Friday, March 27, 2015

Making Your Trading Fist: Five Fingers of Preparation

Coach K has it right: a finger by itself is far less powerful than five fingers joined into a fist.  When a championship basketball team prepares for a game, it doesn't just work on one thing today, another tomorrow, and focus on something else another day.  Rather, it works on fundamental skills and strategies every single day of practice.  That way, each finger of preparation makes a fist of preparation for success.  Coaches know that if a team can't fire on all cylinders in practice, they won't be prepared to give their all at game time.

During my time at Duke, one of the preparation drills for the basketball team was the requirement to make 10 consecutive free throws at the end of practice.  In other words, you couldn't go to the locker room, take your nice hot shower, and get back to your dorm room until you made 10 consecutive shots from the line.  Think about that:  you're tired, sweaty, just wanting to get into that shower--and now you have to concentrate and nail 10 in a row.  Imagine the frustration of making five and clanging the sixth--and then starting over.  Imagine the frustration of seeing your teammates drain their 10th shot and you're still struggling on the line.  

It plays with your head.

And that was the purpose of the drill:  If you could pull it together and make those shots in a challenging practice situation, you'd be better prepared to make that key free throw down the stretch in the heat of a tournament game.  

*That* is preparation:  placing yourself in realistic, challenging situations and training yourself to perform at your highest.  Preparation is not simply writing in a journal or scanning a bunch of charts or reviewing various pieces of research.  Each one of those things is a finger.  Preparation joins the fingers into a fist through full-throttle practice.

Imagine that, after every day, week, or month of poor trading in markets, you had to replay those periods one time unit at a time, make new decisions, and keep replaying those markets until you made the right decisions for the right reasons.  You could not resume real time trading until you successfully relived the periods of bad trading and--in realistic simulation--corrected your errors.

Such an exercise would force you to stay in the right mindset; focus on the right pieces of information; follow the right trading rules; make the right decisions; and manage the positions the right way.  It would join those five fingers of preparation into a practice fist.  

It wouldn't be fun, but it would be a powerful way to ensure that bad trading doesn't turn into bad habits.

Further Reading:  NCAA and Trading Upsets

Thursday, March 26, 2015

Why Courage is Key to Trading Success

As we can see from the above chart, which tracks the five-day moving average of VIX versus the SPX for the past three years, important lows in markets have tended to see spikes in short-term implied volatility (credit to Index Indicators for the chart and data below).  

Interestingly, if we bought SPX when the five-day moving of VIX was less than 15, the next five days in SPX averaged a loss of -.04%.  That would have resulted in a cumulative loss of -3.42% during a period in which the market rose by almost 47%!

Conversely, if we bought SPX when the five-day moving average of VIX was greater than 15, the next five days in SPX averaged a gain of +.52%.  That would have resulted in a cumulative gain of nearly 41%, versus the buy-and-hold of 47%.  In other words, the vast majority of the market's gains have occurred during periods of elevated short-term volatility.

My point here is not to suggest a trading system, though it's not difficult to conceptualize one from the idea of relative volatility spikes.  Rather, the point is that comfortable markets--those with modest volatility--have yielded negative returns.  Uncomfortable markets have yielded the bulk of market returns.  

A trader's returns have been directly proportional to his or her ratio of courage to fear.  Buying ugly markets has made superior returns; stopping out of long positions on ugliness has led to negative timing alpha.  Buying stocks when fear is gone and markets are orderly has not paid off.  

If there's a formula for trading success, prudent courage is not a bad start.  If there's a formula for trading failure, acting on fear--fear of missing out, fear of losses--is also not a bad start.  It's amazing how ramping up trading risk/size and trading frequency can turn prudently courageous traders into fearful ones.  If there's a formula for risk-taking, trading the largest size that enables you to stay prudently courageous during times of ugliness is a good starting point.

Further Reading:  Why Success Lies on the Other Side of Fear
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Wednesday, March 25, 2015

The Three R's: Winning Practices of Successful Traders

For this post, I reflected on the traders I've worked with who have been particularly successful and some of their common practices.  Here are three practices that seem to distinguish the best from the rest:

1)  Reviewing and Learning - The best performers keep score.  They review their performance--good and bad--and they made dedicated efforts to learn from mistakes and best practices.  It's much more than keeping a journal.  The successful traders use their observations of performance to fuel specific goals that they then track relentlessly.  They are not always making money, but they are always learning.  That helps keep them constructively engaged when profits are not flowing.

2)  Rejuvenating - Trading is not an easy business.  Income is very uncertain and markets can change on a dime.  Working twice as hard does not guarantee success, but working half as hard pretty well ensures failure.  Average performance keeps you a job and a paycheck in many areas of life, but in trading it leads to bankruptcy.  Successful traders have strategies for staying happy and healthy through the ups and downs of performance.  My recent post outlines a four-fold scheme for staying happy and healthy.  Successful traders turn wellness into a positive habit pattern.

3)  Reflecting and Preparing - Perhaps the single best predictor of trading success that I've found is the ratio of time spent in preparation relative to the time spent actually trading.  Successful traders spend more time researching markets, observing markets, thinking about markets, and reflecting on their trading of markets than they spend placing orders and managing positions.  A very common pattern of trading failure is ramping up the frequency and sizing of trades, both of which tend to increase the proportion of time spent in a flight-or-fight state and decrease the proportion of time spent in planning and observing.  Successful traders are selective in risk-taking and use the time between trades to work on self and markets. 

So those are the three R's of trading success.  They are all about working on oneself in addition to working on markets.  It's what the trader is doing when not trading that contributes greatly to trading success.

Further Reading:  Traders' Checkup
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Tuesday, March 24, 2015

Best Practices in Trading: Conducting Video Reviews

One of the limitations of reviewing our trading and constructing plans based on our reviews is that our look back usually is tainted by what we recall and what we do not.  Particularly if we trade actively during a day, it's unlikely that we will recollect all the factors that went into good and poor trades.  We may even forget what specifically happened during a particular trade that might have made it work out or not.  Our memories are biased by our emotions, as well as hindsight and the factors that most stick out in our mind.  It is difficult to effectively review our trading if we can't accurately recall our trading!

The way sports teams get around that, of course, is by videorecording each play and examining the video in detail to spot best and worst practices.  Today's best practice is offered by reader Chris Britton, who video records his own trading and uses the review to work on his performance:



"I am a discretionary day trader and I trade the 10 year note and 30 year bond futures.  My pre-market analysis consists of identifying key support/resistance levels (yesterday's value area high, low, vpoc, etc).  For actual trading and getting a feel for the market action, I watch the depth of market with support from a chart to watch for emerging support/resistance levels.  



What I find helpful in doing trade reviews is recording my trading session (using Camtasia or the like).  At the end of the day, I cut down the video to the important parts that consists of trades that I make and trades that I missed or whatever I feel may make an important point.  Then I add in notes on the video that point out interesting clues that I keyed in on or missed.  The finished video is anywhere from 10 to 30 minutes long depending on how many trades I make.  The key points in the video present the context of the price action, the order flow on the depth of market that show why I entered (or did not enter), and, in some cases, why I exited when I did.



How does this help me?  First, the recording helps me identify strengths and weaknesses in my ability to correctly read the order flow.  From that, I have built a library of my own "best setups" or "avoidable pitfalls".  For example, I can review trades that had a successful breakout at some resistance level and compare the order flow from those to trades that had a failed breakout.  The key element is spotting what the order flow was doing that made the difference between the two.  If my skills can't explain it, then at least I have the library to review in the future for when my order flow reading skills will be improved.  



Second, the trade reviews at the end of the day are actually enjoyable.  Even if a trade is a loser, I enjoy watching the video.  That is because in some way, I improve my depth of market reading skills. Before I was making recordings, I dreaded the losing trade reviews and trying to remember what I did wrong.  That opened the door for bias to creep in which make learning from the mistakes harder.  With the recording, I learned that I can't escape my own accountability in making errors.  



Finally, play back reviews during slow periods or on the weekends actually help keep my mind sharp and prepare me for the next trading session.  I have found that while watching these reviews, the dialogue in my mind takes on an instructor type role where I try to explain the play by play action."

I particularly like Chris' observation at the end, where he notes that watching reviews places him in an instructor role.  That reflects the impact of self-coaching.  When Chris watches the videos, he is like a coach reviewing game film with players.  Going to specific portions of the video, reviewing the elements of performance in detail, and noting what could be done differently adds a level of detail to review that is impossible to replicate with a retrospective journal.  As Chris notes, the reviews become enjoyable, because they are constructive--they teach--and don't simply point out negatives.  

If pattern recognition is a function of cognitive focus and amount of exposure to those patterns, then a focused, video-based review is a great way to accelerate a trader's learning curve.  The trader who has watched markets during the trading session and then focused on patterns in post-market review simply has more learning experience per unit of time than the trader who fails to conduct review.  The video review is a powerful tool for learning and self-coaching.

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Monday, March 23, 2015

New Perspectives for a Market Monday

*  Above we see a chart of the total number of SPX stocks making 5, 20, and 100-day new highs vs. new lows each day.  Note the tendency of this multiperiod breadth measure to top ahead of price during intermediate-term market cycles.  The measure has remained strong recently.  Interestingly, going back to 2012, when the multiperiod measure has been positive (more stocks making new highs than lows), the next five days in SPX have averaged a gain of +.15%.  When the measure has been negative, the next five days in SPX have averaged a gain of +.71%.  Yet another example of how momentum trading (buying strength and selling weakness) has not worked for stock index traders in recent years.

Fascinating research on how we can live longer lives, which is also how we can live happier and more successful lives.  Very important topic:  sacrificing quality of life ends up sacrificing life.

*  Trading when you have a full-time job and other valuable insights from Abnormal Returns.

*  Great post from WindoTrader on the importance of preparation in the success of elite performers.

Interesting cross currents in the volatility market from Volatility Made Simple.

*  Crosshairs Trader on the psychology behind three types of traders.

Valuable trading lessons from SMB.

Have a great start to the week!

Brett

Sunday, March 22, 2015

Best Practices in Trading: Maximizing Your Information Processing

The typical trader works from multiple screens and each of the screens carries multiple pieces of information updated in real time.  Some screens update charts; some update news; some are for messaging; some track quotes across many markets.  No trader wants to miss a fast-breaking development, so the temptation is to add screens and add more data to each screen.  Can traders really process all that information in real time?  How much of what appears on our screens truly is information--and how much is distraction?

Today's best practice comes from Terry Liberman from WindoTrader.  He emphasizes the importance of understanding and owning your trading information processing system.  Years of experience in developing effective trading platforms have taught Terry quite a bit about how traders process information.  His key point is that we cannot maximize our processing of market information unless we understand our information processing strengths and play to those.  One of the unusual features of WindoTrader is the ability to overlay information displays on one another, so that the trader can visualize price action on several time frames simultaneously.  For a highly visual information processor, this can provide a significant cognitive efficiency.

As Terry points out, the best practice of streamlining information to fit your processing style is increasingly important, given the explosion of data available to traders:

"As we know, there is no shortage of information because this is the Era of Information Overload on Steroids.  The important thing for those of us who trade is to be able to quickly and easily find the information that meets our requirements as to relevance, usefulness, applicability, and fit.  

One way to think about information processing is to recognize that data are not information and must first be converted into information through your filters of relevance, importance, and applicability.  Once they become information and meet your criteria as information, you now have knowledge and some understanding of it so you can make some decisions about it.  And then, once it meets your requirements, decide how you're going to act on it in alignment with your performance criteria.

To increase your ability to collect the information your require and process it, begin with the information you need, why you need it, and the benefit it will specifically provide you at this moment in time.  Next, determine both the context and the content of the information as well as its validity overall and its validity for you.  And finally, plan the specifics for using it and gaining the most from it in your pursuit of achieving your goal or goals.  To read something fun as well as thought provoking, check out Information Anxiety."

Terry makes a very important point:  trading is, at root, a cognitive process.  It is all about taking in data, assembling data into information and insight, and making decisions based upon the ongoing streams of information and insight.  How much of what is on our screens is truly essential to our decision making?  How many screens would we employ and how cluttered would each screen be if we only focused on the data most relevant to our trading decisions?

Streamlining our information processing forces us to think about our thinking and follow our chains of reasoning in generating sound trading decisions.  Terry's best practice is not just optimizing our screens; it's optimizing our thought processes and then adapting our screens to the best of our processing.  More is not better; many times it's fast information processing that is as important to trading as deep information processing.  By carefully organizing what is on our screens and how it is displayed, we can improve the efficiency as well as the effectiveness of our thought processes.

Further Reading:  What Trading Teaches Us About Life
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Saturday, March 21, 2015

Best Practices in Trading: Breaking Your Cycles

The first step in changing any damaging behavior pattern is interrupting it.  When we interrupt a pattern, we necessarily stand apart from that pattern.  We control it and refuse to let it control us.  When our patterns show up during trading--patterns of negative thinking or patterns of poor trading--a surprisingly powerful response is to simply pause what you're doing, identify the negative pattern, and refuse to let it control you.

One implementation of this idea comes from reader Eldad Nahmnay, a daytrader who shares his five minute rule:

"After reviewing my trading, I saw that I had a lot of repetitive trades.  By this I mean that less than five minutes after I had closed a trade, I was back in a new one.  Usually this occurred after a losing trade.  This made me realize that I hadn't accepted the loss completely and was looking for a sort of revenge.  After understanding this, I added the five minute rule:  after a trade, I close the system for five minutes when I ask myself the following questions:  What have I done well for this trade?  What can I take away to help with later trades?  Do I have any open emotions that can affect me later?  Did I do anything that violated my trading rules?  

After answering these questions, I take a minute or two away from the screen to come back fresh.  The number of poor trades that I took was reduced by more than 70% after I implemented this rule."

Notice this Eldad's rule is really a routine to develop mindfulness in the middle of the trading day.  By taking a break after closing each trade, he is able to stand apart from markets (and his reactions to markets) and ask himself key process questions.  The five minute break interrupts any negative patterns that may have leaked into his trading and helps ensure that a single bad trade doesn't become a series of bad trades.  By instituting the break after every trade, the trader turns mindfulness--and the breaking of negative cycles--into a positive habit pattern that gives both perspective and control.

Further Reading:  Brief Therapy and Becoming Your Own Trading Coach
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Friday, March 20, 2015

Best Practices in Trading: Creating Checkups for Your Trading

There's a lot to be said for a periodic checkup from the neck up.  It is easy to talk ourselves into trades, veering from our edge in markets.  How do we know if we're truly aligned with our best practices?  That's where checklists and checkups can be very helpful.

Today's best practice comes from Mike Bellafiore and Steve Spencer from SMB Capital.  They describe a twice-weekly checkup that helps ensure that junior traders are truly rigorous in their selection of trading ideas.  They describe the process that occurs on their trading floor:

"Each Tuesday and Thursday at 1:30 PM EST we meet in our firm training room in midtown Manhattan for...The PlayBook Checkup.  The PlayBook Checkup?  What, is someone sick?  No, there are no doctors or nurses present; just traders and developing traders.  This is a best practice that has helped our traders identify and maximize their trading edge.

Here's how it works.  A junior trader on our desk prepares a trade in template form--an SMB PlayBook trade--of a setup that makes sense to him or her.  Then, he/she presents this trade to other traders in our training room.  I host this learning session with tough questions to the trader regarding stock selection, a trade catalyst of lack thereof, preparation or lack thereof, thinking, and execution.  Here I 'checkup' on the favorite trades of our new traders--their edge.

The junior trader breaks down a favorite trade into five variables for their presentation (the SMB PlayBook Template):

a.  The Big Picture
b.  Intraday Fundamentals
c.  Technical Analysis
d.  Reading the Tape
e.  Intuition

Each day our new traders archive a setup that made the most sense to them before they leave the trading floor.  From these PlayBook trades they choose one to present under the pressure of constructive scrutiny during the PlayBook Checkup.  They know to choose wisely and be ready to defend their trade.

Some phrases heard in our training room during these sessions:

*  Yeah, don't make that trade again.  You are not going to make money trading plays like that.
*  Where could you have been bigger in that trade?
*  How the heck did we allow a Boston Red Sox fan into this firm?
*  You have to be bigger in this trade.  You are leaving money on the table by not being bigger.
*  If you are not going to properly prepare for a trade, what makes you think the market will let you succeed?
*  This is exactly the type of trade you can build a career around.

Here's what the PlayBook Checkup helps traders accomplish:

1.  Define their favorite setups
2.  Eliminate setups not worth their intellectual, financial, and emotional capital
3.  Guide traders to internalize their trading edge with their PlayBook
4.  Helps traders learn good risk/reward trades from their peers
5.  Offers them a trade review by a trading partner with a deep dive into a specific trade setup
6.  Provides a forum where standards of quality trades for our desk are set
7.  Teaches them how to think through their setups like a pro
8.  Builds an opportunity for us to bond, joke, and share a common learning experience"

This is a great example of how trading can become an effective team sport.  Steve and Mike institute the checkup as part of their training program, but in fact this is a process that any trader could implement with one or more trading buddies.  It enables traders to think about their thinking, hone their edges, and learn from each other.  The cumulative impact of engaging in such checkup review each week is significant.

Further Reading:  The Power of Teamwork in Trading
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Thursday, March 19, 2015

Why Endurance is the Key to Trading Success

There is no characteristic more important to long-term trading success than the ability to weather setbacks and turn them into successes.   It 's not just that successful people endure longer; it's that they gain energy--they derive challenge--from the endurance.

Think about this:  losers are motivated by winning.  They need to win to thrive.  When they don't win, they lose their motivation, and that keeps them from winning.  Winners are motivated by losing.  Their struggles develop their strengths, and that contributes to future wins.

Yesterday was a kick in the teeth for some traders.  Anticipating a prompt pace of Fed normalization of rates, they were expecting a strong dollar and higher rates.  We got just the opposite.

The winners are those reassessing monetary policy, reassessing views and positions, reviewing what they might have missed, adapting to the new information, and learning from the experience.  When trades don't go their way, they may pull back their risk-taking, but they double down on effort, preparation, and the generation of ideas.  

It is that determination to gain from loss that gives the competitor a second wind.  When we're focused on losses, we get winded.  When we're focused on using struggles to better ourselves, we find our wind.  It's tough to finish a marathon race without accessing that second wind.

Further Reading:  Peak Performance Articles
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Wednesday, March 18, 2015

Tracking the Breadth of Market Strength and Weakness

I thought I would share a continuing work in progress.  This is composite index of all NYSE stocks giving buy vs. sell signals for two different technical systems:  Wilder's Parabolic SAR and Bollinger Bands (raw data from Stock Charts).  The chart above tracks a 10-day moving average of the index.  The index provides a general sense of "overbought" and "oversold".  Interestingly, the overbought readings do not lead to reversal on average.  Rather, if we look at the strongest half of signals since June, 2014 (when I began assembling these data), the next three days in SPY have averaged a gain of +.24%.  When we look at the weakest half of signals, the next three days in SPY have averaged a gain of only +.01%.  When many stocks are producing buy signals, there tends to be short-term upside momentum.  When many stocks are producing sell signals, on the other hand, we want to be on the lookout for potential reversal.

Note that we've been seeing overbought and oversold levels in the index at successively higher price levels.  That is what we would expect in an uptrend.  Where I've found the index to be particularly useful is in identifying momentum peaks that tend to precede price peaks during intermediate-term cycles.  The index has also been useful in identifying when we are getting buying interest coming out of oversold levels.  That is what we've been seeing most recently.  I like these kinds of measures, because they tell you how much distinctive strength and weakness we're seeing across the broad range of stocks.

Further Reading:  Identifying Trend Days
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