Audio available at the end of this post.
Last week, I said that finding a profitable strategy isn’t hard. Just copy those who came before you.
But be selective about whom you copy.
As Stockbee wisely points out, if you copy someone who returns 10% annually, your own returns probably won’t exceed 5%. With that in mind, Pradeep says:
“If you have to model your method, you might as well do it on someone like Dan Zanger.”
Specifically, the methods Dan Zanger used during his record-breaking run. (He changed his methods after his account became much larger.)
Famously, Zanger turned $10,775 into:
$2.6 million in 12 months
$18 million in 18 months
$42 million in 23 months
Yes, market environment (the dot-com bubble) played a huge role in those returns. But you can’t return nearly 390,000% in 23 months without skill and discipline.
That’s not just getting lucky with an all-in buy — that’s repeatedly getting in at the right time, riding winners, and getting out and rolling your money into something else when the run is over.
I don’t know about you, but I want to learn from someone like that.
Recap and extra details
Last time, I discussed three key elements to Zanger’s system:
Let’s do a recap of each. I’ll also add some details, or new perspectives, I left out in my previous Zanger stack.
I’ll finish with two elements, related to execution, I didn’t address last time: Zanger’s buying and selling tactics.
1. Stock selection
Last time, I addressed:
To let Zanger bring many of these points together in his own words (June 2000 interview):
“Basically, many of the new issues come from hot new areas of our economy.
“We currently see a technological revolution in internet stocks, ready to fill the public’s appetite. These stocks are very trendy and sexy right now and these companies offer many new technologies that are in great demand.
“These stocks have a tendency to greatly outperform the market, mainly due to the fact that they have little or no institutional ownership.
“This was the case with the cellular phone stocks and the early networking stocks in the mid-80’s. In the early 90’s, the HMO stocks went public.
“These stocks soared in price very rapidly. Institutions eventually purchased the stocks, which pushes prices up.”
Earnings surprise
Another important factor, which I didn’t discuss in much detail in my previous Zanger stack, is earnings surprise.
Take this quote from Zanger:
“As another barometer, I identify powerful percentage changes in earnings and revenue to spot emerging winners.
“Typically, most of my stocks have earnings and revenues up 100% or greater, with a small number of shares that float.
“These characteristics cause stocks to have large changes in price in shorter periods of time as the Street reacts to announcements about the company.”
Or, to put it another way, it’s not just about strong earnings, but about earnings that (positively) take Wall Street by surprise.
Remember: the market is a forward-looking, or discounting, mechanism.
If the big players were already expecting high double- or even triple-figure earnings (or sales), you’re not going to see a successful EP, followed by post-earnings-announcement drift (PEAD), followed by a breakout and another leg higher.
It’s not just about earnings. It’s about the reaction to earnings.
2. Situational awareness
Last time, I addressed:
To add a few points to this:
Use market cycles to manage risk
When asked how he manages risk, Zanger responded:
“It depends on the market and where we are in a market move.
“The further extended you are, combined with time, the more at risk you become.
“In this case, I start to peel back stocks that are very steep in their angle of ascent and add a few more shares to those just coming out of sound bases.
“I will also start looking for shorts and get prepared to go into cash and add shorts as fast as possible when the trend is broken.”
You could see this as a form of progressive exposure.
A systematic trader who uses discretion
Zanger sees himself as a systematic trader, in that he buys “the same types of stocks with the same types of price action, out of the same types of bases on a continuous basis.”
However, discretion comes into things, too:
“If stocks start to fail on their breakouts, I’ll pass on buying those stocks at that time.
“The market is sending a clear signal that a correction is upon us and it’s time to go to cash and/or look for shorts.
“Also, if the price action isn’t what I like, I’ll pass on that stock, even if it’s coming out of an attractive pattern.”
So, yes, know your market cycles. But also know how stocks tend to act within a particular cycle and, more importantly still, know what type of action you’re looking for to maximise your odds of your setup working.
You need experience
In February 2005, Zanger expressed what many others have said too:
“One must experience every trading situation and market condition to be able to fully take advantage of current circumstances.”
As for his own experience:
“I was doing pretty well until I ran into my first market correction and got my head handed to me.
“What the heck is a correction anyway? Ouch! What a way to learn, by the seat of your pants.”
Many traders learn about corrections like this — the hard way.
However, I believe the opposite applies, too. You also have to learn when to press the gas. That’s something I personally still struggle with.
Again, you have to have experienced every type of market before you can take full advantage of your current environment.
3. Chart pattern nuances
Last time, I addressed:
Putting in the reps
Though Zanger doesn’t use the term ‘deep dive’ to describe his chart-flipping habits, he certainly could have.
In a November 2003 interview, he said:
“Once or twice a day, I manually scan about 1,500 stocks […] and look for interesting behaviour.”
During this period, he’d regularly put in 12-hour workdays.
This theme of putting in an immense amount of work repeats itself with every successful trader. In fact, you see it with every successful person, period.
As I keep saying: this requires finding satisfaction in the process itself. Particularly as a trader.
Remember: consistency requires a process-focused mindset; not one that’s focused on the money or results.
There’s more to an edge than just chart patterns
Zanger sums things up nicely in this interview:
“It’s more than just price patterns; it is the combination of patterns and price action of the stock during the day, plus the strength of the groups that these stocks are in, that makes my stock selections so powerful.
“Indicators are lagging in nature, so by the time they issue a buy or sell signal, or tell you that a stock is weakening or strengthening, the stock might have already moved 5 to 20%. This is way too late for me.
“You have to know the meaning of each daily bar combined with its volume to get in or out of a position at what can often turn out to be critical times.”
Execution
These three elements — stock selection, situational awareness and chart pattern nuances — are vital to Dan Zanger’s system.
However, there’s more than that to his strategy, of course.
As I wrote last week, even the best strategy in the world won’t help you if you can’t execute it.
Let’s look at Zanger’s entry and exit tactics.
4. Entries
Different tactics, same strategy
Zanger said in this interview:
“I look at the stock and its behaviour as it nears a breakout. You can see traders trying to nibble quietly so as to get as much of the stock before it goes.
“With some selected stocks, especially ones with low volume, I try to go with them at this point. You have to be careful though, as this can often go against you.”
Though trading involves following your process systematically, you must also apply discretion, depending on:
Market conditions; and
The characteristics of the stock.
As mentioned in my stack about Mark Minervini nuggets, you can and should deploy multiple different tactics within your strategy. Observe what’s working, and adjust accordingly.
Like a builder or carpenter, you need different tools for different parts of the same job.
For Zanger, his chart patterns reflect some of those different ‘tools’. His website currently lists 11 patterns; in a 2003 interview, he mentioned trading around 20 different setups.
Again, they’re all part of the same strategy but, as discussed last time, different patterns work best during different market environments.
Pyramiding into positions
Zanger also explained:
“When the explosion of volume comes and the stock crosses the breakout point, I will add to, or initiate, a position in the stock if I haven’t purchased it yet.
“If the stock really blasts off, then I back up the truck and get as much stock as I can, because I know we’re going for a ride. […]
“If the stock rockets up, then I know I have a winner. At that point, I’ll add to my position on that stock in a big way.
“This is where the big returns come in: concentration of money in the big movers and selling stocks that fail to rocket out of their bases on the first day.”
Put differently, Zanger doesn’t buy his full position in one go, but pyramids into positions. He buys a small position first, and if it’s starting to work, he buys more — much more. Famously, he makes aggressive use of margin.
Here’s why Zanger starts small:
You never know which trades do and don’t work
“I do buy a lot of stocks coming out of bases, as you never know which ones will rocket up and which ones won’t.” [Source.]
This reminds me of what Stanley Druckenmiller said to Paul Tudor Jones in an interview:
“If you’re going to bet big, you have to be ruthlessly objective about your position. I’ve put on positions I was 100% sure I’d have for two or three years, and ten days later, in my opinion, the facts changed, and I’m out of [those positions]. […]
“I [haven’t] used a stop loss in 40 years, but I have exited a lot of positions. Not because the price was down, but because the reason I bought them was starting to change.”
If even some of the best traders in the world don’t know in advance which trades will end up working, you won’t know either.
5. Exits
With that in mind, knowing when to exit is vital too. Setting a stop loss is a big part of that, of course.
But Zanger takes things a step further:
“If a stock doesn’t accelerate quickly out of a basing area, then I’ll sell the stock promptly during that first day.
“I’ll do this even if I’ve been in this stock for only 20 minutes, regardless of profit or loss at that time. If a stock isn’t moving up sharply right away, then the trade must be wrong.
“Why have my capital tied up in a stock that’s going nowhere when I can be in a stock that’s going up quickly? It’s hard to make money in a stock that’s not going anywhere.
“And of course, if a stock is heading south, then I’m out even quicker.
“Remember my motto: the only good stock is a stock going up.”
As to Zanger’s holding periods generally:
“Some [trades] are as short as 20 minutes. These are the ones with no power, as they usually come out of bases and are sold right away.
“Some of my trades last as long as 10 weeks. Most trades in today’s market [late 2003] are about 6–12 days long.”
What strikes me about this is:
Holding periods vary massively depending on the market. This is obvious, but it’s always nice to see someone spell out specific time frames.
How clear Zanger is on what he wants to see — what it looks like for his ‘train to be on schedule’.
And if his train isn’t on schedule, he sells — no questions asked. He can always get back in if the stock sets up again, as he said here:
“When I’m in a stock, I look at its support trendline in order to know when to sell.
“When the break occurs, I am a seller. No questions asked.
“I have lost too much money by not obeying my trendlines and I won’t let it happen again. If the stock turns around and revalidates itself, I can always buy it back.”
“It’s hard to make money in a stock that’s not going anywhere.”
To come back to this quote, Zanger also said:
“I constantly add to or sell stocks as they move around.
“I sell all or part of my stock’s position as it moves up strongly and then roll that money into new stocks as they come out of fresh patterns.
“As stocks move, so does my portfolio. If stocks don’t move, neither does my portfolio.
“There’s no need to own stocks when they, or the market, aren’t going higher. […]
“There’s only one reason you own a stock in your portfolio, and that is to make as much money as possible.”
There’s always another trade
As Zanger explained:
“Selling securities is by far the hardest thing to do in the stock market.
“You can sell too early and miss a $40–$50 move in a matter of weeks, or you can sell too late and miss $30 to $40 points of profit.
“Knowing when to sell took me longer to learn than anything else in the market.
“An important thing I have learned is that if I sell a stock too early I may miss a $30–$50 advance. Yet, there is always another of my stocks close by that may advance $30–$50.”
With that in mind, Zanger doesn’t use targets:
“I never use trailing stops, but I will sell a position of strong stocks moving up quickly or for long periods of time.
“As far as profit targets go, no one has a clue where a stock will ultimately go. Therefore, I never have targets.
“I allow the stock by its own actions to put me into the trade, and then once again by its actions to take me out of the trade.”
Final thoughts
The approach I took today is a little different to previous stacks, leaving much more in the trader’s own words. Let me know if you prefer one approach over the other!
As to what personally struck me the most from the above:
Once again, many of the same ‘best practices’ crop up with Zanger that I recognise from studying other big momentum swing traders.
The lesson around selling immediately if the stock doesn’t go anywhere, and you bought it, expecting it to explode upwards. Even after just 20 minutes, and even if the stock hasn’t gone down from your entry (yet).
That second point isn’t Zanger-specific as far as the principle goes. Consider David Ryan’s Market Wizards interview:
“Stocks should be at a profit the first day you buy them. In fact, having a profit on the first day is one of the best indicators that you are going to make money on the trade.”
But Zanger is much less tolerant than Ryan in terms of giving the stock room. He knows what he wants his purchases to do — and if they don’t do just that, he ruthlessly cuts them.
As Zanger famously says:
“Winning horses don’t back up into the gate.”
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Kyna, I can't wait for your newest essay to hit my inbox everyweek. Thanks for writing
Situational awareness is a timely subject given the current state of the markets. More gold from Kyna.