How to Spot a Market Correction Five Months Away

Editor's note: Chances are, you may not be familiar with the name Greg Diamond.

After he spent 13 years working for hedge funds and pension funds, where he managed multimillion-dollar portfolios across various asset classes, we were thrilled when Greg joined our Stansberry NewsWire team last year. And we're even more excited to launch his brand-new publication, Ten Stock Trader.

His background as a Chartered Market Technician ("CMT") means he takes a different approach to the market than most Stansberry Research analysts.

In today's Masters Series – an exclusive interview with Greg – he talks about his professional background... why he "couldn't care less" about fundamental analysis... and how he was able to successfully predict February's market correction last September...

How to Spot a Market Correction Five Months Away An interview with Greg Diamond, editor, Ten Stock Trader

Sam Latter: Greg, a lot of our readers may not be entirely familiar with you and your work history. Before coming to work for Stansberry Research, you were working for one of the most storied and successful hedge funds in America.

If you don't mind, can you tell us a little about yourself and how you ended up working here?

Greg Diamond: Sure. I got my first trading job at one of the oldest hedge funds in the country.

We had a 24-hour trading desk, with Saturdays off. On a typical day, we'd get in at 7 a.m. and trade 30 to 50 options with about 15 of the top banks around the world. Throughout the day, we had foreign-exchange, commodity, and futures trades worth more than $1 billion. We traded on a lot of leverage. It was a big operation.

Around 4 p.m., the Asia shift would come in. My job toward the end was to run the books for the 24-hour foreign-exchange market. That meant we would have all these different models that would come through and tell us which orders we needed to place over the next 24 hours. We were responsible for executing these trades and letting the Asia and Europe desks know what we needed to buy and sell.

In late 2008, right in the midst of the financial crisis, I was working on the Europe desk. Every day, I would come into the office at 1 a.m. and I wouldn't leave until mid-afternoon. The world was just falling apart. So I would get in and I would have a huge position in German blue-chip futures, for example. The market would open at 2 a.m., and at 2:01 a.m., I would sell it all and watch the markets go. It was a crazy environment.

Eventually, I decided I wanted to step into the world of portfolio management and making my own investment decisions. As a trader at the hedge fund, I could decide when to trade, but I didn't get to choose whether to be a buyer or seller. Everything was based on a model.

Plus, I saw how certain financial advisers behaved, and how they just cared about gathering assets. I wanted to take the knowledge I had gained working at the hedge fund and a multibillion-dollar pension fund, and trading across all kinds of different asset classes, and help people out.

That's what I wanted to do, and ultimately that's why I ended up here. Working at Stansberry Research was my ultimate goal.

Sam: What makes you different from the other analysts at Stansberry Research?

Greg: For one, I'm not sure how many of my fellow colleagues have worked on a large trading desk with as many asset classes as I have.

I'm talking about futures, currencies, commodities, equities, gold, silver, copper, corn, wheat, soybeans, lean hogs, cattle, cotton, coffee, sugar, crude oil, gasoline, aluminum, nickel... all of that stuff.

Beyond that, unlike just about everyone else at Stansberry Research, most of what I do has nothing to do with stock-picking or fundamental analysis. Whereas most of my colleagues determine the value of a stock based on their financial statements and balance sheets, I couldn't care less about a stock's fundamentals.

Of course, if you're buying a stock and planning to hold it for years, fundamentals are critical. But in the short term, fundamentals don't matter.

Sam: So to be clear, do you ignore fundamental analysis all together?

Greg: Fundamental analysis has its place. But what I focus on more is technical analysis.

Some people think technical analysis is synonymous with "chart reading," and that it's all trends and triangles. But it's much more advanced than that... And I want people to think about it in a completely different way.

The history of the market is nothing but people buying and selling. Understanding that history means understanding the market. History never changes – it just goes in cycles. The way people behave goes in cycles, which influences what we see in a chart.

Of course, trends do matter. To borrow a phrase from trading legend Marty Zweig, you don't want to fight the "tape," meaning you don't want to go against major market trends. It takes time and experience to be able to tell when a trend is starting or ending.

Reading charts is part of technical analysis, too. But the biggest component is understanding that technical trading is more about behavioral finance and understanding time and price. Human behavior – meaning what investors are doing in the markets – never changes. And if you can study that history and obsess over patterns, you'll have a better understanding of what's going to happen in the future. That goes in cycles.

Sam: How did you get interested in technical trading?

Greg: When I was 22 and working at the hedge fund, I was studying to be a Chartered Financial Analyst (or "CFA"). My boss worked for Paul Tudor Jones, a living legend and one of the best traders who has ever lived. He came in and asked me what I was doing. I told him, "I want to get my CFA and learn more about the markets." He told me he'd give me $1,000 to set my textbook on fire. I was 22 at the time, so I said, "Where's my match?"

As my boss explained, "It's not that fundamentals don't matter. But to achieve high returns and exceptional trading results, you have to understand how markets move, what markets move, and the psychology behind why markets do what they do."

He explained that fundamentals are backwards-looking. So when the market comes out with something fundamental, it's always what happened, not what's happening. He told me, "To beat the market, you have to know what is happening right now. And technical analysis does that." I dropped the CFA materials and started studying to become a Chartered Market Technician right away.

Sam: A lot of the chart patterns associated with technical trading sound like gobbledygook to investors. The "head and shoulders" pattern, the "cup and handle," "flags," "pennants," "wedges," "double tops and double bottoms," etc.

Are these legitimate ways to make money, or are they some sort of inside joke among traders?

Greg: It's not an inside joke. But where people get it wrong is that they don't understand the total concept of technical analysis. They just look at a pattern and think, "This is what has to happen."

Technical analysis has three different components: understanding the pattern, how to trade it, and how to manage risk. Patterns come into play, but sometimes they fail.

Trading is just like boxing. The No. 1 rule of both trading and boxing is to protect yourself at all times. People are afraid of losing, and they don't understand that losing is part of the game. As long as you properly manage your risk, your winners will more than make up for any minimal losses you take along the way.

Sam: Back in September, you warned Digest readers about a potential correction you saw setting up in the market as early as spring. How on earth did you see that coming?

Greg: It was all based on something called "time cycles." This is a type of technical analysis developed by a legendary trader by the name of W.D. Gann in the early 1900s. And what Gann found was that markets move in symmetrical cycles, meaning that it can be easy to predict tops and bottoms in the market.

Time-cycle analysis can be confusing. There are cycles within cycles, cycles in other markets, and short- and long-term cycles.

But in this case, I saw a familiar setup on the Dow Jones Industrial Average. You see, a previous 26-month period from 2009 to mid-2011 looked remarkably similar to the chart pattern we were seeing back in September.

I noted that if the market continued to be symmetrical, we could see our first 10%-plus correction in nearly two years in the spring...

Sure enough, the time cycles proved correct again as the market fell 10% in early February.

Sam: Another thing I've noticed about making these kinds of predictions is that it seems like there are a lot of "secret" relationships between asset classes.

Greg: You're right. Some move together, and some move in opposite directions.

The dynamics of those correlations change over time. The perfect example that we're seeing right now is interest rates are going up and the U.S. dollar is going down... but gold and silver aren't doing anything. When I see that, I see a huge dislocation in the market. In this specific environment, it is signaling that the precious metals market isn't pricing in a panic despite the stock market volatility we're currently seeing. Oftentimes, gold and silver will be a "safe haven" trade for investors during crises.

These correlations have to do with the cycle we're in. For instance, in a period of high growth, interest rates are going to go up and bonds are going to go down. The dollar should be rallying with that as well, because as interest rates go up, your currency will strengthen. But that's not happening yet. This dislocation won't last forever, and it's a real opportunity for investors.

Sam: Prior to working at Stansberry Research, you were sometimes moving nearly $1 billion a day in trading volume. Were any of your trades particularly memorable?

Greg: Two stick out.

The first was at my hedge fund during the depths of the financial crisis. I had several trades during this particular day to sell close to $1 billion worth of U.S. dollars. I called one bank and got that trade off at a decent spread, meaning I didn't have to pay way above market prices to get the trade off.

Everyone knew what we were doing, so they were front-running us – essentially racing to place their orders before we could. And in the foreign-exchange markets, it's like the Wild West. There's no insider trading – everybody tells everybody what's going on.

So I would call a bank up. Let's say I call Goldman Sachs and say, "Show me a price in 500 euros." Goldman says, "OK." But because the Goldman employee was in a room with 15 other salesmen and 20 traders, the salesperson I spoke to wouldn't say he was on the phone with my firm.

We were one of the biggest foreign-exchange trading firms on Wall Street. That meant if the rest of the salesmen and traders caught wind of it, everyone would pile into the same trade, and I would get a lousy price. So we started to use code names. The guy on the other end of the line would just call me "Ryan."

The second trade happened at the pension fund. It was the last trading day of 2012. On the last day of the year, we had to rebalance our portfolios. Essentially what that means is that at the end of every month, quarter, and year, an asset manager has to rebalance its portfolio and decide whether to allocate more or less money to an asset class. At the end of the year, when you're managing a multibillion-dollar portfolio, those rebalances tend to be big. That year, we had a huge rebalance... but I was the only one in the office.

I had about $600 million worth of equity futures to buy. I was marked against the close, meaning if I didn't do anything and I just waited for the close, I didn't make my firm any money. And if I just bought everything in the open and it closed lower, I would lose my firm millions of dollars.

I had to really be in tune with what the market was going to do that day. I knew that when I started buying 100-, 200-, 300-, 400-contract lots – which is huge – it was going to move the market.

Asset managers get paid based on every basis point that they outperform the benchmark. I ended up making more than four basis points for the firm in a single trading session. That doesn't sound like a whole lot, but every basis point was worth about $1 million... So I ended up making the firm about $4.6 million in one day.

Editor's note: Greg just released a brand-new presentation detailing the types of setups he looks for in the market and what he's looking at right now. Watch this free presentation – and learn more about his brand-new product, Ten Stock Trader – by clicking here.