The Volatility Kings How These Three Pro Traders Consistently Profit in the Face of Volatility By Sue Reddy Silverman
Introduction
“A democracy cannot exist as a permanent form of government. It can only exist until the voters discover that they can vote themselves largesse from the public treasury. From that moment on, the majority always votes for the candidates promising the most benefits from the public treasury with the result that a democracy always collapses over loose fiscal policy, always followed by a dictatorship. The average age of the world's greatest civilizations has been 200 years,” Alexis de Tocqueville from his two-volume study of the American people and their political institutions called Democracy in America. The United States has been one of the world‟s greatest civilizations for the past 237 years. We‟ve surpassed the average by 18%. It would seem, however, that our time is nearly up. China, the world‟s second largest economy and also the banker for the U.S., is soon going to take over the top spot and be the world‟s largest economy. European debt issues are only getting worse and it‟s only a matter of time before Greece exits the Eurozone, which will have earth-shattering implications for the 17-member Eurozone nations. Domestically the New Year brings about a slew of tax increases and regulatory changes that are going to stifle economic growth in the U.S. Prior to Jan 1, the market will see massive tax selling as individuals and funds seek to shelter gains from increasing taxes. So in the immediate future there are definite political and economic events that are going to drive volatility significantly higher and markets lower. In this type of market, options traders thrive and profit. Therefore, now is the perfect time to discover how to consistently profit in the face of volatility. Find out how in this new, up-close-and- personal report “The Volatility Kings: How These Three Pro Traders Consistently Profit in the Face of Volatility.” We asked each trader how they got started trading, why they chose the Equities and Options market in which to trade, their greatest successes, biggest failures and the lessons they've learned along the way. Their responses will enlighten you; some may even surprise you. Perhaps they will even alter the way in which you trade and lead you on a new a faster path to prosperity. We are pleased to share this informative report with you. Matthew Buckley Chief Investment Strategist www.WealthCreationInvesting.com
Expert Equity & Options Traders
An innovator in financial trading, Guy Cohen is the creator and originator of the unique OVI Indicator. Specializing in stocks and options, Guy is the author of best-selling books Options Made Easy, The Bible of Options Strategies, Volatile Markets Made Easy (FT Prentice Hall), and The Insider Edge (Wiley 2012). From 2002 to 2011, NYSE Euronext licensed Guy's options software and recently Guy has also provided options data analysis for The International Securities Exchange (ISE). Guy has an MBA (Finance) from Cass Business School, London.
Guy Cohen
Gareth Feighery
Gareth Feighery is the founder of MarketTamer and has taught thousands of investors globally. Gareth began his professional career as a Silicon Valley Engineer, successfully conceiving multiple patents in fields ranging from microchips to dentistry. Following a successful engineering career which comprised multiple successful startups, Gareth followed his passion for finance and joined a financial services startup, and managed the advisory services division comprising thousands of clients He completed his formal business education with an MBA from the Wharton School of Business, University of Pennsylvania, which has been ranked the number 1 business school globally where he graduated with Director's List Honors. From there, Gareth built MarketTamer to be a global brand servicing a community of followers in more than 100 countries.
A former U.S. Air Force and Commercial Airline Pilot, Chuck Hughes used his downtime to learn how to trade stock indexes using a system. He liked system trading so well that the developed his own trend following system that has garnered him $5 million in trading plus 7 prestigious International Trading Contest titles. Chuck is also an author credited with numerous books, including The Guaranteed Real Income Program, The Fail Safe Financial Program, Market Volatility Profit Secrets, The Wealth Building Formula, The Global PowerTrend System, The Wealth Creation Alliance Course, Stock Market Magic, The Wealth Building Business Course, Sure- Thing Profit Secrets, Weekly Option Winners and Ultra Safe Money Strategies. Chuck Hughes
The Volatility Kings: How These Three Pro Traders Consistently Profit in the Face of Volatility Guy Cohen
Interviewer:
Why don't you talk to me a little bit about your background and how you got started trading?
Guy:
I was always interested in the markets and then I did a finance MBA where I specialized in options trading. I created my own options trading software, which then morphed into being stock trading software and then combining the two. That was really my background, partly academic and partly on the job.
Interviewer:
How novel that you actually got started doing an MBA in options trading.
Guy:
Yes, that's right. And writing my own software of course, that's also fairly unique.
Interviewer:
You trade stocks and options, right?
Guy:
Yes, equities and options. I know this is for the U.S., there are other things they trade . . .
Interviewer:
Well, not necessarily. It's really international.
Guy:
Equities, options, CFDs and spread bet is basically what I can do.
Interviewer:
What was that last one?
Guy:
CFDs and spread betting. Spread betting is basically like CFDs. CFDs and spread betting is basically highly leveraged stock trading.
Interviewer:
Tell me a little bit about what's unique to each market and why you like trading them.
Guy:
Well, with options you can do all kinds of different strategies. With equities it's just plain vanilla. With CFDs you can do plain vanilla but with big leverage and with spread betting you can do big leverage and in theory trade free of tax as well. Those are the four main characteristics of each of those.
Interviewer:
Is there a reason why you don't trade futures or Forex?
Guy:
Yes. In terms of futures, they don't really cover the stocks. Single stock futures never really took off in a way that was relevant to me. Forex is a totally different animal which I've never understood.
Interviewer:
Isn't that interesting, how some people have gravitated towards one market versus another? I would assume if you were a trader that all the markets would be understandable and intriguing.
Guy:
The thing is, actually, they're very different. I once heard someone say that they've been supposedly a Forex trader for 30 years and suddenly they said they were applying the same principles to stock trading and training people on that level. I just knew that couldn't be true. They are completely different animals and have completely different types of set-ups. They exhibit different characteristics, so they have to be traded differently. When it comes to Forex and stocks, they may as well be on different planets.
Interviewer:
What style of trader would you consider yourself?
Guy:
Conservative and aggressive at the same time. How do I explain that? Basically we trade break-outs. That's our bread and butter. We trade break-outs with high probability trades. We don't overtrade; we are very particular about when we want to get into the market. Particularly if we're talking about big size. We use a combination of one or two traditional patterns like consolidations and flags and support and resistance. We combine that with specifically what is going on, a unique indicator that we've built that shows us what is going on in the options world. For example, let's just say we've got a stock like Goldman Sachs. If it's approaching a resistance point as it's rising or going sideways, and we can see that the options transaction is bullish, then that lends weight to the way that we would trade that on a break-out into a new high. We trade break-outs. I think the short answer from what I can say to you is we trade break-outs with the added comfort, if you like, of knowing where the options transactions are, whether they're bullish or bearish.
Interviewer:
I think you answered my next question, which is what's distinctive of how you trade.
Guy:
Well, we have an indicator that is unique. We have an indicator that shows us what is going on with the options transactions of any particular stock, and that gives us where that correlates with the particular pattern that we're looking at or that we're filtering for. Don't forget, we only filter for one or two. Then we have a high probability situation. Where there's not that confluence, we just don't do anything. We're very selective about what we do, but it means that we get very high probability trades. We can act upon those with quite a lot of confidence. Yeah, the uniqueness is the OVI indicator that I created.
Interviewer:
What makes you so successful at what you do?
Guy:
I think it's the fact that we're doing something that is very particular, and we're very comfortable with not having positions on the market. Our view of the markets is when the market is looking like a weak prey, and then we'll be the predator. If the prey doesn't look weak, we won't be the predator. We only go for things where the planets have lined up really well and that way you can be very successful.
Interviewer:
Do global events affect your trading?
Guy:
Global events will affect trading per se, but we do try to avoid specific news events like earnings seasons when we're trading like this. We avoid that. A surprise global event, there's not much we can do about that unless it was telegraphed; unless it was known that it was going to be announced. They'll affect trading inevitably, but we don't trade global events per se.
Interviewer:
Let's talk a bit about volatility. What do you like about trading volatility?
Guy:
When volatility goes in your direction, obviously that's when you're going to make money. We like a market that looks like it's going to explode in our favor. It's our job to make sure that we're only involved when that burst is happening, and when it's happening in our favor. That's what we like about it. Otherwise what we like is a technical market, a market that is easier to predict is what we really prefer. Stable markets with trending. Trends ma y start from an explosion of volatility, so that can also happen.
Interviewer:
What's tricky about trading volatility?
Guy:
The big problem about volatility if you're trading directionally is if you get whipsawed. Again, we do an awful lot to try and minimize our drawdown, and minimize the chance of a whip-saw.
Interviewer:
Specifically, how do you use volatility to profit?
Guy:
Break-outs. We trade break-outs. Obviously when a break-out happens, there will be an inevitable impact of volatility on that as a stock breaks out of a range.
Interviewer:
Can you talk a little bit more about what a break-out is exactly?
Guy:
Let's say a stock's been going sideways for a few bars or even for a few weeks even in some cases, where it's formed a range between a high and a low. What we like to do is trade the break-out of that range, if our indicator, our OVI indicator, is also pointing in that direction of the break-out. That's what we do. Sometimes the break-outs are very small, because they're what we call flag patterns. They only last a few bars. Sometimes they might be quite a lot longer, they might be months' worth of range-bound action with the stock price and then it's getting ready to break out, you can see the stock drifting towards, near the resistance or the support, the OVI indicator is corroborating that, and it can be a break-out from one of those.
Interviewer:
What kind of money management techniques do you use?
Guy:
Very strict. For starters, we always set a conservative profit target, first profit target. What we do is we split the trade into two. We have a first profit target that's conservative, so we have a target that's very easy for the stock to reach. We take half our money off the table at that point, we close up the trade with a profit, and then what we do is we raise our stop for the remainder of the trade to near the breakeven of where that trade is. Then as the stock continues to go in our favor, we will then follow that with a pretty simple trend line. That's how we manage our money, manage our trade in there.
Interviewer:
How important to trading is psychology and can you give me an example of an instance where lack of control of your own psychology lost you money?
Guy:
Well, psychology is important, but not on its own. The key bit to psychology the way we trade it is that our trading plan takes care of your psychology. I'll give you an example here. If you were to trade a stock, you wanted to buy a stock of 50 and it goes up to 55, you're pretty happy. Then you look the next day and it's down at 53. The typical inexperienced trader will say, "Oh, I'll sell it when it gets back up to 55." The next day it's at 51. "I'll sell it when it gets up to 53 or 55." Then the next day they look and now it's at 49. They go, "Oh, well I'm not going to sell it until it gets back to my break even." Then the next day they look and it's at 44. Now they're panicking. Now, traders will then learn their lesson supposedly. The next time they see a stock at 50, it goes up to 55, and they sell the lot. They take their profit at 55. They think, "That's great, I've made 10%, I'm very happy." Being human beings, you always tend to have a quick look at what happened afterwards, even though you're out of the trade, that's just our ego and requirement to be right. What happens is, what happens if he looks the next day and it's now not 55, but it's 65. He missed out on all that profit. Our trading plan specifically addresses the need for a human being to have an immediate result, an immediate reward, for a good trade done, but also the need to hang in there for part of your trade or at least half of it, so if it continues to go in your direction, you're on for that ride. That takes care of both of those very deep seated human needs. The way that we look at it is that you can't necessarily train everyone to be unemotional about trading, because it's not an unemotional game. It is an emotional game. What we have to have is a trading plan that can keep your emotions in check, and to keep you on the straight and narrow, if you like. If your trading plan is good and robust and sensible and has an understanding of human emotions, then you're halfway there. Then if you look at that example, that's a very similar example to what I've done before. Then it's also a very similar example to what everyone's done. Everyone's had a situation where they let a winner turn into a loser, and what we do is we do not let that happen. We set a modest profit target for the first half of the trade, and then the rest can ride. That way we very rarely have a situation where a winner turns into a loser, and that's good psychology from our point of view. Not everyone is psychologically trainable in the way that you would want them to be. What you have to do is you have to have a really good trading plan to take care of that.
Interviewer:
I have two follow-up questions. One of them is, I've heard from other traders that you need to take the emotion completely out of trading.
Guy:
It's impossible. It's a ridiculous comment when they say that. It doesn't mean anything. You can't take emotion out of trading, it is an emotional game. When you have money coming in and money coming out, I defy anyone to say that doesn't affect them emotionally. What you have to do is have a trading plan where the real art of it is to be a predator, only go for the weak prey, i.e. the stocks that are showing absolutely that they look like they're going to do what they need to do for you. Then you need to manage that trade in a way that allows you to take a quick reward, doesn't have you in a situation where your winners turn into losers, but where you can, if the market goes very right for you, you're on for that ride as well. It's such a nothing comment. People go "take the emotion out." It doesn't mean anything. You have to manage those emotions, and everyone's emotions are different anyway. The only way to deal with that in a practical sense, and this is coming from a lot of experience, just practical knowledge, is you've got to have the right trading plan. Without it, I don't care if you're a robot. You're still going to have big emotions if things go wrong for you.
Interviewer:
It's more about managing the emotions that exist as supposed to suppressing them?
Guy:
Yes. I don't believe they can be suppressed. Also you've got to manage your deeper level of what's going on under the hood. Some people actually go into trading in order to lose money, believe it or not. Just like some people go to the casino, they go in with $100 and they go, "I can afford to lose that." They've already prepared themselves to lose it by saying that. A lot of people do the same with trading. They go, "I've got $1,000, that's what I can afford to lose." They're already focusing on that. That's what they've gone into trading to do. There's some sort of weird psychological requirement for them to burn their money. I don't know why, but we've all been there. You have to understand. Only a good trade that just doesn't go my way, that's the only way I'm going to lose. That's the kind of attitude you've got to have. An awful lot of people actually find trading like gambling or rather a lot of people gamble rather than trade anyway in the markets. It just looks like trading because it's in the financial market. People's subconscious needs aren't always going to be constructive.
Interviewer: Guy:
What's your biggest success trading? Biggest success trading is many, many thousands of percent in a several month period, when things went a bit wild and I had some leverage on. We're talking about a lot and I can't quite quantify it. There was one five- month period where I made about 1,400% in that little period that was part of a bigger period as well. That was when I was quite in my early stages as well. That was pretty big.
Here taking a small amount, I think about $14,000 into about $300,000, $350,000 in a few months. That was pretty fun. Interviewer:
What's the best lesson you learned as a trader?
Guy:
It's very difficult to think about just one lesson, to be honest. There are so many that end up creating your style. I think it all boils down to once you have a trading plan that is workable, just stay with it. It'll work out in the medium term.
Interviewer:
That was my other follow-up question. You mentioned the word "robust" when you were talking about a trading plan. Could you talk a little bit more about that? What does it mean to have a robust trading plan?
Guy:
For a robust trading plan, it's got to be one that takes care of the fact that you don't let winners turn into losers, but you also get to ride a trend if a trend materializes in your favor. It's also got to be a trading plan that cuts losses at an acceptable point, where you've assessed the potential risk of a trade. You have to let a trade have some breathing space. You can't just put on a trade and if it doesn't go your way you're out. Otherwise, you've just been making hundreds of trades where you lose a dollar here and a dollar there, and that's not practical. You have to basically have a trading plan that allows you to assess the risk of any trade, the likelihood of it going wrong, and if it goes wrong the fact that you can absorb that. You always have a trading plan where if it does go wrong, it's not because you put in a bad trade or put in a trading plan that was flawed. It was obviously trading is not a 100% game, so you have to make sure that your losses are going to be smaller than your potential winners are. Hopefully over a period of time you'll get a good shot of winning more than you lose.
Interviewer:
What's the number one reason traders fail?
Guy:
It's a number of things, really. It's never just one, because the reason they fail, the principle reason they fail, actually has contributor reasons. It's like a river. It doesn't exist on its own. A river has tributaries. Streams lead into rivers, this is the thing. You could look at greed, you could look at fear, you could look at indiscipline. Greed leads to indiscipline, doesn't it? Greed might be another way of them actually having a deeper seated reason to wanting to lose money. There's a number of reasons, and we could just pick out one for the sake of being dramatic, but it's complex. Ultimately it comes down to being undisciplined for whatever emotional reasons. That indiscipline can also be as a result of actually just not being prepared. Not actually doing their homework, not actually getting the right training. That's another reason. Not having an advantage.
Interviewer:
Speaking of not having the education, what made you decide to become an educator or a mentor?
Guy:
It wasn't a decision, it just sort of happened, to be fair. I was creating software, for me, and other people saw it and wanted it. Therefore it just happened by accident. It wasn't something I intended to do. I built the software for me, but it became a worthwhile endeavor to allow other people to use it and test it and give their feedback on it. I guess it just happened, it wasn't something that I planned.
Interviewer:
It was just a natural evolution from what you created to then have other people use it. You needed to teach them how to use it. That's right. Other people saw me succeed and wanted to use it, and I saw no reason why they shouldn't. Then what really happened is that they give their feedback, and really their feedback led to it being improved.
Guy:
Actually, their feedback led to me creating the OVI in the first place. Weirdly enough. Interviewer:
Symbiotic relationship?
Guy:
Yes, it's very symbiotic, because it led to the creation of a very unique and very state-of-the-art tool that no one else in the world has, and it's a phenomenal tool. That came as a result of one of my students just saying, "How is it that you're able to read the markets so well?" I told them that when I looked at options chains, I remembered what was going on the day before and the day before and the day before. In my head, there was a line that was bumping up and down. Then as the words came out I thought, well, maybe that line would be a good thing to actually have. Let's figure out how to make a line. We created that line. That line came from a thought, which was an answer to a question, and then became a reality. That's been unbelievably valuable. It‟s been a really good thing, that.
Interviewer:
This is perfect timing, because now my next question is let's talk about the proprietary systems that you've developed.
Guy:
I think the one that everyone's talking about now is the OVI, which is a proprietary indicator that condenses any option chain for a particular stock into a line that goes up and down. There is nothing else out there that does anything like that. The line has to be interpreted, which is very simple, the way we do it. What we do is we put that line underneath a stock chart. With a stock chart we're only looking for a couple of patterns, approaches of support and resistance, bull flags and bear flags. Consolidations. We're looking for a situation where we're going to break out of either a sideways pattern or a trend, and we're looking for the OVI to be corroborating that. For example, when the OVI is in positive territory, between zero and plus one, we know that the options market for that stock seems to be more bullish than bearish. That's happening, and we've got approach of resistance coming, either in the form of a flag or the break-out of a new high, then we can be quite confident in various
situations. The same vice-versa. If a stock is drifting towards support or a flaw, and the OVI for that stock has been negative for a few days, then we can have reasonable expectations that if it breaks through it might reach our first profit target. That's basically how we merge the two. We're taking ultimately what's a very well respected, old, and traditional method and we're adding our own indicator to it. Because that's showing you strength of the market that no one else is really seeing in the options market. The third part of the equation is to wrap the trading plan that we've just described on top of it, and that gives you safety of entry and safety of taking the first profits, and also the ability to play for a windfall profit. Because that's another thing that people forget, is that when a trend goes in your favor, that one stock that goes on a big trend in your favor can make the difference between a great year and not such a great year. Interviewer:
Is that a three-step process that you have there?
Guy:
Yes, it's three steps. The first step is the pattern, the second step is our indicator, and the third step is our trading plan.
Interviewer:
Also the way that you take the profits and the way you let it ride at the end?
Guy:
That's right, that's the trading plan part.
Interviewer:
Is that typically always three parts?
Guy:
The three parts are the chart pattern, the indicator, and the trading plan. The trading plan itself is, I guess you could split that into a couple of parts as well. It's the entry, it's the start, and it's taking the profits and then it's the final exit. Three and a half parts.
Interviewer:
What are your favorite tools to use and favorite resources? In addition to the ones that you use, what sort of resources do you consult if any?
Guy:
Very little. Obviously I look at prices and I'm just aware of what's going on in terms of when earnings are coming for a particular stock. We tend not to want to trade this way when earnings are coming up. That's pretty much it. We try to avoid all the noise. The noise is a distraction, so we try to stay very focused.
Interviewer:
What is one piece of advice would you give to a novice trader just starting out?
Guy:
Learn. Spend your time learning, first. I never give one piece of advice, there's a collection of advice. Invest the time to learn.
Interviewer:
Do your homework in other words?
Guy:
If you want to do gambling, go to the casino. My method is not for gambling.
Interviewer:
Would your advice be any different for an experienced trader?
Guy:
It'd be exactly the same. For an experienced trader, if it's not working, then you need to change your plan. That'd be the same thing. Make sure you know what you're doing. You want to gamble, go to the casino.
Interviewer:
What's in your future? What are you looking to do next? What's on the horizon for you?
Guy:
I think that we've got the software now to a really good state. We're getting it so we can put it onto iPads and so we can do it that way; look at our charts on iPads.
Interviewer:
It's going to be mobile?
Guy:
You can always do it on a laptop but it's not the same. Doing it on your little iPhone or iPad is really good, because you can be literally anywhere and you can flick through the charts. That's a really good thing that we're doing.
Interviewer:
Yes, that's exciting.
Guy:
Yes, that is. Further simplification of our websites as well. We'll keep on making things as simple as we can. It's an exciting time, because I think the software is where it needs to be. We have an awful lot of people doing really well with it, and that's the biggest endorsement, if you like, of what we do.
Interviewer:
What's the greatest feedback you've gotten, or what's some of the great feedback you've heard?
Guy:
There‟s a load. From one end of the spectrum you've got one guy who turned $10,000 into $140,000 in two years with our stuff. At the other end of the spectrum, we had people with literally hundreds of pounds who put them into thousands of pounds, or hundreds of dollars into thousands. You've had someone going from $10,000 to over $140,000, and then you've had someone going from literally a few hundred into a few thousand. Again, that's in less than a year. Those kinds of results are very heartwarming.
Interviewer:
You're not surprised by them?
Guy:
No, because we get quite a lot of that now, we get quite a few. Often it depends on where they are in the world. Obviously different countries will allow different leverage, but yes, we've got those stories now in the United States, in Europe, Australia. In every territory where in trading different things, whether it's equities, whether it's stocks themselves or options, or CFDs or spread bets, we've got big successes in each of those silos. It's very nice.
The Volatility Kings: How These Three Pro Traders Consistently Profit in the Face of Volatility Gareth Feighery
Interviewer:
What's your background and how did you get started trading?
Gareth:
My background is, in fact, in engineering. I began as an engineer in Silicon Valley, where I joined a couple of successful start-ups. Joined one, founded another. From that point forward, I used that background in engineering to learn about how to trade systematically and with a process, with rule sets that managed risk and reward appropriately. To some extent I got lucky. I met some individuals who are very successful traders. While I was an engineer, I also was mentored by them. After a process of years of trading myself, I was invited to join them in another company, which was a financial education and trading company which went on to be quite successful. From there, I earned a formal education in finance, graduating with director's list honors at the Wharton School of Business, which has been number one ranked school in the country. Beyond that, went on to start my own company, which was markettamer.com.
Interviewer:
You trade equities and options. Tell me a little about what's unique to each market and why you like trading them.
Gareth:
Sure. Obviously the real attraction to the equity market is the liquidity and the broad basket of stocks that really can be tailored to any individual preferences. If you tend to prefer high volatility or low volatility stocks, there's something there for you. You can choose an industry based on whatever your career profession is, so if you know an area you can be very confident in. In terms of the options world, it's much more attractive in many respects than the equity world, because the leverage is much greater. You can take advantage of similar stock movement and make a much greater return on risk capital in a much shorter time frame because of the leverage associated with options. The other huge benefit of options is that in options, you can take advantage of item decay. As stocks don't move, you can still be profiting from that. As in with an option that you sell, simply by the process of selling it, even if the stock goes nowhere, the option will decay in value and you'll end up profiting. With a stock, you really only end up making money if the stock goes up. Unless you short it, in which case you make money if it goes down. If it goes sideways, you don't make anything. With an option, you can capitalize heavily if it goes up. You can leverage your capital. In so doing, you can also protect yourself if stocks go down. You can buy the insurance, even after the fire has started so to speak. The analogy there is if your house starts to go up on fire, you can't buy insurance then. If a stock starts to plunge downward, you can still purchase insurance to protect it in the options market.
Finally, if a stock simply channels between a range, you can employ some advanced strategy to capitalize on the relative stagnation of the stock. Interviewer:
What style of trader do you consider yourself?
Gareth:
I consider myself a positive expectancy trader. While most traders will try and box themselves in as either a swing trader or a short term, a day trader, or any number of other characteristics, whether it be a fundamental, a technical, an economic, a macro trader, I like to think of the market more in terms of risk and reward. I'm an open opportunist to any approach that is successful, whether that is a fundamental, technical, sentiment, economic, macro, or an approach that incorporates all of those, which tends to be my preference. Regardless of the instrument used, whether it be a stock or an option, I look towards both reward and risk in managing m y portfolio so that it's a positive expectancy portfolio.
Interviewer:
This may be redundant, but what's distinctive about how you trade and what makes you successful at it? That's probably part and parcel of the question you just answered.
Gareth:
Yeah. I think that what is a key component to success is understanding risk management, and that is a function of understanding positive expectancy. I think what a lot of people do is they fall into one of two categories. Most people will fall into a category whereby they don't really like taking big losses, and so they actually take small losses which cumulatively add up and often exceed a big loss. Another component of preferences is that some people will tend to look towards shooting for big gains. That doesn't tend to be the most popular approach. What a lot of people will do is look for shorter term, quick gains, so once they've capitalized on a quick gain in the market, then they exit their position and then they look to another position. Or if they suffer a loss, they take the loss and move on. They don't often give the market the opportunity to essentially move sufficiently in a direction to lead to big wins. Instead of cutting their losses short, they'll often talk themselves into, even though they've started out believing that they would only accept a small loss and get out, they ultimately fall down the slope of hope and start taking much bigger losses in expectation that a stock will turn around when it never does.
Interviewer:
Right and it never does. Every trader I've interviewed says the same thing, it just doesn't.
Gareth:
It just keeps falling.
Interviewer:
Right and people continue to hope that it's going to come back and they're going to recoup their loss, and they just don't.
Gareth:
That's right.
Interviewer:
Is that when people quit trading?
Gareth:
It's until the point of capitulation comes. When capitulation comes is when the traders ultimately panic and sell, and ironically that's the point at which they should be looking to get in and buy. That relates to the psychology of the market, and ultimately it traces back to, there are Nobel Prizes given on the psychology of this. It dictates our preferences. What we tend to like to do as humans is we like taking short-term gains. We don't like taking big losses. Excuse me, we like taking shortterm gains. We also do not like taking multiple losses. If there is a loss to be had, we would almost prefer to take a big loss. That's what you tend to see with a lot of traders, that they look to take little gains. They won't hold on for a big gain, but they will hold for a big loss.
Interviewer:
Isn't that ironic? That's completely the opposite of what they should be doing.
Gareth:
Well, it is the opposite, but if you were to think of an analogy whereby for example, I'll give you two examples. One, you have a partner who is bringing you flowers every day. Which makes you feel better? Do you enjoy coming home for 30 days in a row receiving flowers every single day? Does that feel better than coming home on one particular day and getting the same number of flowers all at once? When the enjoyment is spread over time, you tend to feel better. In the stock market it's the same. People like to take gains all the time that makes them feel better. Similarly, if you're looking at losses, for example if you're looking to potentially pay a bill. If you see that bill hit your statement every single month, it tends to be painful every single month. Whereas if you have to pay it all at once, you probably forget about it for the next 11 months.
Interviewer:
Right, I understand that. I actually have a question about the psychology of trading coming up in a few. Do global events effect your trading, and if so how?
Gareth:
Yeah, absolutely. I don't think it would be fair to say anything other than that in trading. There are always going to be curveballs from both sides hitting you. Whether that be news media, whether it be a fundamental event hitting a stock, or whether it be a macro or a global event. All of that ties into very smart management of a portfolio. The best way to manage a shock or a surprise in a portfolio is to anticipate what I call unknowns. It's not foreseeable, it's not something you can anticipate any given day. In fact if you were to look statistically at an event like that, it would be very much the tail risk of the curve. At the same time, these things tend to happen very frequently. It's much like saying big storms don't occur only maybe once every hundred years on the East Coast of the United States, and yet over the last couple of years we've had two storms that could be counted as one in 100 year storms.
These things tend to often happen more frequently than we anticipate, and as traders we have to account for the fact that statistics won't necessarily play out in reality, and that the reality is shocking events or surprising events can happen more frequently than anticipated. Interviewer:
Did you anticipate the storm? What did you do to protect yourself or your portfolio?
Gareth:
The storm actually hasn't had a huge impact on the markets. There are two schools of thought when it comes to storms like this. One is that they create tremendous economic damage, to the tune, some people thought $20, $30, $40, $50 billion of damage and economic loss. Another school of thought is to say that because of all of the damage that has been created over a short period of time, in the span of three, four, five, six, seven days, or fewer in the case of the storm actually covering an area, that it also creates employment for many, many months. Six, 12 months or longer in those areas. That acts as a stimulus to the economy. When we see that the market sometimes doesn't react negatively to events like this, it's because often the second philosophy is weighing more heavily than the first.
Interviewer:
Let's talk a little bit about volatility. What do you like about trading volatility?
Gareth:
I personally very much appreciate and love trading volatility. The reason is that when stocks are volatile, they move much more quickly. If you understand how to manage risk properly, it means that small movements in a stock often lead to much more exaggerated or large movements in an option. When you eventually get even larger movements in the stock because volatility is higher, it leads ultimately to much, much greater gains in options, often triple digit gains in a very short period of time. When you balance that out across a portfolio, you can risk very small amounts of capital and make very large amounts of capital. In a volatile environment, even if you're wrong, even a considerable portion of the time, the amount you're losing is fixed to a very small amount, whereas the amount you're making can often be in excess of 200, 300, 400, 500%. Even if you're wrong 50% of the time and right 50% of the time, you may lose, for example if you put $5 down on one bet and $5 down on another bet, you may lose the $5 on the one bet but you could make $15 on the other, and ultimately end up positive. It tends to be an environment which if you're a high risk trader leads to higher rewards more quickly. If you tend to be a conservative trader, it also allows for the opportunity to sell premium at very inflated prices. What that means is you can own a portfolio, sell options against that portfolio and ultimately generate much higher rates of return than you
could in a lower implied volatility environment. Interviewer:
What's tricky about trading volatility, and how do you specifically use it to profit?
Gareth: The challenge about trading volatility is that if you are a conservative investor, and you employ higher risk strategies, then you'll very, very quickly find yourself getting whip-sawed in an environment where for example you might have stop losses that are triggered too quickly. If you're the type of trader who happens to be a high-risk or risk-seeking investor, and it turns out that for example a stock moves much more aggressively than you thought and you were selling premium, then again, the movement of the stock can be such that the positions have much greater risk than you might originally have factored in. You can again get whip-sawed out. Ultimately in both cases it falls back to understanding what your risk tolerance and reward preferences are and structuring your portfolio around those two. Interviewer:
What kind of money management techniques do you use?
Gareth:
For money management, the way I like to think about it is that the definition of being 100% bullish or 100% bearish does not mean having 100% bullish positions or 100% bearish positions. In my mind, if you're 100% bullish, your portfolio should still be structured with at most an 80/20 bullish to bearish bias. What that means is that even if a stock doesn't keep going up, or even if the stock market fails to continue moving higher, and if for example an event such as you mentioned earlier, a global event, a macro event, a shock, a surprise, a hurricane, whatever might happen. If it is unexpected, you've also got protection to the tune of at least 20% of your portfolio protecting yourself. Essentially what that does is it manages the volatility, it mitigates the risk to an extent. Similarly, if you're looking to be bearish on the market, in my view an appropriate weighting, no more than 80/20, is fair too. If you've got a bearish outlook on the market and the market is 80%, let's say you're 80% short, 20% long, then in my view that's a very heavily or aggressively bearish position. If the market is not moving aggressively to the downside or the upside, maybe a position that isn't quite as extreme as 80/20. Maybe 70/30 in both cases is more appropriate.
Interviewer:
Now we back to the psychology question. How important to training is psychology and can you give me an example of an instance where your lack of control of your own psychology lost you money?
Gareth: Sure. I would say the two key ingredients to success, which if violated lead to losses, are patience and discipline. A good example of my failure on that part recently was I was asked if I would purchase Facebook. In fact, it was somebody in the Market Tamer community, they asked if they should purchase Facebook. My answer was that when the smart investors are selling, then you shouldn't be
buying. My example of that was Blackstone Group back in 2007, where they went public around $30. Five years later they were still down, their stock price had dropped about 60, 70% about five years later. It never really reached a higher level than it had on its IPO day, even if only marginally so and for a very short period. For the most part, it was a bad investment for the public, but a very smart investment by the insiders, because they were selling at the top. Similarly with Facebook, that was my expectation that the market was at a level which would very much favor the insiders selling their stock, a very poor decision for outsiders to purchase the stock. However, when the stock went public and hit $45, I did not buy. When it hit $40, I did not buy. When it hit $35, I also didn't buy. It then hit $30, and then it bounced. It came back to $30, and my expectation at that point was that it would find a bottom right around $30. Without adhering to the rules of patience and discipline which would have kept me safe by essentially waiting for the stock to bounce up again, technically confirm that it was going to move higher, I looked to bottom fish. I bottom fished right around the $30 range, and one of the things I did at that point was even though I bought the stock, I also bought options to insure myself in case the stock suffered to a greater extent. I limited my risk, which ties into the philosophy that you should never have a position that is on edge. You should always have that 70/30, 80/20 edging. Ultimately, what happened was the stock plummeted from $30 all the way into the teens. While that on the face of it would seem like a very poor trade, as it turned out, with the stock dropping all that way the put option made a lot of money. Using a technique that we invoke at Market Tamer called the „wheel of profit,‟ it ultimately turned out to be a successful trade. It only turned out to be successful by understanding how to manage risk. If I had simply purchased the stock and done nothing else, it would have turned out to be a very poor trade. Interviewer:
What's your biggest success trading?
Gareth:
My biggest success trading is probably measured in a rate of return. That is with a strategy called strike pinning that I used to favor very heavily. Which involves [an expiration] essentially placing iron condors, and really more specifically it's iron butterflies at a specific strike. For example, on expiration day, if a stock is going to close at $100.00, and you sell options at that strike price and protect yourself with options at higher and lower strike prices, you can make phenomenal amounts of money in a very short period of time. Some stocks actually adhere to that on expiration day, because some funds move stocks around to profit from the options expiring at that level.
Those strategies historically have been monster winners for me, in the order of tens of thousands of dollars in the space of just a few hours as the option time decay kicks in and they expire. Interviewer:
What‟s the best lesson you've learned as a trader?
Gareth:
The best lesson I've learned, and maybe the smartest lesson, is that however confident you are in a position you should never take on too much risk. Because the one moment in time where you get extremely confident is the moment whereby the market will, in fact, punish you. Essentially the lesson is to be humble with the market and recognize that it is the collective output of literally billions of decisions coming from millions of people, and that it's very unlikely that you are smarter than all of those people. The market is smarter than you, and once you defer to it and recognize that you should trade with it and not against it, as in what you see in front of you or on the screen is what you should trade, not your opinion, then you end up in a much better place.
Interviewer:
What do you think the number one reason is why traders fail?
Gareth:
I think the number one reason is that they fail to manage risk appropriately. Most traders fail by risking too much on a small number of positions. As a result the psychological damage of that impacts them to such a great extent that they no longer can either tolerate the risk or they don't have the capital left to actually continue trading.
Interviewer:
What made you decide to become an educator?
Gareth:
That's a great question. I came across an individual who, like me, had come from Ireland when he was young. Just like me he'd left college, he came to the U.S. in search of greater opportunities. He built his career over 40 years, he became very successful. He had millions of dollars in retirement funds. He ultimately retired right around 2000. He put all of his money into the market and within a couple of years he was virtually penniless. It signified to me the importance of timing in the market. However, had he, for example, retired in 2002 and enjoyed a big stock market run through 2007, he would have been even more fabulously wealthy. He might at that point have considered himself to be a very smart trader. If he invested in 2000, which he did and lost it all, he might consider himself a very poor trader. The answer is that luck can play a part in these things. If you don't really know what you're doing, you can either consider yourself very lucky or very smart, or you can consider yourself very dumb.
The reality is that ignorance of how to trade properly, which involves smart risk management, understanding how to hedge using options instruments, how to generate cash flow every month, how to protect stocks every month, is really the key aspect to succeeding in the market. Without
having that background in understanding proper portfolio management and management of those instruments, it's very easy to very quickly lose in the market. As a result of that story and that individual who I know well, I was motivated to share my knowledge of how to manage risk appropriately and how to essentially embellish and augment stock market portfolios among retail investors so that that individual, his story, as best as I could, would never be repeated again by anybody else for lack of information. Which is fundamentally what he was missing, he simply didn't have the knowledge, so I was motivated to share the knowledge that would have protected him with as many investors as I could possibly reach. Interviewer:
Now let's talk about the proprietary systems that you've developed.
Gareth:
The Market Timer Algorithm is the proprietary system that I developed, which cannot be duplicated or replicated. It's in fact a system that is pioneering in the industry as one that focuses on expectancy as a key determinant in producing stock ideas that have a high probability, high expectancy of succeeding. The key components of that are that most other systems are static. Most are fixed in time, and most use lagging indicators. What we look to do is we look to the future, and we look at a dynamic algorithm that has clear entries and clear exit points, that also will change as the market changes. Which, ultimately the reality of the true stock market isn't fixed, and static and old, like most trading systems are. We look to get ahead of the curve with the trading system that we use.
Interviewer:
In addition to your Market Timer algorithm, what other tools do you use, and what are some of your favorite resources?
Gareth:
One of the things that I suggest to traders who are beginning is really to be passionate about learning more than passionate about trading. If there's only one thing you could be passionate about, it should be learning, because ultimately the more you learn the more knowledgeable you'll be to protect your portfolio and grow your nest egg. A really good site out there that's entirely free for in vestors is [cboe.com]. For investors who are already experienced and like to get a snapshot of the market, there's a very cool app out there called Stock Touch, which allows you to instantaneously zone in and out of hot sectors in the market, and provides really cutting-edge opportunities if you're a fast trader. Obviously for those who are looking to take advantage of more structured curriculum and have a dedicated focus that they're going to become successful over the long term, Market Tamer will provide structured, tenmodule curriculum, 40-on-demand video lessons that take users through from the novice level to the expert level, including everything from managing risk to trading volatility, protecting their nest egg, generating cash flow ever y month, and
capitalizing on virtually any and every situation the stock market can throw at you. Interviewer:
What is one piece of advice you would give to a novice trader just starting out?
Gareth:
I would say that for a novice investor, the most important thing is really to not trade right away with real capital. It's to trade with virtual capital, and that ties in with the learning comment, that as much as it's fun to dabble in the stock market, if you don't have the requisite information that has demonstrated with proof in your portfolio that you can succeed within the market, then it's not a smart strategy to be investing real capital.
Interviewer:
What about for an experienced trader? What kind of advice would you give them?
Gareth:
For an experienced trader, my suggestion is, if they've been trading a long period of time but have not been successful, focus very carefully on risk management. For an investor who is trading a long time and is successful, I would suggest they do absolutely nothing but keep doing what they're doing, because they're already successful.
Interviewer:
What's next on the horizon?
Gareth:
For me what's next is I'm really excited to be launching a very, very cool new product at Market Tamer, which is the Seasonal Forecaster. It involves really a unique look at the market whereby we analyze historical patterns over as long as 20 years and identify on any given day what stocks are likely to move, either up or down, based on those patterns. What's really surprising about it is that you see patterns repeat year in and year out, and yet most people have absolutely no idea what they are. Most people are aware of the Santa Claus rally, or the old adage "sell in May and stay away," but very few people know on any given day what stock is likely to move based not on some opinion, but based on the fact that it has done so in the past. With a very highly statistical view of the market based on reality and fact and demonstrable proof that can be used again and again, we highlight opportunities for the future.
Interviewer:
When does that launch?
Gareth:
That's actually launching right about now.
The Volatility Kings: How These Three Pro Traders Consistently Profit in the Face of Volatility Charles Hughes
Interviewer: What‟s your background and how did you get started trading? Chuck:
I started out as an Air Force pilot. When I finished my tour in the Air Force, I was a commercial airline pilot. Commercial pilots typically have 15 da ys off a month, and on those days off, I looked into trading to start a second source of income. The airline industry is notorious for being unstable and you could face layoffs or bankruptcies or termination of your pension plan at any time. I wanted a backup source of income, so I started reading books on trading and going to live seminars. That was my hobby that I did when I was an airline pilot, because I could do it part time. Then I went on a medical disability with the airlines as it turns out, and I became a full-time trader at that point.
Interviewer:
You trade equities and options. Tell me a little bit about what‟s unique to each market and why you like trading them.
Chuck:
With the equities, I use a combination of technical and fundamental analysis to select stocks that have the best profit potential. Using that combin ation of fundamental and technical analysis, I can get a real edge in the difficult markets that we‟ve had the last several years, because I can far out-perform the averages. This two-tier approach has worked pretty well. I‟m just looking at a snapshot of my brokerage account, profit/loss statements. Using this strategy in equities, right now I have $419,682 in open trade profits. The stocks that I used have been doing well, despite the difficult markets, far out-performing the major averages. I call these stocks that I use my super- portfolio. They‟ve been doing pretty well. I also trade options and options are very versatile. I use a high-accuracy trade selection process to select options with the best profit potential. This trade selection process has three steps. First I determine the price trend of the underlying stock, or ETF, using my trend following system. Then on any given day there could be hundreds of stocks in a price up-trend. I narrow that list down a little bit. I like to use confirmation indicators that confirm the price trend. I use on-balance volume and I use the new 52-week high list then try to narrow down that list with the stocks with the best profit potential. Then I use the Keltner channels to select an entry point. They act as an over bought, over-sold indicator. I can get a low-risk entry by waiting for the stock to trade down to the middle or lower channel and when it becomes over-sold, then that‟s a good entry point if you‟re going to buy a stock or buy an option. If I‟m going to buy an option, then I purchase in-the-money options with time value that‟s less than 1% of the stock price. When you do this, the stock only has to go up 1% to break even on the trade as opposed to say a 10 or 15% price move to break even. If the stock only has to go up 1%, then this greatly increases the possibility or probability that the trade will be profitable.
This has resulted in very high accuracy with my option portfolio. If you have access to the Internet, you can go to www.chuckhughesic.com to see the performance. The „ic‟ stands for „inner circle.‟ Click at the top there, second from the left, „trade results.‟ You‟ll see the strategies. You can click „options strategies.‟ With my advisory service, these portfolios are updated every day real time, but this is a snapshot as of November first. If you look at the bottom, you‟ll see the stock portfolio has $179,000 current open trade profit, 98.5% return. That‟s the result for my super stock portfolio. Then if you look just above that, second from the bottom, the option portfolio. That lists the open trade profit average return, 224. I use the high accuracy trade selection process to make recommendations for that option portfolio and then I use the super stock selection process for the stock portfolio. Interviewer:
You don‟t trade Forex or futures?
Chuck:
No.
Interviewer:
Why?
Chuck:
Because with Forex and futures, I can‟t get that edge in picking out stocks of the best companies using that fundamental analysis. I like to have that edge. Right now we‟re in a deflationary environment in the world economies and everything‟s very slow growth in the U.S. and especially over in Europe. What we do is we focus on companies that still have consistent growth rates despite the current global environment. That gives us a real edge. We pick stocks that are not dependent on the price of oil or commodities; they‟re not affected by the European debt crisis. They‟re able to grow their earnings, very slow growing, 1% GDP U.S. economy and we just focus on the stocks. That gives us a real edge.
Interviewer:
What style of trader do you consider yourself?
Chuck:
I‟m a trend follower.
Interviewer:
Do global events affect your trading?
Chuck:
Interviewer:
No, not really. My trades are intermediate to longer term, so we take a long-term perspective. Normally it doesn‟t really play into our overall long-term objectives. Daily events may cause a loss that day in the portfolios overall, but for the most part we don‟t really pay any attention to the global events, we just simply follow our strategies and it‟s worked out pretty well for us. What do you like about trading volatility?
Chuck:
The main benefit, of course, of volatility is you have higher option premiums. I‟m a big seller of option premiums, so the more volatility we have, the more premiums I get to sell. That‟s a big part of all our strategies. Now, I have three volatility strategies and if you go back to the trade results page they‟re on the inner circle. I have three volatility portfolios. The first one is the put option portfolio, that‟s the third one down. That has a $90,000 open trade profit, average return of 55%. Right below that is the buy right or covered call portfolio and then below that is the option spread portfolio. Those are our three volatility strategies and they‟ve been working really well. You can see the option spread portfolio has an average return of 503%. These three strategies, they‟re spread strategies and they‟ve been doing really well when there‟s market volatility because these can profit whether a stock goes u p or down. It gives you a real edge in volatile markets.
Interviewer:
Why don‟t you talk a little bit about how you approach the markets? I was reading in your bio about being agnostic on a host of issues?
Chuck:
Yes. Rather than try to guess which way a market is going to go, I‟d rather just use my indicators and go with the indicators. If you use a simple trend following system that‟ll keep you out of trouble if a stock starts to decline. You get a reversal in the trend, you just simply exit your position.
Interviewer:
Do you use money management techniques?
Chuck:
Yes. For stocks, we will exit a stock position if the stock drops 10 to 15% below our entry price. We give a little more leeway with options because they‟re more leveraged. We‟ll sim ply exit an option position if it drops 25 to 35% below our entry price. We also will exit. If we have profitable positions, we‟ll exit those in increments. Maybe a fourth or a third of the position at a time, we‟ll simply exit to lock in profits.
Interviewer:
How important to your trading is psychology?
Chuck:
It‟s not really that important. My trend following system is very simple and basic. That makes it easy to follow. If you maintain a discipline and use the money management, then you can be successful.
Interviewer:
What was your biggest success as a trader?
Chuck:
I guess my biggest trade was, I had a Google option spread, and I made about $110,000 on that one trade.
Interviewer:
What‟s the biggest lesson you‟ve learned as a trader?
Chuck:
Interviewer: Chuck:
Biggest lesson I learned was not to try to predict the short-term price movement of a market. It‟s better just to follow your trend following system rather than try to predict the price trends. What do you think the number one reason traders fail is? In my experience, the biggest factor is people will take trades that the risk is not limited. Like short puts or go naked with options. They take a naked option position or if they‟re too heavily leveraged with futures or Forex. If you‟re leveraged 20 to one on a futures contract, which is pretty typical, if the market moves against you 5% or more you‟re wiped out. If you‟re leveraged 100 to one with Forex or 200 to one, which is typically, it only takes a 1% adverse move and you‟re wiped out. I think most people get into trouble because they don‟t stick to limited risk trades. They risk more than the capital that they have in their account, and if you‟re a put seller, your put selling strategy could go along for six, eight, nine months, do really well, but it only takes that one time when there‟s an overnight event to wipe out your account. I‟ve seen that happen time and time again. In my advisory service and my own personal trading, I limit everything to limited-risk trades and you can‟t lose more than you invest.
Interviewer:
It says here that you won not one but seven live international trading championships?
Chuck:
Yes.
Interviewer:
If you were such a successful trader, what made you become a mentor and an educator?
Chuck:
Well, I‟ve made over $5 million trading, so I don‟t have to worry about money anymore. I‟m happily retired with my six kids. I want to stay active in it and I still enjoy trading and I still trade, but I like to be a mentor to give back to the community some of the fortunes that I‟ve made. I think I really made a difference in people‟s lives, their financial lives, by giving these live seminars and becoming a mentor with my advisory service.
Interviewer:
What are some of your favorite tools and resources to use?
Chuck:
It depends on the strategy. I like stockcharts.com. I can get my indicators from that website. I use the 50-day, 100-day EMA averages. I use on balance volume. I use Keltner channels. I can find all those on stockcharts.com. Then over the years I‟ve developed my own options calculators that will determine the profit/loss potential for an option trade before I take the trade. I developed six calculators that will do this calculation. There‟s one for call option purchase, put option purchase, call option spread, put option spread, covered calls, and married puts.
That‟s the tools I use every day. Before I take an option trade, I‟ll run the trade through the calculator and figure out what the profit/loss potential is for that trade before I take the trade. Interviewer:
What advice would you give to a novice trader starting out and an experienced trader not having tremendous success?
Chuck:
The biggest advice I would give is don‟t over -leverage yourself, and limit your trading to limited-risk trades. That‟s I think the best advice I could give to a novice or an experienced trader, because I‟ve seen it so many times when people are over-leveraged and all of a sudden they panic, and they add their position before they should be. Or if there‟s a big adverse move then, of course, their account gets wiped out. That would be my advice if you‟re an option trader.
Interviewer: Chuck:
What‟s next up on the horizon for you? I‟m developing a retirement program and I have something that‟s a simple trend following system. It‟s a longer -term system. You get in and out of five different asset classes, U.S. stocks, international stocks, commodities, real estate, and bonds. You rotate in and out of these five asset classes using this very simple system and you only check the system once a month. It‟s a great retirement program. That system‟s never had a losing trade since 1973.
Conclusion
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