Lessons From A Market Great: Randy McKay

Summary

• Randy McKay was an enormously successful trader who started his trading career by turning $2,000 into $70,000 in the newly formed currency futures market.
• Randy McKay eventually parlayed his stake of under $10,000 into over $10 million over a 20-year period.
• This article discusses some strategies he used to fuel this performance, as well as specific trades that led to him building his fortune in the futures markets.

In my quest to make today's traders aware of the market greats that are more obscure than the prominent names like Buffett, Graham, Dalio, and Paulson, Randy McKay deserves a top seat on the list of these underrated super-traders. McKay is one of the few famous traders that did not have a rough start which involved some significant setbacks, as McKay was incredibly successful almost from day one. During his first calendar year, he managed to parlay his stake of $2,000 into over $70,000. From there out, there was no looking back. McKay's style is different than most traders as he uses fundamentals in an unconventional way, which was a pivotal component to his success. The below article will discuss core beliefs of McKay's style as well as specific trades that helped McKay to build his fortune.

Randy McKay's early life deviates from that of most traders as he spent what were supposed to be his college years on a tour of duty in Vietnam. He ended up getting drafted after flunking out of his college classes due to a lack of attendance. While he could have got an easier job in the Reserves as his father was a Colonel, McKay decided to take the Marine route as he felt it was his obligation to serve. After returning from Vietnam, McKay worked as a runner on the floor of the Chicago Mercantile Exchange (CME). His big break hit when his brother who was a floor-broker gave him a free seat he received when the International Monetary Market was launched. Before this, seats fetched a price tag of $100,000 and were way out of McKay's budget.

The British Pound Trade

In 1976, the British government announced it was not going to allow the Pound to trade above $1.72. It was concerned that the Pound's strength would lead to increased imports. The Pound at the time was trading near $1.65. Despite this news, the market did not back off, instead it rallied up to $1.72. This surprised McKay as he detailed in the below quote:

"Most of the people I knew said, 'they're not going to let it go above $1.72, we might as well sell it; it's a no-risk trade'. I saw it differently. To me, the market looked like it was locked limit-up. I felt that if the government announced that they were not going to let the price go above a certain level, and the market didn't break, it indicated that there had to be tremendous underlying demand. I thought to myself, this could be the opportunity of a lifetime".

(Source: Market Wizards by Jack Schwager)

Despite what seemed like an obvious trade that made lots of sense to the majority of speculators, the price action was telling a completely different story. If the British government indeed could keep a lid on the Pound, one would have expected the Pound to drop like a stone on this news. Instead, as we can see from the below chart from 1977, the Pound just traded in a range below the $1.72 level with clear support. This price action was what prompted McKay to purchase the Pound and put on his largest position ever (at the time), as the price action was telling a completely different story than common sense would have suggested from the fundamental backdrop. This is a great lesson from McKay on why it's so important to watch price action when making trading decisions and not look solely at the fundamentals. While the fundamentals give us of an idea what should happen in our view, they do not tell us how other market participants will act on this information. The only way to figure out the collective opinion and decisions of the majority of market participants is by monitoring the price action.

(www.poundsterlinglive.com)

Eventually the British Pound pushed through the $1.72 level and McKay had managed to build up a position of over 1,000 contracts near $1.70 which he sold out above the $1.90 level. He ended up netting a profit of $1.3 million on this trade over the course of less than six months.

McKay On Fundamentals

"I watch the market action using fundamentals as a back-drop. I don't use fundamentals in the conventional sense, that is, I don't think: supply is too large and the market is going down. Rather I watch how the market responds to fundamental information."

(Source: Market Wizards by Jack Schwager)

When it comes to fundamentals, everyone seems to be an expert on what a stock or market should do based on several different factors from the supply/demand picture to current policies. The problem with having a bias based on the fundamentals is that it does not allow one to be objective if the price does something different. While an argument can be made that a market should go up if demand is increasing worldwide and supply is shrinking, this is not always how the market works. The reason for this is because one never knows if the market already baked this into the price cake ahead of time as the market is typically forward-looking. I have found McKay's way of looking at fundamentals to be wholly objective and fascinating as it deviates from how most traders/investors use fundamentals. Not only has his use of fundamentals in an unconventional way been extremely profitable over his career, but past events that McKay traded off of have rhymed with current events providing insight into how a market might act.

We've seen great examples of this from the fundamentalists that have been arguing for years that the end of Quantitative Easing would mark the top of the bull market in the S&P 500 (SPY), and the other group of perma-bears in 2012 that told us that issues to do with the European Debt Crisis would be a death knell for the US Markets. The fact that the market was able to not only hold its own but also put in a 13% gain in 2012 in the midst of this was telling us all we needed to know. The market was climbing a wall of worry and shrugging off any bad news that was thrown at it. This told us there was clear underlying demand for US stocks.

McKay provides an example of his unconventional use of fundamental analysis from the early '90s:

"On the eve of the US Air War against Iraq, gold (GLD) was trading near the crucial $400 level. The night our plans started the attack, gold went from $397 to $410 in the Far East markets, and closed the evening at about $390. Thus, gold had broken through the critical $400 level starting the rally that everyone expected, but it finished the evening significantly lower despite the fact that the United States had just entered the war. The next morning the gold market opened sharply lower and it continued to move down in the following months."

(Source: Market Wizards by Jack Schwager)

As McKay discusses from the above example of gold, apparently it was not acting as favorably as it should and did not provide any "fear trade" or safe haven. While gold initially climbed over resistance the night of the news, it was unable to hold onto this level and immediately headed lower. While not as extreme, we saw a similar event play out just last year. When news hit of North Korea firing a missile over Japan last August, many gold bugs were beating their chests and rolling out their $2,000/oz projections once again. While gold briefly rallied on this, the metal was unable to get through the critical $1,360/oz level which was similar to the crucial $400 level back in 1991. By the time the second set of missiles was launched over Japan on September 15th, gold had already topped out at $1,360/oz and barely saw any reaction. This was confirmation that the gold market was not responding all that favorably to what should have aided in the metal in finally busting through stiff resistance at $1,360/oz. Gold slid immediately after from $1,340/oz to $1,260/oz and then saw yet another failure at $1,360/oz earlier this year. The fear trade or safe-haven characteristics that investors in the metal were looking for were not at play, despite tensions coming to a head in Q2 2017. It's fascinating that the market played out similarly twenty-six years later and once again continued lower.

(Source: TradingView.com)

I believe McKay makes some excellent points and has a unique way of using the fundamental news to his advantage. Ultimately his belief is that price is the final arbiter, but he pays extra attention to when a market cannot rally even with the favorable fundamental news. The reason for this is because if a market cannot mobilize and make new highs on some of the best news that traders could hope for, what is going to help it finally move higher?

McKay On Taking The Meat Of A Move

"When the trade was easy, I wanted to be in, and when it wasn't, I wanted to be out. In fact, that is part of my general philosophy on trading. I want to catch the easy part: the meat of the move. The beginning of a price move is usually hard to trade because you're not sure whether you're right about the direction of the trend. The end is hard because people start taking profits and the market gets very choppy. The middle of the move is what I call the easy part. I never try to buy a bottom or sell a top. Even if you manage to pick the bottom, the market could end up sitting there for years and tying up your capital."

(Source: Market Wizards by Jack Schwager)

(Source: TC2000.com)

The third point by McKay is also very fascinating as it goes against popular trend following tenets and relates to one of my recent positions. I was long nearly a full position in Netflix (NFLX) from $98.00 in Q4 2016 and only started taking a significant amount of profits in the first half of this year at an average price of roughly $340.00 per share. The easy part of the move was from $100 to $350, but the stock started to see higher volatility, and this is why I reduced my position significantly. It's entirely possible that the stock heads higher from here as it's still in an uptrend, but I prefer to capture what I believe is the easier part of the move where the trend is the least volatile.

The move from $98.00 to $400.00 had no 20% pullbacks, but the most recent decline has seen the stock come off by 27%, which is a minor change in character. I sold into the parabolic move earlier this year at $417.90 as I thought things were getting overheated from a sentiment standpoint and sold more after the volatile decline off of these highs. While I am still long a 1/3 position in the stock from my initial entry at $98.00, I believe the easy money in Netflix has been made. This does not mean the stock cannot continue higher, but like McKay, I prefer to protect my profits when I think I'm likely in the latter innings of a move. I've never cared for catching the exact bottom nor catching the exact top, and when I've made a nice profit in a stock, I will happily reduce my position and move that money into a new uptrend.

McKay's point is also applicable to those who have been taking a bite out of mining stocks for the past several months. While there's no question that the valuation among mining stocks has improved from the 2016 peak while the Gold Miners Index (GDX) traded at over $30.00, markets rarely ever bottom on fair valuation. This is especially true in volatile cyclical sectors like gold or silver miners where we can see massive overshoots to the upside and downside. Just like Barrick Gold (ABX) did not belong at $55.00 in 2011, it didn't likely belong at $6.00 in 2015 either. Having said that, buying before a move begins is an enormous opportunity cost as McKay points out. While there are a few miners that have barely gone below their Q1 lows like Yamana Gold (AUY), Eldorado Gold (EGO) and Pan American Silver (PAAS) for example, these stocks are still down for the year and have been money pits. While these stocks are down double digits, there are several growth stocks like Amazon (AMZN), Visa (V) and Mastercard (MA) that are up double digits.

As McKay states: While you may catch the bottom in a market if you do get lucky or have great timing, the market may sit there for months or years before it finally decides to get going. This is why I personally never bother with bottom-fishing. It is not enough to get the best price and get the exact low, but one also needs to hope that a new uptrend will finally start to put an investor or trader at a significant profit and reward them for catching that low.

Even if an investor managed to catch the exact low print of $0.80 in Eldorado Gold at the end of March, they are still only up 10% on their position. Meanwhile a stock like Mastercard is up over 40% with significantly less volatility and while paying a small yield.

(Source: TC2000.com)

(Source: TC2000.com)

McKay On Losing Traders

"Sometimes the reason people lose is that they are not sufficiently selective. Upon analysis, a trader may find that if they only concentrates the trades that do well, and lets go of the other types of trades, they may be successful. However, if a trader analyzes their trades and still can't make money, then they should probably try another endeavor."

(Source: Market Wizards by Jack Schwager)

The final point that McKay makes is another great one which discusses the problem I notice with many losing traders, especially those that are short-term. So many traders I see when frequenting message boards seem to need to always be in a trade. Instead of placing 50 great trades per year and stalking their trades, that money is burning a hole in their pocket and they're constantly fishing for ideas even from other traders on what they should be buying this second. I believe the best trades come when one is patient as a great trade should be brutally obvious, you shouldn't have to force it or spend time convincing yourself that it's a good trade. Great trades stick out like sore thumbs and typically come to the trader, especially those traders that are patient.

By always needing action and needing to do something, traders are tying up capital that could be in great trades as they are too impatient and have to be in something for the rush and excitement. These traders are in most case gamblers and should be in Vegas or at the local casino instead. Unfortunately, most losing traders will not admit to this as no one likes to admit that they are gambling. The market should be dull, and trading should be boring the majority of the time. While there are exciting periods every once in a while, if one is always in a rush trading, they are most likely not doing it correctly. This is why early on in my trading I decided to focus on following traders with a sound plan that were unemotional; I would never try to learn from someone that described their trading as fun or exciting.

Randy McKay's journey is beyond impressive given his 20-year track record with only two losing years. His ability to transform less than $10,000 into over $10 million in less than twenty years is unrivaled by most traders except Ed Seykota and a few other heavyweights, and his style above gives some insights into why he was so successful. McKay did not fight price but embraced it; he was not greedy but also aimed to take the easy part of trades, and he was patient when it came to placing his trades. An unemotional, patient and objective plan for trading the markets is the only way to be consistently profitable in my opinion. McKay exuded all of these traits, and it's no surprise that he enjoyed the success that he did.

Disclosure: I am/we are long AMZN, MA, V, NFLX, UPRO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.