Jump Start Your Profits With Model-Driven Trading

• April 1, 2005
• Steve Primo

Editor’s Note:

The following is an interview done by Dave Goodboy in conjunction with

RealWorldTrading.com.

Brice

 

Hi my name is
Dave Goodboy, I’m Executive Producer of Real World Trading, today I am joined
by Steven Primo. Steven is a professional systematic swing trader who has
developed a unique and profitable trading style. Let’s get started:

Dave:
Welcome, Steven. Thank you for joining me today.

Steve:
Thank You for having me.

Dave:
You’ve had an interesting journey leading to your current career. You started
out as a musician?

Steve: Yes,
it was certainly varied. I attended Loyola Marymount and I have a degree in
music. The interesting thing is that they way I got started in the markets was
because of my music career. I was in downtown LA looking to buy a saxophone and
as I was walking the streets, fresh out of college in 1977, I passed the Pacific
Stock Exchange. I needed a summer job so I just went to the visitor’s gallery
and looked down at the floor. I was hooked from that moment on. The next day,
I got a haircut, a new shirt and applied for a job. I started out at the very
bottom as a runner. This was in the old days before it was all automated

Dave: I was surprised to find out how many musicians are traders. Do you
think there is some correlation between music and the markets

Dave: Interesting. Let’s get back to your early career at the exchange,

what exactly does a “runner” do?

Steve:
A runner goes up to the specialist to record the prices on a piece of paper and
hand them to the teletype operator. This is what I did for the first 6 months. I
eventually got hired by a floor broker to be their assistant; I did that for a
couple of years and then I was hired by a specialist to be his trading
assistant and did that for about three or four years until I got my own post as
a specialist. I was a specialist on the floor for nine years as a trader for
Donaldson Lufkin and Jenrette. I worked there until 1994 when I went out on my
own and I’ve been on my own ever since.

Dave: What
was the impetus to leave DLJ and start trading your own account? That must have
taken much nerve, many traders who leave a trading job don’t make it on their
own.

Steve: I had
trouble myself. It was because I had been doing it for so long and I realized
that I had a system in which to trade that had been working fine for me. I
thought why not just take my own capital and do it out of my home office and
even if I made 1/3 of what I was making on the floor, at least it was all going
to me and I would be able to make a nice comfortable living. This was in
1994–long before the Internet; I used to get my data through radio waves…

Dave:
Yes, I remember that radio wave quote thing. The company that is now eSignal
provided it.

Steve: Exactly:
I had to actually place this little antenna out the window that got the radio
waves. When it rained I wasn’t getting very good data and as well I was trading
the full S&P contact and I was trading on the phone, so it was really
antiquated.

Dave: The big S&Ps leave you very little
margin for error. How did you do
when you first started?

Steve: I
did fantastic for the first two months. I thought I was going to be able to retire
before I turned 40. I thought I was going to be a multimillionaire! The same
thing that happened to me happens to most people who do well right off the
bat–the two things that control the market are fear and greed. They get greedy.
I got into this greed mindset where I thought I couldn’t fail and I proceeded
to
lose a good chunk of my nest egg in the next six months. I had to make a
decision. I had to say, “Am I going to be a able to do this–should I throw in
the towel or should I try and become a student of the market and really learn
what method best suits me so I could make consistent profits.” I did that and
ever since then I’ve been a systematic trader.

Dave:
What was your turning point? What allowed you to taste success again?

Steve:
What I had been relying on for so many years was what had worked well for me
on the floor–and that was I was taking a lot of the input there and using the
input from the floor and using the order flow I had to help me make decisions. I
knew if there were buyers around though my information and through being a
specialist in 35-50 stocks. I knew through my book–I could tell by the
loudness on the floor–when it was getting busier–when changes were about to
happen in the market. When we were reaching a higher high, I was getting ready
to short and when we were reaching a low I was getting ready to buy. I tried to
transfer that over to home, but I wasn’t getting any input–no book, no order
flow, no noise level. I realized I had to rely solely on my decisions; I
realized I had to become a student of the market. I started to really get into
technical analysis–which I had always been interested in but I was looking more
for things I could quantify–for patterns or systems and the things I could test
and see that they worked for a number of years. I came up with an idea of my own
that was similar to what I had been trading but I got to quantify it.

Dave:
Can you tell us a little
about that idea?

Steve:
Well
the method basically, like I said, when I was on the floor I would see levels
where there was extreme greed, fear, and panic. Through some special indicators
I use and also through experience I can tell when something is tremendously
overbought or oversold. I will look to take advantage of that. Now, I’m not
just being a contrarian for contrarian sake, that was what I used to do before I
left the floor, and it had terrible results. I don’t advise anyone to do that,
to just buy because they feel things might be oversold. I look at specific
things in the market. I look at trends, and I try to find those places where
there extreme sell offs have occurred, when actually people are thinking the
trend has changed, this is actually in a sense, just a pull back then a trend.
I jump on board when I see it is starting to resume the trend. Most of my trades
last a very short period of time. I would say from half an hour to possibly a
day or two, but nothing in terms of a long-term trend.

Dave:
So you are basically buying pullbacks?

Steve:
Yes. I sell extreme
cases of overbought conditions as well. If you look on the longer term, say a
two-day chart as appose to a 10-15 minute chart, a sharp rise in the market is
only a correction in a larger down trend. It really matters what time frame you
are looking at.

Dave:
I
know you teach a concept called model-driven trading. What exactly do you mean
by model-driven trading?

Steve: Well, it’s a model in a sense
that it has clear and concise rules that one has to follow like a plan on a daily
basis. It’s basically a plan that has been researched, back tested, that you
feel comfortable with and you have developed this plan after doing extensive
research and testing. Plus, it has to fit your personality. You know what your
risk parameters are, and you know what your profit targets are. Then you implement
this plan following a clear set of rules. There are a million things that go
into this plan. It has to be simple and easy enough for you to implement. I know
people who had plans, but they are so complicated that it took a 210 page manual
just to have an entry signal.

Dave: You
feel the simpler the plan, the better?

Steve:
Just like the old
saying KISS, Keep it Simple Stupid. It really is true because when things get
tremendously busy in the market and there are a lot of challenges going on, if
your model is complicated, it will be that much more difficult to carry out and
implement. You want something simple so it’s simple to carry through.

Dave:
Controlling risk is a very key point of any trade. Do you have a risk formula
that you can share?

Steve:
I don’t have an exact
risk formula except that money management is key. There are always the same
adages that you should try to make your profits run, and cut your profits
short. I think the main thing that you have to look at in terms of risk, this
is going back to the idea of back testing your plan, you have to look at your
drawdowns, that is the worse-case scenarios. That is your equity, from peak to
peak, the highest high to the lowest low. Look at your drawdown, say you are
trading the E-mini S&P, and your worst drawdown is 10 points. You have to use
that as a benchmark to know that you may eventually get there again. Maybe
this year, maybe five years from now, maybe next week you will get somewhere
where you may lose 10 points. You have to use that as a benchmark to know how
much you feel comfortable risking. Usually, those benchmarks are either tested
again, or they grow larger. They are something that is meant as a signpost.
Many people only test for a short period of time and think just because it has
only lost one point in whole six months that it works well. I once read that
you should back test for a minimum of ten years to get an adequate
representation of how well your system does. I use that maximum drawdown as a
benchmark to know how to adjust and set my position size.

Dave: So
you are basically setting your position size in relation to the potential
maximum drawdown?

Steve:
Yes, so let’s say my
maximum drawdown is 10 points on the E-mini. That comes out to $500 per
contract. If I know that that could be reached at one point in the future,
whether test it or exceed it, I know that that is the benchmark. So if I can
risk 10 of those contracts, which is $5000, I know my portfolio can risk $5000.
Someone might say I can only risk $2500, so that means they would only trade 5
contracts.

Dave: Let
me see if I am following you–once you are down $500 per contract, you close the
trade out?

Steve:
If that is part of your
plan, sure. For me, rather than closing the trade out, I may cut down my
position size, and maybe go down to half.

Dave: What kind of
benchmarks do you use to measure the viability of your trading
model
plus the performance of system that are based on it?

Steve:
The profit factor is a
very important tool we use here. It is something we use here at the Swing
Trading College because it really is a determining factor whether a system is
going to be traded or not. Simply put, the profit factor is your gross profits
divided by your gross losses over a period of time. Let’s say you have back
tested your system for 10 years, and your gross profits were $100,000, and your
gross losses were $50,000, you then divide 100,000/50,000 and you come up with
the number 2. Now 2 is a very adequate number to have for your profit factor
and you should be gearing to have a profit factor of at least 2. Once you start
getting into higher numbers like 3 or so, that is outstanding. The benchmark we
use here at the Swing Trading College is at least 3. Some systems have profit
factors that go up to like 15, so they are phenomenal. It only means you
are grossing this much more money than you are losing.

Dave:
You believe that a 10-year testing time is what is needed to determine a
successful system?

Steve: Yes…you
want to make sure you cover enough of the market’s behavior to give a justified
and honest picture of what may happen with your system. Everyone likes to
go back and use specific time periods where the market was booming to show
how great their system is working, but then they conveniently take out the
years 2000-2003 where the market was in a drawdown. We all know how some
people were doing fantastic up until that period and then the bottom fell
out and they are no longer in the business. It is because you have to do
back testing and research with the good times and bad. You want to have consistence
regardless of what the market is doing.

Dave:
I imagine it’s difficult to avoid optimization and curve fitting. How
do you manage this issue?

Steve: Well, optimizing
is just curve-fitting, so you are just playing with the numbers to make you
feel more comfortable. It is just a white lie to yourself to make you feel
good about trading it. But ultimately, that fooling with the numbers is going
to come back to bite you, so why would you do that? We don’t trade anything
optimized. We just go back and test something and make sure it meets my
standards. If the draw down is fine, but the profit factor is not up to my
standard, I just won’t trade it because I know that it is going to come back to
get me.

Dave:
Specifically, when you say ‘look at a market,’ do you use candlestick charts,
or
regular bar charts?

Steve:
I use regular bar
charts. I have nothing against candlesticks. I like a particular pattern of
the candlestick, which is the bullish/bearish engulfing pattern. Those are
basically reversing patterns, and I am looking for quick reversals in the
market, whether it be a five-minute chart or a daily bar, that is what I am
looking for. So candlesticks can help, if used properly, but really it’s just
another way to express what’s happening. I’ll also look at dojis, where the
open and close end up being the same. That is really it, I don’t go much into
the details of candlestick charts. I have nothing against them, but I’ll just
maybe look at one or two at the most.

Dave:
When
you are trading throughout the day, is there a particular timeframe you prefer
on the chart?

Steve: Well, if I am day trading
an S&P
chart, I will usually look at a 9-minute chart of the S&P. It divides the whole
day into exact bars. There are 45 9-minute bars, rather than a 60-minute chart
or something that doesn’t configure because of closing 15 minutes after the
hour, so it doesn’t mesh.

Dave:
Do
you use any standard indicators on a chart?

Steve: Oh yeah, I will use a lot
of indicators but I pick and chose what I like from each one. The only indicator
I
really don’t look at it is volume. Like I said, I think everyone has their own
way of trading, and that is the key, is finding a method that works with your
personality. Personally, volume doesn’t seem to matter too much for me. But
I will look at RSI indicators, trend lines, Fibonacci–basically anything that
can
help me to come to an idea.

Dave:
Digging a little deeper into your use of indicators, do you use moving
averages?

Steve: Yes, I do use moving averages. They
help me to determine the trend.

Dave: What
time frame of the moving averages do you recommend?

Steve: All I use is a 20-period
simple moving average. Nothing fancy at all, just keeping it simple. Anything
I use
is just part of the plan, like spokes in a wheel. Nothing has greater
importance over the other. The plan is actually more money management over
anything else. If you have a system that is correct 60% of the time and you
have proper money management, you are going to be fine. I often tell people,
if
you are a systematic trader and you are doing it right, it is very boring.
Because all the work that is done is put together in the plan before you even
traded. Once you pull the trigger, there really isn’t that much work to do
beside wait, it’s just like fishing. The real creativity and the real work is
done in the back testing and formulation of the strategy.

Dave:
Can
your models be applied to individual equities, or just indices?

Steve:
Sure, you can apply
them to individual equities. As we all know, each market has its own
personality and own risk parameters as well. You can trade with stocks,
futures, and indices, just as long as you use that particular method to that
market. A lot of them can transfer over, but can not transfer over exactly,
they have to be molded a little to fit the actual market. You can have a stock
open down 40-50% off news, but rarely do you see any indices open down 50%.

Dave: Do
you have a systematic way of taking profits?

Steve:
Yes, a lot of times
that is actually the most difficult thing. Because there are so many emotional
things that get in the way. First of all, there are only two emotions, but
there are different ways to use them. Let’s say you are fearful because you have
had a series of losing trades, and you are in a trade and you make a little
bit. Chances are you are going to get out when you have just a little profit,
and that is wrong because usually you have a tremendous profit that you see you
left on the table and you are kicking yourself for not following the rules like
you should have. Then there is also the element of greed where you have been
doing great, and now you have a trade in and you think you can do no wrong so
you stay in longer than you should, and you see a nice profit that whittles away
and it turns into a loss. Then you are thinking that you have to stay in
because you are committed. Those are the two things that people have real
trouble with. A great way to do that, systematically, is to always use your
position size to help you determine what makes you feel comfortable. You can
scale out of positions, so if things continue to run, at least you know you
still have some position on. Instead of selling everything and seeing that the
market is taking off, what you can do is sell half or part of it and let the
rest of it run, so you are still in the market if it takes off.

Dave: Can
you tell our members how to find out more about the
Swing Trading College?

Steve:
Yes, the best thing is
to go to our website, which is TradingMarkets.com. We have a tremendous
14-week
package that I teach.

Dave:
This is hands-on, where students are actually watching you and trading with
you in real time

Steve: There are three to four weeks of
hands-on trading where we trade our own capital. So the last three to four
weeks the students will watch me trade a $50,000 account using the actual
systems. Students can follow along and see how we put in the orders, how we get
out, and how we did. We teach seven systems and we give all the guidelines to
follow, but it also an interactive course where you can ask questions over the
webinars that we give, or through email. It’s really hands on and we stay with
you all the way through the 14 weeks.

Dave: We
are almost out of time. Is there anything you would like to leave our members
with?

Steve:
I would just like to
say that discretionary trading is fine, but I know, through 27 years of
experience, that systematic traders have stayed in the business longer. They
have not fallen by the wayside. You look at athletes, actors, and performers;
it’s the ones that continue to stay in the business that have really reached
that success. It is not about hitting that home run, it’s about consistency.
I
believe that is easier through systematic trading, than discretionary trading.

Dave:
Thank you for joining me today Steven.