March 24, 2016
Matt Choi is a Chartered Market Technician (CMT) with over 17 years of trading experience and the founder and chief strategist of Certus Trading, a company dedicated to teaching traders how to trade stocks, ETFs, options, currencies, commodities and financial futures. Matt is a rule-based swing trader who applies the strategy of using proven rules and market patterns to inform his own trading and the education he provides at Certus Trading. Matt derives these trading strategies through long-term testing and deep studying of the markets.
In this short article, Matt addresses 5 areas that traders need to master to ensure consistency.
1. One’s trading personality and understanding it plays a large part in the success of any trader. What’s the one word that would best describe your trading personality and can you explain why?
I’d say the one word that would best describe me as a trader is “rule-based”. If you look at how trading has evolved over the past 50 years, it went from a buy-and-hold environment back in the 70s and 80s to today where computers are doing most of the work.
We see high frequency trading where machines day trade the markets based on a set of rules, rules that are created by human beings. Now, we can’t compete with the speed of machines intra-day, so as a retail trader, I take a slightly longer-term approach. Being a Chartered Market Technician, I’ve been studying and memorizing chart patterns that happen over and over again, like clockwork. From these patterns, I construct a set of rules where I’d say … if 1, 2, and 3 all happen, then I would go long on this stock. Or if X, Y, and Z all happen, then I would go short on this stock.
Of course, it takes time and experience to find these high probability patterns, but once I find them, it goes into my toolbox and I use them every week in my trading, knowing that they work, period. And the best part it is I put these rules into a trading platform, and it literally takes a few seconds to find my trades.
A lot of people have the preconception that I sit in front of the screen all day, but that’s not true at all. I actually don’t need to spend a lot of my time trading because my computer and my rules and my patterns and my strategies do all the work for me. In a way, I am beating Wall Street at its own game. That said, I do spend a good chunk of time developing and testing new patterns and new strategies. Probably for every 100 ideas I test, only 1 will stick. That may not seem like a lot, but remember I can use this 1 strategy over and over again to make money for years to come.
2. Do you have any asset protection or hedging strategies that you use or consider during the time of a sustained market correction? Can you explain in technical terms how these strategies were successful?
I think the term hedging is often wrongly used and incorrectly applied, and as a result, newer traders are basically throwing their money away trying to protect their assets. I talk to a lot of people who have a lot of stocks. I am talking about 7 and 8 figure portfolios. The markets are bullish but they are worried about market corrections, and rightly so.
Everyone wants higher return and no risks. Who doesn’t? However, with today’s super fast trading speed and with high frequency trading as I mentioned earlier, the markets can drop 20 to 30% without warning. So what these folks end up doing to hedge their portfolio is they regularly buy out-of-the-money put options on SPX, which is basically the S&P 500 index. These put options are not cheap and I know people who spend over 50K or even 100K a month hedging, but these puts end up expiring worthless and they lose all options premium. It’s worse than buying insurance … at least with life insurance I know my family would get paid when I die.
Don’t get me wrong, I hedge the downside too, but in a strategic way. With this market being bullish, I do have a lot of long trades. However, even in strong markets, there are a lot of weak stocks that are falling, it’s just that people don’t pay attention in finding those. About 30% and sometimes 40% of my trades are bearish trades. Not only do these bearish trades make money, they also serve as a hedge. If the market plunges, these bearish trades will profit significantly from a down move. Sure, I lose money on the long trades in that situation, but overall they would end up being a wash.
The point here is that I am trading the weak stocks and I am also using them as a hedge. I guess in this case, we can have the cake and eat it too! This is called delta-neutral trading. It is a bit more advanced, but everyone should strive to understand this concept.
3. From your experience in swing trading, do you have guidance that you can share on reversal trades? How can traders profit from these types of trades? What is the most valuable information they need to know?
In any reversal trade, I follow the direction of the trend. So if a stock is trending up, pulls back, then I’d wait for the right setup to go long assuming the uptrend is resuming. There are 3 key elements when looking for that reversal entry point. First, I want to see the pull back to be on a reduced volume. So if during the uptrend the stock trades about 2 million shares a day, I want to see about 70 to 80% of that average during the pull back, so about 1.4 million to 1.6 million shares a day vs. 2 million.
Second, I want to see a reversal candlestick pattern, such as a hammer or a bullish engulfing pattern. It really doesn’t matter which one to use, what matters is to be consistent and don’t jump around using different indicators.
Finally, rather than buying the stock, I use options to 5X to 10X my gains, and to minimize my losses when I am wrong.
The same goes for the short side. Develop a set of rules to identify the downtrend and look for a bounce. Then use a reversal candlestick to help with the entry. Remember, the rules for each strategy must be precise and unambiguous. This way, it eliminates unwanted interpretations, and it completely removes human emotions when I am executing my trades.
4. What advice can you impart on trading bull and bear flags? More specifically, what are ways that traders can find these patterns more frequently?
Flags are one of my favourite patterns because they are very reliable when done right. Most traders like to look for flags on a daily chart, which is fine. However, I prefer using a weekly chart because I find those setups to be more accurate, and because I am using a week’s worth of price movement, the price move is that much more substantial and I can get more return on a single trade.
In a nutshell, here is how I do this. Let’s talk about bull flags. First, I want a stock to be in an uptrend. So, for example, it needs to be trading above the 12-week moving average, or the 5-week moving average is above the 10-week moving average. Then, I look for a strong weekly bar with the stock moving up on at least 50% wider range and 50% more volume. So, let’s say a stock on average has a 4 dollar weekly range and trades 10 million shares, I want to see a 6 dollar range and at least 15 million shares changing hands that week. I call this the upward thrust week.
Once I get that upward thrust with wider range and higher volume, then I want the next 3 to 4 weeks to be down weeks. If at the end of the down weeks, the stock is still trading above the opening price of the upward thrust week, and all of those 3 down weeks having reduced volume, then I am ready to go long that stock.
My most profitable way to trade this pattern is with butterfly spreads using options. They are cheap, scalable, and if constructed properly it gives me a 2X to 3X return on investment within a few weeks. All the stock needs to do is to retest the high. Of course the reverse scenarios works great for bear flags as well.
The best part with using this type of strategy is that I can program all the criteria and rules in my trading platform. This way, I can find bull flags, bear flags, and all other patterns with a few clicks of my mouse. This is exactly how everyone needs to be trading today.
5. As part of your program at Certus Trading, you offer an Options 2-Day Live Mastermind. As part of the Mastermind, you have a rapid fire analysis where you provide the stock symbol and fellow students come up with the options strategies. You then choose who provided the best strategy. This is an interesting exercise and in many ways forces students to balance split second decisions with their overarching trading strategies. What do you feel most students take away from this exercise?
The purpose of the live mastermind is two-fold. First, I am a big believer in the monkey-see-monkey-do concept. The live setting gives my students the opportunity to see my exact thinking and trading processes, and I find that they retain this information at a super high level and are able to mimic and execute what I do when they get home, which is one of the major goals of the 2 days.
Second, because I limit the mastermind to a small group, my students are able to truly network with each other and form long-term friendships. Let’s face it, my students who come to the mastermind are very committed and successful people, and are self-starters. At the mastermind, they form trading groups and trading partnerships, so it doesn’t matter where they live, they communicate with each other after the 2 days. They run trading ideas by each other and they hold each other accountable. Unlike online groups that fade quickly, because my students met face-to-face at the mastermind, they have the inherent trust and their friendships are long lasting.
Back to your question, yes everyone loves the rapid fire segment of the mastermind. I want them to focus, to think fast, and not waste time when they are trading. I only trade for a couple of hours a day because I became very efficient over time. I follow my rule-based strategies to stay focused, so I just need to execute my plan. The process of trading is boring, and it should be boring. However, the results should be fun and happy, and that’s the point I am trying to get across. So with this rapid fire exercise, at first they are all very uncomfortable. I see them trying to cover all the angles, which actually slows down their thinking. They waste a lot of time during this exercise trying to be perfect, which leads to analysis paralysis. After a few rounds, they get the idea of simply following the rules. Think of a flow chart. Is the stock doing A or B. If the answer is A, then proceed to C. Then, at C, is the stock doing D or G. If the answer is G, then go long the stock using a butterfly. There is little thinking involved, it’s just following a path. After this exercise, I see them gain a ton of confidence because they see the simplicity in their trading.
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