The Weekly Trader

The following is an interview I had with former hedge fund manager Shah Gilani. He is also a contributing editor to bothMoney Morning and The Money Map Report.

Q. Would you say that Wall Street is transparent right now?

Gilani: No, it’s not. It’s confusing to investors. The average investor is not privy to how it really works. If you don’t know what is woven into that cloth, then it’s hard to tell what kind of quality it’s going to be. You can’t tell. Investors know there is a problem but they can’t put their finger on it. The problem would be self evident if they had an understanding of values.

Q. What do you see in the market right now?

Gilani: I see more volatility, particularly in the global markets. Debt is the problem in the global picture. The market is incredibly dangerous right now. Although investors want to make back their money, they also don’t want to get duped. They don’t want to be used as a backstop. Sadly, though, many don’t have a choice.

Q. What should investors do?

Gilani: Right now you have to cherry pick stocks. You also have to be an investor-trader. You have to be proactive, and look at your portfolio every day or two. You can’t wait a month anymore. The days of buying and falling asleep are over. You also have to put in stops, and have profit targets. And as your stock goes higher, raise your stops higher. That way, if the market falls, you can get out. The market moves so fast you could lose all of your profits in a matter of days.

Q. What is the problem with the market right now?

Gilani: The market is unfair but it doesn’t have to be that way. In my opinion, volatility has been engineered into the financial markets for the sake of Wall Street and traders, and to the enormous detriment of the public, investors, and the economy.

Q: Could you expand on that?

Gilani: Capital markets are set up to serve to raise cash, equity and debt, to facilitate business development, and to provide liquidity to investors providing financing so businesses can grow and share the wealth. Wall Street was set up to be the capital market’s intermediary, but they realized it’s better if they could be principal risk takers as well as market makers. Then they can trade their own book against the market, which includes their clients. Wall Street doesn’t like a calm market. There isn’t a lot of money to be made when volatility is low and spreads are super tight. In the old days, the market was calmer, which was bad for the traders on Wall Street.

Q. How did they change the system?

Gilani: The first thing they did was eliminate fractions. At the time, it seemed to make sense. After all, fractions came from the days when the Spanish, for example, cut up silver and gold into “pieces of eight.” Unfortunately, by moving to a decimal system, it destroyed liquidity by greatly reducing the “depth” of bids and offers investors were once willing to line up to execute. That changed the market. And now Wall Street specialists and market makers, instead of risking an eighth or a quarter, only risk a penny if they step in front of any client or book orders to try and profit themselves as a principal. Everyone seems to think that decimalization was good for the markets.

Q. Was there anything good about decimalization?

Gilani: The only positive was that transaction costs came down. Another problem it created was that no one knows where the liquidity is anymore. When specialists and market makers can step in front of client orders to take their positions essentially from them, it caused traders and institutional players to look for different venues. Now many high volume traders are going into hidden venues like dark pools. This is not good for investors or traders who don’t have the same access to multiple venues, or the market, but it is good for the Wall Street players. Instead of making the market more efficient for everybody, it decreased liquidity for the general public and increased volatility.

Q. Any other rules that caused problems?

Gilani: Eliminating the uptick rule was another mistake. The uptick rule was working just fine until they took it away. When you think back to all of the rules that Wall Street changed since the eighties: deregulation, decimalization, the uptick rule, allowance for multiple venues, no central order handling book, and the blind pools, it all adds up to a trader’s game. Wall Street is no longer facilitating A and B in the capital markets, but is all about making money for themselves now. That is why the Occupy Wall Street people are protesting. They know that something is wrong, but they don’t know what. They don’t know why they are protesting. Instead of a level playing field, all of the investors have been leveled. The tail is wagging the dog now.

Q. What’s the solution?

Gilani: We have to start looking at what is good for the economy and investors, not just Wall Street. But banks and lobbyists are pushing back. They don’t want the rules to favor investors. Let’s see what happens to the Volcker Rule, which will keep banks out of the securities business. We’ll see if that ever gets implemented as it was originally contemplated.

Q. Are there any other ways to stop the shenanigans?

Gilani: Wrongdoers should be punished. If fraud was done on purpose, and you made a lot of money and caused pain, you should not be able to walk away and hurt the economy and investors. The first place to hit them is in the wallet and claw back that money. If you do it legally, go for it. But if it was illegal, and you manipulated the system, then it’s fraud. If guilty of the crime, you should do the time. Make certain things are punishable by prison time. If guilty, they might even have to sell that second house in the Hamptons.

Below is my extended interview with best-selling author and trader Toni Turner, who gave me a few insights into the current market environment. She is the author of A Beginner’s Guide to Day Trading OnlineA Beginner’s Guide to Short-term Trading(2nd Edition), and Short-term trading in the New Stock Market, to name a few.

Q. What stocks do you study?

Turner: When I’m watching market action, I go through the nine sectors of the S&P 500. I always keep an eye out for sector movement and key industry groups like telecommunications and transportation. I watch these closely as well as the three major indices, which I also watch on weekly and monthly charts, as well as intraday. Often you see patterns on the long term charts that you can’t see intraday.

Q. Do you have a favorite indicator?

Turner: One indicator I use is Average True Range (ATR), which I use on the major indices. When the ATR starts to rise, and when the candlesticks get wider and wider, it means there is more concern and indecision. This year, much of the volatility started with the rebellion in Egypt and went through the spring months. Even though the market was rising, each weekly candle was getting wider and wider. That means the bulls can push the market higher, but the bears can also push it lower.

Q: Don’t traders like volatility?

Turner: We do like volatility but when it turns on a dime, you have to question how you can maintain a bullish or bearish bias. You want volatility, but you want the kind of volatility that makes sense. Currently, all it takes is one phone call between Sarkozy and other world leaders and the market can make a U-turn. My strategy is to establish the boss du jour. During all trading time periods, there is always a boss du jour. There is something that is leading the market; of course, in the case of the U.S. dollar, it might push the market in an inverse direction.

Q: What about right now?

Turner: You always want to identify the boss or whatever market or instrument is leading our financial markets. Right now the euro is the boss du jour. It is having a rough time. On most days, if the euro heads south, the market is going down. I have seen times when oil is the leader, and often it’s the S&P 500 or Dow futures. When there is this much uncertainty in the market, it creates a tremendous amount of volatility, and it’s difficult to play. It’s total uncertainty. It’s a headline-driven market, not driven by fundamentals based on a sound economy. It isn’t sound.

Q: What do you see on the chart?

Turner: Basic technical analysis teaches you how to identify confusion, which we identify by calling it congestion on a chart. Congestion on a chart, especially on a daily chart, is a series of stops and starts, and gap ups and downs. Right now we are witnessing the kind of congestion on stocks that are normally docile. For example, consumer and utility stocks such as Procter and Gamble, Wal-Mart, and Phillip Morris are acting like a kangaroo on speed. Normally, many of these defensive sectors are a yawn. Now, though, some of the most orderly value stocks are rising and falling like growth stocks, which make you wonder what is going on.

Q. Have you seen this before?

Turner: For many stocks, I can’t relate their current disorderly patterns to any recent period in history, possibly with the exception of 2008. Even in usual docile utility stocks, you can see mass confusion.

Q. What advice would you give to investors?

Turner: If you are an investor that is bottom picking, don’t buy an overpriced growth stock with bad fundamentals. I know that hedge funds are waiting to sell them short if there is a market downturn. Check the fundamentals like the P/E ratio, debt ratios, and earnings. If we get another downturn and you’re in a high-flying stock that was bid-up by traders, the hedge funds will come in and short the heck out of it. You might want to look at value stocks rather than growth stocks because value stocks don’t get as hammered as growth stocks in a downturn.

Q. What patterns do you see on a chart?

Turner: Right now in many stocks, I see a bear flag pattern formed of wide candles and big gaps. It tells me that traders are totally confused. The long, wide volatile candles on the S&P is also indicating there is no agreement since the first part of August as to where the market should go. It’s indecision. Perhaps experienced day traders might fare well in this market environment — if you pick the right stocks and catch an upswing or downswing. Experienced traders can make profits, but for most traders, standing aside is the best idea. Again, I think this headline-driven market is difficult for most people.

Q. Any final advice?

Turner: Out of all this chaos comes order. If you’re wise and don’t try to outsmart the market, and stay in cash right now, you’ll have money to trade when the market starts to go your way again.

Note: You can read more about Toni Turner at her website, http://bit.ly/Tseud

I interviewed candlestick expert Steve Nison for Marketwatch.com. Here are the charts that accompany the article:

Welcome to the wonderful but wacky stock market!

Steve Nilson

 

This is an excellent illustration of the candlestick:

Anatomy of Candlestick Line

 

Study the real body to see who is in control, bulls or bears:

Who's in Control

Why traders like the doji:

Doji

 

In addition to what Nison said in the article, he made the following points:

1. “As long as you have an open, high, low, and close, you can use candlestick strategies. Many traders use candlesticks as part of daytrading, but many use them for longer term strategies. I use candlesticks with Western technicals in my own retirement portfolio. I work with many institutional firms who use fundamentals but use the timing of candlesticks to know when to enter or not. No matter what market your readers use, and no matter what time frame, they can harness the power of candlesticks.”

2. “With the increased popularity of candlesticks, there are more misconceptions. For example, we strongly educate traders not to look at candlesticks in isolation. Using candlesticks in isolation is like ‘leaning a ladder against the clouds.’ If you have a wonderful signal, it could be a poor risk-reward investment. Use candlesticks with Western technical indicators. Candlesticks are the final confirmation whether you will do the trade or not.”

3. “To avoid losing money, the quote I like from Warren Buffett is: Rule 1: Don’t lose money. Rule 2. Don’t forget Rule One. It’s not how much you make, but how much you keep that is important.”

4. “It’s not only recognizing the candlestick signal, but learning what to do about it. That’s where most investors and traders make mistakes. For example, you could have the doji that you ignore, where others I would pay attention to. Or you could have a bullish candlestick pattern but the technical indicator shows there is resistance. The risk-reward is too high, so you don’t do the trade.”

5. “An ounce of emotion is worth a pound of facts. There is nothing more irrational than human emotion.”

6. “Candlesticks give you the signal before moving averages. Moving averages are lagging indicators while candlesticks tell you what is happening right now. Readers will find that candlesticks give you the signs of potential turns well before moving averages. That is the real power of candlesticks and why so many investors and traders use them. What’s nice about candlesticks is they help you pick out the potential top or bottom in a rocky environment, especially the support and resistance.”

7. “Learn the doji signal first because it is the easiest.”

8. “To continue your free candlestick education, consider my free bi-weekly video investing and trading newsletter. All contact information is kept strictly confidential. For details go to: http://www.candlecharts.com/free-education.”