Most people don’t know what really goes on behind closed doors at a proprietary trading firm. So, we went to premier shop First New York Securities to get some answers about the business and what they look for in prospective hires …

Damien Hoffman: Gentlemen, what exactly does First New York do?

Joe Schenk: Contrary to popular belief, our business is proprietary trading not day trading. Though we may trade intra-day, we are not day traders.

Our core business is a long-short equity book which is both domestic and international. We trade commodities and macro vehicles such as global interest rates, global FOREX, and Treasuries. We trade fixed income both taxable and tax exempt. We also get diversification by having approximately 250 or so independent decision makers.

Damien: Tell me more about those decision makers. How do you determine who will thrive in your firm?

Donald Motschwiller: The type of talent we generally look for are people spinning out of a bulge bracket banking firm or hedge fund. The people that make the most amount of sense for us are discretionary traders.  Our definition of a discretionary trader is somebody who sources his ideas, sizes his ideas, executes his ideas, manages the risk of his ideas, and most importantly has been paid for his ideas.

When we look for new traders, we look for people that bring to the table another view, another skill set, another style, another strategy. We have an enormous amount of diversification at our firm. We don’t deploy a firm-wide strategy. We don’t have group think.

We also look for people who have a repeatable strategy with good historical returns and scalability so we can add size. And, again, our business is a bottom line business, so the strategy has to be profitable.

So, we are not a healthcare fund or a tech fund. We do not run a balance sheet intensive fund or strategy.

Liquidity drives our business. We need to know, “Is the product exchange traded? Is the product liquid?” All the products must be marked so we can get an accurate profit-and-loss statement. We want the ability to get out of our inventory in a relatively short period of time without impacting the market place or impacting our own portfolio.

Joe Schenk and Donald Motschwiller

Damien: Do you like to see experience on a resume before letting a new trader put a piece of your book at risk?

Joe: The biggest form of risk management in the firm is the fact that we trade only our own capital. So, we don’t have public or private money — we just have our own money. However, our model is a no-money-up model. Unlike many other prop shops, traders don’t have their capital at risk.

While interviewing prospects, we like to ask, “Where did you trade and how did you trade?” We like to see people trading their own money. I’m not saying the guys at bulge bracket banking firms or hedge funds are coy and cavalier about somebody else’s money. But, perhaps we might trade our money and our family’s money a little bit differently than somebody else’s money.

Damien: That seems very psychological. Is there a psychological profile that one needs to have or can successful trading be taught?

Joe: There’s a lot of correlation between successful traders and athletes. A trader does better when they’ve been under pressure and could live with his or her performance. If I were to guess how many of our traders were better than average athletes, I would say it’s a pretty high percentage.

Donald Motschwiller: It’s part of the commercial DNA we look for. If there was a guy who was an athlete in college in a very competitive environment which positively and negatively reinforced his actions, and if he can take the negative reinforcement and return the next day looking to be better, that person has what it takes to do well as a trader. It takes a certain kind of candidate who is able to recognize that it’s a bottom-line business and thrive on a daily basis.

In our business there is nowhere to hide. So, if Damien is a trader here, everyday Damien knows what he made or what he lost. Everyday the firm knows what Damien made or what Damien lost. You can’t hide on the desk if the desk does well but you’re doing poorly. It’s not as if you’re working at a hedge fund or a banking firm where you’re reporting numbers on a monthly basis while intra-month you’re not doing well.

There’s also no netting risk. So, if Damien is trading and Donald is trading and Donald messes up, it doesn’t impact Damien’s ability to get paid. So in many instances, at other shops a stellar performer’s pay may be mitigated by another sector or somebody else having a more challenging time.

Joe: A successful trader must also have a passion for the market. Then we look at academics and experiences. We like people that have good strong mathematical skills. We rely heavily upon our interviewing process which in many instances are four to five separate individuals that challenge the new person on a wide variety of professional and personal experiences.

Donald: The biggest difference between people who have success in our field versus those who have less success is the ability to take risk.

The first time you trade, you react to a script. If the stock makes a certain move over the course of the day, if you’re reacting to what has already happened you’re going to capture a very small percentage of that move. As you get better, you start anticipating. When you start anticipating you start capturing a larger percentage of that move.

But the guys who truly trade the markets the best — the most talented guys in the firm — they trade the markets intuitively. They’ve seen it so many times and are so confident in the decision making process that they’re not reacting. They’re not anticipating. They’re just intuitively going about their business.

Damien: Does that lead to a Darwinian natural selection where you guys are constantly bringing in new talent and replacing talent that can’t necessarily cut it on that level of the game?

Donald: If the trader is as advertised, I believe we are the best place on planet Earth for that person. Over the past few years the talent pool has become much better. So we have been upgrading the talent.

The turnover we experience is more an issue of guys coming in and just not being as advertised. I don’t recall instances when people left the firm because they weren’t given enough money to run or they weren’t making a reasonable amount of money.

The trader here is paid in cash, not in deferred comp or toxic assets. Here, the trader gets a formulaic way of getting paid — so there’s no subjectivity of what he’s going to make.

Therefore, this is a very entrepreneurial shop. If you’re somebody who is accustomed to and ready to stand by your performance, this is a great place to be. If your part of a big conglomerate and your department is up a couple of million, but you’re down three and you still get paid, that’s a whole different thing philosophically.  This is definitely a place for entrepreneurs who have a lot of confidence in their ability. It’s a pure meritocracy.

Damien: Back tracking a tad, how did you make the decision that traders would not use their own money?

Donald: Over the past five years, there have been dynamic changes in market place. We believe capital gives us staying power. And in order for the firm to really be profitable, it has to have an economic model that gives the trader as well as the firm an opportunity to profit.

So, we have a platform of seeding propriety traders. Our platform provides clearance, execution, technology, and capital. And you as a proprietary trader will come in here and bolt your business model onto our platform.

In money-up models there is far less control the firm can have on the trader because the trader is going to take the perspective, “It’s my money and I’m going to do what I want with my money. Since you don’t have the risk, who are you to jiggle me out of positions when the market is going against me.”

Also, generally, in the money-up model most of the traders and firms are thinly capitalized. And I would say our competitive advantage in the market place is the fact we are substantially capitalized.

Damien: Does that imply individual retail traders are at a disadvantage?

Donald: It’s more and more difficult to make money as a day trader. I still think there’s plenty of opportunity for event-driven, catalyst-driven, short-term swing type of traders. But the high-volume, low-margin day trader … that business is more and more challenging because that’s what the computers do. And the computers can think, move, react, and anticipate much quicker than an individual.

Plus access to information has become much more commoditized. Thus, it’s more difficult for the individual to get a leg up on the pros.

Damien: Well, Don and Joe, thanks for giving us a glimpse into the inner workings of a premier prop shop on Wall Street.

Don and Joe: Our pleasure.

Interested in more trading knowledge? Check out our Wall St. Cheat Sheet Top 3 Traders Under 30.

From our appearance on Yahoo Tech Ticker with Henry Blodget at the Nasdaq …

A few years ago, a magazine called Trader Monthly popularized a ranking of the “Top 30 Traders Under 30.”  In those days, successful traders were a dime a dozen and celebrating dynastic wealth was much in vogue, so the magazine’s list was a favorite on Wall Street.

Fast forward a couple of years and Trader Monthly and its “30 traders under 30″ have gone bust, victims of the crash and collapsed advertising revenue.  But Wall Street is back, thanks to the government bailouts and the Fed’s zero-interest-rate-policy.  And traders young and old are minting money again.

Of course, with the country’s unemployment rate still hanging near 10%, celebrating massive windfall wealth is no longer wise, especially at firms bailed out by the taxpayer.  So most of today’s successful Wall Street traders have the good sense to keep their mouths shut.

Earlier this year, the folks at Wall Street Cheat Sheet, Damien and Derek Hoffman, decided to reincarnate the Trader Monthly list.  They spent 8 months looking for 30 traders under 30.  Alas, thanks to institutional reticence and the Hoffmans’ insistence that the traders they celebrated had to have demonstrated a track record longer than a single lucky year, they only came up with 3.

But these 3 traders under 30, the Hoffmans say, are worth their weight in gold. (Which is good, because they’re probably paid at least that much.)   “Definitely they’re making millions,”  says  Damien Hoffman, but beyond that it’s hard to get an exact figure he admits.

Here are the Top 3 Traders Under 30:

#3  Jan Sramek, Goldman Sachs. Age: 23 Sramek  makes his fortune as a trader on the Emerging markets desk at Goldman’s London Office. At the tender age of 23, he’s already published the book Racing Towards Excellence, founded and sold a social media website and has the ear of most of London’s major hedge fund managers.

#2 Gilbert Mendez, SMB Capital. Age: 28 After studying mechanical engineering at Columbia University, Gilbert built a black-box trading model for the global Forex currency market. He then sold it before becoming the “head trader” at SMB and now its youngest partner.  He presently focuses on trading equities.

#1 Adam Guren, First New York Securities. Age: 28 This Duke graduate and former professional soccer player gets little sleep trading markets all over the world, at all hours of the day.  He cut his teeth trading Chinese equities but now looks to profit on any market volatility around the globe.  He starts his process by logging on premarket. Then he spends approximately an hour, sometimes thirty minutes, seeing if there’s news out in the basket of stocks he follows. This is how he figures out if there’s any opportunities because he looks for newsworthy events that are going to move his stocks, according to the Wall Street Cheat Sheet.

For more details, click here to see the original article Wall St. Cheat Sheet Top 3 Traders Under 30.

Since Trader Monthly shuttered, we’ve decided to pick up the popular Top Traders Under 30 ball. However, based on your feedback and our research, we’ve made one huge change: we’ve decided there are not 30 top traders under 30.

Also, we feel these elite traders are worth watching because they have survived the shakeout since the Great Crash of 2008. It’s easy to win when the market goes in one direction. It requires skill to navigate up and down scenarios.

So, after 8 months of due diligence, we are proud to present to you the first annual Wall St. Cheat Sheet Top 3 Traders Under 30 …

3. Jan Sramek – Emerging Markets Trader,

Goldman Sachs

Like LA Lakers phenomenon Kobe Bryant, Jan Sramek — age 23 — has hit the big leagues with a ton of talent and promise. Having made the national headlines in the UK by breaking the world A-level record, Sramek enrolled to read Mathematics on a scholarship at the prestigious Trinity College at the University of Cambridge. Shortly afterward, he transferred to the London School of Economics to work during his studies because London-based hedge funds recognized his potential and snapped him up during his 1st year.

Having accumulated a wealth of experience on both the buy and sell-side during university, Sramek moved over to the area where many of the current superstars of the industry cut their teeth: the emerging markets fixed income trading desk at Goldman’s (NYSE:GS) London office (a very active area given today’s debt and currency volatility). Although neither Sramek nor Goldman would confirm or deny any details about this trading desk, we can assume the group has done extraordinarily well since Goldman’s traders had a perfect 100% win-rate last quarter .

Sramek is considered somewhat of a prodigy in Europe. He has repeatedly made the headlines with his various achievements. Most recently, Financial News named him the youngest financier ever on their list of 100 Rising Stars of Financial Markets Under 40 — a list which previously included the likes of Greg Coffey of Moore Capital and Pierre Andurand of BlueGold.

Out of all the firms with which we spoke, Goldman was the least revealing. Nevertheless, informed sources suggest that Sramek’s mentors include several of London’s most powerful hedge fund managers who are clearly grooming him for the very top. It’s therefore possible Jan deserves a higher place on our list. Regardless, given his age, we are confident he will be considered for Wall St. Cheat Sheet’s Top 3 Traders Under 30 list for many years to come.

Unlike some of his contemporaries, Sramek openly reveals the keys to his success, and makes it all sound quite simple. I highly recommend reading his book Racing Towards Excellence(a top rated book on Amazon). The book is a nice blueprint for anyone looking to maximize their ambition and take the steps necessary to be successful in any competitive environment, including finance.

2. Gilbert Mendez – Equities and Forex Trader,

SMB Capital

Gilbert “Gman” Mendez — age 28 — is as textbook a pro trader as Orlando Magic star Dwight “Superman” Howard is a NBA all-star. After studying mechanical engineering at Columbia University, Gilbert built a black-box trading model for the global Forex currency market. Such an awesome achievement led top Wall Street proprietary trading shop SMB Capital to give Gilbert a desk and trading account. Not long after, the firm awarded him “Head Trader” status.

When I asked about Gilbert’s trading style, he answered:

I trade news driven stocks and whatever sector happens to get in play. In essence I trade the flavor of the day or week. I make my trading decisions based on the intraday fundamentals, the medium term time frame charts (15 minute-hourly), and time my entries using my tape reading skills. My real strength as trader is the ability to read the tape and psychology of the big players behind a chart.

After proving his skills through the biggest equities crash since the Great Depression, Gilbert was recently made partner at SMB Capital. That’s what we’d expect from a guy who SMB co-founder Mike Bellafiore calls, “one of the best young traders on Wall Street.”

Unlike most professional traders, Gilbert is highly accessible to budding traders. He contributes public posts and educational material to SMB’s blog. If you are looking for a glimpse of what it takes to be a top trader on Wall Street, Gilbert has a ton to offer.

1. Adam Guren – Global Equities Trader,

First New York Securities

A year ago we called Adam Guren — age 28 — the Lebron James of trading. Given his consistent success like King James, Adam was the obvious choice for the top spot on our first annual list.

After graduating Duke in 2003, Adam played professional soccer for a season with the Cleveland Force before starting in the prestigious training program at First New York Securities. After a 14 month apprenticeship, Adam started trading his own book while expanding his focus from Europe to Asia.

Now, Adam focuses on global stocks. His day looks much like a British colonel’s when the sun never set on the British Empire. But with patience and discipline, Adam finds a way to replicate his success in multiple markets. He starts his process by logging on premarket. Then he spends approximately an hour, sometimes thirty minutes, seeing if there’s news out in the basket of stocks he follows. This is how he figures out if there’s any opportunities because he looks for newsworthy events that are going to move his stocks.

When I asked Adam about how he makes his moves, he said:

I’m not a technician and I really don’t study charts. That’s not to say I won’t look at them to see where things are. At the same time, I’m not a big fundamental guy based on the nature of how long I hold a position. I mean, I do understand the fundamentals of each stock and what people generally expect, but for the most part I rely heavily on intuition and the feel I have for a stock based on watching it for so long. After watching the same 50-100 names, you start to easily understand how they trade and what moves them. It’s pattern recognition.

Another key to Adam’s success is his risk management:

Every trade I get into I have a very good understanding of the risk-reward. One of the keys to success is measuring risk-reward. And one of the best ways to do that, as elementary as it sounds, is to buy low and sell high. So you want to buy when things are beat up and sell when things are overdone on the upside. I’d say I do a good job of measuring risk. It’s probably one of the main reasons why I am successful at trading.

Although this sounds very basic, it’s obviously easier said than done. Given that over 85% of traders lose money, Adam has proven that mastering the fundamentals is the key to success as a professional trader.

If you would like to nominate traders for future awards, please send us an email or comment below.

After being in the trading business for a few years and spending several hours of my week training new guys I can’t help but chuckle at one mistake I see all of the time. And I laugh because I know HFTs are printing money off this concept. And I see this happen to both experienced and new traders around the whole number, the quarter, the half and any other level easily identified in any time frame.

For this article I want to spice things up a bit and show you this spoof of what I want to call “The Magic Whole Trading System”:

First we have to set a few concepts in place. We buy a stock when we consider it to be cheap, and sell it when we find it expensive – you know buy cheap sell when expensive old school concept. Let’s take a look at the following graph:

The graph shows that a stock gets cheap right above the level (because we always buy in front of it) and expensive right below it (traders are taught to sell it right when it drops). And this happens for every single level, the magic whole, the magic half and even the magic quarter (and if the stock is slow enough, the magic dime). We are also monitoring a second influence; we have a theory that the more zeroes a number has the more significant the level. For instance, 60.00 is clearly more significant than 61.00. 130.00 is much more of a level than 13.00. And the Dow at 10,000… we can’t even comprehend that one.

A typical trading day using this system might look like this: Say the stock is trading 49.87 (obviously a meaningless number (no zeroes at all), but it’s the price you see when you first type it up. You might try a feeler trade here just out of boredom or impulsiveness. Then the stock comes up to 49.99. This is the most expensive the stock will ever be, so obviously you short it. Then the whole lifts and it is 50.03. You buy to cover your short since the stock is so cheap at this price… and the magic whole drops again. Now it’s 49.98. What do you do? Have you been paying attention?!

Obviously… it’s now VERY EXPENSIVE so you sell what you bought above the whole. Now it goes down a bit and you don’t want to be reckless since you just did a few trades, so you wait a while and probably short around 49.92 or so. It trades up to 50.00 and you pause to think about all the zeroes in this number and obviously you buy back the cheap stock and close above the whole as you can. This is a complete trading plan that you can execute the entire day as long as your buying power and stop loss limit permits.

For those of you feeling a little uncomfortable as I just dissected your trading system please stop being a piker. Man up and learn to trade!

Again, this is not a real profitable trading system, just in case you didn’t get my humor.

Gilbert “Gman” Mendez is the head trader at SMB Capital.

There’s some buzz around this Friday’s New York Times (NYT) article about day traders. Some pros I’ve talked with think the article was poorly researched. I think the pros simply broke the first cardinal rule in trading: never get emotional.

The NYT article is about home gamers. These are people who day trade from home. Do not confuse them with proprietary trading firms, big Wall Street banks, or former pros who now work independently. These home gamers are more like the millions of people who purchase screenwriting books or workshops in hopes of getting their big break. Unfortunately, most of them never will.

On the other hand, the pros work for highly capitalized firms which offer many more resources than most home gamers will ever understand. For example, pros who trade for firms are trading other people’s money. Moreover, many are pulling a base salary. These are two very big differences from amateurs trading their own capital and eating only what they kill.

So, was the NYTs article poorly researched? No. It was simply about one niche of day traders. I guess the writer could have made that clearer in the introduction, but the article seems to make that very clear when reading it without emotion.

Gilbert “Gman” Mendez is the Head Trader at SMB Capital.

Many traders focus on trading ideas and trading setups and forget to develop execution skills. I do not believe in just finding the setup, identifying the proper stop, waiting for the entry and bang you are done. I would even argue that with the proper execution skills you can make money on a trade setup that did not work out. Today I want to offer an execution trick I use everyday for my trading that gives me the opportunity to be wrong on a setup and yet be able to profit from it in some cases—heads I win… tails I win.

There is a linear relationship between the risk and probability of setups; normally the higher the probability of the setup the higher the risk in the play. Conversely, the risk is the lowest when the probability of the trade is fairly low. The execution “system” I propose takes advantage of this concept: Start a small position when the setup is developing or when the probability is lower and use the open profits to press on your normal entry. This allows you to have more size for the actual break, have a much better average entry price, and have a lower risk, or even no risk at all, on the play.

Let me illustrate this with an example. Let’s take a look at the following chart of LVS where we wanted to be involved if the stock got above 20.5 as it is a big technical level on the daily and weekly charts. The average trader would look pay the break and put a stop below a support area, most likely around 19.90.

The way I would look to swing trade the play is by initiating with a small position on the pullback to the trend line (around 19-19.20 area) while risking a very small amount and adding size on the actual break at 20.5. For the sake of the example let’s just make some assumptions: One, I would want to risk $1k on the break out play by paying 20.5. Thus I would only be allowed to pay for about 1600 shares. Two, I want to risk only $100 on that first trade – the buy into the pullback of the trendline. Three, my hard stop for the whole trade is 19.9 after buying the break. Four, I have to use my tape reading skills to determine the stop in cents on my initial trade to figure out how much size I can start with.

So say you pick up 500 at $19 and risk to below 18.8. If that trade holds and you get the break at 20.5 then you end up with 500 @ 19 + 1600 @ 20.5 = 2100 @ 20.14. So if the trade doesn’t work then you only lose 24c or $504 on the trade.

But what if you saw something on the tape down there and were able to spot a place where your risk would have been 5c instead of the 20c from the previous example? Then you can pick up 2k shares on the first trade and you end up with 2k @ 19 + 1600 @ 20.5 = 3600 @ 19.66 on the break– twice as much size as standard break trade and with an average price a whopping 25c lower than the stop for the entire position. If the trade were not to work out you would still end up making about $864.

You can use this concept for any other type of setup. We have one trader at our firm that does this very well and for almost every single one of his trades. Always starts by risking about $20 on a scalp trade and leverages that first entry to make $500-1000 trades. Yes he doesn’t crush that many of them but you can’t beat that risk:reward.

So there you have it a simple yet powerful way to minimize your trading risk. Yes, you will get stopped out often on the initial entry but that is why you do shouldn’t risk much on those. But the key to this is that you need to develop tape reading skills to be able to spot those places for your first entry. The better you are at identifying your risk on that initial entry, the bigger your trade will get on the confirmation. And when the stock trades cleanly and you get lucky you can really crush it while taking NO big risk. For the record I legitimately hit the bottom below 19 in LVS but was able to get back in MUCH smaller above 19.5 and then pressed above 20.2 and 20.5. That was a little chipper.

Happy trading!

I have a degree in Mechanical Engineering from Columbia U. Although my days of analyzing control systems and playing with complex math problems are long gone, I still use plenty of those analytical skills to quantify my trading performance.

Seriously, I am so meticulous about my numbers that even Mike, Partner at SMB, thought I was a spy for another firm when I first interviewed at SMB. He thought I was just asking too many detailed questions about performance, risk/ reward on trades, etc.

According to him all those questions only meant I had to have been gathering intel for another prop shop – and there were a lot of them at time trying to play that game just for the record. Actually, I was just being myself, a true number cruncher at heart.

For today’s column I wanted to give you an inside view of how and why I review my trading numbers. Keep in mind that I am a high frequency trader and thus my system requires this kind of analysis, but the same approach towards reviewing your work will serve useful for those not as active. So let’s dig right in.

First, let’s tackle the issue of why it is worth spending the time having a routine to review your work. Though not obvious to most traders, it provides a framework for looking at your work in an unemotional way. Often, we become emotional and overweight the results from any one trade and conclude erroneously whether that is play that must be kept/eliminated from our trading.

Secondly, it gives us the ability to quickly to really see how we make/lose our money. And most importantly, and with the right record keeping, you can tell with excruciating accuracy when the market conditions change and when it is time to shift gears in your trading mentality.

I like to keep track of the following stats that I find useful for my own trading. It has been really more by trial and error that I have come down to this relatively small list – it used to be much bigger. But this list works for me:

• Performance and Volume per time of the day (premarket, open, mid day, close, after hours).
• Max size during the times of the days vs their profitability and percentage of big winners.
• Risk/Reward per trade setup – I have my trades broken down into three categories: A, B and C. A-trades being the ones I have most confidence/size/risk on, and C-trades being the least probable trades that I treat as scalps.
• Profitability per stock and per sector.
• Profitability Longs vs Shorts.
• Profitability per market setup: I want to know how my days is tight up to a trend day, inside day, or just range bound day.
• Profitability per news item: I want to see how my results are for stocks gapping up/down big, stocks with upgrades/downgrades, stocks fresh with earnings (mixed, heavily weighted to one side), secondary offering pricings, etc.
• Average holding time for my different trade categories.
• Liquidity adding percentage per time of the day.

During the weekend I take a couple of hours to go over my results from the week and try to find some patterns. I want to find out if the market conditions have shifted so I know where to spend most of my mental energy in the coming days.

Do I play more C trades and be lighter on my A trades? Do I just load up on my A trades but reduce my price targets to about half of what I usually shoot for? Is my data meaningful or is it littered with emotional/angry trades? If so, then what must I do to correct that mental state? You get the point. The more time you spend on this, the closer you get to knowing who you are as a trader.

Monthly and quarterly I look at my results and update my stock Ban list. These are the stocks that should have a charity named after me, those I just day in and out single handedly donate tons of cash to. Every two quarters I make an effort to give the stock one more shot to come out of the ban list. But normally they are in there for a reason.

In the end what matters is being overly meticulous about your results but only AFTER you have developed the skills to perform day and out. I am at a point in my trading career where I feel I know myself as a trader pretty well and now I am just trying to cut the fat in my trading. Take, for example, a recent analysis I started doing:

I wanted to look further into my trade categories (A, B and C) and do a breakdown on how much I make and lose on each of them. I am trying to figure out if there are some silly losses I could eliminate all together. Doing this analysis showed me something I hadn’t seen before. All of my little losses (paying for information in a stock if you will) could amount to about 50-60k a month in my trading. So it is my recent quest to figure out how to cut some of that fat and put that money back in my pocket.

Again, it does not matter how you analyze your results but you must have a way to look at your numbers from a quantitative point of view. And you must use your journal as a way to help you keep track of your progress. Yes we all have different styles, time frames, risk parameters, types of trades, etc, but in the end we are just trying to squeeze money from the market consistently.

Happy trading!

Gilbert “Gman” Mendez is the head trader at SMB Capital.

Gilbert “Gman” Mendez is the Head Trader at SMB Capital.

The volatility is coming back to the market. Although just not in the way we are used to. This market is punishing those who trade strictly off of old school market patterns and rewarding those with trading skills. Let me explain.

Over time we have found intraday patterns that allow us to stack probability on our side. Here are some common ones:

• We do not buy stocks intraday that have broken long term support and vice versa
• We do not short strong stocks that are consolidating at the highs of the day and vice versa
• If the market gaps up and establishes a tight range on the open it is okay to play the longs on the break of resistance aggressively
• If the market is trending up you should be looking for strong stocks to buy and spend less energy on the weak.

When you possess the knowledge and the market cooperates you can be sloppy with your execution and be often rewarded. As knowledge-based traders you need to have a huge tolerance for pain as the real stops on these plays are often wide. Further, as such trader you can expect to have big daddy swings in PnL, especially when the market is just not cooperating.

One of my traders found the following clip which is quite representative of what a knowledge-based day trader (KBT) — represented by the fancy trick guy — may experience in these sessions. Mother market just waits patiently and quite literally … well I’ll let you watch the clip.

Let me show you a graph of SPY to exemplify what an average day in the market is like with the HFT algos in full force:

The circles above represent areas where a KBT trader may have found confirmation that they are either right or wrong. Let’s talk about them in more detail from left to right

1. This break confirms that the market may go higher after taking premarket resistance with decent volume.
2. This one confirms that the break in 1 was fake. Most would get out. Some with a higher tolerance for pain would have stayed in or even lightened up
3. A new high getting ultra aggressive and chasers to get back in full tier… But there is zero to no follow through after entering and it is all pain from there.
4. Assumes the trader finally threw in the towel and gave up. The longs are now looking at that 5 min flag to get in on the short side.
5. Again market yo-yos to the other side stopping out shorts. The circle highlights a possible flag entry for longs looking to add and those not involved waiting to get in.

As a better exercise I ask you to take a look at any In Play active stock (AAPL, AMZN, GOOG, JPM, GS, etc) and try to trade the “trend” using knowledge based patterns for any day this month. My favorite days to watch your account get slaughtered in amusement so far are Feb 1,3,8,9 … Good luck with that.

So how do we combat these shenanigans? In my opinion the only way to do it is to move onto a skill based system where you are practically trading move-to-move. Yes, it means grinding out money more actively. But if GS is doing it and crushing it, why not join the party? This requires you to be more patient. Be the guy in the video sitting on the sidelines waiting for that trade, and when you see it then crush it … crush it like a grape. Happy trading!

Needless to say, Thursday was nothing short of an orgasmic day for Gold bears and Dollar bulls. The precious metals complex crumbled along with the Euro, while the greenback was higher. In fact, it was such a bad day that Gold officially lost its safe-haven status, according to CNBC. This was also noted by Elliot Wave and The Business Insider. All proclaimed that Gold was no safe haven.

In today’s world, how can you blame them? With the resurgence of day trading and most professionals staring at a computer screen all day, most people are worried about what is going to happen in the next hour, much less the next week or month. Everyone is now a trader, but not an investor. Who can remember the trends of the past quarter or year? Apparently, not CNBC, Elliot Wave and the Business Insider.

Not only has Gold been an excellent hedge for the entire decade (and it was in the 1970s), it rose in value during both of the bear markets in stocks. To those with a time horizon beyond a few nanoseconds, this chart is no surprise.

Meanwhile we hear from the bears that Gold is a “crowded trade” and that because there are a few commercials on television, the public is involved. Such anecdotal evidence is easily refuted by facts.

First of all, only 0.7% of all global assets are in Gold and gold-related equities and exchange traded funds. What does a real Gold bubble look like? That figure was 15% in 1934 and 29% in 1980. While more and more people are buying Gold (that is what happens in a secular bull market, participation rises over time!), it is still extremely under-owned while corporate and government bonds are over-owned. The vast majority of the few that own precious metals in their portfolio have a weighting below 10%. While a lot of money poured into Gold in 2008 and 2009, even more money poured into Bond funds. That is the crowded trade.

Secondly, take a look at this chart (with my annotations) from http://www.sentimentrader.com. Essentially, we see that the public’s view on Gold did not exceed 75% bulls as it did in 2006 and 2008. As Gold broke $1000, the public’s bullish appetite barely increased.

Many gold bears are deflationists. They argue that since all asset classes have trended together and trended against the US$, all fall in a deflationary period. This is the correct view when we look at very short periods of time like July to October 2008. However, in the larger picture Gold performs very well on a relative basis in a deflationary period. It outperforms as other asset classes tumble and more importantly, it is the first asset to recover. Many seem to forget that the entire precious metals sector performed very well from November 2008 to February 2009, while stocks continued to fall and commodities were trying to find a bottom.

Furthermore, the US dollar doesn’t have to decline for Gold to do well. Did you know that since the very end of 2004, the US$ is flat but Gold is up 143%? Since July 20, 2007, Gold is up 56% while the dollar is flat. Since early September 2008, Gold is up 35%, while the dollar is up 1%. The majority of deflationists have been dead wrong on Gold and will continue to be wrong. Give huge credit to those who have been right on deflation and Gold: Bob Hoye and Mike Shedlock.

Turning to the technical situation, we see that traders, who are being confused for real technicians, are bearish on Gold for the near term. Joe Terranova on CNBC’s Fast Money said that the long-term uptrend was broken and that people needed to reduce positions. To be fair, long-term for Fast Money may be just a few days. As we will show, the reality is that Gold has a super-bullish technical outlook. It is in the early stages of a parabolic rise.

In the 1970s, Gold began to go parabolic in the middle of 1979, almost 10 years into the bull market. The important breakout occurred in 1978, and then corrected 20% back just below the breakout point (see the circle). This time around, the important breakout occurred at the end of 2007 and then in 2008 we had the snapback to support, though the snapback was a large 34%. Note that in the last bull market the process of breakout, snapback and parabolic move took a year to develop, while this time it is taking about two years. That means this parabolic move will last longer.

There are some distinct similarities with other bull markets. Look at Oil. Its major breakout occurred in 2004 and its parabolic move began about two and a half years later. The difference is Oil’s snapback to support didn’t occur right away. Its parabolic move began in the ninth year of that bull market.

The DJIA in the 1980s is a classic example. The major breakout occurred in 1983 and the parabolic move began two years later. If the bull market began in 1975, then the parabolic move began 11 years into the bull market.

Take a look again at the Gold chart and you will notice that the parabolic move has already begun. The recognition phase likely will take some time to develop. While Gold could move to $1300 in the spring, we don’t expect sustained new highs until later this year.

The fundamentals support our view as the financial crisis is entering the most bullish phase for Gold. The sovereign debt crisis, which really began in Iceland, will plague Europe this year and eventually spread to the UK and US by early 2011. Nations have no other choice but to monetize their growing obligations while trying to stimulate their economies with deficit spending and near 0% interest rates. It is a perfect storm for Gold as everything is lining up now for such a storm to begin in late 2010 and early 2011.

In closing, the huge winners will be Silver and the emerging Gold & Silver junior producers and explorers. For those looking to take advantage of a historic wealth building opportunity, visit http://www.thedailygold.com/newsletter and consider how we could help you ride this extremely volatile uptrend.

Gilbert “Gman” Mendez is the Head Trader at SMB Capital.

All my pre-hybrid sketchy experiences with NYSE have left me with a sour taste. If you were to sit at my desk, you would hear how I’d pay higher ECN fees to EDGX or get worse fills rather than to give any business to NYSE. I refuse to send any orders through them. And it is not like my 50Mln shares a year would really make a huge difference. Call me loco but I just don’t give them my business.

Although, while reviewing my numbers from last year I realized that being overly stubborn about this cost me close to 40-50k — and that’s just a low ball. Talk about a self-imposed rip. In the words of Chaz played by Will Ferrell in Wedding Crashers: “What an Idiot!!”

So, coming into this year I made changes to my execution hotkeys. I added NYSE sweep keys and I moved them up the ECN toggle list for bidding and offering stock.  And while my ECN fees have come down slightly, I am disturbed by the shenanigans of how my orders are treated. Let me give you a couple of examples.

First, I must admit I have never been a fan of stop orders. But now that I have way too many positions riding at the same time, it is the only way I can manage my risk. Nonetheless, I only use orders triggered by prints locally on my computer to route through ARCA. I have always felt that stop orders that reside at the NYSE exchange can be manipulated. The exchange can argue all they want about the floor specialist not being able to see the orders, but I find it to be too big of a coincidence that stops too often go off at some mysterious prints. Check out what happened to the trader who sits next to me who put in a NYSE buy-stop at 45.24 for 100 shares to cover his short.

Someone please explain how it is possible for a buy-stop that is hosted at the exchange to go off when 45.24 prints but does so only by printing the 100 shares that were in the buy stop. Coincidental? Maybe. Sketchy? Very!

But wait let me show you my personal favorite these days. Getting my orders front run by NYSE. Let me illustrate what this looks like on the tape with the following short clip:

This front running nonsense happens to me at least 5-8 times a day — often when I have size in a position. I am starting to wonder if I am really saving that much money by trading again with my boys at NYSE. I really do wish some of those tens of thousands of dollars that I annually “contribute” to the SEC actually went toward making the system a bit more transparent. It disgusts me that I have to deal with these shenanigans. I am all for businesses making money when offering a service, but this is just ridiculous.

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