Sunday, June 04, 2023


Contact For Trading Firms and Media:  steenbab at aol dot com

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RADICAL RENEWAL - Free blog book on trading, psychology, spirituality, and leading a fulfilling life


The Three Minute Trading Coach Videos


Forbes Articles:

My coaching work applies evidence-based psychological techniques (see my background and my book on the topic) to the improvement of productivity, quality of life, teamwork, leadership, hiring best practices, and creativity/idea generation.  Trading firms, teams, and portfolio managers interested in performance coaching and help with hiring processes can email me at steenbab at aol dot com.  Please note that my work is limited to trading and investment firms, so I cannot provide online advice or coaching services to individual, independent traders


I wish you the best of luck in your development as a trader and in your personal evolution.  In the end, those are one and the same:  paths to becoming who we already are when we are at our best.


The Greatest Challenges of Trading Psychology - III: Mindset


In the first post of this series, we took a look at how one of the greatest challenges to our trading psychology comes from approaching the process of expertise development the wrong way, unwittingly creating stresses and trauma that impact our subsequent learning and trading.  The second post examined how we often view financial markets incorrectly, looking for our edge in trading without properly recognizing that these edges are continually changing.  Doing the same thing again and again in the name of discipline is a great way of getting run over--and damaging your mindset--when markets shift.  

In this post, we will explore how the wrong view of mindset leads traders to trade poorly and ultimately hurt their psychology.  Many traders seek an optimistic and even aggressive mindset in the desire to make meaningful money.  By emphasizing the outcome of trading, they ensure that their mindset will rise and fall with their P/L.  An important performance principle is that focusing on the outcome of performance typically gets in the way of performing.  Does a great painter, while creating a work of art, spend time thinking how much the painting will sell for or whether it will be displayed in a famous museum?  Does a surgeon, performing a procedure in the emergency room, dwell on how wonderful the outcome will be?  Positive self-talk may have its place in our psychology, but surely not in the middle of our performances.  For peak performance, we don't want an aggressive mindset, a positive mindset, or an excited mindset.  We want a focused mindset.

This doesn't mean that we eliminate all emotion from performance.  The flow state is one in which we are so absorbed in the doing of an activity that we lose our sense of time and our self awareness.  That is a pleasurable state in itself and a powerful motivator for those who love what they do.  It's in that flow state that we're most likely to be productive and achieve our best efforts.  Interestingly, the flow state is also our greatest source of creativity.  Quite literally, we see markets better when we are highly focused on what markets are doing.  Our self-talk takes us out of flow and often places us in an aroused, fight-or-fight mode in which narrows our perceptual frame.  It's when we're focused and in a state of emotional well-being that we're most likely to act on opportunity.

This is why a major theme of the Radical Renewal online book is that great trading comes from the soul and not from the ego.  When we are outcome-focused, we are ego-focused and that takes us out of the zone of the flow state.  The right trading mindset is absorbed in markets, opening us to the intuition of implicit learning.  It is not coincidence that my research has found that intellectual curiosity is a number one predictor of trading success.  The truly successful traders are motivated by the process of doing and learning, not just by the outcomes of trading.  When we value learning and growing, we can always extract reward from trading, even when profits aren't there.  

As Earl Nightingale points out above, we are always programming our minds.  What we focus upon, we become.  From that perspective, if there's nothing more important to you than profits and losses, you've already lost.

Further Reading:


Sunday, May 28, 2023

The Greatest Challenges of Trading Psychology - II: Ever-Changing Markets

The first post in this series took a look at how one of the greatest challenges to our trading psychology comes from failing to navigate the process of expertise development.  Too often, traders put their capital at risk before they have properly undergone a process of learning grounded in deliberate practice.

In many performance fields that learning process continues throughout one's career.  As soon as a surgeon masters surgical techniques, new approaches to surgery (microsurgery, robotic surgery) come along and promise better outcomes.  That means that physicians always participate in continuing education, updating and upgrading their skills.

Similarly, in business, consumer interests, needs, and demands are ever-changing.  As technology changes, what consumers wanted yesterday (high performing cars) ends up being very different from what they want today (electric motors) and tomorrow (self-driving vehicles guided by AI).  The successful business thus always reinvents itself.  

Financial markets are ever-changing, and that means that any single "edge" in trading cannot be permanent.  A stationary time series is one that is relatively stable with a constant mean and standard deviation.  Tosses of a fair coin form a stationary time series.  I recent asked ChatGPT4 whether financial time series in the stock market are stationary and the response, in part, was: 

"No, stock market time series are generally not stationary.  Stationarity refers to a time series that exhibits constant statistical properties over time, such as constant mean, constant variance and constant autocovariance structure.  In the context of the stock market, prices and returns tend to exhibit non-stationary behavior.

Stock market prices often show trends, meaning they have a tendency to increase or decrease over time.  Additionally, stock market returns typically exhibit volatility clustering, where periods of high volatility are followed by periods of low volatility, and vice versa. These characteristics violate the assumption of stationarity."

What this means in practice is that the patterns exhibited by the market at one point in time can be very different from other times.  Any trading "setup" that worked in the recent past has no guarantee of working in the future.  Volumes change as market participants change.  That alters volatility and trends.  Just like the surgeon or business person, the successful trader has to reinvent themselves to find new sources of "edge".  Failure to detect market changes and adapt to those is one of the greatest challenges to our trading psychology.  In such cases, it's not simply that our psychology undermines our trading.  Our inability to recognize market shifts creates our drawdowns--and that undermines our psychology.

Many traders ground their edge in a particular set of market conditions:  trend, momentum, bullish or bearish movement, etc.  This makes these traders inherently vulnerable.  The real edge in financial markets is the ability to detect when markets change and identify the nature of that change.  Too many traders simply label markets as "directional" or "choppy".  They make money in the directional markets and lose money in the chop.  This has recently been the case among many stock market traders.

A more promising view is that there are at least three kinds of markets:  trending, cycling, and rotating.  It is often the rotating market that appears to be choppy and impossible to trade.  If, however, we recognize the nature of the rotation, then we can trade trends and cycles in the strongest and weakest market sectors.  (Consider tech stocks and real estate shares in the recent market, for example).  In the rotational market, we have to look under the hood to see what is trading in coherent patterns.  That might point us to AI stocks; it might point us to regional banking shares.  In other macro markets (FX, rates, commodities), rotational conditions might lead us to trade in relative terms rather than outright (long West Texas Intermediate crude vs. short Brent crude, for example) or trade spreads within a given asset class (trading shapes of the yield curve in rates, for instance).  

A successful approach to trading would not first look for trends or reversals.  It would look for conditions of stationarity.  We would first identify what is trading meaningfully.  Not one in ten traders do that.  They look for *their* kinds of markets and impose their meaning onto what they're trading.  That is fertile ground for emotional upheaval. 

Because markets are ever-changing, we must be ever-flexible.  Just as a football team adjusts its offense to field conditions and the defense they're facing; just as a restaurant adjusts its menu to adapt to a new breed of young diner, we have to adjust our trading in the face of markets that sometimes trade in trends, sometimes in cycles, and sometimes rotationally.

An open and flexible mindset is best positioned to be a positive mindset.

Further Reading:

Sunday, May 21, 2023

The Greatest Challenges of Trading Psychology - I: Trauma


There is a common assumption among traders that if they are falling short of their performance expectations, it must be because of their mindset.  If only they can maintain a positive mind frame, the thinking goes, they will be able to succeed.  There is an element of truth of this, and there is an important sense in which it is seriously misguided.

Research suggests that, when we are in our best frames of mind--and especially when we are operating with optimal well-being--we will be more productive and also more creative.  We will engage in our best trading when we are trading consciously, with what I have called a high mental Sharpe ratio.  The right kind of trading interests us, gives us energy, and doesn't deplete us.  The positive mind frame is both a contributor to good trading, and it is also the result of good trading.  Importantly, the proven change methods of psychology can help us find, not only positive emotional experience, but a deep spiritual fulfillment.  That can help make trading personally as well as financially rewarding.  In that sense, trading is not simply about making money.  It is one among many paths toward becoming the greatest person we can be.

It's a logical fallacy, however, to assume that because positive mindset is necessary for optimal trading, then trading success will necessarily follow from improving our mindset.  Negativity can interfere with the performance of an elite athlete, but reaching that elite status requires far more than a positive mind frame.  Mastery is a complex combination of inborn talents, available opportunities, and skills acquired through deliberate practice.  No amount of positivity can substitute for the experience required to gain mastery in any performance domain.  Trading the right way is just as likely to generate positive emotional experience as positivity will help our trading.  

Notice that, in any performance field, the process of gaining mastery is separate from the process of professional performance.  That is, a basketball team will practice offense and defense during the week before playing a weekend game; a singer will practice with a coach before performing in a concert; military troops will practice maneuvers before entering the battlefield.  One of the greatest challenges of trading psychology is that market participants spend relatively little time in pure practice mode and instead hope to gain their experience by putting their capital at risk.  They even justify this by claiming that practice modes cannot duplicate the pressure and stresses of live trading.  Can you imagine battlefield commanders or professional golfers foregoing practice because the stresses are not the same as in actual performance?  It is precisely by cultivating skills through deliberate practice under increasingly realistic conditions that we develop our mastery.

What happens psychologically is that traders who put their capital at risk too quickly encounter losses and P/L volatility that they are not prepared for.  These are experienced as dangers and threats to one's trading successes.  When we take risk too quickly and when we take too much risk in search of high returns on capital, we create emotional upheaval.  This turmoil does not just go away because we tell ourselves to be disciplined and to have a positive mindset.  It is the nature of trauma to stay with us and to be triggered by future experiences similar to those past losses.  I've described this as the dark side of trading:  with unrealistic expectations of profit and premature risk-taking, traders expose themselves to significant emotional turmoil that ultimately unhinges their future performance.

Because market conditions change frequently, even experienced traders need to revisit their learning curves and gain fresh mastery.  If they continue to trade aggressively and with large size based upon past success, they will be vulnerable to significant drawdowns when market themes, trends, and volatility change.  The most successful traders maintain their high mental Sharpe ratios by quickly detecting market changes, avoiding losses, and returning to a mode of observation and practice to gain mastery in the new regime.  If our overriding need is to get bigger and bigger and make more and more money, it's only a matter of time before we traumatize ourselves.  

The best way to learn is to fail fast.  The best way to fail fast is to fail small.

Further Reading:


Sunday, May 14, 2023

Greatness as a Mission-Driven Life

A heroic life is one driven by a noble purpose, an all-absorbing sense of mission.  Past posts have asked the question, "What is the Path to Your Greatness?" and explored what makes for greatness in life and trading.  When we think of life's heroines and heroes, we inevitably focus on people whose lives have been devoted to a noble purpose and who have persisted in the face of challenge to accomplish things that make the world better.  Not all obsessions are paths to greatness--plenty of traders become obsessed with the ups and downs of markets but never invest in the skills, tools, and processes that would build their mastery.  It is difficult to imagine a great life, however, that does not have an overarching sense of mission that becomes a singular focus and theme.  A great life cannot be lived randomly or comfortably.  It has to be mission-driven, in which activity is organized around constructive purposes and challenges.

As Ayn Rand pointed out, we can forgive many people and their shortcomings, but "not those who lack the courage of their own greatness".  It is difficult to imagine a betrayal greater than avoiding who we are and what we can become.  For many of us, greatness seems to be a bridge too far.  The solution-focus in psychology offers a very different perspective.  It tells us that the answer to our challenges is not simply to fix our problems.  Rather, we need to identify what we are currently doing--even in small measure--to be the person we seek to become.  Greatness consists of doing more and more of what we are already doing when we are at our best.  In the talents and passions we experience in the present, we can identify our future:  our missions and our paths to greatness.  

The first step toward a mission-driven life is to live an hour and then a morning, and then a day absorbed in a purpose that speaks to us and gives us energy.  We know we are on the path of our mission when we achieve the peak states described by Maslow in which we are fully absorbed in what we're doing.  Those flow states are ones in which we find our greatest creativity and productivity.  For many of us, those moments of flow are all too few and fleeting--but they *do* occur.  Our challenge is to identify what we're doing when we're most passionate and turn those peak moments into an enduring sense of mission.  Once we recognize that greatness is not an end point, but rather a process for living life, our mission becomes clear:  to live each day meaningfully, purposefully, and creatively in pursuit of a quest worthy of our greatest efforts.

Further Reading:

Blueprint for an Uncompromised Life:  Part One, Part Two, Part Three


Sunday, May 07, 2023

Revisiting the Momentum Curve: Anticipating Market Turns

Back in 2014, I wrote about the Momentum Curve and how it is useful in visualizing market breadth and strength/weakness across different time frames.  It's almost nine years later and I have maintained the Momentum Curve database.  The dataset goes back to 2006 and captures the percentage of stocks in the SPX universe that are above their 3, 5, 10, 20, 50, 100, and 200-day moving averages.  I then look at what the market did going forward, from 1 to 50 days, following various configurations of the curve.

In June, I will be participating in my first webinar in quite a while, as part of the TraderLion conference.  The session will be a group coaching session, in which attendees can bring in their questions and challenges and I will respond with best practices in evidence-based psychology and among successful portfolio managers.  Preceding the coaching session, I will review the Momentum Curve and its application to the present market.  This will offer a nice illustration of how quantitative analyses can great aid our discretionary trading judgement.

As it happens, we recently (on Thursday) hit a point at which fewer than 40% of stocks were trading above their 3, 5, 10, and 20-day averages.  Out of over 4200 days in the database, this has occurred 621 times.  Over every forward time frame, from 1 to 20 days out, the market has--on average--displayed superior returns.  For example, the average next twenty-day return following the oversold occasions has been +1.42% vs. +.55% for the remainder of the sample.  Indeed, we did see a nice trend day higher on Friday.

As the initial article indicates, these analyses provide hypotheses, not firm conclusions.  If we observe a strong historical tendency for a move and then current market behavior follows that tendency, we have the possibility for a trade with the proverbial wind at our back.  I'll offer other examples and applications in the webinar; stay tuned!

Quick update (5/11/23; 9:27 AM ET) - The bounce in the market since the historical study posted above has been choppy at best with very mixed breadth.  If a historical tendency doesn't play out, it's important to ask whether something is making the current situation different or unique.  I'm struck by how few market participants I speak with are taking the prospect of U.S. debt default and large, it's not on their radar.  With only two percentage points standing between the former and current U.S. Presidents; the former President speaking favorably about default; and a Speaker who owes his position to supporters of the former President, could we be in for a constitutional crisis?  I find it important to ask questions and use what-if scenarios for trading and financial planning.


Further Reading:

The Psychology of Quant Analysis

Using Breadth to Track Market Cycles


Sunday, April 30, 2023

The Art of Asking the Right Questions

Note the premise of the Cooperrider quote above:  our questions create our world.  If you want to know--truly know--someone, find out the questions they are asking.  For years, I've participated in recruitment at hedge funds,  helping hire portfolio managers and members of portfolio management teams.  In their interviews, many candidates want to talk about what they know.  Instead, it's worthwhile probing about their questions.  What answers are they seeking?  

Research at multiple money management organizations finds that the number one trait of successful traders is intellectual curiosity.  Not discipline.  Not achievement motivation.  Not the ability to control emotions.  What makes for greatness is the unquenchable desire to learn and know.  Show me a person who isn't actively asking questions and I'll show you someone with a limited capacity to learn and develop.

An important role of trading coaches is helping market participants ask the right questions.  Many times, the questions we find ourselves asking are ones about ourselves:  mistakes we've made, ways we can make more money.  The right questions, however, are often about markets:  how they are moving, what is driving them, the patterns they are displaying.  The focus on trading psychology naturally leads traders to look inward, but the best questions involve the markets and the unique opportunities they are displaying.  It's from new questions that we can generate fresh answers and directions.  I recently began to explore rotational flows within the equity markets: which sectors and industries are strong and weak, and the degree to which they are moving together or separately.  It turns out rotational days display very different opportunities from trending days and need to be traded quite differently.  Focusing on what I think the market will do--and especially on what I want it to do--is a great way to blind myself to what it's actually doing in real time.

What two or three things can I do today to make my day successful and fulfilling?  What can I do to make the week a success, personally and professionally?  What is the one change I can make in my life to improve my relationships?  My energy level?  My connection to my community?  When we ask the right questions, we become more able to live life intentionally. 

Against that backdrop, the one true failure in life is to live an unquestioned--and unquestioning--life.  Life on autopilot is a static life, a life that falls far short of our potential.  Recently I found myself wanting to wake up earlier in the morning and get more accomplished before my usual appointments.  I asked plenty of questions about how I could get myself to start my day earlier.  All were the wrong questions.  Eventually, the right question came to mind:  What could I tackle first thing in the morning that would be so challenging, interesting, and stimulating that I would *have* to wake up early?  The wrong question was about time management.  The right question was about establishing the right priorities.

What are the questions you're asking about your trading?  Your relationships?  Your life?  Those questions will define the answers you find and, ultimately, they will shape the world in which you live.  

Further Reading:


Sunday, April 23, 2023

Three Best Practices for Making Lasting Life Changes


When my colleagues and I reviewed the research literature on psychological change processes, an interesting finding came to light:  It's relatively easy to make changes and relatively difficult to sustain those changes.  This is best appreciated in the field of addiction psychology, where relapse is viewed as an intrinsic part of the change process.  Much of what is written in the area of trading psychology focuses on making changes, with less focus on ways of making those changes stick.  Too often, our efforts at change are like our New Year's resolutions:  well-intended, but fleeting.  Fortunately, research in psychology points the way to making changes last.  Here are three best practices that can help us turn negative patterns around, build new and healthy patterns, and make those changes enduring parts of our lives:

1)  Associate your desired changes with distinctive states of mind and body - Perhaps the most important finding from the aforementioned review was that change is much more likely to last if it is accompanied by shifts in emotional experiencing.  In counseling and therapy, for example, people are most likely to change and hold onto their changes if they are  frustrated by their old patterns and enthusiastically involved in the change process.  Simple talk with a coach or counselor, in itself, is not enough.  It's when we acutely feel the need for change and are eagerly involved in making changes that we are most likely to internalize new ways of doing and viewing.  I recently spoke with my grandson, Ed, who has made a daily commitment to hitting the gym and engaging in rigorous workouts.  Interestingly, as his body has developed, so has his mindset.  In the pumped up state, he internalizes a new sense of himself--and that carries over to many areas of his life.  Similarly, traders I've worked with have reached out to teammates and peers to make a new process a shared experience, creating a fresh social/interactive source of motivation.  Energized by the experience of mutual discovery, those traders find themselves more focused and energized in their trading.

2)  Integrate your desired changes into your daily routine - Ultimately, we want to turn our changes into positive habit patterns, so that we don't have to rely on motivation to do the right things.  What I have found most helpful is to make my desired actions a part of my early morning routine, so that each day begins as a change experience.  Suppose, for instance, that we wanted to develop ourselves spiritually.  Simply thinking spiritual things or reading spiritual texts won't necessarily help us internalize our own spirituality.  Engaging in active prayer or meditation each morning, on the other hand, provides us with a daily, positive, soul-full experience.  Similarly, if we want to become a more caring and loving family member, we have to go beyond good intentions and thoughts and actively set aside time each day for quality time with our loved ones.  Yes, I wake up early in the morning and give my cats food and water and hugs because I love them, but it's equally true that I love them because I spend committed time with them each day.  We become what we do.  A great way to make large changes is to make small changes consistently and build on those.

3)  Keep doing new things - Routine is necessary to build positive habit patterns, but life becomes stale when it is dominated by routine.  Yes, we have reliable and consistent trading processes--and we need those--but we grow when we tackle fresh ways of trading, new markets, and different strategies.  Of course, we engage in those new efforts with small size initially so that we can survive our learning curves, but the joy of discovery and learning pays significant dividends that energize all of our work.  When we make innovation part of our personal and professional lives, we engage in an evolutionary process, where each new thing that we do is a "mutation".  Many of these novelties will not have adaptive value--hence the wisdom of "fail fast"--but the few that thrive will sustain our development and become springboards for yet further innovations.  Imagine tackling one innovation each week.  If only 10% of those efforts prove useful in the long run, we will have gained five profitable additions to our trading.  There are other benefits as well.  Psychologically, the excitement of discovery provides us with the fuel to sustain new learning and, over time, enables us to internalize a sense of creativity and productivity.

There is so much more to changing our lives--and our trading--than writing in a journal and adding items to our "to-do" lists.  Expanding our routine keeps us locked in routine.  Change comes from fresh experience:  it's a function of doing new things in new ways and regularly reshaping our routines.  To build on Churchill's insight above, to change often--and find our perfection--we must live life creatively. 

Further Reading:

Cultivating Winning Habits


Sunday, April 16, 2023

How to Assess the Personality of the Stock Market

Unsuccessful traders look for markets to trade in a style that fits *their* personality.  They look for momentum or trend or reversals of "overbought" or "oversold" moves.  By imposing their biases on markets, they become inflexible and unable to adapt when the market's personality changes.  

Lately, we've seen the stock market's personality shift literally from day to day, as range-bound action has alternated with strong directional moves.  Traders who expect the market to follow themes related to macro and fundamental developments (shifts in inflation, interest rates, economic data, earnings, etc.) have found this rapid shifting of market action to be challenging.  Many traders look for consistency from day to day--thematic continuity--when the market is behaving more like a market of stocks than a unified stock market.  Consider:  over 70% of consumer discretionary stocks (XLY) and energy shares (XLE) closed over their respective five-day moving averages on Friday, but that was true for only a bit over 30% of consumer staples stocks (XLP) and only 20% of real-estate shares (XLRE).

The opposite of a trending stock market is not a choppy market.  The opposite of a trending market is a rotational market.  Many times, the market will indeed follow themes, but the themes play themselves out in relative terms.  Perhaps growth stocks are outperforming defensive sectors; perhaps small caps are outperforming large cap stocks.  The patterns of what is strong and what is weak define the themes for a given market session.  

Part of the challenge of short-term trading is that we cannot blindly assume that yesterday's patterns of strength and weakness will play themselves out today.  Rather, we have to first sit back and observe the various components of the market and how they're behaving to identify today's market personality.  This is key to trading psychology:  an active trader (as opposed to an investor) does not attempt to predict market action based on top-down criteria.  The active trader waits to see the bottom-up activity that reveals the patterns of trading here and now.

Several tools are helpful in assessing the market's personality from day to day:

1)  Volume (and especially relative volume) - How does the volume at a give time of day today compare to yesterday's volume at that time of day and the usual volume at that time of day?  If volume expands meaningfully, we want to see how stocks are behaving with the new market participation.  This will tell us who is participating and whether that participation is showing up in trending behavior or in the relative strength of one market segment vs. another.  Conversely, when volume dries up, we want to see how different parts of the market are impacted by the lack of participation.  What moves directionally in a quiet market tells us an important story.

2)  NYSE TICK - How many stocks are trading on upticks vs. downticks as we move forward in the session and--most crucially--how is the upticking or downticking impacting the price of various segments of the market?  We recently had a range-bound day in the morning that displayed strong selling pressure with negative TICK numbers.  Many parts of the market failed to make new lows on this selling.  The absorption of the selling pressure alerted the savvy trader that sellers would be trapped and, sure enough, their covering helped create a trending move during the day.  Very often, new extremes in the TICK numbers alert us to strong buying or selling interest--and how that interest moves the market (and different parts of the market) tells an important story.

3)  Short-term overbought/oversold readings - I use the adaptive moving average system from John Ehlers, which shows how shorter-term moving averages cross below and above longer-term ones.  The adaptive part is that the readings for short-term and longer-term change depending upon the cyclical character of the market.  As Ehlers has pointed out, this helps remove whipsaws from the indicator.  Basically I want to see short-term oversold levels occurring at successively higher price lows or short-term overbought levels occurring at successively lower price highs.  When sector ETFs show different patterns of overbought and oversold, that highlights a rotational market.  In a strongly trending market, the cyclical quality of the price action will break down and we will get prolonged overbought or oversold readings across multiple market sectors.

An important edge comes from being quicker than other participants to see how the market's character is playing itself out--and how it might be changing over time.  Many traders underperform because they fail to see relative themes playing out in real time.  If your trading is habitually bullish or bearish, you know that you're not doing a good job of assessing and following the personality of the market.

Further Reading:

Adapting to Changing Markets


Sunday, April 09, 2023

What Makes for Success: Five Perspectives From Trading Psychology


Here are a few observations from my recent research and work with traders:

1)  The success of a trader is directly related to the speed by which they turn losing trades and drawdowns into actionable improvements.  The best traders engage in active review processes to ensure that they learn from setbacks.  Those reviews also allow them to learn from successes.  A major source of poor performance among traders is failing to engage in timely and regular deliberate practiceSuccessful market participants study themselves intensively, just as they study markets intensively.  Unsuccessful participants don't study; they are too busy trading.

2)  There are two types of traders:  a) those who are risk-takers and need to learn to limit losses; and b) those who are risk-minimizers and need to expand gains.  We tend to manage our trading the way we manage risks and rewards in other areas of life, because--ultimately--we are managing ourselves emotionally.  The challenge is to understand how we are wired and how to best express and manage that in our trading.  Many trading problems occur when we attempt to take risk in ways that interfere with our self-management.

3)  I'm hearing more from relatively inexperienced traders who are harvesting money by selling option premium.  It makes me cautious.  The history of 2023 thus far has been for game-changing news to greatly impact how markets trade--and how they trade relative to one another.  Note the recent interest in the shadow banking system and its vulnerabilities:  here, here, and here.  After recent banking concerns, it wouldn't take much of a headline to throw markets into a tizzy.  The idea is to maintain flexibility even when acting decisively.  Maintaining "conviction" has not worked well for many traders thus far this year.

4)  Recent posts have focused on breadth as measured sector-by-sector--and especially the phenomenon of breadth thrusts.  My latest research examines differences in breadth between U.S. sectors and how these are related to SPX returns going forward.  At present, consumer staples shares are outperforming consumer discretionary stocks by a pretty good margin over 5 and 20-day periods.  Going back to 2020, when that has occurred, next 10-20 day SPX returns have been negative and significantly below average.  Shifts to more defensive positioning among sectors appear to precede overall market weakness, an idea I'll be exploring in detail going forward.  Breadth shifts may be as important to forward returns as breadth thrusts.

5)  Imagine that you are at a racetrack and you are allowed to alter your bets at set intervals during the race.  No doubt you would alter your risk taking as the race evolves.  The best traders develop good bets, but then actively update risk and reward over the life of the trade to maximize gains and minimize losses.  The inability to update one's "bets" in the face of changing market conditions has been a major source of performance problems so far this year.  Many traders lack a robust process for walking forward and updating risk and reward in real time.

Further Reading:


Sunday, April 02, 2023

Breadth Thrusts in the Stock Market: What Comes Next?

The previous post noted a late week bounce in stocks that had a defensive quality, with consumer staples and utility shares outpacing stocks in such sectors as energy and consumer discretionary.  On Monday there was another bounce, but the percentage of energy shares above their five-day moving averages went from about 22% to almost 96%.  The beaten down real estate stocks went from 43% to 63%; financials went from 17% to 58%.  Consumer discretionary shares went from 25% to 46%.  Tuesday the overall market (SPY) dipped, but again we saw a rising percentage of XLY, XLE, XLF, and XLRE stocks above their five-day averages.  By Wednesday, fully 94% of all SPX stocks were trading above their five-day moving averages.  In other words, we went from a defensive market theme to an aggressive one, creating a breadth thrust:  the great majority of shares participated to the upside.  This strength continued through the week.  The change of market theme was signaled by a shift in the patterning of market breadth.

So what does this market breadth thrust suggest going forward?  We can look from two perspectives:

1)  The presence of strength - I went back to 2006 and identified all market occasions in which more than 90% of SPX stocks were above their 3, 5, and 10-day moving averages at the same time.  Interestingly, out of well over 4000 market days, this only occurred on 42 occasions.  Over the next five trading sessions, the market was down by an average of -.26%, compared with a gain of +.18% for the remainder of the sample.  No particular edge here, even going out 20 days.  Returns over a next 20-day period were volatile, with 17 of the 42 occasions rising or falling by over 5%.

2)  The absence of weakness - If we get a true breadth thrust, we should see very few stocks demonstrating weakness.  I track the number of NYSE stocks giving sell signals on two technical indicator measures:  the Bollinger Bands and the Parabolic SAR.  These track price action over differing time periods.   On Friday, we had 10 or fewer stocks giving sell signals on both measures.  Out of almost 900 market days in my database, this only occurred on 7 occasions.  Again, very unusual.  The number of occasions is too small for reliable statistical inference, but it is noteworthy that the market overall underperformed over the next ten trading sessions and outperformed 30 days out.  Most interesting, four of those seven instances occurred as a cluster in April of 2020.  The question this invites is whether the current period (possible Fed pivot in rate policy due to bank concerns) is similar to the 2020 period (Fed pivot in the face of COVID impact).

Analyses such as these are meant to help in the formulation of credible market hypotheses, not the generation of infallible ideasBreadth thrust may be most important in the context in which it occurs.  If it occurs as a "blowoff" following a period of strength, we would expect volatile and negative returns going forward.  If it occurs following a protracted selloff, we would expect volatile and positive returns going forward as a function of short-covering and new buying.  At present, I'm open to the notion that we are, indeed, seeing a regime shift in the stock market, reflecting a change in central bank policy.  If that is the case, near-term weakness could become an opportunity to participate in longer-term cyclical strength.

Further Reading:

What Market Strength Told Us Earlier This Year