<s> LONG-TERMSECRETSTOSHORT-TERMTRADING
LARRY WILLIAMS
PDF PACKED BY TRADERMAN(IT WASN’T ME THAT MADE THE SCAN, I ONLYPUT IN A MORE PLEASANT FORM.THANX TO THE GUY THAT MADE THE SCAN)
ContentsIntroduction You Are Already a Commodity Trader
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Chapter 1Making Order Out of Short-Term Chaos
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How 1 Learned about the Market
9
Charting the Market
11
The Nonrandom Market
14
Understanding Market Structure
15
Chapter 2It's a Question of Price and Time
23
All You Will Ever Need to Know about Cycles
23
The Natural Cycle of Range Change
27
Where the Trend Is with You-The Second Power PlayPrice Pattern
36
Chapter 3The Real Secret to Short-Term Trading
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It Is All about Time
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Chapter 4Volatility BreakoutsThe Momentum Breakthrough
57
Simple Daily Range Breakouts
61
A Look at Volatility in the S&P 500
66
Separating Buyers from Sellers to Find VolatilityUsing Market Swings to Follow Volatility
71
Results
72
One Step Further
73
Chapter 5The Theory of Short-Term Trading
75
What Is Wrong about the Information Age
78
E. H. Harriman's Rule of Making Millions
79
Chapter 6Getting Closer to the Truth
81
The Market Is Not a Coin Flip
82
Monthly Road Maps
89
Chapter 7Patterns to Profit
93
The Common Element
94
The Questions to Ask
99
My Smash Day Patterns
101
How to Use Smash Day Patterns
104
Specialists' Trap
108
A Vital Note-This Works on Shorter Time Frames as Well
113
Oops! This Is Not a Mistake
113
S&P Oops! Trading
119
Chapter 8Separating the Buyers from the Sellers
121
Greatest Swing Value
123
Stock Index Trading with Greatest Swing Value
124
Some Pointers
128
Chapter 9Short-Term Trading from a Quote Screen
131
How a Quote-Screen Trader Makes Money
132
Swing Points as Trend Change Indication
134
The Three-Bar High/Low System
136
A New Indicator for Short-Term Traders: Will-Tell
138
Will-Spread and the S&P 500 Stock Index
141
Chapter 10Special Short-Term Situations
147
Month-End Trading in Stock Indexes
147
Target Months
148
Making It Better
149
Month-End Trading in the Bond Market
149
Getting Specific
152
Better and Better
153
A Time to Sell as Well
154
Chapter 11When to Get Out of Your Trades
157
Chapter 12Thoughts on the Business of Speculation
159
What Speculation Is All About
160
It's about Time
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Trade Management
161
Essential Points about Speculation
162
Chapter 13Money Management-The Keys to the Kingdom
171
Most Traders Use a Hit-and-Miss Approach
172
Approaches to Money Management-One Is Right for You
173
The Good, the Bad, and the Ugly of Money Management
175
Looking in New Directions, Drawdown as an Asset
178
Back to Ryan and Ralph
183
Chapter 14Thoughts from the Past
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Chapter 15Just What Does Make the Stock Market Rally?
233
Logic 101
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These Words Are My Bond
234
A Look at Data A and Data B
235
Let's Break Some Bad Habits
237
How to Break Bad Habits
238
Comments on Setting Stops-Dollar Loss and Unpredictability
240
Chapter 16Closing Comments
245
It Is just Like Life
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Index
249
Introduction
You Are Already aCommodity Trader
Whether you know it or not, you have been trading commodities all your life. Sure, you may havenever traded a contract of Pork Bellies, but you have almost certainly traded a possession like a car, house,or antique for someone else's money or possession. If you have never done that, for sure you have tradedtime for money. You have traded your time as a teacher, lawyer, pipe fitter, or ditchdigger for someoneelse's money. So, you are halfway there. you just never knew it!When we trade our time, we are actually trading our time plus our skills. That is why a brain surgeongets more per hour than a knee surgeon. That is also why an outstanding quarterback gets more than atackle and surgeon combined. He has a greater career risk. It is not that one skill is inherently morevaluable than the other, it is that one is more difficult to come by and carries higher risk. This characteristicgenerates more dollars for the person selling his or her time and skills.There is no intrinsic value to Michael Jordan's dribbling and shooting skills, but the owner of theChicago Bulls saw an opportunity to make a great deal of money with those seemingly valueless skills by.packing stadiums and getting television revenues. Thus, something of “no value” may have great value.At a trading seminar, I once demonstrated this point by, placing a personal check of mine in a scaledenvelope and then added it to 14 similar envelopes in a clear plastic bag. The attendees each had theopportunity to reach in and draw out an envelope. The person who drew the one with the $5,000 checkwould be allowed to keep it.The bag contained 14 worthless envelopes, but suddenly they had value Although all but one wereempty, there was a 1 in 15 chance of Winning $5,000; thus each envelope, or opportunity to take out anenvelope. Was worth $333.33. Once the participants began taking envelopes out of the bag,
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2those empty, worthless envelopes gained in value. After all, once five empty envelopes were removed, therewas now a 1 in 10 chance and the value had risen to $500. When just two envelopes were left in the bag,people in the audience were willing to pay $2,500 to dip their hand in and pull out an envelope! Suddenly,what was worthless had great value!That is your first lesson in becoming a more aggressive commodity trader. Value, like beauty, is in themind of the beholder. As a trader, the lesson is never to second-guess what value really is: it is what themarket will pay. It (the market or collective judgment of other traders) may not pay that value for long, butprice is King, it is what is. I learned long ago not to argue with what is.In 1974, I reached a value judgment that the price of Cattle would skyrocket so I began loading up,taking my first position at 43 cents a pound. I "knew the value" of Cattle; at this price, it was way undervalue offering a sure trade. So, as price drifted to the 40-cent area, I bought more. After all, if 43 cents wascheap, 40 cents was even better.At 38 cents, where price next went, I had a steal, and being no dummy, I stole some more, only to seeprice plummet to 35 cents, then 30 cents, and finally 28 cents-where, dear reader, I was tapped out. Myresources were limited; this move cost me about $3 million, all in less than 30 days.Two months later, the price of Cattle soared to over 60 cents a pound. But I was not there-a sure-thingtrade had set me back dearly and helped contribute to rumors, afloat still today over a quarter of a centurylater, that I blew out trading, despite a few successes I will get to later in this book.Reflecting on this experience over the years has enabled me to formulate two important rules. The firstis that value is ephemeral: it can be anything, and anything can and will happen trading commodities, orstocks for that matter.The second rule, which carries greater weight is that although market trend and direction are majorconcerns, knowing how to deal with Your resources has the highest priority. After all, had I marshaled outmy resources on the Cattle trade so I could have ridden through the bad times, I would have made arespectable killing.You never know when the markets will do what you think they are supposed to do. Many times, likeGod, the market does not deny, it just delays. Serious traders weave protection against this delay into thefabric of their program. There is no greater rule to learn than that of money management. All the horrorstories you have heard about commodity trading are true. Good people have been totally wiped out by doingthe wrong thing. That wrong thing has never been the market, nor the fact the trader made a bad call. Indeed,every successful trader will have bad calls, losing trades. And lots of them
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The wipeouts you have heard about, every single one of them, have come from placing too large a beton a trade or holding on to a losing position too long. The sooner you learn to master your defeats, thesooner you will be on your way to amass the wealth possible in this business. It is your failures, not yoursuccesses that kill you in this business. Failures do not build character, they destroy your bank account.The foundation to all your success is in the preceding paragraph. Psychics may or may not be able topredict the market, value may or may not prevail. The world of speculation is about predicting the futureand that is difficult at best. The fabled United States military complex, which had supposedly bankrolledthe brightest of the bright, and thousands of intelligence officers, was not able to predict the fall of theBerlin wall' So how can you and I hope to do better?Our inability to see the future very well is proven yearly by such august sports magazines as SportsIllustrated. In 1997, their oracles predicted Penn State would be the number one football team, rankingMichigan number 18. By the end of the season, Michigan was number one and Penn State floundering.Washington was supposed to be number three, but was beaten by lowly Washington State, a team notmentioned in any top 20 list, that went on to win the Pac 10 championship and almost upset Michigan inthe Rose Bowl'People who make their living looking into crystal balls are destined to eat a lot of broken glass.But take heart: although neither you nor I can divine the future, especially price action, we can learnto control our losses. That is a certainty, based on math, that will provide the building blocks for yoursuccesses. Each and every one of them.For years, I chased the prophets of profit, those financial soothsayers who claimed they, or theirindicators, could reveal the future. Eventually, I realized that God does not want us to see the future. It isas simple as that.If we could see "out there," we could all be millionaires many times over. We would bet the ponies,spin the roulette wheel, and roll dice, except of course, no casino would back the other side of anunwinnable wager. Besides, how thoroughly boring life would become if we could know today how everyday of our future would be. Who would want to live that way-- Where's the joy of discovery, the magic ofthe unknown, the thrill of victory, the challenge of overcoming limitations?If we were all be rich from our powers of foresight, who would work for us, grow wheat, raise cattle?There would be no phone company, no movies, and no television, as no one would need to work. Worseyet, who would hire us?Like I said, God with infinite wisdom, does not want us to know much about the future and for surevery little about the future of futures.
4Would-be speculators think this is a game of knowing the future, of knowing that which cannot be known. Itis not. This is a game of developing strategies with winning advantages, getting the odds on your side,working those odds, and staying alert to any potential changes in the game including new players or newideas and concepts.The word speculate comes from the Latin specular, meaning "to observe," as in spectacle (yourglasses). We are not like gamblers, who enter a game they cannot win over time. All they can do is hopechance will run their way, not that of the house. We speculators observe how things should happen in thefuture, but because we know there are no guarantees, we protect our position with appropriate preservationof capital techniques, so we can win at our game.The art of speculation requires one part observation tossed together with one rather large dose ofpreservation.My Most Important Market BeliefBased on my research and experience, I have developed a powerful and profitable belief system:I believe the current trade I am in will be a loser ... a big loser at that.This may sound pretty negative to all you positive thinkers, but positive thinking can give way tothinking you will win-a surefire formula for buying and selling too many contracts and holding on too long.After all, if you are positive things will work out, you are certain to hold for a bounce or turn that nevercomes.I look at it this way, if you get all pumped up and glossed over with positive beliefs about your marketsuccess, your conviction will lead you to mismanage losing trades. That is why belief systems are soimportant to a trader. If your belief system tells you the current trade will be a winner-and it isn't-the need toconfirm that belief in your mind will literally force you to let losses run, to stay with losers, something nosuccessful trader ever does. An outrageously positive belief that the next trade or two will turn your accountaround or make a small fortune for you is most dangerous.Now let's look at my belief that the current trade I am in will be a loser, that I have no pact with God forsuccess on this trade. Indeed, I genuinely believe the market is not precisely perfect. Keep in mind the datafor this belief overwhelmingly supports it; 75 percent of mutual fund managers do not outperform the Dow,80 percent of short-term traders lose their risk capital. On a personal note, many of my own trades do notmake money, and I can positively guarantee many of yours will not succeed.
5No major loss I have ever had, and I have had more than my fair share of them, has been the market's"fault." "They" were never out to get me. I got myself by believing my current trade would be a winner soI did not follow the rules of the game.I agree with those who say you are only as powerful as your belief system because that belief will giveyou the power of taking an action with more certainty and less hesitation. We act out what we believe:those mental beliefs are the scriptwriters for our play of life.Adopt my belief that the current trade will most likely not work out and you sure as heck will protectyourself with stops. You will control disasters, taking the first lifeboat possible instead of going down witha sinking ship.Adopt my belief that the current trade will most likely not work out and you sure as heck will not loadup on a trade, banking on it to ball out all your problems. A tiny loss can wipe you out when you havetaken a very large position or number of shares or contracts.Positive beliefs about future results cause us to take on undue risk. Doing that in a game where theodds are unfavorable to begin with is a sure invitation to disaster.The Beginning of My Career as a SpeculatorI ride rodeo because Im too lazy to work and too honest to steal.-Freckles Brown, World Champion Bull riderMy career as a speculator began in the seventh grade when a kid named Paul Highland showed mehow much money could be made flipping coins, matching quarters or odd man out for the shiny silverdollars we lugged around in our Levies. Growing up in Billings, Montana, was an excellent precursor tospeculation. Flipping quarters was my start; sure I lost some, but if there was anything I understood, otherthan my art classes and playing football, it was that there was plenty of real easy money to be madegambling for quarters and dollars.It may well be that everything I needed to know about speculation I learned in jr. high. It took a while,but I finally figured out that Paul and Virgil Marcurn were taking my money by teaming up. One wouldcontrol his coin so a head came up, the other a tails so I could not win. Later they split the proceeds, and Ihad my first lesson on market manipulation.I did not call the police or any authorities. I handled it in my own way, and to this day distrust thebureaucrats that are supposed to right such wrongs. They don't, at least not in time to help you or me.Jack McAferty was the toughest kid in Billings. Fact is he was the toughest kid in the entire state ofMontana and that's saying a lot considering the number of cowboys, roughnecks, and miners we had in
6the Treasure State. When a big guy hits you on the arm it hurts. When Jack, who was not a big guy, sockedyou on the arm your bone ached. He had unbelievable power, which served him well in every single fight Iever saw him in. No one came close. Fighting became his way of life and jack was killed by an L.A.policeman, supposedly on a freeway chase. The truth, however, is that Jack, a real ladies man, had beendating the cop's wife.Most the guys who were coin-matching speculators would not play with Jack. Usually he would payoff, give you his quarter, but if he decided not to, what was your choice? Threaten him and get the livingcrap beat out of you' . Ah, another lesson in speculation, choose your partners and business associatescarefully.Years later, we took a $5,000 account to over $40,000 trading a Cattle system Richard Ulmerdeveloped. This happened at a brokerage firm owned by George Lane, a guy who claims he is the originatorof the widely followed Stochastics Index. Well, George did not invent Stochastic, and I did not get my$40,000 from the brokerage. The regulators closed old George up and just before they did the funds weredrained from my account!Another thing I learned from jack was that strong people do not respect weak ones. I had put up withenough of Jack's reneging on our coin flips so when he decided not to pay up and kept his quarter, I blastedhim in the stomach as hard as I could. Astonished, he glared at me, asking, "Why the hell did you do that?You know I'm going to clean your clock now."All I could say was, "Well go ahead and do it, I'm just tired of you not playing by the rules. I knowyou're going to break every bone in my body and you'll get a lot of pleasure out of that, but it won't compareto how I feel knowing I stood up to you."jack shot back, "I like that, I respect you," handed me the quarter I had just won, and walked away. Webecame pretty good friends after that, but we never matched coins again.Everyone in Montana works hard. Certainly, my dad worked as hard as anyone, putting in over 40hours a week at a refinery, then more hours on weekends at Doc Zinc's sulfur refinery. And as if that wasn'tenough, he would stay up late at night reading books, taking courses on electronics so he would be morevaluable to Conoco, his career employer. The gambit of hard work and loyalty paid off-he got promoted.One of the advantages of having a father working at the refinery was that his kids could get summerjobs there if they were in college. I did that, too, and it reinforced my strong desire to not do what these guysdid: work. They worked long hours, ever-changing shift work. One week, you went to work at 3:30 P.m., thenext week at 11:30 P.m., and the following week you might pull the 3:30 shift or start at 7:30 A.M. Therewas neither rhyme nor reason to the schedules that I could see. All I saw was the unending hours of
7voluntary servitude in a hot, stench-filled noisy refinery, a place where nothing made sense to me.There must be a million valves in an oil refinery and I am certain they all turn on and off the sameway. My problem was I could never figure out which way was the right way. That was frustrating, not onlybecause it showed my ineptitude, but also because it also reflected on my father, who had all thismechanical stuff down pat. There really was nothing mechanical he could not fix. If I were to have aopen-heart surgery, I would trust him more than a doctor.Dad knew how to build things (our house, delicate cabinetry for mom) and knew how to fix things-inpart, I am sure, because we did not have money to pay to get things fixed. Poor people develop more skillsthan rich people.My ineptness also held me up to ridicule when people compared me with my older brother, who justnaturally knew what to do at the refinery, and seemingly got along well with the older men. My generallaziness coupled with a desire to be alone and a total inability to do anything well, but draw, caused me tofeel inadequate. My initial response to find self-esteem came from sports. But that sense of approval onlylasts through the game. I would lay awake in bed dreaming, scheming about a way to have a better life,wondering how the few people with really big houses achieved success. I was not content; what I wantedwas a way out.Flipping coins seemed reasonable; making fake driver's licenses (for $5 each, birth certificates for$20) paid a lot better. My limited artistic talents made more money and let me work by myself. It alsoincluded a healthy dose of risk. I liked knowing that I was doing something the average person couldn't orwouldn't; and for sure, I was not going to find that kind of satisfaction in what I saw at the time as myfather's humdrum existence. My dad did everything by the book and followed all the rules-with oneexception.When deer season came, the rulebook went out the window. We killed enough deer, antelope, and elkto feed our family for the year. We used the same deer tag or license three or four times. When it comes tosurvival, I learned there are no rules: people must take risks, even my Pops. What did I like most aboutthose hunting trips, bagging my deer or taking the chance of getting caught with too many deer, fish, orother game? I have often thought about that. In their own way, they are both thrilling-my speculative careerbegan on a roll.Really good speculators like thrill, indeed they seek it, as some sort of intellectual rush.Maybe that is why I liked selling newspapers on the street corners after school or Christmas cards andgarden seeds door to door to pick up spending money. I was at risk, never knowing if I would make a sale,but I also might make some decent money for just being there, talking, and showing some stuff.
8I had seen enough hard work to know I did not covet it. Like rodeo riders, I was "too lazy to work” andhad been raised "too honest to steal." Hence going to college or joining the Navy after high school seemedto be the right direction, and it was one my mom and dad encouraged. They always told us to do better, thatthere was an easier life, and college was the door to that life.In 1962, I asked someone what the "most active" list of stocks in the newspaper meant. I was hookedwhen he replied, "Well, see that stock for General Motors was up 1 1/2 for the day? Had you bought ityesterday, you would have made $150 today."$15 0 in one day!Wow, this sure beat flipping quarters! Back then, $150 was more than guys at the refinery made in aweek. This looked easy, and the winnings were staggering. My only two questions were, how did one getstarted and where had I been all my life? There was an instant affinity between me and what looked like easymoney!That affinity led to the greatest challenge of my life, something I have worked hard at just about everyday since 1962. Really, my only "time off" from the markets occurred when I ran for the United StatesSenate in 1978 and 1982. Other than those two interruptions I have spent every day of my life "working,"much to my father's pleasure, I am certain, but it has never resembled work at the refinery or jobs in andafter college.From this experience, I believe three motivators are found in the heart of a successful speculator: anintense desire to make a lot of money, a longing or yearning to show somebody else up, and an internaldiscontent with how things are. Great big chunks of unrest seem to be an important asset for a speculator.Although most people seek balance in their life, I have never found that very healthy; no great achievementswere ever made by perfectly normal people. Sometimes I think about living a more balanced life. Thatthought usually lasts a couple of seconds. I guess my unrest will never go away, but if my lifestyle tells usanything, it is that unrest fans the flames of a speculator's internal fires.I would probably trade the markets without wanting profits if it "proved" my worth to the world, to anold girlfriend, to my parents, my brother, or even someone I cannot identify or dredge from the recesses ofmy mind. Saying I am ego-driven may be correct, but it is not about bragging, it is about showing them I canovercome.It is about letting the world know I found a way out.If these words have resonance for you, cinch up your seat belt, you are going on the ride of your life.
Chapter 1
Making Order Out ofShort-Term Chaos
There are two primacy says we make money trading, catching a big price move with a smallposition or having a large position and catching a small move.-Bill Meehan
If what I have written so far has meshed with your speculative goals. it is time to learn how marketsoperate. Speculation-stock and commodity tradingis not for everybody; it may not be for you. I have evenwondered at times, if it is for me'.
How I Learned about the MarketMy career as a trader began in Portland, Oregon, where I had met a Merrill Lynch broker who thoughtwe could make some money together. He -was half right, we got lucky immediately. He made good moneyon his commissions and I lost money. Worse yet, the money wasn't mine; a fellow I had never met hadasked me to invest it. In hindsight, the initial beating I took was more than fortunate, it was life changing.That event hardened my desire to learn the business; after all. if it Was that easy to lose, it had to bepretty easy to-win, right? My broker was as new to the game as I was and really had very little advice orsuggestions.
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His market insight was to buy good stocks and hold on (a brilliant insight), but my aptitude or desire was tomake money from catching short-term market swings. Thus began my education as a short-term trader.I had no teacher and knew no other traders, so I naturally turned to books to help solve my problems,just as you have in buying this book. The authors all made it sound so easy. I read Joe Granville's classicwork on technical analysis and began keeping daily open, high, low, and closing prices on stocks as well asindicators Joe said we should follow. Before I knew it, I was not only totally consumed by the markets butspending 5 to 6 hours a night and all my weekends on trying to beat Wall Street, gaining a fortune, andbeginning to lose a marriage.My first wife, Alice Fetridge, had become a "chartist's widow" yet still supported my habit. Weeventually left Portland and moved to Monterey, California. We both had jobs, and I was also working onmy law degree. I even sat for and passed the “Baby Bar Exam" (the test given to night school andcorrespondence students). By then, however, I had pretty much given up on becoming a lawyer, especiallyafter working for one. I had thought being a lawyer meant being in court, saving people's lives; the realitywas that it dealt with collecting money from judgments, finding deadbeats, and representing bums andoutright criminals. It was not like trading.Fortunately in Monterey, I met two brokers who, like me, kept charts. Joe Miller and Don Southardwere soon swapping war stories with me, teaching what they knew about the markets. We were all bigfollowers of Granville's On Balance Volume (OBV) work and kept OBV charts on the 30 to 50 stocks wefollowed. I also started to keep moving averages, another tool espoused in all the books back then, just asthey are todayMy stock trading met with some success, but what accelerated my career was a book by Gil Haller,unabashedly called the Haller Theory. I learned a lot about stocks and speculation from the book, then got toknow Gil and to this day appreciate the support and encouragement he provided. Gil's concept was to buystocks that had already moved up a lot. This is now a methodology used by the funds to buy what they call"momentum stocks." Haller was doing it way back in 1964 and making a living. But, he didn't live the wayI wanted to! His desk was an old door atop cinder blocks, stationery was the back of a letter someone elsehad written him. Gil was not cheap, just a frugal spender who precisely counted and saved every extra pennyEventually, I began to envision a theory of how markets work: In the short term, markets spurt inrallies and declines, moving above and below a balance point I could call the "average" price. My objectwas to determine when price was low and should move back to the average. That meant I needed to identifyan overextension of price and then have something that would tell me when this move was over and thespring back to the average had begun.
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Because it all seemed so easy, I was sure there must be some master theory or code to how all this wasdone. There must be some basic undeniable way the market-all markets-moved from point A to point B, Ireasoned.What I eventually found out is that this original thesis is true: there is a way markets move. The goodnews is that there is a structure in how prices move from point A to point B. The bad news is that thestructure is imprecise. Nevertheless, there is a semblance of order to price action, and like a foreignlanguage, it can be learned. It has taken most of my life to figure out the basics of this language that themarket speaks, and I am more than happy to help you learn to use my magic decoding ring.
Charting the MarketIf you have begun your study of the markets, you already know it is a visual world, where charts prevail. Asshown in Figure 1.1, the common charts represent each day's opening price with a horizontal slash mark to the leftside of each bar and the closing price with a horizontal slash on the right side of the bar. The topmost point of the barreflects the highest price reached by the stock or commodity during the day while the bottom of the bar representsjust the opposite, the lowest price the commodity traded at on that day.
Figure 1.1 Typical Chart showing openings, closings, highs, and lows.
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The opening price, as you will see later on, is the most important price of the day. I developed thisnotion with Joe Miller, Don Southard, and Curt Hooper, a naval postgraduate student who-in 1966-was thefirst person I ever worked with using a computer for answers. While we were impressed with OBV, wewanted a more reliable formula; and once we learned that the original OBV work came from two guys fromSan Francisco, Woods and Vignolia, we thought we too could create a better approach.Our chart reading problem begins and gives birth to chaos, when we start combining these daily bars ofprice action on a chart. These graphic representations of price action were "read" for years by folks callingthemselves "chartists." By and