Kevin Haggerty: Exploiting Institutional Action In The StockMarket

When the evening news tells you why the big rally or drop occurred in the stock market today, that’s one thing. When trader Kevin Haggerty tells you, that’s another thing altogether.

As Senior Vice President and Manager of Equity Trading at Fidelity Capital Markets (a division of Fidelity Investments), Haggerty had a close-up view of how things really work on the Street. In charge of U.S. institutional equity trading, he oversaw trading operations and accounted for a significant percentage of the company’s volume on the New York Stock Exchange on a given day.

His unique insight on trading is the direct product of this quarter-century career on the institutional side of the stock market, through which he gained a subtle understanding of the way institutional traders, specialists, program traders, and other market forces shape price action.

One of the most interesting aspects of his story is that he has used his understanding of longer-term position trading strategies as the basis of a short-term stock trading approach he now uses to manage his own money.

Haggerty got into trading as a stock broker in the early 1970s after a short stint in banking. He began hanging out in his firm’s trading department, where he was exposed to various hedging techniques–long convertible bonds and short stock, long warrants and short stock, etc.–designed to make money regardless of whether the market was up or down.

Such a multi-dimensional approach made sense to Haggerty, who began using these techniques with a great deal of success. (They were especially appealing when the stock market was bottoming in 1974.) He moved on to a number of other equity and convertible trading positions on Wall Street, as well as exchange board positions and his successful stint at Fidelity, the fund colossus of the 1990s.

One of the greatest advantages of his career path was that he was exposed to a wide variety of ideas and was able to become intimately familiar with the strategies and tactics of institutional portfolio managers and traders –how they put trades on and took them off, common patterns they reacted to, and the kinds of opportunities they looked to exploit in the markets–information that would prove invaluable when he began developing and trading shorter-term strategies.

“You develop your skills over the years,” says Haggerty. “I started looking at short-term techniques from day one. I’ve been a position trader my whole life, working large orders on the institutional level. You get to see what a multitude of accounts are doing, how they do it, and you get the opportunity to try these things yourself. It soon becomes apparent that in order to be successful, you have to understand short-term trading techniques to be able to maneuver in and out of the market.”

Haggerty trades fast and talks even faster. His enthusiasm for the market is obvious, and there isn’t an aspect of his profession that he doesn’t seem familiar with or hold an opinion on. Here, he shares his insights on trading and what he learned throughout the course of his career.

How would you describe your general approach to short-term stock trading?

Well, I like to work from the long side, for the most part, although I have strategies to play the short side–mostly using options. I stay in the most active names–it doesn’t matter if they’re big cap or small cap. I just want to make sure I’m in an area I know the institutions are going to be interested in.

I also pay close attention to volume. In stocks, you’ll definitely see volume precede price. I want to see a trade break out with no news rather than news. I want the breakout to occur, then have news follow–that’s the better trade. If a stock has been going down, then stops, and volume builds up, I’ll put it on my watch list. The stock may have reached a tradable level.

I trade a lot of pullbacks off the opening move, or any other intraday patterns–congestion patterns, and so forth–that give me low-risk entry points when I see market dynamics pointing in a certain direction.

How did your short-term trading approach grow out of your institutional background?

The edge I’ve gotten from being in the institutional side of the business for so long is to understand the dynamics of individual stocks and recognize what’s “real” buying or selling and what’s not–when a price move has something backing it up and when it doesn’t.

There a lot of practical things average investors don’t understand about institutional trading. For example, the institutions won’t admit it, but they are very technical and many are momentum-oriented. They’ll try to break stocks out of patterns and accelerate the stock to higher levels. They’re not supposed to be “traders,” but sometimes it’s part of the overall process to beat the S&P 500 or it’s simply the style of a particular money manager. The specialists and floor traders are aware of technical levels and patterns, too.

Another example is when analysts at big firms put out recommendations on stocks based on technical developments. If a traditionally popular stock has been in a slump for a while, but has recently made a move back above its, say, 50-day moving average, an analyst might put out a buy on it. It’s a good gamble for them to take, because if the market does run up at that point, they look like geniuses, and the fact that it’s a big-name stock that institutions traditionally like to hold puts the odds in their favor, too.

How do you try to take advantage of this kind of behavior?

It’s a matter of aligning yourself with what the major market forces are doing and finding a pattern that gets you in with a defined risk. Big institutions can’t hide–you can always hear an elephant coming–and what they do results in some fairly easy-to-spot patterns.

Say a stock only opens down slightly on a big down opening and holds its ground in the face of heavy selling in the overall market. There’s a reason for this–somebody has to be holding up this stock. So, I’ll go long when the stock gives an indication it’s ready to take off to the upside–when it makes a move back above the opening, for example. Those can be great trades.

Another example is if a market-leading stock opens up much lower on the opening, but on very light volume–what I like to call a “trap door” scenario. The light volume tips you off that the selling isn’t for real. Institutions often look at this as an opportunity to pick up shares at a lower price or run up a stock, and the turnarounds in these situations can be explosive.

One of my favorite patterns is called Slim Jim. They’re consolidations–horizontal trading ranges, or slim triangles or wedges–just below the high or above the low of the day. The longer and narrower the consolidation, the better. You trade the first breakout of the consolidation–I usually use five-minute bar charts–and use a very tight stop. They’re simple but they give you a low risk, strong momentum breakout play. I stick to big-name S&P issues to make sure the momentum from institutional traders, program buyers, and momentum players piling into the market after it bursts out of its holding pattern is on my side.

It sounds like a fairly straightforward pattern.

It is, but trading isn’t just about looking at chart patterns, it’s about what’s going on around them. This kind of approach works because you’ve got all the players in the market working for you. There will be institutional buyers and program buyers pushing the market up. Also, the specialist might be long, and if he is, you can bet the stock will accelerate to the upside. Hedge funds will be trying to front-run the institutions, and so on. And there will also be the normal technical buying by retail investors. It’s a pile-on effect that can make these turn out to be “moon shot”-type trades—1 1/2 to 2 points in a day.

It’s apparent there’s a strong discretionary element to your trading. If you’re trading a pullback situation, for example, where do you look to enter your trade?

I don’t have set points or rules. I’ll take a shot at any point in the pullback if I see the dynamics pointing in my direction–larger bids and a series of news highs, for example. If a strong stock pulls back, I don’t care if it’s a four-day move or a one-day move; when the dynamics change and that stock moves above its previous high, I want to be there. The specific pattern, or entry point for that matter, isn’t important, as long as it indicates a shift in the stock. The only thing I won’t touch is a strong gap move.

What’s the most important lessons you’ve taken out of the markets in the last 25 years?

Without question, risk management. It doesn’t matter if your other trading skills are great or so-so, if you don’t manage your positions correctly, you’ll never make it. Everybody talks about risk management, but sometimes it’s difficult to know exactly where they’re coming from.

In my case, it’s simple: I shoot for a 2:1 reward/risk ratio on every trade, I never take a position home overnight–unless I’m protected by options–and I almost always limit my risk to a three-eighths of a point or less on an intraday trade.

Why don’t you like to hold positions overnight?

There is too much manipulation in the market these days to go home naked–too many out-of-proportion responses to news items. There’s no advantage to exposing yourself to the kinds of two- or three-day swings that are common now. It’s unnecessary.

I learned my lesson a long time ago: You never know what’s going to happen overnight. Early in my career I was short a stock that kept rising even though the rest of the stocks in its group was going down. I held it one day after another, and it kept gapping up until I finally covered with a significant loss. To make a long story short, the reason the stock was rising was because of a stock-loan fraud case involving a buy-in. But it didn’t matter that the reason for the move wasn’t legitimate, I still lost money. From then on, price action alone was my idol.

How do you reconcile your recognition of the high degree of volatility in the market with the tight stops you use?

A big part of my strategy is being able to take many trades on a given day, and get in and out of positions quickly. Getting stopped out doesn’t bother me–I can get right back in when the market moves through that stop level again in the opposite direction. I’ll still have two or three more chances to trade throughout the day.

The point is to not let the losers be the big trades. If I get a quick half-point or 5/8-point gain on a trade, I’ll take profits on half my position, and follow up on the rest of the position with a trailing stop.

But I’ll get out of a trade almost immediately if it doesn’t go in my direction right away and the dynamics of the market change. If I’m long and a bid disappears or a size offer comes in, I get out–sometimes I can scratch the trade.

What’s the best advice you have for aspiring short-term traders?

Other than risk control, I’d tell traders to ignore most inane market news and opinions. They should look at relationships between price bars, highs and lows, opens and closes, and volume from day to day. These are what tip you off to market dynamics. Are the buyers more aggressive than the sellers or vice-versa? A series of higher closes and higher highs coming out of a pullback situation on increasing volume tells me a story–I don’t need to listen to the news. When you combine this with the institutional side of the story, it gives you a pretty good perspective on the market.

When someone asks me, “Why are you buying that stock?” I tell them, “Because it’s going up, and the stocks in the group and the larger market are up, too.” I don’t try to pick bottoms or tops; I pick my points–if they turn out to be tops or bottoms, so be it. If you’re picking your points based on market dynamics, you’ll pick a lot of tops and bottoms anyway.

A pattern is a pattern–it’s where it occurs that’s important. What are the players doing that will push the market one way or the other? Look for trading ranges, triangles, and other congestion areas that get you into the market with little risk, and let the institutions do the work. I get on board when pieces are in place and the market is gong in the direction I want it to go. If the institutions are interested, I’m interested.

Click here for a Free 1-Week trial to Kevin Haggerty’s Volatility Bands