The New Market Wizards: Conversations with America's Top Traders (39 page)

I also track different indicators. I don’t think the specific choice of indicators is that critical, as long as you have a good feel for interpreting the indicators that you use. Personally, I pay close attention to the tick [the difference between the number of issues whose most recent tick was up and those whose most recent tick was down], TRIN [a measure that relates the price and volume of advancing issues to the corresponding figures for declining issues], and premium [the premium, or discount, of stock index futures to the theoretically equivalent cash index price]. For example, if the tick is at an extreme level and falling—480, –485, –490, –495—and then just pauses—–495, –495, –495—and the other indicators I watch are also oversold, I’ll often go in and buy at the market. Sometimes, I’ve actually bought the low tick of the day using this method.

I really have no fear of buying into breaks or selling into rallies. Sure, once in a while the market will keep on going, and I’ll immediately be down a full point or more on the S&P. However, by waiting for a sufficient extreme, even in such situations, the market will often snap back enough to let me out near even. Perhaps my number one rule is: Don’t try to make a profit on a bad trade, just try to find the best place to get out.

So when you have a bad trade, you don’t dump it immediately.

That’s right. I find that I can usually get out at a better price if I have a little patience, since the reason I got into the trade in the first place was because the market was so overdone that a reaction seemed overdue. Once I’m out, it’s easy for me to get back in. If I buy back at a higher price, I just look at it as a fresh trade.

When did you set up your home trading office?

About three months after leaving the floor.

After spending years surrounded by people on the floor, did you find it difficult to adjust to the isolation of trading from home?

For the first four years, being off the floor was great—no distractions, no outside opinions. Last year, however, the isolation started to really bother me. I got lonely. I tried talking to other traders on the phone during the day, but I found that it was distracting and lowered my productivity. I also tried establishing a trading office with another trader, which worked great for a while until he left to establish a trading operation in New York. And I tried hiring an assistant, but it didn’t add to my bottom line.

Now I try to deal with the isolation by scheduling projects outside of the trading day in order to keep me involved with the outside world. I’m a member of the Market Technicians Association and I try to attend every meeting. I have also worked with a programmer to develop neural network trading indicators, which I’m now using as a market tool. [A key characteristic of neural network programs is that they are not static; rather, they evolve as they “learn” from the data.] This project has also led to lots of calls to other people across the country who are working on applying neural networks to trading.

I recognize that isolation has become a problem, and I keep on trying to find different solutions. I think that eventually I might like to have one or two traders sharing my office again.

Since you’re primarily a trader of stock index futures, I’m curious about what your experiences were during the incredible crash of October 1987.

Ironically, I stopped trading about a month before the crash. I had a phenomenal year up to that point, making more than half a million dollars, which was nearly twice as much as I had made the year before. I couldn’t believe how well I was doing. I had caught all the major market swings. I had a feeling that I had just been too hot and shouldn’t press my luck anymore. At the same time, I had the opportunity to apprentice with a horse trainer whom I had been working with. I decided that it would be a good time to take a trading hiatus.

So you weren’t involved in the market at the time of the October 1987 crash?

Not exactly. I had no positions at the start of that week. However, during the period in which I had stopped trading, I called my husband (he’s a market maker on the Philadelphia Stock Exchange) each morning to find out what was happening in the markets. When I called him from the stables that morning, he said, “You’d better get home and watch this day! All the world markets have crashed, and it looks like the Dow Jones is going to open 200 points lower!” When I heard that, I thought to myself, “Boy, this is great. This is the buying opportunity I’ve been waiting for.”

I rushed home and turned on the news. Everyone was talking panic, panic, panic. Silly old contrarian me is thinking, “This is terrific. Let’s see how low we can open the market.” As you recall, the market kept plummeting all through the day. I had to force myself to hold back from buying. Finally, in the early afternoon, I couldn’t wait any longer. I bought one S&P futures contract. In the final hour of trading, I kept on buying, as the market moved lower. By the end of the day, I was long ten contracts.

When the market closed, were you down for the day?

Oh sure. The market closed near its lows. I was down about a $100,000.

Did that bother you?

No, not really. Of course, I was a little annoyed with myself for not being more patient, because I could have gotten a better average price if I had waited. However, I really wasn’t concerned about the initial loss on the position. The futures market was at such a large discount relative to the cash stock index that I was sure it would open higher the next day, which it did.

Did you get out on the higher opening?

I took profits on only part of the position. My plan was to stay long. I thought that we had seen such a level of stupidity in the market, with people virtually throwing away stocks that had value, that I felt it just had to be a selling exhaustion point. As one example, I remember when I first went down to the floor of the Philadelphia Stock Exchange, Salomon Brothers stock was trading at $32. It eventually ran up to over $60. Here it was on the day of the crash down to $22. To me, it seemed ridiculous that people were pricing stocks that way.

You make it sound like you completely shrugged off the panic that engulfed the markets that week.

I don’t think I underestimated the risk of the trade when I bought ten S&P futures on the day of the crash. However, in retrospect, I certainly was naive in having faith that the markets, clearing firms, and banks would continue to function. The subsequent realization that if the Fed had been less aggressive, my clearing firm, along with many others, could have gone bankrupt, obliterating my account equity in the process, really shook me up.

Does it ever bother you when you lose?

Not at all. It never bothered me to lose, because I always knew that I would make it right back. I always knew that no matter what happened, I could go into any marketplace, with any amount of money, and make a living.

Could you describe the mistakes you’ve made in your trading career that served as learning experiences?

My own particular weakness has always been being a bit premature on entering positions. As the saying goes, “The pioneers are the ones with the arrows in their backs.” I’ve learned to think to myself, “Patience, patience, patience.” I try to wait until things set up just right before I take a trade. Then, when I’m ready to take the trade, I slowly count to ten before I pick up the phone. It’s better to have the wrong idea and good timing than the right idea and bad timing.

Another mistake I’ve frequently made is participating in too many markets at one time, which leads to sloppy trading. I’ve also found that it’s my smallest positions that cause my biggest losses, because they tend to be neglected. It’s natural to be cautious and attentive to big positions. With the small positions, it’s easy to fall into the trap of being complacent. My awareness of this pitfall has made me more careful with such positions.

I realize that I’m only human, and that I’ll always make mistakes. I just try to make them less frequently, recognize them faster, and correct them immediately!

What percentage of your trades are profitable?

About 70 percent.

Is your average winner also larger than your average loser?

On my short-term trades, on a per contract basis, my average win is about $450 (the figure would be higher if I included longer-term trades), and my average loss is just over $200.

With both the percentage and average magnitude of your winning trades outdistancing the losers by a better than two-to-one ratio, it sounds like you would be profitable in every month.

Every month! My philosophy is to try to be profitable every day! Of course, I don’t quite achieve that consistency, but that’s my goal. I’m probably profitable nearly every week. Remember, I do this for a living, and I use my own money. I really value the fact that I’ve learned to trade as a craft. Like any craft, such as piano playing, perfection may be elusive—I’ll never play a piece perfectly, and I’ll never buy the low and sell the high—but consistency is achievable if you practice day in and day out.

I assume that, in part, your consistency can be attributed to the intensity with which you follow the markets. When you described your trading earlier, it sounded like you virtually followed a market tick by tick. I assume this type of approach must limit the number of markets you can trade. How many markets do you follow at one time?

It varies. I analyze twenty markets. But at any given time, I trade no more than about six markets. Ideally, I would like to trade every market, every day, but I know that’s physically impossible.

Couldn’t you train assistants to apply your methodologies to the markets you can’t watch?

I’ve tried that. I hired and trained someone for a year. He was the nicest person you could hope to meet. Any organization would have been proud to have him as an employee. He was extremely hardworking and loyal. He was in perfect physical shape—he ate well and practiced karate every day. Emotionally, he was on such an even keel that I never once saw him get angry at anyone.

I put a lot of time and effort into training him. I even gave him his own account, because I thought that the only way he could learn to trade was by doing it. Unfortunately, it didn’t work out.

What went wrong?

He didn’t seem to have any passion for trading. He couldn’t pull the trigger. I think he didn’t like the idea of taking risks. [Linda describes a typical conversation with her assistant:]

“OK, Steve, what’s your game plan for today?”

“I think I’m going to buy wheat today,” he says, explaining his reasons for the trade.

“That’s great!” I say, trying to encourage him.

At the end of the day, I ask him, “Did you buy the wheat?”

“No,” he answers.

“Well, what did you do?”

“I watched it go up.”

[She laughs wholeheartedly at the recollection.]

Why do you believe you have excelled as a trader?

I believe my most important skill is an ability to perceive patterns in the market. I think this aptitude for pattern recognition is probably related to my heavy involvement with music. Between the ages of five and twenty-one, I practiced piano for several hours every single day. In college, I had a dual major of economics and musical composition. Musical scores are just symbols and patterns. Sitting there for hours every day, analyzing scores, probably helped that part of my brain related to pattern recognition. Also, practicing an instrument for several hours every day helps develop discipline and concentration—two skills that are very useful as a trader.

Could you elaborate some more on the parallels between music and the markets?

A musical piece has a definite structure: there are repeating patterns with variations. Analogously, the markets have patterns, which repeat with variations. Musical pieces have quiet interludes, theme development, and a gradual crescendo to a climax. The market counterparts are price consolidations, major trends, and runaway price moves to major tops or bottoms. You must have patience as a musical piece unfolds and patience until a trade sets up. You can practice, practice, practice, but you’re never going to play a musical piece perfectly, just as you’re never going to buy the low and sell the high on a trade. All you can hope to do is to play a piece (or trade) better than before. In both music and trading, you do best when you’re relaxed, and in both you have to go with the flow.

A final analogy may explain the type of trading I’ve gravitated toward. You must be able to read individual notes and learn a piece of music measure by measure before you can play the whole piece through. Perhaps that’s why I spend most of my energy on short-term trades rather than analyzing the long-term picture.