Tim Bourquin of TraderInterviews.com recently interviewed Steve Palmquist, the author of How to Take Money from the Markets: Creating Profitable Strategies plus Six Ready-to-Use Systems.
Click the play button below to hear the interview or read the transcript below.
Interview transcript:
TraderInterviews.com: Hello, everybody. It's Tim Bourquin. I'm here today with Steve Palmquist and Steve got a new book out that we're going to talk about. He's been around the trading game for quite some time and he's got a website that he talks about some of his trading strategies and things that he's doing. The book is called How to Take Money from the Market. It's also got a subtitle that we'll get from Steve in just a minute, but we're going to talk to him about his overall approach to the markets and how he finds good opportunities. So Steve, thanks very much for joining me on the phone today.
Steve Palmquist: Well, it's good to talk to you.
TraderInterviews.com: All right. Give us that subtitle. We talked about it before we started recording, but it was kind of a long one. So why don't you tell us the full title?
Steve Palmquist: Well, the full title is How to Take Money from the Markets: Creating Profitable Strategies plus Six Ready-to-Use Systems which is quite a mouthful, but then trading takes a little bit of effort.
TraderInterviews.com: Okay. So let's talk about your overall approach to markets and how you've kind of come as your overall strategy and methods for finding good opportunities then we'll talk a little bit about the book as well. So what kind of trader are you? Are you a short-term day trader or swing trader? Kind of talk about that and the markets you trade.
Steve Palmquist: Well, I'm a profitable trader. I don't try to focus on a particular market or a particular holding time. What I do is I look at the market and say it can only really do three things, right? It can be trending up, it can be trending down, or it can be a trading range moving sideways, and I found through testing hundreds of different trading systems that different systems work in each of those market conditions. So the first thing I do is look at the market and if it's trending up, then I open my trading toolbox and I pull out the systems that have shown good results in up-trending markets and if it's moving sideways I open a different tour in the trading toolbox and pull out different systems. But the key is to read the current conditions and use a system that has been tested for that environment.
TraderInterviews.com: How about the specific market or markets that you trade?
Steve Palmquist: I have a database of about 2,500 stocks and what I do is I trade patterns out of those stocks. So I'm looking for a particular price in volume pattern and I don't particularly care what the stock is.
TraderInterviews.com: Okay, and the systems that you talk about, either the six systems or any system, are these automated totally or are they just giving you signals and then you actually decide which signals to take?
Steve Palmquist: Yeah, I run the scans every evening and they give me maybe 20 different stocks that have set-ups that have shown profitable opportunities in the past and then I prioritize those based on the market conditions. For example, if the market is in a very narrow trading range like we've seen in the last five days, I just stand aside. I will ignore the signals from the system because tight trading ranges are an increased risk kind of an environment. If the market is in a wider trading range then I will take and maybe trade half-size positions and if the market is trending then I may trade full-size positions.
TraderInterviews.com: The scans that you're running on a nightly basis, what ideally or how many stocks do you want to give you to be able to look at the next day? How many is too many and how many is just right?
Steve Palmquist: Well, it's interesting. I get that question from my subscribers to my newsletter and one guy wrote me and he said, "Well, you know, we had 15 stocks and they all triggered yesterday and that's just way too many." To my way of thinking, you can't have too many profitable opportunities. You can have too few perhaps but you can't have too many. So it's a question of prioritization. If in my portfolio in the current market condition, say maybe I want to hold a dozen positions and I've got 10 so I'm looking for two new openings, if I see a half a dozen stocks that hit a trigger point and are therefore interesting, then I'll prioritize them based on risk reward ratio. How far did they have to run to the next resistance area? The risk would be my entry point less where my initial stop-loss would go. I will also look at volume patterns. My research has shown that the volume pattern on the stocks is very important. So I use all the things that I have tested to then prioritize those and I just rank order. If I have two openings, I pick the two that filter up to the top.
TraderInterviews.com: Can you give us an example of one of these systems that maybe is your favorite or that you like to use in one specific market environment?
Steve Palmquist: Sure. When the market is trending either up or down, one of my favorite trading systems is to look for what I call a DV pullback. It's a declining volume pullback. So if the stock has been trending up and then you see a lower high three days in a row and you also see lower volume three days in a row, that set-up shows a very good statistical advantage in a trending market.
TraderInterviews.com: So am I going long or am I going short with that?
Steve Palmquist: If it's a pullback and an uptrending stock, then I would take a long position. If it's a retracement and a downtrending stock, then I would take a short position.
TraderInterviews.com: Okay. So when you're talking about these trends, give me a better sense of -- are you looking at a daily chart? Is that where you're determining where that trend is?
Steve Palmquist: I typically look at the daily chart for the last 12 to 14 months, and you look at the chart -- a lot of people say how do you tell if it's an uptrend? The best response is ask a fifth grader. If you have to question whether or not a stock is in an uptrend, it's obviously not. So I'm looking at stocks that are setting a series of higher highs and higher lows. It's a kind of thing you could easily draw a trend line underneath and see as clearly moving up over time on a fairly regular basis without wide erratic kind of swings, and then nothing goes straight up forever. Stocks don't go up every day so they run up for a little bit, they pull back for a little bit, then they run up again and they pull back again. I found in testing that when they pull back on declining volume every day the price drops a little bit and I see where people that are interested in selling kind of a thing. Then I look for a resumption of a trend. I look for another up day on increasing volume, back to where the volume was before to show that perhaps that trend is renewing itself.
TraderInterviews.com: You kind of led to my next question. So when you have these three days of declining volume and declining price, does that mean then you will buy on the open or what do you want to see to confirm that that's going to happen? Where do you decide where that interest is going to be?
Steve Palmquist: Again, it depends on the market conditions, but if it's a bullish market what I'll look for since I look for three days of lower highs, I'll look for that pattern to break. I'll look for the stock to make a higher high, go above the previous day's high, and if it does so on volume above the previous day's volume, then it started a new pattern. It's resumed doing what it used to do in terms of the uptrend and that's the point that I enter.
TraderInterviews.com: Do you try to pick a specific price? Is it right at the price where the high is or above that price? How do you kind of determine then very specifically where you get in?
Steve Palmquist: I set up with my online account to have it beep my cell phone when the stock breaks the previous day's high and then I go look at it. Now, sometimes I guess stocks, most stocks gap up in the morning so you don't get that price exactly. But if it's within half a percent or a percent of that price then I'll go ahead and pick it up. If it gaps up well beyond that price, I'll let it go. There's plenty of others to choose from.
TraderInterviews.com: You talked earlier about the risk reward ratio and how much profit is potentially in that trade. How are you finding a profit target on some of these trades if you're looking up one that's, say, in an uptrend?
Steve Palmquist: In swing trading, my initial target is the next resistance point and that may be a recent high, it may be the upper Bollinger Band, it may be a trend line, it can be either one of those things, and I'll look for the closest one because that's the easiest move for the stock to make. As the stock approaches that resistance area, I'm watching the volume. If it's moving up and the volume is increasing every day, then I say, okay, every day that stock has a higher price more people want to buy it, I'm obviously interested in continuing to hold it. If it approaches one of those resistance areas and the volume is tapering off, then I just exit the stock and move onto another one. I'm not trying to ride a three-month trend in any one stock. I'm trying to piece together a trend in my account by picking off the small runs in different stocks as they trigger.
TraderInterviews.com: How about if it starts to approach that resistance area with declining volume on, say, an hourly chart intraday, do you follow that or is it more just daily charts?
Steve Palmquist: You know, you got to dance with the one that rung you and all of this information, all of the back testing is done on daily charts so that's what I trade. I don't get caught up in watching the five-minute charts or the hourly charts or that sort of thing. I'm just looking for moves to happen on the daily chart.
TraderInterviews.com: All right. How about on the wrong side with the stop-loss, where would you place that and how far away from your initial entry are you looking at?
Steve Palmquist: Well, stops are topic for a whole interview by themselves, but in general with this particular pattern if what I'm looking for is a stock that's been trending up and then pulls back slightly and then moves out of the pullback by making a higher high, then I would place the stop just under the low of that pattern because if it drops below that point it would have invalidated the pattern. I would not have taken the trade; therefore, I exit the stock and go onto something else.
TraderInterviews.com: How many trades are you in and feel comfortable managing at any given time?
Steve Palmquist: It depends on the market condition. If the stock is in a strung uptrend, I might have 15 or more trades. If the stock is in a wide trading range, meaning it takes more than, say, four or five days to move from one end to the other, I might have seven or eight trades. If the stock market is in a very narrow trading range where it can hit the top or the bottom of the trading range within one or two days, then I just treat that as vacation time.
TraderInterviews.com: I was going to say, so you don't have to sit in front of your computer monitoring this position. You're comfortable kind of just putting in your stop, putting in your profit target and walking away?
Steve Palmquist: Yeah, trading is a statistical business. There is no magic formula. There is no feel of it. I've seen these ads for Ninja Traders and be the cowboy and all that kind of stuff, and that's just junk. It's a statistical business so traders make their money by researching a trading system and finding something that has shown an ability to win more often than it loses and have the average winner be larger than the average loser. When you find something that does that then over time you have a reasonable expectation of seeing profits. That doesn't mean you're going to make a profit every day or every hour or every week, but over time given those conditions you would certainly expect to see a profit. So the effort in researching the trading system is how a trader earns a living. It's not sitting in front of the screen watching the daily five-minute bars and that's what this book is about. It's showing people the kind of trading systems that have a statistical edge rather than just trading on some random input.
TraderInterviews.com: Now, when you're back testing and then you're investigating a new system, what do you like to see before you'll start to put into your nightly scan and start getting signals for you? Is it a 50% win rate or a 40%, 70%? What do you like to see?
Steve Palmquist: Well, it depends. I mean if I tell you that I have a system and it only wins 40% of the time, a lot of people say, "Gee, I don't want to trade that." But if every time you win, you get a thousand dollars and every time you lose, you lose a hundred dollars, it suddenly becomes a very interesting system to trade. So it's not one statistic that matters but it's the combination. Does it win more often than it loses and is the average winning trade larger than the average losing trade? If those two conditions are true, then I'm interested in the system. Most of the ones that I go through in the book show winning percentages in the 60s and that's over a period of time through a market condition not each and every trade. Because of the statistic when I enter a trade I have absolutely no idea whether that trade is going to be profitable or not and I don't particularly care. I'm just following the system. I know that over the long run I'm going to do quite well trading that system, and obsessing over what happens to each trade and watching the five-minute charts is just a waste of time.
TraderInterviews.com: One of the questions we've gotten about previous system interviews that we've done is my back testing shows that the maximum number of trades in a row that went against me were four and then all of a sudden I'm using the system and now I've got five or six in a row that don't work out. At what point do I need to start worrying about the system and either throw it out, figure out a way to tweak it, or just look for something new?
Steve Palmquist: Well, you need to do more investigation than just that. If you find a system that only shows four losses in a row over a wide range, you probably made a mistake 'cause there's very few systems that have that kind of statistic. The other way you can get in trouble with that statistic is the computer scans through all the trades and maybe you only had four losses in a row and then you had a winner and then you had another four losses in a row and then you had a winner and another four losses. So you need to look beyond just the number. When you're testing a system you need to go back and look at the trades and not just the summary numbers. It needs to be kind of like an old pair of jeans. It's got to fit comfortably, you got to understand that you got to know how it performs and it takes time. That's why I say traders earn their living when the market is closed, when they're getting to know a trading system not when it's open.
TraderInterviews.com: All right. Now, your book, there's a lot of trading books out there obviously for over the years and there always new ones coming out. How does your differ than what was out there already? Where did you feel there was a hole that you needed to fill?
Steve Palmquist: Well, I probably read 30 or 40 different trading books and I highly recommend that people read a book a month. It's like if you're a doctor, you're required to go to continuing education every year, and traders will hear something at a conference and they'll go out and trade it blindly and that's just amazingly silly. So when I looked at all the books I'd read they all showed four or five examples of a system and when it worked and then said go forth my son and trade your life savings, and I thought, well, that's ridiculous. What I wanted to do is I wanted to get to know a trading system kind of like an old friend. When you meet somebody new you don't know how they're going to react in a given situation, but after you've known somebody for a while you have a pretty good idea of how they're going to react to things. They surprise you occasionally, but you have a pretty good idea. I wanted that kind of familiarity with a trading system. So I took these trading systems and the book goes through and it shows when they work, when they don't work, what makes them work better, what makes them work worse, what kind of filters you should use with them, what kind of market condition you should use with them, and it's all based on some extensive testing of it. So by the time you're done with that system, you have a pretty good idea of what to expect from it.
TraderInterviews.com: People are always looking of the latest system or the hottest system that's working really well. How do you kind of avoid the hype of system trading and just be satisfied, I guess, with something that's working good enough?
Steve Palmquist: Well, actually that's pretty easy. It's the same answer. If you have really evaluated a system and know what to expect and, say, a system is showing on average 60% winning trades, a guy can eat just find off of that. I mean they built those big hotels in Vegas off a 2% spread. If you can trade off a 10% spread, you're going to have dinner, right? And people need to get away from this thing of always looking for something that is better, newer. More often the reason they do that is because what they have isn't working and the reason it isn't working is they never did what traders need to do to earn a living which is analyze the system and understand it. So what I'm trying to do in this book is share my years of research into what works, why it works, and when it works rather than just here's a system, give it a try.
TraderInterviews.com: If they've got a system that they're comfortable with and it matches their risk tolerance, should they try to totally automate it and have the computer take those trades for them?
Steve Palmquist: If you trust the computer more than your life experience, okay. That's an unusual thing. See, the computer will look at things like you mentioned, okay, number of losing trades in a row. Some people will look at that statistic, but I go through and I look and say, let's look at all the trades. When you had 10 losing trades in a row, what happened after that? Okay, did you have a couple of profitable ones and another 10 losing trades? If so, that's not a great system. How long did it take you to get your money back? How often did it show that number of losing trades in a row? If it was once every 10 years, it's not a big issue. If it was once a year, it is a big issue and you need to plan for it. So it keeps coming back to don't trade something you don't understand.
TraderInterviews.com: All right. Well, listeners, we will link to Steve's new book at Traders' Library so you can take a look at that, and we will maybe do a follow-up with Steve. Hopefully, Steve will do an additional interview with you down the road here to get some additional information about system trading, but I think we've sent listeners off in the right direction here. So thanks for your time.
Steve Palmquist: You're welcome.
You can find Steve's book here.
Looking forward to reading your book
Posted by: Liz | August 31, 2010 at 06:04 PM