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Charles Kirk Q&A with Dave Landry, Part 2.

In April, Charles Kirk interviewed me. Below is part 2 of that interview. Charles can be reached at www.kirkreport.com

Kirk:  What mistakes do you think most traders make concerning position sizing?

Dave Landry:  They are inconsistent. Each and every trade has the potential to be wrong. You have to trade with a fixed percentage of your portfolio on every trade.

Kirk:  I know you emphasize the utilization of stops. So, what’s your method to setting stops?

Dave Landry:  I tend to eyeball them. I have an article on my website which goes into more detail but the bottom line is, I just eyeball them. If a stock bounces around 5 points a day, then your stop better be more than 5 points away from your entry. Otherwise, you’re going to be stopped out on noise alone. I think the most common mistake is thinking that you are controlling risk with tight stops. Tight stops actually will create losses.

Kirk:  Do you ever average down into a losing trade? Why or why not?

Dave Landry:  No. I take my licks. In theory, you could average down provided that (for longs) the company never goes out of business and you don’t run out of money. Those are two big ifs.

Kirk:  Can you provide some details regarding your money management system?

Dave Landry:  My basic money management system is to look for to make at least the same amount of my initial stop on half of my position. When this goal is achieved, I move my stop to breakeven on the remainder. This gives me the potential for a home run on those shares and the worst I can do is breakeven-barring overnight gaps. I then trail the protective stop on the remainder at the same distance as my initial risk. For example, if I bought a $30 stock using a $5 stop, I would exit half at $35. I would then trail my stop on the remainder at 5 points below the closing price. If the stock continued to move in my favor, I might open that stop up a bit within reason. This helps me to participate in a longer-term move. One more point, I do trail the stop higher on a favorable move even before the initial profit target is hit, usually on a closing basis. For instance, suppose I bought a stock at $30 and my initial stop was at $25. If the stock closes at $31, I would raise the stop to 5 points below that closing price—to $26. I usually trail on a closing basis unless the profit target is hit, then I immediately move the stop up to breakeven.

I’ve been asked if my money management system is statistical or psychology based. My answer is yes. I like being able to “play with the market’s money.” Once you’ve taken partial profits, it’s a great place to be from a psychological standpoint. From a statistical standpoint, sometimes you’re able to profit from noise alone in less than ideal conditions. One more because I know someone will ask it. If all you ever achieved was the initial profit target and then got stopped out on the remainder, you’re risking twice as much as you are making. Therefore, unless you are extremely accurate, this money management system would have a negative expectancy. The reason is does work is because you have the ability to make many times the initial risk on the occasional homeruns.

I use the work “basic” because there are ways to improve upon this system. In choppy markets I might take partial profits on a “near miss” and in momentum markets I might let things ride a bit. I explain these things in articles on my website and in my weekly webcasts.

Kirk:  I can see how this kind of strategy can work and be useful if employed consistently.

As you know, all good traders dedicate a lot of time and effort to improvement and reducing mistakes. How has your trading method evolved and improved over the years?

Dave Landry:  I’ve become more and more selective, sometimes to a fault. I used to always want to be in the market. I’ve learned that you’re much better off letting the market prove itself before entering. I tend to trade now only when I can’t stand being out of the market because opportunities abound. One thing that I have learned in more recent times is to be a little more quick to adjust to changing volatility. Over the years I also have learned more and more that the real money is in longer-term trends. I think my short-to-intermediate-term approach allows me to have the best of both worlds—short term gains and money management with the potential for longer-term homeruns.

Kirk:  Can you provide an example of something you thought was true when trading early in your career and now believe is just dead wrong?

Dave Landry:  Yes. I thought that there were people out there who knew EXACTLY where the market was headed and that if I studied hard enough, I too would know. I also thought there was a way you could pick tops and bottoms. I now know that you have to wait for some sort of transition in trend before looking trade off a top or bottom.

Every now and then even to this day I get stressed when someone hits upon something that appears to work incredibly well or so they claim. I feel better when they hit the inevitable drawdown. It’s not schadenfreude though. I’m not being malicious. It just makes me realize that no one knows exactly where a market is headed. It also reinforces the fact that I should stick with something simple.

Kirk:  How much time and attention to you pay attention to others’ opinions about the market and/or stocks you are trading?

Dave Landry:  Very little. I know this might seem vain but it tends to cloud my judgment. There are a few people out there that I admire and respect and you are one of the few Charles.

However, again, when I begin listening to them it tends to cloud my judgment. If I agree with them, I tend to become too confident. If I disagree with them when I’m confident, then it tends to shake my beliefs.

Kirk:  I appreciate the sentiment and you know I’m in complete agreement with you on this. Opinions from others can wreak havoc. While they may help to some degree, the traders who do well listen to only one voice - their own.

Please describe a typical trading day for you? How do you organize and dedicate your time?

Dave Landry:  Most of the work is done after hours. I spend hours tooling through charts. In fact, I recently did a webinar on just that. All of what I do is very open. In fact, I even give away my scans. It’s a lot of work. Most aren’t willing to put the time in. As far as actual trading, the open can be a little hectic. After that, much of the time, there’s not much to do. In an ideal world, I just ride out longer-term winners. This gives me time to work on projects, research, and my educational and research business.

Kirk:  Can you give us some idea of what tools you use to monitor the markets (i.e. your trading platform, software, websites, etc?)

Dave Landry:  I use a major brokerage for executions. I would recommend staying with a major brokerage. In theory they should give you better fills and have more shares to borrow. For my methodology, you do not need direct access. In fact, I would caution against it.

As far as websites, since I generally don’t follow anyone, there aren’t any. I do occasionally go to Yahoo Finance to company profiles. I’m not looking for fundamentals when I do this. I’m simply confirming what sector the company is in (when in doubt). For charting, I use TeleCharts. I love it. I sent so many people to the company, they made me a distributor. I do virtually all of my analysis with it stocks, scanning, sectors, ETFs etc. I can go on and on but it will start to sound like an advertisement. I truly do love it and use it. Have your readers contact me directly if they would like to be part of my club there. Again, I’ll even give them my scans.

Kirk:  I know from watching your “Market In A Minute” videos that you stress sector-based technical analysis in your approach. Why is this so important to you?

Dave Landry:  One of the few Wall Street Adages that is true is “a rising tide lifts all boats.” This is even more true for sectors.

Kirk:  Please explain the process of how you go about finding your trading setups.

Dave Landry:  Once a week, I run a simple price volume scan to produce a tradable universe watchlist. “Tradable universe” varies with market conditions. For instance, since we’ve had such a long bear market, I’m considering somewhat lower prices stocks. With that said, right now, I’m looking for stocks with at least 400k average volume with a price of at least $5 per share. This produces around 1600 stocks. I look at my entire tradable universe sorted by volatility usually an hour before the close. From this, I have a pretty good idea where I’ll be focusing the next day. I’ll flag anything that’s interesting and put in a list I have dubbed my “Top 100.” After the close, I run a simple pullback scan on the entire stock universe. Once again, I’m flagging stocks and copying them to my top 100. I do this very quickly. I then go through my top 100 more slowly, paying a little more attention to each stock. On those that I think might have potential, I’ll make a note of them. If I notice that I have a half dozen energy stocks setting up, and not much anywhere else then I know that I should probably focus on the energy stocks the next day. This list is what I call my “Landry List.” I then do my sector analysis which consists of looking through all 239 MorningStar industry groups. I’ll also look a major sector indices such as the XOI, XBD, SOX, etc.. I then look at the top 100 or so ETFs sorted by volume. I don’t use volume as an indicator but rather as a means to sort out less meaningful ETFs. I used to look at all of them, but now that there’s 900 of them, I really don’t care about the super thin ones towards the bottom of the list. For instance, I am interested in what’s going on in the Qs, Russell, Bonds, Gold ETFs which trade thousands of shares daily. I’m not so much interested in South African Monkey Bonds ETF which traded 10 shares today. No offense to those who trade monkey bonds.

Kirk:  Yep, be careful of those monkeys! I’m sure this process would take a lot of time to get used to, but certainly would offer a great preparation for the following trading day.

Like everyone else, we both experience hot and cold hands at times. Are there any “tricks of the trade” that you use to help maintain a consistent successful approach over a long period of time?

Dave Landry:  Longevity is key. If you can survive long enough, you’ll get it. You survive through the use of following your game plan and three other things: money management, money management, money management. The highs are high and the lows are low. Balance is also key. You can’t let it go to your head in good times and you can’t get too depressed in bad times. Good times follow bad but unfortunately, the opposite is also true.

Momentum trading can be streaky. You print money for a while then underperform. Novice traders who begin following me during good times think I’m God. And worse, they begin to think they are too. They begin to get careless, risking too much and trying to outsmart the system. On the flip side, novice traders who follow me during less than ideal conditions think I’m an idiot. They probably wonder if this guy ever makes a buck. They give up right before the next big trends develop. I call this African Queen Syndrome. In the movie African Queen, Charlie (Humphrey Bogart) and Rose (Katharine Hepburn) go through all sorts of trials and tribulations with nature and the enemy as they try to make it to lake at the end of the river. They give up. The camera pans back for one of the most powerful scenes in the history of cinema. They were within feet of the lake. If only they would have hung on a little longer, they would have made it.

Kirk:  I have to rent that movie!

Dave Landry:  You can borrow my copy!

Kirk:  Most traders I know have a set of rules that they have learned from past mistakes. What are a few of yours that you think most traders would benefit from?

Dave Landry:  Keep bets within reason. No matter how great a setup looks, there’s always a chance you can still be wrong.

Don’t fight trends. Trade only when you think you have an edge. Ideally, this means that the market, the sectors, and the stock are all trending. Realize that knowing when not to trade is as important as knowing when to trade. I often joke that we are more wait-ers than trade-ers.

Kirk:  You’ve been trading for some time now. What would you say are the biggest changes in the markets and trading in general you’ve seen during your career both good and bad?

Dave Landry:  The market doesn’t seem to trend as well as it used to. However, I would hesitate to say that something has changed. The market didn’t trend for extended periods in the 70s.

Kirk:  Do you think it is easier or more challenging to trade for a living now than in the past?

Dave Landry:  Volatility dried up after 2000. It became tougher to trade during lower volatility markets. I suppose you need to be careful what you wish for. It’s now back. With volatility comes opportunities but it seems to be tougher to catch trends in more recent years. Don’t get me wrong, we’ve caught some great ones — shorting energies and stocks in general for that matter in ‘08. They (big winners) just seem to be fewer and farther between. It seems like you have to work harder now than you ever did. Again though, longevity is key. When we hit the next great bull market, I’ll be ready. In the meantime, if the market rolls back over, I’ll be shorting it. It’s tough to ride out the retrace rallies, but it comes with the territory.

One other thought since it seems to be a hot topic. I don’t like all the government intervention in more recent times. This has made trading more difficult. Free markets will eventually fix themselves. I think the intervention does more harm than good.

Kirk:  The learning curve to trading successfully is long and expensive for most. Can you tell us about how you navigated this curve successfully?

Dave Landry:  It was no different for me. I spent a ton on education materials and much more in real markets. It took me years to figure out my simple approach. During good conditions, a novice can take my stuff and do exceptionally well. However, human nature eventually rears its ugly head. If conditions continue to be great they tend to try to outsmart the system. They begin looking to anticipate the beginning and ending of the trend. They begin risking too much. When the first inevitable drawdown comes along, they begin looking to change methodologies because trend following no longer works. They start trading choppy market systems, using a bunch of indicators, and so forth. They end up being perpetually out of phase. Fast forward 10 years and they find themselves back to a simple approach. My favorite clients are those who try my stuff, go off to chase rainbows, and then return to me many years later.

Kirk:  I’ve seen the same here Dave. So, what kind of advice would you give a person just now beginning in trading the markets?

Dave Landry:  Start small and build. The markets will always be there. You’ll only be smarter in the future. Paper trade until you are successful. And by the way, I’ve never met an unsuccessful paper trader. Once you think you have a viable methodology, then slowly begin trading it with real money. Only then will you learn about all the psychological pitfalls. Also, you have to be very careful not to confuse brains with a bull or bear market.

Study money management at least as hard as the markets early on. Probably the best thing you could do is to take just one pattern and get good at it. I think something like my Persistent Pullbacks would be a good place to start. They’re easy to recognize and self regulate. You don’t get many or any in choppy markets. You also rarely get any against the trend. In fact, I don’t remember any on the long side in 2008.

Kirk:  What do you think are the greatest misconceptions beginning traders have about trading the markets and about trading systems?

Dave Landry:  That someone actually knows exactly where the market is headed. All systems including mine will have losers and drawdowns.

Kirk:  A number of people who read my website desire to trade for a living. Like you, I receive a lot of questions concerning capital requirements needed to start and how to make the transition to trade full-time. Do you have any words of wisdom or rules of thumb to share along these lines?

Dave Landry:  You have to have your basic needs covered so you’re not trading with the rent money. With my methodology there will be extended periods where there is nothing to do. Trying to make something happen during these conditions because you need the money will create losses. Quoting from a book I’m working on:

“With my style, I find that busy traders make good traders. They tend to trade only when opportunities present themselves and then they go off to save lives, build buildings, and do other great things. Sitting in front of a screen all day is a recipe for disaster. Every little tick becomes larger than life. It’ll look like a new trend is emerging or an old one is ending. You’ll find yourself firing off day trades, micromanaging yourself out of soon-to-become big winners, and taking setups that are mediocre at best. Sitting in front of a screen all day is like sitting in front of a slot machine.

If you do have the luxury of being able to watch the markets all day, make sure you have some other interest to keep you busy. Don’t depend on the market for entertainment. In dull conditions, do some research or study historical markets. Or, enjoy a hobby, start a new business, or pay more attention to your friends and loved ones.“

Trends take time to develop. Be prepared to go many months without making any money and likely losing money. Psychologically, this can be difficult for many. Also, temper your expectations. The best money managers in the world shoot for realistic returns do so with very low drawdowns. If you run money and consistently make low double digit returns with small drawdowns, you’ll have all the money you could ever want to manage. So, treat your own business as if you were professional money manager. It’s okay to press a little now and then. Just make sure it’s the exception and not the norm.

Kirk:  Great advice Dave.  

Courtesy of The Kirk Report

Part 3 coming soon. Check the homepage for updates. 

Disclaimer: Information provided for educational purposes only. See disclaimers at www.davelandry.com