Interview with Mike Swanson 8/29/6, By Mark Steward Young Options

[TTHQ Staff]

Mark S. Young: I'd like to introduce Michael Swanson of Wall Street Window. Mike is a regular contributor to Traders-talk.com and our primary gold specialist, and I'm glad to have him here. Welcome to the chat, Mike!

Michael Swanson: Glad to join you, Mark.

Mark S. Young: Mike, first of all, could you tell us how you got into this business?

Michael Swanson: Well, my background was in history. I got a MA in history in college and was working on a doctorate and ended up dropping out to trade full time. In my first few years of college I inherited $15,000 and started to do some trading with that. I didn't know what I was doing though. I turned that $15,000 into about $50,000 buying some Internet stock I read about in a magazine and then turned that $50,000 into about $7,000 in the course of a year. It took losing that money and then coming back for me to really learn how to trade and invest successfully. That seems to be a common story. I think the difference between successful traders and people who never become successful is if they adjust and learn from first setbacks. Most never learn and just do the same things over and over again, but not on such a volatile scale.

Mark S. Young: I recognize parts of your story in my own. I guess we could say that those who keep making the same types of mistakes are gamblers rather than traders. I know in my case, I learned much more from the early mistakes than the early successes.

Mark S. Young: So, you went from amateur to pro. Tell us about that transition.

Michael Swanson: Well actually when I first started in a way I knew what to do. I just didn't do it. Before I opened an account I read a dozen or so books on trading and investing and one of which called Secrets to Profiting in Bull and Bear Markets by Stan Weinstein really gripped me - he laid out a method of trading that struck me as one that would work - but I didn't really apply it until I had that big losing streak. And a lot of his concepts I use today. But one thing that got me to stop losing I think is that I started to help someone else get started and I had to tell them the right things to do and not to make the more gambling type things I was doing. By helping him I was letting someone else see what I was doing and that controlled my behavior at the time I guess. We have helped each other trade for 7 years now and now run are partners in a hedge fund. I don't think I need a partner to trade, there are benefits and drawbacks to that, but it helped me go from amateur to pro.

Mark S. Young: This is a fascinating co-incidence! When I first started trading, the first thing I read was that piece by Stan Weinstein. I probably still have it around here somewhere!

Michael Swanson: It's a good read.

Mark S. Young: So, you run some money with your trading partner. How did you get into the business of publishing your research?

Michael Swanson: Well it started out as a small email list with some friends on it back in the late 1990's when everything was going up. I'd just pull out my tc2000, look over a thousand stocks or so a night and make a list of breakout candidates. When they'd break out the next day most would go up at least 10%. I was buying them, selling a few days later, then buying the next breakout. That is what really got me to first build my account up and also build up a following. Eventually I started to charge for the service and I had to change my approach to. I don't do that type of trading anymore. It's a different market now then it was then. That was really a once in a lifetime market. It was so crazy.

Michael Swanson: I try to hold positions for several months now and ride out intermediate-term trends. The short-term breakouts stopped working for me in 2,000 and I found an intermediate-term time frame better for using more money.

Mark S. Young: It really was wild. So was the Bear that followed it. So, recently, you've been focusing on energy and gold stocks. Would you say that those sectors are your specialty or is it simply where you think the action is or has been?

Michael Swanson: Gold stocks have become my specialty. They are what I have really concentrated on for the past several years. I've gotten to know people in the gold industry who know some of the fundamental trends of some of the smaller gold companies and I also believe I've come to have a good feel for the trends of the gold market. There are some indicators that have worked well the past several years to detect changes in trend - for instance the XAU/gold relative strength ratio. The action in the stocks tend to lead the action in the metal, so it’s bullish when this is trending up and if that trend changes it has been a reliable exit signal. There are a few other things too that work well with gold. But I don't really have any special indicators when it comes to energy stocks. Just use the basics such as moving averages and trend lines, so I tend to put more money and effort into the gold stocks as I've found that more profitable for me.

Mark S. Young: Back in 2000, I predicted a secular Bull Market in gold and the mining stocks. It looks like I was right. I traded in them, and did well early, but then lost interest during their consolidation. It would appear that you did very well making them your focus. But going back, are you saying that you use fundamental analysis as much TA for trading the metals and energies?

Michael Swanson: You got in earlier than I did. I got in the first quarter of 2002. If you read Stan Weinstein's book and grasp his stage analysis theory, gold stocks bottomed in 2000, and went into a stage one base and broke out of that to enter a bull market in 2002. That was the reason I got into them. Unfortunately right now almost every sector in the market has run up the past few years and is in a stage three topping position - or consolidating - time will tell. The only thing I see that has the potential to go from stage one to a stage two bull market are drug stocks later this year. Technical analysis is the most important thing for me. But sometimes I'll use fundamental analysis to narrow down a list of potential stocks to buy. But I don't use it to make my buy or sell decisions.

Mark S. Young: As far as your fundamental views go, are you just looking for sectors that you can make a pretty sound case for longer-term fundamentals to be improving?

Michael Swanson: When it comes to sector I am more interested in the charts, whether the sector is in a bull or bear market or consolidating. I read the economic news, keep up with what is going on, and have my own theories about the macro-environment and where the economy is headed that isn't in the mainstream. I think we're headed for some sort dollar crisis. But I've found that it is very difficult to trade off of the macro-picture or predict it. If you would have told me in 2000 that the Nasdaq was going to fall like it did I would have thought a lot of bad economic news would have come out. But what happened to the economy was quite tame. Few saw the housing boom and how it helped generate consumer spending. I didn't see that coming. So when it comes to sectors I don't really direct my attention to them by looking at fundamentals or the economy.

What I tend to do is look at the charts first and the try to understand the fundamental reason for what they are suggesting to have more of a conviction of what they are saying. That can help you decide how long lasting a trend can be.

For instance right now the housing stocks are deeply oversold. They look like they are ready to rally and if you bought now you could make some money. But we aren't entering a new housing boom next year so it would have to be more of a short-term trade than a long-term hold for someone trying to play that I'd think.

Mark S. Young: I know what you're saying. I've never seen anyone translate economic analysis into timely trading. The correlations are there, but it's got to be one of the toughest things to figure out how to play. Regarding housing, to be sure, it's hard to make a case for a new bull there, but then again, we know that Bear Market rallies can be a thing to behold. It's just clear that housing isn't likely a good long term buy just from looking at the sector and the economic cycle.

Michael Swanson: Well a problem with economic analysis is timing. You can be right, but it seems like whatever you expect to happen always takes longer than you expect.

Usually I use fundamentals by looking at the earnings of individual stocks. If I can find stocks that have high relative strength in a sector and good earnings growth than I'd rather put money in them then in something with little or no earnings. This really applies to the gold market, because there are a lot of stocks in it with no earnings. One of the best performing stocks a few years ago was Krystallex. It was more of a promotion. It has no earnings. One would have been better to put money into a Yamana Gold or Goldcorp that had similar relative strength and real earnings with growth.

Mark S. Young: So you'd rather trade in good investments rather than wildly speculative stocks...no matter what their relative strength?

Michael Swanson: For the most part. Although with the gold stocks I've been able to get in a few of the more speculative ones, because I've had contacts in the industry who pointed me out to them. You have to really know the story early and get in them before they run up huge though, because many of them are promotions and I'm always a little worried. For instance one of my best stocks last year was a silver company called Silvercorp based in China. I bought it for like 3 and sold around 5 or so. It was a big profit, but I thought the company was over promotional and sold. It went to $18 after I sold. But then I bought into one private placement for a gold company before it started to trade. It ended up getting halted a few days after it opened up by the SEC for suspicion of illegal insider selling in offshore accounts. So the smaller stocks can be a wild ride. Because of the potential for huge returns I'll put a little amount of money into them, but just a small portion.

Mark S. Young: That's an important notion for newer traders, ESPECIALLY in the miners. Let's stress that. Diversification is key when trading in more volatile sectors and in more junior or speculative stocks. There are scam artists in every sector, but in small companies, shells, and promotions, you have to be especially cautious and expect that there's a good chance that ANY of them could blow up overnight.

Michael Swanson: That's right. The thing is though that a lot of people don't realize that.

One problem is that a lot of gold newsletters only recommend the small speculative stocks. They are a part of the industry in a way. There are a few I find worth reading who are totally independent but not many. Jim Dines is one good one.

Mark S. Young: Jim is a legend. He's a legend because (in addition to calling the Internet boom) he's one of the few junior gold stock analysts who plays it straight.

Michael Swanson: Exactly.

Another thing is that the gold industry is really small. There are only 20 or so gold companies trading on the US exchanges that have good production and earnings growth, so it is hard not got get interested in some of the smaller companies.

Mark S. Young: Yes, because the industry is fairly small, there's only so many places to put money. When big money wants to go into them, it really has to look hard for places to go.

Mark S. Young: Thus, a good trader can't completely ignore the smaller, junior companies since they can have some big moves if someone decides that they want to own them.

Michael Swanson: I've even had that problem. I'm not managing that much money in the scheme of things. The fund has about 5 million in and Andy and I are probably trading an additional million or so directly. Plus with the subscribers I'm probably influencing another few million. Last December we sold out of the fund and three other hedge fund managers I know sold out on the same day and we moved gold stocks down. The gold market isn't that liquid. One nice development though is the new GDX exchange traded fund. I've been using it in my own account and in the fund too. A few times the past few months instead of selling a bunch of gold stocks I just shorted the GDX as a hedge. I've used it on the long side too.

That might be a microcosm of the whole stock market though.

Mark S. Young: I've been thinking the same thing. Any thoughts on that?

Michael Swanson: The way it trades now. It seems much more influenced by larger traders making individual trades. Volatility has shrunk the past few years as hedge funds have come to dominate the market and displace the individual investor who was a much larger player in the 90's and now isn't really a factor anymore. There are a lot of signals that used to work in the past that don't work anymore.

For instance in 2000 I started to short stocks. And it worked really well for me for several years. I was using the VIX, put/call ratio, and investor's intelligence survey to track sentiment and then the 60 minute stochastics for entry points. Then in 2003 I continued to do this and it no longer worked. The investors intelligence survey had more bulls than bears all through 2003 and the market kept going higher. Right now there is an interesting shift in this survey. There are more bears than bulls than have been seen in a long-time. I'll be very interested to see what the market does. That's something I'd like to talk with you more about over the next weeks as things unfold as that is your area of expertise.

This is one reason I ended up gravitating towards the gold stocks. What had worked for me to judge the trends during the bear market stopped worked when the cyclical bull market started in 2003. So I ended up focusing on more what was working for me - the gold stocks - instead of trading the Nasdaq and DOW as I had done before then.
Michael Swanson is using a different version of Yahoo! Messenger. Certain features may be unavailable.

Mark S. Young: I have some thoughts on that matter too. In fact, the use of sentiment at tops is one area where I've been trying help folks not get fooled. We'll have to talk more on that later. But going back, I've been wondering what effect the EFT's have been having on less liquid sectors. I mean, what about the Russell's out performance for so long? Is that working a lot like the gold ETF's and those thinner juniors?

BTW, there's a simple elegance just in focusing on the young secular bull market (in a given sector). You're to be credited for that.

Michael Swanson: I've found it a lot easier. Hopefully if we do get a cyclical bear market correction over the next year - which I think we will - then a lot of sectors will line up for a new bull market a year from now. But we'll see. Yes, though I think the ETF's have impacted the Russell out-performance too. It's probably true of all sectors.

Mark S. Young: Mike, I'm interested in your outlook going forward, but before we go there, I have to ask you my "tough question"; What is your favorite or most indispensable indicator (or type of indicator)?

Michael Swanson: Well in any market, stock, sector - whatever it doesn't matter what it is I'm always using the daily and 60 minute stochastics. If the sector is in a bull market I'll look for a dip that causes the daily stochastics to get oversold. When that happens I'll flip to the 60 minute stochastics for a buy signal and use that as an entry point. I used to short during the bear market doing the same thing. Right now as we are talking I have a chart of the XAU up. I think bottomed in June and is now consolidating to go breakout in a few weeks. Gold and the XAU both dipped hard yesterday and are down this morning, but the 60 minute stochastics are oversold. If they cross over and give a buy signal I'd use that an entry point and if you wanted you could then put a stop at the days low.
Michael Swanson: If you get stopped out, you could then sit back and reassess things. Maybe try the same thing again if you still think the bullish trend is intact. I'm not doing this with the gold stocks, because I'm already in from what is on average a lower level, but using this an example of how I use that indicator and trade.

Mark S. Young: So you're using the Stoch's as both trend and Overbought/Oversold   indicators?

Michael Swanson: No I use them just as overbought/oversold indicators. I use them for potential entry points.

Mark S. Young: Gotcha.

Michael Swanson: I have to use the overall chart pattern and position and slope of the moving averages to determine the trend. I find the stochastics useless to identify a trend. If something is trending up overbought stochastics indicators don't mean much, but oversold readings make good entry points.

Mark S. Young: As a follow up, are you using anything to keep you from "catching falling knives" with the stochastic? Larry Katz once told me that in some markets, a buried (rising) stochastic isn't a sell signal, but rather a sign of strength. I've found him to be right many a time.

Michael Swanson: Katz is right. I don't really have anything special to stop from catching falling knives. I don't try to buy when a stock or market is in a downtrend - just when it is in an up trend so usually that isn't a problem. And if the trade is wrong I just exit and sell, so it would take a big gap down to cause a loss to be more than usual.

Mark S. Young: Basically as Stan Weinstein would advise (waiting for the market to enter a Bull before buying)...

Michael Swanson: Actually Weinstein is bullish on gold stocks to. Every once in awhile I get a copy of his service. I'm not sure what else he is saying now though. I think gold stocks are going to consolidate and breakout over the next few weeks. We should know for sure soon though. They should bounce back up to their recent highs over the next few days and if they do their Bollinger bands will shrink and practically touch. This is what has happened the previous few Augusts before they had September rallies. If the XAU were to close below 140 though than this time might be different or there may be more consolidation.

As for the rest of the market - I'm very interested to see what happens. On one hand I'm bearish on the market. And have been the past few months. Last year I started to warn of a coming cyclical bear market because most sectors topped out and started to drop - with the sectors that had led the cyclical bull market that started in 2003 leading the decline. Which is a sign that a bull market is coming to an end. Then the sectors that asserted leadership - commodities, gold, energy, etc. - were sectors that lead at the end of a bull market too. And of course we are starting to see some life now in more defensive sectors - tobacco, drug stocks, utilities, REITs, are all leading sectors so far this year. So the makeup of the leadership and rotational pattern certainly suggests we are starting or in a cyclical bull market. But a rally here wouldn't shock me, especially with the very bullish sentiment readings from a contrarian stand point. So I'm interested in the character of any rally we may get will be and what the sentiment readings do to know if my thesis that we are entering a cyclical bull market is correct. I'm not putting any money on this thesis though. I'm not short and am heavily long gold stocks. But I'm hopeful that abear market comes, because there would be a huge potential to get in new sectors as they turn up a year from now.

I've found the broad market frustrating the past year- a lot of sideways action. And outside of commodities I've experienced it to be hard to make money in so I'd look forward to an environment like that.

Mark S. Young: Yes, in order for us to make money longer term, we need some volatility and maybe even some bargains.

Michael Swanson: Yep. I don't know what they'd be though. Guess we'll have to keep our eye on the charts.

Mark S. Young: So, Mike, Anything else to add?

Michael Swanson: Not right now I think we've covered a lot and thanks for taking the time to talk with me. I'd like to talk with you sometime in the next few months about the sentiment readings, because it’s a subject I'll be very interested in and will need to brush up on with you.

Mark S. Young: I'd be happy to. I've gotten some nice insights today, too. I'm sure folks will have a question or two. Will you be coming by Traders-talk.com to answer them from time to time?

Michael Swanson: Sure, I'll get in the day after you post the interview to see if there are any questions or responses.

Mark S. Young: Great and thanks, Mike. That link is www.traders-talk.com and I suggest folks check out the Fearless Forecasters message board as well as our New Market Analysis Area where you're a regular contributor.

 

For more information about Mike Swanson: click here

For more information about Mark S. Young: click here