(Note from Rob Hanna: The below interview is being republished here with the permission of The Kirk Report. For anyone who may not be familiar with The Kirk Report, I strongly recommend checking it out. I'd like to thank Charles Kirk for taking the time and effort to interview me and for allowing me to republish the interview. I also hope readers find it helpful.)
On a monthly basis I try to introduce you to someone I think offers valuable perspectives that will help you become a better trader and investor. Rob Hanna more than meets that qualification as a hedge fund manager and quant-focused trader.For the past two years I've been a loyal reader of both his Quantifiable Edges' blog and newsletter. What I appreciate most about Rob is his no nonsense statistical research in creating specific quantifiable edges in the market. Those of you who desire to trade with a more analytical, non-emotional/systematic approach, will find Rob's research helpful.
In this Q&A we'll talk about how Rob finds his trading edge and the methods he uses with the goal of making us all better at what we do. Even if your focus is on investing for the long-term, I think you'll find Rob's approach of interest.
We hope you find this Q&A interesting, informative and helpful.
Q&A with Rob Hanna
Kirk: Hi Rob. Welcome to the Q&A and thank you for being willing to share your perspectives with us.
Rob Hanna: Thanks Charles! I'm flattered to have been asked. Having seen many of the past interviews you've done, I hope this one is able to stand up.
Kirk: I'm sure it will!
For those who don't really know you or follow your blog, please tell us a little about your professional and educational background.
Rob Hanna: As far as education goes, I went to Boston College and attended their School of Management for economics. I also did a double major in philosophy. I'm originally from New Jersey and between my junior and senior year of college I got an internship working on the trading floor at Garvin Guybutler in New York. I worked in the area that traded overnight Fed Funds. Back then it was a lot different. There was a floor of brokers with desks and phones. My job was to write their bids and offers on a big marker board using different color magic markers. The marker board acted like a giant, manual, Level II screen. I updated everything as bids and offers changed and deals were done. I remember my first day their they told me - "Welcome aboard. Go sit in the corner and learn your fractions." "Huh? I know my fractions." "No you don't. Not when you have to know everything between 1/64th and 63/64th and where to place that fraction on a marker board in a split second with 10 brokers screaming at you. Now go learn your fractions." So that was my intro to trading.
After graduation I wanted to stay in Boston. After a while I ended up at Thomson Financial. I worked in the investment software division. I sold portfolio management, trading, and accounting software to large money management firms, banks, insurance companies, mutual funds, etc. The software was basically the backbone of their operation so it involved a long sales process, typically 6-12 months where I would become intimately acquainted with the operations of the firm. I had to understand the needs of traders, portfolio managers, compliance, and back office personnel so I could demonstrate how their office could run using our software. I did that for about 7 ½ years. During this time I became very interested in trading myself. Of course I think everyone did during the 90's. Over the course of 4-5 years I taught myself how to trade. I started with William O'Neils' book for intermediate-term and Jeff Cooper's for swing and day-trading. From there I devoured tons of trading books.
In 2001 I left Thomson Financial. Soon after I began Hanna Capital Management and trading became a full-time job.
Kirk: How would you describe your style of trading?
Rob Hanna: Always evolving. Lately I've focused more on quantitative swing trading because that's where I've found some of the best opportunities over the past couple of years. It's also a primary focus of Quantifiable Edges. I do still trade some momentum strategies and I'll execute an occasional daytrade, but most of my effort is in the 2-7 day timeframe.
Kirk: In an average week how many trades do you make? What is your average hold time and how many positions do you have open at any given time?
Rob Hanna: This varies greatly by market action. Perhaps 10-15 trades per week would be an average. Some weeks there will be hardly any, and some weeks much more than that. I consider myself opportunistic with regards to trades.
One of the hardest things for many traders to do is sit in cash if they don't see an edge. They often feel as though they should be taking a shot with something to try and generate income. From my experience I've found that if I need to look too hard to try and find an edge, then it's likely a bit of a stretch. This is not a good situation to trade under.
Here's why. Say a trader has a strategy that he's very comfortable trading. He's confident he has an edge and after placing the trade he knows just how to manage it. He knows how to best size the position. He knows where a stop should be if he uses one. He knows the best way to take profits (or losses) for the particular strategy. If he is able to trade the strategy consistently over time, he should come out ahead.
Now let's say the same trader doesn't see any of his setups triggering. Perhaps he reads something or finds a setup that appears to have a edge. He hasn't traded it before but without any of his regular setups triggering, he might as well take a shot with this other one - marginal as it may be. Now - even if he is right and the trade setup has an edge, does he know the best way to exploit it?
Once the trade is on, knowing it is not an ideal setup, or at least one they're comfortable with, most traders will tighten up. They'll manage the setup in a way that isn't ideal. Whether that means too tightly because they're afraid of losing, or too loosely because they took an extra small position, it doesn't really matter. Effectively, by taking a setup that has a small edge and managing it in a less than ideal fashion, they have effectively eliminated their edge and are now trading with a negative expectancy.
So an "average" number of trades per week has a large standard deviation - which I believe is appropriate.
Kirk: That makes a ton of sense Rob and terrific advice about how important it is to wait for the edge to be found!
Please tell us a little about your initial learning process and anything significant you learned within the first year or two of trading.
Rob Hanna: When I first started trading I actually began learning two very different strategies at the same time. I read William O'Neil's book and subscribed to IBD which got me to adopt a momentum growth approach for the intermediate-term. I also had some friends that were day-trading. I learned how to do a little of that as well. Many of the setups I traded early on were Dave Landry's or from Jeff Cooper's Hit and Run books. The strategies focused primarily on buying breakouts or pullbacks in strong stocks (or short them in weak stocks). Most of Jeff's setups would require a high ADX because he wanted to get into things that were trending.
I used software to scan for stocks that would set up for a daytrade (or possibly a swing trade) the next day and then I'd program them in to buy or short if they triggered. After trading the two very different kinds of strategies for a while I realized 2 things:
1) The best day-trading opportunities often came in the high RS stocks I was looking to buy on an intermediate-term basis.2) The best intermediate-term opportunities often occurred in those stocks that exploded out of my day-trading setups.
This basically led me to marry the two techniques and I would only daytrade stocks that I felt I'd like to hold for an intermediate-term trade. Also, I began trading around my intermediate-term positions. Rather than just sitting in an intermediate-term position for six weeks and trailing a stop, I'd look to jump in and out of that position several times. If I did it well it would basically allow me to reduce the cost of my position and I could profit on intermediate-term trades that would otherwise end up breakeven or worse.
More than anything this taught me that it's possible to learn from others and mimic their style, but ultimately, if you can adapt that style and make it your own, you're much better off.
Kirk: Amen to that. So, where do you think most traders go wrong in the first couple of years?
Rob Hanna: They take trades without a solid concept of the potential risk/reward. Many publicly available strategies, especially if the trades aren't managed properly, won't provide traders with a substantial edge. Poor risk management is also a problem. Although that's not really specific to beginning traders. As was demonstrated so well by a good number of banks, investment firms and governments in the last couple of years, if you don't manage your risk properly, you can really find yourself up a creek.
Kirk: Unless, of course, you have Uncle Sam willing to bail you out!
After the initial learning curve, what do you think marked the next stage of your progress of becoming a successful trader?
Rob Hanna: 2004. It was my worst year. I barely broke even. In 2003 I made fantastic returns and at the end of 2003 I really felt I'd learned so much that year that I should have done much better. I figured it was going to be all up hill from there. Then in 2004 the market changed. It became very rotational. The breakout strategies that had performed so well for me in 2003 were chopping me to bits. To compound that the daytrading strategies I used completely lost their edge because volatility dried up. Every step forward was followed by a step back.
This led me to look into ways to improve the momentum based strategies I'd been employing. The first thing I did was determine where I felt my strategies fell short. The answer was fairly obvious and is likely the same for most trend following techniques. I did great in the middle, but I did poorly at the tops and bottoms. Basically I found myself over invested at tops and under invested at bottoms.
I conducted a huge study into the character of tops and bottoms. I wanted to determine not only how the general market moved but how the different sectors acted as well. What sold off the hardest from the tops? What bounced best off the bottom? The answer to these two questions I found to be fascinating at the time.
The stocks that sold off the hardest were often the most overbought. They were the momentum stocks that had run up the furthest and were leading the market. They were the same stocks I was often long. They were also the same stocks I'd been taught that tend to hold up the best when the market corrects.
At bottoms I'd been taught to look for leading stocks to try and jump aboard. This was dead wrong. The stocks that bounce the best off the bottom are almost always those that are beaten down the most. Take a look at the banks. The S&P is up a little over 60% from the March bottom. The BKX? 175%. Now this is an extreme example and really the outperformance rarely lasts this long. But the 1st few days and weeks off of a substantial bottom you will normally see the really beat up stocks do the best. I addressed this in a timely blog post in January 2008. I also followed up on that post a few weeks later along with some results.
Anyway, my findings when conducting this research along with my poor 2004 performance led me to basically rethink everything I'd been doing. First I decided that the best way to improve my trend-following techniques was not to refine them at all, but rather to design some complimentary techniques that could take advantage of the tops and bottoms. It would allow me to make more efficient use of capital. Trend following is great…in the right market. And mean-reverting strategies are also great…in the right market. So when I realized you could combine the two without having to neuter one of them it was a chocolate/peanut butter moment for me.
The 2nd thing all this research did was to spark my curiosity. I began testing more and more ideas. The more tests I ran, the more ideas I had. It's what led me down the path of developing a huge research database and eventually to begin Quantifiable Edges.
So back to the original question, what led me to progress as a trader? My own struggles. They say necessity is the mother of invention and I think that's certainly true in my case.
Kirk: I remember reading those posts Rob and they helped me quite a bit this year to focus my screening efforts in a way that has helped tremendously. So thank you for doing that!
Given the number of studies and research projects you've undertaken, what would you say is the most significant lesson you've learned about yourself and trading over the past few years?
Rob Hanna: The market is constantly evolving and you need to be able to change with it. For me the best way to do that is by studying it. I'm always trying to find new ways to do things. I've traded using many different techniques, from very short-term intraday to long-term strategies. The one constant I've found is that no strategy works forever. At least no static strategy. You need to adapt your approach as the market changes. Some people think they can learn a couple of easy patterns and just trade using them the rest of their lives and they'll be fine. If those patterns are adaptive somehow, then maybe. If they can work in calm markets and choppy markets and trendy markets and panicky markets then great. Perhaps you can use them forever. I'm not aware of any simple patterns that work in all markets and can be traded often enough to make a living.
Here's an example. Like I said, I was a big fan of Jeff Cooper's stuff when it first came out in the late nineties. There was a pattern in one of his books he called the Hot IPO Pullback. Basically he looked for an IPO that rose a certain amount above its offering price on the first day. The first time it put in a multi-day pullback on the daily chart he would look to jump aboard. At the time many IPO's were taking off and they might double or triple again over their first few days or weeks of trading without ever pulling back. It was the internet craze. So I adapted the strategy. Instead of waiting for a pullback I would look at each IPO that came to market. If it had a great first day (say up 75% or more on day one - which was a little above average those days) then I'd get ready to buy. I was looking to buy on day 2 and my trigger was the high of day 1. This strategy was the best trading strategy I had for about a year and a half. It was mostly day trades but they could make very big money.
Then the 2000 bear came and the IPO market dried up. My best trading strategy was gone...probably forever. Time to adapt. If that strategy isn't working - something is.
Kirk: In other words, none of us can be a "one trick pony" if we expect to excel over the long-term. In addition, if something you're doing right now is working very well, chances are fairly good at some point it won't. That's the nature of the beast.
Those of you who read you know that you share quite a bit of statistical research/studies at both your blog and newsletter. If we can, let's talk about some of those and how you create and backtest those studies.
Among all of the studies you create and share, what are a few of your personal favorites and why?
Rob Hanna: Hmm. I'll pick a few from the blog so everyone can read them if they wish.
I did one last winter that discussed the importance of position. The example I used in the study was a sharp one-day selloff.
If you look at very sharp one day selloffs over time you may get jumbled results. If you instead look at sharp selloffs relative to where the market is trading, then the results will be vastly different. This study looked at 2.5% one day drops. It first looked at such drops immediately following a new short-term high. It then looked at 2.5% drops when they occurred following a short-term low. I won't spoil the ending but the results are vastly different.
Position isn't only important when considering sharp selloffs. It's important no matter what you're examining. The market behaves differently near a top than it does near a bottom. Another example of this was when I looked at how the market behaved intraday following large gaps. I did this for both gaps up and down. The action prior to the gap had a major impact on the potential success of the gap. If the market closed one way for 2 days in a row then had a large gap in that same direction, odds favored a reversal. If the market was not already extended in the direction of the gap (assuming the gap was large), then odds favored continued follow through. I'll get you some links to these studies.
Large Gaps Up After The Market Has Already Risen Putting Large Gaps Down Into Context Another concept I've discussed and found value with that I haven't seen elsewhere is what I call "Time Stretches." Basically I measure the amount of time a security spends above or below a moving average. Once that time period becomes over-extended a reversion back to the other side of the moving average often takes place. This is a concept that I've successfully incorporated into some systems that I track on the website. For systems I've found relatively short-term moving averages, such as the 10-day, work quite well. I think I've written two blogs that discuss time stretch systems - one with a long system and one short.
Subscriber Letter Time Stretch System How Time Stretches Can Provide An Edge Kirk: Beyond these favorite studies, are there any additional studies you think are important for us to be aware of for both the short-term and further out?
Rob Hanna: One thing the recent rally has had is incredible breadth numbers. This is not at all unusual when coming off a long-term bottom. It is unusual several months after the bottom. The rally in July was accompanied by some incredible breadth numbers. To my detriment, I didn't value them enough versus some of the other things I was seeing. We've again had some breadth thrust signals here in September which are suggesting we may not be at the top quite yet.
From a big picture point of view I believe the current market is most like the 1930's. This means I expect both rallies and selloffs will be much more exaggerated than most market participants are used to. Just as the bear market up to March 2009 was incredibly extreme, so has the been the rally since then. I believe there is going to be a lot of back and forth over the next few years and the swings will continue to feel extreme. I wrote a blog post about this in March with several illustrations.
Kirk: What is the catalyst for undertaking a new study? Do you start with a rough concept you wish to further test or do you start with noticing something in your research (or others) and then take the time to verify its value through backtesting?
Rob Hanna: Curiosity and current market conditions are what drives many of the studies. Each night I examine the market to see what happened that day. How were the breadth numbers? What about volume? What was moving the most? How about volatility? I'm basically looking for standout readings in price, volume, breadth, volatility, sentiment, or some indicator I may track. It doesn't have to be anything earth-shattering. Just something that might provide a hint. The market hit an X-day high or low, or breadth was extremely weak, or volume was very high. Anything like that. Here's a simple process for coming up with ideas to test:
1) Observe what's happening in the market.
2) Describe what you're seeing.
3) Test what you just described.
In one of the 1st paragraphs of the subscriber letter each night I just describe that day's action. It's a very simple description. A typical description of the day may sound something like this "The market gapped up big this morning but failed to gain any traction. It pulled back and was trading lower just 45 minutes into the day. After trading down much of the day it rallied strongly in the last hour to close barely above where it opened the day. This was the 3rd day in a row the market closed up and today it made a fresh 20-day high. Breadth was mildly positive as the NYSE Up Issues % came in at 55% and the Up Volume % at 59%. Total volume rose to the highest level in over 2 weeks."
How many studies are there to look at in the above description? Countless. Start broad. What happens after the market gaps up and closes higher on the day? What happens after 3 up days?
Now get more specific.
What if the gap is large vs. small?
Does the fact that the gap filled during the day have an affect?
What if volume is higher than the day before?
What if volume is the highest in 20 days?
What if volume was high and the market rose at least X% but the Up Issues % couldn't even manage 60% advancers?
And like I spoke of earlier, don' forget market position. What if all this is happening at a 20-day high? A 10-day high? After 3 up days?
Most days there really is a lot to look at. If you're having trouble thinking of what might be worthwhile to test, a little reading can often help. What are others noticing about the market? Perhaps there's some action that you didn't notice that others picked up on. For instance perhaps today was the 1st 20-day high in over 2 months. Or perhaps it was the 3rd 20-day high in a row. Those things might matter. After you do these studies for a while you'll get a feel for what things are important and what may not be. You'll know where to look. And if you can't find something then perhaps current action isn't providing that much of an edge - so don't sweat it.
Kirk: Can you slowly walk us through the all of the steps you go through to test a specific datapoint or idea?
Rob Hanna: Once you have some ideas it's just a matter of taking historical data and filtering and sorting it in a way that you can see how the market has performed under similar circumstances in the past. To do this I most often use Tradestation. For certain tests I'll also use Excel. The tool doesn't matter much. If you want to run studies based on observations like I discussed earlier, here's a simple way to do it:
1) Set up each observation as a condition. In Tradestation this would mean something along the lines of condition1 = open > yesterday's close or (Open > Close[1]). In Excel it would be a column. If the opening prices were in column C and the closing prices in column F then it would look something like this: IF(c5>f4,1,0). Remember, you want a new condition for each observation you are going to test.
2) Set up your exit criteria. For most of my testing I normally look out X number of days to see how the market has performed. In Tradestation this would be a statement like: "If barssinceentry = X then sell this bar on close" Then you would optimize on X to create a table with a bunch of different days on it.
3) Like we discussed earlier, start with a broad test and then get more specific. Make sure you look at things a number of different ways. When testing you need to approach it all with an open mind. You're not trying to prove that today's action was bullish or bearish. You're trying to see if there is a convincing edge either way. When you get more specific you're doing so in search of truth. You want to understand if certain observations have a substantial effect on the results. You're not data mining in a effort to find the perfect setup. If you're looking at things a few different ways and consistently seeing the same answer then there is a pretty good chance there's an edge.
4) Let's say you see an edge and looking at it a few different ways confirms it. Another thing that really needs to be done is you need to look at the history of your results. If you are running the test over a long period, the edge may be significantly stronger or weaker now than it was in the 70's or 80's or 90's. You need to take this into account when deciding whether your results suggest an edge. Let's take a simple example. Mondays. From 1960 to until 1987 Mondays were consistently negative. After the Crash of '87 (which happened on a Monday) this no longer held true. Since '87 Mondays have not had a negative bias. Instead they've basically performed in line with the general direction of the market. I'll provide a chart to illustrate this. So if a condition of your test is that you're buying on Friday's close and selling on Monday's close, I probably wouldn't run that test all the way back to 1960. I'd go from '88 - present at the longest.
5) Compare your perceived edge to a baseline. Consider the current market. If I ran a test and found that over the last 6 months, every time the market closed up on higher volume there was a 60% chance it would rise the next day and the average return was about 0.25%, would you say there is an upside edge? Consider the fact that the market is up 60% in the last 6 months. That's 60% in 120 trading days. Now the 0.25% gain per day doesn't look so impressive. If these same results had been achieved in March when the market was down close to 50% over the previous 6 months - well now you're talking a HUGE edge. So make sure you put the results into some context by looking at what the market has done over your test period as well.
Kirk: Wow. I think that process really is helpful Rob. Thank you for sharing it with others.
Given your vast experience, I'm curious to know your opinion on seasonal strategies (like sell in May and go away, buy first day of the trading month, the market tends to gain more on Wednesdays than Mondays, etc.)? Are there are any you think are of importance to pay attention to (or not) that you run into quite a bit?
Rob Hanna: I'm not a huge fan of seasonal strategies. One reason is that the market is always evolving. The Mondays test I just mentioned is a perfect example. With a seasonal edge, especially if it's an annual setup, it may take many years to realize it just isn't working anymore. If there is a reasonable explanation behind a seasonal tendency I tend to give it a little more credence. Outperformance at the beginning and end of the month is an example of this. It supposedly works because that's when 401k contributions arrive and the money gets immediately put to use. So there may be some value there. For my trading, though, I believe breadth, volume, price action, sentiment and volatility carry a much bigger influence on future direction than what day of the week/month/year it is.
There is one seasonal-type influence I do think is worth trading - and that's Fed days. Eight days a year the Fed comes out with an announcement. Over the years there have been some pretty consistent biases that form around these days. I've documented many of them in the blog.
Kirk: In the past your "mythbusting" posts have proved popular. In your experience, what are a few myths that you think traders should know and try to avoid?
Rob Hanna: Volume related myths are the biggest. So many people teach that a low-volume pullback is a bullish. Not necessarily. I did a blog post on this and showed that very light volume on the first day of a pullback often led to a deeper pullback. When volume wasn't extremely low the expectation over the same time period was bullish.
Distribution days are another. Supposedly when the market is in an uptrend and then it suffers a series of high volume selloffs that is a sign of a top. In reality it is often a buying opportunity and not a time to start scaling back.
Of course my biggest series of myth-busting came with regards to follow-through days. I did a series of about 10 posts that looked at follow through days in great detail to determine whether they were a useful tool. My general determination was that they provided little value and certainly were not all that they were cracked up to be. There were some aspects that were useful, though. For instance, while the follow through day itself has almost no predictive value, the action 1-5 days AFTER a follow through day is fairly predictive. I'd encourage traders that utilize follow through days to check out that series.
Kirk: Very interesting. Thinking back, I know at least a few times I've made some poor decisions due to the influence from these myths as I'm sure others have as well.
In your view, are there any studies that even an average investor not devoted to incorporating statistical research into their strategy should be aware of?
Rob Hanna: Here's one: the average investor loses money. Armed with that knowledge I'd incorporate any edge I could to get above average.
The biggest misconception about quantitative / historical / statistical research (or whatever you want to call it) is that it's very difficult to learn and incorporate. It doesn't need to be. Almost all of what I do is simple analysis. Using 2 or 3 conditions I'll tell you how the market has performed under similar circumstances in the past. You don't need to be a math wiz or a computer guru to take advantage of some simple edges.
Here's 3 very simple truths I learned/confirmed through testing:
1) You're generally better off buying pullbacks in an uptrend than you are in a downtrend.
2) You're generally better off shorting rallies in a downtrend that you are in an uptrend.
3) Don't be too eager to short rallies that are coming off a potential long-term bottom (like a 200-day low). Those might steamroll you.
If a beginning trader who wanted to focus on trading pullbacks took those three things into account, they'd likely be much better off than the beginning trader who didn't. If they really take them to heart and they learn to incorporate a few more tricks, then that beginning trader might even be "above average" and make some money.
It isn't necessary for everyone to run studies the way I do to make money. It is necessary to trade with some kind of an edge. Knowledge can provide an edge. Traders should learn about the market and then figure out how to use that knowledge to their advantage.
Kirk: As I hoped, this Q&A is going to encourage many who read it to actually test and validate their strategies. In my experience, this is often something you'll see occur only when traders really get serious about improving their ability to trade. Why you make it look easy Rob, in reality it does take time and practice!
At your subscription-based website, you offer daily updates of the following indicators:
Among all of these, which are your favorites and why?
I use some of the breadth indicators most often. Every night I look at advancers/decliners (Up Issue %) and Advancing/Declining Volume (Up volume %). They give me a lot of test ideas.
My CBI (Capitulative Breadth Indicator) has been a valuable one for me. I have one system I trade called the Catapult system. It looks for individual stocks in the S&P 100 that are undergoing possible capitulative selling. The CBI is basically a count of all the active Catapult signals I have at one time. Generally when you see a large cluster of Catapult trades occur, it strongly suggests the market is likely to bounce. It generally only happens once or twice a year, but there are some nice opportunities when it does happen. There's tons of posts and information on the blog about the CBI, and when it spikes I normally will alert blog readers to it.
The CBI data goes back to 1995. I let subscribers download the whole history in case they want to study it or incorporate it in their on trading.
Kirk: At your website you share a proprietary volume based indicator for the S&P 500 and Nasdaq. Can you share a recent chart of both and explain what both are indicating now?
Rob Hanna: Unfortunately, they aren't saying much of anything right now. Like many indicators I track, they're really only valuable when they hit extremes. The Volume Spyx indicators look for unusual relative volume activity. When there are very high readings - over 80 or 100 then risk/reward swings especially positive for the next day. Very low readings - below 20 or 0 show flat to negative risk/reward for the next day. I'll occasionally conduct studies related to these indicators that may suggest implications farther out than just 1 day. I've posted some of these studies and information to the blog.
Kirk: Many traders keep a close watch on net new highs? Why is this info so important?
Rob Hanna: New highs/new lows data is typically used for two purposes: 1) To spot divergences suggesting a weakening of a trend, and 2) extreme measures can be used to alert traders to probable reversals.
Number one is more popular but I've found limited value with its use. For instance, a few weeks ago I published a study in the subscriber letter that questioned whether a market making higher price highs, but with fewer stocks hitting new highs, had bearish implications. The results were inconclusive. Basically, you were looking at a toss-up in this kind of scenario. In looking at instances where new highs expanded when new price highs were achieved, performance there was substantially better than the 1st test. My conclusion was that the failure to see an expanding number of new highs in a rally was not an actionable red flag. That said, you'd rather see an expansion of highs.
Huge percentages of stocks hitting new lows often lead to at a least short-term reversal. So that's something I do always watch for.
Kirk: How helpful do you think the VIX is and where do most people go wrong using it?
Rob Hanna: I use it in my analysis and have identified some decent edges. Most of my early VIX testing was based on Larry Connors' work. Larry found that absolute levels of the VIX were basically meaningless. Instead he compared the VIX to its short-term moving averages and found that when it became stretched from those moving averages it often was followed by a reversal - both for the VIX and the SPX.
People nowadays will throw 10% bands around a 10-day moving average and when the VIX gets stretched one way or the other they'll consider that a reversal signal. This works ok when the VIX is overbought and the market is oversold, but an oversold VIX is not a very good signal unless it is VERY oversold.
I did a study about a year and a half ago that showed over the previous 10 years, when the VIX was stretched more than 10% below it's 10-day moving average the S&P performed significantly BETTER on average than those times the VIX wasn't stretched far below the 10-ma.
These results were somewhat surprising to most people - including myself. Now when it gets REALLY stretched, then you typically have a decent downside edge for the SPX. Last November I published a study that illustrated this using a 20% stretch from the 10-day moving average.
Another mistake people make is that they try and overanalyze the VIX. Every little wiggle or stretch doesn't necessarily mean something. Although it often trades counter to the index they will sometimes close in the same direction. If this is minor, or involves a weekend volatility adjustment, then it really isn't a big deal. If you get sizable moves in the same direction, especially if it is over a period of several days, then there's a decent chance it can provide you a nice directional clue.
Kirk: Good to know Rob. Thinking back, how did you first learn how to properly backtest your ideas? I'm sure others will be curious to know about how you developed this skill set.
Rob Hanna: Curiosity and determination. I was somewhat familiar with easylanguage so I taught myself how to code better using that. When I got stumped I posted on their forums. I also read a lot of what other people posted there. I showed some of my results to other traders to elicit feedback and listened to where they felt I might be missing something. Eventually you just get it. I wish there was an easier way. Joining a trading group would be one way to go. I've participated in a few email groups over the years and have learned tons from other members.
Kirk: If someone does not already know how to test and create statistical studies like you share or would like to improve their own methods, how do you recommend they learn? Do you have any resources other than your own website (i.e. software, other websites, books, etc.) to share to help get them started in the right direction?
Rob Hanna: The best thing I've seen was in Dr, Brett Steenbarger's newest book "Become Your Own Trading Coach." He dedicated a whole section to historical analysis and described in great detail how to perform studies using Excel. It's a great place to start for anyone wanting begin testing ideas. One very important thing to do is to save templates of all your work. You don't want to have to rewrite every calculation every time you want to perform a study. Save your calcs somewhere so you can easily copy and paste them.
I'm sure there must be a decent number of other resources these days as it is becoming a bit more popular. Since I'm beyond the learning stage I haven't paid attention to most of them in the last few years.
Kirk: How do you properly organize all of the research and studies you undertake in order to know what to review and look at over time?
Rob Hanna: The more studies you conduct the more important this becomes. I imagine most people that do a lot of historical analysis must categorize them in some searchable database. I decided to take it further than that. The problem with having a searchable database is that you still have to do the searching. This means you have to recognize there may be something happening in the market that you've studied before and then you have to be able to find where that study resided.
Instead of searching for my studies I created a program I call the Quantifinder The Quantifinder looks at basically all the market action for the day and then matches it up with all of my previous research studies. It then outputs links to the studies that triggered today along with descriptions of them. So if there is a study I conducted a year ago that I may have forgotten about, I just pull up the Quantifnder and it reminds me. Then it's just a matter of clicking the link and I can read what I wrote back then.
I originally wrote the Quantifinder to make my life easier. I liked it so much that I decided to make it accessible to subscribers as well. The ones that really seem to like it are the overseas subscribers. I tend to work very late at night and sometimes don't get the Subscriber Letter out until European markets are already open. With the Quantifinder they can get a sneak peak at what I'll be writing about.
Kirk: Clearly there are times that studies you've create conflict with each other. Can you give us a recent example of when this occurred and how you deal with it?
Rob Hanna: Oh sure. This conflict always happens and it's perfectly normal. I treat my studies like other people treat a list of indicators. It's pretty rare that ALL your indicators are all lining up and saying the same thing. Same with the studies.
To quantify what the studies are suggesting I created an indicator I call the Quantifiable Edges Aggregator. Basically the Aggregator takes the projections of all of the studies from the past few days or weeks that I consider "active" and generates a short-term projection based on their combination. This result provides a net expectation for the next few trading days. I then look to see how the market has done over the last few days compared to recent net expectations. What I look for to find the most significant long-side edges are 1) positive expectations over the next few days and 2) a market that has underperformed expectations over the last few days (and is therefore considered oversold). For short-side edges I look for exactly the opposite. If I have positive expectations in an overbought market or negative expectations in an oversold market then that is typically considered a neutral configuration.
Kirk: Are there studies recently that no longer have been working as well as they have been in the past? If so, why do you think that might be?
Rob Hanna: Yes. That happens occasionally. When I determine a study has lost its edge I eliminate it from the Quantifinder. A study could lose its edge for a number of reasons. One possible reason is that there really wasn't an edge to begin with. Perhaps the market moves following the setup were coincidental and there wasn't causation. This is always a possibility. I do my best to analyze the studies thoroughly enough that the chances of this are relatively slim.
A second reason is that the market dynamics may have changed. We've already talked about how the market is constantly evolving, so this is something I'm always on the lookout for. A good example here is Put/Call ratio studies. As regulations have changed and as new products have emerged over the years the way investors use options has also changed. What this has done is it has changed what is relatively high and what is relatively low with regards to put/call ratios. For instance a put/call ratio over 1 at some point in 2000 would have been and extremely high reading. In 2008 it was about average. Any study conducted in 2002 that used a put/call of 1 to decipher an edge would be obsolete in 2008. I avoid this problem by normalizing put/call ratios in all my studies, but this does provide an example of how evolving market conditions can render certain studies obsolete.
For more on put/call ratios and the need to normalize them, you could check out the post I published in August.
Lastly, it's important to watch for wholesale shifts in market dynamics. Mass failures of studies over a period of many months or more could suggest such an event. This is fairly rare but does occur. One example is the crash of '87. Many studies I've conducted have shown ineffectiveness prior to this date. After the crash there were numerous new regulations put in place - trading curbs for one. Plus the government seemed afterward to take a more active role in monitoring the stock market. An example of a study that stopped working after '87 is the Mondays study I referenced earlier. My inclination as to why Monday's changed is that Black Monday was so bad that afterwards people began taking extra precautions going into the weekend. Everybody being so afraid of Monday effectively killed the Monday downside edge.
A couple of things to takeaway here. First, I always weight more recent results higher. This is important in case dynamics are changing. Second, monitoring the success rates of many of the studies is always important. Failures may alert you to a change in market dynamics that it could take others many years to realize and adjust to.
Kirk: Great stuff Rob.
Beyond sharing the work of your studies, you seem to talk little about money and risk management? What are your thoughts regarding this important topic?
Rob Hanna: It really needs to be paid attention to. Since I've been running the website I've heard some stories of traders that have basically blown out there accounts. Those that wrote and told me cited the fact that they gotten overly aggressive and failed to manage their risk. While I publish and track some trade ideas in the newsletter I don't ever suggest position sizes. My subscribers vary from beginning traders to large hedge fund and institutional portfolio managers. I can't possibly account for everyone's risk tolerance and experience and so it has become a topic that while I feel it is important, I'm not in a position to offer much guidance.
Kirk: What are your thoughts regarding portfolio position sizing?
Rob Hanna: There's plenty of ways to determine optimal position sizes. Some of the best books on this subject are by Ralph Vince. From my standpoint I think position sizing, being that it is part of risk management, is a very personal decision. If the "optimal" position size for a particular strategy is 10% of your portfolio, but you personally have trouble coping with the swings of a 10% position, then it really isn't the optimal position size. A position that is sized too large will take you out of your comfort zone. In doing so you will likely manage that position in a non-optimal manner and the edge could completely disappear - or worse. So from a position sizing standpoint my general advice is this: take positions that are big enough to help you grow the account but not so big that you're not comfortable trading them.
Kirk: Fair enough. So, when applying a recent study to your trading, how do you know where and how to set your profit targets and stops?
Rob Hanna: I think it important here to distinguish what I refer to as a study vs. what I refer to as a system. A system is a complete set of rules that tells you what to trade and gives an entry trigger and an exit strategy. A study just looks at the market, whichever market that may be, and evaluates how it performed under similar conditions in the past. So if I'm trading a system, then the rules are there for me. If I'm establishing a bias using market studies then stops and profit targets aren't necessarily part of the picture.
Kirk: Can you share some of your personal trading rules?
Rob Hanna: There's really just two rules:
1) If I have an edge - take a position.
2) When the edge is no longer there - get out.
It doesn't matter what my entry point was and it doesn't matter how much I've gained or lost on the trade. When the edge is no longer there, I shouldn't be either. And when it is there - I should stay in the trade. This actually requires some discipline because there's always a temptation to bail when it begins to go against you and there's also always a temptation to try for too much when things are going your way.
Kirk: That's great. In two simple rules, you've pretty much said everything that needs to be said.
As you know,all successful traders dedicate a lot of time and effort to improvement and reducing mistakes. How has your trading method evolved and improved over the years?
Rob Hanna: The biggest change from say 5 years ago is how I incorporate my quantitative research. Knowing a good number of probabilities gives me greater confidence. It's having that confidence that has allowed me to view the market more objectively and then manage my trades in a more optimal - and less emotional - manner.
Kirk: Can you provide an example of something you thought was true when trading early in your career and now believe is just dead wrong?
Rob Hanna: The mythbusting posts we discussed earlier come to mind. Most of the myths I've busted are ones I believed in at some point in time. Another thing I came to realize is that classic chart patterns are not as reliable as I thought they were early on. Don't get me wrong - they're still very useful - they're just not reliable. Take a cup & handle for instance.
The best year I ever had trading cup & handles was 2003. I found some great stocks that doubled, tripled and more and my returns were very good. At the end of the year I went back and ran stats on all my trades. The cup & handle was by far the most common and most successful pattern I traded that year - and I did great with it. Do you know how many of the cup & handle breakouts that I bought were deemed "successful"? Successful in this case meaning they embarked on some kind of uptrend move that I was able to take advantage of and earn better than a scratch or a very small gain. Best year. Best pattern. Are you ready? 10% -15% success rate. Now I traded them very tight around the breakout point and therefore did get shaken out of some eventual winners, but still - 10% - 15% was about 60% worse than what I was led to believe when I first started trading the pattern. Now like I still consider patterns like this very useful and will still trade them. By keeping risk minimal when trading these it only takes 1 winner to make up for a bunch of losers. A 10% success rate still provides some nice risk/reward. You just need to be aware that it takes some hard work and determination (or luck) to wade through enough losers to find those few winners that will make it all worth your while.
In my eyes classic chart patterns don't offer high probability trades. They DO offer nice risk/reward. Buy a breakout of a resistance level. Place a stop under a support level. Hope for a nice trend. It rarely works but when it does its great.
Kirk: As traders are fond of saying, you've got to kiss a lot of frogs out there!
With your intense research, how much time and attention to you pay attention to others' opinions about the market and/or stocks you are trading?
Rob Hanna: None. I do read what others are saying, but mostly just to understand what they are looking at. If it sounds like a worthwhile idea or indicator then I'll test it to see if it does indeed provide an edge.
I don't trust anyone's conclusions (including my own) without testing them.
Kirk: Please describe a typical trading day for you? How do you organize and dedicate your time?
Rob Hanna: I'm not a big morning person - more of a night owl. Therefore I've always done my preparation at night. This allows me to have a game plan ready as soon as I wake up. I often get up between 6:30 and 7 along with the kids. Like everyone else I'll check the markets when I first get up in the morning to see what may have happened since I went to bed. I'll see if any of my positions are looking to gap significantly and then I'll check why if they are. Often I'll write my blog in the morning and then post it between 8-9 am Eastern. Then I'll normally do a little morning reading. Check out some blogs or columns on line.
During the trading day I monitor the markets and execute any ideas I came up with based on last night's research. I don't do much day-trading so few decisions are made in the heat of battle. Most of them have been thought out in advance. With the website now I spend some time each day answering emails, updating the website, and conducting new research. Around 2:30 - 3:00 I'll run the Intraday Quantifinder. This helps me to begin thinking about tomorrow and whether I want to exit or establish any positions at the close.
Once the bell rings I normally take some time off. The only thing I do in the few hours after the bell is to re-run the Quantifinder. I spend family time between 4 and 8 or so and then start to gear everything up again. I'll spend 45 minutes to an hour downloading and updating data, charts, etc. After that the research and writing begin. It's a lot of work each night. I typically get the subscriber letter completed and sent out by sometime between 2-3 am. Then I head up and go to sleep. On weekdays there really isn't much sleep, but my wonderful wife allows me to catch up and sleep late on Saturdays.
Kirk: Can you give us some idea of what tools you use to monitor the markets (i.e. your trading platform, software, websites, etc?)
Rob Hanna: Much of my testing is done on Tradestation, although as I mentioned earlier I also use Excel for some of that. I also trade using Tradestation. I use Quotes Plus and Worden Bros. TC2000 for data as well. The Worden Bros. product I always liked due to its note-taking ability. It allows me to make a brief dated notation on a stock, which keeps me from going back and doing research on it a 2nd and 3rd time if I didn't recall looking at it previously. Most of the reading I do is blogs rather than news services. There's probably about 15-20 blogs I read all the time, and then another group that I look at occasionally. Yours is one I read all the time. All my favorite blogs can be found on my blogroll. The blogroll has grown over the years but it still is only about 30-35 deep.
Kirk: Like everyone else, we both experience hot and cold hands at times. Are there any tricks of the trade that you use to help maintain a consistent successful approach over a long period of time?
Rob Hanna: I try and take a fresh look at the market each night. I find that going through my research and determining an edge helps me to get focused and prepared for the next day. Even if today was horrible, hopefully my edge plays out tomorrow.
Kirk: What would you say are the biggest changes in the markets and trading in general you've seen during your career both good and bad?
Rob Hanna: ETF's and now leveraged ETF's have arrived. SPY has been around a long time, but other than that it was either stocks or mutual funds. I find ETF's to be great trading vehicles. You're less exposed to individual company risk, you've got some great liquidity, and if it's volatility you crave, there's plenty of volatile etf's as well.
Kirk: What kind of advice would you give a person just now beginning in trading the markets?
Rob Hanna: Spend more time studying the markets when they are closed than you do trading them when they are open.
Kirk: I think it was Dr. Steenbarger who said that the best work traders do always come during non-market hours. How very true!
Kirk: Because of your website I'm sure you are privileged to know a lot of different kinds of traders. Where do you see traders missing the boat?
Rob Hanna: Many traders misuse their resources. They'd rather be given a signal than be presented with a few ideas to consider. I often use the term "idea machine." That's what all your resources should be if they are going to foster growth.
Someone that gets my Letter each day and just skips down to the bottom to see if I posted any trade ideas is completely missing the point and will not get a whole lot from my service. It's the same with other services I use. In my mind, something that sparks ideas or teaches something has real value.
The Kirk Report is an excellent example of a resource that both sparks ideas and teaches. Members here that take the time to explore the site and mine for ideas once in a while can benefit a great deal more than those that just read an occasional post.
Kirk: Thank you for saying that Rob, but websites like yours even goes further than I do on a daily basis. No doubt, that's why you've earned so much respect and admiration by so many traders over the past few years. It is well deserved in my view!
So, I must ask, what are some qualities you frequently find among the most successful traders you know?
Rob Hanna: They're incredibly curious. They're disciplined. They work hard when the market is closed. They maintain an open mind to try and understand what the market is saying rather than looking for evidence that backs up their opinion. And perhaps most important, they only trade when they have an edge.
Kirk: Thinking back, what was most instrumental in your development into becoming a successful trader?
Rob Hanna: Never thinking I was. It keeps me humble and alert with regards to my positions. It also keeps me hungry to continue to learn and improve.
Kirk: When all is said and done, in your experience what is the best way to learn how to trade?
Rob Hanna: Wow. I don't know. I was pretty much self-taught. Lots of reading. Lots of actual trading. Lots of studying and testing. I wish there was more of a curriculum to follow. The one person I've read that talks about having a curriculum is Dr. Steenbarger. His "How to become your own trading coach" book which I mentioned earlier is designed to help traders help themselves and it has tons of good ideas.
Beyond that I'd say find someone whose work appeals to you and follow them. If you're comfortable examining company fundamentals, then find someone that does that and follow them. If you're interested in momentum or trend trading, follow someone that does that. Historical analysis, technical analysis, day-trading, options strategies - whatever it is, there is someone doing it and writing about it. Buy their book, get their newsletter, follow their blog, go to their seminar, whatever. Soak up what they know about that particular discipline and then over time adjust what they do to better fit your own personality and interests.
And then keep in mind that you'll need to adapt as the market evolves.
Kirk: I suspect like all good traders you are working on improving your performance in some manner. Can you share what you're specifically working on right now?
Rob Hanna: I have a few projects going on and many, many, more in the pipeline. A big focus for me now is releasing a few systems I've developed. One which is due out in a matter of days is based on my Aggregator chart. The returns of this system have served as strong confirmation of the value of my studies. The system basically looks to trade in the manner that I've always preached: long if the studies are net bullish and the market has been underperforming expectations over the last few days. Short if the studies are net bearish and the market has been outperforming expectations over the last few days.
It's taken a long time to get the system ready for actual trading for two reasons. First, I needed a decent amount of Aggregator history before I could show results. Second, many of the studies are based on end-of-day data. Prior to development of the Quantifinder it was harder to anticipate what studies were going to be active and how that would alter expectations going into the close. Now I can run the Quantifinder intraday and generate a pretty good estimate of how the Aggregator is going to be positioned that night.
I'm also planning on allowing subscribers to download historical Aggregator data. That way they can use it to design new systems or incorporate it into current ones they may have.
One other project I'm involved in is a new website. It's being spearheaded by David Varadi of CSS Analytics and Jeff Pietsch of Market Rewind. There's going to be 5-7 of us that will provide 1-day market predictions near the close each day. It will take the predictions and output an aggregate group prediction. There will also be algorithm at work that weights each of our predictions based on who has the hot hand lately and who is cold. It's an interesting concept, and the list of probable participants is impressive, so I'm excited to be a part of it.
Kirk: I look forward to seeing this and will let others know. No doubt, it will be a lot better than the dubious Ticker Sense sentiment poll.
You seem to trade both discretionary and use systems. How do you feel about one vs. the other?
Rob Hanna: I've never been of the opinion that they need to be mutually exclusive. I use a lot of my systems to help me establish a bias for my trading, rather than simply autotrade them. There are a few I pretty much trade as designed. From my standpoint, I see no reason why discretionary traders couldn't benefit from tracking a few systems to aide them in their decision making.
Kirk: At this point of your career, who do you look up to for inspiration and guidance?
Rob Hanna: The wife and kids provide plenty of inspiration. I've also developed relationships with some other traders with whom I'll share ideas. The back and forth is very helpful. Subscribers are a source of inspiration for me also - in more than 1 way. First, I know I can't slack off if I'm broadcasting my outlooks. Second, feedback and ideas from subscribers has helped me to develop new tools, systems, etc.
Kirk: Although I know both of us share of love for the markets and trading, what are your long-term career plans and future for your website?
Rob Hanna: Quantifiable Edges has evolved since inception. It was just a newsletter and blog to start with. Then subscribers wanted code for some of the systems so I created web pages to allow them to download the code. From there the functionality began to grow. Studies are always being added to the database and I'm constantly looking to implement new tools and ideas (like the Quantifinder).
I love the research and so I don't think I'll ever stop doing that. Long-term who knows what it will look like. I'm a lousy web-designer so the site isn't a good-looking as it should be. That will need to be addressed one of these days. At some point I may consider partnering Quantifiable Edges with another firm. With more resources I think I could really produce some interesting products.
Kirk: What are some of your personal passions beyond the market?
Rob Hanna: My kids are young and I love spending time with them and my wife. Skiing has always been a passion of mine. I spend as much time as I can skiing in the Winter - which isn't nearly as much as it used to be. I've always been a big Celtics fan and try and get to a good number of those games during the year. BC football is also fun to follow. I have a group of 10 friends that I graduated with and we've had tickets forever. It's a great excuse to get together on Saturdays in the Fall. The tailgates - like the market - have evolved over the years. It used to be a bunch of guys with an occasional girlfriend. Then wives began attending. Now we all have kids with us as well. We've had to adapt and now there's more juice boxes than beer in the coolers.
Kirk: Finally, if you had one piece of advice to share with all investors and traders, what would it be?
Rob Hanna: Let your curiosity guide you. Things you are truly interested in and really want to learn about are the things that will drive and motivate you. That may mean studying historical analysis and probabilities like I do. It may mean learning how to be a successful tape-reader. It will likely mean something altogether different and unique. But if you want to be good at it, then you need to truly be interested in it.
Kirk: Thank you Rob for all of the wonderful insights!
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