Hedge fund manager John Netto potentially has a great deal to brag about. His hedge fund is up 35% year-to-date in one of the toughest bear markets in history. But he remains humble. That, he says, is his key to survival in a challenging market environment. A well-respected contributor to TradersWire Interactive known as UWGAMBLER, John is known for his insightful comments and candid opinions. John is also the author of the upcoming book OneShot-One Kill, from John Wiley and Sons. Recently, we conducted two interview sessions with John — Sept 7, 2001, and Oct. 17, 2001, in which he shares with us his background and the key ingredients to his success.
Eddie: How did you first get interested in the market?
John Netto: When I was 11 years old I saw the movie “Wall Street,” and something about the action in that got me going. My father would always preach investing; that led me to ask him about the market, so he gave me some books on the stock market. I grew up understanding the stock market as a means of building one’s net worth, participating in a company, and saving for the future. When I was in high school, I took a bigger interest in it. I started subscribing to the Wall Street Journal and Investor’s Business Daily. I was really attracted by the numbers.
Eddie: What happened after that?
John: I turned 18, I joined the Marine Corps, and I went overseas to Japan. I sent money off to mutual finds to save. I hadn’t understood the trading aspect behind it. I started following the market again when I was 22. I got my first E-Trade account, and that’s when I first began to understand technical studies and going online and looking at chat rooms. Then someone pointed out what a 200-day moving average was and if a stock was above it was good and if it was below it was bad. That’s when I began to discover stocks moved in trends. Before that, I based everything on fundamentals.
When I was in Japan we had the Bhat, which started the Asian currency crisis. I noticed that the market reacted hard to that. I realized that there’s a lot of emotion a lot of psychology involved in how the market works. Greed began to play a role. I thought, “Instead of investing for five years, if I could capture these intraday moves, my goodness.”
Executing The Plan…Marine Style
Eddie: In developing your trading skills so rapidly, what role did the discipline you acquired as a Marine play?
One thing about being a Marine is that through the arduous training we go through, they teach us to deal with a lot of adverse situations. They teach you how to be flexible and how to deal with people — to deal with people who are not necessarily going to be on your side. And taking that kind of discipline, that kind of training and having a mission and sort of executing a plan of that mission, I think draws a number of viable parallels when it comes to trading, when it comes to executing one’s battle plan, so to speak, when you trade. That’s kind of like my nightly news, what I call the nightly battle plan because that’s really what trading is.
“There’s a saying in the Marines that no plan survives first contact with the enemy.”
Eddie: How does that come together when you trade?
John: That comes together in trading in a number of instances. Having a roadmap of where the market’s going to go is sort of the basis from where I trade. The discipline and the preparation that goes into trading is strengthened and galvanized by my background in the military and as a Marine. When you’re trying to run a small hedge fund and trying to get over a lot of hurdles that maybe a lot of large institutions don’t have to contend with, having the sort of discipline and having the stamina and having the endurance and having the leadership to tackle not only a trading career, but also dealing with the day-to-day activities of running a fund, it’s instrumental, and it plays a very large role, I think, in our success.
Eddie: Okay, so tell exactly how you formulate your battle plan each night.
John: The first thing I do when I get home, I’ll step back and look at the market and get a real feel for what happened throughout the day. I have a trading journal that I take notes in throughout the day, and I’ll go over that. When I prepare my nightly report, I’m looking to assess what happened. What surprised me about the day today? What was I expecting? What followed through, what didn’t follow through? I keep all that in mind. I ask myself: Are we likely to continue the trend, or are we likely to change the trend for the next trading day? I look at any pivot points that were formed during the day. Were there any significant highs or lows that were made that can be used as further resistance or support for this market? Having targets is one of the keys to being a successful trader. I’m looking at Fibonacci, Gann — I’m looking to see is there any definable pattern on a daily chat that this market is beginning to follow through with? Those kinds of things that stand out right away.
Netto’s Battlefield Diary, Part I
The following segment of the interview took place on September 7, 2001.
Eddie: Describe your day. What time do you get to the office?
John: 5:15 to 5:30.
Eddie: What are you thinking about when you get to the office?
John: All the preparation I do and homework is done the night before because I want to sleep on everything I analyze — I want it to be ingrained. Most of my analysis and scenario playing has already been factored in before I get in. I try and put together a couple of scenarios that I could see unwinding in the market the next morning. Are we going to gap up, gap down? If I have any overnights, where are they sitting right now? What’s the news?
At 5:30 the traders all get together and give a morning brief. I’m in charge of giving the technicals of that morning brief — I’m, technically, the chief investment strategist of the hedge fund that we created.
I look — what are the futures doing? I look at my charts. How is the overnight session going? I’m looking to find out the news — are there any tech conferences out there? What are the stocks in play? What are the sectors in play? What sectors have been weak the last five days? I’ll go to the TradingMarkets website, and I’ll read the Market Bias page, which gives the Connor’s VIX reversals, and I get a feel for where we’re sitting and take it from there.
Eddie: The market opens. What are you doing?
John: I’m looking to catch the first gravy move of the day. When it opens, it’s going to move in one direction. Someone’s going to win the battle in the first few minutes, and you’re going to know real quick. Are they going to gap us down to some Fibonacci support? If so, is that support going to hold? Do I get a buy signal generated from this? If so, I’ll hit the long side. If I get a short signal generated, I’ll hit the short side.
For instance, today (Sept. 7) I was looking for this market to fall down to 1343 on the Nasdaq futures. A lot of what I trade are the Qs. I like to focus on the semis. I’m a firm believer that if you specialize in a couple of stocks that you really get to know well and you really get a feel for, your trading performance will increase as a result of that. That’s not to say you shouldn’t make yourself open for special situations with stocks that are screaming double tops or screaming double bottoms or have great setups. Most of the time I like to stick to trading the semis, Nasdaq Big Caps, the Qs — mostly, it’s the semis and the Qs.
So, I come in today (Sep 7). I see the Naz futures were as low as 1338 in the pre-market. I was looking for 1343 as my Fib for all my reversal points reversal, so we could have a serious buy signal here. With all this gloom and doom, the retailers were going to come in and get short. They are going to try and slam this market down in the morning. I just stepped back and see if they’re going to do it, and if not, there was going to be a great long opportunity here. I had my price targets in mind. I always have price targets in mind before I come into a trading day.
Boom. Sure enough, we come down. We hit 1341-1342 and just skyrocket. I knew I didn’t get caught in that sucker short position, and so now I say, “OK, cool. Now I’m going to sit back and wait for the first pullback and get long on this move.” And you know what? It never came. (Laughing) I’m always trying to catch the first move of the morning, but if I don’t catch that, there will be — more times than not — a pullback that I can play. So the question after that becomes: where is this run going to if they run it from here? So I’m calculating — where is my resistance, and how am I going to get into this move?
Eddie: What happened as the morning progressed? Did you eventually get an entry and, if so, can you describe how you got in?
John: The market ran up — I got a sell signal on my divergence. The market was right on the Fib resistance and also an area of Gann numbers. I knew the market would give me a second chance; it always does. By the way, I talked about this play on TradersWire. The indicator that I have shows some pretty serious sell divergence going on. I was convinced today that we were going to go back and test those lows one more time. I had to let it exhaust itself before I got in front of a freight train. When you do this long enough, you get used to the risk. What may be perceived as running in front of a freight train, I perceive it as taking money out of the market. One thing I think is important, normally I go with three- and 13-minute time frames, but when the market really starts moving in the morning, I drop it down to a two-minute time frame — it’s much more graphic — you can really get a feel for when a move is about to happen.
Going back to 6:52 this morning, we had the Nasdaq making the first pivot high. There was obviously a great deal of thrust going on at that time. I thought that there was an outside chance that this might be the area where this decides to sell. There was a .382 resistance level sitting right there, and it rallied 40 points off that level. So, when I saw that the next bar could not take out the previous bar’s high, I went ahead and shorted 1000 shares of the Qs. Just nibbling — I wasn’t going to go with too much size. Normally, if the setup is really there, I’ll go with 3000, 4000, 5000 shares. I just kind of nibbled the first time around. That didn’t work out. The market pulled back and then it rallied and took out that high.
A lot of locals will fade the early morning move. A lot of traders, when they see a big move like this off the lows, they step in and fade that move because they’re going to catch the money off that pullback. We get the second run-up, which takes us to 1393, the high on the day. At this point, I’m seeing divergences on my indicator, and I’m also seeing 1393 is a perfect Fibonacci .618 retracement from the previous day’s high. I have divergence, a Fib retracement, and a market that’s rallied 50 points, it’s pulled back and it’s gotten close to an AB=CD correction off of those points. It’s also 7:08 (PT), which is about the time the first move begins to lose a little bit of its steam. I’m looking for this market to close lower on the two-minute bar than the previous close. I got the sell signal at 7:10 (PT), and I initiated 1000 shares. As long as the 15-period contains this trend — as it runs and it pulls back and it hits the 15 and backs down — I’m just going to keep hitting more shares — 1000, 1000, 1000.
The market pulled back down to a perfect .382 Fib retracement. I was expecting that, and I was watching to see how it would handle that retracement. It bounced very nicely off the .382 retracement, so instead of adding to the position, I covered the position and took a quick .19 gain. Because of how strong this market reacted off this first move, I covered this short and locked in some profit. I thought there was a decent shot that the market was going to end up and retest the highs again. I got a Haggerty 1-2-3 close, and I said, “This is going to try and retest the high.” I get back in, which is something I’m not afraid to do. I have no problem reinitiating the short position again. By the way, I’m calling all these trades off on Traderswire Interactive to give people a feel for what’s going on.
Now it’s 7:28 (PT). We had a high on the two-minute bar of 1383, a low of 1377. Boom. We break down, we had a 1-2-3 reversal, and I initiated 1000 again. Now I start using the 15-period moving average to keep me in this move. We rally back up, and the 15-period holds the first pullback. When that starts to roll over, I add another 1000 shares. It falls again. It tries to rally back to the 15 again at about 7:52 (PT). It fails again, so I add another 1000 shares. I made an effort to not cover my short position because I really thought the market was going to retouch the lows off this move. I could have booked a nice profit at this point, but I said, “No, this is how you really bankroll a nice trade.” If you get in these trends, you don’t be the judge of when it’s going to end. Sometimes I’m proactive in taking my stops, other times I let the moving average keep me in the trade until it’s time to get out.
Now I’m sitting back in this trade again. It comes up and makes another higher low at 8:18 (PT), it pulls back, and now I lower my stop to above that 1365 point on the NQ. I’m trading the Qs off the Nasdaq futures themselves. The market naturally pulls back, and then you get a little buying interest there, and they run up and take out my stops. I had 3000 shares sitting out there, and after all that grief, I ended up making about $300 because of where I doubled in. I ended up getting a pretty swift pullback. I don’t quibble with a stop — when it’s time to get stopped out, I get stopped out. If I’m up, if I’m down, whatever, I’m getting stopped out. I thought it might pull an AB=CD correction up, and if it does, I’m going to get back into it with all 3000 shares again.
The market, to the number, rallies from 1352 to 1366, it pulls back to 1358 and rallies to a perfect AB=CD correction at 1372 again. Once I get the closing-price reversal bar, I’m going to get back in this trade. I re-shorted all 3000 shares and rode this thing down to where it made its prior low. When it made its prior low and started to bump up from there, I saw a potential double bottom forming. I didn’t know if they had the juice to send this thing right back down again. I covered my short position for the 3000 shares and took my profits.
Netto’s Weapons Of War
The following segment of the interview took place on October 17, 2001.
Eddie: So John, how about telling us a little bit about the different indicators, setups and patterns you use to identify trading opportunities. Today the market tanked as more and more instances of anthrax exposure popped up in various parts of the country. Can you tell me what led up to the shorts you put on today?
John: Well, kind of like I alluded to in past conversations, I always step back and take a look at my trades, like, from a weekly perspective on in, so kind of like a bigger picture on in so I can try and get an idea of what is credible, or at least more reliable, probability-wise on setups. I step back and kind of look at the market as to where it could head down and bounce. We had a number of Fib expansions, a number of price targets, which were down on the NDX at around 1090, 1100, 1080, 1070, in that area in there. I didn’t play the move off the bottom because I legitimately thought that the market could head past that. But being that that was the level that held up, it seemed to me that what would be a great setup would be if the market came back to fill this gap that it had from the Sept. 11 tragedy. So, I was just kind of on the sidelines licking my chops waiting for the market to come back up and fill that gap. I just thought that it set itself up for a great trade setup to get short the market again. I mean, you and I talked about this two weeks ago. I was going to be sitting on the offer with the shares once we came up to fill the gap because I thought we’d fill the gap, we’d hit that and we’d roll over.
Eddie: And what kind of signs of confirmation were you looking for going into today?
John: There are a couple of things that I use in my analysis. I use an indicator that a gentleman and I sort of formulated together called a trend reversal index. It’s sort of a wacky connotation of an RSI. We kind of manipulate it around and threw the pi variable in to try and find ways that would lend itself to see if a trend was losing strength. I also use a horizontal filter, which is something that is also in Metastock. I also use a couple of other things: moving averages, a five, 15 and 39. None of those were in place at that point in time, but I will occasionally branch out and look at a 50 or even a 200 to see because that’s what a number of institutional traders out there use. And if they seem to offer confirmation as well, then it’s good to go. But the biggest thing that I like to use, along with a lot of Fibonacci, is Gann. A lot of Gann numbers, derived from the square of nine with the proper conversion.
Eddie: Again, though, even when you have Gann, what you’re looking at is a point in time and price at which you could see a probability, a higher-than-normal probability, that some tradable event will happen. But you do need to see a confirmation in the price action before you take action, don’t you?
John: Well, yes and no. I actually use Fibonacci and Gann as the base for the creation of my price targets. My one shot/one kill method is derived from the creation of legitimate price targets. I think to some degree Fibonacci is misunderstood, as far as how it’s applied. I try to create a number of Fibonacci expansions, and the method from which I derive those expansions may be worth delving into a little bit here. But when I have a classic one-by-one Fib expansion that’s confirmed by a downward trendline, that’s confirmed by a .382 retracement from the previous high, that’s confirmed by another .618 area of resistance — Also, some other things I do where I try to create potential Fibonacci confluence areas. In other words, if a market were to arrive at this point and were to pull back, where would a confluence area of a .681 and .382 be? Also, 50%. So, trying to create a strategy that tells if the market were to rally here, where would it likely pull back to, and try and play these scenarios out in my mind, and then plot them on chart, and then from that, what seems a plausible, attainable scenario.
Netto’s Battlefield Diary, Part II
The following segment continues the discussion of the market action on October 17, 2001.
Eddie: Okay. So, now we’re in a completely different world almost. Maybe you can tell me a little bit about how your day was and how you attacked what happened. You kind of set a foundation for me last week. You told me what you thought was setting up. Let’s talk about how you pounced upon it.
John: Well, for those that weren’t privy to that conversation, last week when I spoke to you, I expected some weakness on Monday morning. What’s historically happened is that following a chip rally during the week, either Lehman Brothers or JP Morgan, or one of those big analysts, will come out, more on issues with valuation than anything else, with a downgrade of the semiconductors, being that the semis tend to be the sector that leads the market higher than most.
I had a sense that they might be coming out with a downgrade possibly of an AMAT or Intel or some of these semis which had rallied 30%, 40%, 50% in the previous three weeks. Again, I don’t play fundamentals, but that was kind of the first thing I was looking for is some early weakness on Monday.
But ultimately, there were a number of confluences of price, like I mentioned to you, that took this market to 1445 on the NDX, NDX cash, by the way, up to 1465. We had the downward trendline connecting from the May high off the August high which would run ultimately to today’s high. And we also had a number of Fibonacci confluence areas. We also had a number of Fibonacci extension areas which I’d already managed to set up on the grid, like when I spoke to you, which gave me the idea. When you have that many things pointing to one direction — I mean, there’s no lead-pipe cinch in this market — that to me lends itself to a high probability that that is where the market is headed.
Eddie: What did you do when you came in this morning?
John: And I went ahead and came in this morning. It hasn’t been the best two weeks, as I said earlier. I went short 10,000 back on Oct. 10 and got stopped out. I thought the market was going to rollover. We got that black candlestick there and we looked weak. I took 10,000 short overnight, and I was up at one point in time close to $3,500 on the trade, and I ended up taking a $14,000 loss on that one trade.
So coming into today, this morning, what made this look luscious is that we were gapped up to this point in the morning. A really sharp trader that I’m with, Troy Green, who trades with me, he’s just one of the best intraday market timers I’ve ever seen. The guy’s phenomenal. And he trades with my fund, Emerald City Capital Group, and we agreed when we both looked at the gap up that morning, and he’s been going long the whole time, and I’ve been waiting to get short, but we both agreed this morning that when we saw the gap up, it hit my Fib time confluence. We saw the market not able to push higher in the morning, we just went in to slam it.
You know, I didn’t get my best entry price, but once we saw it begin to weaken, we knew what we could put our stop at. We knew it was a relatively risk-free trade. We had the May trendline to come down and hit us, we had the Fib confluence sitting right there. It’s just, like, you just execute those trades. And if you get stopped out, you get stopped out. I mean, we take losses all the time. We have no qualms at all about revving up the engine, stepping on the gas and kicking it into fifth gear and going. So, we did that. I hit 10,000 short at 35.40. Again, not the best price out there. What I was looking to do, because I saw the potential on the daily chart, was just get in for cost. So, 10,000 shares at 35.40. I went and covered half the position at 35 because I realize that that way I know I have a .45 stop above that, that I can let the other 5k run and look to re-enter on the first pullback after that and then ride the 10,000 down from there. And that’s how I’ve bankrolled my biggest trades is doing it like that.
So, I got in half — boom — sure enough, got my 40 cents, covered half my position at 35, so now I’m short 5,000. It keeps on heading down, and I’m cursing myself, “Why’d you cover half? Why’d you cover half?” But I realize that that’s my plan, and I’m just going to execute it and not worry about that, you know? So, I went ahead. The market rallied back up and then it kind of rolled over again. Then at about 9:15 in the morning, I saw my re-entry signal. It had come up. It had hit the 15-period moving average. It rolled again. It made another high, so I got another 5,000 at 34.30. I rode the 10,000 shares the rest of the day, and now I’m short 10,000 at 34.85. and the market right now is at 32.50.
Netto On Psyching Up For Battle
Eddie: I guess the other thing that occurs to me that comes out with every trader I talk to is the importance of money management and psychology. You’ve already touched on that in our earlier discussion on what military discipline has done for you. What kind of advice would you have for somebody who may be trading right now and may be experiencing some frustration with the bear market?
John: Well, there are a couple of things that I see that are the pitfalls of people. I mean, I’ve been through them myself. I think anyone who’s been trading, we’ve all paid our tuition, and some of us, including myself, keep on paying tuition in the market. I think that my advice to anyone who’s trading out there is the first thing is make sure you define your risk in every trade. The first thing that you should be thinking about when you get into any trade is, “How much can I lose?”
And again, I’m not trying to say to be a worrywart when you trade.
Your money is your troops, and you’re a general in combat, and the question that you need to ask when you’re a general in combat is:
“How am I going allocate my troops, and how am I going to allocate my resources in this particular battle? Is this a battle worth waging? And if this is a battle worth waging, how much mass do I want to use?”
There’s a time when you need to commit your troops for the Armageddon, and there’s a time when you need to resort to guerilla tactics, you know? I think that’s an important psychological mindset to have before you get into any trades.
The next thing you need to know is to sit down and take notes. God, some of the best things I’ve learned are from taking notes and making observations. I’m with a phenomenal team here at my hedge fund, and we always bounce ideas off of each other, and we’re always trading notes with each other, and it’s always helpful to write down what’s working and what’s not working for you when you’re trading. You could probably sit back and if you write down your trades — I mean, I looked at my trade I lost last week. Well, looking back at it, the market was moving up, so I guess I lost money countertrend trading (laughs). I don’t know!
But I think that there’s a time and a place for everything, and knowing what you’ve done and learning from your mistakes is important. There’s as many styles as there are traders out there, and I’m not going to say which is the best style. I’ve found a style that I’ve been able to make really good money with and that I’m confident in trading. But whatever style a person is confident in trading is going to be more indicative of their personality. And just hang in there, man. Just hang in there. You can do this. If I can do this, then anybody can do this because I’ve got a brain the size of a shot glass. I’m a Marine, you know? If a Marine can do this, come on, you know? One shot, one kill, baby!
Eddie: What is the hardest part of trading?
John: Stepping outside your comfort zone. Traders are usually right about a move. What’s difficult is to do things that they’re not comfortable doing. This move in the morning. Most people who have seen this happen 100 times would say that the odds are that this is likely to pull back from here. Actually, getting someone to go ahead and short that move in the morning despite the indicators, it’s difficult for a lot of traders to step out of their comfort zone and do something that they’re not totally familiar with.
How I’ve been able to develop as a trader is I’ve been able to keep an open mind and use the resources and people around me to learn things. I didn’t really feel comfortable at first because it’s like, “That stock is going up. You want me to short it tight there?” Well, yeah. The kind of action I’m telling you is exactly what market makers do to make money. This is exactly what they do. I’ve talked to quite a few of them because they’re in that office. This is how they take money out of the market every day. If you have a plan, you stick to it, you manage your risk. If after a period of time, it’s not working, make some objective decisions as to what to do to bring yourself into profitability. I think what’s helped me the most is stepping outside my comfort zone.
Eddie: What’s the easiest part of trading?
John: It’s something I love doing. It’s not a job, it’s a lifestyle. I love the market. I love being around something that constantly throws you curveballs, that constantly makes you think. The stock market to me is the greatest game of cerebral gymnastics I know. It’s constantly challenging you to improve. Trying to stay a step ahead. Trying to put yourself in a position where you can succeed. It’s that challenge, I think, that attracts the greatest minds in the world.
Eddie: I’m sure we’ll be talking again in the near future. Let’s close off this session this way. If there was one thing you wanted traders out there to fixate on in order to improve their own trading, what would it be?
John: The Marine Corps rifleman’s mantra is “one shot, one kill.”
What it teaches you is that by allocating your resources correctly, by waiting for that setup — like a sniper — one shot, one kill. Focus, discipline, patience, harmony. I put that philosophy into my trading. A lot of the discipline I got as a Marine has proven invaluable in my trading career.