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A great samurai warrior possesses the perfect blend of aggression and discipline. Too much aggression, and the warrior becomes exposed to defeat. Too much discipline, and the warrior may never attack. Proprietary trader Mike Bellafiore is a great samurai warrior on the trading desk.

After pushing the eject-button on a career in law, Mike took his razor sharp analytical mind to Wall Street. After surviving the day trading craze of the tech boom in the late Nineties, Mike teamed up with close friend Steve Spencer to launch their own shop: SMB Capital. Although SMB’s core business is proprietary (“prop”) trading, the firm has been on a mission to become the premier training outfit for traders. After sampling a few of their new educational products, I can attest that the SMB team is well on the way to achieving their goal.

I was recently fortunate to sit down with Mike to learn about his career, how he has been growing SMB Capital, and his sage wisdom for traders. As you will see, Mike offers the type of advice seasoned traders have found in an inspirational classic such as Jack Schwager’s Market Wizards. My hour with the samurai was well worth the trek to his compound on the mountain top …

...Damien: That’s a huge technological jump for us to go from the internet and email to you being able to post video trades, audio, and walk people through them. How do you think the technology will continue to affect trading? How does SMB stay in a leadership position when it comes to evolving technologies?

Mike: Great question. We’re developing something called “Secret Project X” [laughing]. We call it that because it really is the next innovation for training. And it’s something I thought about while pretending to watch TV on a Saturday afternoon. We had Gilbert, our head trainer, start working with some of our programmers on implementing this new training technique. That’s what we’re working on right now. It gives people a way to practice their trading in a very focused way that, through technology, was never possible in the past.

What else is gonna come? I don’t know. But we have to embrace whatever technology changes occur in the future. I can think of some very specific things. I think being able to catalog very specific types of trades is something that technology could certainly bring us. In general, I imagine that they’ll be a lot more innovations to teach people better. But the key is for our firm to be committed to a particular goal so when those technological advantages are born we can take them and immediately improve our training.

Damien: How has SMB embraced a new technology such as Twitter?

Mike: About two months ago we had 36 people following us on Twitter. Now we have 1700. That’s a good example of something we have to embrace. What we do is mainly with StockTwits — not so much with Twitter. For example, we offer our best morning idea for a trade. If we’re seeing something, some resistance or support on the tape, we’ll tweet that. If I read an article I think is interesting for traders, I’ll tweet that. Also, during the midday and close we’ll offer our best trading idea. When we post an article on our blog, we tweet that. The genius of StockTwits is they have a community that’s hyper-interested in trading and they’re all together in one spot. We can now communicate with all those people. StockTwits founder Howard Lindzon said it best in one of your earlier interviews: what we have to do as companies is become a global local store. Don’t try and be everything to everyone. Stick with your niche. Become the best at what you do and then offer it not just to people in NYC, but to people in India, China, Russia, and Argentina. I use those countries very specifically because we’ve had contact with those regions.

Damien: How do you expand the global local store in such a way where you don’t grow too fast, you keep everything moving at a healthy pace, and you make trustworthy connections in those countries?

Mike: It’s taken us a couple failed attempts to develop a very concrete strategy because if you do some of these things you’re going to fail. You can’t just blindly reach out to other regions. You need to reach out to the right people in the right ways. So, very specifically, we will teach someone from another region our training techniques and we will insist they bring in people who are trained the way we teach our traders. We want those traders, no matter who they are, to receive the same training our proprietary traders in NYC receive. We need to make sure we’re working with the right people. To grow a firm takes the ability to be entrepreneurial. We have to be patient. We have to be great teachers. We have to be good recruiters. We have to be good traders. So it really depends on getting the right people.

Damien: So, going from local to global is going to take a lot of time if you’re going to take the time to grow each seed and each plant with such tender care.

Mike: Exactly. And again, we’ll bring in those contacts and expose them to how we trade and train. Those people will also have to have the characteristics I mentioned before. And if we find the right people, those are the only people we’ll expand with.

...Damien: Discipline was a major factor for me in overcoming over-analysis. In your blog posts, you often credit your discipline for your success. Can you talk about how you use your discipline and maybe how other traders should?

Mike: Sure. Trading is about skill development and discipline. It’s not about developing the newest, brightest trading technique. My strength is I never make a trade that doesn’t offer an excellent risk-reward ratio: downside one, upside five. I know statistically the trade is gonna work out six or seven times out of ten. I sit around and patiently wait for those setups. As a trader, that’s what you must do. What style works for you? What trades work for you? When you see them, you make them.

Damien: What other key traits would you say someone needs to become a great trader?

Mike: That’s a great question! First, do you have the temperament for trading? It’s very important to have a calm temperament as a trader. Certainly, if you’re a little bit of a hothead you can learn to calm down. But I think it’s a great starting point to be naturally calm. We test for that in our interviews.

Second, no one should attempt to start trading unless they have a true passion for the markets. I think that some people for whatever reason have this idea that they’re gonna go to some hip bar in the city, get introduced to some attractive young lady who is gonna ask them what they do, they’re gonna say they’re a trader, and that is going to help their social life or social status. That is not a good reason to be a trader.

Last, you must have the ability to quickly admit mistakes. You’re not going to be right all of the time. Even me. If I’m wrong 40% of the time with my trades, that’s a great trading day. Again, we test for that in our interviews. There are certain people who have to be right. They are more interested in being right than making money. I’ve seen that with a lot of traders. Guys will just stay in positions claiming the positions will start to come back in their favor.

Damien: Now that we have some key traits in mind, what is your primary framework for trading?

Mike: There are certain trading plays that I have in my quiver, but there are a lot of them. That’s why I’ve been able to make money in very different markets. When I first started trading there was the Asian financial crisis and I was a swing trader. We were relative strength swing traders, for awhile. Then, when the internet came, we had to be momentum traders. You had to be able to play the offer for a point just to be able to make money — no earnings, no fundamentals. So we learned how to momentum trade. Then, when the bubble burst, we had to learn how to play bounces. In 2001, there were eleven rate cuts and there were two historic bounces. One bounce came on January 3rd where the NASDAQ bounced something like fourteen percent. The other bounce was in March where the NASDAQ bounced about eight percent. Those two bounces were our entire year. We made some money around those bounces, but for the most part that was it.

Between 2003 and 2006 I learned how to fade stocks. It was a range-bound market. To pay the bills you had to learn how to fade. From the middle of 2006 to the summer of 2007 it was an up-trending market — a very slow up-trending market. You had to learn how to buy into pullbacks and hold until the up-trends were broken. In 2007 when the sub-prime crisis first hit, we had to learn how to momentum trade from the short side. Then when the financials crashed we had the same thing: momentum trading from the short side.

Recently we’ve had to learn how to trade Exchange Traded Funds (ETFs). At the beginning of 2009 I think a lot of guys on prop desks started to struggle a little bit. But our guys started trading ETFs and FAZ [triple inverse financial ETF]. We were making significant amounts of money just scalping these ETFs.

After all these experiences, along the way I picked up these trading setups to add to my quiver. If I see a setup I recognize, I’m going to make that trade. And it’s substantial. After trading for ten years, there’s a lot of trades in my playbook.

Damien: Do you have any mentors that you have in the world of trading? Are there any specific people that are a must-read for you insofar as getting advice?

Mike: In psychology, Dr. Brett Steenbarger is an invaluable resource. His blog is TraderFeed. Recently, I’ve learned a lot from Corey Rosenbloom at Afraid to Trade. I think Corey does a nice job formalizing the things that I’ve learned over the years. I also read Trader Mike. The Kirk Report is a must-read. Seeking Alpha is a great site for a lot of the traders.

...Damien: Is there a reason why the big banks are cutting their prop trading desks?

Mike: Yes. They made a lot of their money by making the spread. They also made it off the order flow of their clients. There’s nothing wrong with that, but you can’t really do that anymore. They have to actually trade like we’ve had to trade for the last twelve years: with absolutely no advantage, ever. They have to watch the tape, look at charts, understand fundamental analysis intraday, and make quality risk-reward decisions. If you’ve been making money based on order flow and that order flow is gone, I think that’s probably part of the reason.

Damien: Would you say tape reading is a lost art?

Mike: Absolutely. The thing I see with new and developing traders is their lack of ability to read the tape. When we make trading decisions, we read the tape, look at our charts, and have an understanding of fundamental analysis intraday. But I see too many people who just rely on the charts or their own brand of fundamental intraday analysis. They don’t understand how to read the order flow. And order flow gives us a huge advantage. We can truly see the most important levels of a particular stock. So when I tweet a particular level and you see the trade works out, it’s not a coincidence. If you see that level isn’t on your charts, that’s also not a coincidence. Again, we’re seeing the most important levels intraday because we’re watching where the orders are being exchanged. Having this skill enables you to take much bigger positions at very important levels and decrease the risk you would have in a position. It makes your win rate a lot more consistent. Finally, tape reading gives you an edge over a lot of the market players who you’re competing against. We see too many people who don’t know how to read the order flow, and we’d like to see more traders learn that skill.

...Damien: Thanks, Mike. I really enjoyed this real -life Market Wizards interview!

Mike: Thank you, Damien. The team at SMB Capital appreciates your support and interest.

Source: Interview: Prop Trader Mike Bellafiore