Trading and Day-Trading Stocks and ETFs with Dave Steckler
Changing trading styles – from actual strategies to money management – has been a theme with many of the traders we’ve interviewed as part of the Big Saturday Interview over the past several months as the bear market took its toll. And as the markets have turned upward, those themes have remained as traders continue to fight to stay one step ahead of the herd.
Our Big Saturday Interview guest this week, trader Dave Steckler, is a veteran of many markets: from the boom-time 1990s, through the dot-com bust, the low volatility recovery of the Bush years and the most recent market collapse and rally. In this topic-rich conversation, Dave Steckler shares with us his thoughts on why technical traders need to constantly revisit the indicators they rely on and how looking at old indicators in new ways can help traders find edges in stocks and ETFs.
Dave Steckler is an investment advisor at Global Investment Solutions. In 2002 he developed the Alpha Rotation Program (ARP), a long-short market timing system using no-load mutual funds and exchange-traded funds (ETFs). He also trades a portfolio of stocks and ETFs using methods described in this conversation. You can reach Dave Steckler at DSteckler@aol.com
Enjoy!
Managing Risk and the Three-Legged Stool Theory of Trading
Dave Penn: How would you describe your overall approach to trading right now?
Dave Steckler: I define trading a little differently than other people do and of course, you know it means different things to different people anyway. To me trading is not necessarily, “I’m in at 9. I’m out at 10.”
To me the whole philosophy of making money in the markets is a three-legged stool: what to buy, when to buy it, and when to sell it.
First leg: what to buy. There are so many ways to skin that cat. You could use technical analysis. It could be fundamental analysis. It could be a combination of the two, whatever. There is an excellent data mining and analysis software program available that does both: High Growth Stock Investor. I’ve used it for years. It was reviewed not too long ago in TASC (Technical Analysis of Stocks and Commodities) magazine. However you do it, you come up with your watch list and say, “this is what I’m going to buy.”
Next, when am I going to buy it? That to me is answered by technical analysis, whether it’s price crossing a resistance point, whether it’s a time cycle, whatever. Technical analysis tells me when I’m going to buy it. That’s the second leg.
The third leg is the question, when am I going to sell it? That’s where money management comes in. It also matters if the stock is no longer meeting the reasons why you bought it in the first place, etc.
Penn: Yes. That all makes sense.
Steckler: This is true trading because you predefined what you are going to buy and where you’re going to get in, and used money management to determine where you’re going to get out. That money management may include stop losses, trailing losses, scaling in, scaling out, and so on.
The point is that you are managing risk. To me that’s what trading is – as opposed to buy and hold investing or being an income client looking to buy high dividend stocks without much regard to the principle.
Most of those other methodologies don’t deal with risk control. To me that’s what distinguishes trading from everything else. Trading involves risk management. Do that and you’re so much ahead of the game.
Penn: Were you always sensitive to the importance of risk or was that something that was mostly a product of the post-2000 market?
Steckler: Well, I was always a risk manager. Up until 2000 risk management was really more stop losses and things like that because you knew what direction the market was headed. To paraphrase Dave Landry, “follow the big blue arrow.” The big blue arrow was going lower left to upper right.
Penn: Right.
Steckler: When I first got into this business it was drummed into us that “I really don’t know what I’m doing, but this is what the research department says so they must be right.” But back in 1989, when I left the traditional brokerage world and joined an independent firm, I read every book I could get my hands on about TA. This was before there was all the information we have available today on the web. I subscribed to Daily Graphs and received the chart books every weekend, and I pored over hundreds of charts on Sundays. I gravitated to “I don’t care what everybody else is saying because I’m able to read charts, and I know technical analysis, and I’m a believer in risk management.” That’s why I am a trader. It allows me to manage risk consistent with my investment style.
Prior to 2000, risk management was always in my mind. I always designed my systems with risk management in mind, usually through trailing stops. I used the old “when risk equals reward sell part of your position” maxim. Then raise your stop and let the rest of it ride, etc. You could do the same thing with shorting, too, only using a buy stop instead of a sell stop.
Penn: Right.
Steckler: Fortunately, very early on — and this has a lot to do with the books that I had read and the people I had spoken with – I joined the Market Technician’s Association (MTA) in the 90s, and spoke with a few people about risk management. And then in 2004, I joined the American Association of Professional Technical Analysts (AAPTA) and later served as its president. Here was a group of very skilled, in some cases well-known technicians, and they were all saying, “Hey, risk management is important.” Certainly, risk management has a lot more respect today than it did even as recently as ten years ago.
Penn: Yes.
Steckler: I joined that religion early and it helps. I mean, nobody likes getting stopped out half an hour after they bought a position. But you’re sure happy when that thing dropped another 20 percent and you got out with a 3 percent loss or a 4 percent loss.
Trending and Non-trending Markets, Trending and Non-trending Indicators
Penn: We’ve talked about the technical analysis. Can you talk about either particular indicators that you’ve used over the years that you continue to rely on or a particular setup that maybe you could share with us?
Steckler: Sure, I’d be glad to. One of the things that your readers should understand is that the use of an indicator should not be static. By that I mean just because it was used a certain way five years ago, doesn’t mean it would be as effective to use it in the same way today.
Perfect example, 15 years ago, and I mean it’s still written up, is the moving average crossover. A moving average crossover, as you know, is one of the simplest techniques there is. Buy when you’re above a moving average, sell when you’re below a moving average.
Well, back in the days where a 12-point move in the market was newsworthy, you could do that. Today with the very high volatility, with the violent swings in the market, unless you’re using a very long moving average as your crossover, you get whipsawed all over the place.
Does that mean moving average crossover shouldn’t be used? No. It means you have to use them differently.
Penn: I see.
Steckler: One of the techniques, or one of the indicators I should say, that I’ve used for many years and it’s probably my favorite, single indicator – with the caveat that I don’t just rely on one indicator — is stochastics.
All traditional indicators, except volume, are either trending or non-trending indicators. Examples of trending indicators are moving averages. Examples of non-trending indicators, also known as oscillating indicators, are stochastics and RSI.
People always complain, “Oh, I got whipsawed using moving averages.” And they conclude that moving average crossovers are no good.
Well, if you’re repeatedly getting whipsawed, then the market is probably in a non-trending mode. Trending indicators get whipsawed in non-trending markets.
The converse of that is what happens to non-trending indicators in trending markets. You know the standard way of using stochastics or RSI: buy when it’s oversold below 20 or 30 and sell when it’s overbought above 70 or 80?
Penn: Yes.
Steckler: Well, what happens in trending markets? A trader using a non-trending indicator will say, “Geez, this said to sell when the stock was at 10 and the stock went to 18 before it finally rolled over. I guess that indicator is no good.”
What happened was that the stock went into a trending mode and non-trending indicators, as you know, tend to get you in and out too early or too late in trending markets.
You have to use the right analytic techniques at the right time. Use trending indicators in trending markets, oscillating indicators in oscillating markets.
A number of years ago, I was reading a book by an AAPTA colleague of mine, Connie Brown. She wrote the book, Technical Analysis for the Trading Professional,
and in it she writes about using stochastics in ways we normally don’t think to use them.
Stochastics are definitely an oscillating indicator. Traditionally, oversold is 20 or lower and overbought is 80 or higher. So how can it be used in a trending condition? One of the things Connie wrote in her book — I believe she got this from Andrew Cardwell – was that when a stock is trending higher, those overbought, oversold levels might be 40 or 45 on the low side, and 85, 90 on the high side. When the stock is trending lower, it might be 10 to 15 on the oversold and 60 or so, 65 on the overbought. What she was saying is that if you see the stochastic start making lows in the 40s and consistently getting above 80, I bet you that stock is trending higher. So, shift your overbought/oversold levels up.
If you see the stochastic can’t get much above 60, 65 before the stock turns down, and consistently goes below 20, maybe going down to 15 or something, odds are the stock is trending lower. You want to move your overbought/oversold levels lower.
Penn: Interesting.
Steckler: Basically, what Connie was saying was that you want your overbought/oversold levels to be dynamic, not static. To me, this was wonderful. It was the first time I had seen a practical explanation of how to take not only what’s considered an oscillating indicator and use it in trending markets, but also how to turn a static indicator into a dynamic indicator.
Fifteen, twenty years ago, you didn’t need to do that. Markets didn’t switch that fast between trending and non-trending modes. But as the market has changed, so too has the use of the indicators changed. By and large anybody who says, “Such and such indicator doesn’t work anymore,” well, it may not work the way it used to work, but if you look at it differently, interpret it differently, it’s probably useable again.
Trading Strategies with Stocks and the Stochastic
Steckler: To get back to the question you asked, what are the methods or indicators I like to use? I like to use the stochastic. And now we’ve seen how I’m able to use it in both trending and non-trending markets.
Now, I’ve been doing this for a very long time. I’ve looked at literally tens of thousands of charts in my career. I can look at a price chart and after just a moment I can tell if it’s trending or non-trending.
Penn: Right.
Steckler: So how can someone tell if they don’t have this experience? Indicator number two I rely on is the ADX. ADX, as you know, measures the strength but not the direction of a trend. If Stock A is rising at a 45° angle and Stock B is declining at a 45° angle, over the same time period, they’ll have the same ADX value.
One of the things I observed is that we know when a market has “non-trended long enough,” maybe narrowing into an NR 7 pattern (narrowest range of seven periods), it will begin trending again. The longer it non-trends, the stronger the move will be when it begins trending again.
Penn: Right.
Steckler: Here’s where the ADX helps. What I found is when the ADX is above 25, especially above 30, and rising, the stock is trending. Direction doesn’t matter. It’s trending. When it’s below 25, and falling, the trend is losing strength. When the ADX is below 20, particularly when it gets to 15 or lower, it has non-trended long enough. Look for a new trend to emerge.
Now, if the ADX gets this low, obviously we’re non-trending. So use the stochastic in the conventional mode, the conventional technical analysis mode: oversold/overbought at 20/80, 30/70, whatever the trader is comfortable with. You can look for bullish divergences in the stochastic, as well.
Penn: Sure.
Steckler: The ADX is very low. Maybe we look at the chart from a pattern recognition perspective. If the ADX is that low then obviously the stock is trending sideways. Is it trading in a rectangular base? A triangle? Wait for the breakout.
Next point — and you see this more frequently than you might think — is that a lot of times, you can have a very low ADX and you’ll have a stochastic of 75 or something like that. You might think that this means that market is probably going to break out to the downside. After all, the stochastic is high in overbought territory at a low ADX, wouldn’t that mean the trend should reemerge down? No. Not always. It could be setting up for a stochastic pop.
Back in August 2000 I wrote an article for TASC on the topic of Stochastic Pops. I also wrote a version of the article for the MTA newsletter.
I identify a Stochastic Pop setup when the following set of conditions occur:
1) Recent price action in a tight daily consolidation range;
2) Daily ADX below 20 (preferably below 15);
3) Daily stochastic %K above 70 (preferably above 80) and rising;
4) Weekly stochastic %K above 50 and rising;
5) Stock breakout on above average volume; and
6) Bullish market conditions.
The Stochastic Pop is not a new technical indicator or technique. Jake Bernstein wrote about this phenomenon years ago. The setup conditions I added are refinements that increase the odds of success by requiring confirming signals from both the daily average directional index (ADX) and weekly stochastic signals.
Penn: Fascinating. I really like that strategy with the stochastic.
Steckler: I use it with stocks. I’ve got a portfolio that I use for swing-trading equities. I also have a mutual fund portfolio that I use with Rydex funds, using a methodology I designed so I can go long or short. This was before there was all the inverse market ETFs there are today. But given the very high volatility in the past eight or nine months, by and large, I’ve traded almost nothing but ETFs in the equity portfolio. That is the ETF day-trading methodology that we can discuss next if you want.
Be sure to visit TradingMarkets next weekend for Part 2 of our Big Saturday Interview with Dave Steckler as he shows us his innovative strategy for day-trading ETFs.
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