Traders Interview: Lewis J. Borsellino Talks With Marc Dupee
Marc Dupee: In the last two months we’ve seen a big drop in the S&Ps to a three-year low and then a rally that has taken the index up over 20% off the September lows. I know that you’re very good at integrating market dynamics into your trading plan, and you go over that in your newest book The DayTrader’s Course. Could you discuss how you have incorporated market dynamics into your trading plan in the past few months, particularly at the inflection points: when the market dropped, and when it changed direction and came back.
Lewis Borsellino: I’m a firm believer that if we could take the news out, the market ould have gone down there anyway. The news accelerated the process. Of course,you can’t take the news out, but I think people tend to overreact in times of tragedy. They get up and go to work — unfortunately, not the people in New York — but the rest of the country, and they really haven’t psychologically experienced what most of the people in New York have gone through. What happens is like it’s a one- or two-week eulogy, and then people seem to feel they have to go on — business as normal for those who have to survive the economic downturn.
So I look for inflection points like the August 1998 lows. It had to hold those levels. If it didn’t hold those levels, I think there would have been a major, major problem. The only thing I had to fall back on there was experience.The two major ones that I’ve been through are two major world conflicts and a major correction in 1987. In ’87, we saw that the market corrected percentage-wise more than what we’ve seen recently. But what I saw was when we looked like we were in trouble, the government and the Fed came to the rescue of the markets. Right now, with all the stimulus that is pumped into the market, the money that’s being printed — and it is printed money — that’s why the market has sprung back. People have kind of forgotten about New York — ify ou’re not in New York, you’re everyday life hasn’t changed. The panic — there is still a lot of terrorism out there — but the panic is sort of out of the market.
Marc: So you’re saying you were expecting a kind of a eulogy sell-off to the August ’98 lows and from there a snap back as part of the market dynamics?
Lewis: Exactly. What I’ve seen since Sept. 11 is the market dynamics are starting to switch, where the consolidations are starting to make lower lows and higher highs. And a big key area for us right now is in the 1120 area in the (S&P 500) cash, exactly where we’ve stopped. But the consolidation that took place and the way we defended the important 1050 to1060 area is key. Also the way the Dow defended the 9000 area.
For the first time in almost a year and a half, the sellers are jumping in up there at the tops and guess what, the market is not retracing like they expected. And I think that’s what you saw in the 1050 area, they got short looking for a retest and they stampeded each other to get out.
Marc: Are you talking about locals in the pit where you see them doing that?
Lewis: No, you’ve got to remember that locals are always short. No, just people in general trading the market. The market keeps holding the key levels.The market dynamics right now, as far as I’m concerned, we’re at the do-or-die point. We’re going to have to consolidate now at this point between 1110 to1120, 1100 possibly, basis cash. We need to consolidate this area because the next step is 1200. We’re actually looking for 1160, then 1200. If the market can get to 1200 and the Nasdaq to 2000-2200, and the Dow can get above 10,000, we will finally be, for the first time in almost two years, out of a bear market and into a neutral market.
Does that mean we are out of the woods? No. What it means is we are going to have big, big volatility swings, big ranges.
Marc: A neutral market means big volatility, but range-bound trading?
Lewis: Yes. It will start with big ranges, and then it will consolidate with smaller ranges, and then when that happens, look out. Whatever way we break out from there will be dramatic.
Marc: You say in your book TheDay Trader’s Course that capital preservation and making a well-executed trade should govern everything you do as a trader. How do you define a well-executed trade?
Lewis: I would define a well-executed trade as one where my entry point gave me the least amount of stress and pain and worry from going in a positive direction. Everybody likes to buy the bottom and sell the top. But one of the most painful things that happens to most traders is when you buy it or sell it and it goes immediately against you — within minutes — and you’re stopped out.And you’re sitting there with this loss and you’re asking, “What did I do wrong?”And you have to go back to the drawing board.
Marc: You want it to go in your direction right away.
Lewis: You’d like that to happen. The painful thing is that you may be trading in a consolidation area where it hit your stop and the market turns around and goes back. You would have been right. You’ve got to be able to identify what kind of market or what kind of time period you’re in. You’ve got to develop a system that says “this market is trending, I can get in, I can ride this trend, and I can get out.” A lot of times you get stopped out. I wish over the last 20 years I had a nickel for every time I was stopped out because I was too early in putting on my trade.
Marc: What’s the lesson from that in terms of the well-executed trade? How would — or have you learned to execute better?
Lewis: Well, it comes with being patient. And not believing that if you don’t get into the market this particular time, that you’re going to miss out. One of the things I love to look at is the Market Profile of tick data: where the market has spent most of its trading range for the life of the contract, where it’s spent most of its trading range for the last week, the last month, the last day. I also break it down to hourly.
For example, let’s assume you’re bullish,and you think the market is going to go to, arbitrarily, to 1300. And the market is at (again, arbitrarily) 1200. And the market has a big range of consolidation trading between 1230 to 1235. And you also have a big range at the 1185 area,okay? So the market has spent a lot of time at 1235 and also at 1300 and a lot of time at 1185. You’re at 1235 and think, “This thing is going to consolidate and go to 1300.” Sure enough, you get up to 1235, you get in,and the market spends the rest of the time consolidating that day, not getting much higher than 1235. You put your stop in, let’s say, 600 points (pit points =6.00) from there, and you end up getting stopped out.
The next day the same thing occurs where you break down to the 1185 area. So what happens is the market moves between these consolidation areas and a lot of times, you get in on the wrong side of it because you’re wishing and hoping and projecting that it’s going to get to that 1300 area, and you haven’t let the market make its mind up. You’ve got to watch what happens during those consolidation areas. If you look at most consolidations, they have higher highs and lower lows and then it goes down into a smaller range where you have lower highs and higher lows. When you’re in a consolidation area and you need to be watching it down to the five-minute chart, when it breaks from that consolidation,that’s when you want to jump on that trade, when it’s coming out of that consolidation. Otherwise, you’ll be stuck in a trade that has a chance of going to either of the two consolidation extremes.
Marc: In The DayTrader’s Course, I like the way that you define support and resistance by calling it areas of two-way trade, areas of high volume where traders are willing to commit long AND short to trades, and generally, areas of high volume where the market trades for extended periods of time while it “makes up its mind.”How do you locate areas of two-way trade, especially intraday when volume figures for futures have not been determined or released yet? Some range-bound trade that marks support and resistance comes with light, choppy volume.
Lewis: You don’t need volume, you need price action. You need price and time.You can develop a gut feeling by watching how long it has been churning in that area. That’s precisely what we’ve been talking about right here.Consolidation areas are where everybody’s different opinions come to meet. It’s a period where my opinion and your opinion, where the bulls and the bears, are equally matched. I give the analogy that it’s like the “Rocky” movie. Rocky is getting his head pummeled, and it really looks like he’s going to go down in the first two or three rounds. But what happens? He keeps coming on stronger, the other guy gets tired, and Rocky ends up winning. It’s the same thing with bids and offers. These ranges, the buyers really look like they are going to win on the top, but the sellers keep coming in. And on the bottom it’s the reverse, the sellers keep pushing, but the buyers keep coming in. And eventually, one of them gives up!
That’s how a consolidation gets figured out. That’s one of the things we look at the most. One of the things we learn to do is to walk away from trading in a consolidation range. We wait for it to break out.
Marc: Is there any way to determine where two-way trade is going, or might occur, before it gets there, and where the market will trade to next?
Lewis: I would look at old tops, old highs. But it comes down to this. Once it breaks out, the people that were wrong are getting out, and the people who didn’t get in during the consolidation time are jumping into the market, and what happens is they force it to the next level. And when it gets to the next level,you’ve got the people who were right cashing out. Then the new people are saying,”It broke out of that range, so I’m going to get long here.”
The last time we got together (Oct. 5-6, at TradingMarkets2001 at the Venetian in Las Vegas), you might remember I asked everybody in the room to raise their hand about what they thought would happen because of the(9/11 terrorist) bombing; Is the market going up or going down? Remember about a third thought it was going up, another third thought it was going down, and the other third had no opinion. Well, now you know why markets move.
Marc: I think all traders ask themselves what’s going to happen when the spooz or any market approaches a key zone or level. When you’re looking at potentially “key” zones that you determine in your morning meetings or zones that you let members know about intraday on TradingMarkets.com, these zones, what do you look for (what market dynamics) to determine if it is going to break through or hold at a certain zone? On the floor, you may be able to see this more readily with the pit heating up, with volume and order flow coming in, basically defining the move in one direction through a key level. How can you see that when you screen trade?Basically, how do you get an edge on whether the market will break through or hold at a key level or not?
Lewis: When it gets to one of our key or major areas, and I haven’t been in the market yet, I basically step back and say, “Where were we? How long did it take us to get there? What time of day is it?” When you get to the end of a journey, you’ve got to be able to look and see where you came from and figure out what’s going to be the next leg of this trip. That’s exactly the way I look at it.
For example, the other day I’m looking at it on that rally — we had a consolidation, we came up, rallied, made highs, and got up and made highs in at1128. Early in the morning, though, on the opening, we opened up between 1114 and1116. The range of the opening range was 1113.70 to 14-half. I sold 14-halfs because we had just come off a big rally from the day before, we had a gap(down) opening, opening up 500 lower (5.00), and I knew we had a big consolidation range between 1005 and 1008.50. And I had resistance up there at1118.50 to 20. I let my opinion influence me. I said I think we’re going to break down to the consolidation area because we’ve had a big move up, and I think this move is going to retrace a little, and we’re going to move back to the1108-1110 area, consolidate there, where I think it will be all right to buy it.
Well it opened up and rallied right to our first resistance area at1118, couldn’t get through and went back to the bottom of the opening range and couldn’t get through the opening range. Went back to 18-half and broke back down to the opening range again. This all happens in the first half-hour of trading.When it consolidated above the opening range, I knew I had to get out, and I did.
Marc: How long did it take to bail on that position? When did you decide to get out of your short at 1114.50?
Lewis: After we failed the second time; after we failed to go back through that opening range again. When we broke through that 1120 level, the rest of the day it rallied and made a high at 1128. And it didn’t sell-off until the close.
That was a bad trade, and I’ll tell you why. I was basically sitting in the middle of two consolidation ranges. Here I was at 14-half, and we have strong resistance at 1118 to 20 and strong support from 1108 to 10. Here I am playing in the middle of the frickin’ range.
Marc: Something you just said you choose not to do if you can avoid it.
Lewis: Right, but I did it. Twenty years I’ve been doing this, and I did it.
Marc: One of the things you say in your book is that each time you trade,you are weighing the success and/or failure of your plan (p. 50). Markets change; they are evolutionary beasts, similar to humans. At what point do you say your trading plan no longer works and create a new trading plan?
Lewis: Are we talking in a daytrade or in an overall scope?
Marc: However you want to answer it.
Lewis: Well, right now I think people are going to start reevaluating their plans because I think for the past two years people have been selling highs,looking for retracements. I think the evaluation of your trading plan is a constant process that has to be done every day. It’s done every day. It’s going to be based on your success, what works for you.
Marc: How does that tie in to the notion of following the discipline of your trading plan, if it is changing every day?
Lewis: My overall plan is I’m gonna buy low and sell high. That’s my overall plan. Whether I’m trading from the short side or the long side, that’s my plan.There are some traders that only feel comfortable trading from the long side, or only feel comfortable trading from the short side. If you know that’s your personality, you have to find what your comfort zone is. You may miss out on a lot of other trades, but the point is if you only take the ones you’re comfortable with and you feel you can manage, you’ll be ahead of the game.Because if you get into the ones you’re not comfortable with,you’ll start making irrational decisions.
Marc: What about intraday? How do you go about creating a new trading plan intraday?
Lewis: It would have to be based on market dynamics. Different days might require a different trading plans. For example, today (Friday, Nov. 9, 2001), and last Friday (Nov. 2, 2001), and the Friday before that (Oct. 26, 2001), have had real quick moves between 8:30 (a.m. CT) and 9:30, and if you haven’t caught that move, the market has spent the rest of the day in very small consolidating trading ranges. So there is a plan right there. If I haven’t made my money by 9:45, I missed that move, and I just better forget about trading the rest of the damn Friday. That sounds like, “What kind of advice is that –don’t trade.” But sometimes that’s the best advice. Don’t trade when you’ve seen a pattern of low-volume consolidation and no interest in the market on Friday afternoon.
The nice thing about being a trader is you have a whole array of plans. You have to be able to execute the plan that the market is dictating. People say,”How do you do that?” Look. Marc, you’ve been on the floor with me(click hereto read the article). You walked in and saw what we had. That day we happened to peg the market absolutely perfect.
Marc: Definitely.
Lewis: If I would have gotten short and had gotten my stop stopped out, I would have had to re-evaluate what I was going to do for the rest of day. I’d have to step back and say, “Ok, this didn’t work. Why didn’t it work? Where is the market now, and where could it go from here?” I think that that is crucialthat people don’t do that. They tend to stick with the plan because it is very unnatural for them to take a loss.
Marc: Definitely.That is a difficult thing for some people to do that on the fly. In your book, one of the quotes you use in relation to an element of successful trading, or success in any entrepreneurial venture, is the capacity to”conceive, develop and merchandise a plan, an idea, a new trading strategy.”That can be difficult, to determine a new plan mid-stream.
Lewis: Right. And in business, most people are used to putting a plan together, doing studies — very methodically — working out every detail of that plan. It is the same thing with trading, except your plan gets executed in fast forward. Trading is like watching a movie in fast forward. When you’re wrong,it’s like fast forward. When you’re right, it’s like normal speed. And when you’re trading in markets that aren’t moving, it’s like playing it in slow motion. When you’re right on in your trading, and everything’s going according to your plan, it’s like sitting down and watching a feature — everything flows.The market hits where you expect it to.
It’s almost like being a pro golfer.They tell these pro golfers all the time, “You gotta envision the shot, getup there, make your swing, and the ball should go where you envision it.” Your vision should be determined by your technical analysis. And you should envision what the market is gong to do. And you should adjust you plan according to good research, experience and knowing you have the ability to alter the plan. Even if you get stopped out, that’s really going according to your plan.
Marc: That’s right.
Lewis: Because what you’re saying is if the market reaches this level, this is the part where I would bail because my anticipation of the market was wrong.
Marc: And at that point, you would potentially shift your plan. Because it says, in part, that part of the conception and development of my plan was wrong.
Lewis: Well, part of my plan was wrong — I got stopped out. Now, what do I want to do? Do I want to stop and reverse and use my point of entry as a new stop? There is a conceived plan, if I’m playing this as a support area and it doesn’t work and I get stopped out. And now the market stays onto that area, and it tries to get back above it, and it can’t. Then maybe it’s time for me to short it and use that old entry level of mine just above it as a point to stop me out on the upside. Now that tends to be kind of risky because people get whipsawed. They get whipsawed when they trade consolidation ranges.
Marc: One of the other things you spell out in the book is how you use primary technical indicators like moving averages. And you use them in ways that I find more satisfying than, say, a moving average crossover technique. For instance, you say, (in an up trend) “the farther the market is above any moving average, the less likely it is to break below it on the first attempt.” Now that’s a valuable market dynamic. You relate this to”distance/energy” analysis, applied to moving averages. Would you like to expand on that?
Lewis: I think the other aspect of that is not only how far it is from the average, but how long it has been above it or below it. If you equate the time factor in there, you’ll realize that the longer time it’s spent above the average and the longer time it’s spent below it will impact the move when it moves through the average. Ninety eight percent of most stock traders love to play the 50- and 200-day moving averages. Everybody knows that. So when a stock approaches those moving averages, that’s when market activity increases.Everyone keys off them. That’s when everybody’s opinions are made. This is the time when it’s going through the roof. “It’s worked four times in the past.I gotta buy it.”
Marc: So the longer time it has been away from the moving average, the more difficult it is to go through, like with price?
Lewis: I think it is just the opposite. Here’s the way I like to see it. Intraday, it can dip below it. But I want to see a confirmed close above it or below it.
Marc: So if you’re expecting a breakdown, you want to see a close below it; and if you’re expecting a breakout, you want to see a close above it?
Lewis: Right. When you get a confirmed close below it, say, after six months or a year. That’s when the energy on the downside will continue.
Marc: You mentioned in your last book TheDayTrader, From The Pit To The PC, that you bought the Gann material. Do you use a conversion factor for the S&Ps?
Lewis: No. We use a smoothing factor for time. When you’re talking about time, is it an 8:30 to 3:15 (CT) market, or is it a 24-hour market now? You have to use some smoothing factors because of volume. It’s ironic, though, when you look at the night volume and the night ranges, they usually have a high and a low near two points that have been heavily traded areas — they go there and test them again..
Marc: You had Maury Kravitz on last night in a livewebcast. Maury Kravitz is a major veteran trader from back in the time when the Chicago Mercantile Exchange was the Egg and Butter Exchange and also traded onions. At one time, Maury had the biggest deck — that is, did the most volume — of any broker in the Chicago Merc’s gold pit. The guy is something of a legend. You describe Maury as your mentor in the commodities markets, someone whom you apprenticed for. Besides discipline, which you guys are both huge on, what are some of the specific actual trading techniques or keys that Maury taught you that you still use today?
Lewis: Maury is a guy who got me into the idea of being very well prepared technically. He used to sit up there, before computers, doing his charts by hand.He had this thing about the 60-day moving average (simple) for the S&P index. He’d say, “Lewis, this is a big average when it gets over the60-day.” Maury is the one who said, “Look, when you get a confirmed close above or below this, you get your biggest moves.” He did some historical studies.
And I think that from being a young guy sitting in an arena, flinging numbers around, taking advantage of market gyrations, the biggest thing I learned from Maury was one, try to understand that fundamentals control your environment. Try to become in tune with them. And then base your trading decisions on the environmental situations. I thought most guys just went to work every day. And I think to this day, most of the guys that are floor traders are very bad technicians. Very few of them spend the time to actually find out where the market is and where the market is going to go. They’re in there trying to take advantage of temporary market gyrations — when the market is thrown out of equilibrium by institutional people and retail people putting orders in. So, I think the biggest thing I learned from him is being prepared and trying to understand what makes the market move.
Marc: Markets change. In recent years, are there any specific things that Maury has shared with you?
Lewis: You know, Maury is kind of retired from the business, and he’s been chasing Genghis Khan. Actually, he came in and looked at what we are doing with our trading systems and said, “Lewis, you have far surpassed me in any thing I ever developed.” That man is one of the smartest men I know. And the gold market is his baby. Most people don’t get it when he says gold is a demand product only.
Marc: Which do you think are the most opportune times of the day, week, month or year to trade and why?
Lewis: Definitely the first hour-and-a-half to two hours and the last hour-and-a-half.
Marc: And for days, Fridays?
Lewis: Friday, it depends. Fridays before a big holiday, you want to trade early in the morning. And then the best movement days? The day before a big number. It used to be the day of the number. But people are flattening out the day before. That’s why you’ll see volatility on the Thursday before unemployment(the report).
Marc: Or the Monday before the Tuesday Fed meeting.
Lewis: Well, no. That’s one exception. But the Thursday or Friday before a Tuesday Fed meeting is very volatile. Here’s an interesting point. We had a Fed meeting on Tuesday (Nov. 6, 2001). If you’ve come from a big move… Here’s an example. The week before the Fed we had had a low of 1053. On the Thursday before (Nov. 1, 2001), we tested 1055 for the last time and closed the week up at1090-something. So, we had a 3000 point (30.00) rally from the bottom. The reason being, the shorts gave up and 1055 had been tested before. Because we failed down at the 1055 level three times, the shorts gave up before the weekend,before the Fed meeting, and flattened out. People were talking about time.They’re saying, “We’re running out of time for this market to go through the lows,and we got Greenspan coming, and we know he’s going to do another 50 basis points.”
It’s very simple. Just think if it were you or if you’re a fund manager.You’ve got somebody who potentially can hurt you with a comment. So the market bottomed out.
Marc: And what about the best or worst times to trade on a yearly basis?
Lewis: I can tell you the worst time for me to trade as a trader is during the rollover. Because that two- to three-week period, the front month and the back month, the volume between the two starts to get distorted. So, you don’t actually see the order flow. Plus, you have options expiration with people laying off positions.
Marc: That’s where you’ll cut back on your trading?
Lewis: That’s when I’ll take my vacations!
Marc: Interestingly, your mentor, Maury Kravitz, has been studying Genghis Khan for the past 40 years, and it appears he may have found the long-searched-for tomb in Mongolia of one of history’s greatest conquerors. Khan and the Moguls conquered two-thirds of the world. Your friendship with Maury, one of the world’s authorities on Khan, might give you a special insight. Do you think there is a similarity between great traders and Genghis Khan, and how do you think Khan would have done trading in the pit? He could not succeed if he killed everyone!
Lewis: (Laughing) I said that to him, that I don’t know if I could make money being the only trader in the pit. I would say that Genghis Khan was aggressive and disciplined. He had to be to be the conqueror that he was. And he probably was a disciplined person.
One of the things I look for when I’m recruiting traders is a very well-rounded person who has been an achiever either athletically or intellectually, but well-rounded. I don’t go for somebody that graduates number one in their class at Harvard. Engineers do not make great traders. You can’t say, “Do this, this, and this, and here is the end result.” But people who understand that along the way, that there are going to be bumps, that you have to adjust to the bumps in the road, those are the people who will end up becoming good traders. You have to understand that and havediscipline and understand that everything doesn’t always go right, but that whenthings don’t go right, it isn’t the end of the world. Then you have to have thestrength to go on and make a new decision. People who tend to be high achieversdon’t like the idea of being wrong. And when they get caught up in that, theydon’t like the idea they did not pick the area in the market that wasn’t theexact bottom or wasn’t the exact top. I look for people who are well-rounded,disciplined people. Genghis Khan was probably like that, and not a one-waythinker.
Marc: Finally, what’s changed, if anything, in your thinking abouttrading over the past 18 months, the greatest bear market of our generation?
Lewis: The biggest thing that’s changed — I have to go back more than 18months. The biggest thing that’s impacted the trading world over the last fouryears is the computer — Internet access, heightened anticipation andparticipation from the American public at large. The world has now becometraders. I think that is the biggest thing: market participation. In my opinion,if you think the last market surge we saw on the upside was big, the next onewill make that one look miniscule.
Losing money in trading is like a woman giving birth to a child. When my wifegave birth to our first child, I said she’ll never want to do this again. After,as we were talking, the doctor said, “There is a hormone that is secretedafter the childbirth that kind of blocks the memory of the pain.” And thenthe pleasure of having the baby and raising the child and then the maternalinstincts take over, that’s what allows one to say we’re going to have morekids, more children. Well, the moment the market starts performing on the upsideand people start making money again, they forget about all thepain.
Learn More About Lewis Borsellino’s Strategies & Methodologies.