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Secrets ofthe TradingPros
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Founded in 1807, John Wiley & Sons is the oldest independent publish-ing company in the United States. With ofﬁces in North America, Europe,Australia and Asia, Wiley is globally committed to developing and marketingprint and electronic products and services for our customers’ professionaland personal knowledge and understanding.
The Wiley Trading series features books by traders who have survivedthe market’s ever-changing temperament and have prospered—some byreinventing systems, others by getting back to basics. Whether a novicetrader, professional, or somewhere in between, these books will providethe advice and strategies needed to prosper today and well into the future.For a list of available titles, visit our Web site at www.WileyFinance.com.
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Secrets ofthe TradingPros
Techniques and Tips That Pros Useto Beat the Market
H. JACK BOUROUDJIAN
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Copyright C(cid:2) 2007 by H. Jack Bouroudjian. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey.Published simultaneously in Canada.
Wiley Bicentennial Logo: Richard J. Paciﬁco
No part of this publication may be reproduced, stored in a retrieval system, or transmitted in anyform or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise,except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, withouteither the prior written permission of the Publisher, or authorization through payment of theappropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers,MA 01923, (978) 750-8400, fax (978) 646-8600, or on the Web at www.copyright.com. Requests tothe Publisher for permission should be addressed to the Permissions Department, John Wiley &Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online athttp://www.wiley.com/go/permissions.
Limit of Liability/Disclaimer of Warranty: While the publisher and author have used theirbest efforts in preparing this book, they make no representations or warranties with respectto the accuracy or completeness of the contents of this book and speciﬁcally disclaim anyimplied warranties of merchantability or ﬁtness for a particular purpose. No warranty may becreated or extended by sales representatives or written sales materials. The advice and strategiescontained herein may not be suitable for your situation. You should consult with a professionalwhere appropriate. Neither the publisher nor author shall be liable for any loss of proﬁt or anyother commercial damages, including but not limited to special, incidental, consequential, orother damages.
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Library of Congress Cataloging-in-Publication Data:
Bouroudjian, H. Jack, 1961–
Secrets of the trading pros : techniques and tips that pros use to beat the market /
H. Jack Bouroudjian.
p.
cm. – (Wiley trading series)
Includes index.ISBN: 978-0-470-05411-6 (cloth)
1. Futures–United States. 2. Investments–United States.
I. Title.
HG6024.9.U6B68 2007332.640973–dc22
Printed in the United States of America.
10 9 8 7 6 5 4 3 2 1
2006037553
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To my wonderful wife, Donna, and my beautifulchildren, Robert and Emily. You have made mewealthier than I could have ever imagined.
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Contents
Foreword
About the Author
Acknowledgments
Introduction
CHAPTER 1 Trading Is an Art, Not a Science
CHAPTER 2 Many Are Called, Few Are Chosen
CHAPTER 3 Know Thy Market
CHAPTER 4 Managed Futures: The Holy Grail
CHAPTER 5 Within Every Disappointment, ThereIs a Gem of Opportunity
CHAPTER 6 Technical Analysis
CHAPTER 7 Random Walk Theory
CHAPTER 8 The Psychology of the Marketplace
CHAPTER 9 Demystifying Economic Releases
CHAPTER 10 Information Is Gold
CHAPTER 11 Risk Management
Index
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1
19
35
55
71
89
105
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137
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Foreword
I n Secrets of the Trading Pros, Jack Bouroudjian shares the wisdom of
successful traders who served as his mentors, and at the same timereveals his broad knowledge of market structure and the forces thatmake markets move. He views trading as more of an art than a science andexplains why respecting the market at all times is one of the most importantlessons any trader can learn.
Bouroudjian brings wide experience to the writing of this book. He isa former president of Commerzbank, where he oversaw the creation anddevelopment of equity futures operations, and has been a member of theChicago Mercantile Exchange (CME) since 1987. He also served on the CMEboard of directors from 1996 to 2002.
While providing the breadth of a textbook, Secrets of the Trading Prosis written in a narrative style that makes readers feel as if Bouroudjian weresitting across the table sharing trading anecdotes and offering insights intomarket fundamentals. The book discusses the beneﬁts of knowing the mar-ket and understanding the various players in different industries. It alsoexplores the qualities that make exceptional traders—from exercising dis-cipline and courage to understanding risk and reward—as well as the strate-gies that make them successful.
In addition to breaking down the thought processes of great traders,Secrets of the Trading Pros also delves into external inﬂuences that affectmarkets and trading. These include:
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Capitalizing on other traders’ raging emotionsMaking sense of the trading methodologies that dominate today’smarketplaceUnderstanding the fundamentals of trading, especially futures tradingLearning how headlines can affect a market’s liquidityObserving the effects of economic releases, such as unemployment orhousing, on the direction of the marketTurning disappointment into opportunities
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SECRETS OF THE TRADING PROS
Secrets of the Trading Pros serves as an easy-to-read guide that can helptraders weed out the bad trades from the good and become more successfuloverall. As executive chairman of the largest ﬁnancial exchange in the worldfor trading futures and options, I see this book as a valuable resource forthose looking to break into the world of futures and options as well asfor trading veterans seeking to boost their command of the ever-changingmarketplace.
TERRENCE A. DUFFYExecutive ChairmanChicago Mercantile ExchangeDecember 2006
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About the Author
H agop Jack Bouroudjian has been senior vice president of Equity
Futures for Nikko Securities, the second-largest securities ﬁrm inJapan; Credit Agricole Futures, a wholly owned subsidiary of CreditAgricole, the seventeenth-largest bank in the world; and Commerz Futures,a subsidiary of Commerzbank, the fourth-largest bank in Germany. Jackalso served as president of Commerz Futures from 1999 to 2002. At each ofthese ﬁrms, Jack oversaw the creation and development of the equity futuresoperations. Jack has been a member of the Chicago Mercantile Exchange(CME) since 1987, and he is currently a principal at Brewer InvestmentGroup, LLC.
Jack was a member of the board of directors of the CME from 1996to 2002. During that time he was chairman of the equity indexes commit-tee when the revolutionary e-mini concept was successfully introduced tothe CME membership. Jack was also a member of the strategic planningand executive committees, which planned and executed the exchange ini-tial public offering. He was also chairman or cochairman of over a dozeneducational, product, and regulatory committees during his term.
Aside from industry experience, Jack has had extensive media experi-ence. He has done over 1,000 international and domestic live TV shots overthe last several years, including CNBC, CNN, CNNFN, Bloomberg, PBS, andcountless local and regional broadcasts. He has been interviewed by numer-ous CEOs and CFOs of major corporations. He currently is a Friday regularon the CNBC Squawk Box segment. He appears daily on Bloomberg TV atvarious time slots during the trading session, and hosts a business talk radiobroadcast (The Jack Bouroudjian Show) from 3 to 4 PM central time for theBizRadio network. Jack is a graduate of Loyola University of Chicago andis happily married with two children.
E-mail Jack at: Jack@BrewerFuturesGroup.com.
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Acknowledgments
T his book would not have been possible had it not been for the efforts of
many people. I would like to begin by thanking the folks at John Wiley& Sons, Kevin Commins, Emilie Herman, and Laura Walsh. It must bea bit frustrating guiding a novice writer from start to ﬁnish! Thanks for beingpatient and constructive with your comments and suggestions. Thanks toeveryone at Brewer, including Rita Karpel, Nick Patel, and Victoria Prado,for their assistance in creating this book.
The real heart of the work lies in the stories and experiences thatcame with the time I spent on the ﬂoor. I want to thank Bing Sung, VinceMcLaughlin, Dennis DeCore, Brian McDonald, and a host of other customersand traders not mentioned who helped shape my world and opinions overthe last 20 years on the ﬂoor of the exchange. Along with my experience onthe ﬂoor came the time I spent in CME politics and my three terms on theCME board of directors. During that time, I learned more about the natureof the business than at any other time in my career. I would like to thankLeo Melamed, perhaps the most innovative personality the futures industrywill ever know. Sitting next to you for ﬁve years taught me more than youcould ever imagine! Thanks to Brian Monieson (my political mentor)—mayhe rest in peace! A special thanks to Terry Duffy and Craig Donahue forleading the institution I love into the realm of the great global corporations.The CME could not be in better hands!
The staff at the CME, including Anita Liskey, Rob Kosin, and LeslieMcKeigue, is the ﬁnest in the industry. Not only do they handle dozens oflive shots a day from the CME ﬂoor, but they have the ability to make aﬁve-foot six-inch balding Armenian man look like Tom Cruise—thank you!My gratitude also goes out to Ted Lee Fisher and Rick Santelli for allow-ing me to interview them, which added so much to this manuscript. Theacknowledgments would not be complete without thanking all the person-alities on the ﬂoor who were a part of my life everyday: Adrian Byrne, Johnand Dan Scarnavac, John Fiandaca, George Sereleas, Aaron Reinglass, andMike Tracy. My heartfelt gratitude to Bobby Gault and family for allowingme to share their miracle. Bobby, that experience changed all our lives!
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Thanks to Don Sliter, Steve Helms, and Mark Plantery for showing me howit should be done.
Finally, I would like to thank my friends and family, who have been sucha large part of my life. In particular, I want to thank my sisters, Lola and Sara,and all my cousins (there are too many of you to name). A special thanksto Ani Homolka and Flora Barrowman—I love you gals; thanks for beingmy older sisters! Thanks to Lind Burke for inspiring me to complete thisproject. Thanks to Rafﬁ Antablian, Greg Hadley, and Pete Feit—I cherish ourfriendships more than you could ever know! I would be remiss if I didn’textend a special thank-you to Steve Buending and Gary Homolka. Yourcourage is amazing! Gary, there’s a special place in heaven just for you! Lastbut not least, thanks to my parents, Avedis and Arshalous Bouroudjian; mychildren, Robert and Emily; and my wife, Donna. In the end, family is whatreally matters!
H.J.B.
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Introduction
I remember the ﬁrst time I walked onto the ﬂoor of the Chicago Mer-
cantile Exchange (CME), as a 20-year-old liberal arts major at Loyola. Itseemed like a world away the from the theology and philosophy coursesthat ﬁlled my core curriculum. It’s a feeling that is hard to describe—a com-bination of basic human emotions producing raw energy from every cornerof the large room. It was a very intoxicating tour, and I loved everythingabout what I was experiencing—the way it looked, the way it smelled. If Iclosed my eyes, I could almost smell the money! The feeling is much thesame for those who venture onto one of the few surviving active tradingﬂoors in New York or Chicago for the very ﬁrst time.
If you go to the visitor’s center or have the good fortune to walk ontothe ﬂoor of the CME today, you will still witness a sea of humanity wavingtheir hands frantically as expressions of fear and greed race across theirfaces. It didn’t take long for me to notice that there were two groups oftraders—those who made money and those who struggled. I immediatelyasked myself, “What makes a trader good? Better yet, what makes a tradergreat?” That was over 20 years ago, but that subject is as relevant today asit was the day I ﬁrst asked the question.
Walking onto the exchange ﬂoor today is different than it was back in1982. The pits are still around, the wall boards are still lit up with ﬂashingred and green lights that change as the price of the market moves, but theincredible energy that once exuded from the ﬂoor is now a thing of thepast. It hasn’t disappeared so much as it’s morphed into something that iscompletely unique. It’s now a hybrid market, a combination of open outcryand cyberspace. Simply put, if trading in an open outcry environment is thethesis, the antithesis would be a fully electronic market.
What the CME did was create a synthesis, a blending of the two con-cepts to create something unique, which the rest of the ﬁnancial world hastaken notice of. I guarantee that any exchange that has demutualized, or isconsidering such a move, is using the CME model as a template for futuregrowth and consolidation.
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In the 20-odd years I’ve spent in the futures industry, working my wayup from ﬂoor runner to president of a bank futures commision merchant(FCM), I’ve encountered a range of individuals whom I considered to beteachers and mentors in trading. All of these people had one thing in com-mon: They were all brilliant in their individual accomplishments, and theyall taught me that there are secrets to the market that the professional traderknows but the average trader will never learn. How could that be? How isit possible that millions of traders around the world don’t have access tothe same information, yet they make trading decisions risking thousands ofdollars? It became clear to me at an early age that if I were to succeed inthe industry, I needed to pick up the secrets of these pros.
As a student of the markets, I have taken these lessons and incorporatedthem into my own trading, and I have shared bits and pieces with the publicwhen doing market analysis on TV and when I speak at conferences andseminars. Doing daily appearances on Bloomberg and weekly appearanceson CNBC gave me a platform from which to offer viewers a small doseof the fundamentals I believe everyone should know. The hunger for thistype of fundamental information became very noticeable when I began toreceive e-mail messages from viewers of Bloomberg, CNBC, and ROBTv(Canadian business television) asking me to explain, in greater detail, thepoints I had discussed in that day’s interview. Speaking at industry eventsgives me an opportunity to see what type of information is available tothe trading public. As I walk down the aisles of the conference halls, Inotice hundreds of books on technical analysis—everything from Japanesecandlestick methods to astrological market timing—but the one thing that Iseldom see is anything written about the basic market structure and how toincorporate this type of fundamental information into the process of makingtrading decisions. There seems to be a lack of basic understanding amongthe general trading public about what really makes the market move.
It is so easy to look at a chart and make a simple trading decision basedon what the support and resistance lines indicate, or put on a position basedsolely on technicals without looking at the fundamentals of a given trade.Professional traders will tell you that charts conﬁrm what the fundamentalsare saying and, in some extreme cases, will argue that the only thing thatmatters is fundamental analysis of a market. It has become my mission toenlighten the public about the little things that happen daily that profes-sional traders watch when putting on trades rather than applying a thesisthat explores after-the-fact analysis of market pricing or market timing.
Traders are a rare breed. It’s been said that the life of a moneymakingtrader is a charmed life indeed! Anyone who has ever traded anything wouldhave to agree. The incredible high experienced when you are right and havea winning trade on can be matched only by the depth of disappointmentyou feel when you are covering a position for a loss and know you have
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been dead wrong. It’s the constant swing in emotions that excites traders.We are nothing more than thrill seekers in the most pure form, exceptthat we’ve substituted the market for roller coasters and skydiving. I havebeen fortunate enough in my career to be exposed to some of the greatesttraders in the world, and some of the worst. It might sound silly, but badtraders—even more, horrible traders—taught me more about trading thananyone else.
I have written this book in narrative form rather than creating a textbookon futures trading, as it’s my belief that you can learn much more from thedaily grind of the market—in my case, the ﬂoor of the Chicago MercantileExchange—than anywhere else. Hopefully, the characters and traders whoplayed a role in shaping my career and those who inﬂuenced me the mostwill have the same tutorial effect on you, the reader, as they have had on methroughout the last 20 years of my life. I’ll share with you the thoughts ofmany of the greatest traders as they put trades on—and took them off—fora proﬁt or for a loss.
We’ll explore the psychology of trading and examine the panic andeuphoria that drive the market to extremes and, more important, how agood trader makes a proﬁt from the price aberrations created by those ragingemotions. I’ve seen so many good trades turn into bad trades because thetraders simply didn’t understand the underlying emotion that was driving themarket. A good example is the recent run-up in tech stocks. Sellers just couldnot grasp the euphoria that was driving that sector of the market, and manyold-timers stood in amazement as the Nasdaq soared past 4000, then 5000,asking themselves with painful looks on their faces, “What is happening?”Those investors who did their homework and made a fortune during thelate 1990s understood what was driving the market—a combination of Y2Kspending coupled with an Internet revolution, producing a buying panic thatlaid the groundwork for one of the biggest balloons the stock market hasseen in decades.
It is important to understand who trades futures and why. We will askourselves who trades options and, even more important, how their tradesimpact what we do on a daily basis. We will explore and understand the truenature of liquidity and leverage and realize that these are the concepts thatdetermine the success of an exchange-listed contract. In fact, it can be saidthat what an exchange brings to the end user—any exchange, regardless ofwhether it’s the NYSE or the CME—is simply liquidity and leverage, nothingmore. It is imperative to look at the different participants in the marketplaceand try to understand the logic that underlies the trades that they initiate.What most new traders don’t recognize is that knowing the players in thegame is half the battle! We’ll look at different trading and investing method-ologies that make sense in today’s marketplace. The Peter Lynch method(Chapter 1) is a wonderful example of a simple strategy and perhaps the
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biggest secret in the trading community. If you’re trading futures, know whatyou are trading, and if you’re buying stocks, know what you are buying. Itmight sound simple, but it’s the lesson most often forgotten by experiencedmarket professionals, not to mention the general trading public. These arethe types of mistakes I’ve witnessed over the years, which, if properly an-alyzed, can help teach students of the market what we should know—thenuances of daily market price action. The essence of this work is summedup in that very question: What drives the market from day to day, and howcan I capitalize on the price action created from the volatility?
It’s been said that when it comes to trading in the markets, many arecalled but few are chosen. We must discover what the qualities of those rarefew “chosen” are (Chapter 2). For example, what makes a great scalper aposition trader? What are the qualities that make a great options trader?What is it about risk that these players inherently love, which gives themthe ability, physically, emotionally, and mentally, to take on the markets ona daily basis?
Often, the commentary we hear on the various business televisionshows becomes the extent of our market knowledge. We hear the termscommunized trading or asset allocations, whether it’s a ﬁxed income, eq-uities, or Forex, but do we really understand what the mechanics of thetrade will do to the pricing of the market we’re presently trading (Chapter3)? The impact of these orders can be huge! I’ve described these ordersby saying it’s as if someone is trying to turn around an aircraft carrier ina small bay, leaving a big wake, and it’s up to the trader to capitalize onthat disruption and ride that daily aberration to a greater trade and a betterproﬁt.
We’ll take a good, hard look at news and corporate events and how asingle headline can change the attitude of a given market’s liquidity. Thereare news events and corporate actions that guide traders on a daily basisregardless of earnings, expectations of those earnings, or board actions.We’ll look at arbitrage and the different types of arbitrage opportunitiesthat drive the market and have become a large, important liquidity providerin the marketplace daily.
Understanding the various types of arbitrage hitting the market willgive us a better feel for direction. Keep in mind that there is index arbitrage,statistical arbitrage, and risk arbitrage, and collectively they create a poolof liquidity the market has found essential. And this book would not becomplete without adding the impact that hedge funds have had on marketaction, especially as they become larger in size and trading activity. A ques-tion frequently asked of me when I bring guests to the Chicago MercantileExchange is “What are the traders watching?” The next few chapters shouldgive you the ability to step into a trader’s shoes and view the market theway that that trader would.
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We’ll take an in-depth look at managed futures (Chapter 4), about whichan entire book could be written. This has become an important part of anylesson on futures trading, because the proliferation of these products hasturned managed products into the fastest-growing segment in the alterna-tive investment universe. (I hate using the term alternative investmentswhen referring to managed futures; quite frankly, these are investmentsthat should be regarded as mainstream.) We’ll discuss modern portfoliotheory and unveil another of Wall Street’s well-kept secrets, the exclusionof managed funds from the portfolio.
What most investors don’t know is that every investment model al-locates a portion of assets to commodity-based exposure. But investmentadvisors are asked to eliminate that from the recommended portfolio. Why?For two reasons: The advisor simply doesn’t understand the vehicle (unfor-tunately, a growing problem in the wealth management industry) or theinvestor doesn’t ﬁt into the qualiﬁed investor category. The latter problemhas been solved as a result of the proliferation of registered multiadvisormanaged funds open to general investors. These have low minimums—inthe $10,000 to $25,000 range—and accomplish their main objective, truediversiﬁcation of the portfolio.
We will examine the creation of the e-mini, the most successful conceptthe futures industry has seen in decades. As a former member of the ChicagoMercantile Exchange board of directors and chairman of the equity indexcommittee when the concept was introduced to the trading community, I’llshare my insights into the introduction, marketing, and growth of the prod-ucts that have revolutionized trading futures. Looking at the e-mini, we willdiscover that the role of the market maker on the ﬂoor of the exchange haschanged considerably. In short, the ﬂoor has lost the right of ﬁrst refusal—inessence, what has taken place is that the trading edge has shifted from beinga geographical edge in the pit to being a technological edge off the ﬂoor. Inan open outcry arena, the market maker or local can change from being abuyer to being a seller in an instant, based on order ﬂow and pit positioning.Locals made the market. But now the pit no longer determines the trade,it is no longer the central price discovery mechanism, and in fact, it canbe said that what was previously an open outcry market with a small elec-tronic pool of liquidity attached to it has turned into an enhanced electronicfutures market with a small captive pool of ﬂoor liquidity attached to it.
The psychology of the marketplace is a very important subject. Manybooks have been written on the psychology of trading, but most averagetraders fail to remember that the market is based on two simple human emo-tions: fear and greed. I’ve always tried to understand the emotions drivingthe trade almost as much as the underlying fundamentals of any given mar-ket. I’m a true believer in feeling right about any trade, and understandingthe market sentiment gives the trader an emotional edge. Why is it that the
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best professional traders have had their biggest proﬁts in markets that godown? It’s because they know that the psychology of a breaking market ismuch different from that of a rallying market. Euphoria, greed, panic, fear—these are all very real emotions that play a role in every trading decisionmade.
We will look at random walk theory (Chapter 7), which is a guiding prin-ciple for many professors teaching graduate school in many of the businessprograms around the country. We’ll look at the world of technical analysisand ask ourselves if it really does work and, more important, if there iscredible evidence that it does,