How I Trade for a Living I . . . WILEY ONLINE TRADING FOR A LIVING Electronic Day Trading to Win/Bob Baird and Craig McBurney Day Trade Online/Christopher A. Farrell Trade Options Online/George A. Fontanills Electronic Day Trading 101/Sunny J. Harris How I Trade for a Living/Gary Smith II . . . How I Trade for a Living Gary Smith III . . . This book is printed on acid-free paper. Copyright © 2000 by Gary Smith. All rights reserved. Published by John Wiley & Sons, Inc. Published simultaneously in Canada. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning or otherwise, except as permitted under Sections 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per- copy fee to the Copyright Clearance Center, 222 Rosewood Drive, Danvers, MA 01923, (978) 750- 8400, fax (978) 750-4744. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 605 Third Avenue, New York, NY 10158-0012, (212) 850-6011, fax (212) 850-6008, E-Mail: . . . Nicholas Darvas. Your trading methodology had a big impact on an impressionable 14-year-old in 1961. Bruce Babcock. I will be forever appreciative of everything you did for me. My parents, Sidney and Esther Smith. And, of course, Sandy and the gang— Bandit, Whitney, Beige, Lover Girl, Samson, Tomas, and King. V Contents Acknowledgments ix Prologue 1 A Typical Trading Day Introduction 5 Chapter 1 9 Help for a Desperate Trader Chapter 2 17 Dreams of Easy Money Chapter 3 23 The Futures Market Beckons Chapter 4 31 Almost Down for the Count Chapter 5 41 Putting it All Together VI Chapter 6 45 Why the Stock Market? Chapter 7 51 Trading is a Profession Chapter 8 61 Perceptual Trading Filters Chapter 9 67 My Favorite Indicators Chapter 10 91 Technical Indicators Chapter 11 103 Monthly Seasonality Chapter 12 111 The Nitty-Gritty of Trading Chapter 13 151 Money Management Chapter 14 155 Trading Mutual Funds Chapter 15 183 Trading Junk Bond Funds Chapter 16 193 Trading Stock Index Futures Epilogue 229 Strictly Personal Recommended Resources 231 Reading and Researching Your Way to Success Endnotes 241 Index 249 VII . . . Acknowledgments The three people who helped me most with the charts in How I Trade for a Living deserve special recognition: Bob Miller of Foremost Futures, Chicago, Illinois; Jonathan Matte of Defender Capital, Portland, Oregon, and, most especially, Janet Boivin for her time and patience. Special thanks also to Carl Swenlin at DecisionPoint.com, Eric Calvert at Caveland.net in Glasgow, Kentucky, and John Bollinger CFA, CMT of Bollinger Capital Management and Equitytrader.com. My editor Pamela van Giessen and her assistant Mary Todd are to be commended for effectively dealing with my frustrations during the writing of the manuscript. Michael Detweiler, managing editor at John Wiley & Sons, and Ginny Carroll, of North Market Street Graphics, deserve special mention for their professional handling of the day-to-day production of my book. VIII . . . Prologue— A Typical Trading Day Many traders would be disappointed at how I spend a typical trading day. It's not glamorous nor is it bone-chillingly exciting. That's fine with me because I don't trade for a living for either the glamour or the excitement. I do it for the money and the freedom it brings me. Prior to 1996 I lived out west in Reno, Nevada. Since that time I have lived in the cave-and-cow country of south central Kentucky. The town I reside in reminds me of something out of a 1960s sitcom—like Andy Griffith's Mayberry. After all, our county sheriff is named Barney and the guy who runs the local body shop is Goober. But I digress. I don't get up in the morning until the 9:30 (sometimes later) opening of the stock market. What can I say? Ever since my childhood I have been a late riser. When I lived out west I never slept well knowing I had to be up for the 6:30 A.M. PST opening. Everyday I battled constant fatigue. Since living in the east, I'm always refreshed. However, I do set my VCR to begin recording CNBC at 8:00 A.M. I try to be up by the 9:30 opening since the first 50 minutes of trading often sets the tone for the day. The action of the futures during that time period can often portend how the rest of the day will unfold. It's also during this first 50 minutes of trading that I'm most alert to any developing strength, weakness, or divergences that may be evident on the tape. 1 . . . I'll eat my breakfast/lunch at 10:30 A.M. and review my CNBC tape for any relevant news or interviews I missed during the 1 1/2 hours prior to the market open. After that quick review, I begin recording again. I always have my recorder running during trading hours and the two hours after the close. I don't want to miss anything. Around 11:00 A.M., I turn on my computer and check my e-mails and what's going on in some of the newsgroups. I then check the foreign markets at Yahoo.com and the portfolios of any funds I may be trading or thinking about trading at Quicken.com. This is something I do throughout the trading day. I also check how the various industry groups are performing at the www.dailystocks.com Web site. It's important for me to know each day precisely where the action is in the market. Between 12:00 and 3:00 P.M. I try to sort out the moves I will make in my funds. Almost every day involves a constant adjusting of my trading positions. Will I add or decrease my exposure to the market? I stay in close contact with the CNBC ticker tape throughout the day. I'm sensitive to the slightest changes occurring intraday between the Dow, Standard & Poor's (S&P), the Nasdaq 100, and the Russell 2000 indexes. I am not glued to the TV screen during the trading day until 3:00 P.M. Prior to that time I will shower and if necessary run an errand or two to the bank, post office, or grocery. If I do go out, I play back my tape upon returning to check the behavior of the market while I was gone. It's important that I stay in synch with the daily rhythm of the market. In the old days I couldn't trade without reading my Wall Street Journal and Investor's Business Daily as soon as I got up. Now that I trade primarily pure price action (momentum and divergences), I don't read these papers until much later in the trading day. Between 3:00 and 4:00 P.M. it's showtime, especially the last 30 minutes. This is the home stretch and I have to get ready to make my move before the close of trading. Going into the last hour, I always have some idea of the moves I will be making at the close. In the last hour I'm completely focused on the tape, the stocks in my portfolio, and the action in the various indexes. It's during the last hour that I formulate an exact trading plan, detailing how much and into which fund. There is usually a fake-out move, albeit slight, in the market between 3:30 and 3:45. I call this the Rydex jiggle. The market likes to confuse the Rydex timers, since their orders have to be in before 3:45. I call INVESCO between 3:50 and 4:00 P.M. It can get hectic if I also 2