The Top Secrets of Pro Traders

Do Wall Street pros know something the rest of us don’t? Why are billionaire investors ahead of the curve, while most individual investors are behind it?According to trader Joe Terranova, it’s because money pros regularly employ strategies that regular folk don’t even know exist.In his new book “Buy High and Sell Higher,” Terranova reveals some of those “trade” secrets; edicts that he and his colleagues live by.Click ahead to learn about some of these powerful strategies. Also find out how the Fast Money traders leveraged these concepts in real-world circumstances.By Lee BrodiePosted 26 January 2012

Photo: Peter Dazeley | Getty Images Trader: Dennis Gartman, strategic investor and author of The Gartman LetterJoe Terranova, chief market strategist, Virtus Investment PartnersThough Terranova’s no stranger to exercise, in this case “watch your weight” strictly involves watching the allocation of capital in your portfolio. Pros carefully spread around their capital and are unafraid to cash out. “I make sure that no more than one-third of the value of my total portfolio is devoted to any one sector, such as energy or technology,” he said. “The maximum amount that I allocate to any one ‘player’ in any one year is 12 percent of the total investment.”That concept was perhaps best illustrated by commodities investor Dennis Gartman in December,when he said that although he remained bullish on gold in the long run, he had turned neutral. “With gold in a bull market, there are only three positions you can have, really long, long, or neutral. Right now I’ve scaled out and I’m neutral,” Gartman said.

Photo: Astrid & Hanns-Frieder Michler | Getty Images Trader: Steve Cortes, founder of VeracruzMany retail investors tune out the bond market, and Terranova doesn’t understand why. If it’s a matter of learning the basics, as Nike would say, “just do it.” “Historically, Treasurys lead the stock market; they’re a reliable barometer for anticipating where the equity market is going to be three months from now,” Terranova said. “If you begin to see Treasury yields decline, that means there is something out there that is concerning. Big investors are moving money into Treasurys to seek out safety.”Steve Cortes watches the action in the bond market like a hawk, and low yields last April convinced him that the bull market rally was not sustainable. “Somebody's got to be wrong, and I believe it's going to be the equities,” he said at the time. “I'm betting against stocks by shorting the Nasdaq.”

Photo: Digital Vision | Getty Images Trader: Doug Kass, founder and president, Seabreeze Partners ManagementNo, he’s not talking the singles scene. When Terranova advises investors to start dating, he simply means to keep a calendar, something he says too few retail traders know to do. A string of economic readings, such as the monthly employment report, manufacturing and home sales data, and more are released on a regular basis, and they typically move markets. “This data should be all over your monthly calendar and used to time your trades,” he said.Strategic investor Doug Kass takes the thesis a step further. He relies on his calendar of economic activity to time the broad market, and he’s famed for his market timing. Back in September, when he felt the market was near the lows, Kass said the call was due in part to the economic confluence of positive reports. “All the releases continue to point to nonrecessionary conditions in the U.S.,” he said. (At the time the S&P was trading at 1140.)

Photo: Grant Faint | Riser | Getty Images Trader: Guy Adami, managing director, Drakon Capital; Tim Seymour, founder of EmergingMoney.comYou wouldn’t walk a high wire without a net; there’s no reason to trade without one either. Professionals always set up a net for themselves in the form of a stop-loss order, said Terranova. That is, at the time you enter a trade, request to sell a certain number of shares if a security falls to a specified price. That way if the stock starts falling, you can limit the damage.Stops are something Guy Adami trades with all the time. On Dec. 14, when he suggested a long position in Joy Global, he also said play with a tight stop. Tim Seymour also trades with stops. On Oct. 19, he recommended a long for Freeport with at a stop at $30.

Photo: Les and Dave Jacobs | Cultura | Getty Images Trader: Karen Finerman, president, Metropolitan Capital This trade tenet is so fundamental it may hardly seem like a secret strategy, but Terranova says it separates the best from the rest. “Making money involves reading company reports, crunching numbers, and parsing through a lot boring research,” he said. “I mean no disrespect by this, but I think most investors are lazy. Ninety percent of the trade involves research.” As a value investor, Karen Finerman is known to get out a magnifying glassso she can digest all the fine print before putting her first dollar to work. Doing homework is how she formed her trading thesis after Nelson Peltz attempted to buy Family Dollar.

Photo: Farhad J Parsa | Photolibrary | Getty Images Trader: Steve Grasso, director of institutional sales trading, Stuart FrankelThe concept of half and half goes well beyond your morning cup of coffee. When a stock achieves your upside price target, even if your heart tells you the stock will continue higher, let reason be your guide and sell half. “By selling 50 percent of your position you lock in profits on a sizable portion of the investment,” Terranova said. “And by holding half you still participate in gains if the stock continues higher.”Selling half is a strategy that trader Steve Grasso advocates and practices regularly. On Dec. 7 he tweeted the following:“selling half my $BAC and half my $AKS.”

Photo: Walter Schmid | Stone | Getty Images Trader: Jeffrey Hirsch, editor-in-chief, Stock Trader's Almanac“Institutional investors know seasonality like the back of their hand, but retail investors rarely understand it,” said Terranova. “Certain times of year are more favorable for certain sectors.” For example, historically technology tends to perform best from about Labor Day to the beginning of December. Energy also tends to trade well during the third and fourth quarters.In October, Jeff Hirsch of Stock Trader’s Almanac suggested putting money to work in small-capitalization stocks, because typically the fourth quarter was a strong period. “We had a very typical seasonal downturn from May to October,” he said at the time. “And then we had a nice turnaround on Tuesday, Oct. 4th. It looks to me the seasonal patterns (are intact) and the market is marking to those historical rhythms." On Oct. 4, the iShares Russell 2000 Index (IWM) was trading at $64.80 — on Dec. 30 the small-cap ETF closed at $73.69.

Photo: Steve McAlister | The Image Bank | Getty Images Trader: Pete Najarian, co-founder, optionMONSTER.comLike the band The Mamas and the Papas, Terranova never knows what to make of Monday, Monday. “Whatever the reason, there is always a flood of emotion coursing through the market on Monday, and that makes Monday a volatile day of trade,” he said. Unlike the song, however, Terranova does not agree that every other day (every other day) of the week is fine. “I generally like to execute trades on Wednesday and Thursdays,” he said. “By then the markets have settled down from the emotions of the weekend, and you’re in front of whatever potential rebalancing could occur on Friday.”Pete Najarian is also very cognizant of “day of the week” patternsin the market. Back in 2009, he recognized a phenomenon in which the stock market made big moves almost every Monday from Sept. 14 through Nov. 23. Najarian speculated that the phenomenon was generated by mutual funds putting new money to work at the start of the week.

Photo: Abby Marshall | Flickr Open | Getty Images Trader: Guy Adami, managing director, Drakon CapitalDespite homework and sound analysis, a stock can still defy logic and decline. When that happens, and it will, pros typically are proactive, while retail investors are reactive. “Retail investors will rationalize the trade as a long-term investment and stay with it, while pros recognize the trade for what it is — a bad investment,” he said. “Give up the ghost and get out.”TV personality Regis Philbin fell prey to this very problem in May. He held on to his position in Micron, despite a long decline. “I should have sold it, but I waited,” Philbin said at the time. “When that happens, you’ve got to sell,” counseled Guy Adami. “The remaining money is better used to establish a new position elsewhere.”

Photo: Stephen Weiss, partner, Short Hills Capital Stephen Weiss, partner, Short Hills CapitalIt may sound counterintuitive, but Terranova swears by the “buy high and sell higher” strategy. In fact, he named his book after it. “When you buy high, you’re buying confidence. You’re buying a stock in which there is conviction in price,” he said. “Also confidence has a way of feeding on itself, which in turn propels a stock even higher. It’s what pros mean when they say ‘stick with what’s working.’ ”In the last quarter of 2011, trader Stephen Weiss, partner at Short Hills Capital, said the only way to play the market was with leaders, not laggards. With Europe’s financial crisis and a slowdown in China generating uncertainty about the U.S. economic recovery, fundamentals didn’t matter to the market. Buying momentum was the only trade that worked.

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