Charles Kirk Q&A with Larry Connors, Part 4

Welcome to the final part of Charles Kirk’s (The Kirk Report) interview with Larry Connors. Larry himself has said that this interview is his most extensive and thorough ever and I think those who have come to get to know Larry and his approach to high probability trading will find much in this conversation to appreciate and learn from.

If you missed the earlier parts of this interview series, click here for Part 1, here for Part 2, and here for Part 3.


Courtesy of The Kirk Report.

Charles Kirk: All good traders dedicate a lot of time and effort to improvement and toward reducing mistakes. How have your trading methods evolved and improved over the years?

Larry Connors: Position sizing became a critical part of it. That was number one. Number two, I think I’ve always had a tremendous amount of respect for the market, having lived through 1987 and seen just what the market can do. I have too much respect for the market to think that, at any give time, I’m smarter than the market.

I feel that over time you become more of a risk manager and less of a stock or ETF picker.

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

Connors: Stops. I thought that stops really were required on every trade. If you take a look at anything I published prior to 2003, I suggested using stops.

Cesar and David, who I believe were actually using stops in their own trading at the time, came up to me one day and said, “Look what happens when stops are removed. Look at how this methodology performs.” And what we saw was that strategy performance improved significantly. In the July issue of Stocks and Commodities magazine, quant trader Ernest Chan has independently found the same thing.

If someone is using stops and it’s working for them, continue to use the stops. It’s just the reality that stops do nothing to protect from overnight risk and there are better ways, with position sizing and options hedging, to protect a portfolio.

Kirk: How much time and attention do you pay to other people’s strategies or stocks that they are trading?

Connors: Very little, though one thing that is interesting is when there’s mainstream confirmation in our positions – I get very concerned.

A recent example is we just had one of our few losing trades in our Daily Battle Plan Model Portfolio. It was in EWT, the iShares Taiwan index ETF.

We scaled-in to the position as the ETF pulled back, but I became very concerned when I started seeing a number of mainstream websites referring to EWT as “a great pullback.”

I suspected there was going to be a problem in the trade and there was. We ended up exiting the trade when the exit signal triggered and it ended up being one of our few losing trades so far in 2009.

The bottom line is that I get concerned when everybody is agreeing with our positions because they shouldn’t be. We are usually buying when everyone is selling.

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

Connors: We use multiple trading platforms and multiple trading softwares, including Amibroker.

There are a number of good websites out there – probably too many to mention. I think Index Universe does a terrific job for ETFs. If you’re looking for an aggregator for all information out there I think Seeking Alpha does a wonderful job. I’ve been a big fan of your Kirk Report for years and I think that the job that you are doing is tremendous.

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

Connors: Here’s a story that Shelly Natenberg, who wrote the book Options, Volatility and Pricing – one of the Bibles of the options industry – shared with me. It’s a story I’ll never forget:

Shelly said that people are never better traders than when they first come onto the floor. That’s because they are at their most careful. So they’ll just sit there and they pick their spots. They are absolutely impeccable with their trading.

They’ll often start by trading with just one lot. They’ll have success with that one lot and then decide to increase their position size because they were profitable. What they don’t realize is that they are also increasing their risk. More success, and they go up to a five lot position. All the while they are increasing their exposure, increasing their risk from five lots, to ten lots to 50 or 100 lots.

Then all of a sudden, they disappear. And the next time Shelly sees them, it’s usually when he is hailing a taxi and they’re driving the taxi.

I don’t know if he meant that seriously or facetiously, but he drove home the point to me. The point was that they became overleveraged. They didn’t stay humble. They got cocky. They were perfect when they came in, impeccable: they were underleveraged. But ultimately they lost their humility, became cocky, overleveraged and blew up.

I think that is one trading lesson that I’ve learned many years ago that still stands with me.

Kirk: What kind of advice would you give a person just now beginning trading the markets?

Connors: It would quantify everything. Early on learn to quantify everything that you do. For example, with our Swing Trading College, whether they’re trading only for a couple of years or have been trading on a full-time basis, I try to teach them the same way I taught myself, a walk-through process.

There’s a basic philosophy of how we look at markets. We quantify everything and then be extremely conservative and try to be as under leveraged as possible, especially early on with the trading.

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

Connors: That they’ll get rich overnight. That they’ll take $5000 and turn it into a half-million dollars.

There’s one industry, one asset class – and I’ll let your readers figure out what that asset class is – that has become an incredible huge marketplace because they are allowing people to open up accounts for as little as $250.

To me, that is just a form of gambling. It has nothing to do with professional trading.

The second misconception is that trading skill can be learned overnight. People go to college for four years. A medical student goes to medical school for an additional four years and if they want to become surgeons there are additional years of training after that. My roommate from college is a surgeon. I watched what he went through. He started the process when he was 18. He was done with his schooling at 35 years old and he still goes to conferences throughout the world, always looking to get better. It took him 17 years – because of the type of surgery he specializes in – before he was allowed to operate on his own.

Trading skill is similar. It can’t be developed overnight. It really does have to be learned and experience is the best teacher of them all.

Kirk: A number of people who read my website desire to trade for a living. Like you, I receive a lot of concerning capital requirements you need to start, and so on. Do you have any words of wisdom that you’re able to share along these lines?

Connors: I started in 1987. My goal was to trade professionally for myself. There was no direct path to get there, and it took me seven years to get to the point where I felt I could comfortably support my family from trading.

I tell people that there are a number of pieces that need to come into place.

One, you need to be funded and be able to have money that allows you to not be trading with “scared” money. You need money set aside that really allows you to have maybe one or two years to maintain a normal lifestyle. That’s number one.

Number two, if you are married, your spouse has to support you 100%. In my case, talking it over for more than a year with my wife, her response was, “What is the worst that can happen?” At the time I was working for Donaldson, Lufkin & Jenrette, and it was a wonderful career. It was a wonderful place to work. So there was a major decision that had to be made, especially with us having young children.

She said, “The worst that could happen is that you’d lose everything and we’ll go live with my sister, move into her garage and you’ll start over again. You can always go back.”

Having that type of support in place is very important. I hear a number of people who talk about the fact that their spouse is not used to them all of a sudden at home every day and income is not coming in every day and, especially when you’re doing model driven trading, there are days when there are no trades at all. And, of course, there are days when there are losses. So if there is a spouse, he or she has to support this decision. It is extremely important.

As far as making a living – define what making a living means. There are people who believe that $30K a year is a comfortable living. I live in Manhattan now and making a living is defined as something a lot different than $30K a year.

So making a living is about understanding what your lifestyle is. Are you able to maintain that lifestyle for at least a couple of years with money that you set aside? And then are you funded enough to be able to take an account and to start living off that account? Those are the questions to be answered on the road toward getting there.

Kirk: Like me, you’re privileged to know a lot of different kinds of traders. But do you see most traders missing the boat?

Connors: I don’t know if “missing the boat” is the right phrase. I really do think that it is the emotional side that can always be improved. It’s the mental aspect of the execution and the technological aspect of the execution that are undercovered and underutilized in the industry. There are so many books on strategies – there are no lack of strategies out there. There is a lack of information on proper execution. There is a lack of information on proper technology and that’s where, over time, I think the best time is spent – after people have the strategies.

Kirk: Likewise, what’s – what are some qualities you frequently find among the most successful traders?

Connors: One thing in common is that they are phenomenal risk managers.

Kirk: When all is said and done, in your experience, what is the best way to learn how to trade?

Connors: If you really want to understand quantitative trading and see how it tells a heck of a story, read a great book called Fortune’s Formula by William Poundstone. It is a look inside quantitative trading through the eyes of one of the greats, Ed Thorpe, the man who developed card counting for blackjack and then took his math skills and moved from blackjack into equity trading. It’s a brilliant book to read, so I highly recommend it.

I would also recommend on the risk side reading Ken Grant’s book, Trading Risk. I recommend that to everybody. Grant was the risk manager for two of the biggest hedge funds in the world. I’ve had the privilege to be able to speak with him. We spent a few hours on the phone together and he’s just an absolute gentleman with a brilliant understanding on the risk side. I feel his book really does stand out.

Kirk: At this point of your career, who do you look up to for inspiration and guidance?

Connors: There are too many people to name. We’ve named some of them, but really there are just too many people. I’ve been very privileged to interact with many successful traders – a number of them are under the radar. They aren’t high profile people, but I’m lucky to have the ability to pick up the phone or shoot over an e-mail and just say, “What are you seeing here?”

When it’s all said and done, there are a lot of brilliant minds in this industry.

Kirk: What are some of your personal passions beyond the markets?

Connors: Certainly my family … my wife and children. I also enjoy theatre and sports, especially baseball.

I’m also involved in a number of children’s charities.

Kirk: Finally, if you have one piece to share with all investors and traders, what would it be?

Connors: I could summarize it in three words. Quantify, quantify, quantify.

Kirk: Thank you, Larry.

Connors: Thank you, Charles, for having me. I hope this has been helpful to your readers.

Courtesy of The Kirk Report.

Larry Connors is CEO and Founder of and Connors Research. His two most recent books are Short-Term Strategies That Work and High Probability ETF Trading. Larry also has a daily ETF subscription service. For a free one-week trial, click here.

The Holy Grail of Indicators – Click here to learn the best trading indicator and why you should avoid the popular 14-period RSI.