Intermediate-Term Trader Gary Kaltbaum Chats With Loren Fleckenstein
When I first met
Gary Kaltbaum, I came away with the impression that I had just encountered an
elemental force, rather than a person. Gary is pure, non-stop energy. He thinks
fast, he talks fast, and he has an indefatigable hunger for information. I don’t
know anyone who analyzes more charts than he does on a daily and weekly basis.
And I think Gary probably invented the word “multi-tasking.”
Throughout our interview, Gary was constantly fielding questions at his Orlando,
Fla. office from colleagues and clients seeking technical guidance. Gary runs $120 million as an investment advisor and
technical analyst for
his clients. He also hosts a growing radio program, Investors Edge,
which airs every day after the market close. And since November, 2000, of course, he
contributes the twice-a-week commentary “Intermediate-Term Insights”
at TradingMarkets.com. I’m tempted to call Gary a workaholic, but Gary
seems to enjoy what he does far too much to call it work.
I’ve found that
intermediate-term momentum traders look at the market in similar ways. For
selection of long trades, we aim for high relative strength, high-growth names.
To time our entries, we use similar chart patterns and setups. We use volume to
make sense of price. We’re steeped in the work of legends like William O’Neil,
Nicolas Darvas, Jesse Livermore and Gerald Loeb. However, every great trader
becomes an innovator to some degree. And Gary is no exception. For one thing, he
is among the rare intermediate-term traders I know who have played the short side well.
(Mark Boucher is another.) Gary has also developed his own trading techniques
from his own market research such as his work on insider transactions and gap-up
and gap-down price moves, an area on which Gary will be contributing a lesson in
the near future to TradingMarkets.
Loren
Fleckenstein: Gary,
tell me how you entered your career in professional trading.
Gary
Kaltbaum: Well,
I’ve been in the brokerage business since 1982, but my first years until about
1990 were a complete waste. I didn’t know anything about the market. Everything you can do wrong, I did. I’d just listen to
other people’s opinions and touts. You know, you hear about a company that
someone says is going to be bought, and you say, “Let’s go do it.” You
hear a company is signing a contract. Let’s go do it. That was what the biz was
all about when I started.
Fleckenstein:
So
what changed and put you on the right track?
Kaltbaum:
In
1990, just by luck, I read an interview that Bill O’Neil did in Registered
Representative magazine. I remember the exact words. He was asked, “Do
you think Wall Street has lost its way?” Bill said, yes, that most brokers
were taught how to sell, not how to make money. And Bill said there’s going to
be plenty of room for those brokers or money managers who will follow a strict
investing discipline that works in bad and good times. It was right there and
then that I decided that I had to be one of those people if I was going to to
stay in the business. That’s when I went on my search mission to find out
who the heck knows what to do in the market and how to go about it. I sought out
the top money managers in the country — not the analysts, not the opinion
makers, but people who were physically
managing money and doing it successfully year after year.
Fleckenstein:
Whom
did you study?
Kaltbaum:
For
one thing, I read O’Neil’s book, How to Make Money in Stocks, and I
also went to one of his workshops. I think at the time he came to Boca Raton. I
started practicing some of his methods. And I also studied my own trades. This
is very important. I started keeping a diary, something that I continue to do to
this day. I did phantom trades for the first year without real money. Every
mistake I made, every thought I had about the market, everything good and bad —
I wrote it all down and studied it. It’s critical that you study your own
trading history. You become your biggest critic, and you improve your
performance.
Fleckenstein:
You
are zealous about self-study and record-keeping, aren’t you?
Kaltbaum:
Every
Sunday, I spend an hour going over my diary, and I work backwards for that week.
That’s one of the secrets of my success: I’m my own biggest critic. Whether
you’re an investor or a trader, a short-term trader, a daytrader or an
intermediate-term trader, the most important thing to do is, when you’re wrong,
admit you’re wrong and fix the reason why you were wrong.
Fleckenstein:
You
mentioned that you paper-traded your original adopted system a year before you
put real money to work. Should paper-traders be aware of any limits to paper
trading?
Kaltbaum:
Yes,
absolutely. Once you start trading with real money, trading starts getting
emotional. So start small. As you gain confidence, you can start building. I’m
also not a fan of margin. I consider myself pretty good at this, and I use no
margin. I don’t think margin is needed. If you do it, make sure you’re
diversified enough that one stock does not cripple you to the point where you
cannot come back.
Fleckenstein:
Did
you study other professionals in addition to Bill O’Neil?
Kaltbaum:
Yes,
I threw a wider net. I knew that there‘s more than one way to skin a cat, to
use the old cliché. I found out that the AIM family was very successful. One of
the things they did was find companies that continued to show the ability to
blow away Wall Street estimates. I tested that out, and I found an absolute
direct correlation between the ability to beat estimates and how the stock will
do over the short-to-intermediate term. Of course, a company will not beat the
estimates forever because as it continues to do well, the analysts keep raising
the bar until the company can’t meet it.Â
Fleckenstein:
So
one great criterion for potential buys is locating companies with a track record
of beating the number.
Kaltbaum:
Yes.
I follow every earnings report. I am constantly looking for companies that blew
away the earnings estimate by the widest margin and also that acted well on the
earnings report. Give me the combination of a company that blew away estimates
and breaks out or gaps up on heavy volume, and my antennae go up very quickly.
Fleckenstein:
After a stock
gaps up on positive earnings, you think there’s plenty of upside left to trade?
Kaltbaum:
I
know there are a lot of people who say that when the stock gaps up, it‘s going
to fill the gap. I have studied countless examples of stocks that gapped up not
because of a news announcement or an analyst’s upgrade but because of a blowout
earnings announcement or pre-announcement. I can tell you that the odds have favored the
stock outperforming over the short-to-intermediate term, assuming a decent-to-good general market. Here’s the reason behind this. When you surprise Wall
Street by a wide margin, the analysts’ estimates often go up not only for that
quarter, but for subsequent quarters. That’s because something really good is
happening for the company. Maybe they’re selling a better product, or there’s
been a significant change in the industry. Whatever the reason, it can affect
estimates for a good while.Â
Fleckenstein:
How
about stocks that gap down on negative earnings?
Kaltbaum:
The
same goes for stocks that gap down or break down on an earnings report. I make
those lists to identify possible shorts. AnnTaylor Stores
(
ANN |
Quote |
Chart |
News |
PowerRating), Abercrombie
& Fitch
(
ANF |
Quote |
Chart |
News |
PowerRating), SCI Systems
(
SCI |
Quote |
Chart |
News |
PowerRating), Computer CDW Computer Centers
(
CDWC |
Quote |
Chart |
News |
PowerRating)
all gapped down in the year 2000 on earnings reports because they missed Wall Street estimates. And
all of those stocks continued down after that. A more recent example is Lucent
(
LU |
Quote |
Chart |
News |
PowerRating).
It was a stock that was over-owned by the institutions. Everybody loved it.
Things changed near the highs. The stock gapped down back on July 20, 2000, on a
worsening outlook. For a second time out of three quarters, they missed
estimates. They never saw the light of day. It gapped down again in October. I
have studied thousands of charts of stocks over the years. When a stock has
gapped
down on earnings, it’s amazing how often that has preceded further declines. I find
the worst ones in technology and in small- to mid-cap areas. Once your
technology becomes obsolete, it’s very hard to turn things around vs. a retail
company that can right itself after a quarter or two.
Fleckenstein:
Does
gap activity in large numbers of stocks send you a message about the character
of the general market?
Kaltbaum:
When
the market’s good, you often get a lot of gaps to upside.
Fleckenstein:
Another area that
you search for clues is insider transactions.
Kaltbaum:
Yes,
I really watch insider buying and selling. I look for extreme examples. I found
there’s a direct correlation with stock price performance when the transactions
go to extremes. Insiders as a norm will look for value after their stocks drop. So when insiders
are buying and averaging up into a rising stock, or after a breakout,
that tells you that not only does Wall Street support the stock, the company
execs are putting their stamp of approval on the higher levels as well.
Fleckenstein:
Just
as extreme insider buying can alert you to a potential buy, do you use extreme
insider selling for locating short-selling opportunities?
Kaltbaum:
Yes.
For instance, if a stock drops 30% and insiders continue to sell, that’s got
to tell you something. In early 1996, Informix
(
IFMX |
Quote |
Chart |
News |
PowerRating) just kept dropping
and dropping, and insiders kept selling all the way down. More recently,
insiders in whole a
host of Internet companies could be seen selling massive amounts of stock after 70%
and 80% plunges.
Fleckenstein:
Anyone
who reads your commentaries or listens to your after-market radio program,
either online via eroo.com or on the radio, knows you don’t beat around the
bush. You give your opinions straight up, whereas I know many market analysts who
hedge their opinions with lots of conditions and either/ors. How do you keep
your strong opinions from getting you crosswise with the market when the market
does the unexpected?
Kaltbaum:
When
I give my opinion, I’m not trying to predict the market. I’m evaluating the
market at any given point in time. One thing I know is I can love a stock on
Monday, and that can change on Tuesday. The name of the game is to stay fluid
and nimble, ready to change with the market action. I am not one of these guys
who will give you a stock price target at the end of year. My job is just to
identify the changes as they occur, not predict them. The current market dictates
my opinion.
Fleckenstein:
So
how do you stay in sync with the market? I tend to do my own heavy research on
the weekend, then do daily tracking throughout the week. How do you organize
your weekly and daily research routines?
Kaltbaum:
Well,
on Sundays I get out my Daily Graphs, the hardcover books, and spend
a good three hours writing up lists of individual stocks that are setting up
correctly. Stocks that are showing strong fundamentals and forming sound bases,
stocks that are breaking down and look shortable, shortable sectors, and so on.
That sets me up for the week. Then during the week it’s a constant ongoing
analysis. It’s a constant scanning of price, volume and sectors throughout the
week.
My favorite screens to look at throughout each trading day are stocks
moving on the biggest volume.
Fleckenstein:
When
you say big volume, I assume you mean not just gross volume but volume as a
percentage of some daily moving average…
Kaltbaum:
Yes.
Volume compared to some norm. For example, if the stock in the last ten days
traded a half million and then traded four million, that gets my attention.
I’m looking for standouts that tell me there’s big buying or selling in the
stock.
Fleckenstein:
What’s
your office setup like? How have you set up your desk to watch the market?
Kaltbaum:Â
In front of me, I have at all times Daily Graphs
Online to look at individual charts. I also have two quote machines with
stocks separated by sectors, so I can look at my screens and see in seconds
which sectors are kicking and which sectors are dropping like flies.
Fleckenstein:
After
the close, you go on the air. Do you do any further market research?
Kaltbaum:
When
I go home, I bring printouts of all the stocks on my quote machines — six pages
of stocks. That probably represents 1,500 stocks. After the wife and kids are
asleep, I’ll get on Daily Graphs Online and look at every one of those
names that moved up or down a big number. Stocks that stayed the same I probably
won’t look at. I’m looking for real changes in the direction of a stock. A
lot of people ask me, isn’t that a lot of hard work? And all I can say is that I
love it. I’m addicted to it.
Fleckenstein:
But
you also find this kind of constant in-depth research necessary, don’t you?
Kaltbaum:
Yes.
There’s no way to do this on autopilot, to just have a some computer or magic
indicator tell you how to trade each day. To stay competitive with all the other
investors and traders in the market, you must commit to an ongoing process. I
have found most people will just not put in the time. And there is no predicting
in anything I do. I let the market dictate to me, and I
just continually evaluate the market and react to it. I cannot predict something
is going to happen, but I’ll try to be there and know what it means when it does
happen.
Fleckenstein:
Do
you use options to hedge your positions?
Kaltbaum:
No.
In the past I have done covered call writing. My
biggest problem is it caps your upside while not limiting your downside. So I
don’t do l it very often. I also am not a big proponent of buying puts and
calls. I’d rather just own or short the stock. I know there’s much more
leverage with options but that cuts both ways, and it’s tough enough to pick stock to go a
certain away, let alone in a certain time frame. You’re limited to a time
frame with options, and you also must pay a premium to buy that option. I
know there’s plenty of people who say they make a lot of
money in options, but I think the average trader loses a lot.
Fleckenstein:
While
you rely on your daily and weekly review of thousands of stocks to assess the
market, do you use any secondary indicators?
Kaltbaum:
I’ve
built my own little group of sentiment indicators, some I’ve figured out on my
own, some I’ve borrowed from other people. When those go to extremes, that’s
an alarm bell. There are indicators that have worked more often than not.
There are two indicators that I look at in Investor’s Business Daily.
There’s the put-call ratio. It’s amazing how puts seem to spike up like crazy near
intermediate-term bottoms. Also, I check the percentage of investment advisors
who are bearish vs. bullish. That survey was invented by a guy named Mike Burke.
He did a study a few years back and found that whenever the investment advisors,
who tend to be trend followers, tip one way, that can signal a turn in the
market.
Another good contrarian indicator has been the media. I remember, after the market
tanked back in 1998, all of these magazines — even non-finance magazines like Esquire
— coming out with doom-and-gloom covers predicting a coming crash. I remember Esquire
had a cover with a guy falling down the stairs. That kind of pessimism can
signal a market bottom.
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