Dedication and Discipline: Market Timing with Tom DeMark, Part 2
When we last spoke with trader, author and trading advisor Tom DeMark, he was explaining not just one of his more familiar technical tools, the TD line, but also his overall sense of what market timing is (See “Dedication and Discipline: Market Timing with Tom DeMark”).
For DeMark, trading is increasingly a game of trading reversals, rather than chasing trends. Partly this is a function of some of the traders that DeMark works with — whose large trading sizes make reversal trading a more practical approach to entering and exiting the markets at levels that provide good values. It is also an important strategy for the institutional-level traders with whom Tom DeMark works, who need to be sure that they do not take positions at levels that will cause too much disruption of the markets they are seeking to trade.
In this short coda to our interview with Tom DeMark, we take a big picture look at the difference between trading styles for institutional traders compared to retail traders, whether techniques that are applicable in one time frame should be equally applicable to other time frames, and just what the average Joe or Jane trader needs to do in order to keep up and succeed in a game dominated by big institutional money and points of reference.
David Penn: You were talking about the idea of qualified breakouts when we last talked. The idea that there was a relevant phenomenon. But that phenomena had to be confirmed, have the right follow through…
DeMark: There’s always justification, there’s got to be some reason why the market goes up or goes down. More often than not, markets rally, due to an absence of sellers and markets, top because of an absence of buyers.
When you have buying at what’s perceived to be a low, it’s usually short-covering. Something like that is short-lived. Just like with the bonds at the end of May 2008: the bonds made a low and three consecutive up closes. Usually when markets have three consecutive up closes, that’s short-covering. What happens is you set up a vacuum under the market and the next decline is even steeper than the one you had prior to that. People aren’t smart enough to catch lows with 3 consecutive up closes.
The same thing happens at highs: 3 consecutive down closes gently exhaust the down side. People who believe they’re smart sellers are selling and they just get taken in.
You see a top, then a down close, then an up close, then a down close, there’s a lot of skepticism on the down side. Just as at the bottom there’s skepticism that the market’s a bottom. People cannot be right reading the 3 up closes. It just doesn’t happen that way.
Penn: And something that too few are willing to accept?
DeMark: It’s taken 35 years for institutional investors to accept non-traditional perspectives. For example, they don’t accept technicians. They just don’t. There’s really a resistance. And a lot of these fundamental shops won’t accept market timing as I define it. They understand it, they understand what you say: markets bottom not because of smart buyers because the last sellers sold.
There’s a group of fundamentalists that specialize in every industry or every particular stock or whatever and that’s pretty well defined and they’re in and out of the markets, you get them set up in the model portfolios, they’ve got their approval for what they can trade, and that’s all defined. They’re either buying or selling or neutral. Well that universe is defined and markets are locked generally into a trading range — whether it’s up or down.
What I’ve found is that the markets — and we did this analysis many years ago while at Tudor – 76-82% of the time, the markets are IN A trading range. 18 to 24 % of the time markets will trend and of that 18 to 24% probably 16 to 18% of the time markets will trend to the upside and the balance to the downside which is nominal. 6 to 8% on the downside.
Why is that? Usually when markets rally, people add to their positions, the analysts turn more and more positive, the media’s positive, you hear everything positive and, so it’s really a cumulative buying moment. But when people want to sell they don’t like something if it’s a one decision rather than multiple decisions. That’s why trends to the downside are sharper, they continue over a shorter period of time.
Here’s another thing: if you follow the Wall Street Journal or financial TV news and you want to get an idea of how the market did, all the relationships are based on the prior day’s close.
They’ll say things like “IBM was up 3 points today” when, in fact, they’ve used the opening as their reference point. So if you use the opening as your reference level and you related everything to the open, IBM could be up 3 points. But maybe, in fact, IBM opened 5 points above yesterday’s close, and then closed up 3 points — though down 2 points from the opening.
What you really have is selling in the market rather than buying.
Penn: Are all the strategies you develop equally applicable to markets like forex, as well as stocks and futures?
DeMark: Oh yeah. What’s always bothered me is that people come out, I remember back in the ’70s, ’80s, ’90s, people would come out with a system for trading cattle and use a different system for trading currencies. And what they do is optimize their indicators to have the best results.
Everything I do is homogenous, it applies on all timeframes, whether it’s one minute, or quarterly, or annually, or yearly charts or whatever. It’s the same rules, the same approach, the same conclusions whether it’s the markets, the currency or it’s an egg product. Everything is the same. I don’t try to change anything. There’s no adaptation.
Penn: Is your trading generally short-term in nature? Many of the examples you’ve provided are based on short-term time frames.
DeMark: Well, some is. Steve Cohen’s a short-term trader. John Burbank is a long-term trader. He’ll hold positions for years. I figure if you can be successful short-term trading it’s very simple to take the same techniques and apply them to longer-term.
I don’t refer to short-term or long-term the same way as most people. Most people refer to “short-term” maybe even “long-term” as a unit of time or duration. My interpretation of short, intermediate and long-term has to do with percentage profits. A short-term gain is anything up to about 8%, 1 to 8%. That could happen in one day, it could happen in 3 weeks. Medium term or intermediate term for me is anything from, say, 10% to 20%. That could happen in one day, it could happen in 4 months. Anything long-term is greater than 20%. And that could happen in one day or it could happen in 6 months.
Penn: That’s a very unique approach. I haven’t heard of these interpretations before.
DeMark: My entire investment psyche is different than others. Many traders get caught up in this whole thing: short-term, intermediate term, long-term, and they confuse it. I don’t classify things that way. I’m looking for expected profit, expected return, stop losses and things like that to protect us when we are wrong. But we can hold positions longer and longer and my advice is extending as well. I can just take a weekly chart and look at it as if it were a one minute chart.
Penn: How applicable are your techniques for the retail trader? The average man or woman trading end-of-day, for example.
DeMark: It’s tough for the small guy. The small investor. It’s got to be impossible. With technology the way it is nowadays you’ve got all the arbitrage, derivatives. It’s tough. I mean it’s a full-time job. People that just do it as a hobby – I don’t know how they can be successful.
Penn: Given what you’ve just said, what’s a little guy to do? What’s a TradingMarkets’ reader/subscriber to do, given some of those odds that may be stacked against them?
DeMark: My experience was that probably 99% of the people want to be told, 1% feel that they have the answer and 99% of them are wrong.
I was a keynote speaker at some big event in California and there were a couple thousand people there at least and they opened it up to questions. It was a retail seminar for a number of days, I was the kick-off and I said “are there any questions?” This is not typical of an address but people were asking “what’s the best advice you can give me?” And I said, “don’t go downstairs in the midway” where everybody was selling and I got in trouble.
But it’s true. The small investor can be had. There are so many people out there who are just shysters. I don’t see it that much, but on my hand I can name 3 or 4 people that are technicians that I respect. The other ones are just sharks. I think you know some of these people I’m talking about. It’s a joke.
The best advice for people is probably they’re not gonna be successful if they manage their own money, especially if they get into a market they’re not familiar with. The best thing to do is to follow the advice of someone you respect, maybe your group. That, or give your money to someone else to invest, a professional.
Penn: The odds are that tough, in your view?
DeMark: As far as advice for the small investor, be careful. And make certain that anything they’re gonna do is go and read; review different services.
And you’ve got to have confidence in people. You should give money to someone you know is a professional, who has a good record. People ask me all the time where should I invest, I tell them Treasury bills.
The biggest problem you have if you recommend something to somebody is it could work. But if you don’t give them the other end, when to sell…I remember 30 years ago I told someone to buy Homestake gold. This was back in the ’70s, early ’70s, when gold really took off. He bought it. And I know he bought it because he told me he did.
Right around 4 or 5 years later, he asked what he should do with the stock, I told him to buy. I said “Gold? You can’t buy gold.” (Because gold wasn’t being traded that year.) He said, “the gold stock.” I said you mean the Homestake? He says, “Yeah, the Homestake. But you never told me to sell.”
There’s always the other side to it. So that kind of advice is a no-win proposition. You tell someone to buy something it goes up it was their idea, but if it goes down it was your idea.
Penn: Well, let me ask you this, is there anything that we didn’t cover that you wanted to — that came up in the course of the conversation that you wanted to make sure that we included.
DeMark: There’re a lot of days in the market that are meaningless. You’ve got to determine what days are important and meaningful and which ones aren’t, and then build a system or an indicator that helps you to differentiate.
We’ve been doing that. And we’ve got a lot of horsepower behind us. We’ve probably got more experience and more horsepower than anybody does. I’m not trying to brag or pound my chest or anything, but we really do. We have the resources no one else has.
Last, the trend in trading is more toward timing. More and more people got a taste of it in the ’90s, if you remember all those bucket shops where people were trading. And it’s starting overseas: Russia, China. It’s just starting, I’m seeing it. It’s going to come back here again, too.