Faith was part of the now-legendary, and at times controversial, ‘Turtles’. In the 1980s, Richard Dennis, a Chicago commodities trader who turned $1000 into $200 million, hired a group of 23 people to attempt to prove to his partner William Eckhardt that traders could be taught. Eckhardt thought Dennis’ success came from an innate talent that couldn’t be passed on to others.

The turtles, supposedly named because Dennis said he was going to grow successful traders like a turtle farm he’d seen inSingapore, were taught a long-term trend following system, a set of mechanical rules that attempted to manage risk and capture big moves in a variety of markets.

The project was a success with the Turtles reportedly earning $US175 million profit in five years. Faith, the youngest Turtle, himself earned more than $US30 million efore the group was disbanded. Some, including Jerry Parker of Chesapeake Capital, have gone on to be successful money managers.

The Turtle legend was boosted by the famous interview in Jack Schwager’s Market Wizards, ‘The Silence of the Turtles’. Faith has been one of the few Turtles to speak and write about his Turtle experience. Since the Turtle experiment ended, he has launched businesses, run a fund and traded his personal account. Faith has also written about the Turtles in his books, ‘Way of the Turtle’ and “Inside the Mind of the Turtles’.

His latest book is Trading from Your Gut, which represents his belief that trading success comes not just from following Turtle-like mechanical rules, but from intuition. The book outlines how traders can benefit, not just from left brain analysis, but from increasing their use of right brain instincts.

He spoke with YTE’s Ben Power

The Turtles were basically a group chosen to follow a set of rules. Why do you think it has become something so mythical?

The Turtle story is a distinctly American story and it the same appeal as the rags-to-riches stories of Horatio Alger. Before the Turtles, it was not widely believed that trading could be taught. Richard Dennis proved not only that trading could be taught but by implication that one can learn how to trade well. This idea gives hope to the hundreds of thousands of new traders who come to the markets each year looking to make their fortune.

Taken outside the context of the times, when very few believed it would succeed, it may not seem impressive. Most people now believe that trading can be learned. So it is only in the historical context that it deserves to stand out as an achievement. Consider the guts it took for Richard Dennis to give me $US2 million in 1984 dollars to trade after two-weeks training and one month trading a practice account of about $US75,000.

You’ve said that trend following has become harder. Why?

Trend-following programs have much more money than they once did. So you have a lot of money chasing the same general strategy. This increases the long-term volatility of the markets and makes drawdowns bigger, and you get more false entries and greater slippage.

Do you believe trend following still works, and more specifically, do the Turtle rules still work?

Yes, definitely. I think that trend following will always work. The problem with trend following is that it works long term but may not work for a year or two at a time and this creates large drawdowns for anyone who is a trend follower. If you can stomach the drawdowns, it is a great way to make money over the long run. The other problem with long-term trend following is that it is dead boring. Like watching paint dry.

The Turtle system still works but there are much better ways of trading that are much easier to trade. I don’t understand the obsession many seem to have with the specific rules we traded. They were one way of making money built for the mid-1980s. The big idea of trend following works but the specific rules we used make money but not as much as other easier to execute strategies do today. So you have more pain for less gain. It doesn’t make sense to trade that way. The biggest problem with the Turtle System is that breakouts don’t work as well as they once did. You get a lot more false breakouts than we used to.

One of the keys to successful trading is to find a system that suits your personality. I assume not everyone is wired to be a trend follower?

No. Decidedly, most people are not wired to be a trend-follower. It takes a lot of intestinal fortitude to watch your account go down 25 per cent, 40 per cent, or 60 per cent as you must if you are shooting for large returns as a trend-follower. Most people want the high returns but then can’t handle the drawdowns so they give up at the worst time. That’s why I don’t recommend that most people trade as trend-followers when they start. It is far too likely that you won’t have the patience and ability to weather the drawdowns.

You have said you yourself get bored sticking with one system. Is that why you got interested in the role of instinct and intuition, which you’ve explored in Trading From the Gut?

It wasn’t so much sticking with one system that bored me, it was the fact that when you are trend following, most of the time the trends are either moving slowly in your direction so there is nothing to do, or there aren’t any trends so you make a few trades here and there that end up losing.

As a Turtle, it took me less than an hour a day to trade a $20 million account. The rest of the time was just sitting around glancing at the screen every once in a while and doing something else.

What do you actually mean ‘trade from your gut’? How is it different from trading emotionally?

‘Trading from Your Gut’ is about using your intuition in your trading. Your emotions come from your mid-brain which is not part of the cerebral cortex. Emotions drive decisions but they are not a rational process like both left-brain’s intelligence and right-brain’s intuition.

Your left brain is a control freak. It wants to know who, what, when, where and why before it does anything. It likes checklists and organization. Your right brain builds from the bottom up. It notices patterns. It sees things that aren’t apparent from the details. It looks at the whole.

The best traders use both parts of their brains. They may trade based on an explicit system but they will use their right brain to come up with new trading ideas. Or they might use their right brain to select the markets to trade but enter those markets using a very specific set of rules. Experienced traders can make decisions much more quickly using their right brain than they can with their left. That’s what experience really is. Experience means we have supplied the pattern matching systems in our brain with enough examples that we are likely to make correct decisions very quickly.

Would you say Richard Dennis was primarily an analytical or intuitive trader?

That’s a false dichotomy. The best analysts are always intuitive. Consider Einstein’s analysis of gravity with the General Theory of Relativity. It was a leap of imagination and intuition that made his analysis so insightful.

Richard Dennis was extremely intuitive as a trader. That’s why he is called the ‘Prince of the Pits’. He could make decisions and judge the market by looking at the faces of the other traders in the pits.

At the same time, Rich was very analytical. He spent a lot of time and money doing research on trading algorithms to find the source of the trading edge. The Turtle System was only one of several that he had which made money at the time. It was Rich’s intuition that made him famous. It was Rich’s analysis that made the Turtles famous.

One of the main messages of the book is that you can combine intuition/discretion and systems; that even a systems trader can make use of their gut to trade, and vice versa?

Yes. The main point of the book is that there are two parts to each of our brains. If we only use half of our brain we are missing out on significant potential. We will be more creative traders if we incorporate the right brain as analytical traders. We will be stronger discretionary traders if we analyze and test using our left brains.  Smart traders develop and use both faculties.

When you look at it closely, doesn’t a systems trader use their intuitive and creative side when exploring potential edges and designing new systems?

Yes, exactly. That’s one of the primary ways you can develop a good new trading idea. But it takes courage and intuition to explore something new.

Trading from the gut and intuition requires internalising patterns. Is that just a matter of practice?

Yes, it is a matter of practice. But it takes a particular kind of practice. If you practice in the wrong way, you won’t develop your intuition, you will develop your analytical side. For example, if you want to practice making intuitive evaluations of a chart, then you need to give yourself a brief time limit for your analysis. If you give yourself too much time that gives your left brain time to take over and make a conscious analysis instead of an intuitive one.

Are there any ways to accelerate acquiring the ability to trade from the gut?

Yes, there are many ways. This is especially true in today’s world where the technology and tools has made it possible for anyone in the world to access data and tools for analysis for very little money.

The tools make it possible to practice making intuitive decision and train your mind to notice particular patterns very quickly. It really is a matter of, as you said, “internalizing patterns,” and of seeing enough examples so that you can pull out the commonality in what might at first appear to be different. With modern charting software, for example, one can easily look at hundreds of charts in less than an hour. With modern trading simulation software you can quickly look at charts with specific trades or patterns. This makes it easier to accumulate knowledge.

Isn’t one of the major challenges to trading is you spend months, even years, learning and internalising patterns, the markets change?

Change is the only constant, right? So if you have an idea that is susceptible to change and you are very rigid in your ideas, they won’t hold up as well. That’s where intuition and judgment comes in. Experienced traders are able to tell whether or not the change is typical change or fundamental change that requires a rethinking of a strategy. If you are new to trading, you won’t yet have that judgment. That’s why it pays to spend a lot of time looking at historical data and old charts.

In ‘trading From the Gut’ you advocate swing trading. Is it a sweet spot between trend following and, say, high-frequency trading?

Swing trading is easier on the psyche because the drawdowns don’t last months or years. It is also not so high-speed that you have to be an expert to gain an edge. So it is definitely easier for new traders.

The other benefit is that because the trades are of shorter duration, the stops are closer to the market so the risk is smaller. This makes swing trading practical for a new trader with a few grand in the bank. With long-term trend following, in contrast, it might take $200,000 to trade sufficient markets to gain the full benefit of the diversification required to keep returns in line with risks. So for most people, they don’t have enough money to trade as a trend follower, at first.

Is swing trading psychologically easier than trend following?

Yes. The pain is shorter when you are wrong. The money is less. The drawdowns are less. The drawback is that you can’t trade $1 billion as a swing trader, while as a trend follower you can. It also requires more work on a day to day basis. This means you won’t be as bored but you won’t have as much time for other tasks either.

Are you swing trading yourself?

I tend to trade for a few months here and there, then stop while I’m busy doing something else. When I do trade, I swing trade. It is much easier to stop and start because the trade opportunities are much more common in swing trading. You are looking for a few days movement, not six months or a year. A few percentage points is a good trade. With trend following you might see 10 per cent to 50 per cent on good trades, depending how aggressively you trade.

Can you describe your system a bit?

I like to trade short-term breakdowns in price movement. Reversals around structure, or common technical indicators. I trade five different specific types of ideas all of this general type. I describe one in the book in great detail.

Can you talk us through a recent winning trade and chart?

Sure if you look at a daily chart for GBPUSD, on March 7th there was a breakdown of a breakout of the recent high from November of 1.6250, after hitting the high early the GBP dropped below the previous day’s low. That’s something I like for swing trade entries, a breakout of the range of the previous day. Then over the next few days, the market dropped. It reached a bit lower than 1.6000 this morning. I’ll exit the trade if the market exceeds yesterday’s high (currently 1.6200) and move that stop each day at the previous day’s high if that market goes lower. I’ve got about 150 pips profit in this trade right now. If you look at an hourly chart, this trade looks a lot like a good trend-following trade does on a daily chart.

Finally, what is one thing traders can start doing now to help them succeed?

My best piece of advice to new traders is not to believe anything you hear without checking it out for yourself. Don’t trade other people ideas. Don’t listen to other people’s advice, even mine. Hear the advice, think about it, yes, but question everything and act on your own. See what makes sense to you. The first thing a trader needs to develop is an ability to think for themselves and to make independent decisions.

MORE EXCLUSIVE TRADER INTERVIEWS:

Mark Minervini: Market Wizard and trading legend – How to achieve compound annual returns of 220%

Henry Carstens: Victor Niederhoffer protege — How become a profitable systems trader

Victor ‘Trader Vic’ Sperandeo: Trading legend — Why he’s a gold bull

Ernest Chan: Private quant trader — How private traders can use quant trading to compete with the big banks and hedge funds

Mike Bellafiore: Prop trader — Creating the best trader education programme on Wall Street

Ari Kiev: billionaire Steve Cohen’s late coach and trading psychologist: Walking among trading giants

Dan Zanger: World record trader — How to turn $10,000 into $42 million

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Market Wizard and trading legend David Ryan has called for reregulation of the stock market, including bringing back the uptick rule, to cut excessive volatility caused by computerised trading.

Ryan is one the most successful traders to come out of the storied stable of William O’Neil, the inventor of the aggressive growth/momentum trading strategy CANSLIM.

In an exclusive interview with Your Trading Edge magazine, Ryan said dereregulation has triggered unprecedented volatility.

“They eliminated the up-tick rule which has unleashed some unbelievable forces that creates a lot of this volatility” Ryan said. “They should bring back the up-tick rule”.

The uptick rule, which was scrapped in 2007, refers to a trading restriction that disallowed short selling of securities, except on an uptick. This meant the short must either be at a price above the last traded price of the security, or at the last traded price if that price was higher than the price in the previous trade.

Ryan, who was profiled in Jack Schwager’s Market Wizards book, also laments the loss of market makers and the paying of a quarter spread, feeling that it would be good “just to have some actual humans out there to keep the balance in the market place”.

Computerised high-frequency trading is estimated to now account for between 50 to 70 per cent of stock market turnover.

Ryan said challenging conditions have forced him to adapt CANSLIM method, a checklist of seven key characteristics of big stock market winners developed with William O’Neil.

To deal with the growing risk of the market, Ryan said he has increasingly moved to purchasing pullbacks, rather than CANSLIM breakouts.

“This isn’t a reflection of the CANSLIM method but there are just times when you really have to hold back and be very, very careful in how you’re using it,” he said.

In the interview, Ryan also discusses his hedge fund and performance, what makes William O’Neil a successful trader, how he has evolved CANSLIM, and his recent stock market winners.

The full interview is available at Your Trading Edge.

EXCLUSIVE TRADER INTERVIEWS:

Mark Minervini: Market Wizard and trading legend – How to achieve compound annual returns of 220%

Henry Carstens: Victor Niederhoffer protege — How become a profitable systems trader

Victor ‘Trader Vic’ Sperandeo: Trading legend — Why he’s a gold bull

Ernest Chan: Private quant trader — How private traders can use quant trading to compete with the big banks and hedge funds

Mike Bellafiore: Prop trader — Creating the best trader education programme on Wall Street

Ari Kiev: billionaire Steve Cohen’s late coach and trading psychologist: Walking among trading giants

Dan Zanger: World record trader — How to turn $10,000 into $42 million

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An information dashboard is a single screen displaying information that enables someone at a glance to learn how their trading business, or a key part of the trading business, is performing.

Like the driver’s seat of a car, or the cockpit of a plane, information dashboards allow the trading operation to be driven from that single screen.

That’s right, a single screen!

The key, in case you missed it, is ‘single screen’. You have to be able to look/glance at just ONE screen to get an instant snapshot of how you’re performing as a trader; and if necessary take corrective action.

Creating information dashboards is actually an intricate area. There are even dashboard design gurus. One is Stephen Few, a teacher at theUniversityofCalifornia Berkeley’s MBA program. His books include Information Dashboard Design, the first book on the visual design of dashboards.

There are many commercial trading dashboards available, but I think most dashboard experts agree that to be effective they should be custom-tailored to suit an individual trader.

It focuses you on what really matters

It is possible to DIY dashboards using something as simple as Excel with add-ins such as BonaVista Systems’ Microcharts giving a greater range of charts.

I created a dashboard earlier this year for my writing business and it is a powerful concept that works, because it focuses you on what really matters.

The first step is to work out what goes onto the screen. It’s the hardest and least neglected step. Most people get caught up in fancy graphics and stuff.

Present it graphically

For a trader key things to display might include

*Open positions

* Monthly/daily/ weekly P&L

* Equity curve

* Portfolio risk

* Portfolio volatility

* Stock watchlists

* Win/loss ratio

* Average wins/losses

* Profitability by day of the week

The key is to spend time working out what key factors are variables directly feed into performance and profit. For example, one mistake many traders make is not taking enough risk. You should have worked out how much risk you need to take across your portfolio to meet profit objectives. Your dashboard might display how much risk you are actually taking, and then compare it to how much you need. If it’s clearly displayed, you will be constantly drawn to that ratio and be more inclined to take corrective action and put on more and bigger trades.

Presenting information graphically works best for monitoring because, unlike text, it can be perceived at a glance. Monitoring is a cognitive activity. Vision is our most powerful sense, with some 70 per cent of sense receptors in our eyes.

There are some other key principles to dashboard design:

It’s about monitoring, not analysis

Monitoring is different from analysis where you want to display different charts, move things around, get rid of things, add new things, filter data, etc. With dashboards you don’t want to move things around, and you don’t want the data to be filtered. The display must look EXACTLY the same every time you look at it, except for the data changes. That allows you to rapidly assimilate information.

Avoid clutter

Dashboards tend to be visual in nature and people tend to clutter them with all kinds of graphic indicators, few of which convey information. Many of the gauges on dashboard products have fancy colours and lighting effects that tend to say almost nothing.

Again, keep it on a single screen!

Because of the limitations of working memory, if you have to go to several screens to piece together information, you can’t rapidly monitor and get a high level view of what’s going on. The solution is to collect information you need to monitor, put it together, and find a way to put it all on a single screen.

Give it context

Just displaying numbers doesn’t mean anything unless it’s in the context of meaningful comparisons.

Creating an information dashboard for your trading will help focus you on what really matters; what really drives profit and performance. You can then quickly, with just one glance, work out whether you’re on track.

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“In May 2011, spray painter and foreman Brett Martin was about to fly overseas for a holiday. He received a text message from his boss Jason Hedges, the managing director of DecoGlaze, which makes glass splashbacks. Hedges told Martin he had been sacked. He had failed to mix in an additive, silane, to paint – which helps it stick to glass – and it had cost the company A$74,000.”

Martin lodged an unfair dismissal application with the government’s industrial relations institution, Fair Work Australia (FWA), saying he did not get an opportunity to defend himself and that being sacked by text message while on holiday was inappropriate. FWA commissioner Frank Raffaelli ruled in September that the dismissal was not harsh, unjust or unreasonable and said Martin’s failure to mix the paint additive was an act of “misconduct” and “represented a valid reason for dismissal”.

Read the rest of the story here.

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Do not try and get rich

As a journalist it’s natural to follow media moguls and I’d always been interested in Dennis, so I read the book. I found one of the few books that accurately and honestly discusses wealth and money (Dennis claims the book’s title was ironic).

The major message is do not try and get rich. Dennis writes:

“Seeking substantial wealth is almost always a fool’s game. The statistics show that very few people ever succeed. Most of them should never have made the attempt in the first place. They aren’t suited to it, and if that sounds defeatist, then consider the fact that the search will take up a great deal of your waking life for many, many years.”

Unless you have a compulsion

Actually, what Dennis really says is do not try and get rich … unless you have a compulsion – not a just a desire (which everyone has) – to get rich.

Most people who get rich are either freakishly talented, lucky, or have that compulsion; and that compulsion usually comes from some sense of inferiority and chippiness that they believe money will overcome or cover up.

Wise people deal with their insecurities, which usually rids one of the need to become wealthy. As Hemingway said, when people begin to live seriously within, they begin to live more simply without – and chasing money is the antithesis of simplicity.

Most rich people I know then became relatively poor

I agree with Dennis that for most people, getting rich is almost always a fool’s game, though I’m not as pessimistic as Dennis is about the impact of riches on people.

I have known people who have built substantial wealth and not sold their souls or neglected their children. By the same token most of the rich people I know lost their money: the risks they had to take to become rich came to bite them when the market turned down.

So, yes, trying to become rich for most people is usually a fool’s game.

The goal is to get affluent

So, being sensible (as all this site’s readers are!!!), do we toss the book away and thank Dennis for his advice? No.

While most people shouldn’t seek vast riches, I do think that most people should strive to be affluent, or build a ‘modest fortune’: as real estate author John T Reed says, ‘don’t get rich quickly, get affluent slowly’.

The right mountain

In our quest to become ‘affluent’, we study the rich and pick their ideas and strategies, but we do it in a sensible and balanced way. From that perspective there are a lot of useful things in How to Get Rich: the power of focus, negotiating tips, why execution is more important than ideas … etc.

But for aggressive growth investors there is one extremely powerful idea that Dennis discusses in the fourth chapter, ‘The Search’, and in chapter 17, ‘A recap for Idlers’. It’s the concept of ‘Choosing the right mountain’: in your quest for wealth you should “choose a new mine where you suspect there is money, or an old mine with a different angle to get rich”.

Dennis clearly favours “new mines”: “the mountain that is already making a lot of other people rich would be a good bet” (he cites telecoms, the internet, legalised gambling and property)”.

Always scan for new mines

Why prefer new mines? Because of the availability of risk capital, ignorance and the power of a rising tide.

In my observations there is enormous truth to this: most self-made people are lifted by a rising tide in newer industries or by big trends, like the China-driven commodities boom.

For aggressive growth investors this concept is vital: we must always be scanning for where new mines are, which areas that are making people rich, then we need to allocate capital to it, and hop off (sell) when the mine becomes old.

Right now the major new mines are in mines themselves (the commodities boom), and internet and social networking. I’m scanning for other new, undiscovered mines.

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Gregg S Fisher, the founder of Gerstein Fisher, wrote about it recently in a Forbes column.

The research found that from the the start of 2004 to the end of 2011, in 16 out of 21 countries, a ‘momentum index’ outperformed the benchmark index; on average it outperformed by 3.13 per cent.

The research also found that momentum can reduce volatility when deployed across a diversified international equity portfolio:

“We looked at the average correlation among momentum indices compared to the average correlation among market indices for the 21 non-US developed nations from January 1, 2004 through December 31, 2011. Result: the average correlation among all pairs of momentum indices was 0.68, compared to 0.77 for all pairs of market indices.”

There is significant academic and industry research that proves a momentum premium exists: ie, you can beat the market with momentum stocks. As Fisher said in his article, ‘why’ a premium exists is still debated; some academics also debate whether the premium can be harvested if you strip out costs.

But the fact is that, if you’re trading, you’re better off focussing on an area where considerable and serious research indicates there is a chance to outperform. Otherwise, put your money in index funds.

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Down here in Australia, a train company, QR National, listed on the ASX. But before it listed there was a barrage of negative publicity and about how it was overvalued, etc. It, too, has been a particularly successful IPO.

I haven’t looked closely at Facebook, but make sure you do your own work on it and ignore the media negativity (or hype).

Dan Zanger made $20 million trading Google after its IPO. In an interview I asked him how he ignored the media negativity:

Q: One of your most successful trades was Google. At the time most experts were saying it was way overvalued. What did you see that they didn’t?

Zanger’s Answer: Most of them were talking it down saying it was expensive and overpriced. Actually it was one of the most underpriced stocks I had ever seen. Earnings were up 150 per cent and revenue was up 120 per cent. Even before the internet bubble, a stock growing 100 per cent annually would have a PE of 100. Google had a PE of 45: it was trading at half its growth rate. I haven’t been as excited about a stock as I have on Google. It shows how clueless those broadcasters on TV are.

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Chris Kacher is amazingly talented. He was a child piano prodigy and then worked as a scientist helping produce major breakthroughs in nuclear physics. But his passion is trading.

Like his colleague Gil Morales, Chris is a protégé of William O’Neil, the legendary investor and author of ‘How to Make Money in Stocks’. Along with Morales, Chris is one of the few to have traded O’Neil’s own funds as an in-house money manager.

Chris now runs his own money management operation, but he also teaches traders through his internet site www.virtueofselfishinvesting.com.

Chris and Morales recently released their book ‘Trade Like An O’Neil Disciple: How We Made 18,000% in the Stock Market’ which gives insights into O’Neil’s CAN SLIM strategy and how they’re adapted the strategy for their own needs. The book also tells the story of Chris’s amazing 18,000 per cent return on his private portfolio.

Chris spoke with Your Trading Edge’s Ben Power about how he delivered his amazing returns, his raft of market research discoveries, and the influence of William O’Neil. (The interview was conducted in September 2010)

You’ve had an interesting and diverse career, including music and nuclear physics, so how did you become a trader?

I always tell people to find your bliss, to find your passion. My first love was music and I composed my first song when I was five years old.

I had exposure to the market through my mother, a top broker from Merrill Lynch, and had read about stocks. I bought my first stock when I was 11 years old. While I wasn’t actively trading at that age, I was dabbling, learning, and reading.

I went to grad school – science always came easily to me – where I had an interest in nuclear physics. But half way through my degree I started spending more time in the business library than the particle accelerator, and I realised that my passion was not in science.

At grad school I was reading books, trading the market and building strategies. In 1989 I read William O’Neil’s book (How to Make Money in Stocks), and in 1991 I put everything together and had my first good year in the market; prior to that I was fumbling around.

By 1993 I had my third good year in the stock market and I wanted to switch and go into portfolio management. In 1995, I started one of the first stock investment advisory websites on the internet. The site shared the same URL as the site I run today, www.VirtueOfSelfishInvesting.com, taken from Ayn Rand’s classic book, The Virtue of Selfishness.

You are one of the rare people who have traded William O’Neil’s money. How did you get that opportunity?

At grad school, after deciding to go into portfolio management, I started prospecting and doing informational interviews with a variety of employers. In 1995 there was interest in someone with my – apparently quite unusual – background.

My research group at UC Berkeley made the front page of the New York Times and San Francisco Chronicle doing a confirmation discovery of element 106, then made the first atom of element 110 at the High Energy Linear Accelerator, one of the particle accelerators at Lawrence Berkeley National Laboratory. Having this on my resume made some portfolio managers take notice.

Half way through the year, I got my foot in the door. I got a job with Trust Company in the West working with Charles Larsen. They let me work from UC Berkeley – the first time they had let someone work remotely – and I would provide Charles with my own stock picks. Charles is the one who opened the door for me into this field.

Then Bill O’Neil offered me a job after three rounds of interviews. I joined in January 1995. At that point I told all the companies where I had job possibilities that it wasn’t about the money; it was about being in an environment where I felt I would fit in best. From the very first day I worked with Bill O’Neil it was beyond anything I could have possibly imagined.

Can you describe William O’Neil as a person?

He is very intense, very driven and has what we call ‘insane focus’. We all – Bill, myself and Gil Morales – have it. After sharing some results with him, Bill told me that since I was doing so many research studies I could call him morning noon or night if I had made an interesting finding. It showed how passionate Bill was about the stock market.

I also really appreciated that, despite all his success in the market, he always maintained a humble demeanour. He was always listening to what you had to say. Even if there was a difference of opinion there was a lot of respect. And sometimes we wouldn’t agree.

For example, in the late 90s some internet companies such as Amazon had no earnings. The ‘CA’ in CAN SLIM has to do with earnings. Bill wouldn’t look at a company if it didn’t have earnings. But the price appreciation of these companies was huge. I said to him ‘I think we have to revise CAN SLIM or make an exception’. The first couple of times he wasn’t convinced; the third time he started to change his views. He could see the evidence; it was his flexibility of thinking.

What makes him stand out as an investor?

His humility keeps him grounded even when he’s making a lot of money. He always reviews his trades regularly, printing and marking up stock charts showing where he bought and where he sold. This is a powerful visual and it enables him to analyze his mistakes and learn from them. He also studies many stock charts regularly and marks them up. This enables him to fine-tune his investment strategy even further, which keeps him on track.

He relentlessly focuses and has passion for studying the market every day. The markets will change on you in subtle ways. It’s important to always be on top of the market so you will see those subtle changes.

While you were with O’Neil, you generated amazing returns of 18,241 per cent on your personal account? Were you essentially trading O’Neil’s CANSLIM system, or had you tailored it to yourself?

I always say trading is like a finger print – everybody trades a little differently. My trading, in its inherent logic, shares much with the CANSLIM philosophy. But Bill O’Neil himself doesn’t trade CANSLIM to a tee. CANSLIM is for the retail investor who will read his book and who will benefit enormously from it. But in practice we all have our slight variations.

For example, everybody’s got their own risk management levels and risk tolerance levels. I prefer to hold more than a handful of names; Bill O’Neil and Gil Morales prefer to hold just a handful of stocks and pyramid up. I prefer the lower volatility. I find that even when I traded a small account, I preferred to have 12 to 18 names; and with much larger accounts, I still preferred to hold 12 to 18 names.

You said Bill O’Neil doesn’t trade CANSLIM to a tee, what are some of the things he does differently from what he teaches?

He will sometimes buy a stock that is not breaking out, but will still take a position. Such circumstances are rare, but it often sets him apart from the rest, as he will see divine opportunity to buy where others see chaos or are wholly pessimistic about market conditions.

What is one trade you made during you time with O’Neil that stands out in your mind?

Ebay is a big symbolic trade for a number of reasons. One thing I love about trading is it allows me to keep an eye on changing technology and on the cutting edge of evolution. If there’s a company that’s pushing that evolutionary edge I want to know about it.

Ebay had the first mover advantage in peer-to-peer auctions. I knew they were around, but when I read their pre-IPO of what the company actually did I got very excited about it. I told Bill immediately. But when it IPOed it promptly lost half its value, dragged down in October 98 by the markets that were spiralling downwards when the NASDAQ lost a third of its value.

When the market headed back eBay was the first to turn higher and move aggressively back to its IPO price, forming what I call a ‘U’ pattern. It then gapped up and that was my first buy point. From that point on it went up five times in value before basing again. It was an amazing company with amazing price action.

The market has changed significantly since those heady days: it’s choppier and dominated by high-frequency trading. How has that affected the way you trade?

In 2004 the markets got sloppy. If you look at a chart of the Nasdaq from 2004 to 2005 you see a grinding rally. A lot of base breakouts didn’t work. I realised there was a danger I was going to get ‘nickel and dimed’. That’s when I developed the ‘pocket pivot’ trade. That worked so beautifully that in late 2005 I more than made up for losses. In 2006 I had my seventh triple digit year.

What is a pocket pivot trade?

It lets you buy early in the base before the break out. So your average cost by buying the pocket pivot, then the base breakout, is lower than had you just bought the base breakout alone. You are also in a psychologically stronger position to hold onto the stock instead of getting whipped out of your position, which has been common in the 2000s.  

As with breakouts, you want to focus on fundamentally and technically strong stocks in leading industry groups. The day’s volume should be larger than the highest down volume day over the prior 10 days. My ten rules for pocket pivots are shown at www.virtueofselfishinvesting.com/faqs and many chart examples are given at www.virtueofselfishinvesting.com/reports.

If you miss a breakout, you can still buy into the stock when it flashes a pocket pivot point since some pocket pivots may occur after the stock is extended from the base. If the pivot occurs right near its 10-day moving average, it can be bought; otherwise it is extended and should be avoided. Give the 10-day moving average the chance to catch up to the stock, where the stock would consolidate for a few days, before buying such a pocket pivot.

What is the success rate of pocket pivots?

In practice about half of high quality stocks showing pocket pivots, even in the 90s in the middle of a beautiful bull market, won’t work. This is roughly equivalent to the success rate of standard base breakouts. So, like with any stock they buy, it’s important people keep their stops appropriately tight on every position they initiate.

Do you have an example of a pocket pivot trade?

A recent example is CYT, which manufactures specialty chemicals sold worldwide for the aerospace and adhesives industry. It has strongly rebounded in both earnings and sales, and is in the top 10 per cent of industry groups. It had a pocket pivot on September 10. The next day it traded up 5.7 per cent, which also coincided with a base breakout, so it could have been bought a second time.

IGTE also had a pocket pivot on September 8 and is up 9.7 per cent as of its closing price on September 14. IGTE is in the information technology business, providing business process outsourcing and clinical research services and has enjoyed both accelerating earnings and sales over the last three quarters.

You also trade stocks that gap up, which is something O’Neil doesn’t recommend, particularly if they move too far from the base

Gap ups are something I discovered in 2005 in the challenging, sideways, grinding markets that characterized that year. I found that fundamentally strong stocks that gap up in a certain way, and that have certain technical patterns, can be bought even though they look too expensive up there.

This gap up concept, as with my other concepts such as the pocket pivot, came about from my love of doing research studies in the market. I spent time every day looking at many gap up examples going back decades and marking up charts and isolating key variables. Our book discusses gap ups and pocket pivots in detail.

What are some of the characteristics that make a gap up attractive?

The stock should ideally be a leading stock in a leading industry group. The chart pattern leading up to the gap up should be constructive. Gap ups where the stock jumps 10 per cent or more overnight are often due to fundamentally strong news that can set the stock on a completely new course. So while the stock may seem expensive, it actually can move a lot higher from its gap up price. I’ve created a number of rules on how to identify gap ups, and how to handle them as they move higher, and how to sell them. These rules are discussed in detail in our book.

One of the most important but often neglected parts of CANSLIM is the M – the need to time the market. You’ve created your own market timing model. Can you describe it and how it differs from O’Neil’s?

My model is based on my statistical studies of how the major stock market averages actually behave on a price/volume basis ng back many decades. A live version of the model with past signals can be viewed at www.virtueofselfishinvesting.com. My model is largely responsible for my KPMG-verified long-term track record and has kept me on the right side of the markets since 1991.

I developed the model in the early 1990s. Being in grad school and being very much a quant, I started studying price volume action and created rules. The M in William O’Neil’s CANSLIM stands for market direction. My research studies that started in 1991 were motivated and inspired by that. But there was a lot of confusion as to what, say, was a proper distribution day and a proper follow though day. The different variables were not defined in a way that was consistent and it created a lot of confusion.

My model differs somewhat from O’Neil’s system. O’Neil, for example, used to primarily want to see follow through days in the fourth to seventh days of the attempted rally; but you can sometimes get follow through days that work on the third day, or even the 12^th or 14^th days, as long as the quality is good and it occurs with some leading stocks showing constructive price volume patterns. One important aspect to my model is risk management. Whenever my model issues a buy or sell signal, it has a fail-safe built in so if the signal proves to be false, the model will go to cash.

Do you trade the market timing model as a standalone, or do you use it to guide buys and sells of stocks? (ETFs)

I use the timing model to keep me on the right side of the market. When it issues a buy signal, I look to aggressively accumulate leading stocks in leading industry groups. I buy stocks rather than ETFs because I can make more money buying stocks. That said, with the advent of 2-times and 3-times ETFs, big money can be made going long 100 per cent a 3-times ETF such as TYH which moves 3-times the Russell Technology 1000 and is a relatively good proxy for 3-times the NASDAQ Composite.

What is your view on mechanised trading? Is it something you’re doing?

In 1998 I worked with Rashneesh Gupta, the head programmer at O’Neil. We wanted a computer to identify the quality of a base and act accordingly. But what we found was it’s virtually impossible to tell a computer what Bill O’Neil is seeing or what I’m seeing. There are too many exceptions. There’s no substitute for monitoring a market daily, running screens, looking at charts and hand picking the best of the bunch.

Your colleague Gil Morales has done well shorting, is that something you’re into as well?

I tend not to short individual stocks simply because it doesn’t suit my trading personality. There’s a lot of volatility and I don’t like that degree of volatility. When my model issues a sell signal, I look to buy inverse ETFs such as TYP which is the inverse of TYH I mentioned earlier.

You manage money for wealthy individuals and institutions, but also write newsletters. What attracted you to newsletters?

This dates back to my days in grad school. I always loved to teach and see someone understand what I’m saying. I then went on the road with Bill O’Neil talking to audiences as large as 800 people. I loved the Q&A session at the end. People would come up to us and throw lots of questions to us. People were hungry for knowledge and I’d just love seeing the light bulb go on when they understood something. I also find that I learn much by teaching others, so it keeps my trading on track. Lastly, by sharing my wealth of information with others, I find there is often brilliant reciprocity which gives me ideas for new research projects.

Are there signs the current market is getting healthier? Is it still dominated by what you’re referred to as ‘junk’

My model put in a buy signal on September 1. It’s still on a buy signal (at September 15). We saw evidence of constructive price volume action on leading stocks shortly before September 1. The buy signal was added confirmation and we have taken positions in leading stocks since then.

Keep in mind the market likes to climb a wall of worry. According to sentiment surveys around 50 per cent of investors were recently bearish, compared to just 20 per cent bullish. From a contrarian point of view that’s bullish. So this market may continue to climb a wall of worry. There are a lot of reasons to be worried; there are a lot of headwinds coming up for this market. But until I see evidence of that in price and volume action in major indices and in leading stocks, I’m going to stay bullish.

The best names will often go higher in markets like this. Stocks such as VMW, CTXS, RVBD, CRM, NFLX, APKT, FFIV, ARUN, and MCRS should continue higher, outpacing the general market if it continues to go up. Most of these names have shown pocket pivot action, enabling an investor to get on board early, or buy late if they missed the breakout. They’ve been going higher in force over this downward sideways market.

Finally, what is one thing that a trader can start doing now to improve?

Go back through all your trades for the last two to three years. Print out the charts and take out a red pen and mark where you bought and where you sold. Then make a list of the mistakes you have made. Write out a list of how not to make those mistakes and paste that list up on a wall. Carry the charts with you so you can review them frequently. This reinforces what you did right, and what you did wrong.

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Ahhhhhhh!!!!!

It’s becoming a major issue.

Information, of course, is potential power: it can be used for good or to profit. But the problem now is the sheer volume thrown at us. The market, with constant noise and movement and opinion, is particularly bad.

The constant flow of information draws use closer and closer to the market until we’re completely beholden to it. Before you we know it, our emotions rise and fall with each market rise or fall. We totally lose perspective on what’s happening.

Talking to traders, that’s exactly what happened in 2011: everyone became so obsessed with a bit of volatility and economic doom that they totally forgot it wasn’t a really disastrous year; and that the US market’s are still probably in a bull market.

So what to do? ‘

Here are a few things to help cut information overload:

1. Focus on what is happening, not what might happen

Ignore constant predictions about what might happen, which can cause panic and confusion, and focus on what is happening right now. That is the best clue to the future. For aggressive growth investors, are bullish chart patterns developing? What companies are generating accelerating sales and earnings? What companies are developing innovative new products? When it comes to the broader market, are there signs of accumulation? Is the market in an uptrend or down trend? Are new highs bigger than new lows? Look at the facts now, and stop worrying about the future, which you can’t predict.

2. Look at the bigger picture

As I said, the market draws us in. Practice drawing yourself back out. Look at long-term charts: weekly and monthly. Look at the big picture: is the market actually in a bull market, but just undergoing a correction? Or are we in a long-term downtrend?

3. Turn off the computer and other devices.

Mobile devices are handy, but a nightmare when it comes to information overload. Turn them off, at least, over the weekend, or just check them once or twice. Most people are addicted and it will be difficult. The urge to turn them back on is overwhelming, but try and ride the urges and it will get better. The reward is a clearer head on Monday morning.

During the week turn off every device after work. That includes mobiles, ipads, and computers. Give your brain a rest from the bombardment.

3. Ditch any non-essential information services, newsletters, blogs, etc.

Perform an audit on information you receive: does it actually add value? Does it actually help you make money? Does it contribute directly either to learning new strategies to make money, or directly to trading decisions? If the answer is no, ditch it.

4. Start reading printed products again.

Everything has gone digital. But to help your brain slow down and contemplate start reading printed products and magazines again. I’ve found sitting down and reading The Economist magazine, for example, gives me a fresh perspective on events, particularly big-picture trends; but being printed it’s not delivered in that frazzling, digital blur.

5. Print things out.

Rather than read everything online, which tires out your brain and contributes to overload, print articles and information out and sit somewhere quiet and read it. Again, it’s a slower more contemplative way to absorb information.

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I’ve developed a simple system that helps you monitor hot stocks that you’re about to trade, but also allows you to keep an eye on other stocks that have potential but that you aren’t yet ready to place orders on.

As you can see in the screen shot below, you simply divide stocks into three categories: targets, watchlist, and uptrend. You can do it for longs and shorts as I have.

Every time I do a complete market scan I filter stocks into these three categories

So how do I determine what goes where?

Uptrend stocks – They’re trading above their rising 50-week moving average. But they may be overextended or have slightly sloppy charts. Basically I want to monitor them because they’re strong, but I don’t think I’d be likely to place a trade in the next few weeks at least.

Watchlist stocks – These guys are more interesting. They usually fall into two categories: they’re forming a base/consolidation pattern that means they could be traded in the next few weeks; or a fundamental screen has shown them to have excellent fundamentals. Unlike uptrend stocks, there is potential for a trade in at least the next month. I want to keep a close eye on them.

Target stocks – These are the stocks I have decided to trade and where I have identified a point where I want to buy them. When they hit this category I fill out a spreadsheet with checklist of a series of technical and fundamental factors; I fill out a separate spreadsheet with a checklist of factors that indicate the strength of the market. Finally, before I actually place a trade, I fill out a spreadsheet with details including buy point, stop loss, amount of account I will risk, number of shares, etc.

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