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TraderInterviews.com: Hello everybody and welcome back to TraderInterviews.com. Thank you very much for joining me for another show this week with another trader, we're going to talk to about his approach to the markets. We're going to be speaking with Mike Toma and we actually interviewed Mike some time ago, but I wanted to revisit him and talk to him about any changes he's made to his strategies based on high frequency trading or any other issues in the market these days. So, Mike thanks very much for joining me on the phone today.

Mike: Hi Tim, great to be here and it's good to be back at TI, it's been a while?

TraderInterviews.com: It has. Well, so for people that didn't hear your first interview maybe over a good year ago, talk about the kind of trader you are, what do you trade?

Mike: Predominantly the ES, E-mini futures. I will dabble in some of the ZB, ZN bond trading, the bond futures. I do kind of get exposed to some other areas whether it would be some of the options or the ETS, but for the most part I'm an E-mini futures, ES trader.

TraderInterviews.com: Now bond trader, that's unusual. You don't hear a lot of short term traders trading bonds for whatever reason. I think they just don't feel like they know that market enough, what made you to decide to trade some of that?

Mike: You know Tim, neither did I. It was that trader's expo, I think it was last February or something, and I sat in one room for a bond seminar. I think I was in the wrong room by mistake, and I'm looking and say, "You know what, these setups are pretty good, and they trade clean." Most of my setups I require sort of clean flow of order flow and clean price action and I'm looking at these and say, "Let me do some back testing," and so I subscribed to some of the data feeds for the bond futures and I looked and it's not favorite. I'm still getting sort of comfortable with it, but I track a lot of my trading activity and the numbers are there. So, I do trade on a lower size slots, but I find it interesting and a lot of times the ES trades in these small choppy ranges and when you have these announcements, these bond announcements, these ten-year treasury notes and bill announcements, these bonds can rock. So, it kind of replaces some of the midday doldrums of some of the ES activity.

TraderInterviews.com: Yeah. And if you look at the volume in these things, massive, massive volume and these are what the big boys are trading most of the time, and so you've got a tremendous chance to get in and out quickly certainly and it's not the first thing you'd think of when you think of bonds, it's massive volume and easy exit and fast trading which you certainly can do with that.

Mike: Absolutely. And one of the things and you sometimes learn the hard way as I did, but you do have to learn the professional side, you have to learn how the professionals trade this, where they're going to be probing stops, where they're going to be looking at support and resistance especially during announcement days, it's real careful and one just stay away and just kind of monitor at first, to really know each market has it's own style, and I think you'll talk to a lot of E-mini, the ES traders, the NQs they like it because they understand the style, they understand how it trades. Well, bonds have its own unique way of doing it and it's sort of a learning curve, but once you got to do it, I mean I'm pretty comfortable with it now, I would say maybe 25% of my overall activity is on the ZB contract.

TraderInterviews.com: OK. ZB, Zebra Boy, that's the contract you trade?

Mike: Yeah.

TraderInterviews.com: OK. Are the setups there the same as the setup you trade for the ES?

Mike: Yeah, for the most part. I'd like to say that I develop my own trading system just specifically for the bond trades, but I'm not that intelligent Tim. I pretty much have the same basic setups that I use on there. I will sort of adjust stops, tug it a little more wiggle room especially during news event days. Even when I'm not trading at the actual event itself say the 1 p.m. Eastern news event, it's just there's a lot more activity prior to that and after that, and I do want to give myself a little more risk-reward potential, so I will widen my stop, however, I will widen my target as well.

TraderInterviews.com: All right. Well, let's get right into this and the setups that you do watch in the ES. What's the typical good trade setup for you? What do you like to see on that chart?

Mike: I have 10 setups and we talked about this the last time we met, but really briefly, I try to keep 10 setups. I always look at the horse race where I have 10 horses on my stable and I monitor the activity and monitor my trade performance through all 10 horses so to speak, and if they keep performing I continue to do them more frequently and actually at the higher contract level, and the ones that don't, I either don't use them or actually kick them off my list and now there's an opening for another setup that hopefully as they develop I pick up more things at the expos and then part of my development by reading journals and things like that, talking to other traders. But I'll tell you, since I started doing this about three years ago, the number one setup I have just continues like call the Secretariat because it just continues to perform month and month. It's relatively simple. I mean I use it predominantly in ES, but you can use on the bonds as well. It's basically, if you kind of look at your platform screen, just throw away two moving averages, just throw a 9 EMA, and a 30-weighted moving average, the WMA. And I use a 1224 tick chart, don't ask me why. Actually, I had to change that recently because of the CME data feeds were changed the way they do things. I usually use the 512 tick, but I had to bump that up now to a 1224.

TraderInterviews.com: And so for the people that don't understand, when you say 12, 24 what does that mean?

Mike: Well, I'm sorry it's a 1224 tick chart, so 1224 tick on the chart, sorry about that.

TraderInterviews.com: OK.

Mike: And so I'll setup a chart like that and I'll have a couple of other indicators on it. But for the most part I would tell everybody, sort of keep it simple at the beginning and especially if you want to learn this basic setup, kind of just monitor using those two things, don't confuse, don't put a lot of other grids on your chart or feeds or anything and basically what I'm looking for is that cross of that fast moving average, that nine moving average EMA crossing the 30 upwards, say for example. So, right now I know I'm going to be looking for long. I'm going to looking to go long and I eliminated half any opportunities to go short. So, I'm only thinking long. What I'm looking for now when it breaks out of that range, when it's going to pull back into that zone between the nine and the 30. So, what you're looking at is a big breakout upward, so I know the buys is long looking for a pullback just a slight pullback it could be most of the time it's just average retail profit taking from that initial move, and then I'm looking to get in long and hopefully catch a ride to resume that trend.

TraderInterviews.com: And how did you figure out this worked?

Mike: Practice, lots of practice, lots of back testing. I'm a risk manager by trade, so I consider myself a decent trader, but I'm a really good risk manager. So risk managers think in data driven. They're very data driven. I do a lot of back testing, I do a lot of sample sizing with different types of charts, different five-minute bars, fifteen-minute, different size tick charts. And what I do is I measure the ones that have the optimal return for me given my level of risk that I want to take. So I back test everything. For each to get on my list of my top ten, it has to be back tested rigorously in all different kinds of markets and work for both long and short, and then even when it becomes on my list I'll start it literally at a one contract level.

TraderInterviews.com: Do you screen for these automatically via software for this 10 and then find which ones match those?

Mike: Well, most trading platforms, I mean you put the basic moving averages up and I'll have a couple other barriers such as Fibonacci that I use and to maybe act as a level of confluence, but after a while Tim, you just become ingrained in. I mean this is my business, so I'm very aware I could be doing other things, but just a twitch of an eye at the screen I can tell one of this is setting up. I also have alerts on my screen to show when the moving averages are crossing, so that sort of like the first initial indicator that this particular setup maybe starting to form.

TraderInterviews.com: So, let me ask you this and you've got 10 setups, if the secretariat as you've named it works best, why not just throw as much size as possible and that one and forget worrying about the other nine.

Mike: That's a great question Tim. The really straight answer for that is the price action doesn't always allows for these setups to occur, especially I'll use I said 1224 tick chart, a lot of times you have a trend day. It can just continue and continue and never pull back to that sweet spot that I want to get that level on. I can just buy on a trend day just buy at the high and hopefully it goes higher, but my whole mantra so to speak in my trading is, trade my setups but at the same time get the best price. I want to buy whole sale, I don't want to buy retail and when that pullback comes now that means if it goes back to the original spot where you hit that high, I'm not just breaking even, I'm probably taking off at that point. So, a lot of times it won't allow me, the price action won't allow to get that and even when it does, it doesn't meet my wholesale price and I let it go, and I've missed a lot Tim. There's probably more that I miss than I actually get, but when I do get them, I get a really good price. And if it doesn't work and I get stopped out, my risk is sort of limited because I'm at such a good price. But to answer your question, again to summarize is that the setups don't always occur that way and especially on certain trend days or even during the afternoon shop rarely will you see a setup take place. So, a lot of times I have to target it for that 9:30 a.m. Eastern opening until about 11 o'clock and then I'll see the 2:45 Eastern to the close, that's usually my peak times when I'm really focusing on my Secretariat trade.

TraderInterviews.com: Now, I like the fact though that you're missing trades only in the sense that it means you're not chasing it, you're strict about waiting for that pullback and you're not going to bend on that.

Mike: I can't. It's part of my rules and sometimes I look back and say, "Maybe this rule is a little too strict." And I mean, "Yeah, I'm maybe not getting in that price, but boy I'm missing a lot." I have other setups that I can do and honestly I'm in a position now where I really don't want to take more than, I mean I think the last time we spoke we were talking about eight trades a day I use to do and looking at my notes before our talk today, I'm lucky if I do four now. And of the 10 setups that I have, I would say 80% of them are really focused within three setups.

TraderInterviews.com: All right. Let's talk about some of those other two, but before we do that I want to ask you, do you have each of these 10 setups on a single chart or do you have 10 charts that have each setup on each one?

Mike: We have two or three charts on my main platform. So I'll have that one and my number two, my Secretariat I'll have on one chart, that's something because I'm always looking for that. It's my bread and butter, and that allows me to pay my mortgage and take my cruises and things like that, so I don't want to miss that. I'll have one other chart that has the other two or three that I'm constantly monitoring and I'll have alerts on those. I'm not really trying to watch those. However, during non-peak times like say the 10 a.m. to 2 p.m. Eastern lunchtime shop, there are some other setups I'm looking at. Those are the ones that I'm really focusing on. So, I'll have those under the screen and I'll blow them up and maybe predominantly look at them with an alert on my primary trade.

TraderInterviews.com: Well, let's talk about your second favorite, what's a good close second to the Secretariat in terms of what you watch?

Mike: A couple of them, one actually I was challenged last year by a fellow trader saying, "You have all these setups and you have your trading plan," he was looking at it. He goes, "You need to be able to like teach a kid this." I don't understand it. I need to be simple and it's not that easy, a lot of it psychology knowing where traders want to get out, but it's not just pushing a button when things turn green. I mean doctors and lawyers would be quitting their practices to this if it was that easy. However, I have a basic setup that's just, a part of my rules is that I must be on both side of the momentum, and I think the MACD is there's a lot of services there. I look for it, I do tape reading, but really the MACD is kind of a really good way to the basic form in saying, "Am I on the right side of this move?" And actually last year, I actually got my little eight-year-old nephew involved in this thing and he looks at it as a game and he goes, "Uncle Mike when are going to play this game?" And I say, "Well, first you have to got to school," but it's just a couple of times we play and I actually taught him, when MACD starts to reverse and when you see this and I color coded it so he can kind of visually see it better and I said, "Now, it's time to play the game." And I kind of show him some basic rules and when to get out and the little kid is like one week he was seven and two, seven wins two loses, like a plus twelve points and that was like trading my I got a little account from one contract. I'm saying, "You know what, I think traders as a whole and including myself sometimes, we make this very, very difficult," and I see it through his eyes, the kid has no fear. He doesn't trade from scarcity and he looks at it as a game, and he doesn't connect any monetary value to it. I'm like, "We all need to do that."

TraderInterviews.com: Sure. When you're paper trading and it's not real money, you're trading like an eight-year-old in some sense because you're not worried about, "Well, it's just money, it's not my money," taking that away always, I've never seen a trade that doesn't help. Some people would say no, they need that edge, that little tension to make good trades, for most people they do much better without having to worry about it.

Mike: And it's so powerful because 90% of the people in this business don't make it. And they will trade it in sim and most of them would. So, it's such a powerful thing and there's a lot books in trader psychology and Mark Douglas is great talking about this. But really I read a lot of books about it and try to see like, "This is a really powerful thing." If you can get that psychological edge by taking the money aspect out of it, and then you look at a little eight-year-old kid doing it and I'm saying to myself, "Great!" Of course, the biggest challenge for him is when Sponge Bob comes on, he hops and leaves the screen and, "Uncle Mike, you got a trade going on here, so I got to go." So he is kind of a challenge. I got to work on that with him, but it's something that I personally don't put any profit and loss indicators on my screen and that's still a challenge for me, but I want to put myself in the state of mind where it's not about money, it's just about really implementing a plan.

TraderInterviews.com: I hear that from a lot of good traders, they talk about making the goal anything but money so that they're not focused on that, and yet at the end of the day it's about money. So do you set goals for yourself and you say I want to make so much money for a month or week or what do you do?

Mike: Yeah. Actually, I set goals in non-monetary goals and I really don't even set point goals. My ultimate goal in my trading plan is to follow my plan. So, I have metrics that I measure myself on, did I or did I not follow my plans because I'm pretty confident that my setups are going to get me to where I want to be and the lifestyle that I want to live. Now, it's the question of do I implement it as efficiently as possible. For example, I'll never have something that says, "I want to make an average of three points a day." I had that at one point, but it doesn't really tell me anything. What if the market was able to give me 15 points that day and I took the three or what if the market wasn't giving me anything and I got the three, but I broke a rule to do it. So, I've learned and sometimes pain and agony in P&L that really is have a good plan, have good solid plan I'm comfortable with and just really focus on implementing that. One of my key metrics that I follow is what was my average risk reward for all my trades about the month, and I want that to be at least on certain setups, each of it has a different risk reward level, but say on side if it's three to one, well if I find that on the average that was two to one I need to even look at, what I did there or modify something, but I will consider that a rule breaker. But it has nothing to do with, I mean those trades could have got me 80 points that much, but I still look at that as a rule breaker and I actually have, maybe I'm a little neurotic at it, but I actually have penalties. I mean there's actually a couple of rules I break I have to go on simulation the next day. It's tough for me, I'm a professional trader that's a difficult thing for me to do, but it's kind of like the teacher having me to sit in the corner and boy you don't make that mistake again.

TraderInterviews.com: Interesting. All right. So you're very disciplined about what you do to punish yourself in trading, that's interesting. But let's talk about that risk reward ratio that I know it's interesting to a lot of traders because they have a tough time with that in deciding where that profit target is, where that stop loss is to make that ratio, how do you decide both?

Mike: I really focus. Well, the first thing, the risk manager mentality is for really focusing on the risk. So, I'm really not too concerned at first what my target is going to be, but I really want to focus on how much can I afford to lose on this, how much do I want to lose on it, and more importantly is, there's a big change I've made in the past couple of years, when am I wrong, when do I know I'm wrong? And prior, I would have arbitrary stops like six ticks or two points on ES, and really what I found a lot was today in these crazy world of high volatility and these algorithmic trading that really they didn't tell me if I'm wrong. It said, "OK, my maximum risk has been hit, so I want to get out," but it really didn't tell me that my trade per say was wrong. And of the things I find in this is maybe contrary to public opinion on a lot of traders that I find that having you hear a lot the expos and some of the speaking professional traders, they really want to have two to one, three to one, five to one risk reward. Well that's great, but if I had the setup that's giving me 70%, I don't mind taking one to one on that. And I was actually in one of the expos Kathy Lein who's a professional Forex trader and I don't trade Forex, but I just happen to sit on it. She was actually an advocate of this. And I go, "Wow, finally someone who believes my thinking." It's OK to have that, and I don't think you need if you have a setup that maybe is going to work 50/50, 50% of the time then yes, it's surely I want maybe a two, three, or four to one type of setup risk-reward on those.

TraderInterviews.com: So on your Secretariat, let's talk about specifically the stops you set there. Is it somewhere below that slow-moving average I would guess maybe that you put that stop and how far away from it?

Mike: Yes. Actually, I want on that particular one, in the past I would have let's say right below that second moving average, that 30. Once it breaks that idea of it and really now I want to give you a little room, especially on big trend days, I'll actually have the stop, I'll have a catastrophic stop, so I'll have let's say three points which is sort of my catastrophic three, three and half points depending on the average true range of the day and things, but for the most part my default is three points, and what I really want to do is when it breaks, a five-minute bar is broken below that, now I know I'm wrong. If it's contained and just sticking within that area, even if it's two points and it doesn't look good, but I'm not wrong and if you have lot of these six tick stop players they're out already and the trade hasn't gone bad, but of course I do want to have something in there in case the five-minute bar is a ten-point bar where a big news announcement came out. So, I do have a catastrophic in there and once I start reaching those levels, it really hits my stop. I know I'm wrong, I'm out, I'll actually just close that market and wait for the next opportunity.

TraderInterviews.com: Do you track the winning percentage of all of those setups you have?

Mike: Yes, I do. I actually have grid and I do a monthly report to myself. I try to be accountable for everything I actually have other traders who look at it and review it and it's part of me being accountable. I actually have the results, but I also have the point gain loss, but I also have a broken down by time of the day. So, if you could picture a grid where I have my 10 setups and on the top part I have time of day, and I use to break it down within a five-time areas throughout the regular trading day and what you'll find is a setup that will maybe doing 64% accuracy on is 76% accurate between the 10:15 and noon time slot. And then at 1:30, it's actually below 50%. So what I do is I target, I highlight those areas I have a big poster in my office and I have it I'm always looking at this. So say a certain setup is really ripe around that 10:15 to noon time, I'm going to be focusing on that. So, rarely do I have I'm looking at the wall 10 at the same time, but I know that bread and butter during those time frames that at least historically has proven to be the optimal setup and really all that's doing is it's just give me the extra edge and like I said maybe I'm not the best trader, but I recognize edge, I recognize opportunity and I know what time is it going to hit historically, that's when I want to focus on those times on those setup.

TraderInterviews.com: Interesting you mentioned edge. We just did a whole webinar about that with Corey Rosenbloom about getting your edge. So is your edge then those setups within the right time of day? Does that encompass your edge? Is there something else outside of it that also gives you edge?

Mike: Yeah. Actually, Corey's work is actually really good and we had some coffee at the last trader's expo and we were talking about some of the psychological parts of this game and we're all on the same page, we were laughing, we're almost like twin brothers actually on some of the thoughts that we had. But, yeah, I actually look at into Corey's work because I also look at compliments of support and resistance, so when I'm looking at a certain level and I'll do my work prior to the market open, I'll mark down certain pivot points, certain resistance from the previous day obviously the highs and lows of the previous day, the Globex, the overnight price action, and I'm marking some of these numbers down. These are the areas that I want to really focus on and really be aware of when those hit. So, say you have for example a Secretariat type trade and it's developing right around an area that looked like prior support. That's sweet for me. I'm ready to go and that's what I wait for all day. And so part of my rules that I have to have confluence on each trade and I'll use where the confluence has been the pivots, like throw a Fibonacci on there once in a while to see if it hits that 50 to 62% fib zone that ambush. I'm not a big fib guy, but if it's going to match up with my other support levels I will soon become a fib guy and I will do a lot of work with the market profile, which I know is not a trader's favorite, primarily because it's a little difficult to understand but more importantly, it doesn't usually come with lot of the general trading platform systems that doesn't come on them, but I do subscribe to service that gives you great levels of where you know you're wrong and where you can get in and gives you again that little extra edge.

TraderInterviews.com: Yeah. We just did an interview that's going to be posted in a couple of weeks with somebody who does only market profile and that's all he'd done for 20 years. So, I think it is growing in terms of the fan base there for short term traders. In the past, I think most people have thought about it as an investing strategy, but I think a lot of short term traders are seeing that those like anything else that it works on shorter time frames as well.

Mike: I think it's part of my overall development. I mean in addition to my trading plan and my monthly assessments that I do on myself I have a development plan every year and I look at the things that I want to learn and get exposed to, and a lot of those things I kind of the scribbles get thrown on, basically some trader expos and seminars where I'll make a little note and say someone took that market profile, what's that? And I'll look into it and then this is something that last year I got more involved in from something I heard about a couple of years ago and I said let me look into it, and again once you start playing with it and you get familiar with it, if it works, great, and if it doesn't you put it aside and even maybe works but you're just not comfortable with it, but there's seems to be something that I enjoy, but again I would encourage everyone to just this development plan is not something you have to Google and do this 10-page report, it's just you could list the things that you feel you need improvement in and a lot of times your results when you track them will indicate, "Hey, I need improvement of this or maybe this setup is maybe the way to go, but maybe we go off the wait side, but you know what maybe it's because I'm focusing on two other things." And my development plan this year is to get involved in some other things other parts of this business, but at the same time learn some of the new strategies such as market profile I did last year, I know this algorithm trading is out of control this year and is affecting a lot of people, so I'm learning more about that.

TraderInterviews.com: Yeah. I want to ask you about the development program and then go on that algorithm in the high frequency trading ask how that's affected you, but is there one thing on your development plan that you call it from the past couple years that was particularly good that took you to that next level and this really made a difference in my trading, it took me to a higher level of consistency.

Mike: Yeah. It was. I think the level of my trade tracking was very important, but really the part of my development I think that I really focused on that I really think has brought me to the next level was to trade like a tactician. I mean I want to be a robot when I do this and I found myself getting so involved in each setup and watching everything tick by tick and I'd be exhausted by the end of the day and for the young guy and I was like, I don't know, this is crazy and even on good days I would just end of the day I would say, "Wow, I could see why these big brokers traders like end up going out for the farm and raising chickens and cows and stuff after like five years," I said, "I don't want to be that guy," so I had to make some changes to really accommodate a balanced lifestyle, and now it's part of my development, and it was not just about learning the setup or learning that. Almost in all times my development plan included always being engaged with other traders, always talking to them, finding out which ones work for, what they're doing well and what they're not doing well, and who's struggling with this and who's really doing well with that. And that's how you get exposed to like the bond, the getting exposed to bond trading. But the one thing I would say is just really developing my methods to trade like a tactician and I actually have that on my wall. So trade like a tactician, it's just be robotic and don't worry about market sentiment and if your setup is this and the market is tanking and your setup says to go long, you wait and just trade your plan, it will happen. When you get too emotionally involved and either you miss opportunities because you got scared or you try to make up for things you lost and then you end up getting killed. So my goal in a couple of years ago and I'm still improving at this, I mean you never really get perfect at it, but is to just trade like a robot, trade the plan and really I always call myself a project manager. I'm really a plan implementation specialist, not really a trader, and if I can do that I know I'll be fine.

TraderInterviews.com: It's funny you mentioned too at the expos about interacting with other traders. So many times I moderate a couple of the panels at the trader's expos and I see people, it's almost like they're in this feverish, they jump from workshop to workshop. They'll literally come into a workshop, sit there for 15 seconds and then run out again almost like they're trying to figure out what's the best thing for them to learn right now and it's almost like, well if you just take one thing and just sit there and try and put it into practice you'll probably be better off. But there is like this you can see and their heads down and they're looking at the workshop chart and that's when I see you you're talking to other traders you'll come up and we'll talk for a few minutes, you don't have that frenetic pace. You're like, "I'm here to learn something," but people I think they're looking for the Holy Grail or something. I don't know what they're doing, but there is running the entire time. Do you see that in people too?

Mike: I see it all the time and a lot of times when I talk to some traders to like, "Mike this is really cool. I'm so excited. Could you teach me a few setups?" And I go, "Honestly, that's the easy part." It's not about the setups; it's about building a lifestyle and building a business that you're doing in. And like you said these people are in for 15 minutes, some of them have their laptops with their trading platform on. I don't know what they're doing, but I think the big difference Tim and you would notice better than I do, I know you've meet hundreds of traders and I think the biggest difference is the psychological edge and the investment that traders put into the business. They treat this like a business. I mean most of my work I consider in this business is done before and after the opening and closing bell. It's preparedness. It's learning from others. I'm still learning and I'll probably a hundred year later, if I live that long, I'll still be learning and things change, the markets change, the dynamics change, I think that's the big difference and I see this at the expo and I feel for them because I was that guy too and they just want an edge and I was fortunate to have a mentor when I started out and I owe so much to him, but it got me the right track. But if I just left it at that I'd be dead now in this profession. So treating it like a business, having an office environment where you can do your work as if you're on an office and you'll have a professional attitude. I mean, I get dressed up everybody not in suit and tie, but I mean I have my casual Fridays, but I need to be in that zone when I'm ready to do it, and I don't think I see a lot of people with that type of focus and again the ones you do see they're the top seven, and Tim maybe you can expand on that too.

TraderInterviews.com: What I always tell people too is that at the expo they have some good speakers, but some of the best traders in country are just sitting there in the hallways walking around just like you and me which I think is awesome. I've always got a ton of information about talking to those people. But we're running a little short in time, let me get to the high frequency trading because I know that was an issue that we wanted to talk about. What kind of adjustments have you had to make because of high frequency trading this year?

Mike: What I notice is last year that a lot of my stops wherein I had generally arbitrary stops and maybe two points or six ticks or two and a half points and I noticed and they we're usually below confluence of support, so for it to me to be stopped out, the price had to come and break through what I considered at least multiple layers of support. So if I knew I was wrong below those levels, then I would get stopped out, I'm OK, I knew I was wrong and that's fine, you move on to the next trade. But what I'm finding more and more was that price was being hit and sort of reversed in going with my original direction I wanted to. Now, we always had those times where you always think like everybody is hitting my stops, but when it got to the point where I start to see it in my numbers then I said, "OK," and again this is another great reason to have a trade journal and track things. You say, "OK, I need to look into this a little further and again I think it was last year in Pasadena at the expo someone mentioned about algorithm of trading and I literally scribbled that on a piece of paper and on the plane on the way home I saw this HFT, I don't even know what that means but, "Oh, that's right, that algorithm of trading, I got a look into it." And I started to look into it more and I realized that what I found out at 70% of all the market activities is driven by these algorithmic program trading and they would come and sort of probe an area below what I consider support and then sort of reverse back. So I did some education. I went to some local seminars in New York and one of the cool things about being a risk manager is when you go to hedge fund seminars and gatherings like they welcome you because it's kind of way to get and you talk about risk and they all have risk managers on their staff. But I'm talking to these couple of quant traders I saw at the reception after the seminar. We're basically talking, yeah we go and probe these stops that we're looking at those retail traders, we know they're going to get nervous and if an example say for a breakout trade is you put your sell short at the new low and they look at that, they wait for a way to get in and they start probing them and then they're the first one to get scared when they're going to get stopped out. And so they get scared, they cover the positions and sure these quant guys riding the wave up. Ironically, it happened this morning for like 10 points and now I was only on it for four, but these I think, I need to look at the way I do things because I'm trading like a retail trader and I need to be on the professional side. So, I've had to adjust some of my stops. I had to make them a little more wider, but at the same time I'm actually piggybacking on these quant trades and it's sometimes I think it's a little difficult to detect when they're happening although hindsight is 20/20, but I'm using more time in sales to look at big block trades especially at times at points of new lows and new highs and areas of where the average retail trader would have their stop.

TraderInterviews.com: So, you're thinking like them to say, "OK, I'm going to set my stop way further or I'm actually going to trade on the side that I think the quants are on and buy their stops."

Mike: Well, in my normal setups both. On my normal setups, I have move my stop lower, so I've had to increase my target to maintain my same risk reward, but one thing I know about these, if it's not going to happen, if these high frequency trades aren't going to probe me out and it's going to keep going and let's say that the newer trader has a short at the new low and it keeps going, eventually you're going to know real quick that you're on the wrong side. So, you get stopped out and it's no problem you'll just move on to the next. I actually now have included a new trade that I've done again, done some back testing on and my formal procedure is how I do it, and this is back in September where I would take advantage of some of this newbie panic for a lack of a better word and it is actually now my number three performer. So it's the fastest growing profit engine that I have in my setups and I never thought it would be like this and it's tough it took not just to implement plan to implement a new strategy like this, but here I am buying new lows, I mean that's just like a soccer game.

TraderInterviews.com: Can you describe it? Can you give us an overview of what that is?

Mike: Sure, I mean I'll use a breakout trade as an example, you'll see, and again it doesn't happen all the time because if it did the whole mark would always trade in the range. But say you have an intraday basis you have a high and a low where Globex high and a low and the market comes down to test those lows. A lot times, people would either be buying at the lows or sell short once it broke the new lows. It's got classic trading 101 setup breakout trade. And what happens is a lot of times you'll see big blocks coming until you hit the new lows and it will go down a few ticks and all of a sudden it just starts to reverse, and you had all these little one and two contract traders and I do have my time in sales on the screen during those times and you'll have a lot of one and two contract players, retail traders sitting there who are just short and all of a sudden it'll start to reverse. And now when you see these big blocks coming (a hundred and up) of ES futures coming on the buy side, and now you reverse say a point, a point and a half and you know the newer traders have their stops at six ticks maybe two points and once those start hitting they'll ride that wave and I try to jump on that too.

TraderInterviews.com: Will you wait for those blocks to show before you actually buy into or you try and get in while there's one and two's are going through?

Mike: Yeah I will. I'll actually see those blocks coming in, and what you're going to see is the price action may not jump immediately. I mean maybe it was on the first minute or two because we haven't seen the battle of the one and two contract players going short, shorting the new low, and then you'll see some big blocks on the buy side coming, so some of these buying these things and then usually bigger block. What you really want to see and if doesn't work you'll know right away, so you want to get out pretty quick, but when you start seeing the reversal that maybe a point a quarter, again thinking psychologically you have to know where the average retail is going to start to panic, and once they do, they're going to start covering those shorts and now you're on the ride, I mean now you're just waiting, you're going to ride that wave to your target with the panic. So, it's kind of in a sense taking advantage of panics of some of the maybe newer traders, but it's one of those trades and when it doesn't work, you know right away and you don't have to risk a lot. But I mean today that was the low of the day, just in ten points later it's still going. Again, unfortunately, I'm out of it at four points, but if they do work you have to be careful, but it does take a psychological change because I was never one of those guys who thought like that. I was always just your average retail guy, who just traded his three to five contracts, but now I have to start thinking like the big boys and the volume is really dictating. Algorithmic trading, once you talk to some of these big traders and these hedge fund guys and you see it like it's a totally different game they're playing and we're like little fish in the big pond.

TraderInterviews.com: All right. Last question here, you said four points and it's up to ten, why four points? Why was that your target? Did something change or what?

Mike: Actually, part of my rule is one of my first trades of the day I will take this target just to get some green in my account just for the day, kind of get just like logically in a state of abundance and I'll play with that the rest of the day. So my first trade I usually keep a straight target, but any other type of setup any other time of day, I will have that one even if it's one contract just for that runner because that gets the gravy on everything, But this is actually right at the open and you don't want to mess to much. The first half hour can be a little hectic, little out of swings, so I just took it and left and no regrets. I traded my plan and again that's my measure that I measure my success on and you move on to the next one.

TraderInterviews.com: I first got in touch with David Buffalo because I'd heard he was a great trader. But I also heard he enjoyed talking about his methods. I wasn't disappointed. We immediately began talking about some of his indicators and the actual bar patterns he watches. Take a listen.

David: I use one, not one indicator, but I primarily depend on one indicator. But in the essence of the three-period RSI that's been skewed by not only moving averages, but also it's been skewed by an additional momentum component which will basically revert around either a two- or three-period moving average of that indicator to look for a key crossover. And by that, I mean what you're actually trying to do is identify a pivot. And what do I mean by pivot? I tend to follow the Tom DeMark rule of thinking that let's say for example you're at a regional high. Then you want to have that highest high followed by two lower highs on either side. So, I think that's what Tom DeMark calls a first order pivot high. I believe that's right. The general point is, I've identified a highest high followed by two lower highs at a top, and at a bottom I have a lowest low followed by two higher lows on either side of that.

TraderInterviews.com: Sounds like a head and shoulders.

David: It does. Except that it's very tight on a daily chart. It's a three-bar pattern up, three-bar pattern down. Three up, and you've got the middle, with the middle bar being the highest high. Three down, with the middle bar being the lowest low.

TraderInterviews.com: And the momentum that you said kind of gets put on top of that to find that.

David: Correct.

TraderInterviews.com: Is that so? What do you mean by that momentum? What are you using there for that? David goes on to describe the things he looks for that give him an indication of that momentum, and how he uses it with his special brand of RSI to find great trades. But I also wanted to know what role volume played on his decisions. So we started talking about that and how differences in volume plays into his trading. And you mentioned the volume sum that you want to see increasing volume on those bars, those bullish bars.

David: Yes. I don't have a component per volume in the Neural Net models that I use now, although one thing that my mentor wants me to work on is something that I'm literally going to order computers for today, once I get done doing tax stuff today. In essence, what I want to do, I'll look for increases of volume that may occur around that pivot. Now many times, for example in over-the-counter stocks, many times you won't see volume kick in until after the momentum has turned. And I don't know why the heck is that. I think many times, traders or institutions may want to see a price that will hang around for a while, and then once they see it's hung in there, they'll actually go in and buy after that point. In many times, you may have a stock for example, one that I mentioned today was, let's see. It was TwoFour Incorporated. And this is the one that he mentioned. Literally, you've got, I think an average daily volume somewhere on the order of about 130,000, but there are going to be some days that thing trades half a million shares, and some days it only trades 60. Well, how do you manage that? If you know the company's decent and you know it's got a decent average volume, then what do you do? Well, you have to position yourself around those pivot points so that once volume kicks in, it's kicking in, in your direction.

TraderInterviews.com: David then discusses those pivot points, and how he uses them to find his entry points. Risk management, of course, is huge in any trader's success. But what does it really mean? In this next segment, David talks about how he calculates the risk on every trade he takes.

David: Here's what I do, and this goes back to the old Tom Joseph rule. I don't know if you know who Tom Joseph is. He's an oil trader that if you don't have a trading model that will in aggregate trade with a $1.60 profit to a dollar loss. That is a 1.60 to one win/loss ratio in terms of dollars and it's not 60% right, then you might as well just not trade because he'd developed literally an encyclopedia's statistics trading oil, and trading other commodities, trading stocks. And that's what he found was the basic rule. Now, what I do with my models, is I add another filter today and if I can. What I do is I look at those sets of number, the 1.60 to 1.60%. I also look for average win/loss ratio that is the average of all the trades. But in essence, what you want to do is to be capable of trading those in the right environment, but I want to use the same kind of measured techniques. I want to stay in it for as long as I see a price objective met, and then once I'm done, out of there. I'm going to wait for the next setup. I try two to five percent per trade if I can get it. Now many times, I may only get one percent of even half a percent or just maybe pennies. I will scale up my positions, and scale back my positions either based on success or on drawdown. I tried to use maybe a $500 or $600 which is fairly aggressive delta in the position that I trade. So in other words, in that first delta position, I have to have $500 of profit, then in the second delta position, I'd have to have twice that much or a thousand, third delta would be $1,500, and in essence, build my positions on that basis. Because literally, on a tiny position, I can afford to take anywhere from my $300 to $500 loss. That's what the average true range volatility of my trades would generate for the worst loss I could have on a position on an average basis. What I'm trying to do is scale up by that kind of a delta, which is a fairly aggressive delta. What it means is, you don't take massive risk on any one position you take. I take measured risk. My position sizes are measured. They never get any higher until I meet the profit objective.

TraderInterviews.com: And finally, I talked with David about how he sets his stop losses. David's got about the most specifically I've ever heard of for setting stops, something every trader should be doing. Take a listen.

David: But the point is is that, because there was increasing volatility, I began to get stopped out of trades even more, and particularly in swing trades. So, what I had to learn how to do at that time was to increase, not decrease, the size of the stops to account for the volatility. And that's something that I had to gradually adjust for and that's why I use the average true range. I think you know what's an average true range. Hopefully people know what that is.

TraderInterviews.com: Sure. You're welcome to define it. You never know who's listening who might need it.

David: Well, in essence, the simplest way to define it is the average true range is, well let's define true range. True range is the widest range between two bars in a given day from a high to low, and there's different ways to measure it if you have an up day and a down day. And if you want to go to Investopedia or some place like that, there's a clinical definition in there. But bottom line is what I would look at is a seven-day average true range to measure against so that I could, basically, have sort of a dynamic stop. And in essence, at those turns, usually the average true range is at its highest width. So in essence, you have to have a wide enough variant of a stop, and typically what I would do would be to move the stop at a 200%, that is two times the seven-day average true range below the stop of the previous day that I entered the trade. And then in essence, that would be the lowest point. That would be the lowest stop. I would never move the stop any lower than that because that would be my maximum risk. And then after that, in essence, I'd begin to scale up and move that stop up that line until I got to wear my first price objectives, and then literally, I would move my stop to break even. And then play with the house's money after that.

TraderInterviews.com: David's full interview was a little over 40 minutes, and we covered a ton of ground. Some of it is pretty advanced, but if you want to learn exactly how a great at-home trader makes a living in the markets, it's a great one. As a member, you, of course, have full access to that entire interview and the full transcript. And believe me, for this one, you definitely want the transcript. You'll learn something new every time you read it, or listen again. Next stop, how a three-time trading champion has his computer find all his trades for him. You won't want to miss it.

Interview Highlights with 3-Time Trading Champion

TraderInterviews.com: Hi, this is Tim Bourquin, cofounder of traderinterviews.com. Thanks for joining me for highlights of interview number four. If you've heard about automated trading systems that find trades for you, you'll love this interview. Kevin Davey recently won a worldwide trading contest three years in a row. In the fourth year, he placed second. Now that proof that someone knows what he's doing. Kevin writes automated trading systems and is very candid about how it all works. The first thing I wanted to ask him was how do you know when a black box trading system works in the real world, not just paper trading, and how do you know when you need to make a few adjustments or pitch it out and start again? He begins by talking about drawdowns and then gets into how he knows when a system is working properly. The audio quality on this interview isn't as quite as good as the other ones we normally have, but I think you'll still be able to get a lot out of it just from the highlights.

Kevin: The way I typically trade is by developing systems and then rigidly adhering to those systems. Right now, I'm trading about six different systems for my personal account, and four of those are semi-automated where I will get signals but I'll still have to enter them myself. And then the other two systems are completely automated where I don't even have to be at the computer although I usually still am just to make sure everything works right. What I found is to reduce the drawdowns that occur, I like to diversify and try some different things. So, for example, I'm trading six different systems, so a couple of them are different types of systems with the stock indices, the mini S&P, the mini Russell, mini Nasdaq, so there are a couple systems there. And then I'm also trading some of the agricultural-type commodities and doing some spread trading. So, really what I found was the best way to reduce drawdown is obviously to have a good system in the first place, but drawdowns are kind of inevitable in any system. And so, by combining a couple of systems, what you get is you can use your capital a little bit better and also it kind of takes some of the sting out of some of those drawdowns.

TraderInterviews.com: Yeah. That's a good point, too because I was going to ask you how do you know when it's just a temporary drawdown and it's just maybe four or five trades in a row that have gone bad, and historically maybe you don't have that many but it's still within the parameters. And when it's completely off the tracks like you said, it needs to be revamped completely.

Kevin: Right. And I'll give you an example of a system I started trading last fall. And right away when I started trading with real money, and this probably has happened to a lot of people, it started losing and had pretty significant drawdown right off the bat. And of course, when you're just starting to trade a new system and it immediately doesn't go your way, you start to think, "Well, maybe I did something wrong. Maybe, it's over-optimized. Maybe, the market's changed." And you think of all these things. And so what I did was I went back and looked at the previous history. I did some simulations. I used Monte Carlo simulations to predict a range of the expected performance in the future, and what I found is even this significant drawdown that there was a chance of this happening. It wasn't a big chance, but it was say 10% or 20% chance of this type drawdown happening in this shorter period of time. So knowing that, I felt comfortable that there's nothing wrong with this system. This is doing what it could do. It's not of the range. And so I continued to trade it and sure enough within a couple weeks, it turned around and then just kind of took off.

TraderInterviews.com: Kevin then goes on to talk about some of the adjustments he made to what the system was looking for that made it turn around. I was also curious as to how he gets his new ideas for automated trading systems.

Kevin: Sometimes it's as simple as reading a magazine article. So, for example, reading something out of Futures Magazine that something somebody has tried. And I probably won't test the exact idea that they had but maybe something in that article will spur me to think, "Wow, what if I did this?" Another example of some systems that I just created and just kind of went alive with in the last month. There was this system where probably a couple years ago, I had read an article somewhere about something called the prisoner's dilemma which is kind of like a game theory type situation. I won't go into details about it, but it was about a game theory. And I just kind of found that when I come across these things, I kind of follow them away and I might have, at that time, run a small test on it and didn't really see anything there. But I came with it about a month ago and kind of approached it a different way and lo and behold it turned out to work out pretty well, and it's something I'm trading with real money right now. So, really it can come from a lot of different sources. One of the things I try to do is when I'm not thinking about trading or trading, I try to read books or do things that are kind of, I would say, on the creative side or something totally different than trading. So what I'm trying to do is to get input from, maybe, the other side of my brain, not the thinking part but the artistic part. And what ends up happening is sometimes these ideas just kind of pop in my head and then I'll go and test it. And usually, unfortunately, probably for every 100 to 200 ideas I can come up with little variations, it takes 100 to 200 ideas to actually come up with a system that will work. Most of the stuff just ends up getting thrown in the garbage.

TraderInterviews.com: Now, that's patience. Even trading system programers have to try a lot of different things in order to find something that works. Next, we discussed the types of systems he programs and which ones he likes best. So, could it be a system as simple as you noticed that every year on July first if you buy corn in the morning and sell it the next day at the close, you make 15%. I mean could that be a system in and of itself?

Kevin: Yeah. It could be. Obviously, what I look for is try to do something the simpler the better, but that doesn't always work out that way. Sometimes I start out with some pretty complexed models and then try to make them simpler, so I go both ways. I actually, take simple things and make them more complicated, and take complicated things and make them more simple. But if things like seasonals, some of the systems in trading have some of that in them where they're pretty simple systems, but they seem to work. And part of the reason, I think, some of these work is some of the ways that I control risk isn't necessarily...I like tight stops, for example, but unfortunately, for me, at least the markets I trade doesn't seem, at least the markets I trade doesn't seem to like tight stops in the long run. It seems just to be a way to slowly grind away your money. If you a two-point stop in the mini S&P, for example, you'll probably get stopped out a whole lot. So what I found it's better to go with pretty wide stops, and I think that's where some of the edge in my trading comes from is I take risks that probably a lot of other people don't feel comfortable with. But in the long run, it works out better because you...there's this noise level in the market and I kind of tried to put some of my targets outside of this noise level so that the market will just do what it wants to do and it won't necessarily kick me out.

TraderInterviews.com: Kevin goes on to talk about he software he uses to program his trading systems which is trade station and now he starts with his simple theory and tests it to see if it will work. He then talks about how me makes adjustments to get signals that are just for the most profitable trades. Finally, we talked about why he trades systems rather than just making discretionary trades as sees them happen. With those three years that you were in first or second place and doing really well this year, what does this say about mechanical trading? Does it say that all these computerized-based trading systems will, in the long run, always beat discretionary traders who are trading on gut feel?

Kevin: I guess, I'm not so sure about that. I happen to know a few of the people who won the world cup in years passed were more of discretionary traders and could actually do that. And I know for me personally, there's no way I could discretionary trade because I've tried it, and I'm really good at doing the opposite of what would be a good trader. I sell at the low buy at the peak and if you did the exact opposite, I mean, maybe you could fade out my discretionary trading, so I don't do that anymore. But it really depends on the person, and I think you have to end up doing something you're comfortable with. So, for example, I'm very comfortable with numbers, with statistics, with data, with rigid rules, and I have enough confidence in my abilities to do that that once I come up with the system, I have the confidence to trade it.

TraderInterviews.com: So it's all about knowing your strengths and then concentrating on being the best trader you can be, and knowing your own personality. Kevin's figured that out, and he's hugely successful because of it, and I think that's one of the great things about traderinterviews.com. You get to hear from all kinds of different traders with different methods and different personalities. It's a great way to help you figure out on your own, what your strengths are, and focus on those strategies you're most comfortable with. I spent 45 minutes with Kevin talking more about his systems and of course the full interview and transcripts are available to you as a member. We'll see you tomorrow for highlights of my interview with a business owner, turned trader who talks about how he uses simple candlestick charts to make a lot of money trade in the markets.

Interview Highlights with 3-Time Trading Champion

TraderInterviews.com: Hi. This is Tim Bourquin, cofounder of TraderInterviews.com. John Gilner was a successful business owner prior to becoming a trader but as he says, "Trading is a whole different animal." He's very successful now but it took him a while and he traded several different markets in order to find the one that worked well for him. He started with options but had trouble getting consistent results. Let's listen in.

John: Because I was primarily focused on index options, there's a good measurement for that volatility and therefore, the price of the options of course is the VIX. And so, the basic principle there is you need to develop an ability to understand if options are priced high or priced low relative to the expected volatility of the underlying instrument. So, during the course of trading options, what I was always trying to do is sell expensive premium and buy cheap premiums. And so, you're generally always looking for ways to buy cheap and sell expensive. In all of trading, you have to try to be careful not to think of it like you would think of a salary that you earn at a job because my experience at least, is that my profits are a lot more lumpy from that. That's in a general sense. Now, I think when it comes to option trading, that's even more true because what you're trying to do in option trading, particularly, well, it's really true on the long and short side but particularly the short side where you're trying to sell expensive premium. Those opportunities only come along so often. So, your profits are very, very lumpy in that case.

Yes, you can make a living at that. The problem that I found with it is that in a market that can open up 3% or 4% down on an index, I'm talking about now, it's real easy to get caught on the wrong side of it for reasons that are totally out of your control. In other words, if you're a technical trader like I am, trading on the technicals during the day is one thing but having substantial overnight news risk and that type of thing is entirely another. And so, I think you can make a living out of it but my personality is such that I would rather be out of the market overnight when I don't have any control and then use my ability to interpret the market actions and understand, "Should I go long? Should I go short? Am I going to fade the morning gap?" or, "Am I going to sell a morning gap or buy a morning gap?" So, I think a lot of it comes down to what I've realized is playing to my own personal long suit and that is trading short term based on the technical.

TraderInterviews.com: John then goes on to talk about why he started trading individual stocks. Like most of us, he's been tempted to turn a day trade into an overnight trade when the position has gone against him. In the next segment, he talks about what he does to avoid the temptation now and built that discipline he needed to avoid large losses.

John: I did have some trouble with that early on. So, there are two answers to it. One is the experience has taught me that you never change the rules or the assumptions underlying a given trade. Then, the other way I handle it is I use different accounts for strict swing trades. So, as an example, I have a day trading account where I do substantially all of my day trades and I have two other accounts that I use for swing time frame and that helps me because the swing trade, and this is very interesting as far as the psychology of it all goes. The swing trades that I don't watch the P&L on, I have a much easier time staying in those trades because I don't look at them constantly. I'm not looking at the P&L on whether I'm up or I'm down. I don't see $1000 profit and I take it and I don't see a $500 loss and get scared. So, what I do is I strictly swing trade those accounts and in the trading account where I do the intraday trades, I will also swing trade the same instrument there that I'm trading in the other account but I'll make a point of not looking at it. I'll make a point of not watching the P&L tick by tick by tick.

And the other thing that I started to talk about is that experience have taught me that if you're in a day trade and it's going against you and you feel that temptation and we all feel it, we're all human, and this is why the market acts the way they do. When you're feeling that compulsion to start calling it a swing trade, I have learned. Boy. Have I learned the hard way that you just have to, as they like to say, rip the band-aid off and move on because it's a lot easier to take a $500 than a $5,000 loss. My experience has been that most of the time, and I don't have a percentage for you, but a vast majority of the time, probably 70, 80, 90% of the time, if my gut now is telling me that I should be out, I just need to sell it and get out because the vast majority of times, it gets a lot worse.

TraderInterviews.com: John and I then discussed the homework he does in order to find the individual stocks he's going to trade at the market open the next day. He also talks about coming to the realization that he's just simply going to miss some great trades and how initially missing a trade was worse for him than losing real dollars on a trade he took. Listen in as he talks about how he finds the stocks he's going to watch each day and focuses on the stocks that will offer him the best chance of profits.

John: What I do is I flip through hundreds, even thousands of charts on a regular basis and I don't have a master list, so to speak. What I do is during the course of the day, every trading day, I watch how each sector, how each industry and how the leaders in those industries are behaving. Are they trading up? Are they trading down? Are they leading or lagging that sector on the market? And so, what I do is I develop a feel for what's moving and why. The why behind it is important to understand. In other words, as it relates to, "Is there news? Is the sector responding positively to news and negatively to news? And what does that mean?" So, I watch the leaders, I watch the sectors and then within the leading sector, I flip through hundreds and hundreds of charts looking for the one or two or three, maybe four stocks that have the best looking individual chart within, say a strong sector. Then, what I'll do is I'll move those over on to a watch list and each day after the close, I'll flip through this list and I'll ask myself, "OK. In a strong market tomorrow, which of these represent the most likely long candidate?"

And I'll do the same thing on the short side so that at the end of each day, say an hour or two after the close, I've gone through hundreds and hundreds of charts and I've narrowed it down to, say 15 or 20 in total that represents my best, highest probability long and short trades and that's what I'll focus on the next day. The principle that I trade on, I'm a short-term technical trader and what that means is I'm looking at simply price, volume, and time and I'm looking at that across multiple time frames. So, what I'm looking for is, as a good example would be, looking for stock that's in an up trend. We're talking about a long stock. An up trend on both the daily and the weekly chart but whose intra day chart, say a five or 10-minute time frame, shows consolidation and a convergence of support and resistance level with those longer term time frames. So, for example, if I'm looking at a stock on the daily chart, it keeps pulling back to the ten, 25 range and I see on that ten-minute chart that it's consolidating right above that level or alternatively consolidating just below a level and hasn't quite broken through yet.

What I'll do is watch for that stock to consolidate in a nice tight range on the intra day chart and then break through on volume and that break through of course typically comes from time during the day and what I'll do is, that's my entry, I will buy just as it breaks the short-term consolidation. I always manage my stocks just below that area of consolidation. I will watch for, on a break out like this, I'll watch for it to be confirmed by volume because volume is what tells you if there is enough energy behind it. Is there substantial buying interest? Or is it something that's popped up and no one showed up and then therefore is it more likely to sale. And so, an ideal entry is a very tight consolidation on a, say a 10-minute chart, and then when it's one or two pennies above that consolidation area, if I see volume coming in, that's my entry. So, I really try to get them right as they're breaking out and the reason is for every little bit that you're late, and that stock moves up without you, that's additional risk that you have to take and that's additional profit that you've given up and so that risk reward ratio, which is so important in this trade setup process, changes very very quickly.

So, it's the precision of the entries that really I believe is key. I have the ability to find so many potentially good entries in the market but what would happen is, on any given day, I would have 15 or 20 or 25 alarms going off all at one time and I would miss all of them because you just don't know where to focus. So, what I do now is recognize that to the extent of the market is one sided on the open. I'm just going to miss most of them and I all have two or three stocks that I like the charts the best and I will focus exclusively on those for the first five or 10 or 15 minutes of the day and try to do two or three quality trades in the first 10, 20, 30 minutes, maybe even the first hour and then realize that those other 15 or 20 or 25 that I didn't pay attention to, if they move, I'm just going to miss them and that's trading. That's the way it goes.

TraderInterviews.com: John then goes on to talk about how he sets his stop losses. The situations where he won't set a stop at all and how he determines his trade size on a daily basis. He also talks about his specific way of scaling out of a winning trade. He then talks about his evolution from a new trader to being a wealthy trader and what pushed him over the edge to consistent profits. John's interview runs about 50 minutes, a bit longer than our usual interview that runs 30 or 40 minutes but because he was so upfront with his strategies and mistakes, I had to keep going. TraderInterviews.com: Hi. This is Tim Bourquin, cofounder of TraderInterviews.com. Thanks for coming along for the highlights of our second interview. Stock traders know that getting a feel for how market makers and specialist move shares is critical to seeing the ebb and flow of the market. So, the interviewee here has a huge advantage in that because he's a former market maker himself but now he trades at home just like us. In this interview, he talks about how you can use his knowledge to make better trades. So, let's listen in.

Chris: I always look the market in terms of, it is not fundamental and it's not necessarily technicals that move the market. It's supply and demand imbalances and typically what happens, oftentimes in the media, on a day when the market is up, they often say that there are more buyers than sellers and that's what's driving the market up. Well, that is not necessarily true. For stock to trade, there has to be an equal amount of buyers and an equal amount of sellers or the stock cannot simply trade. So, I view the market basically as a collection of buyers and sellers trying to transact and the market will adjust higher when sellers are able to get a higher price for their stock and it will adjust lower when buyers are able to get a better price for their stock.

So, it is a constant process of negotiation that's going on in every single stock, every second of the day as long as the market is open. So, within that framework, what I like to look for are temporary gaps between where the buyers are willing to buy and the sellers are willing to sell. In other words, a wide gap between where the buyers are trying to buy which is the bid and the sellers are trying to sell which is the ask. Now, as the markets have become more electronic and as we've moved from a market that traded in fractions to a market that traded in decimals. A lot of these gaps between the buyers and the sellers have appeared to narrow. You have to use more tools to view the situation. Now, luckily, there's technology that is at the disposal of any active trader, which allows you to see the depths of the market and that gives you a more true indication of the supply and demand picture in the stock. The less liquid the stock, the more likely there are to be large gaps between where buyers and sellers are.

TraderInterviews.com: Chris then goes on to talk about these technologies and how he find stocks that have the gaps he mentioned earlier so that he can take advantage of the situation but he also goes on to explain what are the more important things traders need to know about the market maker books and the specialist books. It's how he makes nearly all of his trading profits. So, let's take a listen.

Chris: That is one of the most important questions in trading. There's a concept called, and this is a very advanced trading concept but, this is one of the most important things that a trader can learn especially trading in the New York Stock Exchange list of stocks. There's a concept known as clearing the order book and what that means is that if you see a large seller in the market, if you are going to buy from that seller, you have to be sure that whatever price that that transacts at, that that clears the order book. In other words, that price is at a point where that seller's entire order trades.

So, I'll give you an example. Imagine that the stock closed at let's say $5 and on the open you see, five minutes before the stock is open, you see in your Level II screen that there's a seller of 20,000 shares at $4.50. So 50 cents lower than where it closed. When you see that, that is not an indication that the stock is going to open at $4.50 just because that seller is trying to sell at $4.50. He's putting a limit price on it. So he'll say and I'll sell for $4.50 but no lower than $4.50. So if there are, let's say there is a buyer of that equal amount of stock at $4.75. So we have a seller at $4.50 and a buyer at $4.75 and the stock closed at $5. But when you see that, absent any sort of other buy and sell that might be queued up as a market order that no one can see, that stock has a very high probability of opening at $4.75 and that's where that buyer and that seller are going to match and if it is for the same share amounts, if they both have the same amount of shares are willing to be bought and sold, what will happen is that isn't a market clearing price. The order book will have cleared. So, once that seller is out of the way, it is likely that that stock had bounced back to where it closed the prior day absent other market conditions. So it's not a guessing game by any stretch of imagination.

A lot of this is based on just reading where the buyers are and where the sellers are and determining from that where the stock will open and then whether that large buyer or seller gets filled and is then out of the way. This is exactly how the specialist on the floor had traded for decades. They basically set the market clearing price and if there are not enough buyers or sellers available, they'll risk their own capital to help clear that trade and they're going to do it a price level that's favorable to them. They're not in the business of throwing their money away and this explains some of the exaggerated moves that you see, for example, during panic selling where you see stocks just get crushed on the open and then second they print down there, they'd have a drastic move the other way and a lot of times it's based on the fact that the specialist is a large buyer on the open and then people see that print occur. It catches everyone by surprise and they can't believe it and then it brings bargain hunters in and then the specialist who bought a large block of the stock and sells at a lower price level, then feeds it out for the rest of the day and makes some nice trading profit for himself.

If you put buys in that are above where the specialist ends up printing that opening stock, you're going to buy it with him at his price. So that's a way of...It allows you to essentially bet with the house. You know, the specialist is the house. He's the odds maker; he's the price setter.