Today’s Trading Lesson From TradingMarkets

This is
an edited transcript of a TraderTalk workshop conducted for TM members on July
18, 2002, by TradingMarkets CEO
Larry Connors.
For charts, please

click here.

Brice
Wightman: Welcome to
TraderTalk. This afternoon we are fortunate to have TradingMarkets CEO Larry
Connors. As many of you know, he is the author of several books including “Street
Smarts,” “Trading
Connors VIX Reversals,” and “Investment
Secrets of A Hedge Fund Manager.” He also recently completed a new video, “Buy
The Fear, Sell The Greed.” Market volatility has increased the past few
months and with it, not only the potential for increased profits, but also for
increased losses. To tell you more about how you can use this increase in
volatility wisely in your trading, here is Larry.

Larry
Connors:
Good afternoon everyone. Thanks Brice (for sucking up to me). Let’s get started.
Today I had planned to talk about adjusting position size in a volatile market.
I will cover that but I first want to talk about the CVR signals, as they
pertain to the market today. Obviously, the past two weeks, the market has gone
through an extremely hard downturn. In fact, as I was thinking this out last
night, I don’t remember seeing a market sell off this hard without concrete news
behind it.

Previous hard downturns over the past decade have been event-driven. If you look
at early 1994, Greenspan was tightening interest rates. 1998 saw the long-term
capital debacle and 2001 saw the WTC event. This short-term rapid downturn has
not been the result of any one direct event and makes it feel at least to me, a
bit different. With that
said, my

market timing tools, especially the CVR signals, are used to gauge when
market reaches extremes and historically reverse.

Should the VIX drop to 20% (and the 100-day MA remains at 25%), you will trade
approximately 1200 shares (all this math is approximate). Obviously, the VIX
only takes into account the anticipated volatility of the stocks in the OEX, but
it does give you a pretty good measurement of what overall market volatility is
expected to be. Should the stock
you trade have some event such as earnings, takeovers, etc., hit it, you will
want to take that into account in adjusting position size. The main goal here is
to look at the broader market and adjust your position size, based upon its
daily volatility.

Question: Why use
25%…?

Connors:
To make sure everyone
understands, if you look at the 100-day MA of the VIX, it is at approximately
25%. This is the baseline we’re using to adjust our position size to.

Question: Is there another way to adjust your position size, based upon the
volatility of an individual stock?

Connors:
Yes. Simply look at the 100-day volatility of the stock and use this as your
baseline. Then look at the 6-day volatility of the stock.
Use the same guidelines as above. For
example, if the 6-day is double the 100-day, you want to adjust your position
size by half.

Question:
Do you use

Kevin Haggerty’s Volatility Bands to exit a trade? Can you please tell me
who Kevin Haggerty is?

Connors:
Oh yeah,
that guy.
No, I don’t use his bands to exit a trade, but I do see the wisdom of using
them. In fact, I have an outside researcher looking at applying the bands with
the CVR signals as a possible exit/trailing stop strategy.

Question: Do you use an exponential MA or a simple
MA?

Connors:
I use a simple MA for
my calculations.

Question: Larry you
were talking about persistent selling. Have you seen a current situation with
accounting issues at a time when earnings are so important?

Connors:
I personally don’t
equate these accounting problems with the same level of seriousness that Long
Term Capital created in 1998 or that September 11 brought. This is why the
intensity of this sell off somewhat surprises me, but it is also why you need to
have protective stops in when you trade.

Question: If you use
the 6-day volatility of a stock as compared to the 100-day volatility, wouldn’t
that potentially have you putting in a larger position before an explosive move?

Connors:
Yes.
But just because something is trading at a lower reading on a 6-day than its
100-day, does not necessarily mean that the move is going to happen the next
day. Each daily movement will smooth out the position size, but your point is
correct and should be considered as you adjust your positions.

Question: How do you locate individual VIX readings
for individual stocks?

Connors:
I don’t look at the VIX
reading for individual stocks, but I believe you can find those numbers at
www.hamzeianalytics.com

Question: Is there a length of time that you won’t
trade, even if you have a CVR 3 for many days?

Connors:
The CVR 3 is the signal I rely upon the most. Overall, it is the best performing
of the CVR signals, but it tends to be early those few times each year that we
have these persistent one-way moves. With that said, I’m willing to assume the
risk of being too soon and stopped out numerous times, as is occurring now, in
order to be there for the many times that the signal is correct.

Question: Do you find
merit in adjusting position size, based upon the number of VIX signals?

Connors:
Yes, but it gets more complicated than that. I cover a lot of this in

my video course (sorry to do a

Landry and make this an ad) but a CVR 3 alone is more powerful, in my
opinion, than a CVR 1 and 2 combined, which are weaker signals. Also, since
1999, I now use another nine CVR signals and some of those combined are more
powerful than others.

Question: Aren’t you,
by suggesting a reduction in size if volatility increases, implying that your
overall trading is losing money? If not, assuming you are a profitable trader,
why not leave size alone?

Connors:
I’m making no assumptions on past profitability. My goal by doing size
adjustment is to be able to smooth out the returns over a longer period of time.

Question: We all want
to preserve cash for the turn. Yet we are willing to take some risk to be there
at the moment of the BIG reversal. Do you use call options to keep a position on
for that event?

Connors:
No. I have learned from experience and more importantly from Tony Saliba and his
head trader Joe Corona, that long premium (i.e., long calls) is overall a losing
game. Also, please remember what is going on when the market reverses and rises
sharply. Volatility will implode and even though prices are moving in your
favor, volatility and time are moving against you and are eating into your move.
That is why I would prefer to be long the underlying market and use stops to
protect myself.

Question:
Lately, I find myself getting stopped out frequently, sometimes twice, where the
position ultimately goes in my direction without me. How many times do you
re-enter a trade (once, twice, unlimited) before you throw in the towel? Also,
do you use the original entry point to enter or wait for a new signal? For
instance, you have a narrow-range

Trap Door entry, but get stopped out on a subsequent wide-range bar. Do you
use the original entry point or a new entry point based on the wide-range bar?

Connors:
You’re not alone in seeing yourself getting stopped out frequently and the
position reversing in your original direction. Let’s talk about what the market
will usually bring over a 12-month period of time. Within that time frame,
you’ll see periods of low volatility where it will be next to impossible to make
any money because there is no range. You will see markets that move straight up
(as they did in March); you will see markets that move straight down (as they
have done over the past month).

This is not the correct thing to do. Slightly adjusting for example by position
size is correct. But to deviate from your overall plan because of a short-term
abnormality is usually not the smartest thing to do. The thing to do is to look
ahead and ask yourself what will the market likely bring over any 12-month
period of time and then create strategies and money-management strategies to fit
within that framework. This is a very difficult exercise but when done
correctly, it allows you to live within short-term times where market behavior
is abnormal, as we are seeing right now.
I’m going to take a few last questions
and then we will wrap this up.

Connors:
I never advocate adding to a position when volatility increases. I advocate
decreasing position size. Also, I do not add to winning positions. I’m looking
to scale out of winning positions. And the more aggressive the move is in my
favor, the more aggressive I become in looking to take profits.

Question:
Your answer about options makes sense. However,
the other question about constantly getting stopped out seems to be the norm
among most of us. Perhaps the real folly is trying to catch the moment of the
BIG reversal and not waiting for a new trend (blue
arrow). I would like to trade and especially be there for the BIG move, but
it seems like a zero-sum game. How do you manage to do it successfully?

Connors:
This is a very good
question and it gets to the heart of whether or not you should be a
swing/momentum trend trader or a reversal trader.
Dave Landry,
Gary
Kaltbaum and
Tim
Truebenbach are successful swing/momentum traders.
Kevin
Haggerty,
Don Miller and
myself
are reversal traders.

Both styles can be extremely successful, but you can’t say one is better than
the other. The key is to understand how you are wired, how comfortable you are
trading either style, and whether or not you have the strategies to be able to
successfully trade that style. Even though Kevin, Don and I trade the same
styles, we use different strategies. I believe the reason for our success has
less to do with the strategies and more to do with our money management and
discipline.

We each look to buy/sell market
extremes, attempt to minimize risk, and we basically do the same thing, day
after day after day. I can safely say that none of us makes money every day at
trading like this. But the three of us have a combined 60+ years of experience
(most of it Haggerty’s) doing this, and it’s the style that we have found the
most success with. Whether or not this style works for you is 100% your
decision. The only thing I will strongly urge you to do is to select one style
and master it. That’s the key to success in most walks of life, and it’s one of
the keys to success at trading.

I want to thank everyone for spending
the last hour with me. If you would like any more questions answered, please

email them to me directly. I’ll answer you by Sunday. Thanks again.

Brice Wightman:
Thanks, Larry. This chat is archived, lower left of
TradersWire,
just click “archives” for July 18, 2002.