Exclusive Interview: Prop Trader Mike Bellafiore at SMB Capital

Mike Bellafiore

Mike Bellafiore

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 …

Mike Bellafiore Quote

Damien Hoffman: Mike, like myself you’re a lawyer by training. What made you switch boats from lawyering to trading?

Mike: I was in my third year of law school and recognized the law wasn’t something that was going to excite me. My best friend from home, Steve Spencer, invited me to New York City for a dinner party. Steve and his roommate from Wharton [School of Business], Jared Kaban, put on the full court press and convinced me I should consider trading with their firm. So I did. In a nutshell, it was the best opportunity I had graduating from law school.

Damien: What was your reaction when you first saw the trading room and the other guys trading?

Mike: My first reaction is to laugh just thinking about it. Remember this was really back in the day, so when we first started trading there were no charts. Also, there was no CNBC or news feed. We had one computer — and it was that old tube-like big, out-of-date computer. In fact, there was no air conditioning [both laugh].

Damien: What year was that?

Mike: 1998. When it got too hot our solution was to send a bunch of runners for ice cubes and ice cream sandwiches [both laugh]. We were in an unimpressive building at 50 Broad Street. The ceilings were 7-8 feet. We were crowded together, and I probably had six inches to my right and six inches to my left. I think I got to share a phone with one other person. It was certainly not the picture of a really rich Wall Street firm you would see in the movies. But, the environment was competitive, filled with guys who really loved to trade, guys who were making a lot of money, good guys, and funny guys. Even with that unimpressive infrastructure, it was still a great opportunity.

Damien: It sounds like a lot of fun.

Mike: It was!

Damien: How did you blossom from that environment and jump ship to start your own shop?

Mike: That’s a good question. After a year at the firm I made enough money to trade my own account. And, for almost a decade, that’s what I did. Then I got to the point where trading wasn’t enough for me. I wanted to do something more — something bigger for lack of a better word. At the time, I recognized there was a bunch of upstart firms that were bringing in traders. I started to think about how I had learned a lot over the previous ten years and I had some skills that lent themselves very well to starting that kind of firm. We write well, communicate well, and teach well. So, I got the crazy idea I could start my own firm.

I went to talk to Steve about it and, in typical trader fashion, his response was “Why would I want to do that?” [laughing]. He immediately calculated the loss of trading income that would result from having to recruit and teach traders. But after a while I started to explain to him the niche that we could carve out. We could be the best training desk on the street. We had the skills and a unique perspective because we had been traders for so long. We understood that maybe sometimes firms are not sensitive enough to traders. From this unique perspective we could see what we could create, how different it would be from the firms out there, and how much more value we could create for the trader that, for whatever reason, wasn’t present in prop trading at that moment.

Damien Hoffman: What were the first things you targeted to differentiate yourself from other firms?

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Mike Bellafiore

Mike: Very clearly, to create the best teaching desk on the street.

Damien: The other firms weren’t focused on teaching?

Mike: When I first started trading, I think firms were doing as good as they could. Let’s go through a little history lesson. When I first started trading I was trained by probably one of the 50 best day traders of all time. I got the best training I could have when I started. But of what did it consist? The training consisted of me sitting behind a superstar trader for a week, then for the next year and a half I sat next to a tremendous trader. You would think that was a terrific opportunity — and it was at the time. But, I really learned through osmosis because the superstar trader had five positions open with ten thousand plus shares trading in and out at lightning pace speed. If I asked him a question, he would, if he had time, answer it. But he was involved in huge positions and that’s the way I was taught.

In 2006 we saw that technology enabled us to do better. And that’s what we’ve done at our desk. We’ve taken this opportunity we have with technology to teach people better. For example, I can offer — and this certainly wasn’t available in the late ‘90s — a video with audio commentary of the trades that I’ve done during the day. I can break down the best trades I’ve made and show you. We can go in our conference room and review trading tapes from one of the guys on our desk and Steve or myself can critique that trading. We can say, “That was great you loaded up there,” or “Took too much risk there.” We can actually review exactly what our trader has done and offer suggestions. At the desk we can offer an audio feed in real time to exactly what I’m doing. So if you’re trying to learn you can be connected to me. And this is on our desk or remotely over the web. I can tell you what I’m thinking, why I’m buying, why I’m selling, etc. So, technology changed the game. It allowed us to teach much better. This is how a small firm like us broke through. This is how we found our niche. We have made a mission to use this technology, what we have learned over the years, and focus all of our energy on providing the best training to differentiate ourselves.

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 catalogue 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: That sounds like a lot of work. How do you balance your time between managing a growing business and trading your own book?

Mike: I actually let Steve trade as much as he wants, so he literally trades every second of the day [laughter]. Our head trader, Gilbert — affectionately known as Gman — gets to trade every second of the day as well. I do most of the teaching and communicating on the open and close with the newer developing traders. I only trade the open and close. During the midday, I’ll start to make sure we’re getting our work done. I’ll make sure our recruiting, teaching, mentoring, and new business is being handled.

Damien: So, you’ve reduced your time at the trading desk?

Mike: I have. If it’s a really active day I’ll trade all day long. Even though I’m only trading three hours a day, I’m still one of the top five most active traders on the desk.

Damien: Does your experience allow you to be active is shorter spurts of time?

Mike: Yes. Unless the market is incredibly active like it was in fall 2008 or summer 2007. There are still a lot of trading opportunities for me on the open and the close. I would love to trade the entire day. I kid with guys at our desk all the time that I hope one day to be the absolute worst trader on my desk and for the guys who I teach to go out and run our firm. Then, I can sit in some corner somewhere trading all day long and they can call me the old guy and point me out and make fun of me. That’s what I want.

Damien: [Laughing] That goes with the idea that if you surround yourself with the smartest possible people you’ll find the path to success.

Mike: Exactly.

Damien: Now that we’re talking about trading I have a few questions to drill down to. First, I’ve noticed a legal mind can be excellent for trading when used to find loopholes. However, I’ve noticed legal minds can be horrible for trading when the person is an over-analyzer. Mike, as a successful trader, what aspects of your legal mind have been most valuable to you in trading?

Mike: I think in a very logical way. One of the things we teach at our desk is to prepare ‘if-then’ statements for every trade you’re going to make. So at the end of our training program we roll out statistically profitable trades based on our time frame. For example, we look at consolidation plays, support plays, breakout trades, momentum trades, etc. We teach our traders to develop their own ‘if-then’ statements for each of these trades and the subsets of these trades. If I traded and you were to sit down next to me you would see that every single trade I make makes sense. I know why I’m in it, where I’m gonna get out if I’m wrong, where I’m gonna get out if I’m right, I can tell you exactly what type of trade it is, and the catalyst for why I got in.

The exercise we use for our new traders is very similar. If I’m walking around the trading desk, which I do quite often, I’ll tap on somebody’s shoulder when I see they’re in a position and I’ll say, “Why are you in that position?” They should say, “I’m in this position because it’s a consolidation play. If I see X, then I’m gonna get out. If I see Y, then I’m gonna buy more. If I see Z, then I’m gonna scale out.” Thinking very logically — especially in ‘if-then’ statements — is my strength.

I’ll say this though. I totally know what you mean about over-analyzing. I drive my friends nuts with this stuff. If we’re deciding where to go out to eat, I’m useless. I will start to process all of the options we have, and it will take me fifteen minutes before I decide where we should go. On the other hand, they just want to go get something to eat [laughing].

Damien: [Laughing] I know how that goes. It’s built in.

Mike: It can be a curse at times.

Damien: I raised this point because when I first started trading day trading more than swing trading, I was overanalyzing everything because we got stuck in that Holy Grail thing. As I scaled back and started to simplify my indicators, I moved very rapidly from being mediocre to having very high levels of success. But it wasn’t easy to unlearn the tendency to over-analyze.

Mike: I can see that. Over-analyzing is one of the things we try and screen for when we interview a candidate. A lot of really smart people have that issue. They have trouble admitting they’re wrong. For example, if you’re right six out of seven times, you’re downside is one and your upside is five. So, you must make the trade. You can’t control the result or aim for 100% success.



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.

Lastly, 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: How has the playing field changed since you started trading?

Mike: When I was in law school and making trades, I had to get on the phone and call my broker. Even when electronic trading first started, the specialist would hold your order for like a minute before you could actually get stock. So the prop trading desks at the big banks made money by making the spread. Today there are firms where guys spend an awful long time developing electronic trading skills and never make money off the order flow like guys were doing at the big banks on the prop desks. However, we made money by actually looking at the tape — looking at the order flow — and determining stocks that were strong or weak. These skills have put us in a position — especially now that many of the banks are getting rid of their prop trading — where firms like ours, and we’re not the only one, are going to be very big players. And it’s not just going to be in the US market. It’s going to be in a lot of different markets because this is how people trade. People trade electronically at a computer, and that’s only going to expand. So, for us, it’s just very interesting to see how this playing field has changed, especially at home. For someone like yourself, and people that are reading you, there is no reason why someone who is not in NYC, someone who does not work at a big bank, can’t become a terrific trader. That didn’t used to be the case. But now the playing field has been leveled.

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: I’m excited to follow up soon on that specific point. I’m looking forward to showing our audience how they can read the tape and learn that skill to get an edge.

Mike: We’re excited to do that with you once you settle in with the new baby.

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.