Exhibit IV
There are basically three types of gaps. The first is the breakaway gap. This occurs when a stock or futures contract gaps out of a base. It is usually very bullish. The second is a continuation gap, which happens after a stock has already made a move up. The third is the exhaustion gap. It shows up at the end of a move and usually the price action reverses trend shortly thereafter.
Cash Infusions from Mutual Funds
Another interesting pattern is due to automatic investments into mutual funds. The market often is stronger the last day of the old month and the first four of the new, as new money flowing into mutual funds are invested into stocks. This pattern also appears around midmonth, when new cash is often invested in index funds. I note things like “midmonth buying” on my blotter to remind me of this phenomenon. It will be interesting to see how outflows affect the market averages when we enter a bear market.
Three-Day Rule
Whenever a stock like a Microsoft or an Intel has had a large three-day move in one direction, you do not want to be buying on the third day or selling on the third day of a down move. That’s a sucker play. Usually stocks will have big moves in three days. The first day the smart people are moving, the second day the semismart people are moving, and by the third day, the dunces have finally figured it out. This is an important rule. If the stock has bad news and it sells down, by the third day you may want to start looking to buy it because the bad news probably has been fully discounted.
Put/Call Ratios
My friend Marty Zweig was one of the first to identify a contrarian indicator that gauges market sentiment by computing the relationship between the number of puts to calls traded on the Chicago Board Options Exchange. His theory is that market tops and bottoms are often signaled by the actions of small unsophisticated investors who are attracted to the options market by the potential for a big score with a limited risk. The put/call ratio indicates the bullish or bearish expectations of these ineffective investors. When extreme readings take place, the market usually corrects in the opposite direction. Theoretically, an extremely high reading usually means that fear is at a peak and selling will soon stop so the market should rebound. For example, a reading greater than 1.00 shows an extreme bearish sentiment (buy signal), while a reading less than 0.45 shows high call volume and extreme bullish expectations (sell signal). Like all other indicators, this must be used in conjunction with other data to assess an entry point for a successful trade.
How the Market Reacts to News
Bob Zoellner taught me a very important indicator about how the market reacts to news. If the market gets negative news and the market shrugs it off and it continues to go up, this is a bullish reaction because it means the market has already discounted the news. On the other hand, a sign of a fully priced market is one that reacts poorly to good news. In terms of stocks, some investors are puzzled when good news causes a decline in stock price. Investors should understand that this “good news” had already been priced into the issue. My favorite lesson that Bob Zoellner taught me is that when the stress gets so great that you think you might vomit, you should probably double your position, but only if you are then willing to use a tight stop loss on the entire position.
New Highs/New Lows
Financial newspapers have a new-high and new-low list for stocks. Based on the first law of physics, an object in motion will continue in motion until an outside force affects it. A stock that’s going down will continue to go down until it stops going down. A stock that’s going up will continue to go up until it stops going up. So the new-high and new-low list is many times a good place to look for new ideas.
Up Mondays
What I’ve noticed in the past few years is that as the influx of money into index funds has increased dramatically, Mondays are no longer the dull day that they formerly were. Mutual fund managers will put money into the market that may have flowed in over the weekend because they have a responsibility to put that money to work. Since the volume is usually lower than that of other days of the week, this recently has exacerbated the move to the upside.
Market Probability Calendar
Every day I acknowledge and make a mental note of how the markets have done historically on that date. While this might not cause me to take a position, it might make me more cautious of fighting a historical pattern. I keep a copy of Stock Trader’s Almanac’s Market Probability Calendar (1-800-477-3400) on my desk, which gives the probability of the market rising on any trading day of the year, and I have circled the highest and lowest readings. So if we’re in a positive mode and you have a 75 percent chance historically that the day will be up, you might consider going with it.
Option Expirations
I am very cautious of expiration strategies: options and futures have an expiration date, and I’ve noticed that the market will often have a severe drop into the Thursday or Friday the week before expiration, only to then turn up and rally into the following week’s option expiration. If I see this pattern set up, I’m leery of getting caught on the short side because I’ve seen this pattern before. Many times during option expiration, buy and sell programs will hit and shake you out of your position and fool you into leaning the wrong way.
Something else that I’ve observed is that program traders oftentimes will close the market very strongly in the last half hour, and I’ve noticed they go the opposite way the last hour of the following day. I’ve named it the Schwartz Rule of Alternation. I find expiration day very hard to trade and try to stay out because there are many fake-out moves due to the unwinding of options positions.
Trading on the Half Hour
I’ve noticed lately that for some unknown reason, program trading often occurs at half-hour marks: some bozo’s watch reminds him that it’s 11:00 and he pushes a button that starts a buy program; another program trader’s watch is set for 1:30. I’ve also noticed a rising market right around noon that I’ve nicknamed the “noontime rally,” probably so that everyone can attend their martini lunches without too much stress on their minds. The last half-hour of the trading day has been particularly volatile of late, because institutional daylong strategies are completed then.
Take Out the Highs, Take Out the Lows
In nontrending days where the market is trading back and forth in a range, the locals in the futures pits will make money trying to take out the stops, which are oftentimes concentrated around the highs and lows of the day. In a nontrending day, since the locals know where the stops are, they will accommodate both sides and blow out the stops on the highs. No sooner will they do that then they will start heading south and take out the stops on the lows. The way to counteract this is to put bids in below the low and offers above the highs to participate with the locals.
First Trade Back
After taking some time off, make certain you take the first day back to work very slowly to adjust your eyes to the rhythm of the markets. When I have rushed back into the fray, I have invariably gotten myself into trouble before I knew what hit me. Make your first trade upon returning an intellectual one and not an emotional one.
Worst Fears Not Realized
I have stated before that whenever your worst fears are not realized about a trade and the market is letting you out better than you expected, it is not just good luck. Rather, your position is most likely correct and should not only be held but perhaps added to.
Ego
We have met the enemy, and they are us.
—Pogo
I’ve said it before, and I’m going to say it again, because it cannot be overemphasized: the most important change in my trading career occurred when I learned to DIVORCE MY EGO FROM THE TRADE. Trading is a psychological game. Most people think that they’re playing against the market, but the market doesn’t care. You’re really playing against yourself. You have to stop trying to will things to happen in order to prove that you’re right. Listen only to what the market is telling you now. Forget what you thought it was telling
you five minutes ago. The sole objective of trading is not to prove you’re right, but to hear the cash register ring.
My Typical Day
Baseball is 90 percent mental. The other half is physical.
—Yogi Berra
6:45 A.M.
Alarm goes off. I get up begrudgingly. As a kid, I could sleep twelve hours a day. Now, I’m lucky if I can get eight. Anything under eight and I’m not ready for work, I feel like I’ve shorted myself.
6:45-7:20 A.M.
Shower and shave. I used to have a little pager that gave me market prices twenty-four hours a day, and I’d put it next to the mirror so I could watch the prices while I was shaving. But after three years in Florida, my new shrink made me get it out of the house. He wanted me to get all of my machines out of the house. He wanted me to turn my home into a refuge from trading. We compromised by removing the pager, and I must admit that it’s good not having a razor in your hand when you’re watching a position go down the toilet.
7:20-7:30 A.M.
Clean out the plumbing I. My grandfather Pappy Snyder always maintained that you were not ready to start the day until you’d cleaned out your plumbing twice. “When I was a boy your age,” he once told me when we were walking together through New Haven on a cold winter day, “we lived just outside of Kiev and we had to go to an outhouse at thirty below. Try taking a crap in an outhouse in the dead of winter and you’ll always appreciate indoor plumbing.” I do, twice a day.
7:30-7:40 A.M.
Breakfast, a bowl of Kellogg’s Oat Bran, a glass of Blood’s fresh-squeezed grapefruit juice, and two pieces of Pepperidge Farm whole wheat toast. I eat to loosen up, not to fill up. While I’m eating, I look at the New York Times, especially the sports section. I still like to see how my Yankees are doing and what Steinbrenner’s done this time to tighten them up.
7:40 A.M.
I’m at my desk collating all the sheets that have been faxed in overnight. I get a thirty-page report from Bear Stearns, my clearing firm, listing the P&L of all of my accounts and all of my trades from the previous day. I also get sheets from my different commodity brokers. If the sheets aren’t right, I’m on the phone ripping somebody a new asshole, because everything has to be reconciled before the market opens. The market’s so volatile these days that if my accounts aren’t reconciled before it opens, I could lose tens of thousands of dollars at the bell. That’s why I record all of my trades. You can’t trade if you’re emotionally upset, and I want all of my accounts right by 8:00. I start each day with a clean slate. I don’t bring any emotional baggage from the previous day. Each day stands on its own merit, and once it’s over, it’s over. My exhaustive evening work ritual helps put yesterday behind me so I can focus on today. Not doing this is dangerous for me. My biggest losses have always followed my largest profits because overconfidence has led to complacency and careless trading. Trading S&P futures is conducive to this psychological approach because futures are marked-to-market by the clearing firms—all open positions are credited or debited to your account at the end of the day based on their increases or decreases in value. So everyone starts with a clean slate each and every morning. I try to make money every day. I also keep track of my profits and losses for each week, each month, and each year.
8:00-8:10 A.M.
This is when I fly through the Wall Street Journal.
8:10-8:15 A.M.
Clean out the plumbing II. According to Pappy Snyder, I’m now ready to start the day.
8:15 A.M.
I call my bond brokers and get their support and resistance levels on bonds for the day. I write these down on my blotter. I have every ratio calculated: Terry Laundry’s Magic T oscillator, the eighteen-day oscillator from the previous day, the high/low/close on various indexes: the OEX, the S&P, and the XMI.
8:20-8:30 A.M.
Round 1. The bonds open. I have to see if I want to trade bonds. I usually do because bonds are a good way to loosen up. Unless the government is about to release some numbers, they move a lot slower than stocks, options, and some other futures and they’re easier for me to hit. Sparring with the bonds gives me a chance to get a feel for the markets and to work on my timing. Unfortunately, the government has wrecked the bond market. For some perverse reason, their most important releases always seem to come on Friday morning at 8:30. When you’re over fifty, by Friday morning you have a hard time climbing into the ring. You’d think that the government would have the courtesy to make their important announcements earlier in the week so that we senior citizens would still be semifresh.
8:30-8:45 A.M.
During this time I might trade bonds, unless some announcement’s come out. When a news item comes out, the futures exchanges have this thing they call “a fast market” and an F will go up on the machine to let you know that it’s “fast.” That means all the normal rules for trading are suspended and you’re at the mercy of the boys in the pits. I don’t trade bonds when the F sign’s up because you never know what’s happening and it’s too easy to get screwed.
8:45-9:27 A.M.
A lot of different faxes roll in: Cowen and Co., Bear Stearns, various gurus, my friend Mark Cook out in Ohio, Dick West’s daily market comments. I match all of this information with the opinions I’ve written on five-by-eight cards that I’ve taped to my quote machine the night before, and then I check the buy and sell levels I have for the S&P futures based upon 1 percent bands I’ve drawn around my channel lines. There is no excuse for not being prepared. Preparation is simply doing the work. If you have a game plan prepared ahead of time, it can help you find courage in the heat of the battle.
9:28 A.M.
I review my checklist. It’s a handwritten sheet, laminated in plastic and taped to the right-hand corner of my desk where I can’t overlook it. It summarizes my checkpoints for taking positions and contains general strategy reminders.
Check charts and moving averages prior to making a trade—the moving averages work better than any tool that I have. Don’t go against them.
Are we above or below my moving averages, i.e., in positive or negative mode?
Are we above or below a dominant trend line?
Has recent price action taken out previous highs or lows?
Is the MTO (Magic T oscillator) in positive or negative mode?
Always ask before taking a position: do I really want to have this position?
Always know the amount I’m willing to lose before taking a position. Know the uncle point and honor it.
After a very profitable run of trading, reduce the position size.
After a successful period, take a day off as a reward.
9:29 A.M.
I’m on the phone to the S&P pit. The first minute and the last minute of the S&Ps are the most furious of the fight. Anybody who calls me during those times is going to get their head ripped off. I need total concentration. I cannot be disturbed. My adrenaline is pumping, and this can be a problem. When we were in New York, one of my friends’ wives called at 9:29 on my business line one morning looking for Audrey. All of my brokers knew never to call me at 9:29 or 4:14 so I picked up the phone and shouted, “You asshole. I’ve told you never to call me at this time. Who the fuck do you think you are!…Oops, sorry, Molly. Molly?” I sent her a dozen roses, but Molly’s been cool to me ever since. I’ve lost a few friends who’ve called me at 9:29 or 4:14.
9:30-12:30 P.M.
Rounds 2 through 7. The stock market is open. The Merc S&Ps are open. I write all of my orders on my blotter and when a trade is completed, I circle it. If it’s not completed, I either leave it open or cancel it. If I cancel it, I write C-A-N-C-E-L next to it. That way, I have a running log of everything I’ve done and attempted to do during the day. I P&L the blotter every half hour while the market’s open. I like to know exactly how much I’m up or down all of the time and I find it emotionally upsetting if my accounts aren’t right. I have a grid with thirteen different squares, one for each half-hour bracket at the Merc
, and I do incremental rates of change on the NYSE Composite. I’m always looking for patterns. Pattern recognition is my karma.
12:30 P.M.
Lunch. “Seaside Superette, this is Marty Schwartz. I want a number four to go.” The market used to be an old-boy’s club that went from 10:00 until 12:30, and then the old boys would go out for a two-martini lunch, come back and work from 2:00 until 3:00. It was very civilized. Since I’m not a drinker, that’s when I’d get a sandwich and go to post my charts. Not anymore. Now I post charts at my desk.
1:00-4:00 P.M.
Rounds 8 through 14. More of the same. Keep on punching.
4:00-4:15 P.M.
Round 15. There’s a fifteen-minute flurry when the stock market’s closed, but the S&Ps are still trading. This is when you can really get clobbered. The premium level will rise or fall based on the orders for the close and the psychological setup for the next day’s trading.
4:15-6:00 P.M.
Cool down. A little postfight analysis. Work on the P&Ls, get the blotter squared away, go for a workout or a run.
6:00-6:30 P.M.
Dinner.
6:30-7:00 P.M.
Charts. I have my own custom chart book produced by Security Market Research (SMR), a stock-charting service in Boulder, Colorado. I chart about seventy stocks, and I post the oscillators when they are faxed in from SMR.
7:00-8:30 P.M.
Data collection and review. I listen to all my hot lines, transcribe them, work on my moving averages, etc., etc.
8:30-10:30 P.M.
Preparation for tomorrow. Big picture work. five-by-eight cards, strategies, plot inflection points, channel bands, review hot lines, spot trends.
Pit Bull Page 30
