Dedication and Discipline: Market Timing with Tom DeMark
It should come as no surprise to find that a man like Tom DeMark, author, market analyst and trading consultant to some of the most famous names in trading might be more than a little busy when it comes to finding time to do a telephone interview. We caught up with Tom DeMark late in the day, and though the markets were closed, it seemed almost as if Tom DeMark’s day had just begun. Indeed, we were interrupted more than a few times by urgent calls from colleagues and clients – including one famous client in particular who was traveling in Russia at the time and needed to share a few things with Mr. DeMark that could not wait.
Tom DeMark has been in the trading business for more than 30 years and is known to many as a technically-oriented analyst and trader. This is due no doubt to his popular books on his trademark technical tools and set-ups, books like The New Science of Technical Analysis
and New Market Timing Techniques: Innovative Studies in Market Rhythm & Price Exhaustion
. However in conversation with Tom DeMark, he prefers to consider himself a “hybrid” market timer rather than a technical analyst and insists that, in the end, it is the fundamentals that drive everything.
In this, Part 1 of our Big Saturday Interview with Tom DeMark, we discussed what makes some of the legendary traders with whom he’s worked – traders ranging from George Soros and Michael Steinhardt to Paul Tudor Jones and Steve Cohen – so great, and how the average trader can learn to develop those skills and habits. We also started a conversation about some of DeMark’s trading techniques – a conversation that continues in Part 2 – from his unique approach to technical tools to his conviction that bottoms are formed not by “smart buyers” but by the “final dumb seller.”
With that, we hope you enjoy “Dedication and Discipline: Market Timing with Tom DeMark”
David Penn: Let me just start off at the top by talking about some of the people you’ve worked with. You’ve worked with a lot of names – Steve Cohen, John Burbank, Soros funds, Tudor Jones, Steinhardt and so on. Having worked with that caliber of traders – is there anything that you see in those traders that either remind you or sort of say ‘this is why these are the people at the top’?
DeMark: They’re dedicated. They’re 100% involved and committed- they’ve all got the same disposition. They’re all calculators. They’re good money managers. I’d say if one had to break down the reasons for their trading success–it’s probably a 20 to 25 % trading methodology and techniques or systems, whatever they might apply – 25% discipline and 50% money management.
Penn: Really.
DeMark: They’re all good money managers. They all are. I can’t say they’re all good traders. They’re not. They can manage money well. Some of them can take pretty big – a large series of hits and at the same time make money and they cut their losses short.
Penn: Interesting.
DeMark: It really is money management. Surprising. I have worked with the best. Steve (Cohen) is definitely the best trader. He doesn’t have that high a success rate. It’s his disposition, he was built for trading. You can’t describe it. The ability is something innate. Similarly, John Burbank is the best long term investor I have seen in my career and he is a global investor. Just as Steve is the best trader John is the best investor.
They’re all the same, they’re all steely. They’ve got a real determination to win. It’s in their personality.
Penn: Right.
DeMark: They do it the right way, too. A lot of people accuse them of running ahead and having inside information. That isn’t true. None of these guys are that way. None of them that I work with. No they’ve all done it the calculated way. They’ve all grown with the markets, which is what makes them successful. These guys have all adapted.
Penn: Yes.
DeMark: And they’ve all got something that’s unique to each one of them that they specialize in different areas. If they were athletes they’d be the best, if they were in a spelling bee competition they’d be the best. There’s a common denominator. They don’t have a lot of sympathies – as far as the market’s concerned. They’re cutthroat. Not in a negative sense. And it’s something they’re born with. I’ve seen good systems developers, a lot of them, a number of them, and I’ve seen them lose money because they don’t have the money management skills or the discipline so they can have a system that’s 90% and they lose money. It’s just how you manage the money that’s critical.
Penn: That leads to a couple of interesting questions. If success in some respect is 50% of the money management, how much of the money management is having a sound approach to money management and having the psychology to stick with it?
DeMark: Well that’s it. Fifty percent is money management and having something that’s time-tested. Something that they can live with too. The psychology you’re talking about, that discipline factor, is 25%. The other 25% is whatever technique you use. Some are systematic, some aren’t. They’re all fundamentalist by heart. Some say they’re not, some say they’re technical. But they’ve all got a fundamental build.
Penn: Really? That’s interesting.
DeMark: Yeah. They’re all well-educated, too. They really are. I mean, they’re all poker players. Steve was a poker player in college; he was one of the best. They’re all that way. Paul is, too. I didn’t spend that much time with Soros, I was executive vice president at Tudor and I’ve been with Steve now for 12 or 13 years and I’ve been very close to John Burbank the #1 fund manager last year in the country according to “Absolute Return Magazine”. He grew from $800,000 under management in the year 2000, and is currently just over $6 billion and growing fast. John’s company Passport Capital is the biggest success story I am aware of since 2000. Steve has been unmatched when considering the past 20 years performance. He’s had two down months in 200 months? More than that. In eighteen years he’s had two down months. I mean nobody can come close to him. And those months have been less than a percent. (Ed Note: both Steve and John are now investors in Market Studies, Tom’s company as of last month.
Penn: Really?
DeMark: You don’t hear many stories about them because they have been inaccessible but I do speak to them throughout the trading day and their insight is certainly outside the box and they have a knack for anticipating market moves. When they travel, they bring all their trading needs with them, particularly Steve . He flies a couple of planes and they set up a trading operation for him when he travels.
Penn: Wow.
DeMark: This is the man. He was the man. But John Burbank is the global man. He’s got a fix on everything globally. This guy is gonna be really well-known. He’s the next Soros.
Penn: Let’s change gears a little bit. What’s most important when it comes to understanding the market?
DeMark: There are times to buy and times not to buy and times to sell. And the market timing tools I developed are applied to the strategies of my clients and we use the strategies to give us the opportunities.
Everything that I use I developed myself. I haven’t relied on anything in the public domain. I’ve been in the business 36 years from law school and grad school – I got my MBA and then went to work for a fund that had about 250 million and we grew to almost 6 billion. And even though everybody in the fund – the principals were all CPAs, MBAs, and lawyers -represented ourselves as being fundamentalists, we did use market timing and we avoided the 1973-74 crash and we grew.
We were institutional investors while there were guys who were very good on the retail side-people like Larry Williams, you know Larry obviously, right? He has had an influence on many in this industry but his audience has been the retail side of the market.
Penn: Yes, yes.
DeMark: He’s been a friend for 36 years. He’s in the retail end of the business; I’ve been in the institutional side. I’ve dipped my toes a couple of times in the retail side and I’ve written some books and I’ve given some seminars but I really don’t have a presence on the retail side, I don’t sell anything.
The techniques I use are all original. They’re mine. They’ve been time-tested and they’re more adapted for institutional traders. I mean retail traders can use them, but the indicators I’ve developed are anticipatory, they’re trend-exhaustion techniques. So we try to identify when a trend is about to exhaust or a trend is about to reverse. With the large fund that I’ve been aligned with we’ve had to anticipate tops and bottoms, whereas the retail traders usually trade small accounts, or they could be a CTA but still relatively small if you’re under a hundred million. Large investors really couldn’t trade the trend.
Penn: An interesting approach
DeMark: If you buy or sell into a trend and do so in size you’ll experience price gaps and slippage and things like that. You’re competing with everybody. But into a market bottom and top, you can buy and sell as much as you want.
Penn: Right. You raise a couple of interesting points with the technicals and the fundamentals but I don’t want to leave this point that you just made. Would you be trading this way if you weren’t involved with institutions as heavily as you are?
DeMark: It’s the way we’ve always been trading. I think the marketplace has changed. Markets now, after tops and bottoms are made, you can see the reversals are pretty dramatic. You’ve just got to anticipate those turning points, even if you break it down even on a one-minute turn. The reversals are very steep and the only way I think you can be successful is anticipating those.
Whether it’s advising a large trader or trading on my own account which sometimes are large positions or were large positions, I’d use the same approach, I think that’s the way: if you’re going to be successful, you’ve got to anticipate tops and bottoms. I think that’s the trend. I think you’ll see more and more people doing that. Back in the ’70s I developed a lot of these trading tools. I also traded for myself and I was using techniques that CTAs (Commodity Trading Advisors) are using nowadays, like range expansions breakouts, things like that.
Penn: Sure.
DeMark: – adding to the opening price. People weren’t doing that back then. You didn’t have trends, dramatic movements like you do nowadays. So things have evolved. I think just by the reception we’ve had on Bloomberg – we’ve got 35,000 users of my indicators on Bloomberg. And you can see that the whole marketplace has changed. People want to anticipate tops and bottoms. They don’t want to participate after the top or bottom.
That’s the nature of the trader nowadays. At one time it was trend-following but now you just can’t make money following a trend. There’s just too sharp a turn and they haven’t necessarily been – one or two days the trend is over with in some cases. So that’s why I would not change anything. This is the approach and I’m sure – just like it was back in the ’70s when I was doing range-expansion breakouts on my own and wanted some other techniques and those became commonplace and I think now more and more people are going to switch to the trend-anticipation or trend-exhaustion methods. That’s where we’ve been for so long.
Penn: That’s interesting. Coming from a very vanilla, so to speak, technical analyst background, a lot of us had it drummed into our heads that the “trend is your friend”, “you trend trade, that’s the only way”.
DeMark: And then I added a corollary to it, I said “unless the trend is about to end”.
Penn: Truly.
DeMark: And I guess I’ve been known for that for 25 years or so. And it’s true. If you’re a trend follower you buy 20% to the upside then you wait to the top and then you wait for 20% off the top and then what you’ve effectively done is captured the move from 20 to 60%, that middle 40%.
Those moves are so sharp nowadays because traders make one decision and they either get it totally or they get out totally and they just can’t do it. That’s not the way the markets operate nowadays if you’re going to be successful. You’ve got to anticipate
I’ve never been a market technician.
Penn: Though you are known for your technical methods and indicators …
DeMark: I’m a hybrid; I believe fundamentals drive the market, I believe there are techniques you can apply to time the market, I’m well-schooled in all the technical approaches
When I started in the business there were no technical analysts at all. There were trend lines and people all drew them subjectively and each one drew them differently. The way I draw trend lines is totally objective. I have a different approach to trend lines. They wanted to make them objective. Everything I do is very mechanical, very defined, and totally objective.
Technical analysis is, by nature, subjective. And everything I do on Bloomberg, I’ve got 30 indicators on Bloomberg and they’re adding 30 more, and everyone of the indicators is, remains on the screen permanently whereas, I think a lot of technicians do their analysis with a #2 pencil with an eraser. It’s almost like a multiple choice approach – ‘if this one doesn’t work then that one will’ and everything is qualified. Everything is definitive with what I do.
Penn: I know that some years ago someone described your work as ‘original, mechanical, and objective’, and that’s a lot of what I’m hearing right now.
DeMark: That’s true. In fact I’ve always said that all chartist is, if you break the word ‘chartist’ down it’s a chart artist. I’d rather consider myself a ‘chart technician’, a ‘chartician’ or something. Chartist is a chart artist, that’s all it is. I don’t want to describe myself as a chart artist. I’m a market timer. That’s a description of my work. That’s why I think a lot of the institutions like it. I think they all have an appetite for something that’s defined and no one can dispute what the conclusions are. If one person uses the indicator the other person will have the same conclusion and you’re able to communicate with one another in the same terminology and draw the same conclusions.
Penn: Right.
DeMark: That’s something that’s lacking with technical analysts. There’s so many different interpretations; nothing is definitive. I’ve told people that there are three levels of chart analysis: there’s the basic subjective chart analysis where someone looks at a chart and draws his or her conclusions.
Now if the conclusions are based totally on biases, in my mind, you’re going to read something in the paper that’s in the back of your mind or you’re in a position you’ve got that bias. There’s the second level of analysis in the indicators. Indicators are defined; you can go back historically and you can see what’s happened, what indicator readings have been on comparable positions and you can try to crunch from that. Systems are just a short step from indicators. They make definitive rules.
Most of the work I do is indicator based. But I don’t ever exist on the pure chartist level the basic level. The subjective level. That’s what I think causes a lot of the problems for technicians, or those that refer to themselves as technicians. They operate on that basic level. There are too many biases and prejudices and too many influences that will sway your opinions. What I want to make certain is that if I interpret something today, it’s going to be the same interpretation tomorrow. If you’re a subjective technician, you could have totally the opposite deal. The part of the vocabulary for users of my work is all the same and the definition is the same.
Penn: Right. Do you think that at a certain level fundamentalists are prone to the same level of difficulty, that the initial level for them involves bias and prejudice and it’s something that they also need to sort of work their way up from?
DeMark: Sure. In fact there are two large brokerage houses, one was Morgan Stanley, a fella there was a practitioner of my work. My understanding is that before any analyst at Morgan Stanley made a buy recommendation, he had to review it based upon my work. This other firm is doing the same thing, a large one. They don’t want people to know but they have1600 analysts and they want to filter all the recommendations as far as timing, you know what to buy, what to sell, they’ll still have the same have the same recommendation to buy or sell, but they will refine it with my market timing indicators.
Penn: I’d like readers to have a better sense of your indicators and your approach to technical tools, for example, your approach to drawing trendlines.
DeMark: I gave a presentation about 15years ago and I had about 800 in the audience, just traders. I didn’t want to embarrass people but I took a chart and I gave it to 5 people in front and I said “Here’s the S&P. How many use trend lines?” everyone had his hands up. I said: “There’s a chart. You guys draw a trend line”. So I had 5 people drawing trend lines everyone drew them differently.
I said “Well guys here’s an idea that I feel is sound and I think that I can justify it with logic’. But every one out of 5 who did draw a trend line immediately went to the left hand side of the chart, as far back in history as possible, selected a high and they extended into the future and whether they connected with a high maybe 5 days ago, 100 days ago, 200 days ago, whatever, it’s totally arbitrary. I said to them “if you’re going to have a long-term downtrend in the market the best way to define it with a trend line is to go to the most recent peak,” – and I define the most recent peak as being a high surrounded by two lower highs.
Let’s say for example the market has hit lower highs the last 4 days. So 5 days ago you have a high and that high is obviously above the high 4 days ago. If that high 5 days ago is also greater than the high 6 ago that’s greater than the high 4 ago that’s what I call a TD Point. That high was a reversal point, that’s where the market ratings apply and it reversed to the down side. So if you select the most recent peak and then go back in time to the next highest peak look for the same TD point high, I call it where a high is surrounded by two lower highs.
Now connect those two points obviously and, if you extend into the future, that’s your trend line. That’s what I call a TD Line.
If you want to have it longer term you would have different requirements. You’d say two lower highs to the right and two lower highs to the left. But you’d always look at the most recent and the second most recent. You don’t go back in time and take the most distant. Because the market doesn’t have that memory. The market’s memory is always the most recent two peaks.
Penn: Yes.
DeMark: Now if you extend that line in to the future, then you break into the upside … For example you’re in a downtrend and you connect the two most recent peaks as I defined, highs surrounded on either side by lower highs, and the market breaks out above that downtrend. Assuming it’s a qualified breakout – and I’ll give you the definition of a qualified breakout, the market has a tendency to be symmetrical. What’s beneath the line is often reflected above the line so if you take the deepest price between those two points you connected to the breakout the distance from the lowest price to the trend line immediately above it and you add that to the breakout price, that’s your price objective.
You take something as simplistic as a trend line or a TD line, they call it, and once it breaks out you can take the difference between the lowest price and the trend line value immediately above it on the same time period, add that to the breakout that’s your price objective. It works very well.
Penn: Interesting.
DeMark: Now it’s got to be a qualified breakout, and what’s a qualified breakout?
You have the price bar for the daily charts for example. If the day before an upside breakout is a down close, then the market turns to the upside. That’s what is called a qualified breakout. Most often you can enter the market intraday rather than awaiting a close above the upside breakout level.. A lot of traders use trend lines and they enter the market intraday and it fails. Why does it fail? Because they have the perception, as do other traders, that the market’s going to go higher and what typically happens is that markets top not because of smart sellers markets top because of the lack of buying. Conversely at the bottom, there aren’t smart buyers at the bottom it’s just the last dumb sellers sold.
So before a breakout to the upside in a trend line you have a down close because traders are creatures of habit and merely project into the future what happened currently. So if it down closed today they just assume tomorrow’s going to be a down close as well ’cause everyone by nature is a trend follower. So if the market’s made a down close and then the next day you break out above the trend line that I’d label as a qualified breakout, then what happens today when you breakout above the trend line if you buy the breakout (intraday?) rather than waiting for the close which a lot of people do to conserve a breakout. So that’s the whole thesis. If you have a down close the day before the breakout to the upside, that’s more legitimate because traders typically are skeptical because they’re positioned on the downside. They are skeptical at first of all and then by the end of the day they capitulate. That’s why markets typically run.