Links mentioned: OSOKTrading.com | Eurexchange.com

Tim Bourquin: Hi. Tim Bourquin here. Thanks for joining me on traderinterviews.com. We're going to be speaking with John Netto. John has been a guest many times on the show before and also a speaker at all kinds of conferences around. He's a trader's trainer, also a heck of a poker player, and a sports handicapper for ESPN there in Vegas. A lot of times he could kind of correlate to and talk about those. We're going to talk about a few different things today that are on John's mind. So, John, thanks very much for joining me on the phone today.

John Netto: Tim, it's so wonderful to be here and thanks for having me. I look forward to doing these interviews. You're doing a wonderful service in providing, you know, new insights and ideas from traders around the world.

Tim Bourquin: Thanks. I appreciate that, John. Well, now you're one of these guys that has a very kind of specific way that you approach the markets and the way you think about the markets. So for somebody who hasn't heard you talk about that, can you just describe your overall philosophy about trading for us?

John Netto: Sure. I think that trading comes down to identifying spots of value, letting the law of large numbers plod in your favor and then managing the risk accordingly. And so for me my philosophy when it comes to defining value can be had in a number of ways. We have the basic -- you know, one very specific in terms of -- the idea that I like to find for the markets in terms of, you know, very defined plan while still incorporated in the fluid nature of them, I also understand a number of the qualitative aspects of trading as well. And so an example would be -- like the basis of my main methodology is to buy weakness in rising markets, sell strengths in falling markets and take profits in predetermined price points or provide liquidity on the side of the trend. And as our liquidity provided which is what, you know, all my strategies are derived from, I like to use components of being a buy-side trader with compulsive being sell-side liquidity provider and combine those two together to make a strategy.

Tim Bourquin: All right. Now, for a lot of people when they hear provide liquidity to the markets, they think you're buying on the bid and that's what you're doing. What does it mean though to provide liquidity to the markets?

John Netto: I define providing liquidity to markets as fading short-term sentiments, okay, or when there's a need for one side of the market. If I can provide liquidity and take that side of that position and it matches up with all of my technical specifications, that's the ideal situation that I like to take on.

Tim Bourquin: All right. And lately you've been talking -- and you've written some articles about spread trading. Talk about how that has influenced your trading as well.

John Netto: Sure. You know, spread trading is the process of simultaneously buying one leg and short in the other. It can either be two or more legs. It's something at the Eurex exchange, an exchange which has done a lot of great stuff in terms of educating traders out there, you know, commissioned me and has worked with me to teach traders about some of the strategies. And so in essence some of the benefits of spread trading are I can -- you know, whether the markets are going to go up or down one day is a question on to itself but identifying components of the market which may outperform or underperform is not that a lot of people are good at and spread trading allows you to take advantage of that. So I think today it's not just the market is going to go up or down but I may think that the NASDAQ is stronger than the S&P or it may seem that, you know, some of the -- the Europe is be stronger than US. If that's the case I can go long Europe or long The Dow Jones EURO STOXX 50 and I can go short the S&P but I think that Europe will outperform. Conversely, as we saw, you know, during the meltdown of 2008, if I can get a lot of -- you know, dollars are being repatriated in equities while they may underperform in the US and they may be down in the US compared to around the world, I make it long the S&P and short the EURO STOXX 50. So even though the S&P may fall 3% that day, the EURO STOXX 50 may fall 3.2%. And when you take out currency, I actually end up with a very nice gain at net. So spread trading allows you to make money even if you're not right on overall market direction.

Tim Bourquin: So talk about how you figure out which markets would be not correlating to themselves or correlating in opposite directions to know which ones to buy and sell.

John Netto: Sure. First of all, if they're going to spread trade, there's a couple of -- you could spread through a highly correlated markets or, you know, obviously, with everything else, the more risk, the more award. You could step back and trade less correlated market. So a highly correlated spread would be, you know, The Dow Jones EURO STOXX 50 versus The DAX, okay. They both encompass European equity. They both are nominated in Euros so there's no currency risk there. I can, you know, the two have a historical correlation that's pretty strong north of 95%. And as a result of that, if those two spreads deviate, they may present some opportunities there and so as well to that okay. So correlation is the first key component. Second, like I talked to you about is currency. You know, having a spread in currency alleviates some of the currency risks that can come if you spread other products. Third thing is well -- is like an ebb and flow. So with spread trading there are mean reversion strategies. Meaning that if there's a high correlation, that correlation diverges, you play a strategy that they will, you know, come back in line again so that's more, you know, a value proposition. And also trend following strategies as well. You take a look at the crude curve, all right. You know, the energy markets, some of the agricultural markets and when you see crude trend in higher, I mean this isn't always the case clearly but when crude was rallying like it was in late 2007 or early 2008, we had what's called the backwardation dynamic. Meaning that, you know, the price of front month crude contract was actually priced higher than the back month crude contracts. This, you know, was a very tell-tale sign of the dynamic that was in play when crude got as high as $145 a barrel. Whereas, when crude topped out and started to head south, we went all the way back down the, you know, south of $30 a barrel. We had a huge dynamic or a steepening curve. Meaning it's like front month crude was priced at whatever -- $28 a barrel. In one month that was priced at $36 a barrel. Whereas in backwardation, front month was priced to, let's say, $140 a barrel and back month was priced like $137. So those -- that supply and demand dynamic in how those markets are priced all plays a role.

Tim Bourquin: All right. In that case, you're then spread trading within the same security?

John Netto: That's a homogenous product right there. So I'm trading crude on crude. That's homogenous. If I trade NASDAQ versus EURO STOXX 50, those are heterogeneous spread products. So I want to trade silver versus the NASDAQ, obviously the correlation breaks away a little bit but, you know, you might make this -- they played it for the last, you know, a year and a half, the commodities and equities have been strongly correlated. In a risk, you know, carry currencies like Aussie, like Euro, like New Zealand, you know, Brazil real -- those positive carry currencies have also been trying to correlate it with risk appetite. Well, you know, so it's not uncommon to see, you know, the whole risk appetite spectrum rallies a hole and the whole risk appetite spectrum sell off as a whole. Well, the last couple of months have begun to diverge but there's some of the same ideas of spread trading involved in those markets as well.

Tim Bourquin: And how do you know how much size to put on each side to make your risk is even on both because it's not just one contract to one contract always?

John Netto: Not always, no. And that comes into a normalization component. And again I would encourage anyone to check out my spread paper. I have it posted at osoktrading.com. I actually discuss how you want to normalize a ratio. meaning that if you have the Dow Jones price to 10,000 and has to be priced at 1,000, you wouldn't necessarily go long, you know, 10 Mini Dows for one S&P. You need to find a ratio in a way that affects its volatility so that you could do what we call normalize that spread or put the spread in a level that truly dictates, you know, which market is truly outperforming the other market so you can better assess how you can maneuver or what trade you want to make.

Tim Bourquin: Are these typically real short-term day trades?

John Netto: No, spread trading is much less conducive to, you know, the two or three-minute split because you're talking multiple legs in -- there are increased transaction costs. Now, you do have better -- in most cases a better margin capability because obviously you're mitigating a great deal of the market as systemic risk that's involved in the trade but overall you're talking about, you know, trades that may last an hour to three hours to a couple of days especially if you're more of the mean aversion category. But what you see and what I do is I put on a spread trade and the spread trade will be, you know, part of the discretionary overall strategy like if I think that the market is going to go up that day, I may be long, you know ,10x of the S&P, all right. But I think small caps that I perform and so I may be, you know, long forks of small caps or I'll be short and tack, you know, and maneuver the position around that standpoint. So for as much spread trading as I do, I'm more of a hybrid spread trader because my trading methodologies are rooted in that of a discretionary trader. So understanding the relationships between which markets are outperforming is just as important when it comes to deciding which markets I want to go long or short. So even if you're not spreading, okay, you still want to understand the relationships and that's where the normalization ratio comes in to determine which market may provide the best opportunity.

Tim Bourquin: And how are you deciding what's going to underperform and overperform? Is it just news or research? What are you doing to find that out?

John Netto: Well, I use to CQG software when it comes to creating my charts. CQG has extremely robust analytics package for charting spreads between various markets. So I put together a number of spreads there and based on the price flow and some of the other proprietary indicators that I use just to get the sense of where these markets are going. And again, you know, the spread trading charts between those markets can act very similarly to the charts of many underlying products that people are more familiar with. They exhibit, you know, certain Fibonacci resistance points, certain support and resistance levels. Like everything, there's still a qualitative aspect to it in determining the appropriateness or the rhythm or harmony of that respective market whether it's a true spread or whether it's a true market like the S&P per se or it's a synthetic spread or implied spread like a Dow Jones EURO STOXX and a DAX spread.

Tim Bourquin: All right. So I know I'm going to get a few questions about this 'cause this is a little more advanced obviously but people can go read your article at osok.trading.com?

John Netto: Yeah, at osoktrading.com. You can also -- you go there -- I received a great deal of e-mails from this. I had done two different workshops with Eurex last year when we went to a number of prop firms and CTA firms in Chicago and New York and this definitely caught the appeal of a higher level of professional trading corps out there. So, you know, there are a lot of questions but this is something that is like done a great deal. It doesn't get a whole lot of present attention but if anywhere, you know, if there's one place where I can get attention, of course, is at tradeinterviews.com, Tim.

Tim Bourquin: All right. Well, let me switch gears a little bit and talk about something else. You wrote an article for us and for your own site I think a while back called -- I think it was the 10 Attributes of a Successful Trader and talked about some of those things. One of the questions I always get -- all right, well, so what's the most important top 3 there that you can think of? Do you have kind of talk about the most top 3, those attributes, those characteristics that people want to be successful?

John Netto: Sure. You know, ranking them is really dependent upon, you know, the individual's own experience. But for me, we talk about the things like willingness to learn and improve. I think that has to be there. Vision, the ability to really step back and kind of see where things are going is extremely important to me as well. Courage, cannot emphasize enough how critical it is to have courage. I attribute a lot of the development I've had as a trader to step in outside my comfort zone and doing things that I did not feel comfortable at that time but knowing that they were the right thing based on my methodology and system of trading, okay. And so that takes a lot of courage to do something that you're not comfortable with and it's not something that gets a lot of headlines. It's really easy when you come in the morning, the news looks bearish and see if there's an article left talking about, how the markets are down and the feds are going to raise rates and -- but nonetheless, that may be time where your set-up tells you that you need to go along. And so having the courage to take that set-up, having the vision to see how this may play out, all right, and then being willing to do things and to learn or to put yourself in situations that can offer great risk/reward ratios are all critical components. Obviously, patience, dedication, you know, there's this -- we get on the line there. All of them are important, you know, consistency, and whatnot and that's why, you know, that's why I have it as the footer on all my e-mails just to kind of remind myself what's the attribute. So I really -- they are -- my colleagues call them just life in general. The attributes it takes to be a great trader are oftentimes in life the same personality traits that are required to be a successful marine which is where a lot of what I wrote is sort of came from my marine corps background.

Tim Bourquin: And how long did it take you to really get comfortable with these 10 -- incorporate these -- you did -- you said already as a marine but in trading, how long did it take you to become confident in your ability to make money?

John Netto: It's an ongoing process. And Nassim Taleb had, you know, a book called, you know, Fooled by Randomness and just through experience, you get a sense after a while that's like you never really have this game figured out, okay. In any one bit that they do is kidding. I mean I've worked with managers that run hundreds of millions of dollars, guys that, you know, have been all around the curve and at the end of the day, Tim, you just never know. With that being said though, you do know that putting yourself in good spots, managing risk well, staying open, staying impartial and objective, constantly learning, constantly improving -- those are all the kind of qualities that give you the shot to continue to be successful though, okay. So at the end of the day, like I have confidence that I know I can trade and I have confidence that I'm -- with a very high certainty that I'm going to make money. But when the market does crazy things and you just always have to respect that and keep that deference and I think that's a key part to remain successful, actually.

Tim Bourquin: You've taught classes and you've taught a lot of traders over the years, what are some of the questions these days that you're getting right now kind of in this time of this market? Are there some common threads that people are constantly talking about, that you're constantly talking about with traders?

John Netto: Sure. You know, traders often ask me, you know, how do you factor so much information to what you do? And like, you know, and I have eight live panels I put on Webinars, and Infinity Futures I put on several Webinars for them sponsored by CME, sponsored by Eurex. These various outlets are sponsored by The Ice. And really the question I get are like how do you factor all the information you're doing and how are you able to make these calls the way you do? And a lot of it just comes down to hard work, you know. A woman has to think outside the box and in a penchant for taking on risk and managing risk, you know. It's -- you know, people ask questions like what's your favorite set-up or what's -- you know, and honestly like I think context plays a role in a lot of the trading that we do. It's not just about okay, are we pulling back and can I go along here. It's, you know, what's the context of sentiment out there? Is it a very, you know, risk appetite sentiment market right now? Is it risk averse or somewhere in between? All play a role and there's a very fluid nature to what is successfully grabbing that and maneuvering around those positions.

Tim Bourquin: Let's talk about some current market conditions. By the time people listen to this, it may be a week or two after we've recorded it. But, you know, the dollar seems unstoppable right now. It's seems like we're going to break through 11,000 here with no problem. It's pretty amazing to me with everything that's going on. That's the case but what do you make of it?

John Netto: I think the market, you know, the equity markets have been very enigmatic for a number of traders out there in the last four, five, or six weeks or so. January was a pretty good month. We had a return of volatility, the VIX back up near 30 and inconsequential to whether the dollars are rallying or selling off. Volatility has compressed very significantly and so the equity markets right now while a place that I'm involved in and has managed to do okay are not the spot to me that offer the most fertile grounds for trading and I think you got to expand out your branch. A lot of currency that seem to raise its altitude as well but I've seen some opportunities a little more in currency than actually a lot in the ag space. Sugar in particular is a market I would recommend everyone to take a look at because a lot of the signals in multiple use have been very fluid and, you know, there's a lot of speculation in sugar. It's a product that doesn't get a whole lot of play -- it gets a lot of play from the professional side but there's not a lot of people out there who might be aware of just the kind of opportunity that sugar is offering from a day-to-day basis and it's been actually the -- the massive product of trade in the last couple of weeks here because of what's going on. So I think that, you know, like a fisherman that decides which lake has the fattest fish in, trading the S&P with a 7-point range every day and a VIX of 17, it may be not the best use of one's time. But finding a couple of other markets that have a little more range and more opportunity is a better way of doing it. I can handle a market that buys, I handle market that sells inconsequential to whatever the reasons be. But the compression in volatility is a little more troublesome and vexing in terms of, you know, exactly how you manage positions.

Tim Bourquin: Yeah, I like the idea of -- and I've heard a lot more about this. I've heard about sugar even in the last couple of weeks that this is the place to be. So part of being successful as a trader I would imagine is putting your fishing pool in whatever pond has got the biggest fish like you mentioned. I like that analogy.

John Netto: Yeah, it's kind of what I just came up with actually. I was sort of thinking a metaphor for this. Yeah.

Tim Bourquin: That's a good one. So traders are always comfortable doing that, you know. They know the E-mini, they're comfortable with the behavior, you know, to go and do another market and really get a feel for that takes time. So what do you do to kind of adapt quickly?

John Netto: Adapt or fail. What was the first thing I just talked about, Tim? I just talked about the willingness to learn and improve, okay. But if you can't do that, one of the top 10 traits you just can't get so step outside your comfort zone. Have courage. You can't do that or there's two you don't have, okay. Discipline, all right. Don't trade crappy markets. Well, if you trade in a market because you're comfortable with it but it's not moving, then you just failed in number 3. What are your prospects and likelihood for success under the aforementioned scenario?

Tim Bourquin: Just learning to be able to -- just like you have to adjust to different market conditions in a specific market, be able to adjust, and go outside of that and go to other markets as well.

John Netto: Exactly.

Tim Bourquin: Now, do you use the same technical analysis tools on sugar that you would on the E-mini or the currency futures?

John Netto: Markets and harmony typically respond to similar technical tools, all right. There may be -- with sugar you have, you know, backwardation and dynamics mean that you know, like right now your front month contract is in May. It should still be May by the time this interview comes out but in the next month rolls to July and so on and so forth. And so the July, you know, the spread between the front month contract, there are some different dynamics there which play out but overall though, the technicals that I use on all markets is about finding value, providing liquidity on the side of the trend, all right. If the side of -- if short-terms -- if I can fade short-term sentiment in favor of long-term sentiment whether it be sugar, whether it be the S&P, whether it be the Euro, and I keep putting myself in good spots on all those markets, all right. And then define positive risk/reward ratios. If I look after my maximum adverse excursion, meaning that most of the trades goes against me versus my maximum favorable excursion, you always want to have your maximum favorable excursion better than your maximum adverse excursion. If you don't keep those records, you're not aware of what those are, you need to take a step back and stop trading.

Tim Bourquin: All right. Well, we just scratched the surface of a lot of different things here today. You can, of course, go to osoktrading.com for John's website and find out more about him and kind of get a feel for some of the other things we've talked about here. John, thanks for your time today. I appreciate it.

Tim Bourquin: Tim, it's a pleasure to be on here. I love the energy. I love the passion. And good luck to all the traders out there.