search Institute and had some papers out on pattern recognition and some other
things. At the time, these were very popular issues. So we got invited to speak at
Chemical Bank and do some consulting there. In addition, we were invited to
speak and do seminars at several places in the U.S. and Europe. At the end of
those seminars, we ended up in Switzerland and had several offers for us to use
what we had been talking about in our talks for a hedge fund. And so Paul and I
decided to branch out and do that and Tom decided that he wanted to continue
to do research. And so we gave him a research grant and some of our salary and
that’s how we started off.
What was the name of the hedge fund?
Our first hedge fund-was Manning Hedge Fund. A lot of the stuff we used came
from our research as well as some follow-up research we'd done. We had decent
years in the 20 percent range of gains. We had done a lot of research that showed
different patterns and their long-term historical behavior. But one of the things
that we found was that, on an annual basis at turning points, a lot of those
highly reliable patterns went through phases where they were 20 to 30 percent
reliable instead of the 70 to 80 percent that was the norm. And so you could
have fairly substantial drawdowns in rough periods during turning points in the
market.
That led us to do some research that ultimately showed us that it wasn’t
nearly as important what patterns you were using to enter and exit as it was that
you were in the vehicles that were moving. At the time, Tom was doing a lot of
research whereby some money manager or trader would come to him with a sys-
tem and say “look, here’s the system, here’s my track record for it, here’s how it’s
done, here’s exactly what it is, and how can we improve on that?” One of the
projects he had that was really influential involved three people. Two of them
had very elaborate patterns that they were using exclusively to get into positions.
The third had a system in which 90 percent of his criteria was involved in select-
ing a vehicle that was really moving. And he was just using a simple moving av-
MARK BOUCHER @ 95
SS ET a EL IMEI BETS OST EE STR TSP IRL A EEE ESS RS EEE ae
erage on it. . . a moving average that didn’t make money if you tested it on any
vehicle. But that trader was making twice as much as the other two traders.
That led us to look into our own work and realize that vehicle selection was
much more important than picking a correct pattern. And we really wanted to
get into runaway patterns and runaway moves. And if you could do that, that
would certainly give you an edge in terms of reliability and would allow you to
reduce your risk. That was actually much more important than anything else.
When you say “vehicle,” you're talking about a high relative strength issue,
then?
We have what we call “runaway criteria,” which are things like gaps and thrusts.
Bill O’Neil talks about things like follow-through days; that’s really very much
what I call “thrust.” Generally we have a whole set of runaway market criteria,
and we want to get at least five in the last 21 bars. It’s just a set of individual day
patterns that indicates very strong buying or selling. The patterns give us an idea
as to the strength of the trend. So the idea, really, is that you go where the oil is.
The oil in the markets is wherever there are runaway trends. This is because most
markets and most stocks spend more than half the time in trading ranges or con-
solidations where they’re not trending strongly. And about 25 percent of the time
they are really running rapidly. If you have some way of catching just some of
that runaway movement, that’s the time to really risk your capital. The rest of
the time it’s not worth the risk. That’s the concept.
As far as the variables go, did you initially come up with them way back
when you started this hedge fund, the Manning Hedge Fund?
Yes. We contacted O’Neil and found a lot of his research and re-did a lot of it
and came up with our conclusions. We tried to find anybody who had research.
Frank Cappiello had a lot of research, particularly on institutional holdings. We
did a lot of work with Martin Zweig’s stuff, in terms of monetary variables. We
just tried to find anybody that had some very good stuff. We didn’t want to rein-
vent the wheel, but we wanted to find stuff that worked. One of the things that
URSA Ge ER RI OE SEIS TTT 1I IETS
we found concerning a lot of O’Neil’s stuff is that a lot of the CANSLIM stocks
that he looks for are very, very volatile. Over the long run, they tend to make it
hard to produce a very smooth equity curve. You tend to have bigger ups and
downs. A lot of the people that do that can have incredible years. But then you
can also have some tough years and your drops from some of the good periods
can be pretty big. If you happen to get in at the wrong time, your drawdowns
are a little bigger.
We did a lot of research on that and found that there were a number of
ways to cut both return and risk from doing it, but you got a better risk/reward
ratio. We mostly focused on stocks that were undervalued for their growth rate.
Basically, the ones whose P/E is relatively low compared to their earnings growth
rate. And so they've got a little bit of a value component to them even though
they're growth stocks. They tend to have a little bit less volatility on the down-
side and they tend to move up a little bit more slowly, but that allows you to
move up your trailing stops a little more consistently and—
—so that you don't get stopped out quite as much.

That's right.
How do you measure P/E? Is it on trailing earnings?
Yes, its on trailing earnings. If you've got estimates that look like the earnings are
going through the roof, or for some reason to expect that, you want to take that
somewhat into consideration. But basically, if it’s a consistently growing stock
that has three years of higher annual earnings, a long-term earnings growth rate
of at least 25 percent, quarterly earnings that are 25 percent or more, and some
good earnings momentum, we would want a P/E that is 70 percent of the lesser
of the long-term growth rate or the last two quarters’ earnings growth rate. And
if it was a turnaround situation, where you had 70 percent or higher earnings
growth in the last two quarters, then we would want the P/E to be 70 percent of
whichever was the lowest of the last two quarters’ earnings growth rate. So it
gives you some flexibility.
ENE SOAR ERLE PES ESL SAN HS TN TD DETTE TINLEY SSIES

MARK BOUCHER @ 97
a RAS RAE
Stepping back a little, was the Manning Fund your own fund?
I did it with Paul Sutin and we had a partner, who was a financial backer. We
did okay with that, but we had a lot of problems with the financial backer. He
was very eccentric, and the three of us didn’t get along. Paul ended up inheriting
quite a bit of money at the end of the 18-month period that we had pegged as
an initial trial period. And so I went off on my own at the end of that period
and started Midas Trust and Midas High Yield Trust, which initially were trusts
in the British Virgin Islands. Then in 1995, we had loaded up the number of
people in those trusts and the main investor had actually died. So I couldn’t con-
vert those trusts into a hedge fund, but I basically took the profits that I had
from my share of that and started Midas Funds in the Cayman Islands. Those
two are essentially the same, but one allowed for new investors to get in while
the other didn’.
This is when you started running your own ship, then?

Yes.
a.
And you still have both of those funds?

Yes. And then I've got probably 80 percent of the money I manage in private ac-
counts. I trade a lot of different methodologies and a lot of different asset classes.
“Long/short” is one of the categories and I have a couple of strategies for that.
And I usually have a couple of different managers that I farm out half of it to.
And I do the same thing for commodities. I’ve got four or five of my own sys-
tems for commodities that make up half of our commodity exposure. And then
Pll farm out to Trout and Tudor and some of the very top global futures traders,
and | do the same thing with real estate. We cover a whole host of different asset
classes in the fund to try and really produce gains in every year and have a very
low drawdown. While we don't have the best total returns—I think our com-
pound annual return is just barely under 30 percent—we've done that on less
than an 8 percent maximum drawdown over the last seven years.
98 THE MIDAS TOUCH
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I think 30 percent is pretty sensational.

We have volatility in our annual returns. What happens is we have a year like the
beginning of 2000 or a year like 92 or 93 and if we have a decent allocation to
our long and short strategies and our global equity strategies, we tend to do ex-
tremely well. We started in 92 and we were fortunate to have a year that was
over 80 percent.
That's great.
That helped out a lot. We've had a lot of years where we're up in the 10 to 20
percent range. Over the long run, that’s been our average and we've always had
> >
positive double-digit returns, but there’s a lot of volatility in those figures. We

keep the risk down in what we're doing. If it’s a good environment for something
and it looks safe, we're pretty aggressive into it. But as soon as it starts to look
like it might
g not even be safe, were pulling out of it and weve 8 got other asset
ote
classes that we're allocated to all of the time. Our fund basically is designed for a
typical Swiss bank client, because most of our clients are really from Swiss banks
and that’s where 80 percent of the money we have comes from. That money
tends to be even more risk-averse than I would be alone.
It's more risk-averse because you're dealing with high net worth individuals?
You're dealing with high net worth individuals that are not trying to get rich;
they're trying to make a decent return and not lose any money. To a certain ex-
tent, the difference between European hedge fund investors and U.S. ones is that
the Europeans tend to be a lot more risk averse, and particularly the ones that go
through Swiss banks. I’m sort of trying to do a mix between Trout and Zweig
DiMenna, two of my big heroes. Trout has had some phenomenal, almost T-bill
like consistency of producing a 12 to 20 percent return. Zweig DiMenna has
higher returns on a very long-term basis but has a little bit more swings in equity
than I would like to have. If Ihad a 20 percent drawdown, I think I would lose
a substantial portion of my clients. So I really can’t afford to be that aggressive.
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MARK BOUCHER @ 99
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I'm trying to make decent returns, but I’m trying to play it very close to the vest.
The only way to do that is to have a lot of different strategies and lot of different
asset Classes that are totally uncorrelated to each other going at the same time.
How does your fund’s performance compare with the performance of other
hedge funds?
I think Nelson's ranked us in the top 10 for five-year returns for the last four or
five years for the particular type of style that we are. I think Nelson’s put us in
the global asset allocation strategy type. I know that in that group, we are the
lowest drawdown of any fund in there. What really bugs me about all those rat-
ing services is that they're only looking at one number, which is total return.
That really doesn’t give you a very clear picture of what a really good manager is,
in my opinion. Its someone who produces returns on drawdown that are sub-
stantially higher.
Weren't you ranked No. 1 by Nelson's?

-
Two of the last five years I was ranked No. 1 for the last five-year period.
Which years were they?
I believe it was 1997 and 1998.
Can you tell us a little about your long/short strategy in the U.S. market? How
would you enter a position with that strategy?
We have a set of criteria that we call up fuel criteria for stocks. Basically, it’s quite
similar to O’Neil’s stuff. We focus on the growth-at-a-reasonable-price version of
those stocks. We tend to focus on ones that are a little bit lower on the mutual
fund holdings and where institutional sponsorship is going from practically noth-
ing to where it’s starting to pick up sharply. And the stock has a P/E that is 70
percent of either its long-term earnings growth rate or the last two quarters’ earn-
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ings growth rate, depending on whether it’s a turnaround or a consistent-growth

stock. Then our criteria are very similar to O’Neil’s. We tend to look for flag pat-
terns. We use cup-with-handles as well. But my favorite pattern is a flag pattern,
which is something where you've had a very strong run-up of at least 50 percent
or more in the stock and you have four-plus weeks of it going sideways and not
retracing 38 percent of the last major up move. And then you get some volume
accumulation indicators that break out before price. It breaks out with strong
volume and usually with what we call TBBLBG, which means either a thrust, a
gap, or a lap. A thrust is a large-range day with volume higher than the previous
day that closes in the top third of the range and a lap is sort of like a gap from
the closing price level. And you want to have good volume.
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MARK BOUCHER @ 101
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We look for a stock that meets all of our up fuel criteria and also breaks out
of a flag pattern or a cup-with-handle that has a handle in the top half of the
range. We want to see at least three or more accumulation days, which are up
days on higher volume, before the breakout. And the breakout should be on
strong volume and either a gap, lap, or thrust. Those are the two real entry
methods that we use consistently to buy stocks. And we put a protective stop be-
low the last pivot point. Using a percentage stop, we've never really had a lot of
success. | know O'Neil uses an 8 percent stop. What we've found is that tends to
reduce the reliability of the trade over the long run, or at least when using our
methodology. So we use a stop below the last pivot point and try to use the dis-
tance between entry and open protective stop as one of the parameters that tells
us how much to allocate to a particular stock. It’s a little bit different, but it’s
very similar. We do the same thing on the short side. We look for stocks that
have our down fuel criteria and are breaking down from flag patterns on the
down side, down side cup-with-handles, descending triangles, or
four-week-or-longer consolidations that are relatively tight. Again, we want the
breakout to be on higher volume than the prior day at least, and we want it to
*be on a thrust, gap, or lap down if possible.
The long and short setups are basically just a mirror image of themselves.
We run the top relative strength, earnings-per-share, new high list and the bot-
tom relative strength, earnings-per-share, new low list. We do this because basi-
cally we found out that when we tried to go the other way and just find all the
stocks that met our criteria, we would often miss stocks. We would see them at
the end of the week and we'd go back and say “damn it, that stock met our crite-
ria and we missed it.” And there aren't a lot of these stocks that meet all our cri-
teria in the first place. So we ended up saying “you know what? Those are our
criteria, but we're going to watch every damned new high and every damned new
low and make sure we don’t miss any.” Because there just aren't enough of these
to be able to afford to miss them. So we started doing that. And when we started
to do that, we found out that that was actually an extremely valuable list. If you
look at the concentration of groups and subgroups in that list, anytime you've
got a lot of members of a particular group that are breaking out of valid bases at
about the same time, that’s valuable information. Because if you buy any member
102 THE MIDAS TOUCH
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of that group, it’s likely to be a leading group and that move is likely to be more
reliable than if just one or two stocks are breaking out.
So we found that by doing something that just helped us not screw up and
miss a trade, we ended up finding a lot of valuable information from it. And it’s
become a core part of that methodology. Now we really are trying quite a bit
more than we ever did before. Not just to position in the stocks that meet those
criteria, but if we have a choice, to position in the ones that are in the leading
groups as indicated by those lists.
You said your stop loss point would not be based on a percentage off your
entry, but when you undercut a pivot point.
MARK BOUCHER # 103
SS SB SE 1 oh DERE We GEE ESE gS ee
Right. We have an indicator that’s pretty complex for determining that. But basi-
cally anytime you get a low that has six higher lows around it, that’s a pretty good
rule of thumb for the pivot point that we'd be using. Once you get a certain size
move, then of course we have trailing stop techniques that move up pretty quickly.
Really, it’s very rare that you go a month or more without us having to move stops
to breakeven. So we try to play with the house’s money as soon as we can. But we
want to make sure the market has made a low that’s a decent pivot point and then
made a new high off of it before we move our stop.
Do you use any general market indicators in this particular strategy?

I've got 20 different market timing systems that I use in the market timing part of
our allocation. We look at those and they give us a little bit of background as to
how risky or safe the market environment is. But the honest truth is that, over the
years, weve pretty much grown to respect the new high list and the new low list.
The number of stocks that meet our criteria that are breaking out is probably the
best evidence of the health of the market of anything we've got. Early in 2000, we
*had the wonderful environment which you get occasionally, where you had a very
huge amount of opportunities on both the short and the long side at the same
time. That allows you, with very low risk, to leverage your portfolio and get some
pretty spectacular returns. Whenever that happens, and it usually runs for a signifi-
cant amount of time with significant percentage moves in both directions, it’s gen-
erally a turning point in the market one way or the other. You have to be careful
because you can get some very fast gains that turn around on you very quickly. So
as soon as we saw that start to come unglued in early-March 2000, we advised
people to take half profits and took at least that much profit in our own managed
accounts. We had a similar environment in °92—’93 and really hadn't had anything
like it since then.
You're referring to the early-2000 advance in the Nasdaq at the same time that
the Dow and S&P were declining?
104 THE MIDAS TOUCH
A aL 7 RRP A NREL NRA IO EES LL OAL IDEA LLLEIIED
It goes beyond that. Since 1998, you had a two-tiered market. You had a stealth
bear market in the majority of the stocks while a smaller and narrowing group of
stocks dominated by the Nasdaq 100 kept going higher, particularly at the end of
the move. That type of environment can be frustrating for a lot of different strat-
egies. For ours, it’s ideal.
Do you look at sentiment indicators?

Sure. We have a whole host of sentiment indicators that we use in our market
timing approach. That just gives us a background for how risky or how reliable
the environment is.
Would they be anything that you would take trades based on? Or do you just
use them as background information?
We have around 20 different timing models. And we take 1/20 of the capital
that we allocate to timing-model trading and trade each one independently. A lot
of those have a component of sentiment in them.
What is the percentage of a portfolio that you allocate to one position? Do

you like having a lot of different positions that are smaller in size?
We try to be concentrated but diversified at the same time. An ideal number of

positions is somewhere between five and eight.
That's with no leverage.

Right. When we go to leverage, we often get repeat buys and we may have as
many as 20 positions at one point in time. But that’s very rare. Usually, even if
we're fully leveraged, it’s more like 14 or 15 positions. A lot of those, if they're
not repeats of the same stock, are breakouts in others that are in the same indus-
try. So they're really more concentrated in that respect. Basically, we're trying to
play somewhere between six and 10 areas.
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MARK BOUCHER # 105
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Is your initial buy a certain percentage of the account?
We'll never risk more than 2 percent on any one trade—that’s the first money
management rule. That often is the policing as to how much allocation. Gen-
erally, we're looking to put something like 7 or 8 percent in a stock initially. Ba-
sically, we're using risk to determine what our allocation is. Sometimes you can
get a situation where you have a very tight flag pattern that’s been there for
months. And one blink and the stock breaks out nicely and you can allocate sig-
nificantly more to that and still have your portfolio risk be only 2 percent versus
a stock that has a very wide path. We'd never put more than 20 percent initially
into one position and we wouldn't allow a position to get up to more than 25
percent of our portfolio.
But if you started with an 8 percent position, you might add on to it in a

pyramid fashion.
Absolutely.
What books would you recommend to traders?
Cappiello has a good book. I think it’s called Finding the Next Superstock. All of
O’Neil’s books I love, and I think his new one, 24 Essential Lessons for Investment
Success, is particularly better than the first one. It’s probably better-suited for
someone that’s had some experience using his stuff. It’s got a lot more useful in-
formation. His first book was fantastic, but it was designed to take someone
from not investing in stocks to being able to use CANSLIM stuff. I think the
second book is more geared toward refining those things even better. So I like it
better. I like all of Zweig’s books. I like to read the books on money managers, so
Money Masters and all of the Schwager books are good for that kind of thing.
I think what you try and do in any field is to figure out who's very success-
ful at it and then try to figure out what they’re doing. And then you try and take
as much of that as you can and put it into your own stuff. Kroll wrote a book on
futures trading that discusses money management in a way that a lot of stock
106 # THE MIDAS TOUCH
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traders would benefit from. It’s not directly related to stock trading, but I think
the idea of how to manage risk that futures traders have to do to survive is some-
thing that stock traders can really benefit from.
It's been my experience that many traders give short shrift to money
management principles. You're known as a player who places the importance
of money management on a pedestal. Do you think money management is
more important than an actual strategy—
—yeah, I think that I would rather have good money management and a medi-
ocre strategy than have it be the other way around. That’s your defense and tells
you how much youre going to make.
That's a profound point to end on, Mark.

LEWIS BORSELLINO
BIG ITALY
By Marc Dupée
tience, graciousness, and gentility in social situations veil a ferocity that has
made him one of the most famed traders in the world trading arena. Giving
away his vocation is his slightly raspy voice, an occupational hazard common
among pit traders required to scream buy and sell orders in the frenzied and
deafening environment of the open outcry trading pits.
Lewis J. Borsellino took an instant liking to this harried environment, once
commenting, “The moment I walked out onto the trading floor, I thought it was
the greatest thing I ever saw in my life.” He has survived, prospered, and made
millions in his 19-year tenure in the S&P 500 futures pit and has brought many
people along with him, opening doors and showing the ropes to family, friends,
and acquaintances.
At one point during the epoch when trading for both institutional and per-
sonal accounts was still permitted, Borsellino was the largest trader in the S&Ps,
transacting contracts with an annual notional value in the billions. While he still
trades on the floor every day, Borsellino is following the times, expanding his
trading activity and operations into the electronic age.
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A tough competitor and sportsman from Chicago’s West Side, Borsellino

credits his success and trading longevity to discipline, a quality he thanks his fa-
ther for, and one that he ranks in his 10 Commandments of Trading. A man of
intense focus, Borsellino claims that when the markets become crazy, he becomes
more sane: “The wilder the market gets, the more disciplined I become.”
Borsellino wrote a book, The Day Trader, which not only covers his trading expe-
riences, but also depicts his colorful life.
As one of the longest standing veterans in the S&P pit, Borsellino has seen
it all. While an expert in the technicals of trading, he stresses how practice and
discipline have imbued in him a “sixth sense” about trading, a sense that he un-
derscores is critical to his success.
Emphasizing that discipline and practice are required to excel, Borsellino
tells aspiring traders to “perfect their methodology to the point where it becomes
robotic. Once you reach that point where reflexive actions take the place of
thought, you then become a great trader.”
Marc Dupée: Why have you succeeded at this game when so many others
have failed?
Lewis Borsellino: Well, I think the No. 1 thing that any trader has to have to
succeed is discipline. I have The 10 Commandments of Trading that I follow (see
end of interview). You have to be a disciplined trader through all kinds of trad-
ing .. . through good times and bad times. It’s the good times that I see that end
up destroying people. They think that they're invincible . . . they think they can’t
make a wrong decision, that they can’t do anything wrong. And they end up tak-
ing more risk than they're accustomed to. Then all of a sudden, the market does
what it usually does. It surprises people and moves the other way . . . and youre
carrying the guy away because he got too big for his britches. I think that this is
the No. 1 reason why I’ve succeeded. I’ve always been grounded, and have always
been a disciplined person when it comes to trading.
The other thing is, as I often say to people, I don’t really trade for money. I
trade for success, meaning I want my plan to be successful. The product is
money. When Bill Gates formed Microsoft, he wanted the best product and it
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LEWIS BORSELLINO # 109
RN A RA RSNA CS“ on RS
just happened to make him one of the richest men out there. I think that is true
of any trader. If you're successful, you have a good plan, good buys, know where
to stop out, know how to control your losses, and know how to learn from your
losses.
Learning from your losses is probably the biggest key to success, because the
losses actually tell you what you're doing wrong, what kind of market you're in.
If you're in a trend-following market, a reversal market, whatever . . . the losses
will tell you what’s going on.
You mention that, similar to a lot of veteran traders, you have learned to rely
on an ability that is like a sixth sense when it comes to reading the market.
What is that sixth sense? Is it something you think you can garner or detect
in screen trading?
Well, Marc, what a lot of people say I do is use gut and instinct. But what they
don't see is what I’ve done behind the scenes. Like 10 years ago, we bought all
the rights to Gann.
“all the Gann charts, right?
Right. We've always been technicians, we always do our homework and prepare
ourselves for the market. So after 20 years, there is not much that I haven't seen.
And what happens is my brain is like a mini-computer: It’s able to process very
quickly. So it looks like I’m acting instinctively, but there is a fine line. If you're an
expert at pattern recognition—and that’s what the art of charting and technical
analysis is all about—yourre able to recognize patterns very quickly and see scenar-
ios. Then, is it instinct, or is it learned behavior over 20 years? I think it’s a little of
both. I certainly have more gut instinct—I have probably forgotten more about
trading than some guys that are just starting.
i love that story in your book about the time back in October 1987, on the
Thursday following Black Monday, when you stepped into the S&P pit. And
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having been an order filler yourself for four years, you could sense the
nervousness of brokers who had big customer orders to fill.
Just before the opening, a Shearson broker offered 1,000 points lower.
You tested how low they would be willing to go by yelling “2,000 lower.” The
Shearson broker came back, “3,000 lower.” You returned, “4,000 lower” and
then the Shearson broker went 5,000 lower. When the market opened, the
S&Ps were down about 5,600 and you bought 150 contracts, only to turn
around and sell them seconds later to some trader across the pit—2,000
points higher than what you bought them for—pocketing something like $1.3
million.
That move seemed like part bluff in a poker game and partly the
indulgence of participants’ fear of the downside.
Oh, definitely. I mean in ‘87 it was like a ghost town around here . . . not only
the fear of the traders, but the exchange officials, everybody. It's no secret that
(Fed Chairman) Alan Greenspan saved Wall Street and La Salle Street. Margin
calls were not being met, firms were on the brink of going bankrupt, and there is
no doubt in my mind that he saved Wall Street and La Salle Street at the same
time back then. And you've got to understand that 5,600 points, when our big-
gest day ever since the inception of the contract was like a 1,000-point move,
was huge.
What a windfall. Have you had any other trades like that?
I’ve had other days when I’ve made high six figures. I just did an article for
CNBC.com that says daytraders don’t swing for the fences, and I talk about that
trade. But when I look back at my career for the last 20 years, it’s all the singles
and the doubles that have made me all the money, and not the home runs.
A lot of traders say that. And if they are hitting singles and sticking to their
plan, then once in a while they swing and get that homer.
Right. Once in a while you get that homer. So if I can get one every two to three
years, I’m real happy.
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No doubt. Was it the FBI that was investigating that trade? Anyway, you came
to learn that George Soros was on the other side of that Shearson trade.
Actually that had nothing to do with the FBI. What happened then was the
Shearson broker made a mistake and entered the order twice. And when they liq-
uidated the error, it was like a $50 million or $60 million error. Soros sued
Shearson and sued all the participants in the S&P pit.
It was funny when I went there. Their theory was the Shearson broker dis-
closed the order to me, and being the biggest local at the time, that there was
some kind of conspiracy. I said he didn’t have to disclose the order to me, I saw
him shitting in his pants and I offered them lower and he offered them lower. I
had every right to do what I did: I was a member [of the Chicago Mercantile Ex-
change]. As long as I was willing to take everything I offered at that price, there
was nothing they could do about it.
Then, someone hadn't done their homework, because when I bought the
150 contracts, I tried to buy them from the Shearson broker. But the broker be-
hind me, a Salomon broker, hit me on the 150. So you know, it was a clear un-
derstanding of how the market doesn’t work.
e _ Lhere are a lot of people out there who don't understand how the market
works. You think about it. How did the Merc end up with the S&P contract
when they started the Russell, I believe, at the NY Merc at the time? And here
we are in Chicago, Wall Street's there, yet we end up with the S&P contract. You
know everybody was vying for the S&P contract and the Chicago Mercantile
ends up with it. They gave it to us and now all the portfolio managers use it to
hedge their activities.
How did they end up with it?

It is the simple fact that, you know, New York does stocks and Chicago does
commodities. Nobody does it better than Chicago. You've got the Board of
Trade, youve got the Merc; you've got the oldest futures industries in the world.
When you're in the pit, do you find bluffing a useful strategy?

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The one thing you have to be careful about when you start bluffing and push-
ing the market around, is that you're gonna get hit. I often tell people, “When
you're wrong, you'll get as many as you want.” Right? You've got to be careful.
There are times where, when I’m long, I'll give my orders to order fillers and
I'll bid the market up, and other locals and other people may try to bid it up in
front of me.
The one thing about being around as long as I have, being a large trader,
being known for having a pretty good sense of the market, is that a lot of traders
do like to follow me. So it’s a way for me to get out that’s, you know, sort of
bluffing. You've got to be careful. Like I said, when you're wrong, youll get as
many as you want.
In your book The Day Trader, you point out that you will always trade but that
you are making a transition, as the subtitle implies, From The Pit To The PC,
and that you are increasing your focus on your fund, Borsellino Capital
Management. I'm interested in how this transition is going, and if the
formidable skills you've developed in the pit are transferring to the PC.
Well, first of all, we're reorganizing Borsellino Capital Management. The focus
switched after the book came out.
The book was published in mid-1999?

Right, May 1999 is when it came out and that’s what got us to TeachTrade.com.
It’s the role of an educator. And besides that, I got involved in a SOES room
about two or three years ago. I watched people who had no idea of what to do
when it comes to trading. They were just seeking information. And then I
looked out there and saw what people were charging them and what they were
getting for what they were paying. It made me sort of sick.
So that’s how I started TeachTrade.com, and actually it has taken over the
focus. What we're allowing people to do on TeachTrade.com is institutional qual-
ity research. We're not charging for it now, but it will be at retail prices.
Goldman, Merrill . . . all of them have research centers. Over the last 19 years,
a SSE a Se ail en Se RBS DCR a a a nn aa EN SE CM a oes ee hd

SD SA PEE Ae OTD A RETO ST PERE OP eI Sh
weve developed trading systems, we have over 20 years of experience, and we've
invested millions of dollars in research. We're going to let people access that.
And access is by imitation, meaning they'll be able to watch us. We let you
know when we're long, when we're short, and our thought process behind buying
which stocks. We watch the underlying stocks that support the S&P 500 and the
Nasdaq 100. We've met with a lot of success.
As far as the screen trading and making the transition from the pit to the
PC, the difference is you have to be more patient on the screen. You can't scalp.
It’s still the same gut-wrenching sort of mentality and you go through the same
things when you have your trades on. But on the floor you can go to a trade,
where on the screen you've got to wait for a trade to come to you.
For example, if Iwant to buy S&Ps at 1500 and I’ve got a mental stop at
1497.50, if I’m on the screen, I'll buy the 1500s and I’ll put my stops in. That's
the end of the story. When I’m on the floor, I might buy the 1500s, I might buy
nine-halfs (1499.50), I might scale down into it and add more to it. If I’m cor-
rect, I'll sell those nine-halfs and scalp in and out from the long side all the way
up to my upside objective, where on the screen you can’t do that. You've got to
pick your entry point—you may scale into your entry point—but you've got to
fick it and you've got to have your stop and then that’s the end of the story.
In your book you say you're one of the best when it comes to reading support
and resistance and order flow and reading how the market will react to events
such as the Fed's tightening today (March 21, 2000). Could you explain how you
read support and resistance in the pit and whether it's different in your
screen-based trading?
Well, it’s no different. There’s no difference in reading support and resistance.
What happens on the floor, though, is you're able to see it acted out. On the
screen, you don’t have the noise and the emotion and the drama of the other in-
dividuals acting on those resistance points. If you've ever been on the floor and a
key area of resistance has been penetrated or there has been a big up move, the
emotion of that move looks like a big wave when everybody is buying and every-
body is selling. It's a nice feeling of euphoria if you're long and everybody's buy-
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ing, and it’s the feel of terror when youre long and everybody is selling. But
technical support and resistance is the same on the screen as it is being in the pit.
Same question for order flow. Now that the Merc has made rules that require
locals to stand down in the pit, reserving the outer ring for filling brokers,
how do you maintain an edge for interpreting order flow?
That hasn’t really changed the idea of seeing order flow. We're able to stand on
the step below them. When Merrill Lynch is bidding on 500 contracts or 300
contracts, were still seeing that.
Do you feel you can maintain this edge for interpreting order flow off the
floor? If so, how do you do that?
You have to understand that it’s two different types of trading. You remember [|
said I don’t really care about the order flow when I’m trading on the screen.
If youre just scalping in and out on the floor, you are looking at order flow.
Hopefully, if you've got a big order-filler who is 1500-even bid on 200 contracts,
you might be 15 1/2 bid on 50 contracts, leaning on him. That's how people
take advantage of order flow. And, you know, it’s the same as when you look at
the Nasdaq market makers that are bidding, say, 150 for 20,000 shares and
someone bids 150 1/8 for 10,000 shares. It’s the same sort of premise.
You've mentioned that one of the things that has made you successful is your
ability to read how the market will react to the next “twitch or itch” of the
Fed. What signs do you see on the floor that will help you know what the
Fed's move might be? Were you on the floor today?
I was on the floor. I went down there at 1:15 p.m. when the numbers did go
out.
Did you see anything today that gave away what the Fed's move might be,
even though everybody was expecting the 1/4-point interest rate rise?
SPSS BRE RUS EI NOSES DARL ARNDT SE I a I ST PN PES

IREID OE TEE PRBS) SSE IEE LANE NLEARTES OAT EE BES
Three Fake-Outs After A Fed Rate Move: September 2000 S&P 500 Futures (SPUD),
3-minute
(SP U0) S&P 500 Index LAST-3 min C=1471.00 -2.70
mall +
Fake up (3)
Fake up(1)
we seas r Fake down (2)
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Fed announces no rate hike,
but that inflation- risk remains
Created with Omega Research ProSuite 2000) © 1999
Following the Fed’s June 28, 2000 FOMC meeting on interest rates, in an event occurring three
months after the interview, the S&Ps exhibit the same pattern Borsellino describes, only to the
downside. The contract initially rallies, breaks, rallies and then breaks, making Its fourth and
decisive move to the downside.
Well, one of the things that I’ve been looking at over the last couple of months is
the disconnect where the Dow and the S&Ps are lagging behind the Nasdaq.
And today you had the same thing. The Dow was up, the Nasdaq was down, the
S&Ps were down on the opening, and what I looked for today, after that number
came out, was the consolidation. When I saw the Nasdaq, the Dow and the
Spoos all going up, then I laid it in. Then I got long and stayed with them. Be-
cause once we started going, we started going.
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But typically when we have a Fed number, we tell people to look for the
fake-out. What we were looking for was a break, rally, break and then a rally.
And that’s what happened. We got a little bit of a break, it rallied, then a little
bit of a break and then the rally took off.
Why were you looking for that pattern?
Over the years, that’s what we've seen. That’s one of those things that is a gut
thing that we've always seemed to notice.
Is this a familiar pattern that you've seen in the Spoos pit, a fake-out pattern?
We look for that fake-out. Because in the past, I’ve noticed this is bullish. I’m
looking and looking and I'd buy it as soon as the number came out and it would
go down against me and then I'd get out and get chopped up. So what I'll do is
try to stay pretty neutral for the first 10, 15 minutes and then when the rally
starts we look for a good area to get in. Actually, we had 1500 as a big buy-point
area. And then as it got up there, I saw that the Nasdaq and everything had
turned around and I just stayed with my longs.
Are there signs you can see down in the pit besides price action that will let
you know what the next “twitch or itch” of the Fed is going to be?
Well, not of the Fed. But now that we can have wireless connection with my
technical research people, I have a clerk who does nothing but stand right next to
me with a headset on, and talks to our tech guy. And he’s watching news, he’s
watching support and resistance areas and he’s telling my clerk to “tell Lewis to
watch 1505, tell him to watch 1500, if it goes through there we'll be looking for
1497.” One of my techs we call the “human search engine.” He has 25 monitors
in front of him. And that’s all he does. He’s a human search engine.
How can you tell when a program trade comes into the market? Can you key
off of that to make money?
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In the past, years ago, it was a little easier to identify, especially when I was fill-
ing orders. I'd get an order from Salomon Brothers to buy 1,000 S&Ps and I’d
get them done in about four ticks. And I’m like “wow, how does that happen?”
And then I'd watch the cash start ticking down and then I knew they were buy-
ing Spoos and selling cash. There are a lot of different methodologies . . . people
hedging options and doing program trading. Now they're actually arbing the
S&P with the E-Mini and they’re doing an S&P/Nasdaq spread. So the partici-
pants all have something different . . . everybody's looking for that Holy Grail
edge. All I've ever found out is buy low and sell high. That’s the key to success.
Or buy high, sell higher?

Yes.
Off the floor, what specific patterns and parameters do you look for in your
technical analysis to determine when to enter the market?
We like to do a lot of momentum buying. We're also contrarian. My philosophy

Sver the years has always been to look for what everybody's not doing because
when everybody's short and you're long and that thing turns around, youre going
to be in pretty good shape. And we look for very low-risk trades, especially when
we are on the screen.
When we're trading from upstairs, what we look for basically are trades that
have a $2 or $3 stop. And if youre risking $3, you've got to make at least $6. We
look for a lot of support points and a lot of momentum. And like before, when
youre talking about your losers, your losers actually identify what kind of market
youre in. You know, sometimes you're buying new highs and selling new lows,
then all of asudden the market stops, turns around, stops you out and then con-
tinues to go that way.
Or you buy a high and you stop, it turns around and goes the other way, it
goes down to the lows, you get short, put your stop in and you get stopped out
on that. That will tell you if you're in a range-bound market. So should you be
fading new highs at that point? Sure, if you're in a range-bound market, now you
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want to start fading the highs. And if you're in a momentum market, that’s when
you'll buy new highs. So you have to identify those things, and we're pretty good
at doing that.
Are there specific patterns that you look for in defining momentum or is it just
a break of a certain level?
It doesn’t just hit you in one day. Patterns take weeks and sometimes months to
form. For example, why did we think 1500 to 1502 was a big area today? Be-
cause last week on the run-up, it went up and pulled back and we've made a tri-
ple top at 1500. So we knew that once it got through and the news was there
and positive and we had everything moving together, 1500 would be a good buy
because there would be a lot of stops up above it. So you definitely look for chart
formations that show triple tops, triple bottoms; those are the kinds of things
that really jump in. Moving averages . . . the 60-day moving average is a big
moving average for us.
The 60-day moving average works well in the Spoos pit?

Right.
Are there specific patterns you look for to get out of the market? Or again,
like you said, do you get out when it hits a level or hits your target?
We definitely have objectives. We look at the objectives, but then again the old
saying comes, “we never argue with profits either.” One of the things I’ve learned
over the years is that when you turn your profit and you hit your price objective,
take it. Sometimes the market keeps going and you could have made another
$10,000 and I see people moan about that. I look at them and say, “you never
moan about profits.” Profits will never take you out of the business, losses will.
I've heard other world class traders like yourself say that one of the most
difficult things to do is to perfect the exiting of their trade.
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Breakout of Critical 1500 Level: September 2000 S&P 500 Futures (SPUO), 3-minute
(SP MO) S&P 500 Index LAST-Daily C=1475.00 -.20
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June S&Ps break through 1500 at (A) on March 21, 2000, the day the Fed raised interest rates
25-basis points, triggering stops in a move through a triple top pattern.
Oh, definitely. And you think about it, especially with all these newbie stocks.
Everybody's hoping they can catch the next Qualcomm. Who knows where that’s
coming from. The people who caught Qualcomm, caught it . . . it was lucky.
The insiders knew it . . . the guys who spun the company and so on. But if you
got on it, you got on it. You don’ cry over spilled milk. If you made a profit,
you just applaud yourself for having a successful plan, and that’s it.
How or when will you pyramid your trades while screen trading?
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Do you mean how will I add to a position? Well, one of the things we never do
is add to a loser. We never average. We'll pyramid the trade as we see different ar-
eas of support and resistance being tested and firming up and we look for con-
sensus of all three of the indices moving in the same direction . . . definitely
when we're trading Spoos (S&P 500 futures) and Nasdaq. If we get all three
moving the same way, that’s when we like to jump on and add to our positions.
| suppose that makes it a little clearer now, particularly since we've seen
such bifurcation between tech and the blue-chips in 1999 and 2000.
That has made for very difficult trading. I think the period from October 1999
to February 2000 has been one of the most difficult times of trading that I’ve
seen in a long time.
Really?
Yes, and it’s because of the disconnect. Here you are watching Nasdaq making
all-time highs, and you want to buy the Spoos but they keep beating them up.
Every time the Nasdaq makes a new high and you go to buy them, the S&Ps get
a little rally. Then the Dow sells off and the S&Ps sell off and you get chopped
up.
Do you have a clerk near the Nasdaq pit?

Actually the Nasdaq's right in front of me. So I can see it and I can see the
board. And I don’t flash orders up there. If I want to place an order, I tell my
clerk on the phone. He'll call the desk and put in the order for me.
You said you like to do low-risk trades; two to three bucks a stop.
Especially trading upstairs. Definitely upstairs.
Is that what you use as a stop loss rule?

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My stop loss rule is, whatever your stop loss is, I want a 2 1/2-to-1 ratio. If I’m
willing to risk $2 on a trade, then I have to make $5 in profit, a 2 1/2-to-1 ratio.
For every dollar I risk, I want to make 2 1/2.
And will an upper channel be what you'll be looking for to determine what
that upside potential will be?
Exactly.
How do you keep yourself balanced when you're on a run?
(Laughs). You know what, it’s just 19 years. In 1987, I made $4.4 million. In
1988, I made $90,000. Okay? So I’m the ultimate doom-and-gloom guy, and
that’s what I look at. You know most professional traders like to trade from the
short side. Me, I’ve been a bull since I’ve walked into the pit. I love to buy them.
I keep telling guys, you want this thing to crash? You remember 1988 when busi-
ness dried up and brokerages laid off 30 percent of the people? If you want a
healthy market, let's keep going up.
« _ Look, I’ve seen up and I’ve seen down and I understand that you've got to
stay calm. The minute you start to believe in all the accolades that they throw at
you, then that’s when the market is going to show you. I’ve seen it happen to the
biggest guys. I’ve seen Richard Dennis take $600 million and lose 300 of it in six
months. And Victor Niederhoffer, too.
Those two were both trading off the floor.

Right, but I’ve seen guys on the floor who've had tremendous runs and then all
of a sudden the next thing you know they’re trying to borrow money from you.
Did their egos have something to do with why they crashed? Did they believe
everybody that told them they're so great?
I think they had a temporary loss. They’re very good traders, both of them. But
what I think happened is they had a temporary loss of discipline. And they had
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too much pressure on them from their customers to perform. And when that
happens, your plan and your logic sometimes get thrown out the window. I see it
with my new traders. The worst thing that can happen for my new trader is he
comes in and his first five trades are all winners. And I’ve got a cocky kid on my
hand, and the next thing I know he’s in my office the next day telling me he lost
everything that he made in five days, plus double that. And, you know, he’s got
my foot up his ass and I’m telling him, “all right, now you don't have a job any-
more.” I preach that to them. I’m unusual. When I have a bad day, or a couple
bad days in a row, or I’ve overtraded and I’ve lost a lot of money, I go out and |
buy something.
Retail therapy?
I go out and I buy something. Not to make myself feel good. But to remind my-
self what a dollar is and what it gets me. And to remind myself that I’ve been
fortunate to be earning the living that I have over the past 20 years, and have
been fortunate to have been good at what I do.
In dealing with losses, you've said that you view losses as loans made to
somebody else in the market, to somebody else in a zero-sum game. Can you
expand on that a bit and on how that view helps your trading?
Well, that’s my psychological edge. That’s that competitive nature coming out of
me. When I’ve had a bad day . . . in futures, for every winner there's a loser. It is
a zero-sum game, where with stocks it’s not. It definitely gets my adrenaline flow-
ing when I’ve had a bad day. Especially when I’ve made stupid mistakes, rookie
mistakes. I go home and I work out and I try to exhaust myself because I know
I'm going to be up all night waiting for the market to open and the bell to ring
so I can get back in there and get my money back.
That's what you write about in your book, that losses are loans to somebody
else. But that doesn't really calm you. You still want to go get that money
back. It's a temporary loan.
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SE AS RE SP St NTT I EIS aS TE AS A a? Oa
It's a temporary loan. Hopefully! That’s the way I’ve viewed it over the last 19
years. And that’s part of my competitive nature and the idea of trading for suc-
cess. I've said it a million times to people around me: It’s not the money. The
money has been very good and it has been a product of being good at what I do.
But it is the respect and admiration of your peers. It’s the ability of me to be able
to compete against the other person . . . it’s me against the institution and me
against the market. Trading has the highest highs and the lowest lows, Marc, and
hopefully throughout your trading life you experience them both and there are
more highs than lows and you know how to deal with them both.
| understand that dual trading is when you handle both orders from customers
as well as trade your own account. You mentioned that back in the days
when they allowed dual trading, the system worked to your advantage
because you were already handling 30-, 50-, 100-lot sizes and bigger, and it
gave you the confidence to pull the trigger on your own trades. That led you
to become the biggest trader in the S&P pit at one point, transacting up to
one-quarter million contracts annually with a notional value in excess of $62
4illion. Could you describe what it is like to be, as you say in your book, “in
the market flow” or “in the zone,” trading that 100-lot size?
It's a two-edged sword. It’s like being Michael Jordan, going out there every day
and every day people wanting you to score 50 points. And you've got that pres-
sure and you've got your own pressure on yourself and the ability to do it. And
guess what? When you are in the zone and you've got everything going for you,
you cant do anything wrong. You can throw 50-lots and 100-lots around and
you're exiting them and turning profits with them and so on. And when youre
out of that zone, just like Michael Jordan, all of a sudden your'e only hitting 15
percent of your shots. It’s the same thing that happens with trading.
I compare trading to professional athletics. There is the emotional side
and the psychological side. When everything is clicking, you can do no
wrong. And then when you've had a few losing days in a row, then youre out
of sync. And when your'e out of sync, everything you do is wrong, even if it’s
a five-lot.
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But the one thing that I’ve learned is that you can't read your own press. You
don't always have to be the biggest guy; you don't always have to be the biggest
trader. You have to be the most consistent trader. And yeah, to this day I'll still take
a 100-lot, I’ll take a 200-lot. But more on my terms and not on the terms that I’m
trying to prove to somebody that “hey, I’m Lewis Borsellino, I’m the biggest
trader.” When you're 25 to 30 years old, youre a little more cocky than when
youre 43. I don't have anything to prove to anybody anymore at this point.
Do you think it would be possible for a trader without the dual-trading pit
experience to develop that kind of sense that you have, in terms of trading
size and being in the zone like that?
Oh definitely. I've been around some young, new stocks traders that have had
seven-figure years already.
The SOES guys you were working with?

Some SOES guys and some people that have got enough capital behind them.
Youve got to understand that some of those Nasdaq stocks, they have more vola-
tility and more swings than the S&Ps themselves. So if you jumped on Rambus
and caught a $180 move, or if you caught Qualcomm in 1999, then you caught
some of the opportunity that is out there. We are actually doing a lot more stock
trading than we ever did.
Yes, with the volatility there in some tech stocks, it makes sense.
Not only volatility, the trading programs that we have for commodities are work-
ing better with the equities than they are with the commodities, because of the
volatility in the equities.
I read in an interview that you did with a European journalist that you
mentioned that your “biggest weakness stems from the fact that I've been
a
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ic
successful as a trader with a propensity for making profitable trades.” What

does that mean?
I said that? My biggest weakness?
Yes, does that ring a bell? The interview was with an Italian journalist.
Oh, all right. I think I was talking about other business decisions that I’ve made
outside of the trading realm or even in the trading realm. I’ve never been the
type of person to get involved in other businesses, because of the independence
that I have as a trader. I think because of the independence that you get as a
trader and the ability to say to somebody, “look I don’t need your business idea, I
don't need your investments," I’ve passed on some very good ideas that were very
profitable. And it makes you sometimes too independent, and maybe sometimes
closed-minded in your business decisions.
Here I am explaining to people why I'd be a good money manager—‘“I’ve
survived for 20 years, guys’—and I still have people questioning me. Not that
I’m egotistical, but when I look at other money managers, I'll ask them a series
ef questions and I'll find out they haven't had one-tenth of the trading experi-
ence that I’ve had. So that is where I think he quoted me from.
It's hard for me sometimes to explain why I would be good. Not that I’m
the best trader who ever lived, but I’ve lasted 20 years, and this has been my for-
mula of success.
I often make the analogy to that of the golf swing. You look at all the dif
ferent golfers out there and they all have different body types. And they all have
different swings . . . except at the moment of impact, they all look the same. So
there are a lot of different traders out there, different personalities, different
make-ups. But when you get down and you do that interview with them, Marc,
youll find out they all have the same qualities when it comes to discipline, struc-
ture, and so on.
In January 2000, you wrote for CNBC.com, “One thing never changes: If you
want to know what the setup for the market is today, study where it's been
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for the past several days—or longer.” You mentioned earlier in the interview
about price points and about your analysis. I'm curious how you use volatility.
How do you put volatility into your analysis of technical support and
resistance?
Let’s say youre trading in a real volatile market, you buy the 1500s and youre
willing to risk 400 points because that’s what your research is telling you. Well,
in real volatile markets, it may go down and stop you out at 1496, turn around
on a dime and rally through your 1500, and go another 1,000 or 1,500 points.
Here you've missed the move because you got stopped out. And what happened
was, because the markets are volatile and because of the volume that’s being
traded, it has a bigger whipsaw. So when we see those, when we see that sort of
volatility, what we'll do is cut our size back and then expand our stops so that we
ultimately have the same risk . . . but we're adjusting for the volatility.
Or if you have a strong directional bias, you could benefit by doubling up on

your order.
Yes, but when you're talking about volatility, what will happen is that the
bounces will be bigger. With extreme volatility you're better off cutting the size
back and expanding the stops so you don't get stopped out of the move.
Normally, if you're getting a trending market, that’s when you can sell’ em, sell
some more, sell some more, and it trends very orderly to your exit point. It’s the
same thing with buying in an upward trending market.
Is there a standard, or most common method, of calculating pivots in the S&P

pit?
No. Everybody does different pivots. And the terminology that they use is differ-
ent. One of the good pivots that people like to use is when you've gotten the
opening range, and we've traded below the opening range and then we come
back and go through the opening range. And then you have your moving aver-
ages that people use. We use a combination of a lot of different things, a combi-
a aS SS SESE MEER GS LS ones RaToe One gEe ee gt

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nation of a lot of different research. | mean we use stochastics, we use Fibonacci,

we use Gann. We use a combination of things together that I don’t think other
people do.
And the thing about technical analysis is that you can think of it as being
an auto mechanic. You've got your engine, but they're always tweaking it to try
to get it to go faster and try to run smoother. That's the same thing that we do
with our technical analysis. Sometimes the bonds are the leaders and you're
watching the bonds and they're going to give you an indication of what the mar-
kets doing. And sometimes there are different underlying stocks or a group of
underlying stocks that will tell you what the market is doing. So that’s why we
have our analyst with 25 different screens.
So in the S&P pit, what a lot of people look at is the opening range. What
time frame is that? The first half-hour?
No, the first five minutes, I mean the first minute that the market opens up and
the opening range is established. That’s a big one. Old highs, old lows, intraday
highs, intraday lows; those end up becoming pivots.
| spent a day in the S&P pit on Veterans Day in November 1999. One of the
clerks pointed out that the E-Mini volume was exceeding the volume of the
S&Ps, and apparently that was unprecedented. How do you think electronic
trading will affect open outcry, or have your opinions on this subject changed
since you wrote the book?
As the public becomes more educated in the trading of futures, I think eventually
open outcry may fall by the wayside, depending on how big and if the volume
comes. But you have to remember what the role of the local is: He’s there to pro-
vide liquidity. And until there is enough retail and institutional participation to
absorb that liquidity, then the open outcry will exist.
If you were starting out now, what would you do differently?

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I don’t think I'd do anything differently. (Laughs). I think that I may have ex-
panded more within my field.
What does that mean?
I would have branched out and done other ventures and would have been more
open-minded about other things, other markets.
But then I’m a firm believer that you can trade Eskimo futures . . . ice fu-
tures. As long as youre a trader and it moves, you can trade it. But I think I
would have gotten into the equities more. Like I said three years ago, we started
doing equities. I think I would have been into the equities more than I have, be-
cause I’ve always watched them. We have 65-70 stocks we watch every day to
give us an indication. And I’ve watched some big moves go and didn’t participate
in them because I was participating in the S&Ps.
It's hard to have your attention focused everywhere.
Right. But here we're watching these and we've seen some big moves made in
them and that’s why two years ago we started trading more equities. We're actu-
ally getting more involved with equities.
For someone starting off now, how would you advise them to proceed?
First thing I would advise them to do is to get as much education as they can
about the markets. Try to get a job at an exchange or at a brokerage firm or find
a reputable person who has been trading for at least a couple of years so they can
align themselves with them. Id also tell them to go to Teachtrade.com and get
some very good lessons on what they're going to experience as a trader.
And I would ask them to attempt some simulated trading. It’s a good idea,
even if my experience with simulated traders is that there are always eight out of
10 winners, and then when they get to the real thing, they are lucky if they have
one winner out of 10.
ES SS DT EI I DT 2SIE SETI LET IE PIE ERS PE REE
So what I do with my new guys is | make them simulate. | make them

work on the floor and I make them do all of our research. Right now we have
three of our stocks guys doing all of the charting updates and so on. And I make
them do from three to five hours of research a night. And independently of one
another, I make them give me the research on the 60 stocks and their opinion of
how it has been formulated. That is what a lot of trading is. It’s consensus build-
ing. I have three different analysts who work analyzing S&Ps and so on and
they're not allowed to talk with one another.
It sounds like you bring others along with you—people whom you sponsor.
At first | brought my brother and my cousins. When I became successful, I got
so many relatives that found me! And I sponsored them because they were my
relatives and friends. And then about four years ago I started sponsoring other
people. We have four guys on the floor trading and we've got six guys up here
trading. And I have another four people in training right now doing research
who are wannabe traders. And then we have three more people on staff that do
nothing but technical research. We have a team concept and we include the peo-
ple that are doing the research in the profits with the traders. This is good be-
cause what I’ve found over the years is that a lot of people who are good at
research are terrible traders. They just don’t know how to pull the trigger.
That's a good way to pool different people's talents. How or where does the
average trader go wrong?
That’s another thing about trading. There have been so many guys over the
years, where I’ve said, “This guy will definitely make it,” and he doesn't make it.
And there are guys I go, “This guy doesn't have a chance,” and he ends up being
my best trader. It all comes down to one thing: I call it the emotional side of
trading.
People who are good at discipline and controlling their emotions and know-
ing how to pull the trigger and not worrying about the losses and are able to
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handle the winners without getting a big head . . . those are the ones that suc-
ceed.
You have to worry about the losses, but you can’t become like a
deer-in-the-headlights sort of trader after you've had some losses. But I never
know until I throw them into the battle. You know, we get them pretty well pre-
pared. However, when we throw them into the battle, that’s when we see.
ENDNOTE
Borsellino’s 10 Commandments of Trading
1. Trade for success, not money. Sure, we all want to do well and reap the fi-
nancial rewards. But the real goal is the success itself. In trading, this means
doing research and technical analysis, devising a plan of action, executing a
trade with a pre-determined profit target and a “stop” to limit losses, and
following the plan to the ultimate conclusion of a successful trade. Money is
only a byproduct of that success, not the goal.
2. Discipline. If there were one quality that traders must possess above all oth-
ers, it would be discipline. This ability to master your mind, your body, and
your emotions is the key to trading. You can have the best technical analysis
available, but without discipline it will be difficult, if not impossible, to exe-
cute trades consistently and profitably.
3. Know yourself. Are you the kind of person who can handle a lot of risk?
Or do you break out in a cold sweat at the mere thought of risking some-
thing, such as your own capital? Your risk tolerance, coupled with the
amount of capital you have, will determine the kind of trader you will be
(long-term position trader or five-minute scalper). Do you trade based on
systems alone or are you a discretionary trader?
4. Lose your ego. The quickest way to end your career is to allow your ego to
influence your decision-making. You need to silence your ego in order to
listen to the market, to follow what your technical analysis is indicating and
not what you think should happen. When you can put yourself aside and
(SATS SRSA BT TIAL SE LAR SL SE TEES

a IER BS Ge
bow to the whims of the market, you will have a greater chance of success.
But believing that you are successful because you possess a certain skill—or,
more dangerously, to believe that you have mastered the market—is a path
to almost certain ruin. At the same time, you can’t be so emotionally fragile
that unprofitable trades shatter your confidence.
5. Hoping, Wishing, Praying. When it comes to trading, there’s no hoping,
wishing or praying, only the cold, hard reality of the market. You can’t put
on a trade and then hope that the market goes your way. And while you
may get a break now and then, you can’t wish and pray for one. The only
way to trade is with a plan based on technical analysis of the market.
6. Let your profits run, cut your losses quickly. When youre in a profitable
trade, let your profits run to your target and then exit the trade. Don’t kick
yourself if the market continues to go up or down and you lose out on ad-
ditional profits. You'll never go broke taking a profit. And don’t get greedy
and hang onto a profitable trade so long that it becomes a loser. When
youre in a losing position, get out quickly. Always trade with stops based
« upon a pre-determined loss that you can tolerate. Don't hang onto a loser in
hopes that the market will turn around.
7. Know when to trade, when to wait. Being a good trader doesn’t mean
youre in the market every minute and perhaps not even every day. You
trade when your system and your strategy say you have a buy or sell to exe-
cute. If the market doesn’t have a clear direction, then wait on the sidelines
until it does. Keep your mind on the market during those uncertain times,
but keep your money out of it.
8. Love your losers like you love your winners. If you have a bad trade, it’s
not because your broker doesn't like you, somebody gave you wrong advice,
or you weren't loved enough as a child. You made a bad trade because of
some flaw in your analysis or your judgment. Or perhaps the market simply
didn’t do what you thought it would. Remember, the more you trade, the
higher percentage of losing trades that you will have. The key is to keep
your risk and reward in balance so that your net profits will more than
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compensate for your losses. Above all, take responsibility for your losers, an-
alyze them and learn from your mistakes. In trading, you have to love your
losers as much as you love your winners.
. Three losing trades? Take a break. If you have three losing trades in a row,
you need to take a break. This is not the time to take on more risk, but
rather to become extremely disciplined. Sit on the sidelines for a while.
Watch the market. Clear your head. Re-evaluate your strategy, and then put
on another trade.
10. The unbreakable rule. Every once in a while you can break a rule and get
away with it. But one of these days, the rules will break you. If you contin-
ually violate any of these Commandments of Trading, you will eventually
pay for it with your profits. That's the unbreakable rule. If you have trouble
with any of the Commandments listed above, come back and read this one.
Then read it again.
Source: Teach Trade.com

DAVID RYAN
THE TRAIL BLAZER

By Kevin N. Marder
ike many other traders and investors in the 1980s, I was first exposed to
David Ryan through his appearances in Jnvestors Daily commercials that
aired on the Financial News Network. In the 1990s, /nvestor’s Daily became In-
vestors Business Daily and FNN was swallowed up by CNBC, but Ryan contin-
ued to prosper and grow as a trader and money manager. As an employee of
William O’Neil + Co. for 16 years, he benefited from working closely with Bill
O’Neil himself, eventually being promoted to an in-house money manager re-
sponsible for investing the company’s money.
The markets are littered with traders that have had one great, “trophy” year.
Ryan not only won one of the equity divisions of the U.S. Investing Champion-
ship in 1985, but duplicated the feat in 1986 and 1987. The latter year was a
particularly difficult one for many traders, given the extreme emotions of eupho-
ria and depression that prevailed. As an early proponent of the O’Neil style of
buying stocks with fast earnings growth and high relative price strength, Ryan
served as a role model and trailblazer for many aspiring traders.
133
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Like those of other traders influenced by O'Neil, Ryan’s approach to the

market is unlike that of 99 percent of all other market participants. Buying a
stock as it makes a new high in price, a scary prospect for most investors, is busi-
ness as usual for Ryan. Moreover, buying a stock with a rich P/E multiple is also
not apt to make his palms sweat.
On July 1, 1998, Ryan left the O’Neil organization.to pursue a dream: run-
ning his own money management firm, Ryan Capital Management.
Kevin N. Marder: How did you initially get interested in the stock market?
David Ryan: In 1974, when I was 15, I had a trial subscription to Daily Graphs,
the O’Neil chart book product. That's how long ago I started. Although I don’t
know if I ever had a full subscription to Daily Graphs, | would pick them up oc-
casionally. I started reading them and then I think my Dad gave me a subscrip-
tion to Value Line. During the summer, I remember we'd go swimming in the
pool we had at our house. And then at 1:30 we'd all come in and watch “Gene
Morgan Charting The Market,” a show on a Los Angeles PBS station. (Chuckles.)
So I got fascinated by that whole thing. I think I even went to a Gene Morgan
seminar once a long time ago.
| remember watching his show a few times and seeing him draw those trend
lines.
Oh, he was a classic! He was so good at calling the market after the fact. And that’s
how I started watching the McClellan Oscillator and the Summation Index.
Where did you go to college?
University of California at Los Angeles.
Did you immediately start working for Bill O'Neil upon graduating from UCLA?
No, I actually had a job on the floor of the Pacific Coast Stock Exchange as a
runner for about a month. I quit that job a week before they would have laid me
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DAVID RYAN # 135
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off, since they were automating their systems. I don’t know if you know where
the old O’Neil building was . . . it used to be near Olympic and Bundy.
! used to go there on Saturday afternoons and pick up my Daily Graphs. That

was a ritual, seeing all the other stock junkies doing the same thing.
It used to consist of a full bookstore as well as a discount brokerage firm. But

then when IBD came along, they took out the bookstore. I used to go pick up
the charts there and read the books. I found myself saying, “why don’t I just go
up and see what goes on in the rest of this building?” And so one day I just
walked up the stairs and went to the receptionist and asked who I could talk to
about a part-time job or an internship. She sent me to O’Neil’s assistant, with
whom I talked for about half an hour. Even before I got home that day, there
was a message from Kathy Sherman, /nvestor’s Business Datly’s head of communi-
cations, who said that O’Neil wanted to talk with me the next day. So I said
okay, sure.
I'd never been on an interview in my life. And he’s asking me questions.
What do you want to do in the next five years? Do you want to go to busi-
ness school? Etcetera, etcetera. So then I started part-time at O'Neil + Co.,
just working half a day, just doing basic stuff. And then it evolved into a
full-time job and it went from there.
In terms of fundamentals and technicals, what do you look at when you

search for a stock to buy?
I’m looking for two things: a company that has strong earnings in combination
with a strong stock price. If the two aren't confirming each other—if the earnings
are there bur the stock is not performing well—then I'll just continue to track it
until the earnings and price performance do confirm. Especially in 2000, what
with the big focus on technology stocks, it’s amazing how there are a number of
companies trading at very low multiples with great growth records that people
are not even paying attention to.
Seat SE eo VAIO DER:AR NR SA els EAS TO TIDE ETEIIETOPS,
And what if a company has no earnings but is still in a dynamic growth

phase?
The only time we'll buy a company that doesn’t have earnings but has very, very
strong price action—and that includes just about every Internet stock—is if you
have an entire group move occurring. And this has happened at times in the
past. It happened in the biotechs; it happened in cellular stocks in years past. So
there are times where we're just playing the price performance and the relative
strength because the group is so strong.
Why don't you want to buy a stock that's been beaten down?
First of all, you've got a lot of overhead supply. You've got a lot of people who
bought at higher prices who are going to say, “Well, if I can only get back to
where I bought the stock before,” . . . then they would sell out. It constitutes a
lot of supply as the stock moves higher. If you're buying a stock that’s already
gone through that and is trading close to or into new high ground, then there
are only happy shareholders and the only people who are selling the stock are
people who are taking a profit. The stock has a free range above it to continue to
run.
Getting back to the Internet stocks you mentioned, do you have any screens
that you sift through if they don't have earnings? Obviously, companies like
eBay or AOL are profitable, but what about something else in the Internet
world that's losing money now? Is there another fundamental characteristic
that would help you in screening out the stock?
If it doesn’t have earnings, we pretty much rely on the market and try to do
some research into what specific area of the Internet it’s in and what kind of rev-
enue estimates it might have. And we also look at the market cap versus the
other stocks in that similar space because sometimes there is a catch-up in terms
of market cap. But with some of those Internet stocks, you're almost winging it
DAVID RYAN @# 137
NE
SERS SE TS ER
in terms of which one’s really going to make it and which one isn’t. You just
don't know which one is going to sign a deal with another company and see its
stock jump 20 or 30 percent in a day.
When you look for earnings growth, is there a minimum figure you're looking
for, like 20 percent?
Yes, at least 20 to 25 percent. But the bigger the growth, the better off.
Do you find yourself buying many stocks where the earnings are growing in
excess of 100 percent?
Yes.
What sort of size constraints do you put on something you're looking to buy?
Is there a minimum number of shares that trade per day on average, or market
cap, or float, or anything else that you look at?
Our size constraint is usually based on average daily volume of the stock and I
think we really don’t go any lower than something that trades 20,000 shares a
day. We'll go that low if we really like the company, but in most cases a stock
will be trading hundreds of thousands of shares a day.
When you look at entry points on charts, technically, do you have a few
favorite chart patterns that you like to favor?
The cup-and-handle is one of the better ones, but it does not show up nearly as
often as people might think. A cup-and-handle really has to occur in a general
market correction. That’s when a lot of them show up. So if you get a market
that corrects 10 percent, you'll have a lot of the good growth stocks that will pull
back twice that, maybe 20 percent, maybe even 25 percent. And also it would
take maybe about six weeks down and six weeks up and then it should drift off a
(RA 8 TR EE I TE ILE SE POTEET
little bit. The other one I look for a lot is just a flat base, the stock breaking into
new highs off of a fairly long consolidation.
What's interesting about Internet stocks is that they trade in dog time. It’s
said that one year for a dog is the equivalent of seven years for a human. It’s the
same with an Internet stock. If an Internet stock is based out for one week, that's
the equivalent of seven weeks on any normal stock. Everything is compressed on
those Internet stocks. So the time they take to base out, the time they take to
correct, the time they take to move—it’s all in much, much shorter time frames.
With these, it’s hard to get used to buying off short bases. If you've been disci-
plined for so long to be buying a certain way and then things make a 50 percent
move, sit there for three weeks, and then break out and go another 50 percent,
it’s just very hard to change your methods when that is occurring.
I take it you've changed things.

It’s still very, very tough. We do it, but we do it smaller . . . we take smaller-size
positions for those types of stocks. We also vary the size of the position based on
the volatility because I just will not have one of my top positions in a 10-point
trading range every day. It’s very easy to get shaken out of some of those things.
So we tend to buy a basket of them and spread the risk out among a number of
stocks rather than concentrating all in one stock. This is especially important as
you get bigger and bigger size money to handle. You can do that when youre
very small and can get in and out very quickly, but the execution and the price
movement on these things are so big in such a short period of time that it’s hard
to even get out sometimes when you've got 5,000 shares. This is because by the
time you place the order, especially if it’s moving, your execution can be 4 or 5
points lower than the point at which you picked up the phone. So it just makes
it a little bit harder to go through the volatility of these stocks, particularly when
you get up in terms of size.
As far as getting out of a position, what sort of general parameters do you

look for when you're ready to sell a stock?
DAVID RYAN @ 139
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A lot of it—I would say a majority—will be technical in terms of how the stock
is acting. We look at price-and-volume correlations on the stock. We also look at
relative strength. Has its relative strength line gone into new high ground on
maybe its last move into new high ground? We look at moving averages and
trend lines to help us stay in a stock or come out of a stock when it’s time to sell.
And we're also constantly moving up and down the size of the position based on
how the stock is acting. If we feel a stock has had a good run and has gotten very
extended, we might just cut the position size. We can cut it in half; maybe to a
quarter of what we had before, and then just mark time with the stock as it goes
through a correction and then look for another entry point as the stock starts
moving back up again.
Do any of your losing trades stand out in your mind as something that was a
real learning experience for you?
I don't know exactly what the stock was right now, but I just remember—I think
it was in 1988—where after winning that U.S. Investing Championship three
“ears in a row, I started looking at the results more than executing each individ-
ual stock and position. I was taking position sizes that were much too large and
giving myself such a small leeway and room for error. I would take a big position
size, but then if I lost a point or two it would really start adding up. I took a lot
of small losses, but they were on bigger positions. I was trying to get big, huge
gains again, but I was doing it in the wrong way . . . I was breaking some of the
rules and taking positions that were much too big, too quickly. I think I was flat
for 1988.
When you say big-size positions, do you mean 25 to 30 percent?
Oh yeah, I would start off initially and go with a 15 percent position. And
then within that first day or two if it started working out I would add another
5 percent. But then if the stock started turning down, I would have this 20
percent position in a stock that’s starting to fall.
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Do you use the 50-day average for anything at all? A lot of people seem to think
that's a spot where institutions like to come in and provide some support.
Yes, it’s something we look at very closely. We also look at the 10-day and also
the 150-day moving average. I really no longer use the 200-day because the
200-day is a full year of trading and the way stocks are moving these days, they
dont’ really even pay too much attention to the 200-day moving average.
What do you use the 10-day for?
The 10-day is used for shorter-term moves and also for Internet stocks a lot more
than stocks outside the technology area. I look at things like what side of the
stock the 10-day moving average is on, or whether the stock has been above the
average for a long period of time and is now coming through, or whether the
stock is breaking a downtrend and going through it. So we use that fairly often
on the Internets.
Would you buy a stock if it comes down and touches the 10-day moving
average?
It would have to depend on what kind of volume it’s come down on. Is there an-
other support point close by? It depends on exactly where that 10-day moving
average Is.
As far as sell parameters, when you're looking at technicals, is there any

basic rule or two that you use? For instance, if a stock comes down 20
percent off its high, does that concern you?
If its come down 20 percent, we're probably out of a majority of that position
because we're watching it fairly closely. Again, we're looking at other trend lines
and moving averages that it’s probably broken before it’s gotten down to that 20
percent decline point. It all depends, on a stock-by-stock basis, how much we
have sold by that point. In most cases, we will have at least trimmed a quarter to
a half of the position by the time it’s already off 20 percent.
DAVID RYAN @ 141
a a NINE ET IE EIS ERR LE Pac oo ES US CO
As far as general market analysis, what do you look at?

I try not to get too complicated. I look at the daily Dow and that works, but it’s
not foolproof. You can get whipsawed and you have to be careful in using it. It’s
like anything else—nothing is foolproof. I look at some of the McClellan oscilla-
tors and summation indexes for general trends, but a lot of it is based on “Can
we find enough stocks to buy?” and “Are the patterns showing up that we like to
be buying off of?”
Let's say the averages looked a little shaky, maybe after a big run-up or
something. If there were still some stocks out there that were setting up
technically, would you be buying some on the breakout?
As time goes on, you just have to be a little bit more careful, and if they do not
work out, then quickly cut the loss, especially as you get later into a move. It
seems like the last stocks you buy right before the market starts correcting are the
ones you sometimes get hurt the most on. This is because youre buying the
breakout and they can come off very quickly for the sale.
a
When it comes to money management, how do you add to a position? Do you

purchase, say, one-half of your normal-size position on the breakout and then
add another half as it goes up a few percent?
We try to take at least a 1 percent position in a stock as it’s starting out. If it
starts making a nice move on the first breakout then we can quickly move it up
to 2 percent or so, or even more if we like the company. It all depends on how
liquid it is, too. Sometimes it’s hard to buy that much of a stock that quickly if
it’s a smaller-cap stock. Then we'll add to the position as the move continues. Be-
cause we've got a larger-size portfolio now and it’s a lot of other people’s money,
we're not taking huge positions in stocks, especially with the volatility. We proba-
bly have a little over 30 positions and only one of them is over 5 percent. And
that’s also because it’s up between 75 and 100 percent since we bought it, mov-
ing that position to a weighting farther out. But we try to start out with 1 per-
Dg at PR eR PS I RS
cent and then we move it up from there, based on the stock and where it is
technically.
Can you give an example of a stock with an interesting chart that you
recently bought?
You could probably use Home Depot as a good example coming out of that base
at about 45—46 at the end of September. What’s good is that it pulled back down
on top of the base on lighter volume. Then it started moving out and as it went
through 50, we added more. It got up to the mid-50s and spent a few weeks there.
We probably added a little bit more there and then got a nice 56-to-almost-70 run
out of it. Then, when it broke down on big volume on the first day of the year, I
think we cut the position almost in half... because it had a nice, long run.
And then it got hit with that type of volume. That's where we feel, “Hey, it’s
time to lighten up and take some of the profits.” Because when you see that much
volume on a stock getting hit that hard going through the 10-day, then you can say
its probably time it takes a rest, so you can cut back on the position. We still have a
position in the stock and will be ready to add to it if we start seeing the volume in-
crease and the stock starting to come back up through probably 64 or so.
If things break down in this stock and, say, the whole market, will you retain
any core positions or are you going to be all in cash at some point?
Well, if the whole market starts breaking down, then I'll just keep on selling stocks
down. And if I get to a 100 percent cash position, that will just tell me there’s
nothing out there to buy. But I'll also be looking for stocks on the short side to
add to and I'll also hedge some of my positions as the market starts coming off.
Any other charts of interest?
People may laugh at this, but something like Citigroup just broke out. Good vol-
ume. And I like to have some big-caps in my portfolio for stability because if
youve got all high-relative-strength stocks in your portfolio . . . I’ve seen it hap-
ESSE RE RTE ES RAL a TE ETN OST

DAVID RYAN # 143
Series of Buys: Home Depot (HD), Daily
Home Depot Inc-Daily 0441/2000 C=67°3 +%5 O=65°6 H=67%3
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Volume 3714600.90
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@ Created with SuperCharts by Omega Research ® ASS?
pen where all of a sudden you've got all these positions in high-relative-strength
stocks and suddenly the market doesn’t want those any more. And it’s like a light
going out. You can really suffer quickly. So you put a few of these lower-risk
stocks in there and it helps the volatility so you don't have huge swings. It all de-
pends how risk-averse you are and how you structure your portfolio.
A lot of people are under the assumption that shorting is as easy as the long
side of the market. Would you agree with that?
No, especially when the majority of the time the market's going up. You've also
had corrections in 1998 and 1999 that have been swift. These corrections don’t
a ANS RT TAR SS TS Nt IAS I PS RON iALE ERE MOE EO)
last long. Also, some of the rules have changed since Internet stocks have come
along—a stock corrects 50 percent and then comes back and doubles back to its
old highs and then it goes again. Some of those things I had just never seen in all
the years I'd been watching the market—the explosiveness and the moves.
I would say the No. 1 piece of advice I'd give on shorting is “do not short
too soon.” You have to wait until its top has been completed. And that usually
takes two to three months. Too many people are trying to short on that. I even
try to do it because we all want to get that top tick. We all want to say, “I
shorted it right up here.” It's an ego thing. The best shorts are the ones where
the top has been put in for a number of months and then youve got some over-
head resistance. To try to pick off the top in a stock is very, very hard and some-
times you can get extremely lucky and get within those top few days, but it is
tough. I would say your odds are much, much better if you've let the stock base
out, come down, try a few different rallies over a few months’ period of time,
and then see it start rolling down. That’s the best time to short.
Thanks, David.
JEFF COOPER
HIT AND RUN

By Kevin N. Marder
first learned ofJeff Cooper through his first book, Hit and Run Trading. | had
read Larry Connors’ first two books, /nvestment Secrets of aHedge Fund Man-
ager and Street Smarts, and was impressed with his no-nonsense style. Cooper's
book, published by the same company, was written in the same 100 percent
meat, fat-free manner. Although I had already staked out the intermediate-term
time frame as my chosen turf, I couldn't help but be curious about Cooper's
strategy of pulling profits out of the market on an intraday basis.
Whereas daytrading became a fad in the late “90s, Cooper had already had a
decade of experience under his belt. An ocean view home in Malibu attests to his
trading success.
Cooper's greatest legacy, perhaps, is that he serves as a role model for many
aspiring daytraders. This was accomplished through his books, Hit and Run
Trading, Hit and Run Trading II, and The Five-Day Momentum Method, whose
strategies quickly became the prototype used by many daytraders and swing trad-
ers.
145
146 @ HIT AND RUN
eR PAR cae NA AN ST EP RE SN
Kevin N. Marder: How did you first become interested in the stock market, Jeff?
Jeff Cooper: My initial experience was in 1962. My Dad had one of the first pri-
vate hedge funds in the country, and a lot of his business was initial public offer-
ings. In the early-’60s, he retired from the textile business and moved the family
from the East Coast to California. He wasn’t really a golfer or a sportsman, and
he just gravitated to the stock market as a hobby. Before you knew it, brokers
had him buying stocks on margin. |
One day in May 1962, my Mom was in a hospital having an operation and
Europe woke up that morning and decided it wanted to sell stocks because of
Kennedy’s fight with the steel companies. The market tanked and my father was
on margin. Instead of his brokers doing what they said they were going to do,
which was to sell stock A to protect stocks B and C, they waited for a margin
call on stock A, waited for a margin call on stock B, and waited for a margin call
on stock C, and just sold them out accordingly. One of the reasons they did this
was because my father couldn't be found, since, unfortunately, he was in the hos-
pital with my mother.
My father went broke and we had to move back East to where his base
was so he could start working again. That was my first real experience with the
stock market.
Did your father stay away from stocks after that?
Eventually he built up another company and sold it. He always had an axe to
grind with the market and wanted to get back what he had lost. Some of the
brokers that he had done business with had some compunctions and guided him
into the new issue market in the late 60s. It was a hot go-go market then. He
ended up being a real factor in the business at that time. To this day, I remember
being in high school and hearing him, when I would walk by his desk, say “hit
and run.” That’s what he was doing. He became very risk-averse because of his
first experience, and just started turning money over. And he was able to take
back from the market about threefold what he had lost. So I was always enticed
when I saw what he did.
JEFF COOPER @ 147
aa NT EET FT RE A
I got into the sporting goods business in the mid-’70s. When I got out of
that business, I didn’t have anything to do. I looked for something to do and my
father basically handed me the Red Book of securities dealers and said “get on
the phone and I'll tell you what I’m looking to buy, and start calling them.” That
was my initial experience with the stock market. And then I went to work with
Drexel Burnham for a time and decided I really didn’t like the sell side.
Was this the infamous Drexel office on Rodeo Drive in Beverly Hills?
Right. After Drexel, I went back to work with my father for a couple of years.
During the time I worked with him doing new issues, I wanted to understand
what made the markets work. My father couldn't really help me in that way since
he was a great tape reader more than anything else. So I began reading every-
thing I could come across and started matriculating and learning the markets by
trading stocks that were other than new issues . . . and to a large extent, I got
killed. The new issues were a way for me to pay my way over the hump. They
were a cushion for me at the time.
They paid for your education, then.

Precisely.
What was your initial strategy in those early days? Were you short- term
oriented like you are today?
No, I wasn’t. I was taking positions for weeks at a time. My equity curve was ex-
tremely jagged. I didn’t really have a strategy. I didn’t know anything about mar-
ket tone, the overall market. A lot of it had to do with listening to brokers and
their opinions about what earnings would be. That’s how a lot of people get their
initial exposure to the market . . . looking at fundamentals.
So you worked a few more years with your Dad?

148 @ HIT AND RUN
EN SR AE OP I GL SINT TERA TES, I IE TOLL NEILL ETE LIE ED
I went out on my own in 1985, and started making money on my own. I| was
still doing new issues and I also traded, because trading helped create commis-
sions and made me a more-favored client to get bigger pieces of the new issues
from brokers. That’s the name of the game. When ’87 came, I didn’t go broke
like my Dad did in ’62, but I took a big hickey. It wasn’t until the decline in
the summer of 1990 that I became fed up with my equity curve looking like a
roller coaster.
And I decided that if I was to continue to play the market, I wanted to do
it on an extremely risk-averse basis. | became much more concerned about my
return of capital than my return on capital. I figured that the only way to do that
was to become very short-term oriented, with the notion that momentum begets
momentum. When it occurs, it usually lasts for a period of time, meaning at
least one to three hours or one to three days. That’s when I started taking bites
out of stocks, staying in them very short-term, as in one to three hours or one to
three days.
When you began trading the short-term time frame, was your initial strategy
similar to what you use today or was it totally different? Were you looking at
the same things that you look at today?
It took time to develop them. That was the impetus. They developed slowly, and
over the years. It really wasn’t a raging market until the end of 1994, early 1995,
when we started going vertical. I was still doing some new issues, but that was
the base for where the ideas were created. It just came slowly, one by one, you
know.
In your Hit and Run Trading books, you speak of various setups. Did you start
developing them in that period?
Yes.
Do you have a basic set of criteria that you use for entering a position?
EEE DET TR BE I ST ERE ARP SSS EE

JEFF COOPER 149
SEE ASS ES ER I NE ET OS SRI TES, CLT DER at OE TR
Expansion Breakout Setup: Globespan (GSPN), Daily
Globespan Inc-Daily 03/09/2000 C=153.500 -11.000 O=164.344

One of Cooper's favorite setups:calls for a stack to make:a tyvo-morth |
calendar high accompanied hy a daily range equal ta or larger than
the largest daily range of the prior nine trading days.The arrow denotes
such a day, which preceded an 89% run over four days. |}
wa
Fur :
Volume: 1628900.00
se fjae
Basically, in order to make money short-term, you've got to be where the action
is. So I’m looking for stocks that have a lot of volatility and have shown a pro-
pensity for volatility intraday, and on the daily charts as well. The strategies re-
volve around price action and the notion that a stock in motion will remain in
motion, at least in the short-term. One of the things I started looking at was an
expansion of range on breakouts of consolidations, whether they be to new
30-day or 60-day highs. And also I came up with the idea that the nature of
stocks was to thrust, pause, and if they were legitimate thrusts, they should start
to pivot back in the direction of the underlying thrust. I saw that stocks in fast
moves typically would only pull back for two to three days before continuing. So
I would look for stocks with real strong momentum, and assume that institu-
150 HIT AND RUN
(A SP TO ES BT UN GY TP OT REP RET SSTIE SETDET LL SEE SEELEIATL TEED
tions, mutual funds, and money managers, having all the time and money in the
world, would look to buy on pullbacks. My initial strategies were breakout strate-
gies that looked for a larger-than-normal range. I also focused on an expansion of
range to identify strongly-trending stocks that were pivoting out of multiday
pullbacks.
So you were looking for the expansion of range on both price and volume
and—
—not so much volume, at the time. Basically, price. I didn't have enough knowl-
edge about volume studies. One of the things I used to do was take an index
card and hold it over the chart and start moving it forward. I would ask myself
what would I have done here, what would I have done there, and I’d see how
many times I would have been wrong. I found that to be a real good acid test of
trying to learn price behavior.
One of the things I found early about volume was that I saw many break-
outs on increasing volume that failed. And I saw many breakouts on light vol-
ume that succeeded. So I really didn’t know how to interpret it and I ended up
using price as the final arbiter. To this day, I do continue to use volume for the
big picture . . . in other words, for looking at a sequence of distribution days and
accumulation days. But as for a day-to-day basis, I still believe anything can hap-
pen at a given time.
When you say “big picture,” are you referring to the general market?
I'm referring to the big picture of an individual stock and the general market.
Was O'Neil an influence on what you were doing?
O’Neil was a very big influence, Kevin, as I know he was with you, especially be-
cause he was becoming a big influence on so many money managers. Investor’
Business Daily was also becoming a big influence. So many things in the market,
JEFF COOPER @ 151
ERR PE a I RR SE SII N SURI IET PAETh CRT ROE SR Se OE TL
be it a head-and-shoulders pattern or a cup-with-handle pattern, become self-ful-

filling if you have a lot of people looking at the same thing. | felt it was impor-
tant to know what he was looking at and found that a lot of what he was talking
about was conceptually correct. It made a lot of sense.
In my early days, until I read William O'Neil, I was nervous about buying
stocks as they went higher and higher. I thought that the higher it was, the more
vulnerable it must be. But when I started reading O’Neil and I saw the power
and the five- and 10-baggers these stocks would rack up, I started seeing that the
institutions were not as nervous as I was, and would hang on. That’s when I
started realizing that, as a momentum player, you want to buy new highs. In or-
der for a stock to go higher, it’s got to take out prior highs.
This is just pure common sense, yet most investors remain locked in a
strategy that shuns buying a new high.
A lot of times prior to that, I'd faded breakouts and gotten killed. I'd just figured
there was a lot of juice in the stock, and somebody will come and try to take ad-
vantage of that. And it took a while to realize that that didn’t work. The higher
things were, the higher they tended to go, and vice versa.
What is your criteria for exiting a position? Is it based on a percentage drop

or a point drop?
I generally never want to let a position go 1 point against me. My feeling is that
my commissions are 3 cents and 4 cents a share. I would rather re-enter when a
stock revalidates. My belief is that large losses must start with small losses. So ’'m
extremely risk-averse. Most of my positions now are trading positions, intraday
positions. Though sometimes I take positions home overnight, I do this less and
less frequently, especially in a choppy market. Having done this for a number of
years, I’ve been able to accumulate some net worth. The daytrader’s dream is to
be able to make money both ways—not only through intraday trading, but also
through letting money work in Treasury bills at the same time.
152 @ HIT AND RUN
Eg na I AE EI Ti TB AIP IEEPIE OE TO ET TE A EOE,
So before that you were only holding positions overnight?
Yes. Now I'll take the isolated one or two positions home if they're in a very
strong trend and if they've closed well and if the underlying market is in the
same direction as the position I own.
You say that you risk a point. Does that change as the price of the stock
moves up? A lot of stocks here in the last couple of years—
—no, I always deal in points. A stock like Juniper Networks that’s above $150
and into the $200 range, I may give a little more leeway. And that may be a
point and a half. But I’m not using percentage stops. I don’t change my position
size, typically. I’m usually trading 1,000 to 2,000 shares. Sometimes if the stock
is over $200, I'll start with 500 shares and work my way up. But I’m trading in
round lots of positions and using points to exit.
Are there any general market indicators that you particularly favor in terms of
giving you a feel for the overall market? Or does your work, which includes
long and short positions, sort of obviate the need for any kind of general
market analysis?
When all the pieces come together, you have an edge. I say I don’t pay attention
to fundamentals, but I certainly pay attention to what the money supply may be
doing and what the Fed may be doing . . . and if there’s an economic number
that’s coming up . . . and the behavior and the psychology of the market is very
important. Although I key off price and patterns, I’m looking at other market in-
dicators such as the advance-decline line. I’m looking at the put/call ratios for
sentiment and I’m looking at new 52-week highs and new 52-week lows. I also
look at the number of stocks above or below their 200-day moving averages,
those types of things.
We know how you cut a loss short. How do you nail down a winner on the
way up? How do you book that profit when you do have one?
CES TOLL RS ODI DRT TTA PRE PO LR TT SPOTL MBE OIE DDI SEEPS REL EE: TE
JEFF COOPER @ 153
LS
IRRADIATED
RES TI Ae RE NETS OTT ELH
As you know, Kevin, the Nasdaq market has become so hypersensitive to trading
volume and order flows lately. I find that ever since the electronic
communication networks, the ECNs, started dominating the market and squeez-
ing the bid/ask spreads to sixteenths and thirty-seconds, there is very little inven-
tory in Nasdaq stocks available. The market makers just don’t want to make
markets. They don’t want to keep inventory. That's created a lot more volatility,
which can be good or bad. Volatility can be the trader’s friend. It will depend on
market tone for the day and what I think the overall trend is.
In January, February, and March of 2000, I was hanging onto positions,
and there were a lot of trend days. A trend day is when a stock opens at or near
its low, takes out the morning range, and closes at or near its high. I tend to try
to hang onto a position at least until the end of the day. And if something was
just pivoting back out of a pullback—a strongly trending stock that had come
off for a couple of days and done a retracement—and if it was like the first or
second day out of a pullback and closed well, I'd probably continue on until it
tests its prior swing high. But in a choppy market, as a stock starts to move up
Pll let out maybe a third of the position as the ducks are quacking . . . because
you find these spurts of momentum. And then I'll try to target shoot at resis-
tance points—intraday or daily resistance levels.
Do you ever pyramid up into a winner?

In a bull market, yes. During the day, I will.
How do you typically do that? Do you double up as the stock moves higher?
That’s exactly what I'll do. If I’m not sure about what the stock is doing, I
may start off with 500 shares. And then I look for confirmation of the ac-
tion—most of the time I’m using the S&P futures to key off of. IfI find that ev-
erything gets in gear, sometimes I'll anticipate the breakout and I'll put on an
initial position and use a very tight stop and even much less than a
point . . . maybe just a quarter or three-eighths of a point. I'll try to anticipate
the behavior of the stock.
154 HIT AND RUN
17 fit Nr me RIO NO URED CA A RET ST
For instance, if the market has been down during the morning and the
stock has shown real good intraday relative strength, and I see the futures start to
turn around, I’m anticipating the stock may come on again and break out. So I'll
open a position as the stock takes out the prior day’s high or breaks out of an
intraday consolidation, then I'll add on.
So it really sounds as though you're using daily charts to get the overall
pattern setups, the bigger picture, and then you'll drill down and use the
intraday charts.
That's exactly right.
Do you use five-minute bar charts like a lot of traders?
I use 10-minute charts. I don’t know why I gravitate to the 10-minute. It filters
out a little bit of the noise that you get from a five-minute. Basically, what I’m
looking for is volatility and structure. So I’m looking for the structure that a
daily bar chart provides and then I’m looking at the intraday patterns to key off
that.
As far as timing your entry?

Right.
And exit.
Yes.
Do you tend to go with pullbacks more than breakouts?

I would think so. One of the reasons is that, O’Neil might have said this—and I
forget what the exact numbers are—but 60 percent of most all breakouts pull
back for one day and I think another 30 percent pull back for two days. I may
LEE EEA SR DS SA ESA DEE STS RT DS TT

JEFF COOPER # 155
a ne ee Oe See re eee
be wrong about the total being 90 percent, but O'Neil found that a lot of break-
outs pull back. So I’m definitely interested in breakouts and I’m always looking
at new 30- and 60-day highs. And then I want to watch their behavior... I
want to stalk them over the next couple of days. That's how I use breakouts. And
then I'll buy if Isee them come on again.
Is the 1-2-3-4 pattern one of your favorites?

Yes. One of the ways I determine trend is by using the ADX indicator. If you
have an ADX over 30, whether a stock is trending up or down, it’s in a strong
trend. Although it’s an arbitrary number, I’ve found in my research that once the
ADX of a stock gets to 30, it can often go to 40 and 50. Once a stock has
1-2-3-4 Buy, Sell Setups: Nasdaq Composite, Daily
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156 @ HiT AND RUN
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shown it’s in a strong trend, I put it on my hit list. Once I see the stock walk off
an overbought condition by a two-to-three day pullback, then I’m looking for
any kind of sign of resumption of the underlying trend. Larry Connors and |
created this strategy together and it’s stood the test of time.
Where will you look to enter?

Typically, I will consider entering if I see three days of pullback, which could be
an inside day and two lower lows. Once I see the stock take out the high of day
three, that’s the trigger.
If a stock comes down more than three days, say, four, five, six, or seven
days, is there still enough potential thrust back on the upside?
I think so. There are normal trends and then there are runaway trends. Larry and
I first created the 1-2-3-4 concept from runaway trends. Over time, I’ve come to
find that there is a natural tendency of things in the market to play out in threes.
For instance, even stocks that aren't in strong trends that are breaking out from
low-level bases may show three days of pause or pullback to consolidate and then
continue, too. To answer your question, a 1-2-3 pullback, an initial simple pull-
back on a strongly trending stock, is how it was developed. Often you'll find that
pullbacks come in complex, or two-step, pullbacks. That’s where you may see
three or four days down, then an initial move up, and then another move down
of a few days, and then the overall trend begins again. I think a two-step pull-
back like that is -very valid as well, conceptually.
Do you have any favorite books that you've read over the years that have
influenced you more than other books?
Definitely. The first book that influenced me to a great degree was Technical
Analysis of Stock Trends, by Edwards & Magee. I became very interested in pat-
terns. O’Neil’s book, How To Make Money In Stocks, certainly influenced me, as I
said before. I also like a book called Profits In The Stock Market, by Gartley. And
TSS ESR DR UATE LSE RY SS LEAST LET RS FL ENT BIN TOS ES,
JEFF COOPER @ 157
all of Gann’s stuff influenced me a lot because I came to view the market as an
entity that backed and filled and breathed on its own. | was greatly influenced by
Gann’s concepts about the presence of symmetry in the market in terms of time
and price. Although I’ve never seen anybody really make any money consistently
with cycles, I think there’s something to them. I became very interested in that
view of the market. I came to take the view that everything that was in a stock
that’s known about a stock should show up in the price action.
I would never be able to know as much as the next guy regarding the fun-
damentals of a stock. There are a lot of fundamentals that sneak up on the ana-
lysts, too, so how was I going to get a better handle on it than they ever could?
That's why I decided just to watch the track of what the big money and the
smart money were doing. That’s why I believe in technical analysis.
So you don't look at the fundamentals at all, then?

Only in the sense of the big picture, the overall market. Some of the companies I
buy, I have no idea what they do, just maybe what industry group they're in. But
I may not even know what their niche is.
7.
Do you prefer to see a stock belong to a certain industry group? Or does it

really matter?
Yes. I think there’s a much greater edge if I see a whole group having a move. I
want to focus on the leaders in that group. Definitely. ?'d rather do that than try
to find a stock doing a solo run while the group is still dogging it.
What percentage of your trades turn out to be winners?
As I said, I used to be a trading junkie. Even as recently as three or four or five

years ago, I made maybe 25 trades a day. And at that time, I'd say my winning
percentage was 50 to 60 percent. But now that I’m taking much fewer trades and
really trying to wait for the best setups, my winning percentage is higher, just be-
cause I’m willing to wait. In the last year they've been up near 70 to 80 percent.
eT ST IS TL TS I EE BE II LS oYELEY Re ES
158 @ HiT AND RUN
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When assessing the risk/reward ratio of a potential trade, are you willing to
risk a point for a gain of 1 to 2 points, or is it more like 1 to 5 points?
Sometimes I’ll enter a trade and I’ll buy near support if I think the market tone
is turning and I may only risk 1/4 to 3/8 of a point. In those cases, | may only
be looking for 1 point, 1 1/2 points, 2 points. If ’'m risking a point, though, I’m
looking to make two to three. I'll look to sell a piece of a position as the ducks
start quacking and as the stock moves up. And then I'll hold onto the balance of
it, using trailing stops.
| know your books have served as a blueprint for many short-term traders,
particularly your first book, Hit and Run Trading. Do you have any advice for
the aspiring daytrader or short-term trader?
The market is an irrational creature that feeds off the emotions of fear and greed.
To say that the market has bouts of irrational exuberance is missing the point. It
always goes to extremes. Supply and demand don’t really apply when youre talk-
ing about emotions. Everyone wants to get rich quickly, and that’s why a show
like “Who Wants To Be A Millionaire” is so popular. Unfortunately, it doesn't
work that way. You need a plan. My plan is to put numbers on the board and
make them grow every day. The other thing that I think is important is knowing
how to take a loss. For me, knowing how to take a loss is probably the most im-
portant ingredient for a successful trader, especially a short-term trader. We have
to embrace risk every day. If you don't know how to manage the difference be-
tween your ego and taking a loss, you've got a big problem. Managing expecta-
tions is the difference in this business between succeeding and failing. I learned a
long time ago not to let my own personal issues of self-worth or approval have
anything to do with it. It’s a business like any other.
There’s one analogy that I think is very appropriate. Society instills in us the
quest to be correct, to be right all the time. We're wired to win, to be right in
our jobs all the time. We're wired to win—that can be a deadly trait for a trader.
I like to compare the idea of being a trader to that of being a baseball hitter. A
top hitter connects maybe three out of 10 times and makes millions of dollars. If
JEFF COOPER # 159
EARNERS
AK
he lets the other seven “failures” discourage him, he’s not going to be able to get
up there and pull the trigger again. |
I find trading a lot like baseball. I think there are two reasons why most
people get chewed up in trading. First, they're in the wrong stocks. You need to
be in the stocks that are strongly trending and that have some volatility. A more
important reason is that most new traders let small losses turn into large losses
because they live in hope. You've got to know how to take a loss. This paralyzes
them, both emotionally and financially. I can’t tell you how many faxes and let-
ters I've received from people who've read my books and still don’t use protective
stops. You can't use a mental stop if you're not going to honor it. You've got to
give your broker a stop. And if you're going to use a mental stop, you've got to
trust yourself enough to honor it.
Let me say something more about taking losses because I feel it’s so impor-
tant. You cant get your self-worth wrapped up in the idea of taking losses.
There’s a certain psychology that’s required to take a loss. Unfortunately, this
mind frame is totally against the norm for most people. And let me give an ex-
ample. A surgeon is trained to be as close to perfect as possible. Most surgeons
will be successful 90 percent of the time, if not higher, in the surgeries they per-
form. They don't know how to lose. This is wonderful. It's a wonderful trait.
ow the same surgeon retires and decides he wants to spend his retirement trad-
ing. He will trade the same way he practices his earlier profession, absolutely try-
ing to win every time. Taking a loss is not in his psychological makeup. He'll
work a losing position as hard as he works a surgery that’s gone bad. He'll do ev-
erything he can to save the trade, just as he’s done everything in surgery every
day to save patients for the past 35 years.
Most successful individuals are the same. They personalize losses and apply
an |’m-going-to-will-this-thing-to-succeed approach, just as they do to succeed in
other parts of life. In trading, though, this can be the kiss of death. To be profit-
able at the trading game, you've got to learn how to take a loss. You must be
willing to take small losses 40 percent of the time, maybe even 50 percent. The
profits take care of themselves.
When I get into a trade, I’m always approaching it from the standpoint of
not how great it looks, but how’s it going to get me, what’s wrong about this.
160 @ HIT AND RUN
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What’s wrong about the way I’m seeing this? I’ve just been humbled too many
times by the market. And I find that most of the solid traders I've come in con-
tact with have that common trait. They've been humbled by the market and they
have ultimate respect for the market. As soon as I see someone that’s cocky enter-
ing the trading game I just put on the stopwatch, because it’s a matter of time
until the market has eaten his lunch.
Baseball has so many things in common with trading. I recently heard a
story about legendary baseball hitter Ted Williams. Apparently, he seldom re-
sponded to fan mail. But when he got a letter asking him who he modeled his
hitting after, either the great Babe Ruth or the powerful Lou Gehrig, Mr. Wil-
liams replied: “neither.” His idol was Rogers Hornsby, whose strength was the pa-
tience to wait for the right ball. Whereas Babe Ruth swung at nearly everything
that moved—and though he did hit more home runs than anyone of his era, he
also struck out more than anyone—Lou Gehrig was simply able to overpower
pitchers with sheer force. But for Ted Williams, Rogers Hornsby was the man. It
wasnt so much the stance or the swing, but his willingness to wait for the right
pitch that made the difference. When I heard that, it just sent a shiver up my
spine, because that in essence is what a good trader is. You must be willing to
wait for your pitch, your ball. Otherwise, your performance will be erratic. You
cant make the numbers get bigger by trying to overpower the ball.
If you want action, you go to Las Vegas. I take so many fewer trades now
than I used to do, even five years ago. Sometimes the hardest thing to do in this
business, whether it’s trading the short-term as I do, or trading the intermedi-
ate-term, is to sit on your hands and do nothing. You've got to have an
edge . . . sometimes you have to wait for the whites of their eyes, whatever time
frame youre trading on . . . whether you're position trading, short-term trading,
whether you're an intermediate-term speculator. I think you need to have the
wind at your back and to see the whites of their eyes.
WILLIAM GREENSPAN
PIT MECHANIC
By Marc Dupée
ike many S&P 500 futures traders, Bill Greenspan was a “daytrader” long be-
Bore daytrading was a household term. He’s honed his approach down to a
science, dealing with its ups and inevitable downs by sticking to a simple trading
approach that he applies patiently, day in and day out.
It's an approach that’s worked well for him. After 22 years in the pits of the
Chicago Board of Trade (CBOT) and the Chicago Mercantile Exchange (CME),
Greenspan (trading badge: “WIG”) has established himself as one of the more
successful “locals” or pit traders—a fixture in the S&P pit where he trades almost
all day.
Greenspan got his start in the embryonic days of the financial futures mar-
kets in the late 1970s, when grains were still king and the veteran traders didn’t
know what to make of the new contracts on bonds, stock indices, and other fi-
nancial instruments. He had a moving-and-delivery business at the time. But in
1978, when a friend who had made a lot of money trading soybeans suggested
Greenspan try his luck in the fledgling T-bond market at the CBOT, Greenspan
made a Career change.
162 @ PIT MECHANIC
SAREE Png gE e007 a ri A NS EE EE
Greenspan started to make money regularly after three or four months, and
although he admits to some leaner times “during the Reagan years,” he has been
a profitable trader ever since. Greenspan's approach is the essence of simplicity,
honed over roughly a 22-year period of daily trading in the S&Ps.
“In the beginning, I didn’t really know what I was doing,” he says. “I was
scalping, just trying to get in and out.”
He freely admits to being something of a risk hawk, favoring stops that may
be too tight rather than too loose. His basic approach may seem straightforward,
but the fact that he has prospered for such a long period is a testament to its ef-
fectiveness.
Greenspan left the CBOT for its cross-town rival, the CME, in April 1987,
roughly six months before the infamous stock market crash. It was there that he
developed the trading style he uses today, a style based on the philosophy of
making “a million dollars on a million trades, not a million dollars on one
trade.”
Marc Dupée: I've heard there's a high turnover rate for traders in the futures
exchanges in Chicago, something on the order of 25 percent.
William Greenspan: Yes. And even higher.
Even higher? The average career of the pit trader lasts somewhere around 23
months. On the other hand, your career in the pit spans something like 23
years?
It’s actually been 22 years.
Congratulations. To what do you attribute your longevity and your success?
I’m not a stubborn guy when it comes to taking losses. I do run for cover when
I'm wrong. You never go broke taking profits, either. I am a good profit taker.
But I know how to milk a trade. When I catch one running, I will milk it and I
will trail my stops. I think the key is to be humble enough to take losses. I don’t
WILLIAM GREENSPAN @# 163
SSA RE SST ETE SSUES
muscle the market or fight the market, as Lewis Borsellino does or even as Don
Sliter does.
These, of course, are two other S&P traders.
Yeah. They're both excellent traders. I have tremendous respect for both of them.
They trade a completely different style than I do. They do fight the market more
than I do.
What does that mean, “fight the market?”
They'll add to positions. They'll fight the market. They'll go head to head against
the commercial houses like Goldman Sachs or Morgan Stanley or even Salomon
Bros. They think that the market’s going down and Goldman Sachs thinks the
market's going up, and they'll fight it out.
In speaking with Borsellino, he says he loves to buy them. He has a slight buy
bias. Do you have a bias either way?
I've sold the market all the way up. It’s the biggest bull market in the history of
the world. We sold it all the way. I short intraday corrections. I probably initiate
over 70 percent of my trades from the short side.
You're short 70 percent of the time?

I just initiate that side. It’s just the easier side for me to play. I tell them in my
Commodity Boot Camp classes, the longest I’ve ever been is short one [contract].
I like the short side. I’ve probably been hurt more on the short side, considering
its been a bull market. We've had a hell of a run, haven't we?
You said you know how to milk a trade. Do you do that mostly by trailing
stops, or is there some other approach?
164 @ PIT MECHANIC
Intraday Breakdown Failure: September 2000 S&P 500 Futures (SPUO), 5-minute
(SP Uo) S&P 500 IndexLAST-5 min ‘C=1498.00 +24.30

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12:45 1:35 22a

S Giestedwith Cineca bscaaich Pincus pone
On 6/20/2000 at (A), the June S&Ps establish the lows of the day at 1492. At (B), the S&Ps do
not violate the 1492 lows by more than 160 points, triggering a long position in the 1491 area.
Mostly by trailing stops. Like today (June 20, 2000), I have a theory . . . once
the high and the low of the day are established, if the market doesn’t take out the
low of the day by more than 160 S&P points, I think it’s a failure and I buy it.
The low of the day, early, was 1492-even. The market only went down to 1491.
If it had gone down to 1490-30, I would have sold the market. When it went
down to 1491-even, I was able to buy two there. I didn’t buy a great package or
anything.
Then the market responded and immediately went higher, up to 93-even
bid. I put my stops in and trailed it all the way up and the market ended up
(SE
T SE AE AL PR ES AEE a BY a
WILLIAM GREENSPAN @ 165
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closing higher. I think I sold them out at either 97 1/2 or 99-even. I had several
trades at the end of the day, which is a real nice profit on two contracts at the
end of the day—in the last half-hour, to take a quick $4,000 out. If you can
make $4,000 a day, and I make more when I’m trading well, it transfers to a mil-
lion dollars a year, or a million-plus a year.
Darned good income. Why do you say 160 points? Why do you select that
number as a “failure?”
I don't know why. Just out of observation.
Observation?
Observation and experience of trading. I watch . . . if the market penetrates by

more than 150 S&P points (1.50 points)—that’s 160 because of the tick—I’ll
initiate the trade. If it goes from 92-even down to 90.30, that would be 170
points, I would initiate getting short. That just confirms to me that we have fol-
léw-through on the penetration of the low.
On the low of the breakout of the morning?

The low of the breakout. I also do that on the penetration of the high of the
breakout. You have to expand that when you're doing the E-Mini, because the con-
tracts much less of a tick [value] and it’s a little bit more of an emotional market.
So on the E-Mini, I use 2 1/4 points.
And does electronic matching affect the E-Mini as well?
Yes. It’s not just the matching. It’s also that the E-Mini is geared for the small
trader. It’s geared really for risk-averse traders. They're willing to lose that $50 a
handle, where on the S&Ps it’s $250. It’s much harder to swallow.
166 @ PIT MECHANIC
(GSS A LE NN aC I cS a
That's an excellent point. Are there other traders that have been in the pit as
long as you? Lewis Borsellino has been there many years.
I started in the T-bonds in 1978, then I came to the S&P in 1987. Borsellino
was already very well established. So was Don Sliter. 1 knew Don Sliter from the
Board of Trade. He went to the wall several times at the Board of Trade before
he found his niche. I think he really found his niche in the S&P futures.
By “going to the wall,” do you mean going broke?

Yes. And to the wall. It’s just hard. You have to find your way.
Besides pit traders having short career spans, with many lasting fewer than
23 months, the job is hazardous. For instance, I've been told it's difficult to get
insurance. It's one of the highest-risk jobs, rated just below sky diving and
mining.
And air traffic controllers.
Right.
I do have disability insurance. Of course, I have four children and a beautiful
wife. I have life insurance. I’ve carried it for a really long time. Thank God, I’ve
never had to use it. I take care of myself. I kick-box two days a week. I work
with a personal trainer three days a week. I play tennis on Wednesdays.
People mostly recognize pit trading as a financial danger rather than as a

physical danger.
Its mostly an athletic event. It’s pretty vigorous. The athletes seem to do the best.
We have a lot of good athletes in there, a lot of guys who played college ball and
a lot of guys who wrestled in college. It’s very competitive. The athletes seem to
know how to psyche out the competition. They're used to competing and com-
TS
MPSENNSMAN MENINGES
peting at a high level. It’s not as cerebral as it is physical. It depends what you
make of it, though. Everybody has a different style.
It sounds like it’s psychological as well as physical. The Wall Street Journal
wrote an article where some trader took a trade that you had claimed and
then turned around and offered it to you at a higher price. It said you then
“went and slapped him right in the mouth and called him a cheat.”
I've had to curb my temper. The exchange is not a place where you really want
to fight. The fines can be substantial. Last time I had an altercation was in 1984.
What triggered the altercation?
Well, you know, money is on the line. Especially when you're dealing with such
quantities in a fast-moving market.
Is that when altercations leading to fights are more likely to happen, ina
fast-moving market?
A guy steals your trade and offers it to you at a higher price. That is pretty in-
sulting.
That's got to piss you off.
Yeah. That’s pretty insulting. Now, I have a little bit deeper pockets and I’m a lit-
tle bit savvier. If somebody does steal my trade, Pll try to force the market
against them till it doesn’t make it worthwhile for them to steal my trade.
This sounds like one time when you wil/ try to muscle the market.
I will try to use my muscle. I would rather lose money than to see him make
money on that. But when youre able to, what a great feeling! It doesn’t happen
that often. Maybe I’m just getting more mature.
168 @ PIT MECHANIC
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AAW DA NS ATTEN EO ERENCE ORE TS
Would you call Lewis Borsellino, Don Sliter, and yourself the biggest traders
in the S&P pit right now? You three?
No, no. I’m not a big trader. I’m enthusiastic. I never wanted to be a big trader. I
was a big trader when I was younger and I didn’t have a family and I could come
in and swing $60-$80 grand a day. Now, I try to make good money and keep a
lower profile. I think the biggest traders in the pit are those two guys . . . Lewis’
brother, Joey . . . he’s unbelievable . . . also, a guy who goes to the gym every day
and boxes. They're unbelievable. Lewis loves to go head-to-head. He'll go
head-to-head against Salomon [Smith Barney].
When you see Borsellino doing that, what will you do?
When Lewis is doing that, I generally won't go up against him. Another great
trader is Steven Prosniewski. He’s one of the best traders I’ve ever seen, also.
What makes him one of the best?
He's one of the biggest. He'll muscle the market and take a firm position. He's a
tremendous earner.
What size will he trade, for instance?
Steven has taken up to 200 contracts at a time. He probably, quietly, has a lot
more than that. I don’t think he backs away from 50-lot positions at all.
Whereas I like to trade in and out of 10-lot positions. You can jam them down
my throat all day long.
How did you get into this business?

In 1978, I had a moving-and-delivery business. I was doing very well with it. My
friend Marvin Wanger stopped by my apartment and he said, “How you doing
this year?” I said, “Great. I'm probably going to make about $35,000, maybe
$40,000 this year.” He said, “I made that last month trading soy beans.” I was a
TASS ATL ELS LIT ENT ESE OT TT ES SE TT

RRSR DFSES PRE LNB jn ee a
Opening Range Breakout: September 2000 S&P 500 Futures (SPUO), 2-minute
(SP U0) S&P 500 Index LAST-2 min C=1471.40 -2.30

1484.00
S&Ps run nine handles higher
from the low of the opening range.
1482.00
| 1480.00
Opening || } + {
range
] 1478.00
Market fails to break more than

1.50 below the low of the opening
range, triggering a long entry.
a Created with Omega Research ProSuite 2000) © 1999
city kid. I didn’t know. I said, “Where do you get some?” He laughed and said,
“No, no. I’m a member of the Chicago Board of Trade. I want to acquaint you
with this deal they have, they're trying to start these new products.”
The new products were Treasury bonds, commercial paper and gold. They
couldn't get the guys in the agricultural markets to come over and trade the new
financial instruments because they had made so much money in the ‘70s in the
grain markets and they liked the hours. The hours were 9:30 a.m. to 1:15 p.m.
The Treasury bond hours were like 8:00 a.m. to 2:45 p.m. And at 2:45 p.m.,
you cant make the Cub games! So anyways, they offered 50 permits to the pub-
lic. The deal was you had to pay $2,500 a quarter for three years for a total of
$30,000. At the end of three years, you paid another $10,000 and they gave you
an associate membership at the Board of Trade. And you could expense the
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$40,000 off as permit fees. So because of the tax situation, it really only cost you
half, if you were successful.
I ended up getting the last T-bond permit available. Jimmy Carter was Pres-
ident. If you recall, he did things to interest rates that nobody thought was possi-
ble. We went on to make a lot of money. After my three years were in, I got my
associate membership, then I had a membership at the Board of Trade, and I've
rolled that into a full membership at the Board of Trade. I also have three more,
smaller memberships at the Board of Trade that I rent out for income and a full
membership at the Chicago Mercantile Exchange.
What are those seats leasing for right now?
They're not leasing for much now, but they had been leasing very strongly for a
while. One of them leases for like $9,200 a month. A couple of the other ones
lease for a couple hundred dollars a month.
What's the difference between those two?
One, you can only trade Dow futures and muni bond futures. The other one
you can trade anything in the building and anything in the CBOE.
How much is the one for just the Dow futures?

Couple hundred a month.
You've written several articles for Stocks and Commodities Magazine and
other publications, describing the calculation and use of pivots. How would
you characterize your style of trading?
Now I trade the breakouts. Opening range breakouts; breakouts from the high,
low, and close; breakouts from the Globex high and low; and also, chart points
where there’s been a low in the market or a high in the market for several
SL SE TIE EIR EE TSTIGER ITGAME aS
days . . . say a level that the market can’t get through . . . it stops at either 1506
or somewhere between 1506 or 1508. I'll trade off those numbers, too. Also, |
trade the failures. If the market fails to make a new low by more than 160 points
or fails to make a new high by 160 points, I consider those failures and I'll initi-
ate a contrary trade. You'll make a lot of money on those.
Do you incorporate the overnight or the electronic trading activity from

Globex?
Yes. You have to do that. There’s no sense leaving cash on the table. It is a
risk-taking business. I mean, it doesn’t work every time. But it works a high
enough percentage of times that it provides me with a good income.
Is the formula that you currently trade off of the same formula in your
articles?
Oh, absolutely. The pivot formulas work.
Therefore, do you find that these pivot points are just as valid or more valid?
I’m not trading the pivots right now because I’m concentrating on the breakouts.
When the market is trading near its all-time high, like it is now, there’s less trade.
If you take the market, it looks kind of like a bell curve . . . most of the trade
occurs in the middle of the range. There’s more interest there, where people are
buying and selling at that level, thinking it’s going to go higher, or think it’s go-
ing to go lower.
When the market trades up here at the extreme high, like it is right now, it’s
more emotional and there's less trading. So I’m trying to trade the emotion and
the breakouts, the running of the market . . . because it trades very emotionally.
So, I’m not using the pivots. There are people who are trading near me that are
using my pivot technique. We talk about it during the day. I’m just not using it
in the S&Ps right now.
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When you use the overnight prices, do you find the levels are more valid than
just the previous day's high-low-close calculation?
Yes, but if you use the high-low-close, the overnight high, and the overnight low,
and take them together, you have to divide by five. You can’t just divide by three.
Sometimes, they'll take the closing price, the overnight high, and the overnight
low. I would just as soon use all five numbers. You're going to get much more ac-
curate support and resistance levels. |
You also mentioned that you never enter a trade without placing a stop-loss.
Particularly, when I’m off the floor. When I’m on the floor, I'll enter a lot of
trades. You always have a mental stop.
And scratch them if they are not working out?
I don’t really scratch them. You can’t make money scratching trades. If I put a
trade on, if it goes 150, 200 points against me, I get out.
Tell me a little bit about your Commodity Boot Camp.
Its a great course for trading. It teaches new traders how to get in the market,
how to overcome their fear, how to give them the good fundamentals, how to
start trading with the right kind of trading parameters, and how to look for a
3-to-1 profit objective to enter your trade . . . in other words, how to risk $500
to make $1500. You can't go one for one. There’s no percentage in that. Youre
going to end up getting washed out.
It shows you how to decide on making a trade, how to calculate where
youre going to put your stop-loss and enter the trade, and how to put in your
stop-loss order and make your trade’s biggest number. Most people have such a
fear of trading. Most people are risk-averse.
In that 3-to-1 profit objective, how do you define the profit objective?
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A lot of times it’s just on money. You just decide how much you're willing to
lose. You place a trade . . . maybe you're buying above the previous day’s close.
You say if it penetrates the previous day’s close, I’m going to get out or I’m go-
ing to stop and reverse. (He reverses position when stopped out—that is, if
long one contract, he will sell two contracts at his stop level, establishing a
short position.)
So you just hold on until it achieves the 3-to-1 objective and cover?
I’m not a pig about the market. If you set out to make $1500 on your trade and
you make $1500 on your trade, if you stay in that trade you're being a pig. At
least you can trail your stop. Maybe the market will give you more than that.
Not every long trade’s going to the moon. Not every short trade is going into the
sewer. You just have regular trades, regular amounts of risk and profitability, and
you know youre going to make a lot of trades. I don’t ever come in and think
I’m going to make one trade. I don’t think I’ve ever done that in my whole ca-
reer . . . come in and made just one trade. I’ve come in to trade the market and
provide liquidity. That's my job as a member.
I've read that you often do that; you often lose a little just to provide liquidity.
It’s just a big, empty concert hall down there if we don’t get the orders filled. Not
that we want to do it and lose money. Sometimes, we'll facilitate the market and
lose a little money just to get the customers’ orders filled. It's just part of it. We
don’t want to have a big, empty concert hall.
You said you make seven figures trading these techniques.
I have for the last four years.
What kind of margin do you need to maintain to pull down that kind of
money?
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I don’t really know. I own so many memberships. I keep up money in my ac-

count. I never really worry about that. I never trade too big that they ever give
me a margin call.
What would you say is your average annual return on your margin capital?
I dont really have one. My Board of Trade seat is worth about $600,000. My
Merc seat’s worth about three-quarters of a million. The other seats are worth
whatever they're worth. Believe me, if I ever go in the tank and lose money, they
will sell my seats. Those act as my—
—collateral?
Right. They will sell my seats. I don’t ever doubt that. There are no friends. No
prisoners. You're playing for money.
They'll liquidate you.

In God we trust.
You said you wouldn't hesitate to take a 10-lot. But what would you say your
average size trade is?
Probably fives. I probably do 5-lots all day long.
How many trades do you make a day? In an average day.
Maybe 150 to 200. Let’s say 100 to 150. Around 150 trades.
Other than just breaking through or not breaking through certain levels, are
there any other specific technical factors that might get you in on a trade
such as specific technical patterns you see setting up?
I don't really use them. I use the basics of technical analysis, which is the high,
the low, the close, the Globex high, and the Globex low. My first trades are usu-
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ally opening range breakout trades. If the market breaks out on one side or the
other of the opening range, I initiate my trade.
And your stop-loss is just a set point amount . . . you're out after it's hit?
Yes. Particularly, on my scalp trades and my individual trades. There’s no sense

marrying a position. You're going to make a lot of trades during the day. You
don't really want to get a big hole to dig out of. The main thing is to be able to
admit that you're wrong. Youre wrong and you can reverse. If every time you
buy and they keep going against you, I think it’s time to turn around and sell
them.
Sell them and go both ways.
You can't be a one-way trader. The market doesn't accept one-way traders.
It can be difficult to admit you're wrong and reverse.
The thing that’s really most difficult for people is to short the market. They have
a very tough time with that concept: They don’t own it, so they can’t sell it. Peo-
ple rarely short stocks. They're always long.
Long and wrong.
Most of the money here . . . not most, but plenty of the money is made on the
opposite side.
You said 70 percent of your trades are initiated on the short side. Do you ever
consider fundamental factors?
Fundamentals are what you use when youre in the pit. I use the technical trades
to get me in and out. The fundamentals tend to shake you out of more trades
than you can hold on to. Fundamentals are supply and demand. When you see
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everybody selling, that’s supply. When you see everybody buying, that’s demand.
We're governed by supply and demand. We're governed by the fundamentals.
| was referring to fundamentals in a macro-economic sense or news-driven

events.
Of course we use that. God forbid my namesake. For 12 years I’ve been fighting
this guy (Federal Reserve Chairman Alan Greenspan). He rules. He’s been win-
ning. It’s an unbelievable legacy he has. It’s hard for me, when I get on the eleva-
tor with a bunch of interest-rate traders . . . “Your uncle’s really [screwing] up the
economy. He’s really [screwing] up the trading! Did you get the call last night?” I
say, “No. I’m waiting for him to call me right now.” But I’m not related in any
way. It just happens to be a very popular name.
Have you noticed any patterns on days surrounding a big number, in front of a
Greenspan speech or FOMC meeting?
The only pattern I see is that people are much more nervous. When this guy
breaks for lunch, everybody breathes a sigh of relief.
How do you trade off that, when you see that type of psychology in the pits,
that nervousness?
First of all, you can watch the way the order flow’s going. If the orders come in
selling, the locals take the other side of the orders. They're on the long side. If
the orders come in buying, the locals will generally sell the market. They’re gen-
erally short. You can read the pit pretty well to see which way the locals are. If
the locals are long, they're going to have to sell it to cover. If they're short, they're
going to have to buy it to cover. They get one way or the other in anticipation of
what they think the report is going to do.
That's not something your average trader outside the pit can really benefit
from or trade off of.
Se ME SE eee ae eT eat ot Bete te Tee SP eet ect ee eee eee
No. It’s hard. If it were easy, you wouldn't need them. It’s not supposed to be
easy. It’s never been easy. Maybe when Carter was the President it was a little
bit easy.
When you're trading, when or how will you scale up or pyramid the number
of contracts that you're trading?
I dont mind adding to winning positions. I never add to losers. That’s called
cannon-balling. I don’t mind if I’m getting long and the market’s going up, to
buy more. Or I’m getting short and the market’s going down, to sell more, up to
a certain number of contracts. I don’t like to take more than 10, 12, 14 con-
tracts. It’s just too many. I’m not recognized as that big of a trader to be able to
get them back. I do like to add to winners. I never add to losers.
When it's going a certain way, how will you scale up from five to 10 to 14 or
to your maximum?
If I’m long five, I’m bidding . . . it’s called wolfing your position. I’m trying to
bid the market up to get it to go higher. As I get hit, I add to my position. It’s
an open outcry. If everybody’s bidding 6 1/2 and I’m long at 5 1/2, I bid 7-even
for one. I want more bids at 6 1/2. The guy who sells me one at 7-even, he’s go-
ing to bid 6 1/2 because he wants to make a profit. That adds more fuel to the
fire and that means he has to cover his shorts and we try to move the market up
that way. It’s called high-ticking the market.
Why will you decide to do that?

Because I’m convinced I’m right.
How are you convinced that you're right, so much so that you'll double or
triple your position?
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First of all, I can see where I can take my loss. The fundamentals are there, all
the buyers are there, and I’m already long. So, if I have to sell, there are buyers I
can sell to.
How will you recognize them?
The buyers have their palms facing toward them and they're bidding for the mar-
ket. That's how I know where I can get out. When you look at the market and
you see sustained buying coming in, you see one side is stronger than the other. It’s
not that there isn’t an equal number of buyers and sellers, but when the market
goes up, the buyers are more aggressive than the sellers. And when the market goes
down, the sellers are more aggressive than the buyers. Usually, there’s more bid for
or more offered. One side of the market is always stronger than the other. At any
given time of the day, you look at the market and if there’s more people bidding
than there are offering, or there’s more people offering than there are bidding, you
can pick the strong side or you can pick the weak side of the market.
So, when you see it's particularly strong, that’s when you might add to a
position?
Of course.
Do you have an example, or a story of one of your biggest trades?
I don't know. I’ve had so many of them. I’ve gotten carried away a few times. I’ve
made pretty good money. Particularly during the most volatile days. I can take
out some pretty good money. I’ve never had a million-dollar day like Lewis
Borsellino has, but I’ve had my six-figure days. Those are very nice and very
sweet. I always stop at the jewelry store and buy something nice for my sweet-
heart on the way home.
Do you remember the anatomy of any of those trades—how they played out?
SE ST GA NE RT| EN Gi TE TEE Bi Re ibe Si EL PRE eI
They kind of run together. I was here for the ’87 and the ’89 crashes. I’ve been
here for some tremendous bull markets that we had in the 90s. I was there when
the bonds, in the late ’70s and early 1980, went from over par—over
102—down to 56 cents on the dollar. When the Hunt Brothers were buying the
bonds and they were buying silver and gold. I traded the silver and the gold. I
made some pretty good money. It’s been a long career.
Do any particular trades come to mind, the anatomy of how one of those
trades played out?
It just runs together with all of this time. I probably need some of that gingko
biloba stuff to stimulate my brain. They do seem to run together at times.
Understandably. Maybe you have a recollection of a large loss.
Of course you always remember the losses. Do you know why? When you get to
a certain point and you get good at what you do, you expect to make money. In
the big markets when the trade is big and the market is much more volatile and
the tick gets bigger, you expect to go in and make 20 grand a day, make 100
grand a week. When you go in and get careless or stupid, and you lose 40 grand
or something, that sticks out .. . its so out of character. You weren't expecting
that.
Has that ever happened to you?

Of course. Everybody's had that.
What was the anatomy of one of those? How did that play out? What got you
into the trade? What were you thinking?
Cannon balls. I sold some. It went against me.
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Cannon-balling means you added to a loser.
I added to a loser. I ended up short 27 contracts when the market was going
down and the market just kept going. I couldn't get them back. Finally, I just
gave the order to the broker and said, “Buy me 27 at the market. Do the best
you can.” I just took my loss. That’s just how it went.
It’s a fickle place. There are no prisoners. It’s money. Money's dumb. Money
goes to anybody. Gangsters have money. You just ride it out. When you do care-
less things, expect the market to be unforgiving. It's a very unforgiving place.
There’s nothing like it. There’s no place else youd rather be. After all these years,
I’m never late.
Intensely exciting, eh?

Yes, very exciting. It’s a narcotic. It gets you cooking.
In either of those—the big loser or the big gainer—do you feel like you
learned more? Do you feel those are valuable lessons?
I certainly learned not to average and not to cannon-ball. Its much better to just
take losses and get on to the next trade. If you keep adding to losers . . . you sell
four and it goes against you, so you sell four more . . . youve got eight. It con-
tinues to go against you. Now you sell eight more. Now youve got 16. And all
you ever really wanted was a four-contract position. Now you have a 400-percent
larger position than you really wanted and it’s all against you. That’s a good les-
son.
Do you think that has been one of your most valuable lessons in the pit?
Yes, of course. It’s not that I’m a good loser. You show me a good loser, and I'll
show you a loser. I’m a skillful loser. I know how to take losses. I try to take the
best loss that I can.
PER IO EDRINE EPS TE TESA TE DI TENT ORB API A EES EM OTIS, AE NE UTA ET
Do you ever bluff in the pits?
Everybody bluffs in the pits. You close your eyes and offer the market and hope
nobody hits you. Its called wolfing your position. Try to uptick it. Tick it with-
out getting hit. Maybe you have 10, 12 contracts on, but you still want it to go
higher. You bid for it and close your eyes and hope nobody hits you.
Could | ask you to describe that in your own words for somebody who might
not quite understand what you're talking about?
You're long the market at 1490 and the market is at 1493 1/2, and youve bought
at 1490, 1490 1/2, 1491 1/2, 1492—and you've had it. You got on as many
contracts as you really feel comfortable having. You bid for one more and
just . . . you bid to the ceiling. You bid 3 1/2 for one, which would be
1493.50...
Hoping to break the market out at 93 1/2, huh?

Floping to catch the guys who have sold it all the way up from 1490 to 1493.
Now, youre trying to buy one at 1493.50. You touch off some buy stops. But
you really don't want any more. You have as many on as you want. It doesn’t
matter when you bid for the market, whether you bid for one or you bid for 10.
As long as the print goes up, you're going to touch the buy stops and then the
buy stops have to get elected. Once they're elected, they have to be filled.
Why do you use the word “elected”?
It’s not a market order until the print goes on the board. I guess it is a common
word. The stops are elected at that point and they become market orders.
Oh, because they're standing stops... once a print hits the tape...
Right. Then they're elected. Now they're active.
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That's one way to bluff it—trigger some stops. You're long at 90 and it blows
to 93... and then it starts rallying?
That's right. You can sell them at 93 1/2, 94, 94 1/2, 95-even. Sometimes the
stops will run into each other and you can catch a real running market and
maybe make 300, 400, 500 points . . . 700 points.
What about order flow? You mentioned that already as a way to read the
fundamentals in the pits: either the hands are facing in—the pit wants to
buy—or the hands are facing out and the pit wants to sell. That's one way
you read order flow, of course...
That’s fundamental analysis.
Is there any other way? Do you watch certain major players? Do you watch
Goldman?
I watch Goldman Sachs, Morgan Stanley, and Salomon Bros. Those are the key
players. Of course, I have a big house that stands right behind me called
Chi-Corp . . . Chicago Corporation. They trade actual cash stocks against the fu-
tures.
These are program trades?

I think so. They're difficult to trade with. They are a very big player, a very ma-
jor player. They take big money out of the market doing that. They bid for the
market and they have a resting bid on the bid, but as soon as they lose the cash
side, they fill the future side. You can’t really follow what they're doing very
much. I don’t watch the cash stocks.
Are there other types of discernable program trades and strategies going on
with other players?
All over the place.
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It must make the order flow confusing with that?
Yes, of course. Like I said, “It’s not easy.” If it were easy, they wouldn't need me.
Is there any way that you know that screen-based traders can get a feel for
order flow?
Screen-based traders—no. Screen-based traders have to trade technically.
Absolutely no way?
I don't think so, And particularly if they’re off the floor.
Is there any other way when you can tell that a program trade is coming into
the market or how you can key off that to make money?
Off the premium. | don’t really follow it that much. When I see the premium
enter into the cash—because the cash S&P leads to the futures—the premium
ets to be a certain level, then they'll come in to buy the futures to go and sell
the cash stock against it. It’s called “The Basket.” They're basket traders. They do
real well with that.
That's not a method you've ever traded or that you can actually use to key off of?
No. They trade much too big for me to follow.
Do you trade in any other markets?
I like to speculate in the corn-wheat spread. Buy the wheat and sell the corn in
the summer, and sell the wheat and buy the corn in the winter. I like to play
gold. I don’t know why. I don't really make much money at it.
At either one, or just gold?

At gold. The corn-wheat spread has been very good to me.
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Why do you select the corn-wheat spread?

Only because I’ve followed it for years. Sometimes it can break out really wide. I
start watching it very closely when it gets around 50 cents. A few weeks ago, it
was into 15 cents—that’s a tremendous buy. You buy the wheat and sell the corn.
Now, it’s exploded back out to about 62 cents. You put out 20 contracts like
that. You can take some nice money out.
Can you describe that trade in simple terms, for people who may not be
aware of how spreads work and why you do it?
I like to buy the wheat and sell the corn .. . same month. . . at a differential. It
depends on the time of year. In the summer . .
And you do this year round and not just for the summer crop?
Yes, in the winter it’s reversed. In the summer, you try to buy the wheat and sell
the corn because there’s much less wheat and much more corn. The corn isn't
nearly as volatile as the wheat. The wheat is much more weather-sensitive. I stick
away from the soybeans. Soybeans—they got to kill the crop three times a sum-
mer before you can make any money on the damn stuff. A soybean’ll grow in a
crack in a sidewalk because it’s such a hardy plant. But the wheat is much more
vulnerable and that’s what makes it much more volatile. I try to buy the wheat
and sell the corn at a differential of about 40 cents or 50 cents and sometimes it
gets in there more than that. And then I look for it to snap out, depending on
the weather conditions and shortages.
Do you trade gold similarly?
No, [ just speculate in gold, usually from the long side. “Be a friend to gold
when it’s friendless.” That’s my motto. When everybody hates it, get long in it.
When they come for it, they come with both hands.
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Both hands. You like to see the big moves.
I like gold. I don’t like to be short in it.
Looking back or starting over, is there anything . .

I'd like to have a chance again. I'd like them to roll back the clock about 21
years. I'd like to have another chance with this much knowledge.
What would you do differently?
I'd trade bigger. Probably wouldn't have so many kids, either. That kind of slows
you down. Makes you a little nervous.
Makes you a little more cautious?
I have a beautiful home and all that. I certainly don’t want to go back any far-
ther. Kids don’t understand that kind of stuff. It really takes a little bit out.
* With your current knowledge, what do you think you might do differently,
besides trading bigger?
I've learned so much in the last eight, 10 years that I think I would have started
differently. I would have been more experienced in trading the markets. I didn’t
really have anyone to teach me when I came in. I started scalping the market first
and then I started doing these T-Bond spreads. It was all self-taught. I didn’t
know anything about technical analysis or fundamental analysis. I didn’t know
about opening range breakouts or breakouts from the high of the day or the low
of the day. In trading, of course, nobody tells you anything. They don’ tell you
their secrets. That’s their game.
You're sitting here telling us, though.
Yes, because markets are different now. Maybe I’m just more of an open person.
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You've written about “value areas” as well. Could you explain what they are
and how you use them?
The low of the day and the high of the day are the extreme value areas. By the
low of the day, all the people who wanted to sell the market get filled. All the
shorts got filled by the low of the day. The same thing goes with the high of the
day: Everybody who wanted to get long, everybody who.had an idea about buy-
ing the market, they got filled by the high of the day. Every guy . . . the last
trade out, got filled by the high of the day. That's a very strong value area.
The next day, the high and the low are the basics of technical analysis and
are considered very important value areas. When the high of the day gets vio-
lated, the pit will tend to get long. There will be buy stops above the high of the
day. Again, when the low of the day gets violated there will be shorts or sell or-
ders below the low of the day. All the longs will have to get out because it al-
ready violated the low and that was the technical area of support for the market.
Those people who want to get in by selling the market . . . those people are
proven right because the market has violated the low. And they'll be a bunch of
people who got long at that area, who have to get out because it violated the low.
It’s a technical area, a major area of value.
I guess those are defined by the end of the day. Otherwise, the value areas are
very difficult to figure out while you're in the market.
No, they are set intraday. Within the daily trading range, you'll establish a low
and establish a high. It may change throughout the day. By the end of the day,
there is a high of the day and a low of the day. There will be buy stops above the
high of the day, and sell stops below the low of the day.
Where do most people go wrong with their trading and how would you tell
them to proceed?
Particularly when they start out, I would tell them to trade small, trade fre-
quently, try to learn from their trades, and don’t be too egotistical to think you’re
ERS SEORE RET ALE A IRN EE DTI SIP AES I SE

right. The market is bigger than everyone. Take your losses. Taking losses is your
best friend. If you can be humble enough to take losses when you're wrong, you
can last as long as I have. That's the idea. You don’t have to make a million dol-
lars on one trade. You can make a dollar on a million trades and still have a mil-
lion. That's the idea. I’m a daytrader. It’s my job. I want to be around for a long
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JON NAJARIAN
MERCURY RISING
By Laurence A. Connors
Vaan pounding running backs for the Chicago Bears or puts and calls
on the floor of the Chicago Board Options Exchange (CBOE), Jon
Najarian plays to win. With operations on every exchange in the U.S., Jon’s mar-
ket making firm, Mercury Trading, is one of the top three option floor-trading
firms in the country, placing Najarian at the top of the options game.
But he’s paid his dues. Jon started as a clerk on the CBOE floor, where he
worked the first six months for free. And during his unpaid apprenticeship, he
found that his quick reflexes and competitive nature were well-suited to the de-
mands of floor trading.
Soon thereafter, Najarian bought a limited CBOE seat and began trading
his own account in the IBM pit. Within a few years “DRJ”—the letters on his
pit badge that would become his well-known nickname—had established himself
as one of the exchange’s biggest players.
Dr. J’s success in the pit led to the founding of Mercury Trading in 1989.
The firm currently makes markets in more than 90 high-tech and biotech stocks
189
190 # MERCURY RISING
ec ne a PR RAR RDN RI A RAO I I IIL SI FEO I LOTTE ELE TD
at the CBOE, trading between 25,000-40,000 options and 3 million shares of

stock per day.
Najarian also provides regular market commentary on radio and television
for such networks as CNNfn and CNBC. When asked how he finds time for
this, Najarian says he wants “to share the experience that I earned by trading mil-
lions of options and billions of shares of stock over the past 19 years. I want to
show traders how to use options to more effectively build their financial futures.”
Laurence Connors: Let's go through your background real quickly. How did
you get into trading options? How did it all start for you?
Jon Najarian: I was playing football for the Chicago Bears, Larry. This was in
1981. I had just graduated college. The Bears looked like the best opportunity
for me because they were one of the worst teams in the league. And I was a free
agent, a linebacker. The Bears starting middle linebacker was holding out on his
contract and ultimately never came back to play football. He was trading over at
the Chicago Mercantile Exchange during the off-season. And he decided that he
was better off physically and financially to stay over there than he was to come
back and play football for the Bears.
So the opportunity presented itself to play football for them. I took it. I’m
sort of like your partner Kevin Haggerty’s sons that play professional hockey, I
guess. But unfortunately my career was only four pre-season games. At the end of
those four pre-season games, I took the opportunity offered to me by my agent
to come down to the floor of the Chicago Board Option Exchange and be a run-
ner. And like many traders before me and since, I took that job for free, for no
pay.
In college, did you have any type of financial background or any type of math
background to give you a head start in your trading career?
No, I didn't. I was planning on majoring in architecture. That was a five-year de-
gree and I didn’t go back to get the fifth year. Instead I got a degree in design,
not an architectural degree. My math skills were decent because you have to
ES ES LT TREE LT ELT ATE EN EN ELS DE TOE SE ET SD

JON NAJARIAN @ 191
AS AAT. A TRS EAE REET EA NON Botw ot SS Sa) Le ee
know a decent amount of math for architecture. But I did not take any business
courses. I never took a single business course in college.
After you became a runner, what happened?

Then I came down to the floor. I was very frustrated because no one was really
teaching the basics of options. There were books like Larry McMillan’s book. But
as good of a guy as Larry McMillan is, it was way over my head and it was writ-
ten more like a textbook. Bottom line: It wasn’t very helpful for me. So most of
what | learned about trading I had to learn by the school of hard knocks.
Listed put options, Larry, had only been trading on the Chicago Board Op-
tion Exchange since 1979, I think. So when I came down in 1981, I’m not even
sure if all the stocks that were trading had put options on them. Call option
trading dominated and the strategies associated with doing what we can do today
with options—you know, play the upside or the downside of the markets with
puts or calls—weren’t nearly as prevalent as they are today. And experienced floor
traders were kind of protecting their turf by not teaching people how these vari-
ous strategies might behave. Because if you discovered it, it was your little king-
dom until somebody else figured it out. As a result, it was very frustrating being
# young trader because there was really nobody to learn from.
It was about six months before I really figured out what was going on—be-
fore I could really start to put it together, to understand that this is why someone
would do this kind of spread . . . and this is why they would do a bearish posi-
tion .. . and this is why they would take advantage of premiums that they per-
ceived were too high. Or when there were too many sellers and the premium
levels got too low and they were way too cheap, why you would be a buyer and
what type of spreads you would do,
Like I said, it easily took me six months before I got to that point. Then I
began trading. I used the money I made from the Bears and I put $19,000, I
think, into a Midwest seat, which was the smaller of two seats. You had to have
one of the two to be a market maker on our floor—the Chicago Board Option
Exchange. I chose the Midwest seat because it was financially more obtainable. |
began trading down on the floor. And because I really worked hard on develop-
192 @ MERCURY RISING
a ane an RO OART LI Si A EE I
ing my spreading techniques, I began to have pretty good success very quickly. I
was always a pretty disciplined person and I began to make money using the
strategies and taking advantage of market conditions that were considerably dif-
ferent than they are today.
What year was this?

It was 1981-1982. And back in those times, Larry, they didn’t let you have com-
puters on board in the pit like you can today. In fact, there were no computers and
they didn’t even have direct phone access in the pits because they thought it was an
unfair advantage. So everybody in the pit would just stand down there, and it was
how fast you could add and subtract fractions . . . and how early you got in that
morning so you could print the sheets with the various theoretical values.
In other words, I was trading IBM, and IBM was about a $98 stock back
then. So I would run IBM theoretical values with the stock price movement be-
tween $94 and $102, 8 points worth, every quarter-point. I’d have sheets and
sheets, telling me what the July 95 calls would be worth; what the theoretical
value of the July 100 calls would be, what the July 102 calls would be worth,
etc. I had sheets that covered a range of prices from $4 above and $4 below the
market.
You can imagine the inefficiencies of that marketplace. But it was good for
me because I was very quick with fractions, and it was good for the other traders
in the pit who were likewise quick with fractions, and bad for people who weren'.
We've moved 180 degrees in the other direction now, because today every-
body in the pits has handheld computers. And in fact, there are people in the pit
with virtually no knowledge of the markets, who are trading based on how their
computers are color-coded to reflect the options’ strikes that they should buy or
sell. So like I say, you don’t need to have nearly the skill-set today that you did
back when I started trading. Not that I’m an exceptionally gifted trader in that
regard—TI think I’m pretty good—but Larry, there were hundreds of traders that
were equally good and very fast about figuring fractions and trading very quickly.
It became apparent that some of the factors that would contribute to you
being a successful trader were things like counting cards in a game of blackjack.
EEL PT IS a ET ES FD TS
JON NAJARIAN @ 193
SL SS RR ENS SDS ANE DOT SSP RRS, SSSA es aw TES
Because that means you can think in multi-dimensions. If you were a profes-
sional chess player or a backgammon player or a poker player, these were skills
that were very beneficial. These skills helped you to remember that 10 minutes
ago a Schwab broker bid an option just below the market . . . or that on the
other side of the pit, two hours ago, the Merrill Lynch broker was trying to sell
puts, but he was trying to sell them at a price that was above the market and the
market makers were not buyers.
Filing all these little facts away in your mind, you could take advantage of
the market when it started to move by reminding the broker, “hey, do you still
have those calls, are you still 3 1/2 bid for those calls?” The broker would say,
“yeah.” And then you'd say, “Sold! I'll sell you 50 of those.” Motioning to the
other side of the pit you might say, “and I'll buy your puts, Merrill. How many
were you offering?” And then the whole pit would get into a big frenzy trying to
do the same things because they would remember, too. But many of them were
distracted or didn’t have the skill-set to remember and do the multi-tasking that
enabled good traders to make money even when they didn’t have computers to
track all these different things. Now you can just basically program your com-
puter to assist you in much of what I just described.
.
Let's jump ahead. You've been talking about the skills needed to succeed
back in the early- and middle-’80s. What skills are needed to succeed today?
How has it changed?
I wouldn't say this is a skill, but it is certainly a determining factor in how suc-
cessful you are going to be. You guys know, Larry, because you use it every day:
Youve got to be disciplined. The single biggest thing that we look for when we
hire traders is their discipline.
Explain what that means.

The kid could have long hair or he could be bald. The kid could be six-
foot-seven or the kid could be five-foot-two. The physical and the mental are im-
portant, but the most important factor is always going to be discipline.
(SERBS CON, Ne TI I TE SE ES
And explain what discipline means to you. What does that mean?
If you're trading your own money, discipline means to trade within your personal
euidelines. This means determining how much money you are willing to risk on
any given trade in your portfolio, and then not violating those rules. Good disci-
pline means not saying, “Well, but it’s a different situation today. I’m going to let
myself go a little crazy.” You know, that’s obviously a recipe for disaster.
So what we've tried to do when we hire new traders is first explain the guide-
lines. If they can’t trade within the guidelines that we set, we wont keep them as a
trader. If I tell a guy, “I want you to buy and sell options in stock all day, but I
want you to be delta neutral.” That is, as you know, “I want you to not be ex-
posed in the market to the stock. if it opens down $3 tomorrow—to losing hun-
dreds of thousands of dollars because you came in massively long. I want you to
trade within delta neutral or within 5,000 shares of neutral on this particular
stock.”
If we have a trader who doesn’t seem to be able to hang within those guide-
lines, we'll cut them loose immediately. And if you're an individual investor, I
think the same rules apply. Perhaps it’s even tougher for the individual investor,
because you don't have a boss. You are your own boss, and you have to set, and
adhere to, your own guidelines.
We think this is vital, Larry, and when we speak at seminars we also tell in-
vestors, “You have to set a goal for your trade.” Whether you are just buying
stock or whether you're putting on an option spread, what was the goal when
you put the trade on? Is it that ’m buying Harmonic because I think Harmonic
could go up to $50 over the next three months and it’s a $25 stock?
The more that you shorten your time horizon, the more you become a
competitor with other daytraders—which include professional traders down on
the floor—and the more you have to know everything we know about the indus-
try events that are going on. Events such as, is there an analyst conference, is
there a new product introduction, is there pending litigation, or is there an ex-
pected earnings report? The more short term you become, the more you have to
care about those factors. The more long term you are, the less you have to care
about it.
JON NAJARIAN @ 195
PL LS TS A ANT A SENESCENT hI yt anne
Yes, it matters if Unisys—as it did today, June 29, 2000—warned about its
profits going forward and the stock falls from 23 down to 15. That matters and
it hurts. But that is an exceptional event that could hurt any trader or any inves-
tor. If you're just trading for the short term, that’s a killer. If you're a long-term
investor, it hurts. But now you regroup and you decide, do I want to still hold
Unisys, or am I getting out? Is it time to exit this thing altogether?
I think the biggest problem investors have is if they don’t set a goal and
then they don’t reassess where they are in that trade on a regular basis. Like I said,
the shorter term you are, the more you have to care about short-term events. For
instance, my traders and I do this every morning: We sit down and we go
through all 90 stocks that we are trading. For Sun Microsystems we ask, “are we
bullish, bearish or indifferent?” For Micron we ask, “are we bullish, bearish, or
indifferent?” Then we ask, “What is our outlook and when are the next big
events on the horizon that we know of?” There are always exceptional events that
we don't know about, but what are the known events that we can plan for, like
earnings and so forth? We do this every day. Most investors don’t have to do this
because they have a longer time horizon than we do. But we care about very
short-term events as daytraders and as professional traders.
ad
Let's say somebody came to you and said, “I want to do this full-time and I'm
funded to do it full-time, and it can go one of two ways. Which way should |
go? Should | be looking at hundreds and hundreds of different stocks, looking
for positions with a mathematical edge? Basically anytime something is, let's
say, two times the H.V. (historic volatility), I'm going to hedge myself and take
advantage of it that way. Or am | better off just focusing on 10 or 15 stocks
and knowing the companies inside and out and knowing their personality and
behavior and learning how to take advantage of those and forgetting about
the math?”
Its the latter strategy, Larry. I don’t think an individual investor can watch 50 or
100 stocks like we do and like many other professional traders do. I think they
would be really over-extending themselves.
SS20 ad MS OD eh a SDR NOE SE ANG UE A AOE EE TEE EE TELLS,
But strictly looking at it from a math edge versus a fundamental knowledge

edge, is the math—
—If you're getting down to a math edge, youre talking about exploiting a very
small edge, because with the advent of computers and other changes, the playing
field has virtually been leveled for everybody. Most of the edge has been taken
away from the professional trader on the floor. The biggest advantage that I still
have, Larry, is that I don’t have the margin issues that the customers have. I can
buy, as we do routinely, $100 million to $200 million worth of stock. And we do
it because I don’t have the same margin requirements that customers do. Because
of that, the individual investor needs to have a little bit longer of a time horizon,
unless they're just lucky and somebody left them a hell of a lot of money.
I think most investors are not going to focus on and try to exploit that
mathematical edge, because that’s really the trading area of the daytrader or the
pit trader. I think what the regular customer wants to do, whether they trade
fundamentally or technically, is look at stocks that they know or industries that
they're familiar with. We see investors doing the best by buying what they know.
Like Peter Lynch always recommends, trade what you know. And I think that’s
good advice for any investor.
So let's jump to some specifics. When it comes to delta neutral trading, what
is your opinion of someone who wants to do this professionally and full-time?
Could he or she succeed at doing delta neutral trading?
Delta neutral trading, of course, is referring to positions that, at the end of that
trading day, are neutral. When the market closes today, I might have long calls in
Microsoft and be bullish, but I’ve sold some stock to neutralize my exposure over-
night. And then the next morning, if the stock opens up $10, I could be very long
in that position making a lot of money, yet I started from the closing point of the
market last night in a neutral stance. I think when investors look at that, they say,
“Well, how can I make any money?” And if you cant trade at least 10 by 20 size,
its very difficult for an individual to invest or to make money. If you're doing IBM
options and youre buying five of the 115 calls and selling 10 of the 120s, it’s very
ERS ESLER SRL TER SS SS LL RIE EES a DS TT ETT

JON NAJARIAN @ 197
SDAA ACR LT ST MRR SEN AE OLN YG ENE EP he ARS
difficult to make money because commissions are a big factor of that trade. And
then you need a fairly big move in that stock to make money. So if the investor is
able to trade 10 by 20, that investor could be a delta neutral trader.
And Larry, you couldn't have imagined a better environment to be delta
neutral in than today’s environment. I mean we're seeing stocks every
day—Unisys, Bristol-Myers, Lucent—big stocks, making extraordinary moves be-
cause the market is willing to either punish severely or reward wonderfully, de-
pending on the news and how the market reacts to the news. I think that there
are few times when being a delta neutral investor and being a back spreader, you
know, buying premium, could have worked better than in this market.
But that is not going to last forever. If somebody is reading this book five
years from now...
You're absolutely right. And it’s why we tell people that you can’t force the trade
that you love just because you always make money as a back spreader. For instance,
you are always buying premium. There are times when it’s a lousy time to buy pre-
mium, in particular, of course, ahead of earnings. As you're going into that earn-
ings event, the volatilities are sky high. The world is anticipating extraordinary
things. And that’s priced into those options. The option that would normally be
an at-the-money option in Micron Technology, one of our stocks, might normally
be $5, but before earnings it might be trading for 8 1/2.
Do you tend to be a seller into events?

I do. But I also like to buy into events if Idon’t think that the market has priced
in enough of the risk that I think is inherent in that announcement.
Are there any guidelines that you can share with us as to what priced-in
means?
Well, for instance, let’s look at a stock like Micron. If the normal volatility for
Micron—let me just pull it up real quick—the May 2000 options were 74 per-
198 MERCURY RISING
LARLY aesPLS ti EA RL RN A ES SIT NSO
cent, April options were 113 percent, March options were 108 percent, and Feb-
ruary was 95 percent. In other words, this is a very volatile stock. You've got a
stock averaging near triple-digit volatility during that time frame. That’s a volatile
stock, and the stock movement of Micron suggests that as well. When you look
at a chart, it moved from $35 up to $95 a share pretty quickly because the semis
were red-hot.
When I’m talking about volatilities, if I said the average volatility for Micron
was 75 percent, around earnings I would expect it to be up 140 percent from there
or 150 percent. If it were only up 125 percent, then I would say maybe there's not
enough premium in those options. I would rather be a buyer, thinking that Mi-
cron could make an extraordinary move after those earnings are announced.
You'd be a buyer of the options.

Yep, I'd be a buyer. I’m usually looking around earnings, unless it’s like the most
stable Commonwealth Edison kind of utility stock. I’m looking for the earnings
and industry events to move the volatilities probably 140 to 150 percent higher
than normal. And if they’re not, then I tend to buy them.
And, Jon, if it moved 200 percent above normal, you'd be looking to be a

seller?
Yes. But I would try to protect myself by buying some disaster puts if I were sell-
ing puts or disaster calls above the market so that I could protect myself and not
just be naked long or short.
So you're hedging yourself no matter what?

Yes, sir.
Are you always hedged?
We are. We're always hedged.

JON NAJARIAN @ 199
SE I I SE I ETT ET AIO BS NII NE
For you, is that the key to success?
I think it is. What we try to do is be in a diverse portfolio of stocks. We're

mainly in high tech and biotech. So we know that if the market is crapping out
from the tech stocks, it’s going to hurt all the stocks in our portfolio. But we'll
probably have long premium positions in a couple of them and short premium
positions in a boatload of them. This is because overall, the market—especially
in 2000 and for most of 1999—has been trading at unusually high volatilities.
But the market has been justifying that by rocking and rolling the way it has.
Can we jump to sentiment indicators? What do you use for sentiment

indicators for the overall market? What are your favorites?
Well, what we use, of course, are the short-term indicators like the S&P 500 and
the Nasdaq futures. But beyond that, we look at the measure of volatility in the
market, the VIX. What we do, Larry, is we look at the VIX and think of volatil-
eity for stocks or indexes like a rubber band. And I think there’s an equilibrium,
for instance, in the VIX. And if I look at it, that equilibrium looks to be about
26 percent. When the volatility jumps and makes a move up into the 30s, you
know, 32, 34, 36 percent, that’s on the very high end of volatility and it’s almost
unsustainable. In my opinion, it’s almost impossible for the market to sustain
that kind of volatility for a broad market like the VIX represents.
Likewise, when it falls down into the low-20s, which it’s done on a few oc-
casions in the last year, then I’m a big buyer of volatility, thinking that it’s going
to snap back toward that 26 number. This is similar to when it’s overvalued and
trading at 35 or 36. Then, it’s going to snap back down. Generally when we see
a high VIX number, we know that the world is panicked and it needs protection.
That’s normally not when the market makes big moves. The market usually
makes its biggest moves when the world is complacent and no one is buying put
options to protect the downsides of their portfolios. And instead, they are just
overwriting call options and hammering premiums.
200 MERCURY RISING
cS yaaa eer er A EE SE I OT TR
Extreme VIX Readings: CBOE Market Volatility Index (VIX), Daily
CBOE Market Volatility Indexair ay 06/28/2000 C=23.58 0=22.19
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Do you believe the VIX is superior to the put-to-call ratio now?

I do, yes.
| very much agree. You know, we're talking and this is the summer of 2000. It
may be an agenda thing, but the options writer for Barron's seems to think
that the VIX doesn't work. Do you have any thoughts on that?
Well, in fact I know the options writer for Barron’, Erin Arvedlund, and she’s a good
lady. And I think she understands the products pretty well. I guess, Larry, different
opinions are what make a market. Some people want to look at put-call ratios.
JON NAJARIAN @ 201
What I do like, as far as another indicator, is block-option trades.
Tell me what that is.
When I'm seeing blocks of options in the 500-to-1,000 option category, that’s in-
dicating to me that a very big player is getting into the market quickly. And if we
think of the market as an animal like a dog, we say, “Well, the tail is wagging the
dog.” This is when somebody enters a big option order rather than going into
the stock itself. For instance, in Sun Micro, Amazon or whatever, they might
come in and buy a huge amount of call options rather than buy the stock. Why?
Because they can get the trade done in pretty damn good size very quickly. If
they were to go to the Nasdaq market makers to buy stock, they are afraid the
market makers would run the stock up. So they might enter through the options.
Next, the options market makers all go for the stock, as they are going to
hedge themselves for the exposure they just took on. And that’s why I say it wags
the dog in some instances. It just depends where somebody enters the market. So
when I see blocks of options trading, to me that indicates that there is some big
institutional player accumulating a position or selling a position, depending on
what it is.
Because you can tell if a 1,000-lot trades at $7 1/2 and the market at that
time was 7 1/4 or 1/2, I know that that big trade was a big option buyer, not a
big option seller. You know what I mean? So chances are the crowd, the market
makers, and specialists were the big sellers. And we are reactionary; we are trad-
ing defensively. The options market makers are not the guys on the offensive.
We're like the catcher in a game of baseball. We have to just respond to what the
pitcher throws. So like when you, Larry, and your readers are initiating trades,
they are the pitcher. They are determining, they're starting the trade. Market
makers are making markets. And we're making markets based on the underlying
security.
When a customer order comes in, whether it’s Goldman Sachs, Charles
Schwab, whatever, when they come into the market, we react to it. So now I’m
trading defensively. Most of our trading is defensive trading and that’s why we,
the traders on the floor, spread so much. We're acting defensively to a big cus-
202 MERCURY RISING
pSEQESDN We cat ot lp ee EN RSS OTT NC IS I NE TE TIED,
tomer who wants to accumulate options or a small customer that wants to accumu-
late options or vice versa. That's why we're defensively trading. And I think that
when you look at these blocks of options, you can tell when a big player is entering
the market and you'll see it ripple through the stock market in the next few minutes.
So basically you might be able to predict short-term price movement of

stocks by looking at these large blocks coming into the options markets?
Absolutely.
And what do you use? You obviously have software to detect these types of
blocks coming in.
Yes, we do. And that’s what we use to provide the content on 1010Wall
Street.com—our online advisory service.
Is it proprietary software or is it...

It is proprietary. It’s stuff we've developed for ourselves to help us track this.
Do you work with Len Yates from OptionVue?

Yes, Lenny is a good guy. And we in fact use OptionVue 5 a lot. I like the way
Len presents the information in the program. I think it’s easy to use. I think it’s
good solid software, it works well, and it’s reasonably priced.
As far as other sentiment indicators, do you look at anything else beyond the
VIX and beyond the block options?
No, not really. I mean I tend to be a bit of a contrarian anyway, Larry. And that’s
why when Motorola had a big disappointment like they did a month ago or a
month-and-a-half ago, I tend to be a buyer on that. Just like today with Unisys. I
didn't buy it today, but I generally buy it on the second day after one of those
events.
(CRESTS BARTSRSYTS TDS SS SESS LE I TT SS ET TSS ES]

JON NAJARIAN @ 203
AE
NRESE A TRE
Were you buying Amazon, for example, a couple of weeks ago when some
analysts seemed to talk it down?
Well, we've been in and out of Amazon so much, I can’t really say for the long
term that we did anything, except that my partner on the trading desk, Tom
Haugh, thinks the stock is going to zero. We did sell a lot of puts into it,
though, on the drop when it got down into the low-30s. Tom still thinks it’s go-
ing to zero.
But you're taking advantage of the price drop?

Yes. Exactly.
Collecting The Panic: Amazon (AMZN), Daily
Amazon.Com
Inc LAST-Daily 06/28/2000 C=37.875 0=35.188
ober | Buys the 40 and 50 puts
tf betel ty
al
iste
Sells puts, locking in profit and "collecting the -
panic” of investors needing protection after
analyst warning on AMZN.

204 MERCURY RISING
ac HRS AN a a ONLI SESOA SE RR EE I IS ETE
And just to reiterate, when you're selling the puts, you are hedging yourself
one way or another just in case your partner is correct?
Yes, we are. Chances are—I mean Tom was long—he had been buying puts be-
fore that $7 or $8 drop (on June 23, 2000). He was buying the 45 and the 50
puts when it was around those levels. And two days later the stock dropped
down there into the low 30s and he was pounding out 35 and 30 puts because
now he is locking in a lot of the profit from the bigger puts and collecting the
panic from the people that needed protection right as the hurricane was hitting.
Going back to money management, you were talking about this before, what
is the firm’s exposure to any given trade? Are you risking 1 percent of what
you have under the roof, or is there a percentage? What risk are you willing
to assume?
We've never actually looked at it that way, Larry. But there are some big trades
that we do when we sort of have a gun to our head, in Sun Micro or in Micron.
This is because these are super competitive crowds where we are competing
against four different exchanges. We might take down a quarter-of-a-million
share position and have to get ourselves hedged very quickly. That's not a fun po-
sition to be in. And I guess if Ithought about it at that moment when we did it,
it might be 10 percent of the firm. But we don’t do that very often.
Like I say, unfortunately in the competitive world that we are in, we're
forced to step up and do much bigger size trades than we'd like to do to keep the
paper trading on our floor, the CBOE. That’s where our main operation is. We
have operations on all the exchanges except the Philly. But Chicago is our home
base. So for most of the trades, we prefer to do them here.
Let's say | was to give you a quarter-million dollars today and you were no
longer allowed to trade on the floor. Now you've got to grow these
quarter-million dollars and support your family with it. What would you do?
How would you trade? Maybe that's not a fair number for starting. But you are
now a retail trader. What would you do today?
| RSS EDSSACES SUR RR TT FL TS TT TI LTE 2ST

JON NAJARIAN @# 205
ST FE PT CETL LE ETE ETRE DDSI EA TERPS LS LY
Investors at seminars always ask, “Could I quit my day job?” And | say, “How
big is your portfolio?” I mean if youre talking about quitting your day job with a
$50,000 portfolio, the question is always “Is that big enough?” And Id say,
“What can you live on?” If youre telling me that youve got only 50-grand to
trade with and you want to trade relatively conservatively, then I'd say, you've got
to be able to survive on a lot less than you're probably making now.
So with a quarter-million dollar portfolio, could you pretty easily make 25
to 40 percent on that? Yes. Not necessarily easily, but you could do it. For in-
stance, you could buy LEAPS. Most of the long-term successful option folks in
our brokerage firm, I'd say, do that day in and day out and they make the most
consistent money. Buying LEAPS as a surrogate for buying stocks. In lieu of buy-
ing Microsoft or Motorola or IBM or any of these stocks, they're buying the
LEAP in that stock. And then they’re overwriting it each month or each quarter,
depending on how aggressive they are with an option, one to one.
The downside is that they've really neutralized a lot of that because they've
bought a $20 leap instead of a $120 stock and they can have a broad portfolio of
stocks. You do the math all the time, too, I’m sure. Look at what would happen if
I owned a leap on IBM at, let’s say, $17 to $25. And every month I sell an
#out-of-the-money call one strike out of the money for 2 1/2 bucks. Two-and-a-half
times 12 is a pretty nice amount of money that I’m taking in against the $25 in-
vestment.
But that, in your opinion, is the best way for the retail trader to succeed at
this game?
Yes. I would say that, yes.
I'm looking at my notes here and we've covered a lot. Are there any parting
thoughts or any advice that you can give to individual traders? Any thoughts
on what you would tell them?
One other thing would be that the individual investor needs a broker that under-
stands options. Otherwise they're wasting their time. And they need to under-
206 MERCURY RISING
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stand that until there are electronic systems—ECNs if you will, for
options—they can’t really do everything online. When they are doing spreading,
they are going to have to deal with a broker somewhere. For instance, often if
you are only dealing with certain discount firms, youre kind of hosed because
that broker can’t give you any advice—basically by mandate of the firm. They're
not going to give you any advice. And if you give them the strategy wrong, they
are going to execute it and just play the tape back to. you. Do you know what I
mean?
Sure.
So you have to deal with an option broker who can help you with the strategies.
And you don’t want to educate your option broker. You want to find a good one.
And when you find a good one, you'll find that they’re very popular, that every-
body wants to be there. And that’s an important factor. You can’t just go onto the
cheapest online Web site and expect you are going to have great success with that
brokerage firm. You are going to have to find a broker that you can call when
you are doing a spread, so you are not just paying the offer and hitting the bid.
You are probably giving up 10 percent of the investment on that and you need
to narrow that a little bit. A good broker should be able to do that.
And the other thing is, just as this book is doing, you need education. Be-
fore you make any trades, we always tell people to do a lot of paper trading. But
before you really want to dive into options, you want to get some education. Not
everybody can afford a $2,000 or a $3,000 seminar. That’s not the issue. How-
ever, you do need to get educated.
Do you have a favorite book?

I’ve got a book coming out this fall.
What's the name?

JON NAJARIAN @ 207
It's How I Trade Options by Jon Najarian. Its going to be published by Wiley in
late 2000.
That sounds exciting. I'm looking forward to seeing it.

I hope so, thank you.
| don't know if you agree, but Natenberg’s book (Option Volatility and Pricing:
Advanced Trading Strategies and Techniques) in my opinion is one of the
best. I've read through it so many times. And even though it doesn't tell you
what to do, he leads you in the right direction.
Oh, absolutely. Sheldon Natenberg’s book helps investors. That’s a good book.
Okay. Again, this is a pleasure.
It’s my pleasure, too, Larry. Thank you.

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GREG KUHN
PASSIONATE PLAYER
By Kevin N. Marder
(52 Kuhn is simply one of the best stock traders I’ve ever met. In running
up consistently superb, long-term results with his hedge fund, Thorough-
bred Partners, LP, Kuhn breaks most of the rules that many investors worship
blindly.
Buying a stock as it makes a price high, religiously nipping losses in the
bud, adding to winning positions, ignoring a stock’s rich valuation, listening to
the market’s message and not the message of others—these are all traits that
Kuhn practices with precision.
Having been greatly influenced by Bill O'Neil, Kuhn is a classic chartist, fo-
cusing on the patterns themselves and eschewing the indicators that can be de-
rived from them. When it comes to general market timing, he relies on the
tried-and-true, namely an analysis of what the big averages and leading issues are
saying.
Interestingly, Kuhn’s methodology is living proof that someone keying on
just chart patterns and earnings growth can reap outsized rewards year after year.
209
210 # PASSIONATE PLAYER
ea mr ASO RO SS EB TI I ETE LDL LDS
Kevin N. Marder: How did you get your start in the trading business? Were
you a broker first, like so many successful traders?
Gregory J. Kuhn: Yes, I started out as a stockbroker in 1985 with Thomson Mc-
Kinnon Securities, which at the time was one of the top 10 firms. I think they
were No. 10. They considered themselves to be the best-kept secret on the Street.
When it turned out that senior management was skimming off the top and the
company was about to go under, Prudential Securities bought them out. This
was after I left. I spent 18 months with them and then jumped over to Shearson
Lehman Brothers, which is now part of Salomon Smith Barney.
From there, I really started getting into the market. Rather than concentrate
on selling, I decided I wanted to get into the trading end of the business. I felt
the best way to do that without any prior experience was to get as close to trad-
ing desks as I could in New York. So I left Shearson Lehman in 1989 and went
to New York and got a job with Wheat First Securities, which is now part of
First Union. None of the firms I was with are known by the same name. They
were all gobbled up by somebody else. The only way I could get close to these
trading desks was to get a job as a broker. That way, I could at least be in the
city, make some money, earn a small living, and then go around and interview
for trading positions.
I was getting pretty close to hooking up with somebody when, in Au-
gust-September 1990, Iraq invaded Kuwait. The market went down the tubes
and everyone put a hiring freeze on. Here I was, ready to make a move to trad-
ing, and no one wanted to hire me. So I came home one day and told my wife
that I was taking a calculated risk and I was going to leave my job and start my
own money management business with the handful of clients I had as a broker.
Up to that point, I had been using Bill O’Neil’s principles to trade stocks
and I was doing very well for some of the clients that I had in the first half of
1990. That was just before the market sold off, and I was actually able to get cli-
ents out of the market at the top. I felt like I could really give this a go with
some of these people since I was actually managing some of these accounts on a
discretionary basis. But I was only being paid a broker’s commission. Although I
wasnt the best salesman, I think the sales experience did help in running my
TE SEs BIRGER SR FR I SEE RSE,

GREG KUHN @ 211
RS a a A a ES A Fi I PN OT IDEIB oS BE SET a ig ee ee
business . . . you know, being able to interact with the public. So I had had
about four years experience as a broker before I started.
As a trader, what would you consider your time frame to be?
The intermediate term. I look to hold a winning position for a few weeks to a
few months. I don't do any short-term trading or daytrading or anything like
that. So when the market is weak, rather than try to squeeze out a couple of ex-
tra dimes by trading the short-term time frame, I move to a 100 percent cash po-
sition, take some time off, walk away, and wait for another market cycle to reset.
Probably one of the toughest things to do is sit there and do nothing unless
there's absolutely something to do. You go through these little spurts where the
market is acting great and you have all these positions on and youre making
money and youre into it day after day. Then all of a sudden, the market corrects,
you get out of your positions, and you end up with a 100 percent cash position,
waiting until the tide turns. I guess it’s hard for a lot of people to kind of turn it
on and turn it off. It just takes a lot of practice.
Were you able to capitalize on the 1991 bull move that began in October 1990?
I was. I did it just by following some of the basic principles that O’Neil laid out,
such as the follow-through day concept, which was very clear off the October
bottom. | also noticed that a number of stocks were setting up by building bases.
The most fascinating thing about it was that I had just gone to the first O'Neil
seminar about six months before that. And at the seminar, they were going over
all the chart patterns . . . and showing the ones that worked . . . and what you
should look for. And coming off that bottom in October and heading into No-
vember-December, I was seeing these cup-with-handle formations. They were
just flowing left and right on great stocks with great earnings. It was a beautiful
thing because stocks were setting up and, as they were in their base-building
mode, you could see that the earnings growth in these companies was still accel-
erating. So it became a very easy decision in narrowing down which ones I
wanted to buy based on seeing this accelerating growth rate. And I would just
212 PASSIONATE PLAYER
(SAN PB LAP A AP SRE TLE END TT a
wait for the patterns to complete before buying them. So I was able to take ad-
vantage of that right into the end of 1990, and of course into 1991.
What are the basic criteria you look for in your buy candidates?
The first thing I do when I screen through a daily or weekly chart book is to
look at the actual chart formations. It’s the first thing I’m looking for because
timing is the most important part of what I do. Everything else can be right, but
ifI ill-time something, it costs me money. When I get into a stock, I want it to
work so that I’m at a profit by the end of the day that I buy it. So ’ll scan thou-
sands of charts a week and I'll just look at the chart formations. I am looking for
specific chart patterns.
Do you look at a company’s fundamentals in addition to its technicals?

Yes. Just as important, I also look at several fundamental things in a company.
Namely, I am looking at a company’s earnings growth and revenue growth. My
initial screening process is on the technical side, simply because each week I want
to be in touch with which groups and which stocks are actually on the move.
But just looking at the chart is only half the picture. The other half, and just as
important, is what’s going on with the company fundamentally. Specifically, |
look at what’s going on in a company’s income statement. I don't care so much
about its balance sheet, because when youre looking to invest in growth stocks,
what's on the balance sheet really doesn’t matter. For example, a company’s book
value has no bearing on my decision-making. However, on the income statement
side, if the stock’s acting well and the company has a superior new product, then
it should show up on the company’s bottom line. I focus on a company’s annual
and quarterly earnings growth. What I really want to see is, at a minimum, 30
percent growth on an annual as well as quarterly basis.
However, some companies don't have a long enough track record of annual
earnings. For instance, some newer companies may have only started earning
money in the last few years. In that case, I’m really deferring to the last few quar-
ters in terms of its earnings. Again, what I want to see is 30 percent earnings
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GREG KUHN @ 213
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growth at a minimum, but preferably a lot higher . . . the higher, the better. Even
better than that, I want to see the earnings growth rate over the last several quar-
ters accelerate.
What about revenues?
I also look at a company’s revenues to make sure they are strong. Again, I am look-
ing for revenue growth of at least 25 percent over the last couple of quarters. |
measure this by comparing one quarter to the same quarter of the prior year.
When it comes to the annual stuff, I’m looking at the earnings growth as opposed
to anything else. Additionally, and sometimes just as important, I look at a com-
pany’s after-tax profit margin to see if it’s improving. Ideally, if a company’s quar-
terly earnings growth is expanding over the last couple or few quarters, you also
want to see the after-tax profit margin increase percentage-wise. This is a very good
measure of how profitable the company’s bottom line is and how efficiently this
bottom line is being managed. On the other hand, when it comes to some of the
newer, more dynamic industries like Internet, telecommunications services, and
biotechnology, a lot of these companies won't have any earnings. So the thing to
do“there is defer strictly to the company’s revenue growth, which is what the fund
managers have been focusing on. What I really want to see with Internet stocks is
revenue growth of at least 100 percent in the last two to four quarters.
What about companies with no growth? Do you still consider them for
purchase?
With the biotechnology stocks, a lot of times the better moves develop as part of
a group move. A lot of these companies not only don’t have any earnings,
but they don’t have any revenue growth, either. As long as the whole group is
moving, the chart patterns are sound, and the stocks have very high rela-
tive-strength rankings, then it would be okay to go with biotechnology stocks
sans looking at the fundamental picture.
In a nutshell, that’s what I look for. I think too many people either get
caught up in the technical side or the fundamental side. With me, I like to have
214 @ PASSIONATE PLAYER
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all these factors in place. It doesn’t mean you can’t use only a chart or only the
fundamentals to make your decision. But I think in order to increase your proba-
bilities of finding a big winner, you really ought to have all these factors in place.
As I said, if you only have the chart, you only have half the equation. The
other part of the equation is the company’s fundamentals. You can trade off chart
patterns, but in order to have the confidence to hold the stock for a bigger move,
the company really has to have a strong bottom line and a great new product
that is ending up on its bottom line. Basically, it’s a total combination. People
wonder why they're not in some great stocks. They only look at the chart pattern
and as soon as a stock gets into a little trouble, if they don’t know what's going
on with the company, they won't have confidence to hold onto the stock.
What do you want to see when you look at chart patterns?
The main thing I want to see on the chart is a base of at least five weeks in dura-
tion. A base is a sideways period of consolidation. Buying a stock just as it
emerges from a base limits my risk, since the top of the base should act as sup-
port for the stock in case ’m wrong.
I’m looking for three different kinds of bases: either a cup-with-handle for-
mation, a flat base, or a double bottom base. If you look at O’Neil’s historical
studies, I think he came up with a number—about 80 percent—that tells you
what percentage of big winners have a cup-with-handle pattern before they start
to move. These are the bases that work over and over again.
Is there any minimum time length that you want to see a cup-with-handle
form in?
Yes. I would say, at a minimum, six weeks for a cup-with-handle. It’s got to take
the appearance of a cup. You can imagine that if it’s only six weeks and
well-formed, the cup’s got to be pretty shallow. Basically, those small ones will
form in sort of an interruption period in a market's trend. You have a nice trend
forming and you get an interruption sort of like we had in January 2000. The
Nasdaq Composite had this 10 percent correction and went sideways for a
EES LS TL TS SS ESET
GREG KUHN @ 215
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Cup-With-Handle Base: Nokia (NOK), Daily
Nokia Corp-Daily 10/284999 C=27.594 +1.328 0=26.525 H=27594 |
Stock makes 95% gain in 10 weeks tram buy point |
Volume 11477600.00
Created with SuperCharts by Omega Research©1997
month before it swung out of there again. And that’s where you'll see a shallower
or smaller cup-with-handle form. The stock will form the pattern and go up out
of that. Normally, the cup-with-handle is much deeper and longer.
And as far as the flat base goes, are you also looking at only six-week
bases?
A flat base can be as short as five weeks. A lot of times you see a flat base after a
breakout from a bigger chart formation. For example, you see a stock come out of
a four-month, cup-with-handle formation. What happens is that it will break out
of the handle and, for some reason, the market's still in somewhat of a corrective
Flat Base: JDS Uniphase (JDSU), Daily
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period or a bear market. And the stock will just move sideways in a tight pattern
for five weeks before it swings out of there again. That's often when you see a flat
base. Basically, what it does is give you another shot to get on board. Once the
weight of the market comes off, then the stock’s ready to go. So that’s why they
can be a little short. All other bases should be at least six weeks in duration.
And the third pattern you like is the double bottom?

Yes. The double bottom is a rare cup-with-handle. The main difference is the
look of it. In the cup-with-handle, you have more of a rounding bottom, whereas
in the double bottom you get this sharp rally back toward the old high and back
(SERRA FIO UIEaa At Nace i DR SR ES SAR RRL SSSI SRLSTG POD. NLR TED SDE SY SE ASU TI
GREG KUHN @ 217
Re a a RID RRR SS es RR RR RRR ERRATA RS ETE
down toward the low. In a cup-with-handle, the stock will get increasingly quiet
and spend more of its base-building time down around its lows so it will give
you the appearance of a nice cup. The double bottom will look more like a “W”
and have more of a jaggedness to it around the bottom. It won't spend a lot of
time down there. It will sell off, rally up, sell off again. Some of the better ones
have a sort of shakeout move, where the second low will go below the first low
but will only spend a couple days down there and shoot right back up. And then
on the double bottom, instead of waiting for the breakout of the handle to buy,
you can use the midpoint of the “W” as your buy point. But more often than
not, I do see double bottoms form a handle. They will come through the mid-
point of the “W” and back to the old high and you'll still get a little, one-week
pivot area after a handle forms. And if you use your imagination, it almost looks
like a cup-with-handle.
So you're really a pattern player as opposed to an indicator player?

Right. I don’t like to refer to it as technical analysis. It’s really just chart analy-
sis—analyzing supply and demand pressures.
oo
What do you look at on a chart, then? Obviously the price bars and the
volume bars . . . but what else do you want to see there?
Moving averages are important. First of all, I always want to see a prior up trend
before a pattern forms. This will tell you that the stock is already being accumu-
lated. There is interest in the stock and, let’s face it, a stock is only going to
make a big move if we can get the institutional community to jump on board.
But in addition to price-and-volume action, a stock’s got to be above its 200-day
moving average. The breakout point’s got to be above the stock’s 50-day moving
average and, in most all cases, above its 21-day moving average. What will hap-
pen is that, as a stock builds its base and moves back to its old high—which is
often its breakout point—it will automatically be above all of these moving aver-
ages. In the base, I like to see the 50-day moving average or, even more impor-
tant, the 21-day moving average, turning up before the stock starts breaking
218 # PASSIONATE PLAYER
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through a pivot area. . . before it’s really buyable. If the moving averages haven't
turned up at that point, that’s a good tip-off that the base isn’t quite complete.
Sometimes it can get a little tricky when you're looking at a handle. For in-
stance, it might appear to be a handle, but then the stock tries to break out, the
breakout fails, the stock immediately falls back, and it then forms a second handle.
In hindsight, this ends up being the “real handle.” So I usually see moving averages
as a helpful tip-off as to whether the stock is really ready to take off at that point.
Is there anything else that you'd like to see on a chart besides moving
averages, price, and volume?
GREG KUHN # 219
DS Ra 2 PS RETR TEED BGS NET SVK Wat ASST) CoA RR See
No, that’s it. Am I missing something? Were you leading me to something?
What about the relative strength line?

I guess I should be looking at a chart as I’m talking about this (chuckles). Yes, the
relative strength line is definitely important. This is an indicator that measures
how a stock has performed versus an index, such as the S&P 500. It’s plotted on
the chart as a line. An upward-sloping line corresponds with a stock that has out-
performed the index, i.e. the market, and a downward-sloping line relates to an
underperforming stock. As the stock breaks out, I want to see the RS line either
confirm or lead the stock into new high ground. It doesn’t always have to lead
the stock to a new high; in fact, most times it will not. If it does, it’s an added
plus. At the least, I want to see that RS line up near its old high. Once I’ve taken
a position in it, and I look at the chart that night after it breaks out successfully,
I want to see that it’s confirming the move into new highs.
As far as volume goes, what are you looking for in a buy candidate?
Iffyou have a cup-shaped base or double bottom base, you want to see volume
dry up for several days around the lows of the formation. But as the right side of
that cup is being formed, you want to see volume increase. Then, as the base’s
handle forms, you want to see volume dry up again. When it breaks out, you
want to see volume on the breakout day increase by at least 40 percent above its
recent average. In fact, if you look at all big-winning stocks, the weekly volume
should have increased over the prior week. The weekly volume is another thing I
watch at the end of each week. If it’s lower than for the prior week, it may not
be the strongest situation. Almost all of these big-winning stocks have bigger vol-
ume on the breakout week. But of course you have to wait until the end of the
week to determine that. That helps me to determine at the end of the week if
this thing has a chance of really succeeding or whether it might fail. That alone,
however, would not necessarily get me to sell it.
One other thing: I also look at a stock’s relative strength rank. If a stock has
a relative strength rank below the 80 percentile, I won't even consider it regard-
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less of the pattern. There is one exception: if it was a new issue within, let's say,
the last six months. The RS rank would be skewed by that because it’s a
12-month measure of price performance. Most of the weight is put on the last
three months, yet it still has a 12-month weighting. Most of the stocks I buy
have a relative strength of 90 or above. So that’s another good way of narrowing
down your selection process. A lower RS rank tells me that the stock hasn't led
the market long enough to increase my probabilities of jumping on a stock that
will continue to lead. If the RS rank is higher, it suggests that a stock has been
leading the majority of stocks in the market. That just increases the odds that it
will continue to do so in the future.
Speaking of selling, what are your general parameters for telling you when to
get out of a stock?
Interestingly, I have more sell rules than buy rules. When I first started out, I de-
veloped a checklist of sell rules. Each night I would go through and determine if
any of the sell rules were triggered. If they weren't, then I stuck with the stock.
Most of them incorporate the action between the stock’s price movement and the
volume because a lot of what I’m looking for here is the supply/demand equa-
tion. So I use this checklist, essentially making a stock jump through all of these
hoops at the end of the day. And if it could do that, then I thought I had a good
situation on my hands. But as soon as one of the sell rules would be triggered, I
wouldnt’ necessarily sell it; Id wait for further confirmation. If a combination of
sell rules was triggered, then I would know that this was a stock to get out of.
Could you share a few of those sell rules with us?
Yeah. One of the rules has to do with distribution. For example, let’s say you
have a stock that’s about 70 percent extended from its most recent base breakout,
and the volume had been good up to that point. All of a sudden you'll see ex-
tremely heavy volume on one day, perhaps even the heaviest volume day since
the advance began. After being up significantly during the day, the stock will ei-
ther close up slightly, stall out and close unchanged, or actually reverse and close
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GREG KUHN @ 221
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down, but on heavy volume. That churning action and distribution is what you
normally see as the stock is running out of steam at that point. However, that
doesn’t always have to mark the exact top of the run.
Let's say the stock goes up 100 percent. As long as I capture three-quarters
of that move, my work is done. And that’s what these sell rules are designed to
do: to keep you in the majority of the advance since no one is going to get out at
the exact top. In fact, it’s a lot easier to get out on the way up when there’s still
some buyers interested in the stock. As it is, they’re waiting for the thing to break
down. In a situation in which I don't get some of these signals on the way
up—like a distribution signal—I also have rules that tell me to get out if the
thing starts to break down. Sometimes I won't always get those rules on the way
up, so I end up having to sell on the way down. One of these would be if a stock
breaks down, for example, on a 300 percent increase in volume over average daily
volume. Another would be if a stock breaks a 50-day moving average on a 200
percent increase in volume. Things like that would get me out of the stock.
Without any questions, I would just bail.
Any other basic pointers?

The main thing in deciding whether to hold a stock or sell it is the price-and-vol-
ume action. This is my first line of defense. Ideally, what you want to be able to
do is take the volume histogram at the bottom of the chart and shove it up under-
neath the price chart. It should fit like a puzzle. Up days should occur on up vol-
ume, pullback days should occur on declining volume. If you can see that trend
persist, ignore everything else at that point. That is the ideal situation, and is tell-
ing you the stock is still being accumulated. Although it’s not always there, occa-
sionally I do get a stock in which I stay for the whole move based solely on
following that analysis. Eventually, the stock goes into some kind of climactic ad-
vance. Let’s say it takes two months for a stock to go up 70 percent. Then all of a
sudden it goes straight up and the balance of the move is another 25 or 30 percent
in three days. That would be climactic. And sometimes right at the final end of
the move it will gap up in price. It will close higher, but there will be a nice gap
there on the last up bar. And you want to sell right into that.
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In another situation, a stock has favorable price-and-volume action. You don’t

get any distribution at the top and you don’t get low volume at the top. In fact
that day, that gap day, may even occur on one of the biggest volume days since the
advance began. That’s where big volume would be a negative, because that would
be a sign of climactic action. Now, with that said, it would only be a short-term
negative because sometimes there’s still very good volume up at that level. The
stock may still build another base, and longer-term it may still be okay. But I dont
want to sit through the correction. I want to take my profit and wait for the base
to rebuild and get back on if it’s going to go again.
So you don't often sit through a correction in a stock, hoping to play the thing
out for a bigger gain?
Not if Iwant to get paid on a regular basis. Once it looks like the move is over, I
personally do not like to sit and try to hold out for anything bigger. I'll get off
board. I know that if the thing is going to go again, it’s got to build a whole new
base—so I can get a chance to take a breather, step back, and repurchase the po-
sition. There’s no reason why I need to hold onto the whole thing hoping that
the thing actually hangs in there. I’m just not that good. I'd rather get off board
and let the market tell me where to get refocused for the next advance. I do this
by watching which stocks hold up during a corrective period.
As an example, a stock has a nice run-up of 50 percent or so coming out of a

base, and you get on board. Would you be tempted to sell the stock if it drops
20 percent off its peak when it eventually corrects?
I'd usually be out, yes. If other leaders are breaking down, you can start feeling
that something is amiss. At that point, youre also likely to see signs of distribu-
tion in the big averages begin to develop. This is characterized by a down day in
price on increased volume from the day before. That's a sign that the market is
running out of steam. So I will start selling when the thing looks like it's coming
off a little too much. Another rule, which I don't see often, involves a stock peak-
GREG KUHN @ 223
he
ing after an extended advance. A stock will experience its largest down day since
the advance began. That might be on big volume or light volume.
So most of the time you're going to be out before the stock drops 20 percent
off its peak?
Sometimes I follow these rules and I’m out a little earlier. That’s fine with me. |
mean I can drive myself to the nuthouse trying to sell every stock at the top tick,
which is impossible.
You know the saying: The only people that buy the bottom tick and sell the
top tick are liars.
One thing that I do after a stock breaks out is to hold through short-term correc-
tive periods. After a stock breaks out, you have to be willing to sit through the
stock’s first pullback and that can be a little painful. That’s because, if you think
about it, initially you’re up maybe 20 to 30 percent. And on that first pullback,
maybe you've given back half of that as the stock corrects. You worked so hard,
you did all your work, the thing breaks out, runs up, and there’s this nice gain.
Without having a set of rules, your initial thought may be, “Ah, I’m going to nail
this down. I’m going to take it.” But ultimately that might be the biggest winner
in your portfolio. So selling at that point may be selling it too soon. The stock’s
up that much and then it retraces 50 percent of the breakout move. Now youre
only up 12 percent on the stock, let’s say. You've got to be willing to hold
through that. I'll sit through that as the stock tries to regenerate for another
thrust higher. But once it’s made a tremendous move of 60 to 100 percent or
more, if it’s giving me some of these signals, I’m not going to stick around.
As far as money management goes, what percentage of your portfolio will

you allocate to one position?
Six percent.
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Will you start off with a 6 percent position or do you like to build into that?
I like to build into it. I prefer to put that 6 percent position on by the time the
stock’s broken out. I’ve already followed that stock up and I may have looked at
it for three weeks as the base is being built. I think its important to see how a
stock trades before I even buy it. I mean that’s not always possible, but each
stock has its own little character. I like to watch the bid-ask spread and see how
liquid it is and see how it’s trading. So I watch all this stuff as the base is being
completed. For example, let’s say it’s a stock in a cup-with-handle formation. I
know where I’m at in the market, the market's acting fine, the stock is a high
RS stock, and it’s in one of the leading groups. I’ll look to see if the stock pulls
back to form the handle. If it does, and if volume is light as it starts to turn up
on the right side of the handle, I'll start buying it right there to build my posi-
tion even before it breaks out. I may do that in thirds. By the time it breaks
out, if I had to buy a 25,000 share position, the last third is being put on in
the breakout as opposed to trying to buy 25,000 shares on the breakout, which
is not an easy task.
This brings me to another point. One of the things I am also looking at in
buy candidates is which industry group the stock is in. The stock’s got to be a
leading member of one of the leading groups, in most cases. I’m looking for
those companies with superior product lines that are leading their particular
group, a group which at that point in time happens to be where institutional in-
vestor interest is. Interestingly, just by looking at the charts, you automatically
end up in the right groups. They will take you to the right groups.
Do you use leverage much?

I do not.
Why?
I've spent many years building my money management business. I’ve been en-
trusted with the money from many people and I don’t want to take the risk of
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GREG KUHN @ 225
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using leverage even at times when I feel like I should really be slamming it. One
of my theories was that if I used leverage and I doubled the return that I had, it
would be very difficult to build a money management business. It would be hard
for me to decipher between a client who is a legitimate client versus someone
who is looking for a hot money manager. If you end up getting a client who is
looking for a hot money manager, as soon as you have a rough patch in the mar-
ket they're gone. They leave. And that whole process is very disruptive to run-
ning money. So it’s much easier to manage money and build the size of the fund
more with the turtle approach than with the hare approach. Everyone is happier
and it keeps the gains more consistent and the volatility down.
Do you pyramid up into your winners? In other words, do you add on to a

winner as the stock moves up?
No. Its a tricky thing to do. Again, it’s more prudent when youre running
money for other people to have your risk spread out somewhat. So I prefer to
keep my positions even all the way up. In some cases I will double up on a stock,
but I won't get it to a point where I have all the money pyramided into a narrow
list of names. Of course that will cut down on the returns, but it’s just easier to
deal with. Keeping the volatility down makes my job a lot easier when I’m man-
aging money for other people.
What sentiment indicators do you look at?
I look at the CBOE put/call ratio, usually just the total ratio. That can be a
tricky thing, but it essentially ends up being better than a lot of sentiment gauges
out there because a lot of them measure attitude as opposed to what people are
really doing with their money. The drawback to the put/call numbers is that,
over time, the levels of optimism and pessimism—the levels at which you see
turning points in the markets—change. And what was once considered a level of
extreme optimism six years ago isn't anymore.
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Any other sentiment indicators besides the put/call ratio?

No. In fact as time has gone on, I’ve used that less and less and tried to focus on
reading the market. I’ve gotten better over time. It’s just that the sentiment num-
bers look like a real easy thing to use. As human beings, we migrate to the easiest
thing. The hardest thing is to figure out how to read the market, how to look for
signs of accumulation and distribution. With a lot of practice I was able to do it.
It took years to get comfortable with that way of looking at the market. It hap-
pened because I had a passion for what I was doing and I wanted to figure out
the best way to make money in the market with the least amount of risk. I gath-
ered this was a way to do it, just by reading the market. So now I don’t look at
those numbers as much as I used to because they can be misleading. One of the
ways they can be misleading is that sometimes if a trend persists, attitudes or ac-
tion in the market can persist for that entire period of time.
What do you mean by that?
For example, if an up trend has persisted for months, you may see the put/call
ratio stay at a very high level of optimism for, say, the last six, seven weeks of the
move. Then you get to a point where the crowd is right . . . I mean there are
spots where the crowd is right for a time, so there is just no reason to get hung
up on it. Eventually the market will peak and the best way to determine exactly
when it’s going to happen is by looking for signs in the market itself.
So it really sounds like you place much more emphasis on what the market
is doing, as opposed to other indicators, whether they be sentiment
indicators or—
—I would say at this point I put all my emphasis on that. Some of the other
things are great peripherally and they kind of give me an early warning. For ex-
ample, if Isaw a lot of optimism in the market, I would be in more of a height-
ened awareness state looking for distribution signs in the market itself.
GREG KUHN @ 227
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Yet ultimately you are going to ignore what the sentiment indicators say if the
general market is doing something different.
Yes... hands down.
The one topic we have not covered has been general market direction. Can
you tell us exactly what you look at?
Every major bottom that has led to either an intermediate-term advance or a

new bull market has been accompanied by good price follow-through in the in-
dices within days of a low. That’s referred to as an O’Neil follow-through day
and that’s when one or more major indices advances by at least 1 percent on in-
creased volume from the prior day. The follow-through day should occur
within four to 10 days of the exact closing low. The most potent signals usually
occur between the fourth and seventh day off the lowest close. Anything out-
side of that has a higher failure rate. You can get a follow-through day 13, 14,
or 15 days after the exact closing low of a down trend, but these are more fail-
aire-prone. The follow-through day indicates that the sellers are out of the way.
Selling pressure is gone. When an index advances by more than 1| percent on
increased volume that soon after a closing low, it indicates that all of that sell-
ing pressure has been alleviated—fresh buyers are going to carry the market
higher.
So once | get that signal, [’ll immediately start buying stocks that are
ready to break out. Sometimes that signal will be accompanied by no stocks
ready to break out, some stocks ready to break out, or maybe a lot of stocks
ready to break out. Basically, once you get that signal, you want to let the mar-
ket bring you back in from the cash position that you should have built up
during the prior down trend. There’s no reason to get 100 percent invested on
that follow-through day. Let the stocks confirm it for you. On occasion, one of
these signals will actually fail. The beauty of it is that the market will fail
within a few days of the failed signal in most cases. So you'll never be in this
position where you've gotten over-invested based on this one-day signal.
SAS ST a A TRA IR I AG I A I A AP NOE IIT TELE ELG IEE LEIELEI TE
How likely is it that one of these follow-through day signals will fail?
According to O’Neil, they confirm an intermediate-term bottom about 80 per-
cent of the time.
And what do you look at as an indication of a top?

On the top side, you're looking for distribution in one or more of the big aver-
ages, which is characterized by an unchanged or down close on increased volume
from the day before. The main selling will occur on the way up or right around
the area which ultimately ends up being the peak. And that’s sometimes why you
initially see light volume on the way down from the peak. If you're waiting for
the market to be down 15 percent before you sell, it’s just way too late. You'll get
anywhere from three to five of these distribution days within a two- to
three-week period after the market’s already topped. You'll also see some leaders
that have made extensive moves start to break down on hard volume, and recent
breakouts begin to fail. If all that’s clustered together in a very short period of
time, that’s your signal to be totally out of the market.
We discussed the general market at a bottom and the general market at a top,
right? Did we discuss leading stocks at a top?
At an important, intermediate-term top in the market, youll not only get distri-
bution signals in the indices themselves, but the leaders will start to break down
simultaneously . . . recent breakouts will fail.
Your enthusiasm for what you do is quite rabid.

Well, it’s very gratifying to figure out a strategy and see it through to fruition.
I've just had to pour my whole life into building my money management busi-
ness over the last 10 years. Because I’ve done that, I’ve sacrificed a lot of other
things. I’ve given up other opportunities. I don’t golf because I haven't had time
to really get into it. So when you stop, and you have some spare time, youd
better have some other hobbies that you can be involved with, whether it be do-
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GREG KUHN @ 229
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ing yard work, or gardening, or whatever. Because otherwise you'll have this
temptation to always be involved in something and you really don’t have to. It’s
just a whole balancing act.
As a money manager, it’s very gratifying to have people investigate what |
do and go through this whole due diligence process on their own. I have clients
from all over the country. Then they finally make this decision to put their faith
and trust in me and send me money. To be able to come through for them, to
make them money consistently and let them know through this that they made
the right decision . . . it’s just so gratifying for me. To actually have someone
make this big decision to send me their money and to be able to actually come
through for them is very meaningful for me.
It's just amazing to me to look back over the last 12 years, see where I’ve
come from, and see the success I’ve actually developed in the business that I’ve
built. I turned a goose egg into a thriving, little business. There’s no magic pill.
You look at people who are successful in life and you think, boy, it would be
great to be that successful. Gee, I wonder what that person’s motivation was?
Well, the motivation for a lot of successful people, in almost all cases, is not
money. It’s that they had a passion for what they were doing and the money was
ust a by-product of that success.
What would you recommend to aspiring traders?

The only thing I can recommend to aspiring traders is simply this: Understand
that there is no magic pill, other than hard work and perseverance. As much of a
cliché as that may sound, it’s simply the truth. One of the most important things
in trading the markets is finding that critical balance between a good level of
confidence in your trading and a real sense of perpetual humility.
Thanks very much, Greg.

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DAVID KUANG
THE COMEBACK KID

By Kevin N. Marder
t takes most traders at least several years to become successful—let alone be-
|bese a top trader.
Not so with David Kuang.
Despite a calamitous start that included a $20,000 loss in his first nine days
as well as his boss’s comment that he was “redefining the definition of bad luck,”
Kuang skyrocketed up the learning curve.
In only his second full year of daytrading, Kuang earned $1.8 million. In
each of the next two years, he duplicated this seven-figure feat despite trading for
only a fraction of each year.
To put Kuang’s success into perspective, for the 6 1/2-month period ended
July 15, 2000, golf great Tiger Woods had earned $4.9 million, or more than
double the amount of his closest competitor on the PGA tour. By comparison,
Kuang had pocketed $6.5 million!
Interestingly, some daytraders would consider Kuang’s strategy, which fo-
cuses on stocks experiencing extraordinary movement, to be steeped in risk.
Kuang, on the other hand, believes his odds of success to be high.
231
232 THE COMEBACK KID
Sy 2 GL TSE A A A ES I TE
Kevin N. Marder: How did you first become interested in the stock market,
David?
David Kuang: When I was growing up in Europe, we used to look at a lot of

newspapers. One of them was the International Herald Tribune, which my father
used to show me every day. And then at MIT, I was able to pursue finance stud-
ies at the Sloan School. I got to do some undergraduate research in expert trad-
ing systems and technical analysis. The interest has always been there.
Did you actually start trading while you were in college?

No. I didn’t have a lot of money and I was more interested in other pursuits at the
time. I think it was something that I was interested in, but not something that I
was throwing myself into during my college years.
What happened when you got out of college? Did you get a job in the
investments field?
I had a couple of job offers. They were slightly different. One was an opportunity
to trade options and the other involved securities litigation, securities litigation be-
ing when shareholders sue companies for sudden stock price drops. The securities
litigation job was more of a consulting/analyst position. I thought that would be
more interesting because it would allow me to go to either law school or business
school. And if I was still interested in trading, I could go into trading.
So I decided to pursue securities litigation, which I did for a year and a half.
Then, after working for many long hours, I decided I really wanted to trade, pri-
marily because of the instant gratification, the meritocracy, and basically the fact
that you can be your own boss. So that was how the first couple of years evolved
following my graduation.
What was your major at MIT?
Originally, I went in as a chemical engineering major. After not doing so well at

engineering, I pursued finance. My undergraduate degree is a management de-
DAVID KUANG @ 233
gree, but I particularly focused on finance courses . . . a lot of stats, a lot of

probability, a lot of math.
After your 18-month stint at the securities litigation job, where was your next
stop?
I really wanted to leave that job quite badly. So I was willing to take almost any
job possible in New York City. I had a friend at Smith Barney who mentioned a
company called Datek. Back then, they weren't a brokerage. They were purely a
daytrading operation. I didn’t know anything about them.
They waived the first interview since I had flown myself out for the meet-
ing, which showed them I was serious and interested in the position. And then
the so-called second interview consisted of one 15-minute meeting. The head of
the firm liked my watch and actually tried to buy it from me before he offered
me the job. So that was pretty simple.
And what was that job all about?
[gaytrading . . . purely SOES (the Nasdaq's Small Order Execution System). You
had to take the Series 7, 63, and 24 exams and you started trading as a registered
representative.
Were you trading the firm’s proprietary account?

Yes. This was back in December 1996.
Back in the days when they used to refer to these types of trading rooms as
SOES rooms.
Yeah. SOES rooms... SOES bandits.
Right.
234 @ THE COMEBACK KID
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Within three days they sat you down, gave you a computer and a million-dollar
account, and you started trading.
Did you have to put up any money of your own to get started?
No.
With just a couple of days to work with, the training they gave you must have
been pretty minimal.
It was.
Back in 1996, because it was the seminal days of what | call the New Era of
Daytrading, the market was a lot less efficient. You could really benefit from
looking at Level Il changes. Is that the way your initial strategy came about,
or was there something else you started focusing on back then?
I think, back then, liquidity was a little worse because only market makers could
participate. As a result, momentum was a little bit easier. Back then, we were able
to actually do SOES momentum very clearly. I think now, with the introduction
of ECNs, plus a lot more liquidity, plus a lot more participants in the market-
place, momentum still exists. However, there’s a lot of noise. Small buyers and
small sellers will come in and momentarily cloud the market on the Level II.
So I think youre right, Kevin, back then Level II was a lot easier to interpret.
However, as for how you use that, it’s changed now. People are making more
money now than three or four years ago. That's because there’s more liquidity now.
We're able to take larger size with less risk.
When you refer to SOES momentum, what are you referring to?
Three or four years ago, the primary strategy people used to make money—and
they still do today—was to find a stock moving upward with strong bids. We
would buy stock at the offer on SOES. As the offers were lifting, we would sell
our stock at the offer price back to the market makers on SelectNet.
DAVID KUANG @ 235
SL ARREARS
You were at Datek for a couple of years?

I was an employee, a registered rep, for nine months, after which I had made
enough money where I was given the option to become a customer . . . a cus-
tomer basically being someone who traded their own account through Datek’s
technology and paid Datek commissions.
So you began doing that, then?
Right.
Did you have success in the beginning?
Ah! (Laughs). | have some great stories. My trainer, my mentor whom they as-
signed me to, was not so good, not very conservative. My first day I wrote
87,000 shares and within my first nine days I had lost $20,000. It was a really
tough time. The head of the firm once came over and said “David, you are rede-
fining the definition of bad luck.” I remember one time I came in on a Tuesday
and I had 1,000 shares ofa stock down 12 points on bad earnings.
a
Wow.
Then the very next day I went home with 2,000 shares of an airline company
that was very strong. And their plane crashed that night.
Sheeez.
So, you know, things were really rough. It took me about three months to really
get on my feet and begin to consistently make money every day. After six
months, I had broken even. After nine months, I had made a lot of money.
So in the beginning, they had said it was okay to take home positions
overnight?
236 # THE COMEBACK KID
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Back then there used to be a lot of position-taking overnight. I think one of the
reasons was because of the lack of liquidity.
And from there, you traded your own Datek account through that same trading
room?
Yes. I was a customer at Datek for about six months. And then I left Datek and
came to what is now known as Tradescape, or Momentum Securities. Momen-
tum Securities is the brokerage arm of Tradescape.
| remember that in those seminal days back in 1996, you had to trade from a
SOES trading room, since you couldn't trade from home and get instant
executions. Nowadays, in 2000, you can trade from home just about as easily
as at one of the trading rooms. Obviously you see some sort of advantage in
trading among other traders versus doing it at home alone.
Actually I’ve done both. I was out in L.A. for a year, trading from home. The
real difference is the ability to take large size with a comfort level. Regardless of
your connection, any investor could take a couple hundred shares or a thousand
shares of a position and not have to worry about too much slippage or a
slow-speed connection that’s really going to cost them a lot of money. In March
and April 2000, we were taking 30,000-, 40,000-, 50,000-share positions in
stocks . . . $5 million to $10 million worth of stock intraday.
Basically, the issue came down to making sure we have the best execution
with the best tech support. Since we trade a half million shares a day, even if it’s 10
milliseconds faster, that adds up to a couple thousand dollars a day if we're not
careful. So the reason why I came back after taking a year off was to pick up my
trading again and really make sure I had the best technology. It’s really a comfort
level issue. I think you can trade from home with a high degree of success. It’s just
that if you want to take it to the next level of success, it’s important, for me at
least, to have a comfort level with tech support and technology.
What's the typical size of your order?
ERLE TTS TRILL LAE TNE LE NR EE BD PSE A TE A LS FT TE RE TTT SEED

DAVID KUANG @ 237
LAS A I RE I i eae SE OR NP,
The minimum is 1,000 shares . . . sometimes 500 shares if you're just trying to
get a feel for a stock. And then, as your position size builds, the minimum size
obviously increases. So you might have 1,000-share orders going in up to maybe
a 10,000-share position, at which point you might increase it by 2,000 or 3,000.
It really depends on your stock and the amount of liquidity and the situation.
| take it that you do add on to your winners as they rise.
Actually, I almost never add on to my winners, only in certain situations. But I do

not believe in rot-and-hold. I'll say that right now. I believe in being patient and
waiting for very good opportunities. Basically, I could spend 90 percent of the day
just watching the market. But within the other 10 percent of the day, there’s usu-
ally a couple of really good opportunities where you could buy a large amount of
stock within a short price range within a short amount of time at a very good
price.
And that’s what we use the technology for. We'll be patient and wait. We
wont just average down into a position. We'll specifically try and identify a turn-
ing point or a buying opportunity which maybe will last 20 seconds. We'll buy
as much stock as possible, and as the stock goes up we will then kick out shares.
al hat’s how I trade.
So you're operating with another one or two traders as a team, then?
Yeah, I have a trading desk. I primarily work with one other trader.
Once you identify the opportunity, are the two of you just trying to buy as
much in 1,000-share lots as you can?
He has a totally different style of trading and that’s why I work with him. He
gives me a different point of view. I usually try and buy as much as I can be-
cause I usually have enough capital where I can buy all the stock that’s out
there. At Tradescape, or at this firm at least, most of the good traders do not sit
together. Very bad results can occur from having very big traders sit next to
each other.
CAE RS cm aN TO STI SC
Let's get back to the speed of your connection for a second. One reason that
you like being over at Tradescape is that you've got the tech support there. So
when something goes wrong, you can just raise your hand and someone will
come right over to your workstation. The other thing is that the connections
are just a teeny bit faster.
Typically, if you trade from home, unless you have a direct connection like with a
T-1 line, a lot of places go through the Internet. And with the Internet, you lose
maybe 20 or 40 milliseconds on the data transfer.
In terms of your overall strategy, what are your buy criteria?
It’s pretty simple, actually. I look for inefficient situations, places where stocks are
overbought or oversold based on order imbalances or panic or sentiment or mar-
ket conditions. I do not try and play news. That’s the biggest criterion. I dont
think that I’m the smartest person in the world and I’m not going to compete
with these institutions that are selling stocks on earnings or buying stocks on
earnings. I’m looking purely for situations where maybe a retail order has come
in and is driving a stock down.
Herzog is an example of a market maker who does a lot of retail. If Herzog
is selling, selling, selling, driving a stock down in the morning because he has a
morning order to sell, and I can identify on Level II that he’s close to finishing
his selling, I will begin to accumulate stock. The odds are very high that as soon
as Herzog is done with that retail order, the stock’s going to go back up.
Do you use any sort of overbought/oversold oscillator to help you in that, or is

the information all gleaned from Level II?
Mostly from Level II. I look at tick charts and I try to identify rapid price move-
ment. That’s my key criterion. I need to see rapid price movement. Basically, this
is a price move that, if it were to continue for a couple of hours, the stock would
go to zero. That’s an example of an unsustainable price move.
Common logic would say that if you see a stock drop that fast and the
move was to continue, in a couple of hours it would be at zero. It’s not sustain-
ERDAS INSSEN A AT ETRAL RE I EG

DAVID KUANG @# 239
aS REPENS BE A SE, RE EERE ASRD ECC HG AMOR
able. So there has to be something: either there's news, it’s going to stop and
turn, it's going to continue going down . . . something’s going to happen. That’s
what I think special daytraders look for . . . situations where they know some-
thing is going to happen. Once you identify that, there’s profit potential.
Does that sort of setup occur with nearly 100 percent of your trades, or do you
have other types of setups that you're trying to find as well?
No, there’s a lot of other types of setups. You can play the multi-day play, look
for momentum in the morning, shorts in the morning. There’s a wide variety.
But I would say 90 percent of the high-profit trades that I do are those situa-
tions .. . looking for overbought or oversold situations.
Do you use five-minute bar charts to determine that sort of extraordinary

movement?
We currently have one-minute charts. But if you can get hold of tick charts,
those are great.
7.
Which do you prefer, tick charts or one-minute charts?

I really like the tick. That’s the great thing about being in the office—we can ac-
cess tick charts with a minimal amount of upload delay.
In that particular setup, then, it's a matter of you waiting until there’s some
type of price reversal occurring. So if something's speeding higher and it
looks like you've identified some sort of unsustainable price movement,
you're not going to buy as the thing continues. You're going to take a short
position when you see some sort of opposite movement, right?
Correct. On the way up, if it looks very, very strong, I might pick up a couple
thousand shares. But I will not take any sort of significant size. I’m still reeeally
a te ea A Ta a PSM IS TS A NE 2 NE OS
looking for that top . . . I’m looking for signs where, right before the top, I can
really load up on a short position.
Sometimes if it looks really dangerous and it looks like the stock could con-
tinue a lot higher, I'll step back and just wait for a secondary top. An example
would be if it’s run up 20 points, comes off 3 points really fast, tries to make a
new high, fails to make that new high . . . I'l hit all the high bids.
Everyone seems to have a different take on this next point. Some traders, in a
reversal situation, don't want to see one bar reverse. They want to see one
bar reverse and then they want to see the following bar take out the low of
the previous bar. Do you like to see that sort of confirmation or is it not that
important?
It sounds so complicated. I’ve never thought of it that way at all. I purely think
of stocks in terms of price levels.
What are your general thoughts on shorting?

I have two things to say about shorting. First, I think shorting is very dangerous.
You can make a lot of money very fast. But you can also lose a lot of money, be-
cause of the uptick rule, the short-sale rule. Invariably, you'll find yourself out of
the money before you're in the money when youre shorting a stock. I don’t rec-
ommend that to people who are interested in getting into daytrading as a pri-
mary strategy. I’ve gone through a lot of pain shorting and it’s not fun.
Secondly, I think it’s very important to think of stocks in terms of their
price levels. If you know there are sellers at a certain price and buyers at a certain
price and if you can identify those support and resistance levels, you can often
get really good price execution. If you're waiting for five-minute bars to overlap
and cross and close gaps, you're giving up a lot of slippage. You might be waiting
for an extra half-point for the stock to cross some bar when you know there are a
lot of sellers and you can get that extra half-point.
And that's what looking at Level II gives you.
RRA NSESET ASD SEPR GTS ER LN TRE PLAT TR A I, NEAT ESR SC TE

DAVID KUANG @ 241
LS LEAR TIERS BETGIE BES AIBEE S548 S81 SRNR ARI BIS ESA ES LPO
Exactly.
Do you look at the different ECN books, like the Island book, to see where the
other bids and asks are beyond the Level II?
Correct. Looking at the ECNs is extremely important. They give you a true mea-
sure of the bids and offers. Market makers don't always honor their quotes because
they're allowed a certain time delay to update their quotes. But the real bids and
offers are often established by the ECNs. So it’s important to utilize the Level II to
identify the ECNs and see where the true limit orders are bidding and offering
stock.
As far as an unsustainable price movement goes, is this something that lasts

a minute or so?
Its over different time frames. It could be over a minute, it could be over 30
minutes, or it could be over a day. I'll give three different examples. First, on July
12, 2000, Ciena (CIEN) went from 170 to 156 1/2 in about five minutes. There
was a rumor about accounting.
Another one is Research Frontiers (REFR), when the market was collapsing
in April 2000. I bought 10,000 shares at 10 that morning. In five days, the stock
goes from 30 to 10. Is it going to go to negative 10 in another five days? No.
Absolutely not. There is going to be a reversal there somewhere. That's a classic
example. You don’t even have to be a daytrader. You could be a swing trader. You
could be an intraweek trader. You could have made a lot of money on that one.
Again, the thing that tells you exactly when to get in is Nasdaq Level Il.
You're seeing the orders stack up, and you say “gee, it looks like things are
going to reverse here.”
Yes. There’s one other piece of technology we have here which helps a lot. It’s
scanning technology. Scanning technology is really important. It frees up our
time by scanning the market for profit opportunities that we're interested in, so
9 Sa a eR 2 SD TE EEE LOEES
Unsustainable Price Movement: Ciena (CIEN), 5-minute
[Ciena Corp LAST-5 min 07/12/2000 C=161.250 O=154.500
~ Created with Omega Research ProSuite 2000: © 1999
that we don't burn out. We can relax in the morning. It shows us which stocks
are moving and then we can trade those stocks. And then if nothing’s moving
during the day, we can relax and rest and do our research. I think to successfully
daytrade, it’s important to use some sort of scanning technology.
Out of all the trades you make, what percent would be on the short side?
A year ago, it was 90 percent. Now, it’s maybe 10 percent.
Is this because you've determined that the odds are better on the long side?
DAVID KUANG @ 243
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Yes.
Approximately how many trades do you make a day on average?
Right now it’s about 100 roundtrips a day.
I'm a little surprised since you'd given me the impression that you were sort
of kicking back waiting for that primo setup to happen.
I'll give you an example of a primo trade where you just burn tickets, but you
make a lot of money. New Era of Networks (NEON) on July 13, 2000 from
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7:00 a.m. EST began collapsing from 45. I began buying at 32 1/2 down to 31 1/2.
In that situation, I was buying 20,000 shares, 30,000 shares . . . looking for that
double bottom, which it established. That was one situation where I did begin to
buy on the way up, because I wanted it to establish that secondary bottom.
Did you buy as it was coming down the first time or on the retest?
It bottomed on the first bottom, where I sold it on that first little blip up be-
cause I knew it was probably going to retest its low. When it went down again, I
cleaned out my position just to be careful. And then at the turn, I took out all
DAVID KUANG @ 245
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the offers . . . took out everything. So that’s a situation where we did a lot of
trades, a lot of volume, but in one stock .. . in one situation.
Was there anything specific that told you to get in on that first leg down?
Unsustainable price movement.
Was there something that was keying you, like on Level Il, that this was an
opportunity?
Yes. Yes. You can identify the buyers and sellers. You can begin to tell when bids
are Coming in.
The momentum is changing.
Yeah, you can tell. I also look for support across several days. If you go to a daily
chart of the stock, 32 or 31 1/2 is a definite support level. In hindsight, it’s
pretty obvious. I try to keep my daytrading as simple as possible.
od
Do you create a hit list every night for the next day of stocks ready to break out?
I don’t do research. I used to really believe in doing research. The problem with
research is that it gives preconceived notions going into the stock market, which
changes minute by minute and day by day. What invariably happens when you
focus on putting your stock list together and your news list together and your hit
list together is that you end up missing out on opportunities that aren't on your
list. You might want to look at these five stocks today, but if these five stocks
don’t move, or even if they do move, you're giving up an opportunity of a better
return on a better situation in a better stock.
I see so many people create hit lists. And they do well. However, the
amount of time and energy that they spend on it [isn’t worth it] and it pigeon-
holes their focus for the new day. So I really don’t do that. I tell all my traders
A SI CR SDT SE AB NS I YN I a EO
“don’t read newspapers, go home, get some rest, think about your trades, think
about how you can trade better, how you can execute better, don't try and pre-
dict which way the stock’s going to go.”
Some traders will only take a trade if it has a minimum reward/risk ratio. Do
you have a ballpark ratio you work with? | know some players look for a
2 1/2-to-1 ratio, or a 3-to-1 ratio.
Yes. I use a 4-to-1 ratio.
Do you get into a trade and know where your exit point is instinctively? Do
you do it on a point system, whereby you never risk more than a point?
I think in terms of points. When you think in points, it gives you a little bit
more leeway to be wrong.
Is it always 1 point, for example?
It depends on the stock. If it’s a highly liquid stock, I'll give it a quarter-point,
maybe an eighth. If it’s a stock that’s going down 10 points, I'll give it 2 points,
3 points. But the whole ratio should be roughly around 4 to 1. I like a 4-to-1
ratio.
When you're looking at a setup, how do you figure out what to base your
reward expectation on?
By looking at the bids and the offers. Depending on the price at which I bought
stock, I look to see how many bids I would have to hit in order to get out. On
the upside, I look at the number of offers that have to lift before I can sell my
stock at a profit. Depending on that price range, I can determine the appropriate
reward-to-risk ratio. If I feel that the price at which I would like to sell my stock
is within the potential rebound price range of the stock, then I would consider
the reward-to-risk ratio legitimate.
ESLER TE LTR LIA OE A RI ST OTOS EE RE DRE LE EET SMT ESE SE TOS

DAVID KUANG @ 247
‘Sa eI ARRAN A AS an aA EA 2M NR BNL Ne
I'm assuming that you don't take positions home overnight.

Not really.
Do you like this time frame over others because of the instant gratification?
Or is there something else you enjoy about doing so many trades in such a
slim time frame?
I think the real happiness factor stems from knowing that my odds of success are
so high . . . that our edge in our profession is so high relative to other time
frames of investing.
So you think it's easier to make money in the daytrading time frame than the
swing time frame or intermediate time frame? Or maybe “easy” isn't the
word. How about “consistent?”
I think consistent is the word.
What are your selling techniques? For example, on a pullback after a run-up.
That's a really good question. I try to identify a resistance level . . . a price level
where I feel people are definitely going to be selling. Let’s say a stock goes from
70 to 63 and I know there are a lot of sellers at 68. First, I’ll give myself one
price haircut at 67, which is where I’m assuming all the other daytraders are go-
ing to sell. I'll then give it one more haircut to a lower price, which is where |
sell. I try to identify where retail is going to sell or daytraders are going to sell.
And I want to be right in front of that. I’ll also use Level I to identify how high
these guys are willing to pay within a stock rebound.
When you say “where the daytraders are,” what are you referring to?
Looking at the Island ECN. That’ a classic example. It’s primarily used by a lot
of daytraders.
the EN RD SME Aa ON SN EEE SS TL ST ELT SEI OIE,
And as far as the retail crowd, would that be your bigger market makers, like
Merrill and people like that?
Also sometimes Spear, Leeds will go through REDIBook, the ECN. You try to
identify which ECNs are coming to the offer.
What are you paying in commissions?

Right now I’m paying approximately $10 per thousand shares.
That's a penny a share. Is that critical to your success, or merely important to

your success?
I think the average daytrader worries way too much about the commission rate,
about getting the best deal. If you have a good system and youre happy and
youre making money and youre not writing 50,000 shares or 20,000 shares or
even 10,000 shares a day, stick with the system . . .stick with the technology that
enables you to make money.
The commission should always be secondary. Now with that said, if you're a
daytrader whose trading is going to the next level where you're doing 100 trades
a day, 100,000 shares a day, commissions add up. It’s starts adding up by an extra
$1,000 a day in commissions. At that point in time, I would recommend people
begin looking for comparable technology at a cheaper commission rate. But for
the average daytrader, don’t fret too much about it. Learn good trading technique
first and get some decent technology.
How do you determine what the axe, or dominant player, is in a stock? Is

there anything that tells you this is the guy that's controlling this issue?
I think a lot of daytraders are taught to trade high-volume, high-liquidity stocks,

like Cisco (CSCO) and Sun (SUNW) . . . or maybe even high-volume secondary
stocks, such as Yahoo! (YHOO) and Akamai (AKAM). I think it’s very difficult
to determine the axe in these types of stocks because there’s so much liquidity
ea AE a SR AR a AR PLE BRE I SINE FS TST ST ES EE SRST TORR

DAVID KUANG @ 249
ARO ER I ONL Eo SA aBM aR RR TTP SN ETON ZEIT SERIE OL" RTT ceSTI
and so many market makers going in and out. But even in those stocks, there are
certain situations where one or two market makers will obviously be making a
stand. Those types of identifiable situations occur not when a stock is going up,
but when it’s going down.
Here's an example. A stock goes up 15 points. You'd think it would come
off. People are hitting bids. Merrill Lynch is soaking up stock on the bid. That’s
when you identify it . . . when the stock is moving contrary to his position and
he is holding the stock. In lower liquidity stocks, it's much more obvious. On a
stock with a 2-point spread, you'll have Herzog’s offer at 1 1/2 points below any-
one else's offer. I’m not saying he’s the axe, but at that moment in time, he defi-
nitely wants to sell.
As far as your performance goes, how have you done over the last three
years?
In 1998, I made $1.8 million. In 1999, after I returned from some time off, I
traded for four months and did $1.5 million. This year through mid-July, ’m up
$6.5 million. I might add that you don’t always use all of your capital to trade
avery single day. I only used a half-million in buying power today, for example.
Do you have any advice for newer traders that are just getting into this game?
Is there anything that you think they need to know before they get started, or
things to be aware of?
There are three things. First, be careful whom you learn from. Make sure you
learn something which is good for you . . . a style which is good for
you . . . something which you are comfortable with. Make sure you don’t just
follow blindly what someone says. Sit back and think about the logic behind the
trading strategy . . . very, very important. If you're never comfortable or you
never fully understand your trading strategy, you'll never grow as a trader.
Second, don’t try and make a large amount of money right away. Learn how
to make money consistently as soon as possible, every single day . . . a way which
is comfortable and safe . . . very, very important . . . because that’s what enables
nus eat A LBS aE Tans a MOREA SS SAD IES ESERIES RTE
you to survive this business and then to grow on that trading strategy and ex-
pand your trading strategy.
Third, and foremost: Have fun. If you're not having fun, youre going to
burn out, youre going to do something stupid, and you'll lose a lot of money. Be
sure the enjoyment factor is still there for you. Identify it. It's different for every-
one. It could be the thrill of finding a good opportunity. Or it could be making
a lot of money. Whatever that thrill is, identify it and appreciate it. And I think
that leads to success.
Also, here’s something that’s very important. eeyoure starting daytrading,
make sure that you've set enough money aside so that you dont have to worry
about rent and food and bills for three to six months. If you trade with that
hanging over your head, it can really put a lot of strain and stress on you. You'll
try too hard or you wont be patient enough and you'll lose money.
Okay.
I think everyone should try it if they have an opportunity to try it.
Thanks very much for your time, David.

UN THE CUSP
()*" of the wonderful things about Wall Street is that new talent is con-
stantly surfacing above the noise. The following three gentlemen, though
young in age, are just beginning to hit their stride. Two run hedge funds with
solid returns; the third has made himselfa millionaire from daytrading. What we
ound interesting is that even though they do not have the same seasoning as
some of the veteran traders we interviewed, they do share the exact same disci-
plines and in-depth knowledge that’s needed to reach the top of this game.
251
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DAVID BAKER
THE WHIZ KID

By Kevin N. Marder
avid Baker represents the new breed of daytraders that journalists love to
hate. Over a three-year period of time, Baker grew a five-figure trading ac-
@unt into a seven-figure account by daytrading, both on the long and the short
side. What makes Baker even more impressive is the fact that, in spite of his age,
his knowledge of the markets and understanding of market dynamics is equal to
some of the finest traders I’ve ever had the privilege of meeting.
The test of all great traders is how they respond to adversity. Baker showed
his true mettle by snapping back from a 50 percent drawdown early in his career.
To do this, he completely withdrew from trading for months, preferring to spend
nearly every waking hour examining his prior trading mistakes. During this
wood-shedding period, Baker totally reformulated his money management plan,
including a revision of his approach to cutting losses and limiting risk.
Baker emerged from this hibernation reinvigorated and eager to do battle.
Armed with a fresh approach backed up by many hours of research, he quickly re-
built his trading account—and never looked back.
253
254 @ THE WHIZ KID
Sa a PT I RT PE EOE TS ETO
Kevin N. Marder: Dave, how did you first become interested in trading?
David Baker: Early in my college years at the University of California, Irvine, a
friend introduced me to the market. After he described it to me one day, he took
me down to a brokerage firm and, with his guidance, I opened an account.
About two hours after leaving the brokerage office, I ran home and bought a
stock based on my friend’s tip. I watched that stock go up 15 percent in two
days and I realized it was something I wanted to pursue. Later on, another friend
took me under his wing and introduced me to options trading. We made some
money and then eventually lost it. I then realized I had to do my own research. I
had just quit my job and had my initial investment remaining, thanks to a few
winning trades. I took some time off from trading and began reading a lot of dif-
ferent books on options and stocks, trying to figure out how it all worked.
So I spent the summer after my freshman year in college studying the mar-
ket. When I finally picked my first stock, it did well, but it took a couple of
weeks to make a meaningful move. The next stock I bought moved within 90
minutes of when Id gotten into it. At that point, I realized that buying a stock
that moved was something I wanted to do every day. I wanted to find a stock
that would move a couple of dollars every day instead of having to panic each
day and hold something overnight. At that point, I realized that there was a lot
less stress trading that way. It’s a lot easier to sleep when you don’t go home with
any positions, especially things that are speculative that youre not familiar with.
How did you develop your early technique?
I learned a lot of how daytrading works through some friends I'd met in a chat
room on the Internet. They gave me the basics and a small course to teach me
what they did. They were scalpers mostly . . . they were going after small gains.
The first two daytrades that I made were stocks that probably moved from $20
to $25 in one day. So that’s what I was looking for.
Were the friends that you had met in the chat room scalping for eighths and
quarters?
SEER LET ES IE LPS LES ELIA SES LST EE TSI YL EBLE TE

DAVID BAKER # 255
a aN aE SNR TRIANON a ae
Yeah. After a couple of months of on-and-off gains and losses, I realized that that
was too risky because the risk-reward ratio was too great. I was risking too much
to be picking up a quarter-point.
Were you financially supporting yourself through your daytrading at this

point?
In the beginning, I was living mainly off my savings from my prior job. Not too
long after I started, I began to live off my trading, since I'd had a couple of good
winners right from the beginning.
You were still in college, though.
Yes. By my sophomore year, I had scheduled all of my classes so that I would

only be in class after the market closed each day. That way I would have time to
watch the market during trading hours. By then, I had moved out of my parents’
house, was living on my own, and was totally supporting myself through my
daytrading.
~-
You mean you put yourself through the last three years of college at the
University of California at Irvine, then, paying your tuition, books, rent, and all
living expenses, just through your profits as a daytrader?
Yes. But after I was trading for a couple of months, I had a little trading tragedy
where my account shrank by at least 50 percent, if not more.
And you consider that to be a little tragedy?
Well, at least it didn’t wipe me out! (Chuckles). I had to take a break because at
that point I had been through scalping and that was very stressful. Having a big
loss when youre used to taking a lot of small gains really kills your mentality and
makes it difficult to not be afraid to pull the trigger next time. At that point, I
took a little break of about three months to figure out a new trading style. During
256 @ THE WHIZ KID
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this period of time, I paper-traded mostly. And then I lined up some financial
backing to re-enter the trading world. I still had part of my account left.
At that point I got back in and looked for something that was better than
scalping, but was still considered daytrading. I wanted to find a strategy that
would give me gains of 1 to 5 points instead ofjust small gains. I had read all of
these books about the psychology of trading and risk versus reward, and I real-
ized I was risking too much versus what I was making. So I changed my style
and paper-traded stocks and futures for a little while. All along, I had been doing
some options trading on the side to generate income . . . a lot of covered calls
and naked puts. Then I moved back into daytrading again.
How did you bring your account down by 50 percent? Was it one or two
trades?
It was sort of a chain reaction. It all started when I placed my first market order
on a hot-moving stock one day. By the time I got a confirmation that my order
had been filled, the stock was already down 5 points. And I had bought a signifi-
cant number of shares. At that point, I didn’t know what to do and panicked and
just sold it and took a big hit. Following that, I fell into that trap of trying to
make back what I had lost. And so I got burned a couple more times, not for the
same reason, but just because I was panicked, trying to make back what money I
had lost, and not taking good trades.
As a daytrader, you're basically looking at five-minute bar charts, right?

Yes. For my intraday setups I use five-minute bars, but as my trading has ma-
tured I have shifted my focus to include more daytrades based on breakouts from
daily charts. For those trades, I use a combination of daily bars as well as
five-minute bars.
Do you go short as much as you go long?

DAVID BAKER 25/7
a ae ae Bee ee, ee ie ee
This is dependent upon market positions. When the market is strongly trending
upwards, I’m hesitant to take many short positions because I’m always afraid of
buyers coming in on the dips. If I’m shorting a stock based on a breakdown from
a daily pattern, as opposed to an intraday pattern, it’s a different story. In this
case, the short is based on something that has been forming over a greater period
of time .. . its been building up. When daytrading futures, I’m not hesitant to
take short positions.
So what do you look for in a daytrade?

I have two patterns that I love to trade. The first is when a stock is consolidating
either near the high or low of the day, which is similar to what Kevin Haggerty
refers to as a Slim Jim. I look for stocks that have usually spiked in the
early-morning part of the trading day and then they consolidate on lower vol-
ume. They then make a strong-volume move out of the consolidation. I look for
consolidations that have gone on for at least 40 minutes in a range that’s any-
where from 1/2 point to 2 points, depending on the price of the stock. I look for
those to break out in the same direction as the original trend. So if they're con-
solidating near their high, I’m looking for them to break out to the upside. Be-
fore I enter, I will usually wait for a follow-through because I’ve been caught by
too many false breakouts.
When you say “follow-through,” what do you mean?
I either look for the opening of another five-minute bar to eclipse the high of the
previous bar—
—the previous bar being the breakout bar.

Yes, the breakout bar.
So that's the first pattern that you like to trade. What's the second?
258 @ THE WHIZ KID
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In the second case, I'll put a position on when a stock’s bouncing off the same
trend line over and over again. I use the same simple moving averages that I use
on a daily chart, the 5-, 10-, and 20-period. Some stocks that trend higher or
lower throughout the day move along one moving average.
Are the 5- and 10-period moving averages the most common?
Yeah. When a stock’s move starts to accelerate, I look for the shorter-term moy-
ing average to pick the stock up and carry it higher. And I use that as a trend
line for the rest of the day. I watch for breaks in those trend lines as sell signals.
DAVID BAKER @# 259
SE A RE I TEETER SSN
So if you see an upwardly trending stock touch its five-period moving

average line, you would be buying it once it touches the moving average
line?
I look for a bounce off the moving average line, because it’s not a mechanical sys-
tem. It’s very common that a stock will dip below the line by 1/8 or 1/4 point,
so I don't use a system like that. It’s a combination of watching the bounce and
watching the Level II quote system and the time-and-sales data as the orders go
through. This gives me a feel for the continuation of the move. I don’t like to
open any positions based solely on a feeling, or because I simply think that it’s
headed higher. Instead, I like to see some kind of pattern on the intraday charts
beyond simply a trend. For example, strongly-trending stocks often tend to enter
intraday consolidations, or form shelves. I look at these patterns as pauses before
a continuation. I prefer to enter a position on a breakout of such a pattern.
Something key to my trading is avoiding blatant speculation. Thus I won't just
buy when the stock enters a consolidation on the belief that it will move higher.
I want to see the breakout.
What are you looking for on the Level II quotes? If the stock's trending higher,
ase you looking for a lot of people on the bid side?
I want to see a lot of people on the bid side, and not just a lot of shares from
one market maker or ECN. I prefer to see several—the more, the better, because
the amount they're bidding is not always reflecting the number of shares they
have. And I look for large bids as well as the bid size greater than the ask. I also
want to see the ask side slowly disappear as the orders go through. The best thing
I like to see is a lot of trades at the asking price . . . an acceleration of trades at
the asking price. I want to see all of that combined with strong volume on the
five-minute bars. Strong volume is my favorite indicator.
Do you confirm your decision to enter a trade by looking at bigger time frame
charts?
260 @ THE WHiz KID
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Yes. Before I buy anything, I always glance over at the 30-minute and daily bar
charts to look for resistance points. This is because if a stock had a lot of trouble
eoing through a certain price maybe five days ago, and the breakout point is just
under that price, I’m not going to take the position until it goes through that
price.
Let's step back for a second. You said that you want to see more than one
person on the bid side. Is it more important to see a lot of different bids or
just a couple of bids with 10,000-share lots?
If it’s a significant number of shares, like 10,000, then I’m happy to see two or
three. However, I rarely see this. If it’s a lot of small orders of 100 shares or 500
shares, I want to see a lot of buyers. It always catches my eye when the big bro-
kers are buying, too, as opposed to the market makers and ECNs, which are
where many daytraders route their orders.
And the big brokers are who? Goldman—
—Merrill Lynch, Goldman, DLJ. If I see them bidding for 50,000 shares, I
know that it’s more than just a daytrader trying to scalp an eighth.
What are the daytraders looking at?
They're probably looking at the most active ECNs and market makers, like
Knight/Trimark, Island, Instinet, Redibook, and Attain. Most daytraders that I
know use these systems to place their trades, and not the big brokers that I’m on
the lookout for.
Where would your sell point be on these trades?

If it’s a trade that I took because it was a breakout from a consolidation, and if I
get in too early and it’s a false breakout, even after a second bar I will hold it un-
DAVID BAKER @ 261
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til it breaks the bottom part of the trading range that it’s been in. Now if a
stock’s been trending for three or more five-minute bars, I like to try to draw a
trend line, usually after three bars, which is enough points to draw an adequate
line of some kind.
Or [ll use a system that I have developed over the last few years which I
call “The Baker Five-and-Dime Method.” What I’ve noticed is that if the
five-period moving average on a five-minute chart carries a stock higher, the
next greater one, the 10-period, will act as a secondary support. So if some-
thing has been trending higher and I’ve been in the position for maybe 30 min-
utes and it breaks through the first moving average that was carrying it, I use
262 @ THE WHIZ KID
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that as a signal to sell. But then I wait for some sort of confirmation like a
break of the next moving average, such as the 10-period. Of course, all of this
depends on how much I’m up on the position. If I’m up 1 point, and the chart
is starting to show weakness, I may exit the position on a small break of the
five-period moving average.
I also have a 4-point rule, where I will sell, or at least place a stop on, at
least one-half of my position on a profit of 4 points.
So in this example, all price has to do is dip down below the 10-period for a
few seconds?
Actually, I would prefer to see it close below that level and then continue roughly
1/4-point lower. I tend to be a more aggressive seller on the more volatile stocks. If
I enter a stock based on a setup from an intraday pattern, ’'m more willing to lock
in profits quickly. If I open a position based on a longer-term setup from the daily
charts, I’m willing to wait through more volatility, because the trend lines I’m us-
ing have been built over more time, theoretically making them stronger. But it
honestly depends on how much I’m up on the position. ’m much happier to get
out with no loss at all than to gamble for a couple of points, because there’s always
another opportunity. I would prefer to start with a fresh trade than to have to
make a decision when I’m at a loss.
Do you always use that technique—a break of the trend line or a break of the
next higher moving average?
That’s my favorite technique. But at the same time, if I notice that the entire
market is collapsing, and I have a long position in some high-flying stock, I’ll
tend to start worrying a little more and be more willing to pull the trigger and
sell something if it starts to pull back. I look at points, not percentages. So if it’s
a $200 stock and it’s up 5 points or it’s a $10 stock and it’s up 5 points, I still
look at it the same way. I don’t wait for a certain percentage dip.
DAVID BAKER # 263
ete
Do you look at both time-and-sales and Level II when you're thinking of

getting out of a position as well as when you're considering entry?
Yes, always. If I’m in a long position, I’m always looking to see if people are pull-
ing away their bids even though the price isn’t falling. Sometimes if there’s three
10,000-share bids, all of a sudden there’s just one party bidding. And then I
watch to see if the trades are going through at the bid or the ask, particularly if
its next to a whole number, like 10, 20, 30, 40, 50. Those often cause problems,
especially if it’s near 50, 100, or 200. For short-term trading, I always notice that
those numbers cause problems.
So when you see a lot of bids start to dry up, you're thinking the thing's really
going to head lower, right?
Yeah. I always have my sell order ready as soon as | have the confirmation of my
fill. I’m pretty much looking to get out if the bids are drying up. I don’t want to
be the last one out.
Would you short a stock based on the same criteria that you would buy a
stock if the trend on that day is down? Or do you have to see that both the
intermediate-term trend (a few weeks to a few months), and short-term trend
(a few days to a few weeks), are both down?
I’m not too concerned with the short-, intermediate-, or long-term trends. But |
still look at the 30-minute and daily charts and I draw my support and resistance
levels on them. And I make sure that I’m aware of where all of the moving aver-
ages are, especially the 50-day and 200-day. Otherwise, I use the same criteria. I
would prefer to short a stock that’s been moving down that day. I never try to
call tops and bottoms—I’ve learned bad lessons from that.
When you speak of “the trend,” are you referring to the trend of that day?
Yes.
264 @ THE WHIZ KID
CLARA ade a ORY EN I EAI A TIO TES EER NTI SEP LLOOL DS
If it's before the open of trading, and it looks like there will be a big gap-up
opening in the averages, do you consider that to be an up trend even though
the day hasn't yet begun?
In the first hour of trading, if there is a gap and everything’s moving higher, I’m
looking to catch the momentum of the first 15 minutes or 30 minutes of trad-
ing. And then I look for reversals. Over the years, I’ve noticed that these reversals
occur earlier and earlier in the day. A stock will gap up 10 points and then sud-
denly fall. I really like to play the reversals when the entire market is reversing.
I'd rather not go against the trend. Never fight the trend. If I didn’t do anything
in the opening 30 minutes, I usually look for flip-top openings. That’s where the
stock spikes up, spikes down, and then crosses the morning high again, or vice
versa for shorts. I like to enter when price takes out the morning high. I know of
a lot of daytraders who don’t watch the rest of the market and don’t care about it
at all. But I like to watch the Nasdaq futures just to get a feel. I primarily only
use momentum techniques in the first hour of trading, otherwise I focus on re-
versals and flip-tops.
When you play the open, and let's say Sun Microsystems is expected to open
5 points higher, do you ever get in right when the first trade happens 5 points
higher because you think it's going to move up another couple of points?
Depending on the stock, sometimes I'll get in during pre-market trading, espe-
cially if the stock has been trading in the pre-market for long positions at the
asking price all morning. As my trading has matured, I prefer to avoid speculat-
ing and I'd rather wait for a confirmation. I almost never place market orders, let
alone at the open. If I feel the momentum is there, I consider buying in the first
five minutes. I try to let five minutes go by just to see—
—if the move’s going to extend a little bit.

Yes. And if I’m going to trade something at the open, I want to trade something
that has a wide average daily range. This is usually whatever the popular stock of
ESLER SASL ENE EET Ee SED EKTRE TSO ETS SE

DAVID BAKER # 265
RANE
8 21TE MLE AT GTS IESE IR ks
the week is . . . whatever the hot sector is. Those stocks usually have a huge
range because everybody's trading them. So if a stock only moves an average of 1
point a day .. . I mean I’m not going to try to trade a drug stock at the open
while some telecom stock trades every day with a range of 10 to 20 points.
So, when you trade the open, you're looking more for the flip-top than
anything else.
Yeah. My favorite thing would be reversals. Either there’s some carryover from
the day before when the market closes at its high of the day and then runs up a
little more before it sells off, or vice versa. In some cases, there’s some profit-tak-
ing after a big run-up . . . but it will just be a small amount of profit-taking. Af-
ter a while you can almost tell how much it’s going to be.
And so after it opens down a little bit you're going to watch it reverse. Now
would you enter one tick above that day's high?
That would be my goal. In the first 30 minutes, you can see a complete flip-top,
where it opens up, moves down, then takes out the morning high. You can see
all of that occur in 30 minutes now—if not less—and often in three- or four-,
five-minute bars.
To short a down flip-top opening when price initially moves down, comes
back up, then goes down again, you're going to short a tick below the early
low?
Not necessarily. I don’t have a very mechanical system, I guess. But, yes, some-
where roughly around that area.
Will you ever short it before it takes out the morning low?
I used to do that all the time. But I learned a couple of expensive lessons doing
that, thinking that it would have to go lower.
266 THE WHIZ KID
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It doesn't always take out the low.
No. Sometimes it goes 1/8 or 1/4 below, but I try to wait for it to go at least 3/8
below the earlier low.
A lot of people are looking at that same trade then, which is why it doesn't
work. :
Probably.
So your favorite way of playing the open is a reversal type of trade, right?
I guess my two favorite ways would be catching the momentum, when everyone
just wants to buy something right at the open. You can see the orders rushing in
right when the market opens at 9:30. I like to bid 1/16 over everybody else, get
ahead of them, and ride it up for a couple of points. Or the flip-top. I love the
flip-top because everybody sells, thinking they got out at a higher price, and the
stock falls 2 points. And all of a sudden it reverses, and then they realize that that
was all the profit-taking there was going to be. And everyone thinks they missed
the train and has to jump back in. So you catch that momentum and sell it at
someone else’s expense.
How many stocks do you typically follow at one time?
I keep a list of about 30 to 40 stocks on my screen every day that I consider to

be the most popular flavors of the month. I use these to hunt for intraday setups,
as opposed to my other list, which I daytrade based on longer-term setups. This
latter list is comprised of stocks that show the most trading activity as they ap-
proach their old price highs.
Are there some stocks you trade more often than others?
Yes. I followed Knight/Trimark for months. I didn’t initially look at it as a
daytrade. But after following it for awhile, I noticed that ic repeated the same
CE SAE SS SS a
DAVID BAKER # 267
a SNORE
patterns over and over. For roughly 60 to 65 days straight, I traded it every day
based on almost the same pattern. You always notice recurring patterns in the
same stocks. Every stock has its own personality. So different trends and different
patterns work differently for different stocks.
You saw the exact same thing happening in Knight every day for 65 days?
Yes.
I'm in suspense. What was the pattern?

After it made a morning move, it would break out from a consolidation. Also,
youd often see it sell off toward the close, and then gap up the next morning at
the open. It would then run up for a couple of minutes and then consolidate, so
I would set my audible alerts just outside of the trading range.
Some days it would break out higher, above the consolidation, and some days
ft would break down lower, below the consolidation. You didn’t know which
way it would go.
Yes. And most of the action always took place in the last hour, so you could wait
all day.
Do you look at any indicators for general market direction? Or, since you're a
daytrader, aren't you basically just looking at how the Nasdaq futures are going
to open each morning before the open?
Yeah. For my early-morning trades, all I care about is what’s happening right in
the first 15 minutes before the market opens. For a lot of my daytrades or my
swing trades, I like to see stocks that are mimicking the charts of the Nasdaq or
the S&P. A lot of tech charts look exactly like the Nasdag charts, so when I see
a bounce in the broader market, I'll see the same bounce in the same type
names.
268 @ THE WHIZ KID
SL EL ae A AR RR Na i A A A I EI OES
In the Nasdaq futures, you mean.

Well, the Nasdaq futures as well as the Nasdaq Composite. For the pre-open, I
use the futures because they trade close to 24 hours a day, whereas the Compos-
ite doesn't. That gives me the best indication of how people reacted to the news
from the previous day’s close and overnight. Intraday, I watch the futures. I’ve al-
ways thought that they were a leading indicator . . . they move a lot faster than
the Nasdaq Composite.
Now, why wouldn't you be looking at the NDX, the Nasdaq 100? That's really
more of a pure play on tech than the Nasdaq Comp.
Usually, when I’m looking to see where I think the Nasdaq in general is going to
be, I look at the big-name tech stocks. They used to call them the Four Horse-
men or the Five Jewels. Some of those stocks make up a large percentage of the
index.
You mean like Intel and Cisco?
And also Microsoft, JDS Uniphase, and Oracle. Those are the five that have the
largest weighting in the Nasdaq Composite.
So you're saying it's better to look at the Four Horsemen or Five Jewels?
I like to see where the leaders of the day, the current market leaders, are going,
rather than look at the NDX. I don’t see the charts of the Composite and the
NDX as being that much different. Most people see the Composite in the news-
paper and on television. If that’s what everybody else is watching, I want to know
what they’re looking at. Lately I have been focusing more on the futures, as lead-
ership in the Nasdaq continues to change each day. It’s so important to let your
trading evolve with the times. What worked three years ago 95 percent of the
time might only work 50 percent of the time today. Just the other day, I was in
two long positions in the tech sector and I started to see the Nasdaq futures take
SES ED SES SE A DS SS
DAVID BAKER # 269
ATE
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out their intraday support level. After seeing a continuation to the downside, |
started to close out my positions. By the end of the day the same stocks that
brought me a profit of several points broke down and closed negative.
Do you spend much time looking at market sentiment indicators like

put-to-call ratios, the VIX, things like that?
I look at them when they're at extreme levels. There was a time when a 20 on
the VIX was a sell signal and a 30 was a buy signal. I compare them to the charts
of the indices. You can see where reversals have occurred relative to those indica-
tors.
As far as money management goes, how much of your account do you put in
one position?
I base my trades on the number of shares. I usually rank each stock on a scale of
1 through 4. This tells me if Ishould buy 300, 500, 800, or 1,000 shares for a
faytrade. The stocks that I’m more familiar with, that I’ve traded a lot more,
whose trends I feel that I know better, I’m more willing to call a “4,” which
would be 1,000 shares. Something that is more volatile, and which I consider to
be riskier, I would take a smaller position in. I don’t have a percentage that I use.
I base it on shares.
Do you add more to a winning position as it moves higher?

No. I am willing to cost-average down in a daytrade. This is where a combina-
tion of gut feeling and the charts come into play. I don’t think daytrading can be
a mechanical system. There are other underlying factors at any moment that tell
you to hold on or to sell.
Are there any trading books that you've found particularly interesting?
My favorite book is Thomas Bulkowski’s Encyclopedia of Chart Patterns. Initially,

the only books I'd wanted to read were about chart patterns. I read Jeff Cooper's
270 @ THE WHiz KID
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books and I learned a lot from them. I narrowed down some of his patterns to
the ones that I liked. Later on, after I'd stopped trying to find all the different
patterns, I started to read more about the psychology of trading. Since one’s
emotions play a greater role in the daytrader’s decision-making process, I found
that that was pretty interesting. There’s a lot of psychology involved in trading,
which is why I like Alexander Elder’s Trading for a Living. It covers the topic
quite well. Trading takes a certain personality.
Do you see yourself doing anything but trading for the rest of your life?
One day I would like to run a hedge fund, Kevin, but I guess I always want to
be involved in trading. I can’t see myself doing anything else.
Thanks, David.
MANUEL OCHOA
STEALTH
By Marc Dupée
Mz Ochoa has established himself as one of the rising stars in the hedge
fund business. Early in his career, MAR Hedge recognized the perfor-
mance of his global macro fund, ranking it third in the world among global
macro funds for its performance in 1997. He currently runs three funds and has
achieved consistently high annual returns, putting him on the map as one of the
best young hedge fund managers. Futures Magazine called Manuel Ochoa, now
31, “one of America’s hottest new traders.”
Ochoa applies both longer-term, trend-following, and swing-trading tech-
niques in the futures markets, focusing on financial futures, specifically, T-bonds,
S&Ps, and currencies. He relies on a discretionary approach for many of his mar-
ket decisions, but at the same time employs mechanical trading systems he has
developed in many markets to reduce the overall volatility of his portfolio.
He launched his trading career while still a finance student at the University
of Southern California (USC) in the late 1980s and drew inspiration from fi-
nance professors, one of whom traded currencies full-time.
271
272 @ STEALTH
SLA oc gS OT A A a Le Ae RP PT AEE BADE OEY EES IEG SHI
Ochoa began researching trading strategies at the USC computer labs,

combining coursework with his research, and learning about price behavior and
market correlations that subsequently laid the groundwork for both his future
trading systems and discretionary trading approach. While earning his degree at
USC, he also began trading.
“IT traded the S&Ps early in my career with a seat-of-the-pants approach.
Needless to say, it was a bad experience: I was losing money. I opened an account
and lost all of it. I started learning from there.”
After college, he spent two more years researching, testing, and trading his
own account using a short-term, discretionary approach before becoming a con-
sistently successful trader. He then shopped his performance to land his first in-
vestors and now has primarily banks and large institutions as clients.
Ringing a similar bell to other success stories, Ochoa’s early failures served as
catalysts that led to the design and development of the trading systems and port-
folio diversification and risk-management models that serve him in the markets
today. His years of studying and trading have gifted him with an ability to
“sense” the market and to interpret what the market is “thinking,” keeping him
in step with, or one-step ahead of, major market movements and price swings.
Marc Dupée: Tell me about the hedge funds that you manage.
Manuel Ochoa: The style of trading that’s done is called “global macro,” as op-
posed to other styles like “event driven,” “distressed securities,” or “market timing.”
How would you define the global macro style of trading?
Instead of trying to pick winning stocks, for example, you just try to determine
whether the market's going to be going up or down. What you do is buy the
whole basket of stocks, like the S&P 500 futures. So you’re making a macro call
instead of making a micro call like a stock picker would.
Which markets do you trade?

MANUEL OCHOA @ 273
‘LAT A IPR re te iy PO RR I RS TS DES RT OnA
All the major global financials, like the U.S. stock market, U.S. bond market,
European stocks, European bonds, Asian stocks, and Asian bonds.
Do you trade indexes on all of those?

Yes.
And do you trade at different exchanges, too, or mostly in the U.S.?

I trade on all different exchanges.
What criteria or parameters do you use to decide when to get into a market?
Basically, I use a blend of technical indicators and fundamental data that come
out pretty much every day. You just start getting a picture of what's going on,
and what the markets are thinking, and then you start seeing when people begin
to get real scared when bad news hits. You then see how that interacts with price
action. On the other end of the spectrum, you see people begin to get really eu-
phoric when a batch of bullish economic reports comes out. You see how price
action acts in conjunction with those reports and then you see patterns begin to
develop. Basically that’s how you get a feel for what your strategy is.
For technical indicators, could you give an example of a recent trade in

currencies, bonds, or a stock index? Could you qualify what the
fundamental overtones were and provide us with specific parameters that
got you into the trade?
Recently, you saw some interesting price action in the S&Ps. Recently, it has
been the Nasdaq stocks that were getting sold off hard due to profit-taking. And
then bearish comments coming out from various sources have accelerated down-
ward price movement in the Nasdaq.
274 @ STEALTH
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You're talking about that three-day decline from its March 10, 2000 high
through March 15, when the Nasdaq fell as much as 11 percent?
Yes, and then you look at the S&P 500 and see that it’s basically got downward
pressure but it hasn’t really taken out any major recent support levels. That's tell-
ing you that the sell-off is basically a function of rotation going on. There's
money leaving high-tech stocks, but a lot of the money is going back into the
stocks that haven't been doing as well, like in the S&P_500 and the Dow Jones.
That's a tip-off.
So then you look to see if there’s a catalyst that’s going to come out to cause
any kind of rally. On March 16, 2000, the producer price index (PPI) report
came in pretty much as expected. There weren't any big surprises in it, and that
was a catalyst for a sigh of relief. Selling was concentrated on the Nasdaq. That
was a good trade setup to go long S&Ps and it worked out. It doesn’t always
work out. Sometimes you're wrong but those are the times that you want to be
trading because when youre right, those are the times when youre really right.
Were you long on March 15, 2000?

Yes.
So when the Nasdaq was selling down hard on March 13, 14 and 15...
Then I started buying June S&P futures. I saw the S&Ps were still in a conges-
tion zone and hadn‘ really taken out the recent lows.
The lows around Feb. 28, 2000?

Yes, those lows right around there. If we had taken those lows out afterward, I
would have thrown in the towel. But I knew there was going to be a bottom
somewhere right around there. And it worked out. It doesn’t always work out,
though. Sometimes youre wrong.
Twenty points on the S&Ps is a lot.
RESTATE SS TT LT CRT GE SE SE
MANUEL OCHOA @ 275
ST
SEI SEES SATUS PENN IAI Go PENLT eGE E EIE OA AE
Reading The Market Ahead Of A Catalyst: June 2000 S&P 500 Futures (SPMO), Daily
(SP MO) S&P 500 Index LAST-Daily C=1475.00 -.20

1560.00
|
1520.00
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| 1480.00
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Created with Omega Research ProSuite 20001 © 1999
The S&P futures bounce off a longer-term trendline (A to C) but fail to take out the low at (B).
The S&Ps hold in a congestion zone between (C) and (D) as the Nasdaq sells off as much as
11 percent from its March highs in the three days prior to an economic report “catalyst.” This
divergence implied a rotation from tech into S&P 500 stocks, where Ochoa established long
S&P futures positions. On March 15, 2000 at (D), one day prior to the release of the Producer
Price Index report (PPI), the S&Ps rise in anticipation of a friendly (non-inflationary) PPI as the
Nasdaq extends its slide. At (E), the S&Ps soar an unusual 65 points on the PPI report.
If you can’t risk at least 20 points per S&P contract, you probably shouldn't be
trading it because the best S&P traders are the guys that can put big enough
stops where they’re not going to get stopped out all the time. Either that or youd
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better start trading S&P E-Minis. If the guys are risking $2 or $3 per contract, |
guarantee you that, assuming they're even profitable, theyre nowhere near the
profitability level of the guys that are risking $20.
You said that you had started buying June S&Ps when the Nasdaq was
selling down hard and as the S&Ps held in a congestion zone prior to the PPI
release on March 13 and 14. What were you looking for in terms of your price
objective or your price target?
Originally, I was looking for a 1430 profit target. But then the market rallied so
much on March 15, the day before the PPI, that we already had had a $35 rally,
a bigger-than-average profit at that point. I looked at my other positions and
looked at how much money I already had on the table. And then I sensed that
the market was already anticipating a friendly PPI report. So part of that dis-
counting process may have already started. Usually, that’s the way it will work.
But this week was the exception because it didn’t work out that way. In actuality,
I would have been better off holding out, because the next day we got that huge
rally in the S&P, where it was up $65.
You got out before then?
Yes. I got out the day before that, because I just thought, “Wait a second. The
market looks like it’s already discounting a good PPI report.”
You mean the $35 rally on the day before the PPI was due to the S&Ps
discounting the news?
Yes, it was already anticipating. There were a lot of people who were already an-
ticipating a friendly PPI report.
So you were afraid they would “buy the rumor and sell the news?”
Yes, I was afraid it was already getting too discounted. So I said to myself, “You
know what, I’ve got a feeling this is going on, so I’m getting out at the close.” So
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MANUEL OCHOA @ 277
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I got out at the close. In retrospect, that was the wrong thing to do, because the
next day it rallied even more.
Did you jump back in?
No, I didn’t. But, you know, you don’t trade based on moves that happened like
those in the past two days. This is because those types of moves only happen
once a year. So if you're trying to be a consistent money maker, you don’t trade
for the things that usually dont happen, you trade for the things that usually do
happen. That was unusual price action that we got on March 15 and 16.
How do you usually place your price-target objectives, then?
You know, recent highs and lows. Sometimes, you just trail the stops. And some-
times there isn’t even a price objective. My price objective was the recent high in
the 1430 area.
You mean on March 15, 2000?

ad
Yes. It all depends. It’s like the pitcher and the batter. Each pitch is never exactly
the same as the one before it.
How do you place stops?

Most of the time, it’s a question of recent volatility. If you know the recent vola-
tility on the S&P is fluctuating and the average daily range over the last couple
of days has been $25, you have to assume that from one day to the next it will
be somewhat close to that same level of fluctuation. So you extrapolate that.
Other times, you can get lucky. You can use a tighter stop than that based on
just chart points and the number of potential catalysts in the next 24 hours.
By catalysts, you mean... ?

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al
Like a report. If a report comes out and it’s bullish, for example an infla-
tion-friendly producer price index report, you know your stop is not going to get
hit because you're going to be right, immediately . . . and the S&P 500 futures will
blow back or will gap up on the open, anyway. So it’s a combination of different
setups. You can trade S&Ps on a purely mechanical basis, but there are certain
things that you'll never be able to do as well as actually being able to understand
what's going on and really seeing why things are moving and what potential moves
are going to come up in the future. You can't program that into a trading system.
If the stops that you place are not mechanical...

Some of them are.
But it sounds like they're mental stops. It also sounds like you'll qualify them
if the context and tone of the market has changed...
Yes, basically, it's a discretionary process. That’s what it is.
Your stops are discretionary?

Yes. Sometimes it’s for a technical reason that you take a trade, sometimes it’s a
mixture of technicals and fundamentals. But the best way to trade S&Ps or any
market is that you only trade it at the times when you know there's a report
coming out. . . and if you're right, the market is going to immediately move in
your favor. This is as opposed to just putting a trade on, you know, from one
random dayto the next, where you don't have any market-moving event and
youre just sitting there in the market hoping that it’s going to edge up your way.
Do you have rules for stops?
As I said, I use the average true range, where I know that I’li have to use at least
25 stop because that’s been the average range in the last couple of days in the
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So you'll use the average true range from wherever your entry point is. Will
you be out of a position if it drops below that?
Yes, and sometimes I'll just use chart points I like... where if you know that it
makes a new low on the S&P, and you know that the reason it’s going to be
making that new low is because bearish data came out on the PPI, then even
though the average true range was, let’s say, $25, you know that in actuality you
don't have to use $25 stops. This is because most likely it’s just going to keep go-
ing against you if it goes past, say, $12 and $13 below your entry point. This is
because you know what's going on. A lot of fundamental investors—there’s a lot
of them out there—are going to look at that PPI data and they're going to get
scared and they're going to start selling stocks. The S&P will be down 40. So
why wait until it’s down 25 when you can get out when it’s only down 12?
Do you sometimes have an initial risk on a swing trade that is larger than or
close to your profit target?
Yes, because of the random price movement in the markets. If you place your
stops too close there is a good chance that you will be stopped out of too many
erades. In the end, you wind up trading with tight stops that all get hit, leaving
you with a big loss.
Sounds like your trading is extremely discretionary. Do you have any

hard-and-fast technical rules that help get you in and out of trades, or some
type of system? | know you're a big developer of systems.
Yeah. I do a lot of systems trading but, to tell you the truth, I really only apply it
to the smaller commodity markets where I don’t have a good knowledge of the
fundamental backdrop. That’s mainly what I use systems trading for.
In which markets?
All the commodity markets, you know, like crude oil.

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What's the overview of that mechanical trading system?
It’s a combination of momentum and counter-momentum strategies. For a trend,

I would put up a 25-day moving average and then trade whatever its telling me,
whether the trend is up or down.
So if it stays above the 25-day moving average, you stay in?

Yes.
How would you define a counter-trend?

In a counter-trend, I'll use an oscillator like an RSI. If the RSI gets up too high,
then I'll start peeling off the long contracts.
Do you use any type of system like that in the markets that you're more
familiar with, like the S&Ps?
I use them in the currencies. But in the bonds and the S&Ps, I pretty much stick
with the patterns I was telling you about before . . . a discretionary type of trading.
It's a discretionary approach to trading based on your knowledge of the

markets, the news, and your opinion of the news?
Yes.
In a sense, it’s more fundamental.
But I use technicals, too. It’s a combination.
Where do you get your fundamental information from and how do you qualify it?
I look for people who know more about the economy than I do and I just read
their reports and kind of get a feel for what they're thinking. Those people, such
as analysts at major brokerage houses, are widely read by a lot of big fund man-
ESE eS OSG EGLO SIA TTDI BL RS NS NE ET LPS BEI GRRE TET TS BOE
MANUEL OCHOA @ 281
agers. Then I'll look at Bloomberg financial news . . . they've got stories all the
time. You get a feel for who is doing what, who is good. You just get estimates,
consensus estimates.
Do you tend to stick with the consensus?
No, not really. I don’t really make my opinion one way or another. I just look for
differences from the consensus, like what the actual numbers are versus the con-
sensus. Then you see the price reaction to it and it gives you a snapshot of what’s
going on. So many times when the bonds have a bearish number they spike
down and that’s it. They'll spend the rest of the session coming back up again
because that news was already discounted. So, even though the number came in
more bearish than expected, if you see that the market starts rallying back you
know that everyone that wanted to sell has already sold. And then you get these
slow moves back up. And then if you're short you probably want to cover and try
to get short again at a higher price.
Getting back to your stops, do you ever use a percentage loss of your
Portfolio as a stop-loss level? Is that ever one of your rules?
Down a certain amount? Yes. If Iever lost more than 10 percent in one month I
would probably shut down for a month. That’s never happened to me.
That would probably be over several trades. But do you have a percentage
loss rule for any one trade?
Yes, I usually don’t like to risk more than 2 percent on any one trade.
What about on the upside? Do you ever average up when things are going
your way?
Not usually, no. I normally don’t because that creates a lot of volatility. Usually if
youre going to be out, you're not in a market that’s moving strongly in your fa-
I
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vor and usually when you get markets like that nowadays, you have these violent
corrections in between. So if you're averaging up, that strategy is not nearly as
good as it used to be. There are too many speculators in the market.
So what happens?
If you're averaging up before a correction, you dont know exactly when it is go-
ing to occur, and ultimately you end up taking major heat. You have a temporary
loss on your portfolio. You might get out of there, because it keeps going up the
day after, but you take more of a loss than youd like to. I’ve got clients who fol-
low their equity on a daily basis. Next thing you know, they’re on the phone ask-
ing me why I lost 3 percent in one day. I know people that do it, but that’s not
my style. I don’t like to trade like that because you're trading based on having a
one-way move and usually it’s not that easy. You always get profit-taking in the
interim, and even on these strong rallies you get these strong corrections in the
Nasdaq.
Then you get hammered.
Yeah, then you get hammered and puke everything during the correction. Then,
the next day, it starts going back up again after it got you out.
A lot of the stuff you describe is reading the market in terms of gauging the
sentiment of the market. Do you have any favorite sentiment indicators that
you use?
Not really. I used to look at the put-to-call ratio, but that’s been distorted. You've
got a lot of hedging going on there. You've got a lot of synthetic strategies going
on. It’s not a clean measure anymore. I wouldn't use it anymore.
You sometimes talk about the shotgun approach and the rifle approach. Can
you expand on that a little bit? Which one are you currently trading and why?
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MANUEL OCHOA @ 283
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The shotgun approach would be the macro approach. The rifle approach would
be the micro. The stock pickers are using the rifle, and the macro is for guys like
me that don’t know . . . we don’t have the ability to pick out companies. I don’t
want to know. All I want to know is whether the whole market is going to go up
or down .. . and I'd buy a little bit of volatility just to catch the train. You know,
it would be great if Icould do both, but there’s just not enough time to be able
to do both of those well.
Can you give us a feel of what you do, in general?
Most of my clients are institutional clients that are looking for diversification in
their existing bond and stock portfolios. They're looking for guys who are going
to be able to make some money if the market starts going down or sideways.
They're looking for an alternative investment, which is the category that guys like
me fall under. It’s not for somebody who doesn’t have a regular portfolio already.
Our clients usually have regular portfolios and they're looking for something dif-
ferent to round it out more. It’s not usually a good idea to put all your money in
something like this first.
o
How did you fall into having banks give you a million dollars? You're young.
I’m 31 years old.
How long have you been trading this account size? And how did you get your
start?
I got my start while I was in college in the late ’80s. I was a business major at
the University of Southern California and my finance professors got me inter-
ested in how markets work and why markets do what they do. And I started
from there. Then I began trading and I lost all of my money. The first time I
traded, I opened up an account with something like 10 grand and lost all of it. I
kind of started learning from there. (Chuckles).
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So what would you do differently today if put back in that same position?
I would have waited a lot longer before risking real money in the market. I had
just begun trading. Youre eager to start. It takes a while before you can have a
chance at making money. I would have studied more. I would have paper-traded
more and done more simulated trading. I was just too eager. Most people start
trading with too small of a bankroll. In other words, they don't have enough capi-
tal to start trading.
After you lost all of your money, how did you end up getting a bank or
institution to give you a million dollars?
I managed to get some more capital and I traded that for about five years. I de-
cided that’s really what I should be doing. Then I just shopped my performance
around for a few years after doing it for myself on a small scale. And I got a cou-
ple of investors. The more investors you get, the easier it is to get the next one.
Nobody wants to talk to you when youre small.
So it was difficult to get your first break?

Yes, very difficult.
You described how you've developed a discretionary style to your global

macro trading. How did you arrive at the current foundation of your trading
strategy?
Observation and testing.
Are your systems something you don't discuss or is there something you can
tell us, without giving anything away?
Basically, they're trend-based, trend-following systems. You're not trying to guess
or make any type of judgment on the market. You're just following the system to
jump on or off the train. There’s nothing special about that. A lot of people use
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MANUEL OCHOA @ 285
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it. The only reason I do that is it helps round out my risk-reward portfolio. It
helps lower my volatility. Some days when I’m really wrong on my discretionary
trading, I'll make money off my trend trading. I’ve found that they tend to bal-
ance each other out pretty well. There’s nothing special about it, though. There
are a million guys that do that. I don’t try to sell myself based on that. Anybody
can do that. It’s easy.
What type of easy, trend-following systems are you describing?
Oh, they're like pre-packaged, man. Just buy TradeStation. They have something
on the order of 30 pre-packaged ones in there, ready to go . . . breakouts, RSI, etc.
Are there some that you think are better than others?
No, they're all based on the same principle: trend following. They’re just different
variations. They're all trying to do the same thing. Some years one does better
than the other, then vice versa the next year. There’s nothing special about it. It’s
real easy. The only comment | have about that is that most people don’t have the
discipline to follow the systems. That's the only thing of interest to say about
that. People just don’t follow it. They don’t have the discipline to do it.
Many traders are uncomfortable with trading systems because they feel like
they lack control over their trading.
If a trader feels uneasy using a system it’s probably because he doesn’t understand
the nature of it. There are certain advantages and disadvantages to systems. The
advantage is it gives you a tool with which you can use to approach the markets
every day, a specific trade plan that you can execute and make a profit with in
the long run.
But you also have to realize that most systems are only right about 40 per-
cent of the time, so it can be very difficult to follow your system during losing
periods. If the trader doesn’t understand the nature of his system he will almost
surely quit using it and end up taking a loss.
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I adopted a systems approach because I saw patterns that developed over the
years. Tradable patterns can be very simple. For example, when a market makes
new highs there is usually follow-through. Or if the market makes a new high
and then fails, it usually makes a big move the other way. To execute these pat-
terns, | programmed them and started trading them. Once a system is up and
running, I can use my time to research other ideas.
Can you compare the success of swing trading systems with the average
trend-following system?
Swing trading has a higher winning percentage of trades than trend-following.
Swing trades should average at least 60 percent winners because you are taking
small profits very often and you need those to cover the occasional loser. Trend
following has a much lower percentage of winning trades because you are trying
to make most of your money in one or two big trades. You're going for the home
run, so to speak. The rest of the trades are losers and small winners.
What is your time frame? Or do you have varying time frames?
My time frame varies. Shorter-term and longer-term . . . I kind of just pick a lit-
tle bit of each one. That’s the best way to do it; instead of being strictly
long-term, or short-term only. The problem with that is that you get erratic per-
formance. And if you're a money manager like me, after a year of not making
money, clients begin to get impatient and they start leaving. You're better off
making a little bit every year and keeping them.
You trade across a range of markets and in different time frames. Can you
give an overview of the importance of diversification, both in terms of
markets and time frames?
Diversification is important if you are systems trading because you don’t know
where you are going to make your money in the future. There are only a couple
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MANUEL OCHOA @ 287
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of markets that make very big moves each year, simply because the supply-de-
mand situation doesn’t fluctuate that much on a year-to-year basis.
However, once in a while you do have a major shift in the outlook for a
market which causes the big moves that systems traders can profit from. One
way to improve your chances is to diversify the time frame of your systems. You
can have a system that looks back at the last 50 days of data to make its decision,
and then you can use one that only looks back at the last five days. The advan-
tage is that you can trade moves that are five days in length and also the longer
ones at 50 days. These systems will behave differently and their losing periods are
much less likely to occur at the same time than would two systems that look
back 50 days. This way, you smooth out your returns.
You're better off varying your time-frame strategy and diversifying . . . you get
better results. Speaking of results . . .
My average annual return is around 20 percent.
What happened differently in 1998 from your better-performing years when

you were up 47 and 27 percent? And what did you learn from that?
In 1998, I started trading tech stocks. The problem was that, instead of scaling
into it, I made the mistake ofjust piling into it at once. Unfortunately, just after
I started trading them, I went into an immediate drawdown. That was the prob-
lem. So the moral of the story is that whenever you are going to start trading a
new style, instead of just piling in one day, you're better off taking it piece by
piece, in little pieces.
In other words, if you find a new system, like for example you trade bonds,
and you decide that you're going to trade 10 contracts per signal, you're better off
kind of easing into it over the course of, say, six months. You start trading more
and more contracts per signal. So at the first buy signal that you get, you might
take two or three contracts. And then maybe a month later, you add some more
contracts or start trading six-lots, instead of starting to trade 10 right off the bat.
What happens is that everything is cyclical. You go through up trends in equity
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and drawdowns. I had the very unfortunate luck of immediately going into a
drawdown. It hurt my performance. That was a learning lesson.
What kind of software do you utilize?

I use custom software that I had programmed and I also use some off-the-shelf
software. It depends on what I need. If I need very complex calculations, I'll use
my custom software. For easier tasks, I use the other software . . . whatever it
takes to get the job done.
Are commissions and slippage a big factor in your trading?

Yes, definitely.
Which markets do you find the most difficult for getting good fills?
You know, the thinner markets, some of the smaller commodity markets. And
Nasdaq futures. The slippage there is, wow, $500. It’s real big. And that’s per
side. A thousand dollars round turn.
Then do you enter with market orders in the Nasdaq futures?

Sometimes, yes.
Why don’t you use limit orders?

Because the contract is so big, $1000 doesn’t even mean anything. It is just like
the juice . . . you've got to pay for the right to play. The contract is a $400,000
contract. One of the worst things you can do is be right and not make any
money.
What size account do you think somebody should start with?
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MANUEL OCHOA @ 289
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People shouldn't start trading unless they have at least 50 grand. Otherwise,
youre not diversified enough.
What would you tell someone new to trading?
To trade a couple of different markets for diversification . . . to have starting cap-

ital of at least $25,000, which would be for trading E-Mini contracts.
Thank you very much for sharing your ideas, Manuel.

You're welcome, Marc.
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JIM WHITNER
ONLY THE HUMBLE SURVIVE

By Marc Dupée
emoved from the bustle and frenzied distraction of an urban environment,

Jim Whitner has emerged as one of a new breed of money managers to
watch. The quiet and solitude of the bucolic Blue Ridge Mountains in Virginia
help Whitner focus and zero-in on emerging technologies and economic trends
that become the winning trades of his Stargazer One hedge fund.
Unfettered by the noise of the Street, Whitner spends long hours research-
ing and voraciously reading to arrive at independent judgments of the driving
forces and enterprises that are shaping the economy. In its debut year in 1999,
the fund achieved a 170 percent return.
This has always been his way. For the several years leading up to the launch-
ing of his hedge fund, Jim scrupulously researched the world’s greatest traders
and studied industry trends, company fundamentals, and chart patterns to un-
cover what the best-performing traders and stocks had in common. He also
gained real-world experience trading and managing his family’s money. Learning
from his mistakes, he developed the analytical model he now uses in his hedge
fund to get into the right stocks at the right time.
291
292 ONLY THE HUMBLE SURVIVE
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A competitive amateur equestrian, Whitner is as meticulous with his stock

picking as he is in training for a horse race. For instance, in his preparation for
the Paul Mellon trophy of the Foxhunters’ Chase in 1999, Whitner walked the
3-1/2-mile course so many times that he commented, “I know it so well that, by
now, I walk for the sheer pleasure of it.”
Jim is unassuming. Like most successful traders, he is extremely risk-averse
and displays an interpersonal humility that, he believes, must be extended to the
market. For one of the greatest dangers, Whitner feels, is to allow success to
blind a trader as to what the market is saying at any given moment. Paraphrasing
Intel’s Andy Grove, Whitner sees that “In the markets, only the humble survive.”
Marc Dupée: Jim, tell us about your hedge fund.
Jim Whitner: What we have is, by definition, a hedge fund. But I like to refer to
it as an investment partnership, because in the traditional definition of a hedge
fund, you'll go long and short. We're not really very good at going short. We
don’t like to experiment with our clients’ money, so in learning how to go short,
I'd rather lose my own money.
How would you define the focus of your fund, and how well has that
approach worked for you?
In 1999, we did 170 percent. I can only give you that figure as a track record,
since we started the fund in 1999. But during that single year, we also did 15
percent in the third quarter during which the market got clobbered. The Nasdaq
was up 2 percent, the Dow was down 7 percent, and the S&P 500 was down 6
percent in that same period. We did this by using an investment strategy that not
only helped you make money, but helped you protect your money in a correc-
tion. Our fund is a small, mid-cap growth stock fund. We set it up that way be-
cause we felt we could add a lot of value to a sophisticated investor's portfolio by
giving him exposure to what we call the “entrepreneurial growth in the U.S.
economy.” Everybody has their own definition of market cap, but we like to de-
fine that area as the “sweet spot” of the small, mid-cap segment. That is, we fo-
Caen aa SEES
JIM WHITNER @ 293
ALT CA ER RIT STE GPE TT RE TE I TIE PELE STL RM, SEEM ER GTR ATER
cus on stocks with a market value between $300 million and $5 billion as the
territory between small-cap and big-cap. We'll buy stocks within that range, but
we might even hold them until they grow as large as $12 billion. If you hook
into a Dell Computer, Microsoft, or Cisco, you're not going to sell that gorilla
prematurely if you can help it. The small, mid-cap area is a dynamic area. That’s
where all these new companies that are coming to market with these new prod-
ucts and services are. It’s where the new industries are developing.
How did you get started investing in the stock market?
I was an econ major in college. That happened to be the one area in which I was
getting good grades. From economics I gained an interest in the stock market.
My family needed some help with their personal finances and they asked me to
help them out. Through that, I got a lot of exposure to the markets. Then I
went to business school in the late-’80s and we did a lot of case studies and I re-
alized that I really loved doing research. And I developed a real interest in analyz-
ing companies. The more | read and learned, the more I realized that the classical
edyication you get from the classroom about the stock market isn’t going to make
you very successful.
That's what | expected to hear.

Yeah. So I decided that I was going to read everything that has been written
since the turn of the century about the successful money managers. I’m an avid
reader, so I took off. I read everything I could about Warren Buffett, Philip
Fisher, Peter Lynch, Gerald Loeb, Bill O’Neil. The more I read, the more I began
to understand the dynamics behind the market.
What did you wind up with when you began to synthesize the strategies of
these legends?
I started with a value perspective because I had always idolized Warren
Buffett . . . and I still do. I think Warren Buffett is one of the greatest investors
SERS TST SA CR Na I TESS UO A SESS TR ILS SE ATTIRE REPS EET TEE
of all time. However, I think his value paradigms don’t work very well in the new
economy. But what he did through 1998 was just amazing. The way he managed
the risk in his portfolio was head-and-shoulders above everybody else.
But it sounds like your thinking evolved over time.

As I progressed in my reading, a number of things started to become a lot more
obvious. I started to get a greater appreciation for technical research as opposed
to the purely fundamental approach I started out with. I began to understand
how fundamental and technical research could work together to help me capital-
ize on certain trends in the markets.
How did you arrive at the foundation of your trading strategy?

I read Bill O’Neil’s book. His investment model, CANSLIM, was the founda-
tion. I liked his approach because it encompassed the views of a lot of the great
past money management approaches. But it was a starting point. One of the
most important things I’ve learned is that you have to constantly refine your in-
vestment model as the markets evolve and develop, and as new industries come
into focus.
How do you go about that refinement?
I constantly study the past performance of big winners. For example, I'll go back
and study the big winners of 1999, whether or not I owned them. I'll analyze all
their charts. [’ll study the companies’ fundamentals, technicals, and group confir-
mation. One of the things we've discovered in our research that deviates from the
pure O'Neil approach is that you've got to back off the primary focus on earn-
ings in many cases. You had a number of companies that were huge winners
whose earnings were not very strong. But what distinguished them was that they
had a new product or service in markets that had huge growth potential. Wall
Street was taking notice of these companies. A significant number of big winners
did not have very strong earnings or revenue growth relative to other companies
STL I BS LL AS RS NIL TE I ESS SS IE

JIM WHITNER @ 295
PS SRE SE A RT BEST TG SSS) ST RE RE
that also made big moves. Qualcomm’s revenue numbers weren't that exciting at
first. As economies change and new industries come into focus, you're going to
realize that there are different criteria that help you separate the winners from the
losers.
Early in your career did you make any big mistakes that shaped your current
approach?
In the beginning I wasn't very good and had just average returns. I was trying to
blend growth and value strategies together. I was also listening to others’ opinions
too much. One of the things that really helped my performance was that I
stopped reading everything I could about what was going on in Wall Street and
avoided the weekly articles that appeared in Forbes. That’s not to say that the in-
formation wasn't worthwhile. Rather, I decided that I had to rely upon and make
decisions on the basis of my own research. If Iwas going to follow anything, it
was going to be research and information sources that were in harmony with my
approach. In this business, you have to manage information-overload. In the in-
formation economy, we all have to deal with that. I realized that I needed to
maintain a focus. I learned that successful money managers of the past were fo-
cused. They didn’t let the noise of the Street distract them.
You mentioned earlier that you analyze past winners in order to build a model
of what will be successful in the future. Tell us about how you applied that
model in 1999. What exactly did you look for in a stock in order to produce
the 170 percent return you realized?
We try to focus on those industries that are benefiting from fundamental trends
in the economy. We're looking for companies that are bringing new products and
services to market and that have the potential for tremendous growth over the
next few years. We also want to see that growth evidenced in their quarterly
earnings and revenue numbers. We're looking for companies that are experienc-
ing dramatic growth as a result of a new product or service or new industry
trend.
296 @ ONLY THE HUMBLE SURVIVE
[NRA ai SERce tL ct ke A i A AOC AE AE EA SEE
That probably requires a lot of research, doesn't it?

Definitely. You have to focus on the dominant trends unfolding in the economy
right now, whether it’s broadband data applications, e-commerce, or e-business.
Once you understand what’s going on in those areas, you can relate to telecom
equipment companies, Internet software, Internet security solutions, ISP hosting,
ASP service providers, and wireless broadband applications. You can even get into
biotech and genomics. With this model, we're looking for companies that are
part of dynamic industries whose growth is driven by powerful economic trends.
I look for companies that are evidencing this growth through very strong quar-
terly earnings and revenue numbers. Then we'll check on the story on these com-
panies and see how they fit in with their industry groups.
What do you do with this model that seems to focus primarily on fundamental
analysis?
We'll use technical analysis to help us pick our buy and sell points as well as to
manage the risk. Let me use a couple of examples to illustrate how we do this.
My two biggest winners of 1999 fit the criteria very well. One was MicroStrategy
and the other was i2 Technologies. These were two stocks that had significant
earnings and revenue growth. The enterprise software group was hot. It was one
of the big leading groups in the market. These were two companies with strong
fundamentals and the technical situation looked very promising. So we started
building positions in them.
What did you like about the technical situation? Let's start with i2.
We were catching these stocks breaking out of good, solid bases. That’s always
the key. You don’t want to chase extended stocks, stocks that have already risen a
substantial amount from their bases. Those are going to be the first to pull back
against you. If you can start off from a winning position, then you're much more
able to ride out the next correction. We first bought i2 on Oct. 27, 1999. It had
JIM WHITNER @ 297
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broken out a couple of days before on big volume out of a base around 23 or so.
Then it formed another little base and broke out again. It jumped from 29 to 31
and that’s where we took our first position. That was a pretty good breakout.
The market was just getting ready to take off. i2 was a company with mutual
fund ownership running at about 35 percent of the float at the time, and they
were well-covered by a number of good brokerage firms. They had just recorded
a real solid quarter on the earnings. In the previous quarter, earnings were up
300 percent and revenues were up 53 percent. For the previous couple of quar-
ters they had exhibited very strong quarterly revenue numbers.
{SEAS eS RAR AR NE CA NER RN PE DEES ITE SS LEED,
What about MSTR? Similar setup? Looking at the chart | can see that the
stock broke out in late November.
MSTR was a similar setup. We actually started buying MicroStrategies on
September 23, 1999, which was right in the middle of the third-quarter market
correction. If you look at it on a weekly chart, it was just starting to break out.
They had very strong earnings and revenue numbers on a quarterly basis.
That's interesting that you mustered up the confidence to buy MSTR during a
market correction.
One of the things that’s important about the investment model is that if you go
back and study the characteristics of past winners, its so much easier for you to
step up to the plate and open a position in the next good idea that fits your pa-
rameters—even in a correction. You've seen it happen time and time again. If you
understand that a company fits the parameters of the past Dells and Microsofts,
you feel a lot more comfortable doing this. That’s one way in which money man-
agers manage the risk in a portfolio: They put money into the best ideas they can
find. Admittedly, I missed a lot of the biotech advance of late 1999 and early 2000
mainly because it was really hard for me to wrap my hands around those compa-
nies when they were going from 20 to 80. That’s not to say I didn’t think they
could be big winners. Rather, the issue was more in managing the risk.
In other words, you couldn't see examples of past winners that the hot
genomic group within the biotech sector resembled, right?
That's it. We didn’t understand this particular industry as well as we understood
Internet-related companies. But we're starting to learn a lot about biotechs and
we'll be in a position as we go forward to step up to the plate.
What industry trends do you see on the horizon that you imagine you might be
participating in down the road? Earlier we touched on the subject of biotech.
Do you see yourself getting into that?
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JIM WHITNER # 299
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Well, if you just look at what happened in the biotech stocks in late 1999 and
early 2000 and consider how they showed tremendous strength in the January
2000 market correction, it reminds me of the big trend in Internet stocks back
in 1996 and 1997 when Yahoo! and America Online came on the scene. Re-
member those nasty corrections we had back then? They weren't beaten up
much at all! They held their own. You could say they were trading at huge val-
uations relative to their earnings numbers back then. The biotechs seem to have
started to come into their own. They’re starting to gain a lot of recognition on
the Street. Technology is rapidly making dynamic changes in the research-
and-development process.
300 @ ONLY THE HUMBLE SURVIVE
SSE Ae ENE SLT A EE LL
Now let's talk about how you go about dumping your losers . . . if there are any.
(Laughs) Yeah, there are losers. The thing is, risk management is the most impor-
tant part of our investment strategy. We set a stop 8 to 10 percent below where
we bought our first position. We will walk into the position. Let's say we want to
own 8,000 to 10,000 shares ofa stock. We might buy 3,000 shares, wait for it to
jump up 2 points to buy another 3,000 shares, and then another two points to
buy another 3,000 shares. So we'll average in. This way, we're committing the
smallest amount of capital to the position each time we buy some shares in the
stock. The idea is that when we initially jump in, were committing a small
amount of our capital so that when we take a loss, it’s a smaller loss. There are
exceptions to the rule, of course. When we feel like the market is starting to turn
and we're getting into a bull market, we'll just all of a sudden go full margin.
We'll just max out. But even when we do that, we'll treat each individual posi-
tion on its own merit. We're not afraid to sell them. (Whitner snaps his fingers
quite loudly.)
The most important thing you can do in managing money is to manage the
risk of each position. It’s more important than all your research. If you go back
and study some of those guys like Paul Tudor Jones, Dreyfus, Bill O'Neil, you'll
find that they were all obsessed with managing the risk of their positions. It all
goes back to that very simple concept: If you cut your losses short and let your
winners ride, you're going to make a lot of money in the market.
What are your criteria for selling?
First, it’s the stop. In addition, we'll use the 10-, 30-, and 50-day moving aver-
ages as additional exit indicators. We'll look at the stock crossing the 30-day MA.
If it’s starting to hit the 30-day MA and it’s not very extended, we'll usually get
out. Another significant selling signal is when the 10-day MA starts to turn be-
low the 30-day MA. A lot of times when a stock climaxes after an advance and it
just starts to fall apart, you'll see the stock break below the 30-day MA. And then
you might see it bounce back up, and then you'll see the 10-day MA start to
JIM WHITNER @ 301
TI PE ST PELL TT ES De RINE TT AO EOL PIED 2 SF OTT MTU, RV ED OT ae
break below the 30-day MA. Usually, I find that by the time the 10-day MA
drops below the 30-day MA, the stock has lost its institutional support.
Where does the 50-day MA come in?
If the stock hits the 50-day MA, that’s usually the big warning signal.
Can you give a scenario as to how these moving averages work together in
order to help you exit a losing trade?
The idea is that these stocks we get into are trading above their 30-day MA and
they should continue to trend up above the 30-day MA. Say you have a large
amount of appreciation in a certain position. Say youre up 100 percent; you
bought the stock at 80 and it goes to 160. Then you come into this correction
and the stock pulls back to 140 and it’s hitting the 30-day MA. We probably
wouldnt sell it if it’s holding up better relative to other stocks in the market and
its sector. Your big winners will tend to form another base in a correction and
trade sideways. They'll be the first to break out on the next rally. When you start
t6 see stocks fall below the 50-day MA across the board, that’s a pretty negative
kind of signal and it’s also a very negative indicator for the health of the market.
When the market falls apart like that, you'll want to go to cash.
Do you have any particular indicators you like for market timing?
Well, one of the things I do is focus on the interest rate outlook. I'll try to have a
feel for what the Fed is doing and how the market is reacting to their decisions. I'll
just look at the daily charts and look at moving averages for the major indices. I
like to look at the indices as a group. We like to look at the Dow, the OEX, S&P
500, the Nasdaq Composite, and the Nasdaq 100 and see how they're behaving as
a group. I also look at what the leading industry groups are. If all the leaders start
to fall apart, I know it’s time to take my money off the table.
RS ll Re UE WS I A IE EO I I TDS SE
Let's talk about your trading psychology. You keep a detailed record of
winners you've studied which gives you the confidence to enter new
positions when you see stocks that fit that model. You've also mentioned that
you're isolated from the rest of the world. You don't read other people's
opinions and you live way out in the boonies. Tell us a little about your whole
thought process when it comes to trading.
Let’s make an important distinction. I read profusely..I read all day long, seven
days a week. A lot of the reading I’m doing is on different industries and compa-
nies. What I avoid is other people’s opinions. It’s not that I don’t respect their
opinions. But they just cloud my judgment. There are a lot of smart people out
there and they all have systems that work for them. And I love to sit down and
talk to people about the market. But I'll be the first to say that I don't know
what the market’s going to do tomorrow or over the next two quarters or over
the next five to 10 years. I’ve got some pretty good ideas of where | think the
growth is based on the current economic situation and certain fundamental
trends in the economy. And I’ve got a pretty good idea of where I might want to
put my money to work. But it’s very important to keep an open mind, be flexi-
ble, and try not to predict anything.
I think it’s important to be humble. To borrow a quote from Andy
Grove—who said, “only the paranoid survive’—only the humble survive in the
stock market. As soon as you think youre smarter than the market and smarter
than everybody else, you're going to get your head handed to you. As soon as I
buy into a position, I totally go on the defense. I’m more concerned about losing
money in a position than I am winning it. Like Paul Tudor Jones, I’m obsessed
with defense. —
Your obsession with risk extends to where you live, doesn't it?
Well, actually the reason I moved out here has nothing to do with the stock mar-
ket. We live in probably some of the most beautiful country in the world. It’s
Middleburg, Virginia, which is in the foothills of the Blue Ridge Mountains. It’s
actually a very historic area because a lot of Civil War battles were fought here.
ie BD ean a te TTY
JIM WHITNER @ 303
Probably more Americans died in the surrounding area than in any other place in
the world. It’s also big horse country. I love to ride and train.
Do you find that isolation helps you?

If you were to ask me where I'd move next, I would tell you that I wouldn't
move back to New York. If I did live in New York, I would operate in isolation
from the market establishment. The reason is that I want to let my research tell
me what to do and not listen to the gossip on the Street. You look at Warren
Buffett living out there in Omaha, Nebraska, okay? He achieved all that success
living out there. I think that’s a perfect example of how guys are able to get away
from the Street and do their good-quality research and succeed. That's not to say
the Street is a bad place. It’s just that for my particular type of personality, the
isolation works for me. I'd say I’ve almost become kind of a hermit over the last
five years. A lot of my friends who live in other parts of the country complain
because they never hear from me. It’s really because I get so absorbed in my
work,
‘take it that you must put in a lot of hours.

One of the great aspects about the market is that there are always another couple
of good ideas coming down the pipe. The only catch is, you've got to do your re-
search. If you're going to invest in these markets, you've got to be willing to put
in the time and effort to do the research. | probably do 60 or 70 hours a week of
mostly research. It’s something I enjoy doing.
Thanks, Jim. Best of luck to you.

Same to you, Marc.
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FINAL THOUGHTS
he world of the top trader reeks of mystique and intrigue. Unlike the glam-
orous persona depicted by the media, the outstanding trader must con-
stantly deal with a sea of conflicting emotions and extreme ups and downs, all
the while railing against a set of odds stacked firmly against him or her. It is our
hope that this book sheds fresh light on the strategies, emotions, and thought
processes associated with the best.
Many aspiring traders believe that a sound strategy is all it takes to succeed
in the world of trading. If only it was this easy!
Those readers in search of the mysterious “Holy Grail,” some sort of elusive
indicator or trading system that promises to deliver fat profits to a trader's door
step, will no doubt come away from these pages disappointed. The Holy Grail
simply doesn’t exist. The outstanding players in this book reached the top not by
possessing a Holy Grail, but rather by developing and maintaining an edge over
their competition. In itself, understanding that there is no such thing as a Holy
Grail is one of this book’s most valuable lessons.
Those who had hoped to learn more about specific trading strategies will no
doubt be able to walk away from this book with a greater knowledge of how the
top traders do it. If youre like us, you will, in short order, seek to apply some of
305
306 @ FINAL THOUGHTS
ase ace a0)a aS RO RR eT EA OE SPER I TEI a NE IEEE,
the techniques discussed inside—be they entry setups, exit criteria, or pyramiding
methods—to your own trading.
Meanwhile, there are those who were drawn to these pages purely out of a
desire to learn more about the intangibles—that sense of je ne sais quoi—that go
with being a top trader. It is you whom we suspect will glean the most from
these chapters.
Along these lines, it is our expectation that this book’s coverage of these
“big-picture qualities’-—among them discipline, flexibility, persistence, patience,
desire, passion, and humility—will give you a keener grasp of exactly what it
takes to become a top trader.
Interestingly, by the time we had wrapped up our interviews, it became
clear that, despite these traders’ differing strategies and backgrounds, a number of
common threads ran throughout. The most obvious to us was an all-consuming
passion for the markets. Comments such as “When I walked out onto the trad-
ing floor, I thought it was the greatest thing I ever saw in my life” are typical of
these traders’ near-obsession with the markets. Others confessed to being “trad-
ing junkies” or made comments such as “there is no place youd rather be: it’s
a narcotic.” Stull another trader is so obsessed with trading that he reads about
the market while driving.
But while these traders’ love of the markets appears on the verge of obses-
sion, their passion is anything but reckless. In fact, of all the qualities needed to
put a trader on top, we noticed that “discipline” was the one that came up the
most in our conversations. Here, discipline means to have a trading plan and to
“follow your plan in all kinds of market environments.”
Tied in to discipline, outstanding traders share a level of risk aversion that
compels them to adhere rigorously to a loss-management plan. Simply, they're not
afraid to pull the trigger on a trade gone sour, take their loss, and move on to the
next trade. As one trader put it, “I would rather have a mediocre strategy and a
good money management system than a good strategy and a mediocre money
management system.
Indeed, we came into this project knowing that discipline is important in
developing success as a trader. Somehow, though, hearing it from some of the
world’s top traders drives the point home like no other! Thus, by the time this
FREESE
P SRA Sh 5 Ra E ES
FINAL THOUGHTS @# 307
er
project was completed, we became convinced that discipline is the end-all and
be-all. With it, a trader has a chance at being an outstanding performer. Without
it, he hasn't a chance.
It makes sense to think that a big ego goes hand-in-hand with being a great
trader. For us, however, one of the biggest surprises of this project was the real-
ization that these gentlemen cast their egos aside when it comes to battling the
market. Early in their careers, they realized that the market is smarter than they;
to trade egotistically is to trade foolishly. They learned, sometimes the hard way,
that a large ego has no place in the mindset ofa highly successful trader.
Once we understood the make-up of a top trader, we came to the following
conclusion: Certainly, the biggest downfall for most aspiring traders is a belief
that they know more than the market. Learning how to throw in the towel on a
trade, then, is absolutely crucial.
Perseverance was another quality that permeates the careers of these players.
They hunker down during trying periods, redouble their resolve to win, and do
not accept failure under any circumstances.
All of these top performers struck us as being less interested in the monetary
spoils of their profession and much more interested in the game itself. They trade
decause they want to see their trading plan succeed. The money they make, then,
is a by-product of the proper execution of their trading plan and the spoil of the
achievement of successful trading.
Ultimately, the litmus test of any book about trading is its effect on the
reader—not only in the present, but also in the future. With this in mind, we are
confident the reader will find it worthwhile to revisit these pages from time to
time so as to reinforce the concepts and ideas presented herein. We know that we
will.
Passion, discipline, competitiveness, humility, flexibility, perseverance, and
the ability to learn from mistakes are the recurring characteristics that emerged
from these interviews. These are the traits that bring these gentlemen unusual
success in the markets. These are the characteristics that allow a trader to step
away from the rest of the pack, to develop instinct, a certain sixth sense, about
the markets.
These are the qualities that put a trader on top.
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Other Books from

M. GORDON
PUBLISHING GROUP
www.mgordonpub.com
HIT AND RUN TRADING

The Short-Term Stock Traders’ Bible
JEFF COOPER
Written by professional equities trader, Jeff Cooper, this best-selling manual teaches traders
how to day-trade and short-term trade stocks. Jeff’s strategies identify daily the ideal
stocks to trade and point out the exact entry and protective exit point. Most trades risk 1
point or less and last from a few hours to a few days.
Among the strategies taught are:
* Stepping In Front Of Size—You will be taught how to identify when a large
institution is desperately attempting to buy or sell a large block of stock. You will
then be taught how to step in front of this institution before the stock explodes or
implodes. This strategy many times leads to gains from 1/4 point to 4 points
within minutes.
* 1-2-3-4s—Rapidly moving stocks tend to pause for a few days before they
a explode again. You will be taught the three-day setup that consistently triggers
solid gains within days.
¢ Expansion Breakouts—Most breakouts are false! You will learn the one breakout
pattern that consistently leads to further gains. This pattern alone is worth the
price of the manual.
¢ Also, you will learn how to trade market explosions (Boomers), how to trade
secondary offerings, how to trade Slingshots, and you will learn a number of
other profitable strategies that will make you a stronger trader.
160 PAGES HARD COVER $100.00
STREET SMARTS
High Probability Short-Term Trading Strategies
LAURENCE A. CONNORS AND LINDA BRADFORD RASCHKE

Published in 1996 and written by Larry Connors and New Market Wizard Linda Raschke,
this 245-page manual is considered by many to be one of the best books written on trading
futures. Twenty-five years of combined trading experience is divulged as you will learn 20
of their best strategies. Among the methods you will be taught are:
* Swing Trading—The backbone of Linda’s success. Not only will you learn
exactly how to swing trade, you will also learn specific advanced techniques
never before made public.
* News—Among the strategies revealed is an intraday news strategy they use to
exploit the herd when the 8:30 A.M. economic reports are released. This strategy
will be especially appreciated by bond traders and currency traders.
* Pattern Recognition—You will learn some of the best short-term setup patterns
available. Larry and Linda will also teach you how they combine these patterns
with other strategies to identify explosive moves.
e ADX—In our opinion, ADX is one of the most powerful and misunderstood
indicators available to traders. Now, for the first time, they reveal a handful of
short-term trading strategies they use in conjunction with this terrific indicator.
° Volatility—You will learn how to identify markets that are about to explode and
how to trade these exciting situations.
° Also, included are chapters on trading the smart money index, trading Crabel,
trading gap reversals, a special chapter on professional money management, and
many other trading strategies!
HIT AND RUN TRADING II

CAPTURING EXPLOSIVE SHORT-TERM MOVES IN STOCKS
JEFF COOPER
212 fact-filled pages of new trading strategies from Jeff Cooper. You will learn the best mo-
mentum continuation and reversal strategies to trade. You will also be taught the best
day-trading strategies that have allowed Jeff to make his living trading for the past de-
cade. Also included is a special five-chapter bonus section entitled, “Techniques of a Pro-
fessional Trader” where Jeff teaches you the most important aspects of trading, including
money management, stop placement, daily preparation, and profit-taking strategies.
If you aspire to become a full-time professional trader, this is the book for you.
THE 5-DAY MOMENTUM METHOD

JEFF COOPER
Strongly trending stocks always pause before they resume their move. The 5-Day Momen-
tum Method identifies three- to seven-day explosive moves on strongly trending momen-
SP TR I ET PNA A SO STEP DATA SERIA IEF ee dk i, SE ge
tum stocks. Highly recommended for traders who are looking for larger than normal
short-term gains and who do not want to sit in front of the screen during the day. The
5-Day Momentum Method works as well shorting declining stocks as it does buying rising
stocks. Also, there is a special section written for option traders.
SPIRAL BOUND $50.00
INVESTMENT SECRETS OF A HEDGE FUND MANAGER

Exploiting the Herd Mentality of the Financial Markets
LAURENCE A. CONNORS AND BLAKE E. HAYWARD
Released in 1995, this top-selling trading book reveals strategies that give you the tools to
stand apart from the crowd.
Among the strategies you will learn from this book are:
* Connors-Hayward Historical Volatility System—The most powerful chapter in
the book, this revolutionary method utilizes historical volatility to pinpoint
markets that are ready to explode.
* News Reversals—A rule-based strategy to exploit the irrational crowd
psychology caused by news events.
* NDX-SPX—An early-warning signal that uses the NASDAQ 100 Index to
anticipate moves in the S&P 500.
* Globex—Cutting edge techniques that identify mispricings that regularly occur on
the Globex markets.
e 225 PAGES CLOTH COVER $49.95
CONNORS ON ADVANCED TRADING STRATEGIES

31 Chapters on Beating the Markets
LAURENCE A. CONNORS
Written by Larry Connors, this new book is broken into seven sections; S&P and stock
market timing, volatility, new patterns, equities, day-trading, options, and more advanced
trading strategies and concepts. Thirty-one chapters of in-depth knowledge to bring you
up to the same level of trading as the professionals.
Among the strategies you will learn are:
* Connors VIX Reversals I, II and III (Chapter 2)—Three of the most powerful
strategies ever revealed. You will learn how the CBOE OEX Volatility Index (VIX)
pinpoints short-term highs and lows in the S&Ps and the stock market. The
average profit/trade for this method is among the highest Larry has ever
released.
* The 15 Minute ADX Breakout Method (Chapter 20)— Especially for
day-traders! This dynamic method teaches you how to specifically trade the most
explosive futures and stocks everyday! This strategy alone is worth the price of
the book.
* Options (Section 5)—Four chapters and numerous in-depth strategies for trading
options. You will learn the strategies used by the best Market Makers and a small
handful of professionals to consistently capture options gains!
° Crash, Burn, and Profit (Chapter 11)—Huge profits occur when stocks implode.
During a recent 12-month period, the Crash, Burn and Profit strategy shorted
Centennial Technologies at 49 1/8; six weeks later it was at 2 1/2! It shorted
Diana Corp. at 67 3/8; a few months later it collapsed to 4 3/8! It recently
shorted Fine Host at 35; eight weeks later the stock was halted from trading at
10! This strategy will be an even bigger bonanza for you in a bear market.
° Advanced Volatility Strategies (Section 2)—Numerous, never-before revealed
strategies and concepts using volatility to identify markets immediately before
they explode.
¢ and much, much more!
METHOD IN DEALING IN STOCKS

Reading the Mind of the Market on a Daily Basis
JOSEPH H. KERR, JR.
This gem was originally published in 1931 by Joseph Kerr has been expanded and up-
dated to reflect today’s markets. This book is considered to be the bible of interpreting
both daily market action and daily news events.
150 PAGES PAPERBACK $35.00
TO ORDER CALL:
1-800-797-2584 or 1-213-955-5777 (outside the U.S.)
OR FAX YOUR ORDER TO:
1-213-955-4242
OR MAIL YOUR ORDER TO:
M. Gordon Publishing Group, 445 S. Figueroa St.,
Suite 2930, Los Angeles, CA 90071
www.mgordonpub.com
All orders please add $6 + $1 each add'l item; Priority Mail: $8 + $1 each add'l item:
Airborne Int'l: $25 for shipping and handling.
California residents include 8.25% sales tax.
FREE REPORT
Maximize Your Trading Profits Immediately!
David Landry, TradingMarkets.com Director of Re-

search, has put together a set of simple money manage-
ment rules to help all traders become more successful
in his report The True Secret to Trading Success: Simple
Money Management Rules That Will Make You a More
Profitable Trader!
To obtain this report, send your request along with
your name and address to:
M. Gordon Publishing Group, Inc.
445 S. Figueroa Street, Suite 2930, Dept. H2
Los Angeles, CA 90071
Or
Fax your information to 213-955-4242.
Your report will be mailed immediately.
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ABOUT THE AUTHORS
evin N. Marder, an equity trader since 1986, is president of Los Angeles-

based Marder Investment Advisors. Previously, he was editor-in-chief of
TradingMarkets.com and a co-founder of CBS MarketWatch, where his market com-
ments were broadcast over the CBS Radio Network several times daily. Marder has
b@en written about in Forbes, the Los Angeles Times, Red Herring, and Online Investor,
among other publications.
From 1990 to 1995, Marder provided equity research services to a hedge fund
and developed fixed-income portfolio analytic software for use by institutional portfo-
lio managers and brokerage firms. Marder is a contributing author to the
Prentice-Hall book, Computerized Trading.
He received an MBA with honors in Investments and Corporate Finance from
the University of Southern California.
M* Dupée is futures editor of TradingMarkets.com. A trader of stock index fu-

tures and currencies, he got his start in the financial markets on the floor of the
Comex.
319
316 ABOUT THE AUTHORS
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Dupée received a B.A. in Political Economy from the University of California,

Berkeley and an International MBA from the University of San Diego. Dupée is a U.S.
Coast Guard-licensed captain and has circumnavigated the globe on sailing vessels.
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M. GORDON PUBLISHING GROUP
Aboutthe Authors
Kevin N. Marder, an equity trader since 1986, is editor-in-

chief of TradingMarkets.com. Previously, he was a Cco-
founder of CBS MarketWatch, where his market comments
were broadcast over the CBS Radio Network several times
daily. Marder has been written about in Forbes, the Los
Angeles Times, Red Herring, and Online Investor, among
other publications.
Marder has provided equity research services to a hedge
fund and developed fixed-income portfolio analytic
software for use by institutional portfolio managers and
brokerage firms. Marder is a contributing author to the
Prentice-Hall book, Computerized Trading. He received an
MBA with honors in Investments and Corporate Finance
from the University of Southern California.
Marc Dupée is futures editor for TradingMarkets.com. A

trader of stock index futures and currencies, he got his start
in the financial markets on the floor of the Comex.
Previously, Dupée developed business curriculum for the
University of California, Berkeley Haas School of Business’
program and created documentary programming for CNN
and NBC.
Dupée received a B.A. in Political Economy from the
University of California, Berkeley and an MBA in
International Business from the University of San Diego.
Dupée is also a U.S. Coast Guard licensed captain and has
circumnavigated the globe on sailing vessels.
445 S. Figueroa Street, Suite 2930

Los Angeles, California 90071
213.955.5777 Fax: 213.955.4242
Become An Even Better Trader www.mgordonpub.com

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445 S. Figueroa Street, Suite 2930

04. GORDON P hese SHING GHROUOr

Printed in the United States of America

lo Barbara Dupée, my mother,

TRADING WITH THE GENERALS 33

THE TRAIL BLAZER 133

HIT AND RUN 145

PIT MECHANIC 161

MERCURY RISING 189

PASSIONATE PLAYER 209

THE COMEBACK KID 231

ONLY THE HUMBLE SURVIVE 291

TEEN 5 ETE SCRA POE EERE SET UL SLEPT TTL TE A I SS UTS TS

FINAL THOUGHTS 305

Wisse (al iweres

SE STE EA I ELE HE SANE ENG ST ED

A, ~ : ; Md tergaieesn: oete gerade ine, “ihetote

than, 4 = » « 4 as ve he ' e. (pe rr) oo rn! @e ia

nen eda et eum aly treyion y™ Salt Prien firey aabaeeaal

Long live the California Momentum School.

Y would be hard-pressed to find a trader with a more outstanding track re-

(SEES TERS ES, STAR AE Pe PS RAD

BESIDES SLE RSLS RES Oe TS TE ET SS

Kacher: I finished my BS degree in chemistry at Berkeley and I went right into

(STEUNSITE TRESS PSE LDN AT STS

What did you start doing for the company?

EXER SSS BE TEES RSET SR AE TS PT SE SNE TRUE

And if you're 200 percent long?

Kacher: I'll typically have anywhere between 10 and 15.

Whereas the first example of the more-liquid, institutional-quality name

So you might have up to 35 percent or so in one position if you really feel

TESIENGENEE SL NER ES EN, I ER a ED SS

What were your results in 1999?

What percentage weighting do you place on your fundamental analysis

Whereas the first example of the more-liquid, institutional-quality name

So you might have up to 35 percent or so in one position if you really feel

What were your results in 1999?

What percentage weighting do you place on your fundamental analysis

Right away, meaning the first day?

ERE WE aMTSE SE NS ES RR DE STE SET EES RON TE ET ST SO IEE IG

So a lot of institutions are really watching that 50-day, then.

To me, the toughest decision is the sell-to-nail-down-a-profit decision. The

EE aS SES TEES UTS SNE MED SAT SS TS SE SS A TT

Climax Top: Sun Microsystems (SUNW), Daily

Sun Microsystems Inc-Daily- 0107/2000 .C=71.875 .43.875 .O=67.188

Volume 20139000 .00 Volume declmes

all dai likiluisll

How would you have handled JDS Uniphase?

Morales: It depends on my cost basis.

That's pretty significant, then.

Morales: Yeah, but you were getting tremendous gains.

SESE TT RSE RSG OR TEHDI LT. SS TL a NTS a

So that means that you might extend yourself up to 30 to 40 percent long

Wedging Top: Verity (VRTY), Daily

Verity Inc-Daily .1214/1999 C=49.090 -5.000 G=55.063 H=55.063 |

~ Created withSuperCharts byOmega Research © 1997

Failed Breakout: Razorfish (RAZF), Daily

Razorfish Inc-Daily 01/07/2000 C=39.500 +3.969 O=38.000