CHAPTER NINE Daily Trading Versus Longer Term Trading

JUST now I took a small triangular piece of blotting paper three-eighths of an inch at its widest, and stuck it on the end of a pin. I then threw a blot of ink on a paper and put the blotter into contact. The ink fairly jumped up into the blotter, leaving the paper comparatively dry.

This is exactly how the market acts on the tape when its absorptive powers are greater than the supply - large quantities are taken at the offered prices and at the higher levels. Prices leap forward. The demand seems insatiable. After two or three blots had thus been absorbed, the blotter would take no more. It was thoroughly saturated. Its demands were satisfied. Just in this way the market comes to a standstill at the top of a rise and hangs there. Supply and demand are equalized at the new price level.

Then I filled my pen with ink, and let the fluid run off the point and onto the blotter. (This illustrated the distribution of stocks in the market). Beyond a certain point the blotter would take no more. A drop formed and fell to the paper. (Supply exceeded demand). The more I put on the blotter the faster fell the drops. (Liquidation - market seeking a lower level). This is a simple way of fixing in our minds the principal opposing forces that are constantly operating in the market-absorption and distribution, demand and supply, support and pressure. The more adept a Tape Reader becomes in weighing and measuring these elements, the more successful he will be. But he must remember that even his most accurate readings will often be nullified by events that are transpiring every moment of the day. His stock may start upward with a rush-apparently with power enough to carry it several points; but after advancing a couple of points it may run up against a larger quantity of stock than can be absorbed or some unforeseen incident may change the whole complexion of the market.

To show how an operator may be caught twice on the wrong side in one day and still come out ahead, let us look at the tape of December 21, 1908. Union Pacific opened below the previous night's close: 500 @ 179 6000 @ 178 3/4 and for the first few moments looked as though there was some inside support. Supposing the Tape Reader had bought 100 Union Pacific at 178 7/8, he would have soon noticed fresh selling orders in sufficient volume to produce weakness. Upon this he would have immediately sold 200 Union Pacific at 178ź, putting him short one hundred at the latter price. The weakness increased and after a drive to 176 1/2, two or three warnings were given that the pressure was temporarily off. A comparatively strong undertone developed in Southern Pacific as well as other stocks and short covering began in Union Pacific, which came 600 @ 176 5/8 1000 @ 176 ž then 177ź. Assuming that the operator considered this the turn, he would have, bought 200 Union Pacific at 176 7/8, which was the next quotation. This would have put him long. Thereafter the market showed more resiliency, but only small lots appeared on the tape.

A little later the market quiets down. The rally does not hold well. He expects the stock to react again to the low point. This it does, but it fails to halt there; it goes driving through to 176, accompanied by considerable weakness in the other active stocks. This is his indication that fresh liquidation has started. So he, sells 200 Union Pacific at 176 That is, he dumps over his long stock and goes short at 176. The weakness continues and there is no sign of a rally until after the stock his struck 174 1/2. This being a break of 6ź points since yesterday, the Tape Reader is now wide awake for signs of a turn, realizing that every additional fraction brings him nearer to that point, wherever it may be. After touching 174 1/2 the trend of the market changes completely. Larger lots are in demand at the offered prices. There is a final drive but very little stock comes out on it. During this drive he, buys 100 Union Pacific at 175 7/8, and as signs of a rally multiply he buys 100 at 175 1/4 From that moment it is easy sailing. There is ample opportunity for him to unload his last purchase just before the close when he sells 100 at 176 5/8.

Bought Sold Loss Profit
178 7/8 178 1/4 62.50 -
176 7/8 178 1/4 - 137.50
176 7/8 176 87.50 -
174 7/6 176 - 112.50
175 1/4 176 5/8 - 137.50

Commissions & Taxes 135.00 -

Totals 285.00 387.50

Less Loss -285.00

Net Profit For Day

This is doing very well considering he was caught twice on the wrong side and in his anxious trading paid $135.00 in commissions and taxes. Success in trading comes down to a question of reducing and eliminating losses, commissions, interest and taxes.

Let us see whether he might have used better judgment. His first trade seems to have been made on what appeared to be inside buying. No trend had developed. He saw round lots being taken at 178 3/4 and over and reasoned that a rally should naturally follow pronounced support. His mistake was in not waiting for a clearly defined trend. If waiting for the buying was strong enough to absorb all offerings and turn the market, he would have done better to have waited until this was certain. When a stock holds steady within a half point radius it does not signify a reversal of trend, but rather a halting place from which a new move in either direction may begin. Had he followed the first sharp move, his original trade would have been on the short not the long side. This would have saved him his first loss with its attendant expenses, aggregating $89.50, and would have nearly doubled the day's profits.

His second loss was made on a trade which involved one of the finest points in the art of Tape Reading - that of distinguishing a rally from a change in trend. A good way to do this successfully is to figure where a stock is due to come after it makes an upturn, allowing that a normal rally is from one-half to two-thirds of the decline. That is, when a stock declines two and a half points we can look for at least a point and a quarter rally unless the pressure is still on. In case the decline is not over, the rally will fall short. What did Union do after it touched 176˝? It sold at 176 5/8 177 ž - 177 ź . Having declined from 179 1/8 to 176 ˝, 2 5/8 points, it was due to rally at least 1ź points, or to 177 ž . Its failing to make this figure indicated that the decline was not over and that his short position should be maintained. Also, that last jump of half a point between sales showed an unhealthy condition of the market. For a few moments there was evidently a cessation of selling, then somebody reached for a hundred shares offered at 177ź. As the next sale was 176 7/8 the hollowness of the rise became apparent. While this rally lasted, the lots were small. This of itself was reason for not covering. Had a genuine demand sprung from either longs or shorts a steady rise, on increasing volumes, would have taken place. The absence of such indications seems to us now a reason for not covering and going long at 176 7/8.

It is very difficult for anyone to say what he would actually have done under the circumstances, but had both these trades been avoided for the reasons mentioned, the profit for the day would have been $421, as the 100 sold at 178 ź would have been covered at 174 7/8, and the long at 175 ź sold out at 176 5/8. So we can see the advantage of studying our losses and mistakes, with a view to benefiting in future transactions.

As previously explained, the number of dollars profit is subordinate to whether the trader can make profits at all and whether the points made exceed the points lost. With success from this standpoint it is only a question of increased capital enabling one to enlarge his trading unit. A good way to watch the progress of an account is to keep a book showing dates, quantities, prices, profits and losses, also commission, tax and interest charges. Beside each trade should be entered the number of points net profit or loss, together with a running total showing just how many points the account is ahead or behind. A chart of these latter figures will prevent anyone fooling himself as to his progress. People are too apt to remember their profits and forget their losses. The losses taken by an expert Tape Reader are so small that he can trade in much larger units than one who is away from the tape or who is trading with an arbitrary stop. The Tape Reader will seldom take over half a point to a point loss for the reason that he will generally buy or sell at, or close to, the pivotal point or the line of resistance. Therefore, should the trend of his stock suddenly reverse, he is with it in a moment.

The losses in the above mentioned Union Pacific transactions (5/8 and 7/8 respectively) are perhaps a fair average, but frequently he will be able to trade with a risk of only ź, 3/8, or ˝ point. The fact that this possible loss is confined to a fraction should not lead him to trade too frequently. It is better to look on part of the time; to rest the mind and allow the judgment to clarify. Dull days will often constrain one for a time and are therefore beneficial. The big money in Tape Reading is made during very active markets. Big swings and large volumes produce unmistakable indications and a harvest for the experienced operator. He welcomes twenty, thirty and fifty-point moves in stocks like Reading, Union or Consolidated Gas-powerful plays by financial giants. And this fact reminds us: Is it better to close trades each day, or hold through reactions, and if necessary, for several days or weeks in order to secure a large profit? The answer to this question depends somewhat upon the temperament of the Tape Reader. If his make-up be such that he can closely follow the small swings with profit, gradually becoming more expert and steadily increasing his commitments, he will shortly "arrive" by that route. If his nerves are such that he cannot trade in and out actively, but is content to wait for big opportunities and patient enough to hold on for large profits, he will also "get there." It is impossible to say which style of trading would produce the best average results, because it depends altogether upon individual qualifications, attitudes and tolerance of risk. Looking at the question broadly, we should say that the Tape Reader who understood the lines thus far suggested in this series, might find it both difficult and less profitable to operate solely for the long swings. In the first place, he would be obliged to let twenty or thirty opportunities pass by to every one that he would accept. The small swings of one to three points greatly outnumber the five and ten-point movements, and there would be a considerable percentage of losing trades no matter how he operated.

Many of the indications, such as the extent of reactions, lines of resistance, etc., will be found equally operative in the broader swings, just as an enlargement of a photograph retains the lines of its original. Tape Reading seems essentially a profession for the person who is mentally active and flexible, capable of making quick and accurate decisions and keenly sensitive to the smallest and almost imperceptible signals and indications.

On the other hand, trading for the larger swings requires one to ignore the minor indications and to put some stress upon the influential news of the day, and its effect upon sentiment; he must stand ready to take larger losses and in many ways handle himself in a manner altogether different from that of the day trader. The more closely we look at the differences between the longer-term trader/investor and the day trader, the more the two methods of operating seem to disunite, the long-term investing player appearing best adapted to those who are not in continuous touch with the market and who therefore have the advantage of distance and perspective.

There is no reason why the Tape Reader should not make long-term trading an auxiliary profit producer if he can keep such trades from influencing his daily operations. For example, in the previously mentioned shake-down in Reading from 144 3/8 to 118, on his first buying indication he could have taken on an extra lot for the long swing, knowing that if the turn had really been made, a rally to over 130 was due. A stop order would have limited his risk and conserved his profits as they rolled up and there is no telling how much of the subsequent forty point rise he might been able to ride. Another case was when Steel broke from 58 3/4 (November, 1908) to 41ź in February. The market at the time was hinging on Steel and it was likely that the Tape Reader would be operating in it. His first long trade under this plan would be for at least a hundred shares more than his usual amount, with a stop on the long pull lot at say 40 3/4. He would naturally expect a rally of at least 8 3/4 points (to 50), but would, in a sense, forget this hundred shares, so long as the market showed no signs of another important decline. When it reached 60 he might still be holding it.

The above are merely a couple of opportunities. Dozens of such show themselves every year and should form no small part of the Tape Reader's income. But he must separate such trades from his regular daily trading; to allow them to conflict with each other would destroy the effectiveness of both. If he finds the long pull trade interfering with the accuracy of his judgment, he should close it out at once. He must play on one side of the fence if he cannot operate on both. You can readily foresee how a trader with one hundred shares of Steel at 43 for the long-term, and two hundred for the day, would be tempted to close out all three hundred on indications of a decline. This is where he can test his ability to act in a dual capacity. He must ask himself: Have I good reason for thinking Steel will sell down five points before up five? Is this a small reaction or a big shake-down? Are we still in a bull swing? Has the stock had its normal rally from the last decline? These and many other questions will enable him to decide whether he should hold this hundred shares or "clean house."

It takes an exceptionally strong will and clear head to act in this way without interfering with your regular trading. Anyone can sell two hundred and hold one hundred; but will his judgment be biased because he is simultaneously long and short-bullish and bearish? There's the problem! The real Day Trader is more likely to prefer a clean slate at market closing every day, so that he can sit down to his ticker at the next morning's opening and say, "I have no commitments and no opinion. I will follow the first strong indication." He would rather average $100 a day for ten days than make $1,000 on one trade in the same length of time. The risk is generally limited to a fraction and having arrived at a point where he is showing even small average daily profits, his required capital per 100 shares need not be over $1,500 to $2,000. Suppose for sixty days on 100 share a day trading his average profits over losses were only a quarter of a point or $25 a day. At the end of that time his capital would have been increased by $1,500, enabling him to trade in 200 share lots. Another thirty days with similar results and he could trade in 300 share lots, and so on. I don't mention these figures for any other purpose than to again emphasize that the objective point in Tape Reading is not large individual profits, but a continuous chipping in of small average net profits per day.

Some time ago, I am told, a man from the West Coast came into my office and said that he had been impressed by this series on Tape Reading, and had come to New York for the sole purpose of trying his hand at it. He had $1,000 which he was willing to lose in demonstrating whether he was fitted for the work. I was later informed that he called again and related some of his experiences. It seems that he could not abstain from trading, but started within two or three days after he decided on a brokerage house. He stated that during the two months he had made forty-two trades of ten shares each and had never had on hand over twenty full shares at any one time. He admitted that he had frequently mixed guesswork and tips with his Tape Reading but as a rule he had followed the tape. His losses were seldom over a point and his greatest loss was one and a half points. His maximum profit was three points. He had at times traded in other stocks beside the leaders. In spite of his inexperience, and his attempt to mix tips and guess with shrewd judgment, he was ahead of the game, after paying commissions, taxes, etc. This was especially surprising in view of the trader's market through which be had passed. While the amount of his net profit was small, the fact that he had shown any profit during this study period was reason enough for congratulations.

Another handicap which he did not perhaps realize was his environment. He had been trading in an office where he could hear and see what everyone else was doing, and where news, gossip and opinions were freely and openly expressed by many people. All these things tended to influence him, and to switch him from his foundation in Tape Reading fundamentals to other methods but he is persisting and shows some signs of discipline. I have no doubt that having mastered the art of cutting losses and keeping commitments down and returning to Tape Reading fundamentals, he will soon overcome his other deficiencies and begin showing remarkable progress. Given a broad, active market, he should show increasing average daily profits. Speculation is a business. It must he learned.