Trend Trading for a Living

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Trend Trading 
for a Living

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from passion to
profession
INTRODUCTION
1
BRAINSTORMwith me for a minute: what does the stock
market represent to you? What images come to mind?
What feelings do you associate with trading, with Wall
Street, with the global markets? When I reflect on what the
markets mean to me, this is what I come up with:
• A free-flowing stream of numbers, numbers,
numbers
• Greens and reds, ups and downs, peaks and
troughs, ebbs and flows
• A melting pot of products, services, technologies,
commodities, and information
• Manhattan high culture, soot-stained buildings,
suspenders and pinstripes
• A barometer of the economic and psychological
state of the nation, and of the world
• Power, greed, discipline, corruption, intelligence,
ecstasy, and agony
• The playground of very energetic people who
love making money
Copyright © 2008 by Thomas K. Carr. Click here for terms of use.
• Icon of free-market capitalism, of democracy, of
America
• An efficient, highly accessible vehicle for creating
wealth, freedom, opportunity
Obviously, my impression of the stock market is an
amalgam of a variety of things. The market represents to
me the most challenging and most stimulating arena in all
of human culture. I love art, literature, architecture, science, film, and fashion. I am a religiously committed person and am conversant with many of the world’s major
philosophies. But of all products of human making, no
other so totally engages my intellect, my will, my passionas
does the stock market.
My introduction to the stock market came through a
recurring image in the pages of my favorite serial comic
book character: Richie Rich. There stood the “poor little
rich boy” in front of a glass-enclosed machine, slender tape
in hand, scrutinizing the ever-growing Rich fortune he was
destined to inherit. The neural network this image hardwired into my six-year-old brain must have been permanent, for I have been striving ever since to understand what
Master Rich must have understood as he stared at that long
stream of paper. If I wanted to live like he lived (and what
young boy wouldn’t?), I knew I would one day have to
unlock the secrets of that mysterious ticker tape.
On my eighth birthday I asked for, and received, the
original, 1968 deluxe version of the Whitman Stock Market
Game. This classic game is played just like Monopoly, only
instead of buying famous streets, you accumulate shares in
some of the world’s biggest and fastest-growing companies.

2 TREND TRADING FOR A LIVING
At the time, those companies included Maytag, Woolworth,
American Motors, International Shoe, and General Mills
(how times have changed!). Players barter and bid for shares
and are forced to pay dividends when they land on a stock in
someone else’s portfolio. Unfortunately, I could not get any
of my playmates excited enough about the stock market to
play with me. So for the most part I played alone, often for
hours at a stretch, bidding against myself as I amassed a small
fortune. Funny thing, I always won! As an aside, the 1968
Whitman Deluxe Stock Market Game is no longer manufactured, but you can occasionally find one for sale on eBay
for about $20.
My next childhood association with the stock market
came when I turned 12 and was old enough to walk on my
own to the downtown public library after school. The first
book I remember checking out with my new library card
was a biography of Howard Hughes. I devoured every
page, seeing in Hughes a real-life, grown-up version of
Richie Rich. While I remember not liking the man very
much, I recall wanting to do with my life what he was able
to do with his. I remember making the connection in my
mind between the ideas of risk, speculation, and passionate investment on the one hand, and on the other, the kind
of freedom and power both Rich and Hughes enjoyed.
On my next visit to the library I walked up to the
librarian and asked, “Do you have any books on the stock
market?” Managing to hide a smile, the woman escorted
me quite courteously to a shelf located upstairs in a far,
dark corner. After looking over the neatly stacked books,
she pulled one down and handed it to me. “Here,” she said,
“you might like this one.” The book’s title couldn’t have

FROM PASSION TO PROFESSION 3
been more perfect: How I Made $2,000,000 in the Stock
Market. It described how a young professional dancer
named Nicolas Darvas amassed a fortune by trading stocks
on only three bits of information: the high of the day, the
low of the day, and the close. Darvas invested in fundamentally sound, growing companies breaking out of consolidation bases on strong volume. Once he made a
purchase, Darvas would simply record the boxes the stock
price made as it moved above the base. A box was what
Darvas called the trading range the stock tended to trade
within, based on its daily highs and lows. If it broke above
the upper edge of the box, he would move the box up to a
higher level, but if it broke the lower edge of the box, he
would sell the stock and cut his losses.
Although I didn’t know it at the time, Darvas’s book
was my first introduction to systems trading—and I was
hooked. But I also knew that the kind of fundamental
analysis Darvas applied to the companies he traded was
beyond the competencies of my 12-year-old brain. So a
couple years passed before I picked up another stock market book.When I did, I found a real winner, one that taught
me how a profitable system can turn the stock market into
a virtual money machine. It was Robert Lichello’s 1977
best-seller, How to Make $1,000,000 in the Stock Market
Automatically!Written in response to the 1970s bear market, Lichello developed a system that exploited the type of
volatility that typically appears at market tops and bottoms.
Like Darvas’s box method, Lichello’s system was simple
and mechanical: after buying an initial position in a stock,
you buy more shares if the price goes down and you sell
shares if the price goes up. A mathematical formula was

4 TREND TRADING FOR A LIVING
applied to the closing price at the end of each week to
determine what to do with your position: buy a little, sell a
little, or hold. In this way, Lichello claimed, a stock could
move up and down within a range—netting the buy-andholder very little—and still yield a handsome profit to the
one using his automatic investment management (AIM)
system.
After I finished Lichello’s book I decided to experiment with his system to see whether it worked. I asked my
father to explain that odd section of the paper with tiny
print that listed all the New York Stock Exchange (NYSE)
companies and how they fared in that day’s trading. He
showed me how to read the numbers and suggested I focus
on a company I was familiar with. I chose McDonald’s. We
ate their hamburgers at least once a week, and though I
didn’t know that it was the fastest-growing franchise in the
United States, I was well aware from the big sign out front
that the number of hamburgers served at our local restaurant kept going higher. So I put the AIM method to work
with an imaginary 500 shares of McDonald’s.
Lichello’s AIM method requires only a weekly glance
at the closing price of a stock in order to work the system.
I decided that was too infrequent, so I checked the price
every day. I still remember feeling absolutely elated that
first day after my imaginary purchase upon learning that
MCD had closed 1
/4 point, netting me a paper profit of
$100. By the end of that first week, as I recall, MCD was
up a whole dollar. A $500 return in one week!
The problem with Lichello’s method is that it only
works with stocks making large up and down swings. However impressive a $1 move might be, it did nothing to trig

FROM PASSION TO PROFESSION 5
ger AIM’s signal to sell shares. That would have required
at least a $3 move. So I watched again the next week. Each
day I checked the paper to see how my shares did on the
big board battlefield, and each day my hopes would rise and
fall with each quarter-point advance or decline. This went
on for about two more weeks before I finally gave up out
of sheer boredom.
I decided to give Darvas’s box method another read. I
dog-eared the library’s copy ofHow I Made $2,000,000 in
the Stock Market, carefully taking notes on how to apply
every aspect of the system. Again, I took an imaginary
investment in my favorite company, McDonald’s. It certainly fit the Darvas profile: strong earnings growth, hot
prospects, and trading in a long-range base. So early in the
summer of 1974 I “bought” 500 shares of MCD in my
make-believe trading account and excitedly set about putting Darvas’s system to the test. I drew up a kind of primitive spreadsheet for keeping track of the daily highs and
lows in order to determine the boxes necessary to manage
the open position. At that time, MCD was trading in the
low 40s. It had recently broken out of a months-long trading range with a lower edge in the upper 20s and an upper
edge in the mid-30s. I already knew MCD was a fundamentally sound company, and this base breakout qualified
as a Darvas entry point. So I went long the stock around
$42 per share and set my stop-loss just under the lower
edge of the new trading range, around $37. About three
weeks later, the stock rallied to near $48 before closing the
month at $44, so I dutifully moved the Darvas box up two
points. My stop-loss now stood at $39, and I was comfortably ahead nearly $1,000. Life was good!
6 TREND TRADING FOR A LIVING
For a while things looked promising. The position
came close to getting stopped out following a stern earnings warning, but my box was not touched and I remained
in the trade. Then disaster struck. MCD declared earnings
that fell below even their lowered prediction, and this was
followed promptly by several high-level downgrades. In a
swift New York minute I was taken out of the trade for an
imaginary, but no less painful, loss of $1,500. Suddenly, and
decidedly, my career as a teenage Wall Street tycoon had
come to an end.
I grew up a bit after that. I got interested in sports,
girls, parties—the usual adolescent distractions. At 18 I
went off to university to study medicine, until I discovered
I hated being in hospitals and felt nauseated at the sight of
blood. So I switched to religious studies and philosophy,
and 10 years of graduate study later found myself with a
doctorate in the subject, teaching the rudiments of Plato
and Aquinas to undergraduates.
Having weathered a very frugal decade as a starving
graduate student, and with a mountain of student loans and
credit card debt to pay off, not even a full-time professor’s
salary could tempt me back into the trading game. But
when I took up an offer to teach summer school, the $5,000
bonus brought with it, rather unexpectedly, a return of the
old trading bug.
The year was 1996 and a new trading tool was all the
rage: 24-hour financial television. First came the CNNFinancial Network, and then CNBC and Bloomberg Television. When this input coupled with Internet trading chat
rooms, online discount brokers, and cheap charting Web
sites, Wall Street quickly became Main Street. The market
FROM PASSION TO PROFESSION 7
had just put in a huge year in what was then the middle of
the great bull market of the 1990s. Cab drivers shared stock
tips, bus boys traded between shifts—the age of the day
trader had dawned. The smell of quick profits was in the
air, and I wanted to inhale as deeply as possible. So I opened
an online brokerage account that summer and put the
entire $5,000 into it. In those days, there were no pattern
day trader rules, so with $5,000 you could buy up to
$10,000 worth of stock on margin and trade it repeatedly
throughout the day.
I decided that with such a small amount of capital to
work with I had better stick with lower-priced stocks. So I
scanned the chat rooms and investor threads for ideas. I
soon found one. On all the major sites, traders were
buzzing with talk about a small public company that was
developing a process by which to turn sewage into safe
drinking water. There were rumors that the CEO was
going to be interviewed on a network news show sometime
that week, and that he would drink a full glass of former
sewage in front of the cameras to prove his confidence in
his company’s system. Speculation ran wild that this exposure to millions of viewers would drive institutional
investors to buy up shares in droves.
This seemed about as close to a sure thing as I could
find. So I decided to make my first real-money stock purchase in this wastewater treatment company. This small-cap
Nasdaq issue was trading around $2.00 at the time, so I
bought a starter position of 1,000 shares. I anxiously
watched the news that night, but there was no mention of
the company. The rumors persisted, and on the next day the
stock opened around $2.50. In my euphoria, I bought 1,000
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