The Secrets of Trading Like an O’Neil Disciplegraphics.moneyshow.com/pdf/lvms12_The-secrets-of-tr… · · 2016-09-07The Secrets of Trading Like an O’Neil Disciple ... and the

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The MoneyShow Las Vegas, May 14-17, 2012 Tuesday, May 15, 2012 The Secrets of Trading Like an O’Neil Disciple Gil Morales, Managing Director and Chief Portfolio Manager, MoKa Investors, LLC GIL: Just want to make sure everybody knows they’re at the right workshop; this is Beginning Karaoke. Everybody, did you bring your own mic? (INAUDIBLE) GIL: It’s 2:05; I think we’re ready to go. Its 2:05, so welcome everybody, thanks for coming. This is not Beginning Karaoke; it’s actually Advanced Karaoke, also known as Trade Like an O’Neill Disciple, so we’re stuck with each other now for four hours, unless you choose to leave earlier. We’re stuck here, though, for the full four hours, and we intend to fill it as well as we can. How many people have attended this or any of our similar workshops or discussions before? Frank, you don’t count. Okay. I have to acknowledge an old friend, Kathy Phillips; how’re you doing? You look great, by the way, so; I haven’t seen you for a long time, so you actually look younger than the last time I saw you, but that’s what I tell my wife every morning too, but anyways. What we’re going to cover today, we’re hoping by the time you leave here today you’ll have a strong grasp of some potent weapons that you can use in the market on the buy side in terms of pocket pivot buy points; we’re going to cover that first, and then we’re going to move on to buyable gap-ups and cover those in detail. Then Dr. K is going to run through a trading simulation to show how these work in real time in conjunction with what we call the seven week rule, which is our sell discipline, and I’m hoping, if I can, to get Dr. K to go off script and maybe have you guys pick a couple of stocks that have done well or however they’ve done over the last three or four months to see how a trading simulation will work with those just to kind of keep him on his toes. DR. K.: Actually those stocks that you picked, I intentionally haven’t looked at them, so they are off script. GIL: Well, no, they’re the same ones; they’re the same ones as last time. DR. K.: Ok, well I haven’t looked into them in six months, but… GIL: But I’m thinking I’m going to give you something new, so, anyway, but I’ve got my E-signal up just in case we want to look at some charts. And what’s going on today in the market, but then after that because that’s the third hour, and then the last hour we’re going to spend on short selling, and that may or may not be relevant to some of you in this market environment with the NASDAQ breaching 2900 support today, and the S&P 500; it looks like it broke that 1340 or 1350 level pretty good and it all kind of let go at the end of the day. It was interesting, we were doing a presentation at 11:30 this morning, and one of the points I was making is that Apple is a big market stock, and that if Apple starts to break, watch out, and pretty much at that moment Apple started to break down from around 560, and of course the market shortly thereafter went through 2900. You can feel free; Dr. K doesn’t speak much, but he does look good, doesn’t he? DR. K.: You know Penn and Teller. GIL: Penn and Teller, right. So, anyway, so we’re going to try and have some fun, and hopefully you guys will learn some stuff and in the process maybe help us expand our understanding of what people pick up quickly or don’t pick up quickly when we’re talking about these. I, myself, have not taken PowerPoint 101, so I’m not that facile with it, but bear with me here. We want to look at Slide Show, correct? From the beginning. Okay and we’ll begin at the beginning. Buying techniques one. Nice title; sounds good, but our primary weapon when we’re buying stock is the Pocket Pivot Buy Point, and the term Pocket Pivot comes from a musical term, “In the pocket”; anybody who’s a musician probably is familiar with that, and Dr. K came up with that being that he’s a piano player, I’m a guitar player. His dad is accomplished guitar player and the inventor of the Wa-Wa pedal; Dale Kacher; he used to play with Frank Zappa, so music is kind of both in our bloods, and so the term “Pocket Pivot” makes a lot of sense to us viscerally, and Dr. K came up with that. He also


identified the characteristics of a pocket pivot. Interestingly in the mid-2000s, I know I’d spent a lot of time looking at stocks coming up off the 20-day or looking at stocks where the volume dries up excessively, and then it shows just a pick-up in volume; not necessarily above average volume and then it moves out of a nice consolidation within a base, and I was looking at that as an advanced or early buy point, and Dr. K came along and we joined up forces again in 2009, back at O’Neill where I was Chief Market Strategist and Internal Portfolio Manager; Dr. K was a Portfolio Manager and a Research Analyst. He used to assist me, and actually very key assistance in dealing with the institutional clients that we had to advise back then, and then of course institutional clients are very sophisticated only in the sense that they’re very good at speaking a language known as statistics; some of you may be fluent in that, or maybe not, as I’m not, but Dr. K is very fluent in statistics, and he can nail things down statistically, and he has done that with the Pocket Pivot Buy Point, so before we get going, though, I just want to clue you in on our moving averages. We like to use Magenta as a ten-day moving average, and these are all simple except for the black one, which really the 65-day exponential, which is the black moving average you’ll see on these charts is really, I only use it on the short side, so we’ll really be focusing on that in the final module of the day; in the fourth hour when everybody’s ready to have dinner. There is no food yet, but the prime rib and the lobster should be showing up, so we’ll see; we did ask them to move on that, and then we use green for 20-day, blue is the 50-day, simple, black 65-day exponential, as I said, and then the red is the 200-day simple moving average. We primarily use the 10- and the 50-day; we call the 10-day a magenta, but it’s really pink, and as I pointed out in my previous presentation, real men do use pink moving averages, but I think of it as a dainty moving average, but anyway, what is a pocket pivot? It sounds cool, but what is it? It’s basically an early buy point in a potential leaning stock’s consolidation or basing pattern, so you see them in the base primarily. We also have another type of pocket pivot; a continuation buy point, and what differentiates the two, is that an early buy point within the base; a pocket pivot within the base is utilized as a buy point within the consolidation or base to provide early mover advantage to the investor to start building a position of potential leading stock within the base before it breaks out. One of the big problems, I think, in 2012, and even as we moved in past 2000 is that Bill O’Neill was really the first guy to figure out how to get a chart to print out on the plotter printer, and this was back in the 1960s; back then that was a huge deal. Before that you had people putting up hand-made charts. DR. K.: It was all manual before Bill. GIL: It was all tracked manually, yeah, and portfolio management hired teams of young Turks to, as they called them, to do that for them. Now, Bill O’Neill figured out how to do it on a plotter printer, automated the process, and since then everybody has charts, and today everybody has charts, and everybody coming up to me after the first presentation today, they got Think or Swim, you’ve got E-Signal, you’ve got High Growth Stock Investor, you name it. Everybody’s got charts, so everybody sees everything at the same time, assuming you’re all awake at the same time, and so things become very obvious very quickly, and one of the things we noticed in the 2000s is a very choppy trend during the 2000s; the markets have been, there’s been a lot of stop and go and a lot of breakouts failing, and a lot of that might be due to the fact that everybody sees a breakout to new highs when it happens it’s very obvious. Even those who take Technical Analysis 101 and are not necessarily O’Neill type followers or use the O’Neill methodologies will see that sort of breakout as a consolidation breakout, and everybody’s on top of it, and I think a lot of times those will fail because the crowd sees them, and I do know from having advised institutional investors that some of them actually create breakouts because they know that they can sell into them if they’re trying to unload stocks. That would be a late-stage base, and that’s why the phenomenon of a late-stage base breakout can fail, and why you have late-stage based failures. Institutions are using that last breakout by the time it becomes obvious to dump stock and so with everybody seeing breakouts, the pocket pivot gives you this early buy point that’s a very strong tool in terms of getting in early and having a little bit of an edge in markets where it’s very difficult to find an edge. Now, pocket pivot also solves the problem of where you add to your position once you buy leading stock as it’s coming out of a base, so the way we look at this, you buy, on a pocket pivot within the base, then you can buy on the breakout and add to your position. Your average cost should be lower because you started out buying within the base on the first pocket pivot, and as you move up, rather than using this sort of nebulous, ill-defined rule that if it goes up 2% you add to your position, and if it goes up another X percent you add to your position. We have this concept known as a continuation pocket pivot, which is a pocket pivot that occurs either off the ten-day moving average or the 50-day moving average as a stock is already in an uptrend and extended from its base breakout, and this basically, it offers both a way to get on-board strong leaders later on in their up-trends, as well as an


extremely reliable and powerful tool for adding to positions purchased earlier when the stock was still within or just emerging from its original consolidation or basing formation, and we find buying continuation pocket pivots and adding to our positions on continuation pocket pivots rather than adding on some arbitrary percentage is much more powerful and something that allows you to do it with more confidence, but it is true that pocket pivots are unique buy points, and we feel that this particular tool has added to the O’Neill vernacular, and so we consider it original work; honest work where we have added to the techniques that Bill O’Neill uses, and built upon them as former portfolio managers for O’Neill. I know that they don’t acknowledge it, but I think it’s foolish of them not to, but that’s their business, but they work, and we know from literally hundreds of people we’ve talked to that they do work, and they work to great effect, in fact, so, in any case, you can see here, so this is in the base pocket pivot allows you to get an early price; in this case the base doesn’t break out, it actually goes sideways, and this is actually in 2010, after the flash crash here, the market was actually going sideways and very choppy, so this was actually constructive action relative to what the market was doing, and these were months where a lot of people lost money in general if they were trying to play the market. You can see the two pocket pivots occur within the base and those are your early buy points to begin building a position in the stock so that you have an edge when it finally does break out, and you can see the third point; the standard base break out; that’s where most people would be buying the stock, but theoretically with two pocket pivots in the base you would have an early start and you would be building on a position that you already had at a lower cost. Now, the third pocket pivot in the formation is coming off of the ten-day, that is a continuation pocket pivot because you can see the stock is extended up to the 154 price level already, and it has been moving up in a nice uptrend and there’s your add point, and it’s a very sound add point because you’re using the ten-day moving average; the movement off the ten-day moving average defines the continuation of pocket pivot and it also provides you with your selling guide if the stock should fail from that point, but we’ll get into more of that, but we basically just want to outline what a pocket pivot is relative to a standard base breakout, and that it is, in fact, a unique buy point, so the basic premise of the pocket pivot is this, and when Dr. K was going through the process of codifying this what we might call the discovery of the pocket pivot, if we know that institutional buying creates new high-base breakouts we also know that institutional buying occurs within bases or consolidations, and also during uptrends, and in fact, having advised institutional investors, I know for a fact that the majority of them don’t want to start initiating a position on a breakout, they want to be buying stocks in the bottoms of bases, and they’re the ones who form the bottoms of bases, so intuitively then, it would make sense that if institutions do engage in this activity, that you would be able to identify their buying, so this buying within the consolidations and uptrends should, theoretically, have its particular identifying price and volume signature, so the pocket pivot describes that signature and provides a clear buyable pivot point or pocket pivot buy point. It also, as we pointed out earlier with the continuation pocket pivot it provides a tool for buying leading stocks as they progress higher within uptrends and are extended from a prior base or price consolidation breakout, so basically pocket pivots are just a way to identify institutional investors footprints within a base or an uptrend, and for those of you who don’t know what institutional investors footprints look like, that’s what they look like. Some of them, they don’t wear shoes either. They may wear, what do they call those little sandals that fall apart all the time? DR. K.: Birkenstocks? GIL: Yeah, they may wear those, definitely, but that’s what they look like and we like to follow along in their footsteps, and as you know if you follow O’Neill, the whole philosophy of O’Neill or the ethos of O’Neill that that’s essentially what you’re doing is you’re getting on for the ride that the institutional investors are generating with their huge amount of buying, which is exemplified by these giant footprints, so, not that we’re extremely religious; we’re not religious, we’re spiritual right; is that how it works? We have the ten commandments of pocket pivots, and so we did have to climb up a mountain to get these, but we did come down with them, and I know this looks a little daunting at first, you see ten commandments of pocket pivots; ten basic rules for pocket pivot, so what we’re going to do is we’re going to break this down rule by rule and show you what’s going on, so let’s just start, and this should be in your handouts; everybody has their handouts, yes? So we’ll start with the first three of them, and just like with base breakouts you want proper pocket pivots coming out of or emerging from constructive basing patterns, okay, and of course number two, the stock’s fundamentals should be strong; the usual leadership characteristics, strong earnings, sales, pre-tax margins, in other words your classic O’Neill growth parameters. The other consideration and exception that you might make is that something should also or may, instead of having these huge fundamentals, should have a compelling thematic basis for consideration, and there are exceptions where you have companies that have huge price moves, but the fundamentals aren’t always there, but there is a


compelling thematic basis such as, for example, Rare Earth Metals, last year. Those stocks had a big move; I think it was 2011 or was it 2010. DR. K.: 2010 into 2011. GIL: Now, number three; I almost overlooked that one. The thing that identifies a pocket pivot is that the volume on a pocket pivot day will be larger than the highest down volume day over the prior ten days. Okay, you can have a day, so we’re going back to this CMG, but you can see here, uh oh, what’s going on here. Do you have your pointer? Want to point out you can see the volume on this first pocket pivot within the base. You see that volume bar; it is definitely higher than any downside volume over the prior ten days. Now, you could have a higher upside volume bar; in other words, on this chart another blue bar that’s higher, and it would still be valid as a pocket pivot volume signature, so the essential characteristic you’re always looking for in a pocket pivot is the volume characteristic, which is the volume is going to be up volume higher than any down volume day over the prior ten days, and you can see in the second pocket pivot that in fact the volume bar is actually pretty small, and it’s hard to make that out, but I’m assuming your charting system has a tracking window where you can actually see. DR. K.: Yeah, the tracker. GIL: Where the volume lies, and you can see, in this case, even though it’s tiny volume, it’s higher than any down volume bar in the pattern over the prior ten days, okay. Now that makes it a little more subtle, and that’s the beauty of some pocket pivots is that they’re very subtle and most people don’t see them, and a lot of people ask us, well, you guys have written a book about this, you talk about it, how many people are really using it; can you get a critical mass of people using it so that it becomes less effective. I would say right now the community is very small; certainly probably smaller than the O’Neill community, and that’s a community that’s still pretty small relative to the universe of investors out there in the world. I think these days it’s probably shrinking because I think the markets have been such that unless somebody’s very good handling some of these high octane growth stocks, they’ve been beaten up pretty good, so I don’t think they’re big enough; the communities are big enough that you would create sort of a crowd phenomenon where they don’t work anymore because of that because too many people are using it. DR. K.: I would even say that the base breakouts, the reason they stopped working in 2004 and 2005 was not because everyone was seeing base breakouts, but really it was a function of the general market, which was sideways and compressed, and relatively trendless, and certainly not what we all enjoyed in the 1990s, so a lot of these stocks, even if they are leading stocks, they break out and if the weight of the market comes on those stocks, it’s going to suppress the upward movement of those stocks. GIL: Here’s some pocket pivots in Michael Kors. Anybody in the room play Michael Kors? So, did you do well with it? So, it started out, the whole move started out with the first pocket pivot right there. I’ve got to admit I never bought it. I looked at Michael Kors, oh, boutique retailer, yeah, what’s that going to do. That just shows how don’t have an opinion about stocks ahead of time. Go with the technical action. In this case I should have because not only did this issue a sort of a breakout pocket pivot, but you see, the problem this would cause for a standard O’Neill follower is that the stock never really formed a long base. It’s a little flag pattern and as it’s coming out it issues a pocket pivot and then you notice it moves up higher and you get a second pocket pivot along the ten-day moving average, and then a third one, so by the time you get to the third one, you should have a pretty big position; a good-sized position so that you can be in on that big gap up that occurred a few days later and took the stock a lot higher, but you can see how you could catch the breakout here, and if it’s not your standard five, six, seven, eight week long base, you can still buy the pocket pivot on that basis alone since it’s coming out of a very nice constructive pattern, but you can see that, again, the volume, even though on the second and third pocket pivot, you can’t really see those bars; you can definitely see that they’re higher than any down volume bar in the pattern over the prior ten days. DR. K.: By the way, can you just go back?


GIL: Sure. DR. K.: That was the first day of trade; that was the IPO, so you had this real quick formation that the standard techniques wouldn’t catch because it’s not by technical means, this is not a long enough base, but in terms of pocket pivots it doesn’t matter. You just want to see constructive price volume action leading up to that pocket pivot for it to be a valid buy point. GIL: InvenSense had a short lifespan; what do you call it, a half-life? Stock has blown up since then, but it did have a nice move, and it was very playable. It was almost pretty much a double if you were in on it early, and what this shows, again, you have the upside volume that is higher than any down volume over the prior ten days, again, but notice in this case the stock isn’t breaking out to new highs; it’s what you might call a low base sort of breakout or move up, but if you’re a standard O’Neill follower, you’re not buying it until it comes out where… DR. K.: Until this day here. GIL: Yeah up there. DR. K.: New highs. GIL: You’re getting higher, so if you had bought on that first pocket pivot you could have bought again and added to your position on the new high breakout, and you can do that with confidence because even if it does pull back a little bit, you’re already in earlier on the first pocket pivot. Now, you can see the move from there very sharp to the upside, and then you actually get another pocket pivot as it comes back above the ten-day moving average, after the pull-back that basically retraces half of the prior move, and that’s a pocket pivot as well. A little; would you say that’s a little less well defined though? What is it…. DR. K.: Well, the thing is usually, I would never touch a pocket pivot that looked like this because it’s straight down and straight up, but what redeems the quality of this pocket pivot is that it is a buyable gap up, so in other words it closed there, opens there, on big volume, that’s enough for me. It’s had huge momentum to the upside prior to that, so on a day like that I’m a buyer. GIL: Yeah, and you can see the stock went through and then it comes off the 50-day moving average at the right side there, and in addition to being a valid bounce off the 50 day moving average, which is an O’Neill add point, it’s also a pocket pivot so it gives us double confirmation on that, but again, leading stocks, strong fundamentals, and coming out of proper consolidations on the initial move out. Molycorp Now, here’s what I’m talking about where a stock has to be a leading stock. You’re trying to pick the best leaders in any market, and not only can you use fundamentals or rely on strong fundamentals, return in equity, etc., but there also are other drivers for stocks in that they may have a compelling fundamental theme, so as you all know back in 2010, they started with the Rare Earth Metals theme where China was going to corner the market in rare earth metals; I’m not sure what happened to that, did they end up cornering all the rare earth metals, or did they have to give them back, but anyway, that turned into a crisis that never really occurred, but it did cause movement in these rare earth stocks. There’s another RAREF, which is Rare Earth Metals, I believe, but Molycorp is the one that we played, and you can actually see that it has pocket pivots within the base, but one of the things to notice about a pocket pivot is that it should be coming out of a consolidation, so where the stock has settled down; notice it comes down, so you’re actually in a down trend and you get this pocket pivot here, which is technically defined as a pocket pivot and a volume that’s higher than any down volume over the prior ten days, coming up to the 50-day moving average, but notice there’s a downtrend here first, so it’s a premature, and what happens is it needs to back up, back and fill a little bit, and then once it settles down and it’s moving sideways now you have another pocket pivot in here, and this one actually ends up working, and actually I think there’s another one right here. DR. K.: There’s one right there. GIL: Yeah, so by the time you’re in here and here, you won’t want to buy this one because it’s coming down, and there hasn’t been a period of what we call quietness, there’s nice tight sideways constructive action, but again, this is a stock


where you have negative earnings, but yet there’s a compelling fundamental driver, and that’s one of the things that I learned working for Bill O’Neill is that people know about CAN SLIM and you have to have strong earnings and the higher the better, but there are also leaders that can emerge during certain market cycles when there’s a compelling fundamental theme. I would touch upon, say, for example, I played Lockheed Martin in late 2001 into early 2002 as the market was rolling over and it went higher, but of course there was a fundamental driver there, which was the US was going onto a war footing as a result of 9/11, and so in that case Lockheed didn’t have the most perfect fundamentals, but it definitely became a big stock and there was a theme to drive that one; in fact, going back to that example there was a lot of pocket pivots in that pattern back in 2001, 2002, but in 2010 Rare Earth Metals were a very key fundamental driver as a theme; as a thematic play, and so pocket pivots showing up in something like that are something we’ll definitely be paying attention to, and you should as well. Now, Molycorp ran up, and you can see that; you see this uptrend here coming up, this was after the last pocket pivot here; down here, and it had this nice move, very sharp move, and then it started to base again and it spent about, I’m going to say two and a half to three months basing and then you’ve got another pocket pivot coming off the lows of the base where it comes up the ten day moving average, and again you have volume that’s higher than any down volume over the prior ten days. Now notice this is not a breakout to new highs, and you probably, if you were playing this on a breakout basis you were probably not buying the stock until it was well above 60, which might have been what, about a week or two later, and so you’d be coming in later. Notice how the action is a little more halting after that, and it’s much more difficult to hold a stock when you buy a breakout like that and it doesn’t make a lot of progress or kind of flips back and forth. Notice though, right after that pocket pivot it tends to move faster, and that’s one thing we notice about certain pocket pivots is that they will have pretty quick moves following the pocket pivot. Here’s Decker’s Outdoor Corporation; it was a big name in the prior bull cycle. Now the thing’s been getting blown to pieces, and I’ll actually cover that as a short sell example when we get to the final module today, but again you can see the pocket pivot within the base; the first one, and then you can see that the base breakout, and I think this is a good example, you can see how; you could call that a base breakout, it’s still actually below the high on the left side of the base at around 56, but that’s also a pocket pivot and then you have the gap up three days later that probably would be the breakout that most people would be buying, but you could have been in there early twice; two points within the base on very subtle pocket pivot buy points in there, so again, you can see the constant leading stocks strong earnings. Here’s Baidu. If you recall, anybody own this one in December of 2010, the stock broke down through the 50 day moving average after the Vice President came out and said something about sales not being up to snuff or something like that, and it basically scared everybody out. Stock held tight and moved back above the 50 day moving average with a little pocket pivot and then later on had another pocket pivot before it gapped up, so the pocket pivots within the base as the stock is moving along sideways in there is telling you that the stock is strong, and of course that is confirmed by the time it finally gaps up back in late January. iShares Silver Trust is a stock that we played, or not a stock but a commodities ETF and it actually started its move in August of 2010 as a pocket pivot buy point before it broke out and then it gaps out the next day and has a wonderful move. I remember being on Fox Business News talking with Liz Claiborne, and telling her I thought silver was a buy at $21, and of course her immediate response was that well, silver is at a 30 year high, how’re you going to buy that? Well, what do you think is going to happen; it’s going to make, at the ten year that’s going to make it 30 year high first, right, or 50, or whatever, in other words the stock that’s going from 50 to 100 or 20 to 50 as silver did, it’s got to get to 25 and 30, and 35, so, but it’s interesting how on television, on financial TV they sort of feed into this whole reversion to the mean thing that things that are at 30 year highs are too high when those of us who follow O’Neill methodologies know that when a stock is coming up to a 30 year high, it may be breaking out of a big consolidation and starting a big move, and that’s exactly what silver was doing back then, and it’s interesting that we’re able to get on to that very early by using pocket pivots. Now, an interesting point I should make here, and people will ask about this, can you use pocket pivots with indexed ETFs or with indexes or sector ETFs? And what we find is that an ETF, if it’s going to work as a pocket pivot it’s best to be a very narrow ETF; in other words the iShares Silver Trust is a single commodity ETF whereas if you were buying the QID or the QLD rather, the two times NASDAQ ETF, you would not be able to use pocket pivots with that because it’s too broad, and it’s dependent on the action of too many stocks. Even a sector ETF like the SOXL, which is a two-times semiconductor ETF, it’s very difficult to try and buy those on pocket pivots, but a single commodity ETF like silver and also gold, the GLD; we’ve used the pocket pivot with great effect in both of those, and so if it’s a narrow ETF you can use them, and that question does come up a lot.


All right, let’s go to commandment number four, and that is that pocket pivots sometimes coincide with base breakouts or with gap-ups. This can be thought of as added upside power and confirmation should this occur, so a pocket pivot can also be a new high breakout if it meets the definition of a pocket pivot, in other words coming off the ten day or the 50-day moving average on volume that is higher than any down volume over the prior ten days. You’ll probably start having dreams with that phrase of going over and over in your head, but that may be a good thing, but you can also see that this has a breakout here, so this is a base breakout in LULU, but you also notice as it breaks out it comes back and drops just below the ten day moving average and then comes up again; as it’s coming up again there’s another pocket pivot in there. Right there. So you could be adding there, and then there’s actually a pocket pivot the day before it gaps up; right in there, so there’s pocket pivots all over the place, and what I like about pocket pivots is that they’re very clear and easily definable buy points, and again you use a violation of the ten day moving average if it’s coming up off the ten day moving average or you use a violation of the 50-day moving average if it’s coming up off the 50-day moving average as your selling guide, so you have an easy out point. This whole business of adding to your position when it goes up 2% and 2% and all this, where do you get out? How do you get out? How do you know when the thing’s really failing because a lot of stocks can pull back 2% in the morning and by the end of the day they’re up 4%, so to me it’s very negligible. That’s always an issue I had with Bill on that one because I just thought it was poorly defined, and it doesn’t…yes? (INAUDIBLE QUESTION) GIL: All my positions are outside, so it’s hard for me to answer; maybe ask, Dr. K. what do you got on that? DR. K.: What are you trying to find out? (INAUDIBLE QUESTION). GIL: And you already got an early start, yeah. Oh, I see what, yeah. DR. K.: It’s a powerful breakout, probably. GIL: It’s contextual, really, I mean if it looks like it’s really going to run and all the ducks were in a row and the market was good, then sure, I would go in bigger, but I would have to see evidence of that. Obviously if I have a cushion in a stock that I’m going to be a little more flexible with it, but on the other hand if we’re in a very fierce bull market then I’m going to be, just because I have cushion in a stock doesn’t mean I want to hold on to it. I want to force feed my money into the fastest horses out there, like I did in the 1990s, just constantly, and my turnover rate was huge just because I wanted my money to be working for me at maximum speed all the time, especially when you get these open windows. GIL: You’re talking about just loading the boat, right Frank? I like to do that on buyable gap ups, so, and we’ll get to that part. Usually when something is so powerful as it usually results in a buyable gap up, which is the second module we’ll get to, and that’s usually when I’ll really go in heavy, and I’ll go into some war stories on that, but again, you could also see, the point here is just to show that a base breakout can also be a pocket pivot buy point, and we probably should’ve picked a better example because sometimes you can have a base breakout where the volume is 20% above average. Now, for a standard O’Neill breakout that’s not buyable, right, because it’s only 20% above average; you need to see it at 50% above average, but what we find is that if it’s only say, 20% above average, but it is also a pocket pivot buy point, it meets the definition of a pocket pivot, we can go ahead and buy that breakout even though it doesn’t have the 50% volume increase that O’Neill prescribes because we find that all you need is to have that volume higher than any down volume over the prior ten days on the breakout, and it works. This is… DR. K.: Yeah, what’s actually more important is the quality of the price volume action leading up to the pocket pivot as opposed to the actual percentage volume increase, so we’re not requiring that the stock is up more than 50% or 100%. GIL: But that’s the one advantage the pocket pivot gives you on breakouts that may seem marginal, and I’m sure a lot of you have probably seen that, and more so in recent markets where you’ll see a stock break out and the volume isn’t really there, and then it continues higher and the volume is only 20% higher, 25% higher on the breakout but what we’ve noticed


is that that breakout, more often than not was a pocket pivot buy point, so we would just be buying it on that basis, so again, it overrides some of the anomalies that you see in the markets these days, and I can name several stocks where we’ve had breakouts and no volume, and then, but they’re pocket pivots, and so it helps you buy a breakout that otherwise you might not get into. Riverbed Technologies; you see one is a breakouts and one is a gap-up, and so they’re both pocket pivots; very powerful move in Riverbed Technologies. Commandments number five and six. If the pocket pivot occurs in an uptrend after the stock has broken out, it should act constructively around its ten day moving average. That’s generally what we like to see. Once a stock breaks out and it’s moving up and out of there, they generally will follow along their ten day moving average. We don’t have any problem with it dipping below the ten day moving average along the way as long as it shows resilience by showing volume that is greater than the highest down volume day over the prior ten days, so in other words that’s a pocket pivot, and these are the types of pocket pivots that occur after the stock has extended from the base; the continuation pocket pivot. What you like to see, though, on a continuation pocket pivot is that it should occur right around the ten day moving average. If you’re extended, and the move or the pocket pivot occurs say 1% or 2% above the ten day moving average, it can be a little big extended, and we’ll show some examples of that, so for example, anybody play this one; Coffee Holding Company. You thought Starbuck’s was hot, or Green Mountain, this one is even hotter; this thing went up three times in like, three weeks just about, but you can see it started with pocket pivot off the ten day moving average, and then the big one occurred right off the ten day at the end of June 2011, and look at the move that that led to. Now, of course if you bought that pocket pivot you should be able to identify a sort of the climactic run up, which the next five days were, certainly you hopefully would be selling into that, but you can see how even with an obscure stock like this; strong earnings though, that the movement, as far as the pocket pivots go, is very valid, and it works. DR. K.: Also, back to that. GIL: Sorry. DR. K.: This is a cheap stock down here, so we generally don’t play things that are under $12 a share, let alone $15, especially in this kind of market environment, which is very unkind to small caps and cheap stocks, but what I like about this one is that it went on our radar because it had such huge volume here, and then you can track it; you could price track it and then when it basically runs right into the ten day and relative to that huge move that is a constructive price volume action right into the ten day and then you get the perfect pocket pivot right there, and then you’ve got this beautiful climax top, so that you wouldn’t be holding it really; this day right here is obviously where you’re going to be selling it because the volume is huge and it just drops like a stone, but the time value on this kind of a trade is like a gift because you make a big percentage and it’s just a matter of days. GIL: Right, and you can see how the second pocket pivot is a continuation pocket pivot coming off the ten day moving average, and you can see at that point its 50% or more extended past the breakout level of just under $9 a share; probably about $8.50, something like that. Okay. Now when don’t you buy pocket pivots? You do not buy pocket pivots if the overall chart formation is in a multi-month downtrend, so that would be five months or longer, and it’s best to wait for the base to sort of round out; if a stock is in a downtrend you want to wait for it to round out and try to form at least the lows of a base because sometimes you have a leading stock will run up and then pull down hard. If you have pocket pivots as its pulling down hard you don’t want to be buying there, you want to let it sort of round out and the pocket pivots may start to show up on this side of the base; on the right side of the base, and we actually do have bottom fishing pocket pivots for those of you who just can’t resist buying cheap stocks or buying when things are down and dirty, but there are such things as bottom fishing pocket pivots, and we’ll get to that. Anyway. Number eight; do not buy pocket pivots if a stock is under a critical moving average such as a 50-day moving average or a 200-day moving average. If it’s well under the 50-day moving average and getting support near the 200 DMA or daily moving average, it can be bought provided the base is constructive. An example of a do not buy pocket pivot: Here’s a pocket pivot, but you can see its occurring below the ten day and actually every single moving average, and you notice all the moving average are moving down, and I should interject here that we have a friend; Fred Richards, he has a site; stratinv.net. Fred Richards actually grew up with Bill O’Neill, but Fred has done some work on pocket pivots, and he actually does a workshop on these, which he calls the power of three, and that is you want to see a pocket pivot occurring when at least three of the moving averages are


turning up, so he uses a ten day, the 22, the 50, and the 200 day, and in this case you can see they’re all pointing down, so you definitely don’t want to be in this, so I would extrapolate from Fred’s rule that when all the moving averages are looking like this, you probably don’t want to be buying any pocket pivots, but you can see it’s in a downtrend, and even though you have the volume signature that’s higher than any down volume over the prior ten days, it’s just not going to work. Same thing with Research In Motion back in May of 2011; you get a little pocket pivot, and this one actually comes above the ten day moving average, but still it’s in a multi-month downtrend, so you can get a sense just looking at these, that that’s not really what you’re looking at, and you know from the prior examples we looked at that you’re looking for a nice sideways consolidation. Number nine. Do not buy pocket pivots if the stock forms a V where it sells off hard down through the ten day moving average or 50-day moving average and then shoots straight back up in a V formation; straight down, straight up basically, because such formations are failure prone, such as Lululemon did this little V-shaped pocket pivot and you can see that it had a pocket pivot coming up through the 50-day moving average and then it dropped down below. Now, LULU did actually back-end fill for a little while and it set up again and went, but in this case because it’s V-shaped you don’t really want to be buying that. I don’t think I’ve seen very many of those work if at all when that happens. Like I said, you need to see a stock in a formation where it’s been settling down and moving sideways, and you can definitely see that this stock is jerking around the 50-day and just under it before that pocket pivot. Amazon; here’s kind of a V-shape, went straight down and straight back up through the 50-day moving average it just stalls out. Technically that’s a pocket pivot, but that fails and that’s not really what you want to see there because the stock is also drifting down to the down side before it has that pocket pivot and V’s back up, so really again, you’re not seeing a situation where the base is constructive and really quiet, moving sideways. Yes. (INAUDIBLE QUESTION) GIL: The day before that, yeah, well it actually didn’t close above the 50-day moving average; just shy of it, so it doesn’t technically qualify, but it is coming up off the ten day moving average, but again it’s also an example of something that’s V-shaped, still coming up off that V-shaped formation, and also beyond that, beyond the fact that you have that little, I’d call it a little six-day formation where over that six days it’s down three and then up three, before that look at the reaction; the stock is just kind of ranging and wobbling back and forth. It’s not really setting up and getting tight sideways, so that’s really what you want to see; you want to see it quiet down and that’s the essence of a pocket pivot within a base is that it gets very quiet within the base and then you start to see those little pickups in volume that tells you institutions are starting to come in and nibble away. Institutions can take a long time to buy stocks. Our trader, Bill Griffith used to work for, was it RBC Capital? DR. K.: RCM. GIL: RCM Capital and he was in charge of running something like $26 billion or trading it; was the head trader on their desk, and he’s told me guys are giving million, and gals too, who are portfolio managers would give them orders to sell a million shares, and they would tell them to take three weeks and don’t move it too much, so they’ll sit there and ping away at things in small amounts; they don’t always come in with huge volume, but when they find out, and Bill’s told me this as well; Bill Griffith, not Bill O’Neill, but Bill Griffith, that if it gets to a point where he can’t get any stock and he goes back to the PM; the portfolio manager, and tell me we can’t get any stock and then the portfolio manager would tell him, well, start buying it up, and that’s when the breakout occurs, so when you know people who work in institutional investment houses and mutual funds, and what not; hedge funds, and you listen to some of their war stories you understand a lot of these concepts as to how breakouts occur are true, but there’s also this idea that they will steadily and very slowly buy something within a base, and for the most part they don’t want you to see what they’re doing, but you can pick it up with very subtle pocket pivots, at least that’s our theory, and in practice it does seem to prove out, so where are we. Last; number ten. Avoid pocket pivots that occur after wedging patterns. Does everybody know what a wedging pattern is, when we use that term? Wedging pattern is simply the idea that something is rallying on volume that is either very light or is declining as it rallies, so if something is moving up and the volume is dropping as it moves up, what is that telling you? That demand for the stock is declining as it moves up. That’s a wedging pattern, so you don’t want to be buying pocket pivots that occur off of these slow drift ups like you see in this example of Carpenter Technology. You can see the stock drifting up and look at the volume bars; there aren’t any real big upside volume bars in the pattern until it has the pocket pivot.


DR. K.: Yeah, also the price increase tends to be a bit disorderly relative to proper uptrends, so I think that’s also a key in terms of, you’ve got the wedge here, but you also, in this case the volume is pretty much sideways, but the important part is this is pretty sloppy price action, so not constructive, and subject to a correction. GIL: It’s just drifting; it just drifts higher. Okay, and these actually are, oh yeah, there’s a little wedging pattern there, and see that was wedging that kind of worked, but then it drifted back down below the ten day moving average, and this one, actually, if you were early on this on this particular day; the first pocket pivot there on the big volume and you bought it close to the ten day moving average you might have been able to hold that one, but you can see its slightly wedging just before it comes off. Those will tend to have a lower probability of working; not that they can’t, or that they don’t create a buy point that you have to sit through afterwards, but you notice that LULU really gets going when it has that second pocket pivot that’s really occurring after a more constructive pattern; I wouldn’t really call that very V-shaped because it’s roughly on a percentage basis it’s hanging in there okay. Now, our selling discipline is based on what we call the seven week rule, and it’s very well defined, and it’s very simple, and I have to tell you the seven week rule would have gotten you out of apple computer somewhere around $618, $620, somewhere around there on a ten week moving average violation, and we’ll show that later when we use some real-world examples, but recently over the last week or so Apple’s now had a 50-day moving average violation, so in our view the stock for now is topped, and it may need to build a whole new base if it’s going to come back, but we could see the stock was a sell long before the pundits could see that because they’re not using any real technical rules, they’re just assuming the stock is going to $1000 because somebody up there ordained that it was to be, but even though the crowd loves Apple, it’s clear after today with Apple breaking its lows and let’s face it, Apple does not love the crowd, so what is the seven week rule? It’s basically this. Like I was saying earlier at the outset of this presentation that we use the ten day and the 50-day moving average; 200-day comes into play sometimes, 20-day maybe sometimes, and I only use the 65-day exponential for shorting, so we rely primarily on the long side, on the ten day and the 50-day moving averages because what we find, and what Dr. K. has found in his statistical work is stocks will tend to follow one or the other moving average; they will follow the ten day, and if they follow the ten day for at least seven weeks from a buy point, then we will use the ten day moving average as our selling guide, okay. Now if they do not follow the ten day move, and let’s say they have a pocket pivot and they start moving along the ten day moving average for three weeks and then suddenly they break down below it, and they start following the 50-day, we will then revert to using the 50-day moving average as our selling guide, okay? So, it’s basically one or the other, it’s a binary sort of thing. It either follows the ten day or the 50-day, and how do we know that it follows the ten day? It has to do it for at least seven weeks, if it doesn’t then we’re going to use the 50-day moving average, and what this rule does, it’ll help prevent you from selling a stock prematurely if it is simply not its nature to hold the ten day moving average. I know there are some high octane traders out there who will use the ten day moving average and just trade along until a stock moves below it, but it has to violate it, number one, and number two it has to show that it is its character to follow the ten day moving average because if you look at enough charts, some stocks tend to follow their ten day moving average, I mean, look Monster Beverage since January, for example, that’s the one that follows the ten day moving average very well, and then, you know some stocks like Apple prior to January of this year though, historically over the last several years has tended to follow its 50-day moving average, so with stocks that’s their character, they have the character of following the ten day moving average or the 50-day moving average and that’s what we find statistically to be the case, so we simply rely on those two moving averages as our selling guides, so, and a violation of a moving average, now most people think of a violation of a moving average as a stock moves below a moving average, and that’s the simple way to look at it, but moving averages in my view are just designed to fake people out, so things will tend to slide past the moving average, so what we find is things will dip below a moving average and even close one day below the moving average, but in order for it to violate the moving average it not only needs to close below the moving average, but over the following day or days, it must also move below the low of the day that it first closed below the moving average; if that makes sense, but we’ll show you some examples, okay, so let’s just look at, we’ll go back to the Chipotle Mexican Grill. I don’t really like their food, but I think the stock is great, and it has _______ and it’s provided many pocket pivots and it’s a lot of great examples, but Chipotle Mexican Grill is an example of a stock that, notice after the second pocket pivot it pretty much followed its ten day moving average all the way up. Now you’ll notice there are points where it closes below the ten day moving average, but it never actually moves below that first day below the ten day moving average, so you’re using the ten day moving average for Chipotle Mexican Grill as your selling guide, and you’ll notice back when you get up to the peak when it finally violates the ten day; can you show that point, Dr. K. That’s where you close below and where do you violate? That’s your close, and then the next, it’s like one, two, three, four, five, six days later you actually move below that; you see that?


That’s your violation, that’s where you’re selling, and that would be your selling guide. You would be out and then waiting for the next, hopefully, pocket pivot buy point to show up where you can re-enter, assuming the stock is able to build a new base and continue higher, which CMG was able to do several times, but you never know that for sure in real-time, and so it’s nice to have a handy selling guide to lock in a very nice profit because the stock went up about, oh, well over 50%, right, about what would you say, 100 points, so it’s actually more like 60%. DR. K.: Yeah, it was a good 70% move. GIL: Yeah, so you want to lock that in and the ten day moving average because CMG tended to follow it after that buy point back at the end of August, that would be your selling guide, and you can see it gets you out nicely, and it tends to work in practice. There are some times when it will shake you out, and that happens from time to time, but for the most part it’s a pretty good rule that we find in terms of handling a stock that immediately shows it is its character to follow the ten day moving average. Now, here’s Apple, and we can see that Apple actually violates the ten day moving average very shortly after it breaks out. You can see that initial pocket pivot buy point, that’s also a breakout there, it runs up and then it pulls back, closes below the ten day moving average, how many days after, that’s about eleven days after or ten days after and then it finally moves below that, and that’s your violation. Now, it turns around and it comes back up, but see what you know at that point is since it’s not; seven weeks has not elapsed from that first breakout, you’re going to use the 50-day moving average, so you revert to using the 50-day moving average and you’ll notice it has a lot of ten day moving average violations, so obviously it is not Apple’s character, at least in 2010, to follow the ten day moving average. It’s its character to follow the 50-day moving average. In 2012, interestingly, Apple’s characteristic has been to follow the ten day, and it did do that quite religiously since breaking out in January, and just about, what, a month ago it finally violated the ten day moving average above $600, and now I think its trading at $553 as of today’s close, but does everybody understand how that works, and you can see between the two charts, right away you can see how it is CMG’s character is that it wants to follow the ten day moving average and if it does it for at least seven weeks, then you use that as your selling guide. You can see with Apple that within two weeks after breaking out it’s already violating its ten day moving average, so you’re not going to use that as your selling guide, you’re going to revert to using the 50-day or the blue line as your selling guide and you can see that the stock does a very nice job of holding that line, and that was its character until very, very recently in 2012, so that’s basically how you define whether you’re going to use the ten or 50-day moving average. Is that clear to everybody? Yes sir? (INAUDIBLE QUESTION) DR. K.: Well, the first think we do is look for the fundamentals. A stock has to measure up as a potential leader on a fundamental level, meaning we’re looking for the story, potential first mover advantage and of course the numbers; the earnings, sales acceleration, pretax margin, return on equity, all of that, and then once we have that list of stocks, then we’re looking for buy points; technical buy points. In other words the chart pattern has to be set up properly and, of course, pocket pivots would be a very common buy point for a leading stock that we would use to get into the stock and then potentially pyramid it higher. (INAUDIBLE QUESTION) GIL: Right. Well, not necessarily a news item per se, but there is a fundamental driver there, and the theme there was the shortage of rare earth metals. DR. K.: Yeah, and the Chinese market cornering. (INAUDIBLE QUESTION) DR. K.: The corner of the market, right. GIL: Corner of the market, right.


(INAUDIBLE QUESTION) GIL: Yeah. DR. K.: Right, and actually everything is contextual including fundamentals. In other words, we do a lot of reading on a regular basis day-to-day, so we get an idea of where this story, in terms of importance, is going to fit in to the technological landscape. In terms of rare earth metals and the facts of the scarcity of these metals, and then the number of companies that were publically traded on the stock exchange, the only two real buyable companies were MCP and REE. REE was clearly second rate compared to MCP, so MCP was their stock, and that was the one we were tracking, and that was the one that actually did perform the best at that point in time. GIL: So this is basically the essence of the seven week rule, and how we apply it. We have it in our book, we have it on our website, and so if you need more detailed discussion or you want to review it, you can go to our website, selfishinvesting.com, in the FAQ section we cover it in pretty good detail. Okay. This is what people love, and also I think there is, Andrew, I don’t know if you have a problem with people talking to you during the breaks or afterwards, but you can talk to Andrew; he’s used pocket pivots over the last few, he was up 70% last year. We were lucky enough to go to Joel Robuchon Restaurant last night, which some of you may know is the three Michelin stars for dinner when we got into town, and lo-and-behold our waiter is one of our subscribers, and actually somebody who’s been very successful using these tools; there he is over there, and also you should go to Joel Robuchon Restaurant, and that was the cheapest expensive dinner I’ve ever had, but I should point out that Andrew was gracious enough to actually cover our dinner for us just to thank us for what we’ve taught him, and I have to tell you that that’s probably the most touching thing that’s happened to me since my kids made me a Father’s Day card out of old charts I had thrown away, but that’s another story, but no, I appreciated that, but it was really nice just to hear, here is somebody who has a day job; well, it’s actually a night job, right? Right Andrew, but he’s able to succeed in the markets, and the tools that we use and are showing people are helping him, and I think that’s very gratifying, so I just wanted to point out that he’s there and he’s had some success, and I think he has a very good chart eye, and I think the guy understands the stuff even better than I do sometimes, and so ask him; don’t take my word for it. Okay, bottom fishing pocket pivots. For some reason this is one of the more popular items, but these are always the trickiest, and I would say if you’re going to try pocket pivots as bottom fishing sort of exercise or activities, you want to pick on stocks that are the biggest leaders, and they will usually be stocks that are coming out of a base or the lows of a base, rounding out a base after they’ve broken down with the market, so we all know May 2010, the flash crash. DR. K.: Actually, that’s a key point, what you just said. They’ve broken down with the market. In other words, I don’t recommend anyone ever buy a bottom fishing pocket pivot unless the market has been in a correction or a bear market. GIL: Exactly. DR. K.: And we all know that this was the flash crash which brought all these stocks in the whole general market down with it, and then this base rounds out; you can see here it’s rounding out, it’s getting tighter and more constructive and then it comes back up through… GIL: Selling volume declines. DR. K.: …some critical moving averages, so this is a valid buy point here because relative to what the market did this is a constructive pattern, and we had lots of bottom; I’d say the largest number of bottom fishing pocket pivots I’ve ever seen was in early 2009 after the huge collapse of 2008, so you had a lot of legitimate leading companies that had been leaders before and were turning back around and looking really good like ISRG in, I think it was what, April of 2009. GIL: When ISRG… DR. K.: ISRG came back around, in fact yeah; we’ve got a slide of that.


GIL: But you notice here that this is coming up; the first one occurs as it’s coming up through the 50-day and the second one occurs as it’s coming up from the 200-day moving average. Now I mentioned something about the rule of three and our friend, Fred Richards, and how he applies it, and you’ll notice how at this point when these are occurring you have the 200-day he’s in an upslope and the ten-day and the 20-day, which roughly coincides with the 22-day; Fred uses the 22-day, I use the 20-day, and you can see three of those four moving averages are actually turning up together at the time that this is coming up to the 50-day and the 200-day and having pocket pivots, so you could actually buy this on this basis, it’s trickier though. Here’s Google and it did the same thing, it corrected with the market in May of 2010, and broke down, and then it kind of rounded out, and it formed this little tight area just above the 50-day moving average, and you can see how we drew the dotted line to kind of show you how it rounds out, and that was positive too, and notice you have; at that point, you don’t have the 200-day tilting upward, but you do have the 50-day, the 10- and the 20-day, and so I would throw that in there, and it’s something Fred has pointed out to us, and I think it actually adds to the validity of pocket pivots, but I think most of all it’s very helpful in determining when you may be dealing with a pocket pivot in a base that’s going to work. Now, you might ask, why not the other ones back, say early August you can see one there, and that’s a potential one as well, but you would have been stopped out on that one pretty quickly, so again, if you’re using the ten day moving average, in that case, you would be out of there pretty quickly, so it helps you at least define where your out point is coming up off the bottom. DR. K.: That one, though, that would not be a legitimate one because you had a gap down there, just a few weeks before, and you’ve had a lot of noise in the pattern, so that, to me would be a very suspect one; it’d be a low quality one, and you really want to; there’s a lot of pocket pivots especially when the window of opportunity is open, so you have the luxury of picking only the best ones, and this would be after this huge market correction and it being Google, this would be one such playable pocket pivot. GIL: Here’s Intuitive Surgical, and what’s interesting, I actually bought Intuitive Surgical in April of 2009 and it ran up a bit there, like $140, and then I sold it, and it was interesting, I ran into Dr. K. for the first time since, like 2001, when he left O’Neill, and I ran into him in August of that year, and we were talking about this, and that was actually a pocket pivot too, but I bought it just on the basis of the volume move coming up to the 50-day moving average, and notice though how it has rounded out and see how it got really tight, nice and tight and quiet in there just before that happened, and you could have bought that one right there, and I actually did buy it, but I didn’t play it out, and for me it’s very hard for me to play something coming off the bottom because I’m always worried about that overhead supply, but in this case one could’ve bought a position there and just held on to it, and they would have been fine. LinkedIn, believe it or not, earlier this year had a couple of bottom fishing pocket pivots as it was coming up off its base, and again, you see the same concept. Notice the first pocket pivot in here; look at the volume drying up, the selling volume dries up in the extreme, and of course it pulls back a little bit but never really violates the ten day moving average, and then it comes off again and it’s another pocket pivot, and so you could be into that stock right there with a little position, and then notice about a week later you have that big gap up on earnings; that’s a buyable gap up, and that’s going to be our next module; buyable gap ups, but anyway, so just summarizing real quickly, pocket pivots function as two things; early buy points within a base, so you get an early start before the breakouts to new highs that everybody sees, or, and I think more importantly is continuation buy points once a stock is extended from a prior breakout and it’s already in its uptrend. Pocket pivots also, you talk about, and O’Neill talks a lot about this too, when you have a market correcting you see stocks holding up tightly in bases, that tells you that that stock is likely to lead again if the market comes out, or be a leader if the market comes out. It’s a sign of strength in a weak market, but even better, if you’re seeing that in a stock at the same time that it’s showing pocket pivots within its base during a market correction, that’s a very strong clue that during the market correction this thing is just kind of simmering along and getting ready to boil out and break out. It’s a sign, also, of a market’s tone improving; if you start to see a lot of potential leading stocks showing pocket pivots, and we noticed that in August of 2010 because we were in New York at that time; we’d just come out with the first book and I remember everybody was bearish. I went on Fox and everybody was bearish, and I told everybody that I was constructive on the market, and then on September 1, 2010, we had a follow through, and that was late August, and the reason I was, and we were, actually, is because we were starting to see a lot of pocket pivots, though our pocket pivot screens were firing off all kinds of names, even as we were moving through the beginning of August, and so we kind of got a sense that the tone of this market underneath the surface; under the hood, so to speak, is improving, and so you can kind of see it coming, so that’s another way that pocket pivots are confirming clues, because it’s one thing to see a stock holding up nicely, but you


know a stock is actually probably pretty powerful if during the correction within its base it’s firing off pocket pivots, because it’s telling you it really wants to go up but the market’s holding it down, so, but like anything in the market it’s not a panacea, okay, it’s not perfect. Sometimes they’ll just misfire; they won’t work, but you always have your outpoint, and that’s the one thing I like about pocket pivots, it’s a readily definable exit point, and it’s usually a much quicker exit point than 7% or 8% to the downside, but I think they give you an edge in today’s markets, and I don’t know anybody who’s traded; the two of us started our careers in the 1990s, and if anybody looks at a chart of the 1990s, the 1990s are this beautiful parabolic move that started in 1991 and go to 2000; a beautiful parabolic move, so if you’re an investor, you know we came of age in that period, and I’m grateful I was able to make pretty much, most of the money I made in the markets during that period, but it was so perfect, and then you run into the 2000s and the market’s just this big sideways chop and slop thing, and so in today’s markets it’s very difficult to get an edge, and I think they do provide an edge that otherwise you don’t have if you’re just buying standard breakouts, and as always you have to employ proper risk management, and then that is scaling position sizes; Dr. K. likes to start with 10%, generally 20%, sometimes 25% whereas I like to go in whole hog all the time. DR. K.: Depending on the situation. GIL: But you’ve got to have risk management that’s consistent with your own psychology and he’ll get into that when he gets into the trading simulation at the end of the day. Let’s see, now we’ll go to… does anybody want to take a quick break, does anybody need the bathroom, or are we going to go straight into buyable gap ups. Shall we take a vote? What’s that? (INAUDIBLE QUESTION) DR. K.: The lobsters. GIL: Oh, the lobsters. DR. K.: It looks like they’ve got some bread back there. GIL: I’ll just have some bread and I wish I had lobster. Actually, after that dinner last night at Joel Robuchon, that was enough for me; that’s enough frou-frou food to last me like six months. Anyway, buyable gap-ups. Buyable gap-ups are my favorite, and I didn’t know that I was using these techniques myself until Dr. K. and I ran into each other because I used them to buy Apple in 2004, which I’ll get to, but again, real quickly, remember what our moving averages are; ten-day, 20-day, 50-day, 65-day exponential, and 200-day; those are the color codes, and I should mention all charts are courtesy of High Growth Stock Investor, and High Growth Stock Investor, they actually have included in their system; they have a pocket pivot screen as well as a pocket pivot chart overlay, so you can actually put their overlay on a chart and it identifies all the pocket pivots on the chart for you, now you have to kind of go through them and make sure that they’re exactly right, but for the most part it makes it easy to visually pick out all the pocket pivots in a chart pattern, and we worked with them on that, and you may ask why aren’t we using O’Neill’s charts? They won’t let us use them, and don’t ask me why, but you might help us out by calling them up or writing them and asking them why don’t you let these guys use your charts in their presentations? It’s good advertising, frankly, and High Growth Stock Investor has experienced a huge amount of growth in the people that subscribe to their service as a result of putting our stuff on their systems, so. DR. K.: I think O’Neill’s policy has always been to never share with anyone. Period. It’s not like they let anyone use their charts, so I think that’s just standard policy. GIL: But that’s why outfits like stockcharts.com and even High Growth Stock Investor are eating their lunch for them because they understand marketing, so we would like to use O’Neill charts in our presentations, to be quite honest because that’s what we use, and if people told them, hey, are we hurting them? We’re not hurting them; I don’t think so. I think we just add to the work. DR. K.: We create awareness for what they do.


GIL: But anyway, that’s another workshop altogether. But I will admit that it is a bit frustrating for me not to be able to use the charts that I would normally use, and the charts that I grew up with, so, but in any case, High Growth Stock Investor does a good job; we can pretty much emulate the same kind of chart along with E-Signal as well, and we use their charts as well, and they all love using their charts. Anyways, getting off of that, gap-up moves, you know the first thing about a gap-up move when you see it is it always looks too crazy to buy, anybody will tell you, you’re going to buy this stock? Heck no, that’s done, it’s finished its move, that’s it, I missed it. Sure you did. It goes higher. That’s Croc’s in 2007, so that’s what I looked at at the point of impact when it broke out on the gap-up, and that’s what happened afterwards, and look at that move; that’s a very nice, coherent move; it follows the ten-day moving average right after that, and just moves higher, and what we find is that especially in their early emerging stages, stocks that have huge volume gap-up moves out of constructive basing patterns or even shallow constructive uptrends where it’s a very nice trend channel that they often start very powerful upside moves after that, and what’s interesting is that most people, when you show them a chart like that they absolutely won’t touch it with a ten-foot pole or any size pole, really, because it does look too high, I mean look at that, that looks too high, right? And if you didn’t see this would you immediately say I’ve got to buy that stock right there? Would you? No, you’d be scared to death; no, and that’s a normal human reaction because it looks like it’s done, and that’s basically what I call a reversion to the mean mentality which is what Liz Claiborne was doing with silver, is that when something goes up too much, oh, it has to come back because all stocks do this, right; trend big, just channel back and forth, but that’s not true. The big leaders have powerful moves and then they go crazy, so why do buyable gap-ups work? I mean there’s several reasons, basically the idea is that at any point in time there’s an argument between buyers and sellers regarding a stock and when the stock gaps up on tremendous volume, guess what, the argument has been won, and not just won but decisively won by the buyers, okay, and so the power or the decisiveness with which this argument is won is characterized by the sharp upside price movement; the gap-up, accompanied by significant increase in volume, so that’s the real essence or signature of a buyable gap-up is this massive volume spike, and that’s, huge volume is a sign of what; and if you go back to the beginning of the first module, the footprints of the institutions; those are big footprints, so those are boot prints really, and that’s what it is, it’s huge institutional buying done with conviction, and the other thing, and I think this is why buyable gap-ups really work is that there’s sort of a contrarian aspect to it because we know that the market tries to fool most of the people most of the time, or most investors most of the time, and so since everybody is deathly afraid of buying a gap-up because it looks too high, it has a contrarian aspect because nobody wants to believe it and so it does work because the crowd doesn’t believe it; they think it’s too high, and so I think if you’re the type of person who understands how to buy a buyable gap-up, you have an edge over the crowd because most of them are just scared to death, and so that’s one of the main reasons, and I’ll tell you I am most comfortable buying buyable gap-ups than any other pattern in any other buy point, and I will go in heavy, heavy, heavy when I see a nice big fat buyable gap-up, like Biogen in April of last year when they had this buyable gap-up coming up through 75, you see the huge volume spike and it continues higher, and you’ll know that if you’ve been following Biogen since then it’s gone over $100 and I think got to $127 or $128; somewhere around $130 I think was the peak recently, and so that led to a big move, so again, huge volume gap-ups are the biggest footprints of institutional investors, so I love that picture though, so many, should make a poster of it, anyway. So, characteristics of buyable gap-ups. Well, we’re going to go back to this concept that they need to occur in fundamentally strong and sound leading stocks, so you’re always trying to pick the best leading stocks, as Jesse Livermore used to say, as Richard Wyckoff used to say, the leading stocks are the leading issues of the day, so what are the leading issues of the day in these days? They were Apple, Intuitive Surgical, Priceline, those are the big stocks, and so that’s where you want to be, and the same thing with pocket pivots. Now, number two, a buyable gap up move must be at least 0.75 times the stock’s 40-day average true range. Now it isn’t very technical, but this is the statistical thing that Dr. K. found, but I can tell you from a practical aspect or a practical viewpoint is that you can see it when it happens. You don’t need to measure out 0.75 times a stock’s 40-day average true range. Who knows what an average true range is, anyway? You can get it on certain charting modules; you can put it on and it’ll calculate it for you, and you would use a 40-day average true range, but you can eyeball these things and you can see that the move is big enough to be a big gap-up, and one of the things in our new book, our second book, which we just finished writing and should be coming out in the summertime; we have a lot of exercises and ideas to train your chart eye in recognizing these things at a quick glance rather than having to measure whether it’s at least 0.75 times a stock’s 40-day average true range, but statistically that’s about what they tend to be, correct? DR. K.: That’s right.


GIL: But you can eyeball it, okay, and also you… DR. K.: I mean yeah, you get used to seeing all these chart patterns over and over and over again, and I can tell you I never use that metric of that I discovered 0.75 times a stock’s 40-day because it just becomes very apparent. I mean there are micro-gaps, but then again the micro-gaps you can see would not measure up and qualify as a buyable gap-up; they might qualify as a pocket pivot on the other hand. GIL: And of course the volume is the big thing too; the buyable gap-up move must occur in volume that is at least 1.5 times or 150% above the 50-day moving average of daily trading volume is that right? DR. K.: Yeah, that’s right. GIL: So, if it trades a million shares a day on average, how much volume should it trade? DR. K.: Well, you want 150% above the 50-day, so if your average, if it trades a million shares a day, then you’re going to want to see 150% above that, so in other words 1.5 million. GIL: Okay, isn’t that only 50% above it? DR. K.: No, it’s 150%. It’s semantics here, if it’s 100% that means it’s right on average. It’s at the average of the 50-day lines. You really want 50% above the average; I think that would be a better way to put it. GIL: Yeah, so 1.5 times, so, and also buyable gap-ups should occur within an uptrend or constructive consolidation, not while a stock is in a downtrend, and fifth and most importantly a buyable gap-up should always hold, roughly hold above the intra-day low of the gap-up day, and that’s the real trick with buyable gap-ups, so let’s look at Netflix; Netflix is probably the most difficult stock to handle in 2011. (INAUDIBLE QUESTION) GIL: Pardon me? DR. K.: Sure. GIL: Sure. (INAUDIBLE QUESTION) GIL: We’ll actually get to that. DR. K.: That’s a good question, and we’ll go through that. GIL: Because a lot of times if a stock has three gap-ups in a pattern within, say, the last six months to a year, that can become too obvious, and when you see a lot of stocks by the third gap-up in a pattern that they’ll fail, but Netflix was interesting in that it had a number of gap-ups; you can look at this chart and you can actually see two prior gap-ups; one in October and one in November, but we’re just going to focus on this one in January of 2011, and you see how we’re able to get the average true range on E-Signal, and so you can see that it is the 40-day average true range is 6.26 the day before the gap-up, so 0.75 of that is 4.69; the stock gaps up 24.12 points; is that more or less than 0.75 times 6.26? Quite a bit more, but you can also see how you can just eyeball that, so, I’m the kind of guy I like to eyeball things; I’m very visual, I’m an ex-cartoonist. You can go on Amazon and you’ll not only find my books on the markets, but you’ll also find my cartoon collections, so, and my kids tell me that the two go together very well, at least from what they see in the stock market. I think they like Jim Kramer, so he’s like a big cartoon character, so, but anyway, here’s BIDU; same thing, see


the big volume, see the big gap-up move, I mean there’s no question there, but notice how on a buyable gap-up you’re using the intra-day low of the gap-up day as your stop, okay, so we drew a little dotted line from the low of the gap-up day all the way to the right, and you can see that it has a day where it tests the intra-day low of the gap-up day, but it doesn’t actually close below it, and so it holds. Now, there’s a key point to consider here is that we generally like to give what we call 1% to 2% porosity below that intra-day low, so you see where that dotted line is, we’ll allow 1% to 2%, particularly if the stock shows a tendency to be volatile or if it’s a newer issue, or just a generally more volatile aggressive growth stock, right, you want to expand on that? DR. K.: Yeah, sure. These stocks that we’ll just call them high octane stocks; they can whip around a bit, and you want to give it a little more flexibility than just cutting the position if it undercuts the low of that gap-up day, so in this case it undercuts that low probably by about 1.5% or not even, and that’s fine. In context with the chart pattern, that’s normal price action, so you’re going to hold on to it, and you can do this with most of these gap-ups. Gap-ups also, just by their very nature, you have a stock that’s moving along at a fairly steady or slower pace, and then the gap-up can change the whole dynamics behind the price volume action such that a formerly quiet stock after gapping up might turn into a much more volatile name and of course we’re talking about capitalizing on upside volatility, but in the meantime that very stock may undercut that low of the gap-up day by 1% or 2%, so we allow for that. GIL: Yeah, so we use the low of the gap-up day plus 1% or 2%, just to give yourself a little bit of room. Here you have Priceline gapping up. We looked at this chart in the bottom fishing pocket pivot so you can see that it had those pocket pivots back in early July, and then you have the big gap-up, but you notice the stock never even got close to dropping below the intra-day low of that gap-up day, so in this case it’s a perfect stock, but you see, most people will not buy that pattern, but yet what happens; it never really looks back from there, and you go back to that Croc’s pattern at the very beginning of this module; it never looked back. Even Rovi Corp had a little shake out before it gapped up, and look at the huge volume on the gap-up and you use the intra-day low of that day and they’ve never looked back. DR. K.: You know the nice thing about the pocket pivots that I find in my trading is if you go back to that other slide, there’s a pocket pivot right before the gap-up day, so you could have bought it here, and then when it gaps up in a way it gives you a little more psychological strength to go ahead and buy it on that day because your average cost is somewhere in here. GIL: Yeah, or even if you even bought some on the bottom fishing pocket pivot, so. (INAUDIBLE QUESTION) GIL: Would I have had – No, well if I had not bought on that first gap-up, I might have come after it on the second day, but I don’t think I would just add on the basis of that. What I would be doing on this, if I bought that gap-up I’d be looking at pocket pivots along the ten day moving average as it starts to move higher to add to my position, so, I would probably be in whole hog. DR. K.: Actually, on this day, let’s say you missed that day; let’s say you’re away from the markets, and you noticed after the market closed that this thing had gapped up. The next day you can buy this thing; it’s not terribly extended, say somewhere in the lower part of its intra-day range, so you could take a position there. (INAUDIBLE QUESTION) GIL: Netflix. DR. K.: I’m sorry? (INAUDIBLE QUESTION) GIL: Well…


DR. K.: You could buy it the second day in that case just because the lower part of the intra-day range on the second day was contextually not extended because let’s say you use 2%. GIL: You’re within range. DR. K.: Yeah, you’re within range of the buyable gap-up day, and you also know your exit point; if you’re going to allow, say, 1.5% below the low of that day and you’re buying it the next day, you know exactly what your sell stop is going to be and what your potential loss is. GIL: Now, here you can see Netflix, and this is an example we looked at before when we were just going through the math of the gap-up. That was a third gap-up in the pattern, you can see how it did run up, so that could have been a profitable short-term trade, but once it starts to break down below the intra-day low of that gap-up day it’s failed, and you can see it fails, but we also find that after the third gap-up that it generally has a lower probability of working because it becomes too obvious, but if you had sold out, you could have come back several days later on a pocket pivot buy point as it comes up to the 50-day, which is that last arrow on the right side that we show, and buyable gap-ups and pocket pivots, the whole thing kind of works together, and you use those tools as ways to handle stocks. Riverbed Technology; big gap-up, that started out its move back in October of 2010, and you can see that one never looked back; big move, big gap-up. Acme Packet, same thing, you see how it tries to come back and test that gap-up day, and doesn’t quite do it so it held, moved higher. This stock never really had a big move from here though but the buyable gap-up did initially work and then you finally had a failed breakout to the right over there that probably would have sent you out of the stock, but when Acme Packet really got moving, and I contrast this because this gap-up occurs later on in the stock’s move, and it does lead to some gains, but the most powerful one occurs very early in the stock’s lifecycle, and you can see that one really signaled the beginning of the move for Acme Packet. It was a cheap stock, but in that case look at the massive, massive volume there. DR. K.: Right, well that’s where you can also make exceptions where generally I’m not going to look at stocks that are under $12, this gaps up, well it’s over $12. It’s still a cheap stock, but what I love about this name is that the volume is just incredibly impressive, and I do have a sub-rule which says if a stock has more than 1000% of its average daily trade, do pay attention because some of those stocks will rocket just to the moon like this one did. GIL: Yeah, and that’s institutional money coming into a stock right at the outset of a move. Jazz Pharmaceuticals was a very interesting stock, I mean that stock had a nice move from this buyable gap-up, and we saw this back when that happened, and look at the huge volume, again, and it never looked back; never looked back and you had several pocket pivot buy points along the ten day moving average; can you identify those, where do you see them, I think I see them. DR. K.: Let’s see, you’ve got this one here, and you’ve got that one, well that one’s extended, so you’ve really got this one, this is perfect, because it’s quiet and it goes right into that. GIL: This one here. DR. K.: That’s perfect because, I love these; the ones that undercut. They undercut and then they shoot back up through there. Your success is pretty good for those, so there’s your volume, and then let’s see, it looks like you’ve got potentially; that’s a little extended, that’s a little extended, these are extended, but then over here… GIL: Yeah, we can see, like.. DR. K.: …it looks like this one, that one back here was; where’d it go, there. That one looks like it’s a good one, and then that one looks like a good one as well, at the very edge. GIL: You should point out, you see here. We actually didn’t bring this up in the first module, but you can see here; see this second blue day here coming up off the ten day, this is a pocket pivot volume signature, but notice how it’s extended from the ten day moving average; you wouldn’t necessarily want to buy that pocket pivot. I just thought I should mention


that. Here’s Croc’s again; we showed this one at the outset. Google, when it got going, again, on its second leg up. The first leg up occurred in the latter part of 2004, and then its second leg occurred after this big gap-up, so again, there it is. BIDU in 2007. Now, here’s BIDU, notice how it has a gap-up and it kind of flops just below the intra-day low. Dr. K, do you want to discuss this further. There’s a couple of factors here.. DR. K.: Yeah, what’s interesting about this one, first of all, it’s a straight up off the bottom move and then gaps up, so you’ve got to give it a little bit more porosity than you would normally; what it does here is not unexpected just because it’s gone straight up like this. I believe; what was its percentage loss, it looks like that low was about $123, and it went down to about $120, so that is probably just over 2%; 2.2%, and that’s fine because, again, we say 1% to 2% is your guideline, but in this case, in the context of what the stock did before, you can give it a little bit more; a little more room, like 2.5%. GIL: The other think to keep in mind here is that this was just coming out of a long base, BIDU was a hot IPO in 2005, and it really had come public and ran up, and this is split adjusted, so it ran up and you actually were coming up to the right side of the base, and it was still kind an emerging situation, so there was some contextual factors there, but you probably could have come back in on a pocket pivot later on, right? DR. K.: Yeah, let’s say you had gotten scared of the position and you sold here; this stock still sets up again, and gives you additional opportunity via pocket pivots. GIL: Well, right here this is a flag breakout; that’s a pocket pivot, so that could have worked. See its breaking out of this range here. DR. K.: Yeah, that would have been legitimate. That one’s extended; you wouldn’t want to touch that one. These, let’s see, it looks like those two there are possible; I don’t think those are extended. Yeah, it looks like those two; both of those would be potential. (INAUDIBLE QUESTION) GIL: What’s that? (INAUDIBLE QUESTION) GIL: Well on this you would just be buying somewhere in this range on the day. What you want to do is when you see a gap-up occur, sometimes you buy it immediately on the open because some of them will just streak hard, so you can just buy a little bit there and then see where it goes for the rest of the day, and once it establishes an intra-day low you can operate off that low, so, but that’s generally, you’re trying to get as close to the low of that day as possible, but a powerful gap-up will continue to streak higher. DR. K.: Yeah, on this one. GIL: Like Apple. DR. K.: Because of this formation that preceded the gap-up I wouldn’t be buying it at the open because it could have opened up here and closed down there. On the other hand, I’m not sure where this opened, but I would be waiting toward the latter part of the day to initiate a position in the context of this chart. (INAUDIBLE QUESTION) DR. K.: Generally I’m pretty quick to cut. I prefer to keep my losses to a minimum, so if it’s extended by more than that factor, I don’t look for excuses, I just cut and run, and I think that’s a very important habit to develop is to just get used to selling your positions when they’ve hit your sell stops because I know that it’s all too easy to look for excuses why you want to hold a stock and give it a little bit more room and a little bit more room, and then eventually what the stock’s


actually telling you is that it’s in trouble and then the next day it gaps down, and I’ve seen this happen to so many traders. I mean, Gil and I are very fortunate that I think we’re just so averse to the risk side of things that in our trading careers I’ve encountered one gap-down, and in fact it was a stock that was a semi-conductor and it was hitting new highs and the next day it gapped down. Bizarre. Fortunately, that kind of action is almost unprecedented, and generally most of these gap-downs you see the stock always gave ample warning, generally it violated a major moving average. GIL: Yeah. (INAUDIBLE QUESTION) DR. K.: Calls. Oh, options, yeah, I don’t do options. GIL: He never uses them. DR. K.: I would always say; we have some members who do use options. GIL: This is a call. DR. K.: And it’s always the same story; always know your risk because options can carry so much more risk depending on the nature of the options so, whatever options you’re using. (INAUDIBLE QUESTION) DR. K.: I’m sorry? (INAUDIBLE QUESTION) GIL: That’s true. Right. (INAUDIBLE QUESTION) GIL: Well, my answer to that would be you can use either. You can use either. I’ve used call options and stocks when I’ve run out of money in my account I’m so loaded up in the stock and I’ve just got to get more. I mean, the example I use, and it’s in our book is CQ Microsystems (SP?), in 1995, when it bounced off the 50-day moving average and gapped up off of 3750 and that was a powerful gap-up, and I was basically out of money, but I was able to afford 1500 November 50 calls, and this was in October of 1995, and so I bought them for $1.50, and the stock hit 95 in November when they expired so I had 45 points on those options, and that worked really well. Yeah, so I think, sure you can use call options. (INAUDIBLE QUESTION) GIL: Well, on a gap-up you might get a huge volatility premium and then that evaporates over the ensuing days. DR. K.: Right. GIL: So you need to know what you’re doing if you’re going to use options because they are different animals. DR. K.: The other issue is they could be fairly thin, and there could be a really wide spread, and again, I don’t trade options, but I have friends who do, and I had a friend who started with, he ran about $50,000 up at about $250,000 very quickly with base breakouts; it was the right time to do that, but what was interesting is by the time he crossed $300,000 he was moving the markets; there was a lot of slippage in his trades, in other words, so he realized that based on his type of strategy he couldn’t really use that kind of money for the type of options he was trading.


(INAUDIBLE QUESTION) DR. K.: Right. Well, I would say it’s the other Jazz chart; the one where it undercuts. GIL: Is it this one? DR. K.: No, well actually, yeah this one right here. GIL: Yeah, I know …. DR. K.: And then it… (INAUDIBLE QUESTION) DR. K.: Absolutely because, and I love that these upside reversals on volume can be quite powerful. I prefer to see that than just the typical regular run-of-the-mill pocket pivot, and it works in reverse too, if you see a reversal to the downside on big volume, that’s a big warning sign, and not often if you see a climax top; a great gift is a climax top that ends that way because you can not only sell the stock, you can short it. GIL: Now here’s Apple, this is gap-up occurred after a shallow uptrend. You can see the stock. I’m using like, the cursor on the PC rather than the pointer, but you can see this actually occurred, here’s a breakout here, and it actually occurs after the shallow uptrend, and then the stock really gets going. I had this stock back in 2004, and I remember buying; I bought a little in here, and I bought 50,000 here, and then I sold them and then I bought 50,000 back and I sold them, and I bought 100,000, sold 50,000, bought 50,000 back, and I just kept going back and forth, and I had 50,000 shares on this day right here, and at that point that was after you left, and Bill told me I needed to get an analyst, so I hired some kid out of Wharton; big mistake because the day before I said to him, okay, we’re going into Apple earning, should I be buying the stock; should I be adding to my position? He says, oh, no. Apple is fully valued here, so I had 50,000 shares, the next day it gaps up like this and I’m buying another 250,000 shares on that gap-up because it’s just so powerful, and I know, when the line of least resistance is broken, Jesse Livermore talks about that, and being able to sense that when it happens, just look at the massive volume in this stock, and I was all over this thing back then. I think I went from like minus 13% that year, up to something like, I don’t know, 70 something, just on Apple alone, and, well, Google was in there too, but you can see that this actually comes out. The stock just wears you out because it breaks out it doesn’t really go anywhere, it’s moving up slowly, and then all of a sudden boom, this happens, and you may be averse to buying it because it’s a gap-up, but this is when it really starts its move, so even coming out of this shallow uptrend it really gets going. You notice if you look at the charts of CMG over the last year, it’s done the same thing, when it has a gap-up out of a shallow uptrend that just bores you to tears, and then the thing takes off. Here’s a gap-up in Apple; it’s within a base, but that works as well, so the thing about buyable gap-ups is you can buy any of them and if they look right you can buy them because you have a pretty easy out, and I think generally 3% or 4% is your maximum in downside risk in most cases. Here’s Biogen, now here’s that gap-up we were showing you earlier, and look at where that one; that just took off, and then notice you get this other gap-up. At that point, somebody was asking when does it get a little climactic? I think at this point you can say it’s climactic because it’s just going crazy and it’s already occurring from an extended position as the stock is almost moving straight up and it is the second gap-up in the pattern, so you can see how that one; this one here, you’re not going to buy this one, but this is the one to buy. Finisar had a nice gap-up to the 20 level or the 22 level back last year; it was in December, no two years ago almost; a year and a half ago, let’s say, but that one worked, nice gap-up. Herbalife; nice gap-up there. Now, notice he had, again, here’s this idea, you had one gap-up here, second gap-up here, and now the third gap-up probably becomes a little bit obvious because the stock has already been moving for a while and it’s already had two successful gap-ups. DR. K.: Right, and that’s also a V formation; the kind of formation you want to avoid. GIL: Oh, exactly. I will have to use that as an example for a…


(INAUDIBLE QUESTION) DR. K.: Well, it’s a V shaped pocket; there’s something not quite right with this formation because of the undercut here, and the volume is pretty appreciable there, I mean look at that red. It’s not a high quality buyable gap-up based on this, also because it’s had such a big move, and it’s gapping up for the third time. GIL: BIDU, there’s that gap-up again that we talked about. (INAUDIBLE QUESTION) GIL: Yeah, we went by that. DR. K.: Right, if it’s a rumor, like Monster, what was it MNST. GIL: That wasn’t a gap-up though, that thing just started moving. DR. K.: Yeah, these, if it’s a gap-up motivated by a rumor or in the case of Monster, in a way, didn’t they halt it for trading and then it just resumed it and it was up huge. GIL: No, they never halted it. DR. K.: They never, so it just had a huge move because of this rumor that it was going to get bought out, and those are rumors, so that, to me is not legitimate. (INAUDIBLE QUESTION) DR. K.: I’d like to see a buyable gap-up based on news that is material to the company; company’s internals, so in other words an excellent earnings report. That’s classic. Maybe the company has some breakthrough drug, things like that. GIL: Well, Biogen’s gap-ups are based on that because they have the drug for MS. DR. K.: Right. GIL: Yeah. Here’s Apple. This is Apple in 2012, just to show you that buyable gap-ups not only work on a historical basis, but they work in the present day, and this is in January of this year. You had a nice big buyable gap-up on earnings, and I actually bought this one two days after the gap-up because I wanted to see how it settled in. I remember reading articles; some guy is writing an article on SeekingAlpha.com that Alpha’s gone too far too fast, and he sold his shares, and he’s going to buy them back when the stock pulls back to 429, and I thought how does he know it’s going back to 429; I want that charting system, whatever that is, but I felt that Apple was prime to have another move if we were starting a bull move it probably lead, and it took off, so I bought it at 444, which I call the sign of the Gilmo, and the stock took off from there, I mean the rest is history, and Apple actually followed the ten day moving average all the way up. Priceline, as well, started out in January of this year with a big gap-up move and you could have bought that, and it never looked back, so I mean you can see these in real time. Tractor Supply you can see the buyable gap-ups in here, even after it’s coming off of this little shallow area, and it acts pretty well, and Monster back here, back in January it had a buyable gap-up; that was a buyable gap-up right there, a very quiet one really, it wasn’t a huge mover, but we bought that stock right there, and it roughly followed the ten day moving average, never violated it, doesn’t look like it. Did it violate it here? DR. K.: You’d have to expand that. It looks like it did. GIL: That’s a close call.


DR. K.: It looks like it violated the ten day in seven weeks or less, so you would use the 50-day as your selling guide, and in other words you’d still be in this. Well, actually what happens, okay this is a good case study; it violates the ten day here, so you switch to using the 50-day; however, from this violation it goes seven weeks without violating the ten day, so you switch back to the ten day as your selling guide, and you’re still, it looks like it here, did it violate it there? It looks like it violated the ten day there after not violating it for at least seven weeks, is that right? GIL: It looks like it made it; I think we did….. DR. K.: Or did it violate it here again, so you’d just still be on the 50-day. Well, the point is if it keeps violating the ten day in seven weeks or less you’d be using the 50-day moving average, you’d still be in this stock. If, for the sake of argument, this was your first ten day violation in greater than seven weeks, that would be your sell point, you’d be out of the stock on that day. You would have missed the gap-up, but then this gap-up is probably going to set up again and give an additional buy point, since this stock seems to continue to show leadership qualities. GIL: Well, we’ll see if that turns out to be the case. All I know is that this was a great buyable gap-up right here, and that was the best spot to get in. This move here, of course, that was on the buy_______ but you know what, if you own a stock like that and let’s say you had bought this here, you want to sell into something like that and when it starts streaking up and going crazy like that. DR. K.: Yeah, I remember the news came out and it was complete; there was no confirmation that they were going to get bought out; it was a rumor and I was surprised that the stock went up as far as it did. If I was sitting on the position, it was a very easy sell to get rid of it right up in this zone here, just because it’s made an accelerated move and there’s still no confirmation, and my thinking was well, if it’s going to get bought out, it’s probably going to get bought out around here, so I’m just going to sell it anyway. GIL: Right, and I think you’d be out, but that’s another issue altogether. Now here’s a gap-up that occurs here. Now, I kind of color coded this red because what it does is it opens up here closer to 75 and it closes down here. That’s heavy volume. In my view that’s a little bit of a weak gap-up there and I actually color code my charts to be red or turn red if it opens higher than it closes, so I can sense whether a move to the upside was really strong where it actually starts at a lower price during the day and moves higher. In this case it reversed, but the problem with this buyable gap-up, I think, and you can chime in on this if you want to, is that you have some overhead from here, and there’s people who were very silly buying this stock in here thinking they were going to score on a buyout or something by Coca-Cola, and so I think you have some overhead. This may work its way through. So far, has it been holding? It broke down today, so I think it’s out of the question now, but we can actually check that, let’s see. DR. K.: Yeah, you should have… GIL: Well, we’ll go back later. See, it’s on there. It looks like a failure analysis, so here’s this concept again; notice you actually in this you have one, two, three, four buyable gap-ups; the fourth one here fails, and I would actually say, you may not, I don’t know if this actually came out of a proper base, but definitely these two, and so when you start to see a bunch of them in a pattern within several months, it tends to get too obvious, so that’s something to keep in mind. The best buyable gap-ups, as we showed in stocks like Croc’s with that one chart of Acme Packet when it came up through $12. When Apple was just getting going in 2004, the best buyable gap-ups occur earlier in the stock’s lifecycle, not later, although you can have some later on that will work, but the best ones tend to be at the very beginning of a stock’s lifecycle, and if it’s a name that you’ve never heard of before; it’s a recent new issue and you see a buyable gap up coming out of a proper base, that’s probably a big sign to be jumping all over that thing. Citrix Systems, this is one that kind of failed. I thought this pattern was a little erratic before it had the gap-up, and also I don’t think the earnings were all that stellar. I know this system is showing 39% increase. I don’t think it was that high, I think they’re using Reuter’s numbers, but what would you say about this one in terms of the failure? It failed pretty quickly….. DR. K.: Well, yeah, you’re out of this stock on the third day after buying it because it undercuts by more than that acceptable porosity.


GIL: Yeah, and that’s what I mean when I’m telling you, you can buy any gap-up if it looks right, and this actually kind of looks right. This could be a little more coherent; it’s kind of choppy in here and not as smooth, I mean if you go back and look at that Apple example, that was a nice, smooth uptrend before the gap-up; this is a little choppy, but the beauty of it is you have a quick out. If it doesn’t work you’re out quickly, and so in reality a buyable gap-up is almost a lower risk buy point, particularly if you can buy as close to the intra-day low of the gap-up day, and a lot of times it’s a lot less than 7% or 8% that you’re buying on a normal base breakouts. We went through that one. I’m not sure why this guy keeps jumping but he does. Intuitive Surgical, you know here’s another example of a stock that had had prior gap-ups in the pattern, but again if you bought it, it immediately fails and you’re out as soon as it starts to break down below that low, plus another 1% or 2% depending on how tight you want to run it. I can tell you, didn’t we use less than 1% on LinkedIn and we got shaken out around 97? DR. K.: Yeah that was interesting real time error. The markets weren’t looking good and sometimes you want to tighten your stops, and that’s what we did. We ended up selling prematurely because things did not look right in the general market. GIL: And again, we use the seven week rule as our selling guides. Once things get up and going, you know buyable gap-up you’re obviously using the intra-day low of the gap-up day, but once it gets moving you’re reverting back to this and I don’t think we need to review this, but it’s basically the idea that once you have a buy point where there’s a pocket pivot or a buyable gap-up and the stock starts trending higher, you can figure out whether it has a tendency to follow the ten day moving average or the 50-day moving average, and then use one or the other as your selling guide, depending on whether it follows the ten day for seven weeks or more, so the seven week rule works pretty well. Here is an example of this, so here’s Intuitive Surgical, which immediately you have a gap-up here and see it gaps up and it runs up; can everybody see my cursor okay on there? I think it’s better than the red dot, and you can see that it immediately violates the ten day moving average, so you're not going to use the ten day moving average as your selling guide you’re going to revert to using the 50 day; the blue line, so in this case again violates the ten day moving average within I'm going to say, one, two, about four weeks of the buyable gap-up, so you're using the seven week rule, tells you you’re using the 50-day moving average. Okay, now on the other hand, again, here’s Lululemon Athletica does not hold the ten day moving average here, so you revert to using the 50-day. Apple is a great example of one that’s held the ten day; I’ll let you pull that one up, so I just want to summarize that buyable gap-ups are often too high to buy and thus increase the contrarian odds of success since the crowd is almost always scared away, and I really do think that’s your one advantage in buyable gap-ups. You know as I was telling you at the very beginning of this workshop, everybody’s got charts, and everybody sees the standard issue base breakout, but everybody also has charts and everybody sees buyable gap-ups; the one thing we know is they’re usually way too scared to buy them, and I think that’s where you have an edge there if you understand how to handle them, so we think that it’s an even easier buy point, and like I said earlier, a buyable gap-up in the earlier stages of a stock’s lifecycle is your best bet, and usually when they start their big move, and the ones that occur and the strongest fundamental leaders; the big leading stocks, those have the best probability of success. Yes. (INAUDIBLE QUESTION) GIL: Which one? Okay. (INAUDIBLE QUESTION) GIL: One more? They’re in the handouts too; did you get handouts? (INAUDIBLE QUESTION) GIL: Nowhere in the handouts? How did that happen? DR. K.: It is on the website if you go to the FAQ and type in Seven Week Rule, you’ll get the FAQ that contains these, but that’s a good way to do it.


(INAUDIBLE QUESTION) GIL: We’ll probably have them up on our website. We’ll fix them up. If that was somehow excluded in the handouts, we will probably… DR. K.: Yeah, we should probably go ahead … GIL: If you go to the website it’s all there. I mean we have… (INAUDIBLE QUESTION) GIL: Really? Something happened. Oh well. DR. K.: It must have been the same people doing the lobster and the prime rib I guess. GIL: I don’t know, snafus are always part of the Money Show, I guess, but you can always go over to the Trader’s Press book store that they have and you can borrow a book and it’s got it in there. Not that you make a lot of money writing a book, I can tell you that much, but it is a lot of fun, and my kids think I’m really cool because of it, so. Yes? (INAUDIBLE QUESTION) DR. K.: Markets are fractal, but only to a point, and I would say we’re in the age of high frequency trading; we have a lot of cross-currents on a day-trading level that has knocked a lot of day traders out of the game, so I would argue that I would avoid using minute charts and intra-day charts to day trade these concepts. GIL: I want to go over some current examples because I wanted to cover Apple. I think this is a really interesting example. Now, you notice Apple, you know how I color code these charts; Apple did actually open higher than it closed on that day, and it showed up red, and that was the reason why I waited a couple of days to buy it, because I wanted to see if it would hold, and I did, and when I read that article on Seeking Alpha, some guy telling you to sell your Apple shares here because it’s pulling back to 429, I just marveled at that because I wasn’t quite sure how he came up with that number, but you can see that what it did after the gap-up it followed the ten day moving average and even though it moves below here it only closes below here, and it has followed all the way, so by this point we’re using the ten day moving average as our selling guide, so right here you close below the moving average and right here as it breaks below that low I’m gone. I’m selling the stock and it had one bounce back up into the ten day moving average; it actually shorted the stock there and it broke to the 50-day and I covered it. Actually I’ve been shorting the stock on the rallies, and today I actually covered my position today because my thinking was it’s going to undercut this low and then maybe try to bounce, but the way it’s looking today it looks like it just wants to go lower, but my point here is by using, in this case with the buyable gap-up, and we talked about pocket pivots as well, where we use this seven week rule and the ten day or 50-day moving averages are selling it, you can see that with Apple you don’t have to worry about whether analysts think it’s going to 1000, whether they’re going to declare a dividend, which means everybody’s grandmother’s going to suddenly buy the stock, so that’s going to push it higher. You don’t need to worry about any of that stuff just look at the price volume action, so regardless of what the analysts are saying about having to buy Apple because it’s going to 1000, and of course they pay a dividend now. We saw the ten day moving average violation as a sell signal and we’re out of the stock, and its topped. I’m sorry… (INAUDIBLE QUESTION) GIL: There was actually like a 2% pull back there; a 1% or 2%; it wasn’t very much off the low because I think he went… DR. K.: It was within a 2%. GIL: I can actually; let’s see if I can.


(INAUDIBLE QUESTION) GIL: Oh, here? Well, I’ve got to tell you, if I’m along the stock I’m actually probably dumping it on the day when it’s starting to break down through the ten and the 20 just because there seems to be some velocity here, plus the stock had a huge move, and at this point also, everybody on the planet loves this stock, and I don’t think there wasn’t an analyst on the planet who didn’t have at least an $800 price target, and I think back in my own experience; when I owned Schwab in 1998 and in early 1999, what’d the stock get up to, like $150-something. Analysts were putting $200 and $300 price targets on it, and you can go back and look at any big leading stock; the story is perfect, the analysts are raising the targets up to the moon and beyond, and that’s a top, and even in Apple, that stock topped. It has topped for now. Maybe it needs to build a new base, maybe it will, maybe it won’t; how do you know? One thing that’s bothered me about Apple is it’s had this fifteen times forward estimates PE for the last year, and you wonder why does the market value Apple’s forward earning stream so poorly. Why isn’t it selling at 40X; 40 times earnings; why isn’t it trading at 1500, and so those are questions I have and the fact that now they’ve announced the dividend, where are all these dividend buyers that are kind of come into the stock that everybody’s talking about. They’re not there, but you can worry about all that, but the bottom line is if you’re just operating with these basic rules; the seven week rules and the ten day moving average in Apple’s case, you’re out, and you would be out of the stock, so anybody who still owns the stock, guess what, you missed the sell signals because you didn’t attend this workshop last time you did it, anyway, or read our book, but it’s right there and it works, and we’re gone. I don’t even… DR. K.: Yeah, I wouldn’t; in practice I don’t give really much porosity at all, virtually zero porosity to moving average violation, so ten day or 50 day. GIL: Right, you don’t want to….. DR. K.: I’m not giving it 1%. I’ll give it a dime, really minimal. GIL: Especially after a big move because the bottom line also is, let’s say that you do sell and the stock does set up again and turn around; there are going to be more buy points; there’s going to be pocket pivots probably in the base, and to tell you the truth I’ve been waiting to see if Apple would form some kind of pocket pivot because the other thing to consider that is if this is a first stage base and it breaks out here, okay, and this is a first stage base; we’re starting a new bull rally, then this first correction, this is going to be your second stage base, and most stocks have their best move off the second stage base, but it’s not really happening, but on the other hand I don’t have to worry about it because I’m already out of the stock base on the ten day moving average violation here; way back here, long before anybody was talking about dividends or even; when did they announce a dividend, like _____ or something, or was that earlier; I forget, but really it’s irrelevant now, so don’t get sucked in by all that stuff, it’s all noise, and I think price volume action tells you everything you need to know, and I’m just afraid that tomorrow that I covered my short today because maybe it’s headed for the 200-day _______. DR. K.: It’s not looking good, neither is the general market. I’m glad my model’s on a cell signal. GIL: Yes. (INAUDIBLE QUESTION) GIL: Oh I remember it very clearly; I remember basically cussing out my analyst, and that was October 15, 2004. It was October; I believe it was the fifteenth or the thirteenth, I know it was the day after they announced earnings after the close, and I just bought the thing, we can go all the way back there. (INAUDIBLE QUESTION) GIL: Right. No, probably on the pocket pivot; like I was telling you earlier, I like to see something powerful and decisive, and that's the way Bill traded too; O’Neill trades that way too, I mean he’s in there, boom, boom, boom. What’d they used to call him; they had a name for him. The Bolt; the bolt in the trading room because usually when he’d come in the door


would fly open and he’d start screaming at the trading desk; buy 100,000 this and he’d just be moving on something because he’s like a lightning bolt coming into the trading room, and I kind of learned that sort of thing from him, so, the essential idea is that, what Jesse Livermore talks about, when he sees that the line of least resistance has been broken that’s when the real move starts, and so a lot of times a buyable gap-up, particularly with Apple in 2004, that’s when the real move started because everything before that was just kind of slow, and it was constructive but it was slow and it was boring me to tears because I was in and out, in and out, in and out, and it wasn’t until that gap-up that I started to get heavy, and to me that’s one of the most powerful buy points and probably the easiest one to buy because you have a quick out point if it fails, so I love buyable gap-ups, and like I said the earlier in a stock’s lifecycle the better, and so that should get you guys excited because hopefully you come away with something that nobody else out there is really inclined to buy, and I think when you have a tool like that, that most people are scared to death of implementing because things look too high when they gap-up, you have an advantage, I think. Do you? DR. K.: I think there’s another point, is that on a buyable gap-up, especially when it changes the overall tone of a stock, so a stock goes from having a certain price bond characteristic to having a major buyable gap-up, there’s a lot of volume traded on that day, so, and it’s institutional volume coming in, so it’s not like everyone jumping on all of a sudden is going to really change the success rate of buyable gap-ups; it’s got that in its corner as well. GIL: Look at Chipotle; this is back just, what. I don’t know what they do to my screen; whenever I plug this thing in it makes my screen here go crazy. Can you see the year down at the bottom? DR. K.: No, it’s cutting off the bottom. GIL: Okay, this is recently; I think it’s like a year ago or something like that, let’s count _______, a couple years, but you can see; notice, see it’s moving up, actually this is in 2010 so this occurs; see how it’s just in a nice constructive trend channel, and I remember getting e-mails from people and it’s like, Gil, I own CMG, and I bought the breakout and it’s just going really slow and I’m watching these other stocks go higher, and I tell them just stay with it, it’s acting fine, just stay with it. No reason to sell it unless you want to be stupid, but then once, and there it is; there’s the buyable gap-up and now it starts to move. (INAUDIBLE QUESTION) GIL: Pardon me? DR. K.: Well, right there. There’s your date. GIL: Hey, thanks. DR. K.: But you can’t….. GIL: But you can see here on October 22, 2010, finally; it’s bored you to tears and I know somebody e-mailed me and said they sold it a few days before this, but look at the gap-up, it’s huge, and that’s actually when it starts a much sharper upside move, and you actually could have blown all this off, and just come in here and I think you’d do a lot better. DR. K.: And by the way, this is not a wedging pattern; this is where people can get also mixed up with. Wedging patterns are, I’ve noticed, pretty difficult for even traders back at days at O’Neill to identify properly, but this is not a wedging pattern primarily because it’s actually a tight; the price line is very tight here compared to what it’s done before, so this is actually constructive, even though the volume might not be outrageously large. GIL: But it shows you how things will be quiet, and this is what I’m talking about, when the line of least resistance is broken, the thing really starts to move, and I think this is where Jesse Livermore would be buying it; maybe not so much here, but this is where he’d be going in real heavy.


(INAUDIBLE QUESTION) DR. K.: Pardon me? GIL: CMG is actually, yeah, because I think it had followed the ten day and you’re using the ten day moving average because you’ll see you get closes, but it never moves below the lows of these closes, and then finally here, you close below and now you break down below it, so now you’re gone, and now you’ve violated the 50-day as well, so like Apple, it’s a sell, and I think Priceline is getting there as well, because Priceline, yeah. DR. K.: Yeah, it looks like Apple. GIL: In fact here, this here is a close below the ten day because the ten day is $739.67, you close here at $735.18; that’s enough, and then the next day you move down, you’re gone there, so if you’re still on Priceline you’re waiting too long, but then you didn’t have this tool. Now, what you notice is just three days ago it violated the 50-day moving average finally, so in our view this stock has topped, and I don’t necessarily think that this is undercutting to create a double bottom because if that’s a double bottom base, that’s a really ugly looking double bottom base; you’re only two weeks down on the left side. Usually on a double bottom base you only see four or five weeks on the left side of the W, so if this is going to turn into a W, that’s a very bizarre double bottom. I think possibly it could’ve topped, and I think some of these stocks may be topping for good because a lot of them have been going for a long time. If you consider the QE bull market has started in March of 2009, then they have been going. Some people want to think maybe we started a new bull market in January because of the fact that we had, if you look at, this is January here; we had this brutal correction, which is over 20%, so was that enough to be a bear market, and to reset everything? Maybe it was, but on the other hand you have to look at sort of the macro-move off the 2009. I think a lot of this market has been driven by quantitative easing. It doesn’t invalidate the fact that you can make money in stocks if you know how to buy them, but I think a lot of this has just been one big QE bull market and whether we’re going to get another leg or not remains to be seen, but if we are, these stocks like Priceline and Apple will, they’ll build bases and come out, but for now these things have topped as far as I’m concerned. I’m not looking to buy them; I wish I’d actually shorted Priceline right up here, but not really a shortable pattern, but we’re going to let Dr. K. do a trading simulation and go through step-by-step. What I was thinking you could do if you wanted to is use this and just kind of go through a few days like this if you want to do a few of them. Do you want to do the ones that we already had preset? DR. K.: Yeah, ______ then we could see Ford. GIL: How about this, let’s have them go through two stocks that have been leading stocks over the last several months. (INAUDIBLE QUESTION) GIL: Which one? TGP. Nah, not a big enough leader. Give me a big leading stock; what’s a big leading stock? (INAUDIBLE QUESTION) GIL: Okay, we’ll have him do LinkedIn, that’s a good one. Okay. You know LinkedIn it really hasn’t broken out. It reminds me of BIDU after it came public, so, and Frank was talking about Facebook. How many people think Facebook is going to be the type of IPO like Google or say, eBay back in 1998, where it comes public, sets up at a base, and goes higher? How many people think that’s going to happen? (INAUDIBLE QUESTION) GIL: What? Okay, sorry, sorry. Not Frank ________, but he likes to get into that, but I don’t think you can compare them; I think it’s going to be more like LinkedIn or BIDU because of the stage of the cycle that it’s coming in, so, but I certainly wouldn’t be buying it on the first day of trading, I’d just let it set up, but the earnings, they came out and announced earnings, they weren’t all that hot, so we’ll have him do LinkedIn, how about, what other ones have been big hot leaders?


(INAUDIBLE QUESTION) GIL: Which one? Hold on a second. Okay, everybody can take a break for a little bit. Where is the move though in these things? From here to here in January; not really a huge leader and then it broke down really soon. How about another one; let’s, I’m thinking maybe we should let him go through, how about Intuitive Surgical? I like that one; anybody like that one? All right, so we’re going to have him do LinkedIn, and you know what, I’ll put in a third one, so he’s going to do LinkedIn, ISRG, and what was the other one, SSYS? (INAUDIBLE QUESTION) GIL: Amylin Pharmaceuticals, yeah, I’m familiar with that; they make a type of Insulin. Yeah, my son is Type I; it’s for Type II, yeah, so we follow a lot of that. (INAUDIBLE QUESTION) GIL: No, is it a buyout? (INAUDIBLE QUESTION) GIL: I guess my feeling is that you’re buying a news play, so not really something I would do. I mean because the news could shift on you, I mean whoever bought Monster on the…. That’s a good example, but this one actually, surprisingly looks very coherent, but you have three gap-ups now in the pattern, so. (INAUDIBLE QUESTION) GIL: Oh, and you think he’s in there, well and don’t forget Carl Icahn bought Yahoo when it was 28, so he takes a lot of swings, and I’m not going to say the guy’s an idiot because he’s a heck of a lot richer than I am, so you know, keeping score that way, he’s much smarter, but he has his mistakes. He sold out what? (INAUDIBLE QUESTION) GIL: Just, yeah, right, and he actually, but he was very humble about that; I saw an interview with him and he’s like, you know I think it’s great for the company. I’m glad to see it. I’m sorry I missed the move, but he says I’m not perfect, and that’s true, and I think if you’re going to be successful in the markets you have to allow yourself to make a lot of mistakes. All right, I’m going to take a break. {BREAK} GIL: We’re ready to proceed with the second two-fifths. So, the last two modules we have, we’re going to have Dr. K. do a forced trading simulation on stocks that you guys have chosen, so you guys have chosen LinkedIn, Intuitive Surgical, and SSYS, for him to go through, and where do you want to start these, Dr. K. Do you want to start at the beginning? DR. K.: Yeah, let’s start LinkedIn from the beginning. GIL: We’ll start LinkedIn in the beginning, he’s going to run through this in terms of all the buy points and sell points, and how you might handle this, and then once we’re done with this; hopefully a half hour or so, and then we’ll finish up the last modules on short selling, which may or may not become relevant here at this current stage of the market, so, Dr. K. DR. K.: Okay, so we’ve got the IPO Day; it’s a wide band. LinkedIn was a hot IPO because it’s the social networking leader in business, so there was a lot of fanfare about this IPO then, and here’s the reason you don’t want to be buying an IPO on the first day; it can do this, straight down, and I think the market was weak as well, so this is following the direction


of the market, and then comes back around, and looks like to me like this could qualify as a buyable gap-up; this day right here. GIL: Here? DR. K.: Yeah, right there, and it is a pocket pivot, I would treat that more as a buyable gap-up, so you might take a position there, and let’s say you took a half position because the market was probably still questionable at this point, and then it goes higher; these are all extended pocket pivots, then on this day, I remember this was a tricky day. The market has a pocket pivot that goes straight up and clears that old high point, and big volume. And I think we took a position in that one or I know I did, and then it reverses all the way back down, and so that’s a big warning flag when you buy into a pocket pivot that looks great and then it closes toward the low. I didn’t sell it. I waited to see what would happen, and it stabilizes; it doesn’t go any lower, and then it violates the ten day moving average in earnest here, and basically you’ve got to be out of this thing at the worst point, at the low of that pocket pivot day, that should be your ultimate sell point, and then it gets shredded here, goes straight down; it’s very volatile and rocky here. I’m not even looking for pocket pivots in here, but the price formation is not right, but then over here you have this day where it comes back around, closes at the 50-day or just above it on volume, so you could say there’s a bit of a rounding action; it’s a little bit more constructive. I’ll take a half position because it’s still low in the base and there’s still a little bit of noise going on in there, so you take a half position there, and then you can see here there’s a couple more pocket pivots, so you might round out your half position with a full position here and here, and this is what makes a stock like LinkedIn so tricky, and again, the success rate on pocket pivot is like that of base breakouts; even in the late 1990s, I remember Bill O’Neill telling me that his success rate on base breakouts is at best 50%, and I would say that the same goes for pocket pivots, so this is a good classic example of why it mays to always obey your stops and always know your exit points, so if you had bought here, and then you’d bought another half position here, so you’re sitting with a full position, by the way, if I’d bought here and rounded out my full position I wouldn’t be buying here because the price hasn’t really moved; it hasn’t really appreciated, so I’d ignore that pocket pivot, and then as it goes back into the base here, I’d probably cut my position in at least half as it sinks back into the base; it’s also violating the ten day, so I’d probably be out of the position somewhere in here before it even has a chance to undercut the 50-day and violate the 50-day. Now, there’s nothing to do here; it rounds out here, this is interesting. It’s below the 50-day, so I wouldn’t touch it until it clears the 50-day. You could buy a half position here because this is a constructive price formation; it’s rounded out, closes above the 50-day, so you could do a half position there. GIL: Actually, you’ve got a pocket pivot right here on this day. DR. K.: Right. If it closes right at or just above the 50-day there, and then it looks to me like you’ve got another pocket pivot on this day here. Right there, so you could buy your first position there, you could buy another half position there. GIL: Question; why isn’t this a pocket pivot? DR. K.: That is a pocket pivot, but it’s extended, if you look relative to the overall chart, so you wouldn’t touch that one. This one; this one’s okay. I wouldn’t buy this one because, again, the price hasn’t really moved, so I’ve already bought my half position there. Half here, half there, I’m going to wait for this stock to appreciate a little further before adding to my position, so I’m going to ignore that pocket pivot. Then you’ve got a buyable gap-up; definitely taking a position on that day at the open because this is overall constructive enough and then you’ve got a good buyable gap-up out of this formation, so now we’re sitting on, say, a position size that’s 1.5 times normal, then from this point on it looks like you’ve got a pocket pivot here on this day, yeah, that’s a pocket pivot, so now it hasn’t gone anywhere since the buyable gap-up, so I may just ignore that pocket pivot altogether and in practice that’s what I would do, so I’m sitting on 1.5 times the size of my normal position, but then, I love this, it undercuts and then closes close to the high, actually is that a pocket pivot day? No, that volume’s not great enough there, so that would be ignored, and then you have a buyable gap-up there, so that’s a second buyable gap-up, but I’m sitting on a position that’s 1.5 times the size of my normal, so I might just sit with my position, and then it looks like it undercuts, yeah, it does undercut but within the 1% to 2% porosity level, so in other words I would be; this is also instructive, let’s say I had bought another half position there, so I’m sitting on twice the normal size of my position. If this had violated that by more than 2%, I would just sell that half position, so I’d still be sitting on 150%; 1.5 times my normal size, but I’d be selling that piece in there. In this case if I had bought there, I’m


sitting on twice my normal size. It doesn’t violate it, so it doesn’t undercut by more than 2%, so I’m sitting on twice my normal size, and it goes back and forth, and then it has a gap-up there. That’s a buyable gap-up, a third one. Now, the nice thing is my average cost is somewhere down in here, on twice the size I would normally have in my portfolio, and right after this buyable gap-up it undercuts, breaks the 2% porosity, I’m out, so my average cost was somewhere in here and I’m out right at there, and so it’s a very profitable trade. GIL: Something else to keep in mind here is remember how we talked about the three buyable gap-ups in a pattern, so here’s one, here’s two, and now the third one gets a little too obvious and it fails immediately after the buyable gap-up, so again, here’s this example where it becomes a little bit too obvious, and we kind of saw that because we didn’t buy that one at all. DR. K.: That’s right. GIL: So, what would you be doing with it now? Would you be holding this stock? It’s still holding this breakout but it’s just kind of hanging here. I guess people are anticipating the Facebook IPO. DR. K.: Yeah, my view is on a fundamental level Facebook is the leader if we’re going to see a strong market, and that’s a big if, but let’s say we see a QE motivated market drawn in by QE3; an announcement by the feds, say, hypothetically and so we get another nice uptrend. I would expect Facebook to round out and issue a pocket pivot of some sort and lead the way. It is a better stock than LinkedIn; LinkedIn is more of a second rate stock on a fundamental basis, and I mean LinkedIn is probably going to benefit from strong action in Facebook, but again, you always want to have your money in the leading stocks, not the secondary names. Yeah? (INAUDIBLE QUESTION) DR. K.: Which one? December? December 20, back here. Oh, in here. Yeah, you never touch that; I mean I’m not looking for anything in there, there’s too much volatility; I’m ignoring it. I’m waiting for it to round out, so it starts to round out here, gets constructive and then goes through the 50-day on pocket pivot volume. (INAUDIBLE QUESTION) DR. K.: Under what kind of numbers? Oh, yeah, sure. It’s like the Livermore technique. It’s one factor. I do pay attention to a stock that’s around the century mark, 100, 200, 300, and see how it trades, but again it’s just one tool of many. (INAUDIBLE QUESTION) DR. K.: Yeah, it could be an add point, sure. I mean if I’ve got a good cushion in the stock, and it busts through, goes right through say 200 with a strong volume, I might add a quarter position onto the overall size. It, of course, depends on how much I already own. (INAUDIBLE QUESTION) The reasoning is Facebook is, it’s done everything right in terms of expansion. It’s got 800 million users, and just the other day it seems it had 500 million, so it’s growing exponentially; it still has a huge market it hasn’t tapped, and it is by far, bar none the largest social networking site in the world. It is adding on apps almost, it seems like, on a daily rate, or functionality of the website. It essentially wants to monopolize the whole Internet, so in other words you get all your ads on there. Imagine all the business transactions on there; you can get to know people on there, way ahead of LinkedIn. LinkedIn to me; I do use LinkedIn, it’s a site for having a profile up, but Facebook is something that is so interactive that the average person spends a number of hours a day just having Facebook up; I mean I always have it up because it’s a chat service too, you’re connected to so many people and when someone wants to get a hold of you, you’ll hear that specific sound, that tone that comes from your computer. They’re doing everything right to make sure that the average


person is going to want to use Facebook at least an hour a day, and LinkedIn doesn’t have that power, in fact I don’t know of any social networking site that does have that kind of staying power. (INAUDIBLE QUESTION) DR. K.: Those are very good questions. GIL: I think you’ll be able to tell once it comes public and starts trading, and you can see the price volume action because that’ll tell you everything you need to know. DR. K.: Right. There’s a lot of conjecture about their ad revenues. I’ve got to tell you, Google is ahead of Facebook; they were the first mover advantage in terms of ad revenues, and in terms of advertising, and they’re still the juggernaut on the web. Facebook, I’ve used their advertising for various things; it’s a weak sister, and the question is, are they going to be able to catch up. That’s a big if. Google is still a giant, ahead of Facebook in certain forms, but in terms of the social aspect, Facebook is absolutely number one. So, I am curious to see how the pricing falling plays out after the IPO. GIL: Excellent, let’s go to the next one. So, we’ll start actually here. You know what’s interesting is that this thing was moving up long before the market had turned in December, and it started moving, it started to move, when would you say it started to move? Here? DR. K: Yeah, it’s been pretty sloppy. GIL: So, going from here you actually, is this a viable gap up? The problem is it occurs during a market correction, and you haven’t run the bottom. So, would you buy that during the market correction? DR. K: You mean on this day? GIL.: On the viable gap up, yeah. DR. K: Yeah, it’s reasonable. It’s reasonable enough. You have the correction in here, and you have a lot of choppy action in the market, and here’s the thing. You know that the market has been choppy, trendless, the whole year has been very tough, and so if I were to have bought it on that day, I would probably just buying a half position just because the market environment has been volatile and challenging, so if I did buy on that day, that clearly doesn’t violate the 1% to 2% porosity, so I would be just sitting on that half position, and let’s see where it goes from here. GIL.: I remember at this time I saw this gap up, and when I looked at it here you have this gap up here, and it just failed. I thought in a good market you can’t sustain a move here, and in a bad market, this doesn’t have a chance, but unfortunately in reality it did and held up in a continued ____…. DR. K: The general market just failed here, so that just brought all these stocks down with it. So, this actually, I look at this context as that’s a plus because you had a gap up there, that just got dragged down with the rest of the market, so I don’t really look at that as a whole negative. I look at just the whole pattern in general, and I really weigh that in. If it didn’t have that gap up there and it just was a very sloppy pattern, I might just shy away from that gap up altogether, but because of that prior gap up, that gap up has more weight, I’d do only half a position because of the sloppiness of this pattern. As you can see here, it violates the ten day within seven weeks. So, then I would switch to the 50-day moving average, and a lot of time has gone by, so by the time the 50-day moving average is violated, it’s probably going to be somewhere near my price point where I bought it. So, on a risk level, I’m not really giving back much on the trade. So, as we go forward, you can see here that indeed it holds the 50 day. It looks like there is a, yeah, that’s a pocket pivot there. Actually both of those days look like pocket pivots, but it’s pretty sloppy in there. It goes almost down to the 50 day there. So, I bought here. I don’t know if I would be adding to my position there. I’d be a little gun shy, because this is pretty sloppy. Then it looks like it has a pocket pivot up there, but that’s extended. So, basically I’d be sitting on my half position all the way through this whole move here just because simply it’s just not that constructive. The market hadn’t been


constructive all year, it’s been sideways, trendless, and volatile, so in a year like 2011, I’m more than happy that I got a half position in a stock that is now showing me a profit. Anyway, if you go forward from here, that’s nice. You have a gap down. So, you bought here, you have a half position here, and at the open. I don’t wait. When a stock gaps down, I’m out at the open, at the opening bell. So, in this case it looks like it opened right there. So, in this case buying there and selling there, the trade would almost break even, maybe 1% or 2% gain on the trade. GIL.: This is actually, you could have bought back on this breakout, couldn’t you? DR. K: Well, it had a gap down, so I would be really gun-shy to buy it there because of that gap down. That makes 2012 very tricky. 2012 and 2011 have been the trickiest years I’ve seen in over 20 years of trading, but also in the history of the NASDAQ. If you go back to 1971, because of the patterns, gap up, gap down, news driven markets that don’t go anywhere, and then you have patterns like this where you have a gap down and you don’t want to buying a stock right after it gaps down, and then yet it works. It’s like the market is designed to fool the maximum number of people this year than it’s ever fooled before. That’s what it feels like. We’ve had a lot of comments actually of people who are just very frustrated with the market environment and when someone says, “You know, I’m going to take a break, I’m going to take a vacation, selling may go away. I’m going to be back in a few months.” I tell them, “You know, that’s probably pretty wise.” I’m not going to say other. You know, if you want to take a break in this environment, there’s nothing wrong with that. Livermore used to talk about waiting for the window of opportunity, and the window of opportunity does not seem like it’s open at this time, but I always tell them keep a foothold in the market, because things can turn from bad to worse to excellent in a heartbeat. The year 1999 is a great example where the second and third quarter was very rocky, unprecedentedly rocky for the NASDAQ, and we all remember at O’Neill we all had fairly large drawdowns by October of 1999 from our peak, and October 15 that everything righted itself. Literally in a week everything righted itself and we found ourselves on full margin within days of that buy point in mid-October. GIL: Actually I think it was on October 25, 2012, you had a follow through, and actually three days before that Bill told me that the market is through. It was so bad and so ugly. I have it in my diary where he calls me up and says, “This market is through, it’s done, it’s cooked.” He was just really disgusted with the whole thing. DR. K.: We were all feeling the same way. GIL: Three days later we had a follow-through day, and we were all buying stocks, so you know, it goes to show that what he thought three days earlier doesn’t matter, and in that case Bill was all over that follow-through and we made a ton of money. Dr. K.: That last quarter was, I think, our most profitable quarter, and that first quarter in 1999 was also extremely profitable, which is how we did the returns we did, 500% plus in both accounts. GIL: Which just goes to show you just before a big bull market, there are no signs people are putting up telling you it’s about to happen. Nobody is ringing a bell. It generally happens when you least expect it, and it’s something to keep in mind in this environment where it almost seems like right now it’s very exasperating. DR. K.: Actually in a perverse way I like that because when the market is as challenging as it is this year, it doesn’t stay this way forever. There’s always light at the end of the tunnel, and that light comes sooner than I would have ever guessed. I would never have guessed the markets would have turned around as they did so fiercely in October of 1999. Also, in 1998, October, after that big Long-Term capital management induced bear market, October I remember a lot of colleagues were going short the market, and when the market just fell out of bed and had that mid-bar close off the low, everyone was mounting up on their short positions. GIL: What year was that? Dr. K.: 1998. October of 1998.


GIL: I remember that. DR. K.: Then my model had a buy signal three days after that point, and the strongest stocks were hitting new highs, and I remember being on full margin within about three days from that point much to the disbelief of so many investors who had been knocked around in 1998 and continued to be stubbornly short or more commonly just in cash. They didn’t believe that the market was just going to rocket to the upside and yet that last quarter of 1998 was also one of the most powerful quarters on record in the history of the NASDAQ. So, moving forward to today, we have this gap up here, and then it undercuts, violates, by more than 2%, so if you had bought it there, you’d be out. You bought it on the open. It looks like this trade would have probably cost you 4% of the trade or something, 4% or 5%, and then it goes back to the 50 day here, and there’s nothing to do with the stock. I’m watching this stock because it’s shown leadership qualities many times, but until it issues that bonified pocket pivot, there’s nothing to do or a viable gap up, one or the other. GIL: I would interject something here on this move here back here where you’re talking about this gap up. I remember this gap or gap down. I remember at first it looked pretty weak. What I notice is you close at peak and above the 50-day moving average, so I looked at this and saw this as a supporting day, and the fact that it was able to maintain the 50 day more or less and then move up and then break out, to me that was a new buy signal, and you could have come in viewing this as potentially supporting action because it did not fail or move below the low of that. That’s kind of how I interpret it. So, it shows you how two different people then come up with different conclusions, and if you recall, we actually did buy this in our fund. DR. K.: Right. GIL: I bought it when you weren’t looking. It may continue higher, but then it’s starting to fail, but it had some pocket pivots on the way up. I think there was one here, right here, right? This one is extended from the ten day. DR. K.: A lot of these are extended. GIL: Very subtle. Here is another one right here, but a little extended. You know, ISRG has been one of those persistent stocks, but again here’s a gap up that fails, and now the stock is looking like it’s ready to violate the 50-day moving average, but you know, even though it’s been a great stock to own since January and it’s been okay, you can see that, and he and I are debating this move here. It just kind of shows you how this market has been. It’s been very difficult. DR. K.: Also, I mean, I do have certain rules. I agree with Gil’s analysis of exactly it got a lot of support here on huge buying and closes at the top and then remains constructive after that point, but I have an overriding rule which says if the stock gapped down, and of course, why did it gap down, that’s obviously a factor as well. So, if it gaps down on a bad earnings report, that’s a big red flag for me, so my thinking is, you know, in the most normal markets, there’s a lot of other stocks to play, so I’m just going to ignore this one for the time being, wait for it to correct it as a defect, which usually takes a number of months for a gap down to be corrected. You know, the stock needs to really trade through and validate itself. So, I would just ignore this one, but in a year like 2012, there are so few stocks that are actually doing well. You’ve got Apple, you’ve got Priceline, you have some retailers, you have MNST. GIL: But this move here occurred when the market in Japan opened up. They improved by what I’ve got to say the equivalent of the Japanese FDA, or whatever, or Medicare, and to pay for those robotic procedures, so that opens up the market there. Dr. K: Right, and that’s actually, that’s where news is relevant. GIL.: There’s another factor to figure in, so you kind of see how you have to take the context of these moves as well, because their earnings, if ISRG was still just operating in the U.S. and European markets, and the earnings were poor and it gapped down, somebody knew something, that’s what I think, and on this day, that’s when they announced that the market in Japan was opening up, which was a significant opportunity, but it’s still tough, tough to play these. DR. K: Some new news. Material news to a company can also supersede a bad earnings report.


GIL.: You know which one I’m going to go through , I’m going to go through this one. (INAUDIBLE QUESTION) GIL: That’s fine, but when I say bad earnings report, I mean in general, the report was looked upon unfavorably by institutional investors. So, in that case, that would qualify as a bad earnings report. Bad guidance, that’s far worse actually than just missing earnings these days. (INAUDIBLE QUESTION) GIL: Is there a robotics surgery group? It’s Mason Medical Equipment, right? Which is a broad group. So I don’t know. What they do is kind of unique in terms of medical equipment, so you know. (INAUDIBLE QUESTION) GIL: No, it just trundles higher, yeah. (INAUDIBLE QUESTION) GIL: Right. (INAUDIBLE QUESTION) DR. K.: Right, fundamentals are the first, that’s half of the strategy. The stock has to measure up on a fundamental level, which ISRG does, but the technicals ultimately determine positioning and number of pyramid points and size because if a stock has enough pocket pivots and it keeps going higher, then I may find myself from a starting position of say 15% or 20% all the way up to sitting on a 50% or 60% position. So, technicals rule the day when it comes to position sizing and also when it comes to selling. DR. K.: What was the other one? People were asking about this one, do you like this one? GIL: SSYS. DR. K.: SSYS. I mean it’s not really much of a move here, because you have this big break here and it tries to come around, and then it runs up. It’s just kind of going nowhere. We can do this one, it’s not that exciting. Yeah, it’s pretty sloppy in here. GIL: Would you buy this one here. DR. K.: I’m not looking at it in here. It’s trying to come back around. It’s still a bit erratic, and then it looks like it’s got a buyable gap up on that day there, but you know what I don’t like, I really don’t like this action. I have a real problem. That’s a lot of volume. It’s a gap down. Then it’s pretty choppy in there, and then it has a buyable gap up there, but I would ignore it because it’s still, the price volume that preceded this buyable gap up to me is not constructive. Like I said, these gap downs usually need a number of months to say for stock to validate itself, a way to redeem itself after it’s done this kind of move, this huge downward move. So, to me it’s not enough time. The stock hasn’t put in enough time for me to get interested in this buyable gap up. So, I would ignore that. So, if we go forward from there. If we go forward a couple months say, now, okay, by this point, look, we’ve got, what, six months or five months since that huge drop, so this looks like a valid pocket pivot. Also the pattern got tight there as you noticed. It hit the 50 day, and then it goes through the 200 on volume. That’s a legitimate pocket pivot, so I would be a buyer there. Then it goes, let’s see, it violates the ten day, so then you’d switch to the 50-day moving average as your selling guide. It keeps violating the ten day, violating it, and then it violates 50 day, so you have to sell there. So, you bought there, you sold there, it looks to me like the trade at best was 2% or 3% profitable. Then there’s nothing to do with this because it’s still basing and it’s under the 50 day


here. It looks like the volume qualifies for the pocket pivot, but it’s still in the base, and it’s under the 50 day, so I wouldn’t be doing anything with it. Then it gaps up, it’s a buyable gap up. Yeah, you could argue that it’s a buyable gap up, so you could take maybe a position in that, and then you would be sitting and waiting. It’s violated the ten day, so then you switch to the 50 day. You bought it down in there, so use the 50 day as your selling guide. The 50 day, the slope of it is such that at worst this trade is probably going to closed out at break even and more likely, if the market gets strong and this is a legitimate stock, it will probably keep going higher. Then you could be looking at a reasonable profit. GIL: So, maybe that gives you an idea. In the new book we have some trading simulations that we do in great detail in the new book, and that’s something to look for, and we go through these examples day by day and just showing the decision-making process. You can even see that we’ll debate things. So, for any of you, things are not always black and white. You’re trying to operate within the range of these rules, and that’s really what you need to focus on, because you won’t always be right, but the rules definitely keep you in the game and keep you alive. Definitely. Anyway, I’m going to move. (INAUDIBLE QUESTION) DR. K.: Yeah. If the gap downs, even if they’re micro gap downs on volume, you know, I’m probably going to cut the position by at least 50%, and in terms of gap ups and pocket pivots that are constructive, I’ll pyramid the position if warranted. In MCP’s case, it was very aggressive to the upside, so I was aggressive in turn to add to my position. I wasn’t shy about mounting MCP, so at one point I think I had 50% or 60% of my portfolio in that. With an average cost, that was quite a bit lower than where it was trading. So, I had a good psychological cushion being in that stock at that percentage. (INAUDBILE QUESTION) DR. K.: Yeah, we could take a look at the chart, I could tell you, okay, I bought here, here, and here, and usually the average cost is somewhere between the first buy point and the last buy point, because I don’t want to be averaging if the stock hasn’t moved, so as it moves higher and higher, and as it offers new buy points, I’ll just add, add, and add. I never go top heavy. In other words, if I bought 20% first position, I’m not going to buy 30% for my second position generally. Of course, it’s not a hard and fast rule, but generally speaking as the stock goes higher, I might keep that 20% rhythm, or I might pyramid a little bit less each time because as the stock is going higher, that core percentage is also becoming a large percentage of my portfolio, especially if it’s a fast mover, and I don’t want to necessarily all of a sudden be so top heavy into stock. You know, all of a sudden the stock is 100% of my portfolio. Of course, Gil and Bill O’Neilll, I know guys that do that. They love that. They might hold two stocks in their whole portfolio at full margin, and that works really well for them. I like to break it down on a little bit. I like to have typically a few names, five, six, seven. In good market environments, I’ll typically have twelve to eighteen names because that gives me a lot of resolution in terms of being able to size in and size out of stronger versus weaker names. It gives me a little bit more resolution, if you know what I mean, as opposed to just doing three to four names. In years like 2011, or 2012, where there’s a lot of stocks that are failing and not really moving, or not trending, then in those cases it makes more sense to really mount a stock. If you have three stocks and all it takes is one of those stocks to do really well, providing you have size in that stock. So, sometimes you have to switch your strategies, and of course, in 2011 I wasn’t shy about, say, buying a 40% position, initial position in a stock with the intention that if this stock is going to work, I am probably own 80% of it when I’m finally selling it. GIL: I should point out that Chris’ technique where he has 12 to 18 names, that’s actually in direct contradiction to what O’Neilll teaches. He tells you even if you have $100,000, you want to have four stocks, right. For $1 million dollars, you might have six stocks, and he actually challenged you on that, and you actually proved to him that it’s possible to make big money with a broader portfolio, and you actually lower your risk profile because you’re a little bit more diversified. So, there’s more than one way to skin a cat, and in terms of the way we approach it, it’s a much broader approach to O’Neilll style investing than simply what is taught, I think….


DR. K.: A good thing about O’Neilll is that he’s flexible. So, I remember the day he came in and he said, “You know, your method works.” We would go back and forth through these debates, because he said, “Call me any time you want to talk about the markets. If you find something interesting, call me at 3 in the morning.” I love that spirit of his. In the late 1990s, there were companies doing well that had no earnings, and that’s completely anathema to the CAN SLIM model. I just said, “Look, there’s this, this, and this. There’s so much evidence.” At first he wouldn’t budge, but it only took him a few months to start to realize, yeah, okay, the model needs to be adjusted. I think all models always will go through adjustment phases no matter how good they are simply because markets do change in material ways. (INAUDIBLE QUESTION) DR. K: It’s contextual, completely, there are times where in more uncertain environments, I’m probably not going to have 12 to 18 names. In very powerful bull markets where I have 12 to 18 names, I’m not particularly shy about being top heavy in one sector simply because in a strong environment, I probably already have cushion. Lots of examples of let’s say the first quarter of 1998 I was up over 100% just that first quarter so I have all this cushion. I’m not shy about being top heavy in the Internets. That’s exactly why, every single stock I had going into, was it, I think April, was in Internet stock and I remember when the INX topped and reversed, when it reversed, it just reversed a knife through butter. It was brutal and I remember talking to Gil before the market opened and I said something’s wrong and within five minutes after the open, I gave a long laundry list because I had like 18 names to sell, sell, sell, sell, sell, and that saved me because I was able to keep most of my profits whereas other people who weren’t up nearly that much, they might be up maybe 20% by the end of that first quarter, that they got their heads handed to them if they didn’t act literally within, I’d say, the first few hours of that day and because what happened is the stocks got hit so hard that first day, it was hard for people to sell because now they were down. A lot of stocks got knocked down 12%, 15%, so what do they do? They think it’s going to come back the next day. Well it didn’t and the next three or four days, it just like, the hot knife through butter, just all these stocks got cratered, they got killed and that’s what made that year so tough is a lot of people just so early on in the year, a few months into the year, were sitting on huge losses as a result of that type of price action, and that also just taught me you always have to stay on top of the market and day to day even if you only can watch it 20 minutes a day, at least look at the open, look at the close, and that tells you what you need to know. GIL: Alright, next one, next, everybody ready for short selling? It’s the most exciting and glamorous part of the market. It’s also the most dangerous. I can tell you. I mean, I’ve made 100% in one month short selling, I’ve lost 30%, 40%, 50% in one month in some cases, but you have to be able to handle that sort of thing when you’re short selling otherwise you’re doing it in a smaller size, but I do think in a bear market, if you understand when to short sell and you’re picking on the right candidates, you also understand where you are in the market cycle. As we go through this, I can explain some of the mistakes that I’ve made learning how to short sell. I mean I first started short selling in 1998 and that was the year when I started running money for Bill O’Neilll. The first quarter I was up 45% on the long side and the market started to get wobbly and I started shorting and before I knew it, by October I was down 32%, so I’ve done a 70 something percent Endo as we called it but by the end of the year, I ended up 82% so I turned it all around. I remember Bill O’Neilll coming into my office at the end of the year and laughing and saying, you know, for a minute there, I didn’t think you were going to make it, but the fact that you were able to come back from that so strongly tells me you’ll make it as a trader, and I do think that’s always the case if you run into trouble, you have to enough confidence in yourself to come back and so if you’re the type of person who can handle some serious draw downs which can occur on the short side, then you have the psychology to short sell, but you do have to be able to sit through sometimes some pretty hairy price movement because stocks will tend to be more volatile on the upside when they’re in a down trend so in other words, the bounces are very sharp, but we’ll get into this again, the moving averages, so I basically over the years have developed what I call the golden rules of short selling and I began my foray into short selling by finding, when I first showed up at O’Neilll in 1997, the office they gave me, there was a bunch of stuff in the files, old stuff, and somebody who was there before had left all this stuff and I found a pamphlet on short selling that Bill had published in 1976. It was about, what 29 pages or something. It was very short. DR. K: Very thin volume,


GIL: And of course it was done during the 70s when it was a very difficult, choppy, sideways market, much like the 2000’s have been in many ways, and so I began studying it from that angle and of course, 98 as I just told you, there were some horrendous mistakes made. By the time I got into 2000, 2001, for that market, I had pretty much figured it out and I did very well in 2001. I was up 160 something percent that year on the short side and so I started getting it down, but then in 2009, I ran into some problems trying, shifting my whole mentality from trying to short things on a fundamental basis and one of my big mistakes on the short side was being short financials in 2009, in March of 2009 on the basis of my detailed studies of their 10ks and 10qs so my conclusion is that all the banks were insolvent and that they all had to go under and that the government would protect depositors by shoring up FDIC and letting the banks go under and the exact opposite happened. They let the depositors go down the toilet and they shored up the banksters as they’re now known, and of course, I was very stubborn about that and didn’t pay attention to technical signs, as well as the fact that by March of 2009, we were well into the latter stages of a bear market and so rule number one is that not only do you want to short only during clear bear market trends, but you also want to short as close to the beginning of the bear market trend as possible, and that also means you need to understand where you are in the phase of the bear market in terms of the down legs. How many down legs have you had? One, two, three, if it’s the first or second down leg, you’re probably in a good spot to make money on the short side. If you’re getting to the third or the fourth leg, which we were in March of 2009, then another technical fact that I overlooked because I was focusing too much on the fundamental situation and also the idea that the government would do the right thing by protecting depositors and letting banks go under as they should’ve, that was a very stupid assumption, but I think the main problem there was that by March of 2009, you were well into the latter stages of a bear market. It was becoming very obvious to everybody, so you always want to make sure you’re not coming in late and I think one way to do this is if you feel like you’re going to go short, start asking your other friends who are traders and if they all agree with you, you don’t want to short. DR. K: So, by that time, it’s just way too obvious. GIL: So you want to focus on the earlier parts of a bear market trend and obviously what goes up, must come down. You want to focus on the biggest upside leaders from the prior bull market, okay, so just as Apple say now has been a big leader in 2012 and if it has topped, if it begins to develop a topping formation that I can identify, it would become a candidate and just as Netflix and Green Mountain Coffee last year were outstanding short sale plays, and you know that those were beautiful plays. I know some of you have told me you played those, and those were discussed on our website. Those were former leaders that had broken down in head and shoulders tops and that’s what you want to go after, and the key thing to remember is that when you’re shorting, there isn’t usually a whole, 50 candidates to go after. There are usually two, three, four, five, key prior leaders that are really breaking down so let’s think about last year. Netflix and Green Mountain Coffee were probably two of the biggest short sale plays out there and other than that, there were not that many that were set up as well, so the key is to be patient and to wait for that exact technical setup in prior leaders as they start to break down because as institutions pile into a stock, they’re going to pile out once that stock and it’s story is over with and the fundamentals begin to deteriorate and they will do so before the fundamentals break down, so again, you can never short on the basis of fundamental analysis. It’s always based on technicals because the fundamentals will always look good at the top and probably always look worse at the bottom. The other thing is that you never want to be shorting stocks off of their peaks and that’s a general rule but there are some setups that I have found, such as late stage base failures where you can short reasonably close to the peak, but usually it is within three to four weeks. Usually they’ll take eight to 12 weeks off the peak before they start to break down and we’ll see that in some of the examples. Mainly, they need time to break down the bullish sentiment in a stock, so let’s take Apple as an example right now. Everybody’s convinced it’s going to 1000. Everybody still loves it and you’re rather early off the peak so you would expect it to have numerous rallies as people see the stock as being cheap once it gets down say into the mid to low 500s which is where it’s getting to now, so it’s still premature to be shorting that unless you’re using some other tricks that I’ve used to short it, which is basically the inverse of moving average violations, but that’s not something I tend to cover in this workshop. I’m basically going to cover the essential setups during a bear market. You also want to make sure that you’re trading stocks that are very liquid. I used to like a million shares a day. These days that’s fairly common now. I can see two, three million shares a day trading at least. The other thing is without fail, set tight stops on the upside of 3% to 5% just to keep yourself out of trouble. I found that I get into trouble when I let my stop


sort of slide or when I use a stop that is a little too big or I don’t keep it in control because they can get out of control very quickly. Secondly, or lastly rather, you want to set profit projections for your initial short sale positions and you basically want to take your profits when you have them because what happens is stocks will come down for several days, sometimes two or three or four weeks, and by the time you get down there, peoples start to panic and once you’ve sort of washed out all the sellers, the stock in prone to just lifting and when that happens, you can really get raked if you stay short too long so you definitely want to operate with clear upside stocks, 3% to 5%, and then on the downside, you want to be taking profits anywhere from 15% to 30% depending on what the market is giving you. So there are essentially three short sale setups and everybody knows about the head and shoulders. Anybody who hasn’t heard of a head and shoulders setup? Short sale setup? No, and then there’s the late-stage fail base, an LSFB, and this occurs when a breakout becomes too obvious and a late-stage base breakout will fail and a lof times you will have a very sharp breakdown from there so we’ll talk about that, and then there’s another pattern that I’ve done a lot of work on which is called a punch bowl of death, or a POD, not an iPod but just a pod, and it’s basically when you have a hot stock that runs up very sharply and then breaks down just as sharply and then runs up again just as sharply to form this big sort of V-shaped bowl or punch bowl and obviously punchbowl of death is what it becomes because it breaks down, so those are the three basic setups. The head and shoulders is probably your more reliable one. It’s much more rare that the late-stage fail base tends to occur more often. So let’s start, just some examples of a head and shoulders topping formation. The one thing you always want to keep in mind is that the head and shoulders is characterized by a huge volume price break off of the peak and you can see how Finisar just blows wide open off the peak. That becomes the right side of the head. So the whole thing is kind of tilting over. It’s got to tilt over and be, it’s very weak. In the book that I wrote with Bill O’Neilll, or I should say that I wrote for Bill O’Neilll, How to Make Money Selling Stock Short, there’s a diagram of what a setup looks like and it’s actually incorrect and going back and seeing that, we’re planning our next book, it’s going to be on short selling and I’m going to correct a lot of the errors in that book. The main one being that that diagram is incorrect. The right shoulder should always be lower than the left shoulder so that the whole thing looks like it’s tilting over, like it’s going to topple over, and your poster child type short sale setups when it comes to head and shoulders will almost always look like this and you can see Crocs in 2007, the same thing, and there you have the key identifying characteristic is that huge volume break off the peak that forms the right side of the head, and you can see how this works when this starts to set up, and you can’t short that break. Sometimes you actually can but you can see how, how does that happen? You might even say this here is a base, a late-stage base, and it’s also a late-stage base failure, so in some cases, a late-stage base failure is what forms the head and that failure creates the right side of the head and when I studied these, I thought to myself, you know, if I could somehow find a way to catch it here and play this initial move, that’d get me ahead of the game and I’ll get into that with the late-stage fail base setups. Now this illustrates the idea of ascending versus descending necklines and like I told you, you want to see the whole thing leaning over so you see Freeport McMoRan has an ascending neckline here and this one’s ascending here and this head and shoulders actually does break down. You actually could’ve played that but you had to be very nimble here and cover as it got down to these lows I guess and I actually did short and then I had to cover. I think I made a little bit of money but it didn’t really break down probably because you had an ascending neckline. What you want to see is more of a descending neckline like the second head and shoulders that it formed because finally when it breaks through that, that now is telling you that it’s getting much weaker and it breaks down very sharply, so that’s a key feature to watch for; ascending neckline, you don’t want to go for, although there are some that will work, but the descending neckline is really telling you when a stock is starting to weaken. Here’s Potash in 2008, you can actually, if you draw the neckline along the lows here, you can see that it’s a descending neckline, same concept. You can see Netflix in 2011. Here it is, the head and shoulders pattern, and you remember there was a lot of people on the way up telling you you had to short Netflix and it kept going higher. There was a guy, who’s that guy that was on CNBC and then you went on the radio to counter him? DR. K: Asenio. GIL: Yeah, DR. K: Asensio I think.


GIL: Non-sensio was his name? DR. K: Yeah, correct. GIL: And then there of course is Whitney Tilson who was trying to short it all the way up, but they were shorting it on the basis of fundamentals and we don’t short on the basis of fundamentals because stocks can go a lot further than you think and I think Whitney Tilson was way off base in trying to short a stock in a very clear and coherent uptrend because there’s really no breakdown. It’s not until it starts to break down in here that you begin to see the volume picking up on the downside and it starts to weaken, it breaks, it violates the 50-day moving average and breaks down through the 200-day moving average, and as it breaks down through the lows on through the descending neckline here, it gaps down and it breaks down very rapidly, so this is when it’s ripe. It’s definitely not ripe to short anywhere in here regardless of what you think about the fundamentals. Green Mountain Coffee, this was actually a left shoulder. You’ve got the head. Now, there’s one thing a little bit different about this and it’s subject to interpretation. I talked about you have to see a big break off the peak to define the right side of the head. In this case, you did have a pretty good volume pickup here relative to the pattern, but I think at this stage, you could start to see that Green Mountain was doing some things that it really hadn’t done before. You’re starting to see these big breaks, kind of loose, so you could see this as a late-stage kind of wide and loose base on the weekly chart and then it fails and this becomes your right shoulder. We actually recommended his to our subscribers right at the peak of the right shoulder here just before it broke down and then I think Michael Einhorn or David Einhorn came out and panned the stock and it blew to pieces. DR. K: Yeah, it went right up to the 50-day so it was an easy recommendation. GIL: Right, but see the thing is you could, what’s going on, here we go, you could argue that this was the left shoulder and then this whole thing here is the head because here’s the big break here and that this then was the next right shoulder and this is actually the proper head and shoulders. You could say that as well. This is going to drive me nuts if this keeps doing this, but you could say that. It just did it again, but I’ve got him figured out, so but it’s not really a right shoulder but you can see the pattern here and once it starts to break down here, it’s definitely shortable, but that’s the essence of the pattern. You can see it occurs in Green Mountain and in Netflix and those were big leading stocks during the prior bull phase. Now here’s Deckers so everybody, we talked about Deckers earlier in the workshop as a leading stock, but here you can see, here’s a big, what am I doing here, something’s going on here. Something went wrong. What happened? Okay, I see what’s going on now. Okay, Deckers, yeah now you can see how it has the two right shoulders and then it gaps down here and a lot of times, this is a daily chart so I’m giving you an idea of how these things play out on the daily, but when you start see a gap down coming off a right shoulder, a lot of times you can just hit that right there and it’s almost like the reverse of a buyable gap up. It becomes a shortable gap down so instead of a BGU it’s an SGD and so in that case, you could try and come after the stock right at that point. Let’s see if I’m getting this. Now let’s go to late-stage fail base top formation. This is now Qualcomm, if anybody remembers Qualcomm, it had a big climax top and then it formed this base and this was an improper wide and loose base structure and it breaks down here and actually becomes shortable on the breakdown, so there’s a late-stage fail base and a lot of times, these things will fail. It’s just like O’Neilll teaches you don’t want to be buying these at a late-stage when they’re wide and loose, and you can definitely see that’s much wider and looser relative to the rest of the pattern. Yahoo, same thing. Had a big run up and here’s sort of a cup base and it fails down very quickly, and this move here is what is shortable at this point and later on, it tries to become a head and shoulders type formation with some right shoulders, but this position here is shortable as it breaks down. Let’s see if I can keep this going the right way. Same thing with Oracle. I actually played Oracle in 1999. Did you ever play Oracle? You didn’t play that one, so, yeah, and it had a beautiful move and then here’s an improper base that’s kind of an ugly, wide, loose, double bottom with a handle and as it fails, it fails here and then notice how you have these little rallies up in the 10-week moving average of the blue line which is corresponding to the 50-day moving average on the daily chart, and then you get a couple little rallies up here and this is how they typically occur. If you can’t really identify this as a head and shoulders, you might say this is a head, this is a left shoulder and here’s a right shoulder here, but right at this point, it’s really just a late-stage base failure. Once that breakout fails and it drops below the 50-day or 10-week moving average, you get a couple of rallies back up in the line and you can try shorting it or put out the short position into the rally that occurs coming up into the 10-week moving average. Whoops, Travelzoo is a recent example from 2011. You can see here’s a double-bottom base and this is a weekly chart, so you break out here and you can see


once this thing breaks the 10-week moving average, now you’re coming after it on any bounce back up into the 10-week moving average, and this one came down pretty nicely from there. Riverbed Technology, another double-bottom base but you’ll notice here this is an improper double-bottom base because the second low is above the first low and for those of you who are familiar with the O’Neilll double-bottom base, the second low should undercut the first low for a proper double bottom, and of course this thing tries to break out here and once it fails, it’s just gone and it breaks down very quickly. Research in Motion: Now this is what I’m talking about. Sometimes a pattern can sort of be a combination of two patterns and I shorted this one two different ways. I looked at this as sort of a big cup, almost like a big pod, and here’s the little left shoulder here. I put these little dotted lines in kind of faint to they don’t overpower the chart, but you can see here’s the left shoulder. This could be a little head. I call it a pinhead, and then a right shoulder here but really what it is, here’s a cup with a handle so it’d kind of a late-stage formation and it fails and once it starts to break down here, you can come after the stock here and it breaks down very nicely. SunPower in 2007, nice move during that year, and then when it broke down, it finally formed this little improper cup with a handle and it reversed very quickly off the breakout and so you could’ve come after it just as it’s popping through the 10-week moving average and it broke down very quickly. I noticed that late-stage base failures can be your fastest downside movers and produce big profits very quickly. It’s this sort of pattern that I tend to key on in the earlier stages of a bear market and it’s this type of pattern also that enables me often to have a, you know what I’m talking about, that 100% in one month type of performance hitting a couple of these on this type of a move because this is a massive break within a month. (INAUDIBLE QUESTION) GIL: Well, you’ll notice that this right now, it could be. I don’t know for sure but I’m looking for another leg down so if we’re starting another leg down, I’m looking for patterns right now that are setting up and mostly what I see right now are late-stage base failures. So you can even see, look at SunPower. Where does it fail? The failure appears in January of 2008 and if you go look at a chart of the NASDAQ at that time, the NASDAQ was actually starting its second leg down in the bear market. Punch bowl of death formation: I love this graphic. It looks like something I had in college. But I first noticed the pattern. Actually the first time I noticed the patter was in Sintex, looking at an old Sintex chart. It had formed, had a big run and then it formed this big giant bowl and it basically comes straight up the right side. You see how that happens? And I think a lot of that occurs because people saw this other move and then they’re trying to catch this one. It’s a laggard because at this period in the end of 99, a lot of Internet stocks were running and a lot of these, Schwab I consider an Internet stock so I consider a latecomer and it’s trying to come back and the market’s topping right in here in March and so it comes up and goes straight up, sort of like a dog is barking now and then it blows to pieces, and in three weeks, you have a pretty nice gain, and you’ll notice here it forms another cup with another handle and when it breaks down here, it takes a little bit longer, but you’re able to put out positions up into the 10-week moving average and you can start to see this becomes a resistance level right here and it breaks down from there, but this really is the pod that you make the big move on and this is what you’re looking for, where it has a big move and then finally shoots up to the upside, gets very near the highs, and as it starts to break down, that’s where you can come after it. Usually I’m looking at a 20-day moving average break, somewhere up here in this sort of formation. America Online, same situation. Straight up and then it comes down and then almost straight back up and a lot of that is because people see a former leader as cheap and, of course, it’s really kind of a laggard but it tries to move with the Internet group at the end of 99 and notice how it actually tops out before the market tops in March, but that’s a classic pattern. In this case, you could’ve used the 10-week moving average as your guide as to when to time your short sale as it starts to break down, but generally what they’ll do is they’ll come down through this 10-week moving average and they’ll spend a couple three weeks kind of flittering or fluttering on either side of the moving average before they really start to break down, so you kind of have to be laying your position out and being a little bit patient, waiting for it to come off. Amazon was another one. Now this type of pod, you see this is a very narrow one and it only lasts, one, two, three, four, five, six to the low, and then one, two, three, four, five, six, seven, eight, nine to the peak so it is 15 weeks long and I’ve noticed that when you get this type of pattern, the shorter it is, the better because they’ll break down very, very sharply, and usually the 50-day moving average is too low, the 10-week moving average is too low, so you’re looking at the 20-day moving average on a daily chart, which is usually where it will start to break down, but what happens is you could probably identify this as a cup with handle on the daily chart. Once that breakout fails, this


thing will come down very rapidly, but you’re basically looking for this really ugly, very loose, very wide in terms of the weekly ranges, sort of almost V-shaped big cup or big bowl, and you notice this one’s longer and it takes longer to break down, but when this is so sharp back to the upside, the breakdown tends to be very quick. Taser’s a good example. You have sort of like multiple pods in here. Here’s one and then it forms this big one and then this is a little easier to handle because if the 10-week moving average is pretty close to where it breaks down, but you can see the breakdown here is very rapid and one thing to notice is watch how as it comes up the right side, watch where the volume comes in, or rather doesn’t come in in this case, because you’ll see very, very weak volume on the breakout attempt and that’s telling you that it’s probably exhausted all the buying interest because basically what you have here, these are late buyers. They saw this, they missed this, and now they think this action here now is their second chance and it starts to move and it sucks more and more of them in, but the institutions aren’t playing along with them and it just collapses and fails. (INAUDIBLE QUESTION) GIL: This one here or here or here? Here? You might have been stopped out but it also could be contextual to the market because if you recall in October, November, the market in 2004 was in an uptrend and so the market didn’t really start to break down until January and you start to have a little… DR. K: Didn’t we have a minor correction in early 2005? Yeah, that’s right, I mean, the end of the year was strong for 2004, you wouldn’t want to… GIL: Yeah, I’m going to get that part because the other part is you’re looking at these patterns but you’re also watching the market and the market will tell you when these things are likely to break down because the market itself will start to weaken and so it’s always contextual to the general market and that’s another thing to keep in mind. Here’s DryShips which work pretty well. I don’t have this continuing but the stock did go all the way down to like $6 from here and you know what’s really interesting is this chart of DryShips looks exactly like Reading Railroad in 1907. Believe they’re on the same kind of pattern. Rapid move up and then it had this little kind of weird double bottom and straight back up and I was actually shorting DryShips as it broke the 20-day moving average and as it broke the 20-day moving average on the daily chart, it found resistance on ensuing rallies on the daily chart during this week and then it really blew apart and then once the bear market really took hold, it really got blasted, but that’s still the essential idea. The essential idea is a huge move so that’s something that really wows everybody and then it just blows to pieces and now it starts to move again and as people remember this, it’s imprinted in their memories and they start to see this go again, it sucks people in but the institutions really aren’t participating this time and they use the rally then to unload the rest of their positions. TBS International, that’s another perfect one, but you can get a sense of the duration. Like I said, the shorter the duration, the better. In this case you’re going one, two, three, four, five, six, seven, eight, nine, 10, 11, 12, to the bottom and one, two, three, four, five, six, seven, eight, nine, 10, 11, 12, 13, 14, 15, 16, 17 to the top. How many is that altogether? DR. K: 30, 29 weeks, 39 weeks, probably 29 weeks. GIL: Yeah, so I’ve found that the best period is generally 28 to 30 weeks or less so the more narrow they are, the better they tend to work. And again, you’ll see these things break down. If you go around now and you look at charts, you can see some patterns like that. Let’s see, where am I? LDK Solar, this is a great one. I actually played this one back then because it had, look at this, this one is only, I guess he goes one, two, three, four, five, six, seven, eight, nine, and then only three weeks, two weeks, two to three weeks to come up the right side. That is not a sustainable move, so whenever you see this, big move up, breakdown, and then it’s all the way back to the highs, I’d love to play that on the long side if I had a way to do that, but it’s just too ugly, but that can’t be sustained. There’s no way that this things going to shoot up on a weekly pattern and just run from the mid-20s up through 75, 80, and so once you start to weaken in here, even start sort of an exhaustion gap in here, I don’t know what that looks like on a daily, but once it starts to break down, you can really come after it and you can even see how once it breaks the 10-week here, you could’ve come after this, but it’s definitely a pattern that you’ll see and it will work. (INAUDIBLE QUESTION)


GIL: Yeah, that’s when all the solars came out in 2007, and some of them topped spectacular. I think the only one that really hung in there and continue to do well into 2008, was First Solar and that was really the big leader. DR. K: That was the leader. GIL: Among the whole group so these all were secondary stocks but just look at that pattern and you’ll see that. If you ever see that and as it reaches the peak on the left side, start looking for clues on the daily chart if it’s starting to break down and that might be a break below the 20-day moving average so I’ll use the 20-day moving average on these when I’m shorting a pod and looking for our break below because then I can use the 20-day moving average as my guide on the upside to get me out, but it’s a little bit tricky, but when you catch them, it’s big money very quickly. (INAUDIBLE QUESTION) GIL: Who drove it? Probably just retail buyers which makes it even more shortable because there’s nobody backing that. DR. K: No institutional behind that. GIL: There’s nobody behind it so you’re only need to get a couple of suckers and a few brokers calling their clients to buy it. DR. K: It was pretty thin, too, so it could’ve been retail money. GIL: Yeah, I always like it when we get a call or an email from someone that says, oh, I bought this $3 stock and it’s at $5 now and it trades 12,000 shares a day. What should I do? It’s like sell it, it’s like you and five other people are buying it and you probably all have the same broker because brokers will be on… (INAUDIBLE QUESTION) GIL: On this one? It actually traded a fair amount of volume so if you look at this on the weekly chart, the average is 11.83 million shares so on a daily basis, that’s for one week, and so on a daily basis, that’s over a million shares, so it qualified at the time, but if it didn’t, then you wouldn’t want to play. VeriSign in 2000, another big ugly formation, but you can see how these pods are just big, ugly, late-stage, either cups with handles or big ugly double bottoms but I just kind of made up the term pod because it kind of encompasses all of them, but they’re just these big, bowl-like things that then start to fail, and you can actually see here that you’re starting to fail here so you could’ve gotten stopped out here, but eventually you catch this move and it’s very profitable. Broadcom, interestingly Broadcom in a big breakdown and this took a while to break down but you also might notice this is a little bit head and shoulders like here and the handle, this is a cup with a handle, but if you’re looking at this pattern and you see this cup with handle, are you going to buy that cup with handle? No. It’s so ugly, it’s so wide and loose, but once it starts to let go and break, it comes down very sharply and what’s interesting on this is that first Solar was similar in that you have this ugly cup with handle. The handle is like really ugly and it’s very wide and loose. First Solar was less so but it started to, it did the same thing, sort of an improper cup with handle. The handle’s low and so it runs up very quickly. It takes some time to break down because it was a big leader and it did have a lot of institutional ownership but once it broke down, in this case, once it broke down through the 200-day moving average, you have a couple of rallies up into it and then it just blew to pieces. In July of 2008, I was at the IBD Meet up in New York, big meeting, it was like 150 people, I don’t know how many was that, Frank? You remember. I was there and I was speaking and I was talking about short sales, First Solar, what’s that? (INAUDIBLE QUESTION) GIL: Yeah, they had a big group and they were in the Microsoft building, but I talked about First Solar and that was in July of 2008 so it’s actually up in here and I pointed out how it looked like Broadcom to me and that it probably was going to top here and a couple three months later I get an email from a guy and he says, Mr. Morales, I saw you present in New


York and I saw your presentation on First Solar as a short sale so I went and bought $40,000 worth of 300 puts and now they’re worth $1.44 million, and he said what do I do? He owes me a house. He owes me a house. But you know what’s even lamer is I never even played the thing. I was, it was my idea, I never even did it so but that just goes to show that while we can put out ideas on our websites and what not, we don’t end up using a lot of them and sometimes some of the best ones somebody emails me with their success story, but this guy took $40,000, it’s $1.44 million, and he says what do I do? Well, what do you mean what do you do? He said I don’t want to pay the taxes, and so I said to him, just gift me your gain and I’ll pay the taxes for you and you won’t have to worry about it, but you’re right, I should get that guy back on his, send him an email and say, you know, by the way, you owe me a house, or at least a small, some sort of yacht or something. Actually maybe some jet fuel, I could use that. Okay, what happened? We got lost. Aw, now we getting to the nitty gritty. Short selling mechanics: And these aren’t guys who wear blue overalls. They’re the mechanics of short selling and really the nitty gritty is on the daily chart. I can show you weekly charts all day long and you can nod and okay you get it, but really when you get down to the nitty gritty, it’s all about daily charts, and I thought one of the flaws in the book that I wrote with Bill O’Neilll, How to Make Money Selling Stock Short is that there are no daily charts in that book, and a lot of the gap downs that look like nice, straight moves down on the weekly chart, really on the daily chart were big gap downs, and they never traded in the range that the weekly chart will show, so the daily charts are really where it’s at but you can see, let’s just take the period, we’re going to take the NASDAQ during 2007 through 2008 and this was the brutal bear market during that period, and the market actually topped in October of 2007 and so you had one leg down off the peak and I would consider this to be a minor leg. This is where it starts to break, and so what I think what you’re looking at right now, assuming that’s happening, you’re probably in this stage here and you may then have a rolling period and then maybe if it does extend into a real bear market, this then is your real first big down leg. You may find some short sale opportunities in this area here, Crocs actually was one that started to break down, but I think Crocs, did it break down in October? No, it actually topped in October because a lot of guys at O’Neilll had that stock. They got creamed. There’s that earnings report where it broke down really hard and then it finally broke down from a head and shoulders at this point, and then at this stage of the bear market, you started to see head and shoulders formations forming in stocks like Mosaic, Potash, a lot of the stuff stocks, so we’ll see how that works. See, here’s Crocs breaking down and you can see how the head and the late-stage base failure really here because this is a short little flat base here and it breaks down so the head coincides with the market here, and notice how the market almost is forming a little head. Here’s a right shoulder and here’s a little head here, and so Crocs forms it’s head, or the right side of its head, in synchrony with the market as the market’s peaking, so right now, I think that’s the stage you’re probably in, if you are going into a bear market. So what you’re going to start to see initially, your first setups will be late-stage base failures, but they could develop into head and shoulders over the next several months, and that’s what happened with Crocs. The right side of the head forms here just after the beginning of November so you can see that corresponding here, and then it rolls sideways for a couple of months, just like the market, and when the market breaks here, now it breaks from the right shoulder here and it starts to break down in earnest, so, I do remember my son at the time, I think he was like 6 and telling me to short Crocs because all the kids at school were not into them or something because at the time, they had those little like buttons that you could stick in them, what were those called? I forget. Yeah, Jibbitz, or yeah, and so he told me the kids are not into it anymore, dad, just short it, and he saw the pattern too. He’s the only 6-year-old who knows what a head and shoulder is, but when my kids were babies, I used to go through chart books and they’d sit in my lap and I’d show them the charts and talk to them about them, so they’re ready to tell me to buy the Market, Smith. (INAUDIBLE QUESTION) GIL: Sometimes. I mean, people have asked us, yeah, if there’s anything such as an inverted pocket pivot but I don’t think you really need to operate on that basis, but yeah, there is some, you do have that action occur where it starts out, it’s not really a huge volume break but it starts to break in area of support with sort of an inverted pocket pivot or reverse pocket pivot, is that what you’re talking, yeah, I’ve noticed that, and if you find you can use those, then go for it. I think any tool that you get comfortable with and you find you can use on the short side is definitely going to help, but what I’m trying to point out here is how these things break down so Crocs is really your first stage short sale candidate, and as the bear market progressed throughout the summer or into the spring, actually, of 2008, it just continued going lower, so you’re able to play it all through this period and you notice the breakdown here. This leg down coincides with the


breakdown here and sets it off. Now, as we, now here’s the daily chart, okay, so you can actually see how the break, this occurred on earnings; you have this gap down. Now, you could consider this a late-stage base failure and now these days I use what I call the shortable gap down or SGD is something that I’m looking at now but I notice that here this thing gaps and you could’ve just shorted it right there and you could’ve made money on that. It’s something we need to probably test more. DR. K: Shortable gap downs versus buyable gap ups. GIL: Yeah, and I think but a lot of the principles do hold up both ways in an inverted sort of way, but you can see here though the right shoulder, you’re trying to rally above the 200-day moving average here and now notice, one thing to keep an eye on, too, is this black cross. When the 50-day moving average drops below the 200-day, and I’ve noticed in a head and shoulders formation, somewhere along in the right shoulders, you’ll see this occur and a lot of times that occurs coincident or slightly before the breakdown. You see that that happens right here, it crosses and then boom, it goes, but I think in this case, you could’ve been shorting Crocs on this really weak rally up in the 200-day moving average and it goes just a little bit beyond so you always have to add 2% or 3%, 3% to 5% above that if you’re shorting into the 200-day moving average to make sure you’re not stopped out too quickly, but sometimes it just slides just past, sometimes they go right up to it, sometimes it’ll just roll over but there are several spots to short it here and then here you get this rally, which is a declining volume rally, a wedging rally, and it just kind of rolls over from here and I think my son was telling me to short it right about in here and then of course, it gapped down. Now here’s a gap down off of a right shoulder and notice here is the shortable gap down phenomenon that we’re talking about where it does gap down on huge volume. You could’ve shorted there, used the high of this day, the intraday high of this day, as your stop and you could’ve continued to play it to the down side. Here’s DryShips. Now, remember we’re going back here and we see this leg down occurs here, but notice that as the market’s rallying back up in here, this is where DryShips is also trying to rally back and it’s trying to come back but it’s forming a pod and then it breaks down in here and this actually coincides with the market breaking down here, so you can see as the market starts to roll over, there are certain stocks that are sort of mimicking the market and those are the ones that you want to go after, and we’ll get, as we continue through here, then you’ll see the next wave of stocks like Mosaic was, it’s not in here, but you see Mosaic blows up around here and you can go look at those charts on your own, MOS, AGU, CF, HOT, FCX, the steels and the metals, X, US Steel all blew apart on this leg down and they had all formed head and shoulders and were blowing down through their right shoulders at the same time, so you always want to see what stocks are forming bearish formations that look similar to what the market’s doing and so they’ll be in the position to break down as the market goes on a down leg, and usually the first three are your most profitable down legs. Why does this keep doing this? There’s a gremlin in this computer. Here’s DryShips. Remember I was talking about this and how, you can see the green 200-day moving average. The way I handled this one and if anybody reads Gilmore Reports, pretty well documented in there when I was telling people how to handle this, you break down through the 20-day moving average and so this thing has started to reverse. Look at the mass of volume off the peak for two days. So right there, that’s telling you this thing is done, so once it drops below the 20-day moving average, rallies back up into it, now I figure I’ve got a reference on the upside to use as a stop so that’s what I’m talking about when I say sometimes these pods, once they break below the 20-day moving average, that’s what you can use as your upside guide on a rally back up into that moving average, and also using that as your stop roughly. Now let’s look at NASDAQ deposit index 2011 and this is August of 2011, and a huge break. This is just last year and you can sort of see here, let’s see, what am I doing here, you can see how this market in this environment, you actually had a breakdown here and so this breakdown you’ve got this head and shoulders, but this head formed here and then it took about three more months to form out the right shoulder. Now notice the right shoulder’s on May 11 coincides with the breakdown here in the market here, now in this case, you’re not really in a bear market but you are in a sort of a choppy sort of corrective phase here and so there are stocks setting up and as the market rolls over starting in May, 2011, you can see how that is precisely Finisar rolls off the peak of its right shoulder and break downs so there is some synchrony in the market. I’m just showing this to contrast with an absolute bear market versus a market that’s weakening and starting to top and some stocks are starting to break down in synchrony with the down waves in the market as it’s starting to build what is really a big rolling top, and then we can see how, well, let’s look at the daily trading. You can see how this one works. This is pretty easy actually. I think we pegged this one, too, because it came right into the 50-day moving average, you could’ve been shorting it here and catch this rollover, so you can see how here’s the left shoulder,


here’s the right shoulder, here’s the head, and again, sort of a shortable gap down and it continues to lower but you might’ve gotten stopped out here, but this one’s probably too far down to short. I would say we’re going to have to do some more work on this and figure out what’s an optimal gap down when they become too excessive, but the rally back up after this gap down is kind of weak in here and you’ll notice, especially right in this area, right in early May, you see the wedging action? You see how the volume is really drawing up right into the 50-day? You could’ve come after right here and that coincides with the market coming down on this leg here. Netflix breaks down and when does it really start to break down? Well, when the market starts to break down in this period and go into a very deep correction and as this correction’s working itself out, Netflix is breaking down in September, so here is August when the market started to break and it starts to break down in here and the gap down is where you’re coming after it. Here’s the breakdown through the neckline on the daily chart. Again, there’s a shortable gap down. You could’ve shorted here, in fact, we told our subscribers to short it using the high of the day as your stop, and that thing just blew apart. So and you can see how this started to break down in August in earnest but once you got the gap down in September, you could’ve come after that, but you are in a weak market at that period, so. What’ll be interesting to see is how this one pans out, assuming that it does. Here’s F5 networks in 2011. This is kind of a left shoulder and here’s a pinhead and again it rolls over again, but notice how this one takes a long time and you’ve got several right shoulders and finally it starts to break down just before August when the general market starts to break down. So again, you’re probably trying to time this in conjunction with the market breaking down and at this point, it becomes very weak and gets dragged in with the market very quickly, and here again, here’s your head and shoulders and this really is the first time we’re ever talking about this shortable gap down but you can see once you’ve formed the head and shoulders, you have several right shoulders and you get a gap down break from a right shoulder like that on huge volume. Again, you short it using the peak of this day as your stop and there’s, well a lot of examples where this works. We’re going to have to do some work here to get the statistics down so we can figure out what the optimal parameters are but you guys can see it’s evident here that this can work and this is what I would be watching for and I think it’s a very potent short sale tool which we used in Netflix last year. Aruba Networks is a recent short. I know I was talking to Andrew over there. We were talking about Aruba so he had some great charts showing how he handled it and it was a really nice seeing a head and shoulders. Again, look at the right side of the head is defined by this massive volume break, which also is a late-stage base failure as well, so you can kind of see how this breakout fails and once it gets below the 50-day moving average, you could treat it as a V-shaped base that fails here and once it gets below the 50-day or 10-week moving average, you could actually try shorting it in here and you might be able to catch this break, but if you didn’t, now when it has its break, that’s the right side of the head and now it’s telling you this stock is weak, it should be monitored for rallies as it forms a right shoulder and sure enough, what do you notice here? See the 10-week moving average, the 50-day, and the 200-day, 40-week moving average, the red line, you get the black cross and right there it happens there and that’s when the stock starts to break down from the right shoulder. Yes sir. (INAUDIBLE QUESTION) GIL: I’m sorry, what? (INAUDIBLE QUESTION) GIL: Right there? Here? Where is there another gap down? This one? That’s off the peak, yeah I don’t think you would’ve been able to short that one. That’s probably too soon. What we notice is the gap downs after the stock has been able to form one or two or three right shoulders, that’s who you’re coming after. Now, I’m going to show you something here. Look at Aruba Networks. When it breaks down here? Notice something here. Where does that start? It starts here and see here’s a gap down coming off a right shoulder where it breaks down and you get huge volume on that. It’s a double average and you could use the high of that as your stop and notice that the 50-day moving average is coming down, you could’ve used that, too, as your guide, and you give a little cross sitting in there, but again, that’s almost like a shortable gap down right there, but you can see the left shoulder here, the head, here’s the head, and there’s the big volume that declined on the weekly chart here and if I’m confusing you by flipping back and forth too fast, let me know, but you can see how that works, and once it starts to break down in this gap down, now it’s really coming down and that’s a nice profit and 20%, if you can get 20% to 30% profit on a short sale position, you should definitely take


it. Travelzoo, similar situation. We already showed this one but look at how that broke down really nicely on the breakout failure, but here again, on a breakout failure, the gap down, you could’ve shorted on the gap down and used the high of the day as your stop, so on this case though, it’s a late-stage base failure so I would probably be using the high there as a stop, and in this case, I don’t think I would use the 50-day moving average because it’s a little bit too high there, but you see how when it’s on massive volume like that, they generally don’t look back and you’ve seen as several stocks recently started to do that, RAX recently broke down hard on a gap down off its peak price. Again, here’s Green Mountain Coffee Roasters and whoops, what happened, you notice here, here’s your left shoulder, head, right shoulders and here’s the gap down and that was actually a shortable gap down. Amazing. 2010 summer correction. I bring this up because it was in May of 2010 that I was able to make about 100% on the short side and I just wanted to point out how this was done. It was mainly done in US Steel and I think that US Steel’s a great example of a QE market because this was the bottom of the QE market and look at these bases; V-shaped, V-shaped, are you ever going to buy any of these things? But it continues to break out and then V-shaped and break out again. Finally you got to this one and as the market was starting to roll over, it failed right here as sort of a late-stage failure because you’ve got one, two, and this is like a third V-shaped cup base. I mean how many of these are going to work in a row because this is kind of a bizarre pattern don’t you think so? DR. K: Well, they’re just non-constructive entirely. GIL: Finally I like that downside reversal there off the peak. Like I was saying before, sometimes those are shortable. You can short into seeming strength. The stock hit a relatively new high but then it closed on the low and that is a sometimes shortable pattern. DR. K: Right. GIL: And here’s basically how I handled this one and this is where I shorted it so it broke down, it failed on the breakout, so it breaks the 50-day moving average and you get a weak, low volume rally, here’s the low volume down here, right up into the 50-day moving average and I started shorting it there. It broke down. I actually covered off the 200-day moving average and so here’s what I’m talking about. If you’re shorting here, it’s around $60 and it breaks down to around $50, you’re getting close to 15%, 20%, well, almost 20%, but it’s coming to the 200-day moving average so if you short it here, you know that there’s likely to be logical bounce so when I’m talking about setting profit objectives, you can use a percentage or you can look at the chart and figure out where it’s like to move down to and then bounce off of and in this case, I played this perfectly because I shorted it here, big position, and it hit the 200-day, I covered it and then it bounced up and then on this day, Goldman Sachs came out with a buy recommendation and the stock gapped up and I thought if Goldman’s putting out a buy recommendation, they’re probably doing it to help one of their clients get out of the position so I decided to come after it again very heavy and it broke down very sharply and if you get, whoops, what happened? There’s a gremlin. Whoops, whoops, nope, give me a second, okay. Yeah, you can see how this breakdown, but if you get, and I play huge positions. I’ll go 40%, 50%, sometimes 100% to 150% short and when you get a 20% or 30% breakdown in a stock, you’re making 40%, 50% so you do have to hit them at the right time but you can kind of see how the mechanics work and definitely if you get a stock that’s breaking down and for all practical purposes is technically very weak and some broker comes out and recommends it, it’s a buy based on valuation or that it’s cheap or something like that, and it gaps up or something, you can usually short into that if the pattern is weak and you’re coming up into an area of resistance so you can see here the lows along here. Now once it breaks below these lows, these become resistance and so this move up, I looked at this and I said, okay, I could wait for it to get to the 50-day, which it could, okay, or I could come after it here initially and if it fails, just really get aggressive by the end of the day and have a big position because this is also logical resistance on the upside, and of course, the second test of the 200-day does not work and it just continues lower and continues to break down, but this is one way to set profit objectives so that you know you’re covering at the right spots and taking profits and I’ll just use some examples, some of the shorts I’ve been doing recently. Here’s a late-stage base failure, CF Industries, this is a fertilizer stock, but let’s look at a weekly chart here. If you look at CF, it’s really had a long move from here and it’s been weak before and you get this big, ugly, double bottom but remember, the second low should undercut the first one so this is really an improper pattern. You may even notice this


looks like Broadcom and First Solar where it forms a big, ugly, bowl pattern or whatever, in this case a double bottom and then this handle here, it actually looks okay in the handle but you’ll notice that you have more red volume in the handle than you do big upside blue volume in here and once it fails, okay, on the daily chart, I’m actually, once it comes in here, I’m actually shorting it right there and then the other day, three days ago, I covered my position and then yesterday we had to come here and so I didn’t put it back out again on this bounce, but you can see how I took my profit, 183 down to 167 is roughly how many percent, 10% move, so I took because it’s undercutting this low and hitting the 200-day and I probably should’ve tried to come back after it here because now it’s breaking down through the 200-day moving average, but still, you have to set up or you have to look at areas within the pattern where it’s logical for it to bounce because you have to take profits and you have to be much more active on the short side than on the long side. Some other ones that have been looking ugly, F5, here’s a late-stage failure. This stock’s had a big move. It tried to form a big, this is kind of a big pod on the weekly chart, you see that, big bowl-type pattern. Now it’s starting to break down here. Is that really the 10-week moving, no, that’s alright. That’s because I’m showing it, yes. (INAUDIBLE QUESTION) GIL: Which one? You know what, I’ve been messing with that one and yeah and I was hitting it here and then we got this break and that worked out pretty well but then it undercut this low so I covered and on this day but it kept going lower and then it closed right back so it made me feel a little bit better, but then it’s getting this wedging rally and yeah, I think this looks possibly shortable here. Yeah, that this is probably going to break again, but that’s a lot of volume right there. Was that on earnings I guess? But to me it looks like you’re starting to roll over so yeah, I’d look at that as potentially an area to start shorting the stock. In CRM, Salesforce.com, that’s another one breaking down from here so actually on this day, in fact, what was it last week, before it even broke, I could tell this thing was looking like it was going to break down because the other stocks, F5 and VMware, were also breaking down, but see here’s, it breaks the 50-day moving average so I actually just shorted this here and it broke down, rallied once up into this area and then broke down and then you cover it because it’s undercutting this low and see this is another way to set profit targets on the downside or price objectives because what happens is you have a little consolidation here. When they undercut a prior low somewhere, a lot of times that is where they will rally back. You can even see that as it moves down from here to here, it undercuts these lows here and that causes a little teeny rally, so if you were late and you didn’t see this and you wanted to come back after it, you know that there’s a logical or potential for a logical rally after undercutting these lows, it comes up right into resistance in here, doesn’t really get too much past these lows on the upside, and you could’ve come after it again here and it rolls over. I know a couple people did. They emailed me and were all happy about it, and now this is starting to look like an inverted flag. The company comes out with their earnings tomorrow, no, Thursday after the close, and I’m going to guess that on earnings, it’s going to blow wide open, so short a 1% position into earnings. (INAUDIBLE QUESTION) GIL: Oh, you mean going after the stock recently, well, Netflix was, and this is where I’m testing this shortable gap down because we know that this shortable gap down was definitely viable here, okay, this is a daily chart, but a lot of short sale setups you’ll have this big breakdown and then they’ll come and try to rally back and then sort of like a second stage big right shoulder here off this giant, consider this a giant head, but this is a gap down and I went after it. We didn’t put anything out to the subscribers because I wasn’t really sure whether it would work, but I looked at it two ways here. You had a shortable gap down so you could’ve shorted here using the high of the day as your stop. The other thing that you having working for you is that the 90 level is underneath these lows and so I thought this might work as upside resistance as well although it’s kind of a short area but I figured this might work, came all the way down right on top of this little basing area and so I just recently covered and now it’s bouncing up, so I’m watching to see how the 20-day comes down, maybe it gets up into $80, maybe a little above and maybe it will roll over again. I do think Netflix is probably going lower so I don’t think their business model, I mean, you look at their margins. They’re just compressing unless they’ve got something else up their sleeve and I don’t really see that anybody else would buy them, so that’s just the reason, and that worked out. You go from $90 to about, I covered like around $72 so you know, you’re getting a good 20 something percent on that one. That was actually a nice one recently, but it’s mostly, I was testing this shortable gap down thing and I think you guys could try it if you’re prone to that sort of thing. I know men like to do that. It’s very macho, come after


something like that and take a huge position, and you could try this concept of shortable gap downs but it’s probably the newest concept that I’ve come up with in short selling and all it is it’s a reverse of a buyable gap up and so in the next book that we write, it’s going to be all about short selling incorporating some of his work on rocket stocks, as you call them, and I think this shortable gap down is definitely a viable concept that we’ll probably cover in more detail, as well as having more daily charts in the book because I think the thing that’s really missing in the book that I wrote with Bill O’Neilll, are any daily charts and Bill didn’t want to put daily charts in there, so he said it would complicate it too much. But I would make the point that short selling is a heck of a lot more complicated than going long and so you should explain it on the daily charts because that’s really where the rubber meets the road. But it’s possible to make big money short selling and I feel like at this stage having gone through my mistakes in March and April of 2009, I really ironed out what I think are the final kinks in understanding how to short and when to come after stocks and when to not be shorting, so but a lot of times you get outside your head and you also have to remember that in March, was it 2008 when Bear Stearns went under, I actually had two hedge funds, about $60 million worth of hedge funds at Bear Stearns that week and all week long I’m noticing the stock, in fact, what I’m doing is I’m shorting Bear Stearns. It’s like $140 and I’m shorting it. It’s breaking down to $120, or maybe it was a few weeks before that, and I covered my shorts and I was thinking I was smart and then this thing just starts plummeting, $60 and hangs out there for awhile and then it goes lower and then that week I remember calling our reps at Bear Stearns, what’s going on? Your stock is plummeting and I think Lehman had just gone under right before that, right? Or were they right before, so I was concerned and by Wednesday, it’s really starting to plummet so I liquidated the funds. I sold everything to get them into cash and I knew by Wednesday if I sold Wednesday, you’re T plus 3, I’m not going to settle until Monday, so I’ll be in cash Monday and the idea was once we’re cash on Monday, we’re going to wire it to where we had set up a safety valve account at J.P. Morgan and the irony is that J.P. Morgan bought Bear Stearns but I just remember I had gone to cash and then Friday, the stocks halted at $2 right? And all I know is I think my stomach was coming out my ears and my brain had dropped somewhere down into my feet, just that whole weekend nobody knew what was happening and so my psychology had been so jarred by this experience. You have two hedge funds, something like 30 something investors in the two funds and for all we know, we’re poof and that’s all I know that weekend, so on Monday morning, we find out J.P. Morgan is going to buy the company, we’re in cash, I remember playing at a golf tournament, a charitable golf tournament that day and I was not having fun until I got to about the 10th hole and my partner, Kevin Larter, called me to let me know that all the money had wired out of Bear Stearns. It was in J.P. Morgan in Denver, so at that point I could live my life again, but that was a very emotionally wrenching experience if you think about that. Not as bad as the guy I knew who put all his money into Bear Stearns stock at like $6 just before they tanked so it took him three days to lose $300,000, all of his IRA. So, but just to point out that you have to be careful what happens to your psychology and events like that can jar your psychology so much that by the time we got to a year later in April, March of 2009, I had done this research on the fundamental research on the banks coming to the conclusion that they were basically insolvent and they are to this day. They’re only allowed to, they don’t have to mark anything to market because rule 144 is it 141, or 142, whatever it is, the mark to market rule, FASB has eliminated that so they can just pretend to mark to fantasy and that’s what they do now, so really they’re all insolvent. They just pretend all these mortgages are worth something when they’re probably not, but my mistake was in not understanding that the Fed and the government could step in and prop up the banks and let the depositors go down the toilet, but my whole mentality was so focused on what had happened to me a year ahead of time, that I really couldn’t see any other outcome than utter disaster in several big money center banks going belly up and being taken over by the government, so I couldn’t see outside of all that psychological cloud and so that was a big problem, too, so, you know, the other thing is if you’re going to sell short, make sure your psychology’s very clear and your mind is very clear about what you’re doing, you don’t get too caught up into the whole negativity of the situation because in short selling, you’re taking advantage of a bear market and bear markets tend to get very ugly, a lot of negativity, but don’t allow yourself psychologically to get sucked into that even though you may be making money on the short side, because when the market finally turns, you’ll be so locked into a bearish point of view, a negative point of view, you won’t see it when it happens, and that’s exactly what happened to me in March, April of 2009, but live and learn and my techniques now account for all of this and I understand now that no matter what happens, you could never let your psychology or how you feel based on your experience, even if it was a harrowing experience like having money at Bear Stearns when they go under, get in your way. You must always focus on price volume match and what it’s telling you. DR. K: Yes.


(INAUDIBLE QUESTION) GIL: Well, I know what books I would read. I would read everything by Richard Wyckoff, anything about Jessie Livermore, and I’ll let him finish the rest. DR. K: The Jack Schwager books, the market wizard books, I just wrote a blurb for the new Hedge Fund Market Wizards by Jack Schwager. It should be out I guess in the next couple months. It’s excellent. It lives up to all his other books. It doesn’t matter if you’re not a hedge fund manager. It’s irrelevant. It’s for the retail investor and the experienced investor. It’s fantastic. Someone with any level of experience should read Jack Schwager’s books, including the hedge fund one. GIL: Yeah, definitely, and there’s new one that you actually are… DR. K: Yeah, that’s the one. Hedge Fund Market Wizards so that will be out, Wiley and Sons, probably in the next few months, and then in terms of websites, there’s a few out there that I quite like. There’s… DR. K: I like investors.com, that’s a good website. GIL: Yeah, the archives are good and there’s decisionmoose.com. That site is one of the few sites that actually has a good market timing track record from when it started I think 1999 through 2008. Decisionmoose.com. DR. K: I also live Michael Covel’s books. GIL: Yeah, Michael Covel’s great. Trend Following is a classic, or it’s not a classic but it should be a classic in the years to come. DR. K: We are trend followers. Basic methodology is that we’re trend followers because we follow the trend. When the market’s going up, we’re long and when the market’s going down, we’re out or we’re trying to short so we’re following the trend. We’re asymmetric in that regard whereas most institutional investors are just symmetric. They go up with the market and they go down with the market, so we’re trend followers and so I like Michael Covel’s book because it keeps you on track as a trend follower that there are times when there is no trend or when the trend is hard to define and that you need to tough it out through those periods and understand that it’s probably a time to play light, but never veer away from your discipline because there will come a time when everything is new again, right? GIL: Right, and like we’ve discovered, sometimes the market can turn on a dime. August of 2011 is one example when it just got hit very hard and people who were long inverse ETFs did very well. October of 1999. Market turned on a dime. Everything went from looking bad to worse to excellent in a span of a few weeks. Now I was going to say about decisionmoose, I still like the site even though since 2009, it’s been underperforming. The reason I like it is because the writer is very aware of why it’s underperforming. He just can’t do anything about it, but he’s very cognizant and experienced in terms of his writing ability and his ability to size up the situation of what the market is throwing at us. I mean in the most recent letter, he writes these every week, something along the lines of sell in May, and go away. DR. K: He should probably just take an extended vacation and just sit in cash for the next number of months until the elections just because there are so many tipping points going on in the market today. GIL: I would agree to a point. There is certainly more challenges that befall us in terms of the market environment today than I can remember, but I always remember also, markets can turn on a dime. Things can look as bleak as possible and then within a matter of days or a few weeks, there’s all of a sudden a huge profit opportunity, so to take your eye off the ball and go on vacation, I wouldn’t recommend that, but I would say if you say want to stay in cash or pyramid in slowly in your positions, in a challenging environment, that’s completely viable because if you end up being wrong, you’re going to lose a lot less, and then outside of that, what other websites? Can you think of any? DR. K: I don’t really know, I like decisionpoint is another good one. Decisionpoint.com. That’s Carl Swenlin’s site. He has a lot of great sentiment data on there and just a whole lot of different charts and things to look at that I think are


interesting, but I don’t think it’s all that critical. I think you should definitely read all of Bill’s books, Bill O’Neilll’s books and read them forwards and backwards, right? Pretty much. GIL: Oh, and of course the Jesse Livermore books are excellent. The thin volume that he wrote, what is it called? How to… DR. K: How to Trade in Stocks. It’s only about 80 pages. Absolute classic. That’s a book that, I remember an old friend of mine at O’Neilll who retired at the age of 33 because he reached his retirement point in terms of his trading count, he had that book marked up left, right, sideways. GIL: Was it Dan? DR. K: Yeah, Dan Morris. That book was the Bible to him and… GIL: And then the classic, the Lefevre book, Reminiscences of a Stock Operator, that’s a book that I’ve read several times. DR. K: Probably more than a dozen times, actually. GIL: Is there anybody here who hasn’t read that book? Reminiscences of a Stock Operator? DR. K: Okay, everyone’s read it. GIL: Yeah, I mean that’s like to me that’s like the Bible, so… DR. K: Every time you read it and you’ve acquired experience in the market, the books takes on new deeper shades of meaning. That’s why it’s so invaluable. GIL: Yeah, definitely, in fact, I’m rereading it now and it definitely makes sense. DR. K: And I would say that our methods, our tradition comes from O’Neilll but really, we’ve kind of taken and broadened it out, but it all still is based on a basic, what I would call an ethos, a basic way of looking at the markets that is really, what we now refer to as the OWL methodology which is O’Neilll, Wyckoff, and Livermore, and if you go back and read Wyckoff’s early books in the early 1900s, he talks about treating your portfolio like you’re running a store and so you know O’Neilll has the red dress, yellow dress story. He had another story that’s similar to that in terms of if you have a product in your store and it’s selling, you want to go buy more of those and once it’s not selling, you want to get rid of them. Even though Bill claims he never read Wyckoff, but I think he probably saw something at one point, but if you read Richard Wyckoff, a lot of the original, just whole way of thinking. Wyckoff was using charts back in the early 1900s and he talked about the proper way to use charts and the fact that a lot of people think of them as voodoo or witchcraft or whatever, but that you definitely need to use charts and so he was one of the first ones to advocate the use of charts as a valid tool. He also understood institutional sponsorship back then in the form of the trust and the pools and so he describes what O’Neilll talks about now in terms of the mutual funds and the hedge funds and the pension funds. Back then, they were trusts and pools because back then, you could collude and you could operate on inside information. That’s how Joseph Kennedy made his fortune was shorting the markets. So there’s this whole, O’Neilll’s work stems from Livermore and a lot of it strikes me similar to Wyckoff so we see them as influences so anything related to them and what they write, what they would’ve written or what’s written about them, we think people should read because it’s all part of the general ethos and it is a particular way of looking at the market, so we’re going to come up with a little owl characters, kind of like Angry Birds, we’re going to call them angry owls. (INAUDIBLE QUESTION)


DR. K: I don’t really think they changed it. What it helps me do is sort of frame what the roots are of the whole philosophy in bringing you back and reinforcing those basic philosophical tenants of the way we invest. You don’t pay attention to news. Don’t pay attention to numerous charts, price volume action tells you everything. Institutions, the big money moves the markets. Invest, focus on the leading issues of the day as Wyckoff and Livermore used to say. What else? GIL: They’re just principles. The books give us, underscores the principles but in terms of things like pocket pivots and viable gap ups and things discovered along the way, I mean the books don’t help there. They just allow us to exercise the principles while doing research studies. In other words, the research studies that I carry out have to have inherent logic behind every study otherwise it’s not even worth pursuing the study and the books provide that framework through that level of inherent logic. DR. K: Yeah, and I think you need these books also to kind of bring you back on track because you can get off track and you just kind of need to review and I think looking at a lot of thought of these people, Wyckoff, Livermore, and who else? Even Nicolas Darvas. His concepts, although they’re very simplistic. O’Neilll derived all of his stuff from that but he took it a lot further, so, I mean somebody was getting on my case for deriding Bill O’Neilll and I’m not at all. I’m just saying there are influences from the early 1900s and Livermore, O’Neilll definitely pays homage to Livermore as a huge influence but Livermore in turn during his days, Richard Wyckoff was also a big influence during that time as well, and he was the one who originally chronicled Livermore’s exploits in the magazine of Wall Street, which he published in the early 1900s. GIL: Yeah, some of those copies as to… DR. K: Yeah, and all the common sense you could read those books, like Stock Market Technique 1 and 2, Richard Wyckoff’s Stock Market Technique 1 and 2 that I, you should definitely read and you’ll kind of chuckle to yourself as you go through because you see where a lot of O’Neilll’s philosophy and thinking came from, but again, I would emphasize that O’Neilll too it a lot further and actually codified it and put it into a form that offers retail or individual investors a practical methodology and framework to use to invest in the market, so, anyway. That’s all we’ve got. We have to go to a dinner with the founder of MoneyShow, which I don’t know what he wants, where is he, is he here? GIL: We have to meet him at the meeting. I’m going to go the… DR. K: Anyway, thanks for coming everybody. It was a pleasure and I hope you learned something that makes up for the money that you spent on this today. GIL: Hopefully. Okay, good to know.

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The Secrets of Trading Like an O’Neil Disciplegraphics.moneyshow.com/pdf/lvms12_The-secrets-of-tr… · · 2016-09-07The Secrets of Trading Like an O’Neil Disciple ... and the