by Brady Dahl
Your second strategy was a hit...
I learned that my naive idea of finding a pattern and playing it over and over again could really be done, because I had just done it! With hypothetical money, of course. But my interest in trading really comes from this experience. Plus I was always into numbers. And really into football. I would memori2e statistics and spend hours pouring over the numbers doing my own calculations on them.
Like what?
I wanted to know how they calculated the quarterback passer rating, so I reverse engineered it and figured out the formula. Unfortunately these days I could just get it on the Internet, but back then I couldn’t find it anywhere.
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I like how you think it’s unfortunate they give it away for free on the Internet now…
Well, I went through all that work.
But it’s things like that which led you to where you are today...
Yes, you train from a very young age. One of the common themes in self-improvement and performance enhancement books is how society likes to believe that some of the most successful people are prodigies with a magic gift. But when you dig more deeply you find that the most successful people have usually just worked the most. Everyone loves to say Mozart wrote his first symphony at 5 years old, but people don’t realize he was being groomed to be a musician ever since he could hit a piano key. It’s not a genetic gift where somebody sits down one day and realizes they’re amazing.
You’re speaking to the debate over whether or not trading is an innate skill or learned…
Personally, I see the evolution of how the brain develops over time to get good at something. To me there’s a strong connection. Reverse engineering formulas as a kid ties right into trading with figuring out risk/reward ratios and things like that. Although if I had been using that talent in an academic way, instead of for football statistics, I probably could have had a nice career.
Or you could have been a great NFL analyst…
(laughs) Well, maybe. But later on I came back almost full circle to where that passion became relevant to stocks. Around 15 or 16 years old, they asked us what we wanted to be when we grew up and I actually had an answer. I wanted to make a living betting on football games while trading stocks in the off-season.
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Trading was only for the off-season…
(laughs) Well, I was young. There was no online trading at the time I didn’t really know how I would do it. I just knew I wanted to do it.
But in reality you ended up doing a few other things first, including a stint building swing sets, right?
Yes. I’ve always had the entrepreneurial urge. I like to get my hands dirty and make creative things. So when I saw an ad looking for contractors to build high-end swings sets, it wasn’t completely out of character to give it a shot. They teased something like $300 to $500 a day, so I was skeptical, but I thought if I could even make half of that, I’d be happy. I was supposed to be a contractor with a truck, insurance, workman’s comp, and all those things. I was 23 years old, so I just gave them the answers they wanted: Yes, I’m covered. Then I actually went out and became a contractor with legitimate workman’s comp, insurance, and everything.
So how do you go from swing sets to swing trades?
There were several key influences that brought me to remember my earlier dream of trading stocks. It was 1998, during the early stages of the Internet bubble, and another contractor that worked for the swing set company would talk about online trading and making $1K a day if you picked the right stock. I didn’t actually believe it was that easy, but it got me thinking. Day trading was also starting to be talked about in the media quite a bit. There was even an article in my local paper about a day trader making $250K a year. Meanwhile summer had turned to fall and I was looking at some downtime because there aren’t a lot of people building swing sets in the snow. I had been saving a good portion of my income in the bank in order to pay taxes in April so I realized I had a few months to possibly give this stock trading thing a try.
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Yes, why not risk your payment to Uncle Sam.
Well, at first it was just an idea. But then it sort of snowballed. I started going to the library, reading the Wall Street Journal, and researching on the Internet, although there was so much less information for trading back then. But I got the bug and soon I was using every spare moment I had to research. At times I was putting in close to 40 hours a week. I didn’t want to place a trade until I knew what I was doing. I wanted to find a pattern again, like I had in school, and trade it for two or three months, pay the taxes in April, and then go back to work. It was late December before I eventually discovered something.
A new pattern?
Essentially it was a variation of a parabolic short. My own version. I also found two other patterns I played back then. One of them was buying these big parabolic charts after they returned to Earth. There was just so much hype back then I could pretty much count the days until they would repeat. I’d be long a stock that looked like it was dead, and then it would just rocket up again out of nowhere one day.
Did you start trading this new pattern as soon as you found it?
I wanted to play it the very next day, but I had to work. Eventually I just told them I needed some time off. I had already opened a trading account, so in early January 1999,1 logged on and it only took a day or two before I spotted the pattern.
How did that first trade go?
It worked. In researching that pattern, I had found approximately 80
instances of it over the course of a year, which was all done by hand, by the way, since I couldn’t just download the data. But it showed that two days after entry the average return was 17 percent per trade, while three days after entry the average return was 21 percent. Give it additional time and the percentage return kind of tapered off, so the
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to break it up. When I put on my first position, I start to get a different sense of how it’s trading just because now I'm involved, now I’m a participant in the market. I can see how quickly my order gets executed, how the price reacts to my liquidity being added market, and things like that. I also like to set the last one or two orders at a slightly higher price, just in case. Then, as the stock continues trade and I have confirmation that the setup is working, I might lower those last two orders to increase the odds of a fill or even convert them to a marketable limit order if the price starts to crack. I also feel like it’s difficult to hit a precise price on any stock. So if I think stock will hit a high of $10 and I’m trying to short it, I’ll have a few orders at $9.89, $9.92, $9.95 and so on. That way if it peaks out penny below $10,1 still get filled some shares.
What about exits? You might not set strict targets, but you definitely must have a sense for where you feel these large swing short stocks are more appropriately valued…
A simplified version of the answer is that targets are a function of time and price. It’s not strictly price, nor strictly time. I’m looking to see how far the price goes and how quickly. There are plenty of times I think a stock is such garbage I expect it to drop 50 percent in one day (laughs), but that’s not usually how it works. If I give it three days and it still hasn’t moved as far as I expected, I must adjust my expectations.
Volatility is disappearing, the initial catalyst is getting stale, and now other risks may pop up, like a secondary catalyst that will push it back up, or borrows becoming scarce, or buy-ins. The best way to think about all these different things, like entries, exits, stops, profit targets, etc, is as long as the thesis for the trade remains intact, I want to stay in the trade. As soon as the thesis for the trade starts to deteriorate, I want to get out of the trade. Setting a price where I’m just going to execute a stop order is very arbitrary. It has nothing to do with whether or not the trade is working. If I short a
stock expecting it to fade following the catalyst, but it just dips and then resume it’s momentum, I will stop out. But that stop is not based on price, stop is based on the fact that my thesis for the trade is not holding.
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Conditions constantly change and you must change with them…
Yes, exactly. And the same goes for taking profits. If I’m short a stock and expecting an extended fade as people slowly lose interest, but the stock instantly craters instead, my thesis is gone and I’m just going to get out. Maybe it didn’t go as far as I thought, but my thesis is gone because it didn’t do what I expected. It no longer fits the whole setup I had in mind. So I’m not predicting what the stock will do. I think predictions are a big mistake. With nearly infinite outcomes, accurate predictions are next to impossible.
So if you’re not predicting, what are you doing then?
Reacting. As a trader, I find the best state of mind to be in is always one of reacting. So I set up the story, I have my thesis, and then I react to the trade. If it doesn’t do what I expect, I adapt accordingly.
So risk management is really governed by your trade thesis. In other words, you don’t have rules about what percentage of your account you’ll risk, etc…
Yes, I don’t believe in that approach. For the way I trade, it feels too arbitrary. That doesn’t mean it’s not necessary for some traders, especially those with smaller accounts because it might improve their odds of not blowing up, but it does not work for me.
And you let winners run until they no longer hold to your thesis?
Yes. If I had the potential to make $10K in a trade but I had a personal rule where I took profits at $5K, I just left $5K on the table.
It doesn’t make sense to me. Why would I do that?
Again, it’s arbitrary…
Yes, I don’t believe in arbitrary rules. The laws of mathematics, probabilities, maximum potentials have nothing to do with arbitrary rules. Mv theoretical outcome without them is actually much better.
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The best possible decision at any given moment in a trade has nothing to do with how much money I have in it, how much profit I’m currently holding, how much I’m willing to risk, or how much I’m trying to gain. They’re all arbitrary items completely unrelated to the chart itself, the stock itself, and what the price is actually going to do.
How much does the overall market play into your trading?
If I could make a list of, say, 30 potential variables on any given trade, usually only one to maybe five of them ate going to be highly relevant.
Occasionally the overall market is one of those variables. Other times the market is completely irrelevant, zero, doesn’t matter. An extreme example of when the market was relevant is the flash crash in May 2010. When that happened, the overall market was the most important variable in most trades by a huge magnitude. I don’t care what catalyst my stock had, it became almost irrelevant in comparison. Traders must recognize when the market is becoming an influence on their stocks.
What’s your biggest loss?
I had a really good year in 2005 and made over $2 million in profits. It was my best year up to that point. So heading into 2006, I was very motivated. And I’ve always been into different types of self-improvement, trying to find ways to enhance my own performance and achieve greater results. As a self-taught trader it takes a certain level of focus on self, because I don’t have a mentor or boss to hold me accountable. So I have to find ways to bring out improvement from within. I learned one way to elevate my performance is to create goals, so I set a goal for 2006 to make $3 million, about another million per year than the last. It was a conscious effort to trade a little bit more size and be a little bit more aggressive. The profits were decent until April, when along came FMXIQ, a penny stock on the pink sheets that started making a parabolic move. And in 2006, I was still heavily technically based, looking at the chart and playing of the patterns, and FMXIQ was a really attractive setup. I have a personal ranking system for setups. And it’s not highly scientific. It’s actually a pretty simple 1 to 5 rating. There’s no magic formula behind it.
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So it’s no quarterback rating…
(laughs) Yes, a little more simple than that. But this trade was a 5 out of 5. A golden setup. When I first started to short into the setup, I was not overly aggressive. But as the stock started to accelerate I got more aggressive and more aggressive, and it kept going. Not to say there weren’t any pullbacks, there were some. I wasn’t looking to just short it and hold it forever. I was going to take a profit and move on. But this is kind of one of those unfortunate rules of trading. . If I ever short a stock, then tell myself I’ll cover into the first pullback, but then miss my exit on that pullback by the narrowest of margins, like by a penny or something ridiculous, it’s a sign I’m about to get screwed. I’ve had it happen enough times to know.
Why do you think that is?
Well there are many times in trading when it seems like the market is out to get you, but it’s just bad luck, coincidence, or what I think is a form of groupthink. I don’t believe it’s actually some market maker or HFT who’s actually looking to screw you. Other traders who are similar to you are looking at the exact same thing. You’re looking at the same chart, the same news, the same information, and you all come across the idea simultaneously. But when everyone has the same idea, that’s when you have the pullback that doesn’t quite get to your order, because it’s crowded. Yes, the market is corrupt. Yes, there are a lot of bad players out there. And yes, sometimes they do screw you, but much less than you think. You’re not even on their radars.
Where did you start shorting FMXIQ?
It came up from $0.25 where it had been in a dead pattern with not much volatility or volume. I started shorting at $1.26 per share. Within days I was adding larger size. Remember, it was a conscious effort in 2006 to increase size in order to step up my game and elevate myself.
By the time it hit $2.50 per share I had 251,500 shares at about a $1.55
average. I kept wiring in money from other accounts to avoid the margin call. I was getting carried away, but then again so is the stock.
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The broker I was using to short FMX1Q was a small firm who knew me by name, and the guy who usually helped me knew I had a reputation for calling and getting large locates. Unfortunately he kind of fed into my ego, my weakness, and what should have been avoided when he said, “Well let’s just ask for a million shares.” I should have been more cautious, but he was feeding the mentality I was already in.
Here l am holding a quarter million shares at a dollar loss per share. It was definitely bad, but I had been through far worse drawdowns even up to that point in my life, so it was not yet a disaster. It was still within the realms of manageable, and I still expected to turn it around and make a profit.
So he gets you an enormous locate and what did you do?
I shorted away. By the end of that day, I had shorted another 300K
shares. So now, after four days, I had 551,500 shares with an average of $2.02, and the stock closed around $2.50. At that point I recognized I the danger and went into a mode of risk minimization. I needed a pullback to get the position size down quickly, even if it was for a loss.
I really wasn’t expecting the stock to collapse, but based on the chart it still looked like a great setup. I was simply way too early. I had done it before and survived. In fact, I had profited. So my confidence wasn’t destroyed, but I recognized the need to minimize my exposure to the risk. Day six the nightmare intensified. Against my own expectations, the stock started going up more. If I hadn’t been already in the stock, I would have be shorting it then, but now I was being forced to trade it based on risk exposure, so I was essentially doing the opposite of what I would have been doing — I was covering. And there was really no choice. The broker was starting to get scared, even though I continue to wire in money fro
m every account I had. My policy was always to be proactive with margin calls as a trader, so I always stayed ahead of them with wires. But one of the wires got screwed up and delayed, so the broker started to panic and put pressure on me to cover. The stock was at $3.38 per share and I was in the hole $700K to $800K. I had on outsized position with concentrated risk, and brokers are allowed to force you out even if there is no margin call. It’s actually legal. I ended up covering some to pull off some risk, but the next day it got worse.
The broker went into complete panic. Their branch office in New
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York actually had a conference call with their parent office in Los Angeles because of me. (laughs) But the really frustrating part is that they were in a panic even though there was no margin call. I avoided it.
They said if the stock goes up another dollar or two you’ll be below zero, and my reply was, but it isn’t already up another dollar or two.
If, if, if…
Yes, the hypothetical “ifs” can happen to anyone, but it didn’t happen yet, so let’s not do this! But he was covering anyway and some of that covering was. . at.. the. . top! My account was part of the short squeeze. At one point I was down $1.3 million, and my broker was making the situation worse by forcing my covers and driving the price even higher. I did end up holding a decent amount for several more weeks and covered the last small piece in August.
All said and done, how much did you lose?
$772K on that trade. And this was supposed to be the year I was going to up my game, apply all this self-improvement and development, but it completely backfired. It completely shattered my confidence. I was honestly ready to quit. We talked about if you have a $10K account, it’s worth it to risk the whole thing to try to make a million, but when you have a million and you risk it all, die question becomes “why?” In my case I probably had about $2.5 million in the bank at that point. Why would I risk it when my life is already forever changed because of what I’ve achieved. In pursuit of more money? I’ve never felt like I’m highly driven by money. $2.5 million was already phenomenal. At what point do I turn that risk down?
