Trading equities for a living can be a tough endeavor. Tougher than most people think it is.
That is why we at Investing Thesis have long been intrigued and curious to interview an independent professional trader. We got that chance a couple of weeks ago, when a Vancouver based trader we contacted graciously accepted our proposal to do an interview. Some of you might be familiar with this trader as he also is quite the prolific blogger. The tagline for his blog ‘Zentrader‘ happens to be ‘mastering the markets with quiet fortitude and inner calm.’ If you are wondering about the ethos behind that tagline, we trust that you will get a better sense after reading the interview.
Jeff Pierce happens to be the blogger behind ZenTrader. He also happens to be a professional equity trader. (It’s probably apt to mention that Jeff is a trader first and blogger second) Jeff has racked up an impressive track record as evidenced by Covestor, a website that allows investors to automatically import all of their trades and holdings and keeps detailed performance and risk metrics on portfolios. Jeff tracks his performance against the Russell 2000 index (read on to find out why) and has averaged an annualized 17.74% since inception in June of 2008 compared to a miserable -1.23% return for the Russell 2000 for the same period.
Jeff’s take on trading and life are non-conventional to say the least and in the interview you’ll find out his sources of inspiration and the path that led him to be the successful trader that he is today. For starters, Jeff watches no television. Well, he might on occasion catch a show or two online but he doesn’t subscribe to cable. The reason stems from wanting to stay free of outside influence, especially when it comes to trading. He tries to avoid being swayed by news as that is how biases creep in, he says. He reckons he just needs to watch the reaction follow through in the price action.
Jeff also mentions that he mainly trades U.S. equities as the data provider he uses for his proprietary system doesn’t update Canadian quotes in real time. Furthermore, his broker doesn’t allow Canadian trades on U.S. holidays. So even if it’s not a holiday in Canada, he cant buy or sell a Canadian stock on a U.S. holiday.
When asked for a trade he might recommend to others, Jeff pointed to the Barclays iShares 20+ Year Treasury Bond Fund, trading under the symbol ‘TLT’ on the NYSE. Jeff reckons, despite the recent breather that TLT has taken, that the ETF will eventually end up in the $150+ area before the ” bond bubble” pops. For more, we recommend reading a post Jeff recently wrote on this idea entitled ‘Bond Bubble Not Over‘.
If you like what you read, Jeff mentioned that he is getting ready to utilize a function on Covestor, whereby he is going to allow people to mirror his trades and get paid a percentage of the performance. If this is something that interests you, we would recommend visiting Jeff’s blog and maybe sending him an email at: tradewithzen (at) gmail.com
Now, without further ado …
Q: Jeff, why don’t you start by telling us how you got started trading equities?
A: Ok, how I got started. Well, I didn’t know anything about the stock market. And I had tried different things to make money and I thought, why not the stock market? In high school I think everybody has that economics class where you do stock market for a week. You buy something and you track it. So that was my first exposure. And then I kind of forgot about it.
After I graduated, I had saved up some money and just started watching a television show by the name of Money Line hosted by Lou Dobbs on CNN. I started watching him and I subscribed to a couple newsletters at the time. One was a fundamental and one was technical. And I would try to look at what they were buying and the rationale and then I would try and trade around that position. And I really discovered that I was more of a technical trader then because two of my worst trades of all time occurred within my first couple years of trading. One was a stock by the name of Waste Management and it was a fundamental play. They were having accounting problems and I got stuck in this trade. Another one was Rite Aid which is a pharmacy. And after some really bad experiences with fundamental stocks, I was like ‘enough with that’. Consequently, I really gravitated more towards tech, NASDAQ stocks, because those are really the real leaders in the market. So those are the ones that are really giving you signals as to the health of the market. In my opinion, tech will always lead. That’s why I really only pay attention to the NASDAQ. Yeah, I’ll note, when maybe the Dow is outperforming the NASDAQ on certain times. But for the most part, the NASDAQ is always what I pay attention to. So, it was more or less a progression just through general reading and watching television, to newsletters, to Investor’s Business Daily. I really got a good education from them. Yeah, I don’t think you can get it here in Canada, only online. But I mean, it’s a daily newspaper, so I’d always be reading and that really got me into technical analysis and kind of the know. They talk about some fundamental stuff, but it got me into that. But the thing that really convinced me and sold me on technical investing, or technical trading, is earnings. How many times have you seen company report stellar earnings, you know record, and then the stock bombs? And vice versa, pitiful earnings and then the stock goes up. And I just thought to myself, ‘what’s the point of going through all this fundamental stuff’. Use the charts, and the charts really do tell you, they tell you what’s going on, when stocks are topping and when they’re bottoming. So, after Investor’s Business Daily, being a trader, it’s just a progression, it just continues. And I’m still learning.
Q: When you first started trading, were you successful, not successful?
A: Well, when I started out it was at the end of ’98, in November. My first trade was Iomega. I made like $380 in half an hour. No, like three and a half hours. And I was hooked. So yeah, my first couple years I did really well. I had really high percentage returns. And then when the bubble burst, I gave a lot of it back. I gave a lot of it back and I actually questioned whether or not I even wanted to trade, because it was just brutal. But you step back and you look at what you’re doing and you look at what’s not working and then you change your strategy. And I survived that. So good years after that. Because I actually learned how to short at that time. Whereas before that, number one, I didn’t even know shorting really existed, number two, there was no need. You know what I mean? Nobody was shorting anything. So I had to develop a whole strategy in that whole area.
Q: Other than the shorting, did you actually change the any of the technical indicators that you looked at?
A: You have to. And this is something too that I have discovered, this could be different for other people. You’d think that if you find something that works in the long side in terms of a certain look of the chart, certain indicators hitting certain areas, kind of maybe ‘sweet spots’ if you want to call them, you’d think logically you could just flip it and it would work. But it doesn’t work, and here’s why. It’s because there are two different emotions that are driving each. Greed when stocks go up, and fear when they go down. And they act completely different in the charts. Fear happens much quicker. And so that’s why when stocks drop, they drop fast. They drop so fast often times it doesn’t give investors an opportunity to get involved in the trade. And so what happens is they feel like they’ve missed out. So then after the stocks already dropped a lot, they get in and then there’s a bounce up and then they get scared again and they sell, and then it goes down more, you know what I mean? So you really have to develop completely different strategies for shorting, not just take and flip what you do when you go long. It’s that emotion that’s different.
Q: That brings me to my next question, Jeff, which is are you a discretionary trader, or a mechanical trader?
A: A little of both, and here’s why… I just finished ‘Trend Following
‘ by Michael Covel for the second time. I get a lot out of the second time I read books. ‘Trading in the Zone
‘ - great book on psychology. The first time I read it, I was like ‘what’s the big deal’. You know, I put it back on my shelf and I’m like ‘I don’t see anything’. But the second time around, like a year later, I picked it up and I was like ‘Ahh’. I learned I was normal. Not the same thing with ‘Trend Following‘. I found it interesting the first time. But the second time I found myself highlighting a lot more. There were a lot of really good nuggets in there. I have a system that tells me when to be long, when to be short, when to be in cash. That’s the mechanical system of my trading. The discretionary bit comes into maybe when to trim and when to add within that system.
Q: You mean discretion plays a role when you are deciding the size of positions to take …?
A: Yes. Position sizing, exactly. Because a lot of people have found this market to be very difficult to trade. I’ve been having a completely different experience, ever since April when I really, really started really using this strategy that I’ve developed. I think what has really given me a lot of success is the ability to be quick in taking profits. I think a lot of people, they want to time the total position. Instead of trimming out, they’ll just sell it all. And often times a couple things will happen, they’ll sell it and the stock will keep going in the direction of the trend they were in and they’ll get frustrated, and they think they should probably get back in, and that’s just bad. But if you have a profit, trim some of it and then set a stop at your original position. And then what happens is if it keeps going, well that’s good because you still have some. But if it reverses and hits your stop, it keeps you sane. Yeah, it sucks that your position got stopped out, but you cashed out on maybe half your position already. I think so many people, they don’t do that. And I really think that it keeps you mentally in the game. Because again, that’s what trading boils down to. You really are only as good as your last three trades. If you’re last three trades have been not good, then you start to question. You don’t pull the trigger, and then you missed out on another trade.
Q: Just a follow-up a little bit on position sizing. Do you want to get into that a bit? Say your market tells you to go long or short, say for example you find candidates to go long and short, how do you decide how much to allocate to your positions?
A: Well, it really depends on how much you want to lose, how much you’re willing to risk. Well, one way I do is if I want to put say $10,000 into a position, and I want to risk say $500 on that particular trade. So if I’m buying long, and the stock breaks out, and I’m looking to buy it on a pull-back, I will figure out what area. So lets say it breaks out and it’s at $20 per share, and the break-out was like at $19, I’ll figure out on the chart what area I will leave, what would be a good risk and when to get in. Then if the stock drops below a certain area, that’s like my exit. So I’ll want to try and buy as close to that area as possible. So basically as the stock is pulling back everyday, if the difference between where the stock is at and lets say I want to buy 1000 shares, where I’m buying at is say $0.50 above my stock, that would be $500. So you always want to know in advance what you’re willing to risk. So many people don’t do that. They don’t even consider it. Now as far as position size, again, because the market has been so choppy, I haven’t been fully invested in a long time. I can’t even, it’s been a long time. And I’ve scaled back my position sizing. I’m actually, I’m slowly starting to increase them as I get more and more comfortable with my system. And that’s another thing, once you develop a system, give it time to prove itself, and then slowly increase your positions. Don’t go from investing $30,000 to say $60,000 in the span of a week because if there’s something that causes your system to go against you, you might give up all your gains. And then you’re all frustrated. But the position sizing really depends on what the overall market is doing as well.
Q: So you don’t have a fixed percentage in mind - like 2% per trade? Is it’s completely discretionary?
A: Yeah. It’s not like I can give you a special formula. Essentially, I’ll just take x amount of my portfolio and when the market is choppy and volatile, I’ll just employ maybe 25% of it total. And I’m slowly starting to edge that up. So again, it’s like I’ve had pretty decent, consistent gains since April. And that’s not even using really more than 25-30% of my cash. It’s like, would you rather have small, consistent gains, or would you rather get eaten up alive in markets like this.
Q: So this mechanical trading program that you’ve created, is it fairly new? What exactly does the system look at?
A: Fairly new, yeah. It’s something that I’ve been working on for a while now, but it’s really just come together this year. I can’t really talk about it. But I’ll say this, it’s not as complicated as it sounds. Well, look at the ‘Trend Following‘, the ‘Turtle Traders
‘, theirs was a simple moving average cross-over. I’m not a big fan of moving average cross-overs because I think they lag quite a bit. But it’s part sentiment. Basically, what I do on my blog is I, whenever it gets a signal, I always share it with my readers. But it’s like if you find something that works, you don’t want it to get out, right? And it’s interesting in that, in the ‘Turtle Traders‘ book that I was just reading, I caught a little quote by somebody, it said, ‘don’t read books, don’t listen to gurus, don’t do it, because anything that they’re saying isn’t necessarily ‘what they’re doing.’ So that’s why I never watch tv.
Q: Is trading is your primary income source? Also, what instruments do you trade?
A: Yeah - trading is my primary income source. As for instruments - I don’t trade FOREX. I don’t understand it. I do trade some options, but not a lot. Probably only makes up maybe only 5% of my total trading. I don’t trade futures either.
Q: So you predominantly trade equities listed on the NASDAQ - yes?
A: Well, it doesn’t have to be. I buy NASDAQ, I buy DOW, I buy companies in the S&P 500. But my system is based on the NASDAQ. You don’t want to follow two, you just want to pick. Like, if you were more of a fundamental trader, I would maybe use the Dow as a benchmark as some kind of a system. Or the S&P. Or even the Russell 2000, I guess. It’s mainly equities and I definitely don’t trade these 2X, 3X leveraged ETFs. The reason being that sometimes you’ll see an index that is being tracking UP, and the ETFs actually DOWN, and some of the guys who actually make these ETFs have come out and said that they don’t track properly. Well, in the course of that day, often times they do. But, let’s say it took a month for an index to go down 10% and you held an ETF that is 2x leveraged - it wouldn’t be down 20%. So, I don’t know. I just don’t like anything that’s rigged. And the leveraged ETFs really reek of a rigged game. Why put yourself at a disadvantage? If you really want exposure and you really want leverage, use options. At least they’re a little more in your favor. The thing about options I’m really not crazy about is the spread. But I mean, if you’re buying options on the market, they’re pretty good. But if you’re buying them on individual stocks, you just have to be mindful of the spreads.
Q: With regards to the system that you use, have you back-tested it?
A: You see, I don’t believe in back-testing. Here’s why, see there was a piece of software called VectorVest. It’s good. It’s a really good piece of software. I learned a lot. That was another part of my education. I don’t use it anymore because it used to be a piece of software that you downloaded and then all you did was you downloaded the feed at night. It was all on your computer, so it was really fast. And then they went to everything with internet base. And I just didn’t like the usability of it. It felt slow and laggy. And I guess maybe I kind of outgrew it. But it’s a phenomenal tool. It’s got good scanning capabilities. They have proprietary indicators that they use. I guess my biggest problem is, if I was going to use their system, then I am reliant on them being in my business forever. Because their market timing and their relative strength and their relative value are all proprietary. But it’s a great piece of software, and I do recommend it. It’s a little pricey per month. Where was I going with that?
Back-testing …
Back testing, yes. It’s a fun tool. You can develop a scan, plug in your parameters, and then pick dates and do an ‘okay, if I bought the top ten stocks for this scan between these dates, what would my result be?’ The reason why back-testing doesn’t work is because the same set of circumstances are never the same. So if you determined, lets say you have a system that you can actually quantify, this date between this date the market was in a down trend. And then a year later, this date between this date the market was in a down trend. So I want to take this system, I want to take this scan, and I want to get the top ten results of this scan and I want to know how those ten fared between this date and that date. And lets say you were short, and lets say that you yielded like a 10% return on the short side. Well the same thing for this one, there’s just so many different variables that you have to consider, you know what I mean? And it’s not as simplistic as saying ‘okay’ because the government could come in and do something. And that’s another thing that really made me mad in ’08 is when the government started really getting involved in and basically changing the game, this and that, and making it illegal to short certain stocks. And coming in with all their quantitative easing. ’08 was a difficult year. We had a market bottom then. I just don’t think back-testing is, in that sense, really accurate.
Jeff further elaborates on back-testing in a recent post on his blog ‘Backtesting Day Trading Strategies‘
Q: To follow it up, how would you know if your system ever stopped working?
A: Well, because it gives very specific times to get in and get out. So basically, I guess I’ll cross that bridge when I come to it. But I feel pretty confident that the signals that it gives. Despite the choppiness of the last few months it’s been very, very accurate. There hasn’t even been like a nice long trend. And if my system works in this kind of market, it’s going to work even better in a long-trending market. I guess I don’t have a really good answer for how would I know. But that’s where also some discretionary. I’ve had the opportunity now to live through the bubble and the crash. So your eye gets trained to see different things. And I read somewhere that it really takes 10 years to really grasp everything you need to as a trader. I don’t know how many hours per year that would be. And you really have to live through some different scenarios. Because I remember when the market was collapsing in late 2008, I was actually either short or in cash. So when the market was collapsing, it was fascinating to watch because I wasn’t under this pressure. I wasn’t stressed. It was so fascinating to watch from a completely detached, completely emotionless point of view. So okay, getting back to your question, I kind of want to try and answer it. Remember when we had the flash crash? Per my system for about, I think it happened on a Wednesday or a Thursday, and my system got me short on Friday. And then I think what really makes my system effective is the discretionary taking the profits part of it.
Q: Since you don’t want to talk about the specific of your proprietary system, what about the discretionary part?
A: I use Bollinger Bands a lot for profit taking. Well there’s a couple different ways I take profits. Individual stocks, if you have a 10% gain, you better be taking some money off the table, at least half of your position. Too many times I’ve done it, I’ve been guilty. But if you let a 10% gain on your stocks evaporate and go negative, you know what that does to you? It crushes you mentally. So again, take some profits on your individual stocks. But once I have, so once my system initiates a buy, and this is something that I’ve been doing differently because this market has been really choppy, I’ve been trading a lot of ETFs. This is not normal for me. But this is another way that I’ve adapted to the changing market environment. See, I prefer to be researching momentum stocks and finding small caps that really look like they could go on a big run. But we haven’t had a long trend for these kinds of stocks to really develop. So I’m looking forward to a really good trending market. But we just haven’t had that. So you have to adapt to what the market is doing. I guess that’s really why I’ve been buying ETFs.
Q: Can you talk about a recent winner and loser?
A: So, I can’t even answer that right now because all of my gains over the last four months, five months, have been kind of to take a little bit out of the market 1-2% a day. I haven’t had a losing position since sometime before March 2010. So that’s a good thing. But I haven’t hit any home-runs either. Because I’ve really been staying away from individual stocks because they have been very volatile. So I’m just not comfortable owning individual names right now because we haven’t had a steady trend.
Q: So your system tells you when to get in or out of the overall equity markets?
A: Yes, my system tell me when to be long, short or when to be in cash. My approach to the market is top down. Market first and then specific stocks or ETFs. What I do is when I get a signal either way, I always wait another day to confirm it. That’s just a little tweak that I’ve added. When I get a long signal, I won’t get long right away. But what I do is I start to look at my individual long scans. My whole trading platform/system, is based around this one piece of software – StrategyDesk by TD Ameritrade. The reason why I do that is because it’s not proprietary in any way. There are other software pieces out there. I think MetaStock is one. I think there’s one called Equis. Basically if TD American shut down software, I could go somewhere else and recreate it. Essentially what it does is that it allows for me to have different watch lists each with a different track, set alerts, create scans that run throughout the day. So you don’t actually have to go in and run them like you do with Stockcharts. They just will run throughout the day and if certain criteria are met an alert pops up. It’s just a phenomenal tool. It resembles an Excel spreadsheet.
So I don’t sit in front of my computer all day. Like I used to. I used to have this need to stay in front of my computer. I was afraid I was going to miss something. But I don’t really have that anymore. There’s a lot of tools now that are available to really automate a lot of things.
So once my system triggers a long, then I’ll start paying attention to my long scan looking for some results to show up because without fail, the day that I get a long signal in the markets, I don’t get any results on my scans. Because they’re so oversold. So what that does is, lets say on Monday I get a bullish signal, I’m going to start looking for longs. I might not get any long candidates on Monday. And then lets say I’m not getting any results for three days, lets say the market reverses on the fourth day and starts to head lower. It keeps me out of the market. Instead of getting heavily invested in the long side on the day of the signal and then finding myself underwater in these positions, it gives me a little bit of cushion. So the market has to prove itself with individual stocks on top of my signal.
Q: So what are some of the technical indicators that you use? You mentioned RSI …
A: Yes. I use RSI, Bollinger Bands and ADX. Those are the three I use. ADX is a directional indicator. It takes a while to really get a feel for this particular indicator because it looks like a mess. I actually avoided it for many, many, many years. And then I came across a trader, a good friend of mine in California, and she really kind of helped me with this particular indicator. And it opened me up to how important this indicator is in terms of trend strength. Now see, this is another thing like your education, you learn from other traders and you kind of take what bits that you like. And you kind of create your own investment style.
I only use MACD in one specific way. For instance, if I’m in a stock long, a lot of the times the MACD will go under the signal line long before it peaks. And basically it’s just a way for it to tell me if the trend is slowing down. So a lot of times, I’ll make sure I’m not in any stocks when the MACD goes negative.
Q: Are there any books, tools, or things that you use?
A: I just use StockCharts, that’s the only thing I pay for. But the books that I recommend are…
There’s only a couple books really that I think, ‘Technical Analysis of Stock Trends by Robert D. Edwards and John Magee
, that’s kind of the Bible of technical analysis. It takes a while to get through it but it’s something that I reference all the time. There’s some really good nuggets of information in there. ‘Trading in the Zone‘ by Mark Douglas, for the psychological part. ‘Reminiscences of a Stock Operator
‘, these are all, they’re classics. ‘The Complete TurtleTrader
‘. Well, two books that might not normally be associated with trading, one is called ‘The Power of Your Subconscious Mind
‘, it’s by Dr. Joseph Murphy. Incredible, incredible book. And another one is ‘A New Earth
‘ by Eckhart Tolle. It’s about your ego. There’s a lot of good nuggets in there that if people could just get over their ego, they could become better traders.
Funny thing is, that I can read just about anything and somehow bring it back to trading. But I remember two summers ago we were vacationing in Okanagan, and I was reading ‘A New Earth‘, and there were so many things in that book that just really, that people need to get outside of themselves and get their ego out of the trading because too many times you’re a product of your last three trades. And if you have three spectacular trades, you start to feel like god. And you start to trade outside your plan and maybe put on too heavy of a position. Nothing good ever comes of that ever.
Q: What would you recommend to people who are new to trading? Do you think people should begin paper trading?
A: In most cases paper trading doesn’t work. What paper trading is good for is maybe testing a strategy. But you have to know that it’s not 100% accurate because there’s no emotions involved. And the emotions are what drives you to hit the sell button or the buy button. Paper trading is an easier way to test something in the now instead of trying to write down where I would have bought. So it’s good that way, but I’m not a big fan of back-testing. You have to develop some kind of strategy and then trade by it. Keep your position sizes really small when you’re testing it because the only way to know if it works is to actually do it. To actually have some kind of real money on the line. And know where you’re going to get out of the trade before you get into it because still today I talk to a lot of people who will get into a trade, they’ll average down, and as a trader you should never do that. Know when the trade is not working out is very important. Had I known that when I was in that Waste Management trade, and that Rite Aid trade, it would have saved me thousands of dollars. That’s so very important. And also have some kind of profit-taking strategy as well. There’s so many things you have got to consider when you buy a trade. You’ve got to know where you’re going to sell for a loss. You’ve got to have a general idea of where you want to take some profits.
I’m very hopeful and I’m very bullish on Canada because of the resources. I do have some Canadian scans that I run looking for some mining stocks that might be on the verge of some major breakouts. But for the most part, there’s just not a lot of volume behind these moves. So it makes it hard to trade because of the spread. So, I’m hopeful that down the road, the volume will come in. Maybe the TSX will get bigger. It might take, when the US, Canada, and Mexico formed their one currency, it might help the growth of the TSX that way.
On that note, after a solid 2 or more hours of conversation, we ended the interview. We want to thank you, Jeff, for being amenable to this interview and would like to wish you the very best with your trading.
Let us know what you thought of this interview in the comments below. Did we ask right questions? Do you have any suggestions that will improve future interviews?
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