We had an interesting situation on Thursday in which both the price of the S&P 500 Index (SPY) and the ten-year Treasury yield hit 40 day highs during the session. Rising rates have been the bane of many a bull market, but how have they affected prices recently?
I went back to 2004 (N = 819 trading days) and examined what happened in the S&P 500 Index following rising vs. falling 40-day periods in the 10-year yield. When the yield has been up over the past 40 days (N = 398), the next 40 days in SPY have averaged a gain of only .12% (206 up, 192 down).
When 40-day yields have fallen (N = 421), the next 40 days in SPY have averaged a healthy gain of 2.54% (326 up, 95 down).
What that tells us is that much of the rise of the recent bull market is associated with periods of falling yields. This, in addition to the tepid participation in the recent rise, is a reason I'm not chasing current highs in U.S. equities.
Thursday, May 31, 2007
Market Notes and Observations for a Thursday
The headlines are noting the closing record highs in the Dow and S&P 500 Indices. Here are a few observations from my data:
* Short-Term New Highs/Lows Are Tepid - On Wednesday's record close, we had 851 fresh 20-day highs across the NYSE, NASDAQ, and ASE and 751 new 20-day lows. Hardly broad participation. I'm looking at the current action as a topping process unless we can see a broadening of the rally.
* Demand/Supply Is Also Mediocre - Demand (an index of the number of stocks across the three exchanges closing above the volatility envelopes surrounding their moving averages) was 85; Supply (index of issues closing below their volatility envelopes) was 64. This is actually a loss of momentum relative to the prior trading session.
* Even S&P New Highs Are Weak - Wednesday was a record close, but only 48 S&P 500 stocks made new 52-week highs. That's down from over 70 two weeks ago and almost 90 last month.
* The Dow is Getting Popular - I took a look at the top 25 dollar volume issues on Wednesday. DIA was number seven. Before the recent market rise, DIA only very occasionally hit 10,000,000 shares--and those occasions occurred during selloffs. We've now had five consecutive weeks above 10,000,000 shares in DIA, four of which have occurred during rising weeks.
* Energy is the Hot Sector - Of the top 25 dollar volume issues, six are energy related: XOM (#6); OIH (#10); XLE (#14); VLO (#20); COP (#23); and CVX (#24).
* Emerging Markets Have Already Emerged - I notice that EEM was #11 in dollar volume traded on Wednesday. On signs of waning money flows, I will happily short energy and emerging markets. The key is being patient and letting those dollar volume flows lead the way.
* New Readings - I've updated the Articles page on my personal site, with articles divided into trading techniques and trading psychology and also organized chronologically.
* Short-Term New Highs/Lows Are Tepid - On Wednesday's record close, we had 851 fresh 20-day highs across the NYSE, NASDAQ, and ASE and 751 new 20-day lows. Hardly broad participation. I'm looking at the current action as a topping process unless we can see a broadening of the rally.
* Demand/Supply Is Also Mediocre - Demand (an index of the number of stocks across the three exchanges closing above the volatility envelopes surrounding their moving averages) was 85; Supply (index of issues closing below their volatility envelopes) was 64. This is actually a loss of momentum relative to the prior trading session.
* Even S&P New Highs Are Weak - Wednesday was a record close, but only 48 S&P 500 stocks made new 52-week highs. That's down from over 70 two weeks ago and almost 90 last month.
* The Dow is Getting Popular - I took a look at the top 25 dollar volume issues on Wednesday. DIA was number seven. Before the recent market rise, DIA only very occasionally hit 10,000,000 shares--and those occasions occurred during selloffs. We've now had five consecutive weeks above 10,000,000 shares in DIA, four of which have occurred during rising weeks.
* Energy is the Hot Sector - Of the top 25 dollar volume issues, six are energy related: XOM (#6); OIH (#10); XLE (#14); VLO (#20); COP (#23); and CVX (#24).
* Emerging Markets Have Already Emerged - I notice that EEM was #11 in dollar volume traded on Wednesday. On signs of waning money flows, I will happily short energy and emerging markets. The key is being patient and letting those dollar volume flows lead the way.
* New Readings - I've updated the Articles page on my personal site, with articles divided into trading techniques and trading psychology and also organized chronologically.
Wednesday, May 30, 2007
Trading Patterns: Identifying Transitional Structures
With this post I'll begin a series on trading patterns for short-term traders. I refer to today's pattern as a transitional structure; it is a common sequence that marks the shift from one trend to another.Above (top chart) we see the five-minute ES futures for Tuesday, 5/29 and below (bottom chart) we have the corresponding chart of the NYSE TICK. This particular transitional structure is one from a declining market to a rising one. In future posts, I'll display transitions from rising markets to falling ones.
The pattern begins with a very high volume decline on very negative NYSE TICK. If you're also tracking intraday new highs/lows among a basket of stocks or ETFs, this is frequently the point at which a maximum number of issues make concurrent new short-term lows. We can see that this high volume decline occurred a little after 12:00 Noon CT. This is the momentum low for the market. Whenever you see a major elevation of volume and a selloff across a broad range of stocks, you want to consider the possibility that a momentum low is being put into place.
After the momentum low, we typically get a decent bounce on strong NYSE TICK readings. This occurred around 13:00 CT. The solid TICK readings tell us that there is widespread buying interest across a broad range of stocks. That means that traders are finding some bargains at the lower prices and are accumulating shares. If the bounce occurs on weaker TICK readings (below +500, for example), it is much more likely that the rally is mere short covering. That often suggests that the market needs to go still lower to find that bargain-hunting among traders and investors.
After this bounce, we typically get a test of the momentum lows; frequently we get new price lows as a result of this test. This test often occurs on very weak TICK readings. Note that, after 13:00, we saw a very weak NYSE TICK, but price could not make new lows. This is the inefficiency pattern I've described in previous posts. If broad selling sentiment can't push the ES lower, you want to consider the possibility that the decline is becoming exhausted.
Another characteristic of these tests of momentum lows is that they invariably occur on lower volume. Note how volume steadily dropped from the point of the momentum low to the NYSE TICK lows after 13:00. This is yet another indication of selling drying up: the big traders are no longer participating to the downside.
Once the market successfully completes its test, we typically get solid buying on strong NYSE TICK readings. Volume will typically expand on this buying--an excellent indication that buyers are taking control. By making this identification early, you can benefit from the short covering that typically follows a market turn.
These transitional structures occur over varying time frames; no two are identical. The basic dynamics of the momentum peak, the subsequent test, the inefficiency, the drying up of volume, and the subsequent increase of volume on the countertrend move are common to these structures. With practice you can see these patterns emerge and use them for excellent short-term directional trades.
RELEVANT POSTS:
The Structure of Market Reversals
Tracking the Large Trader
When Do I Get Out of a Trade?
Five Principles of Short-Term Trading
Tuesday, May 29, 2007
Update on the Trader Coaching Project
I recently announced a Trader Coaching project on my Trader Performance page and on this blog. The idea was to select a single trader to coach--free of charge--for a month and then post the ongoing process and results to the blog, so that readers could learn from the experience.
The response to the project has been overwhelming, and I thank everyone who has volunteered. At this juncture I must stop accepting volunteers and spend my time responding to the many fine traders who have expressed interest. It's a highly diverse group, from beginners to pros, with many applicants coming from outside the U.S.
If I have not yet gotten back to you, please don't take this as an indication of a lack of interest. I did not plan for so many responses, and--given that I'm leaving town for two days to work with traders--I won't be making any selection until the weekend. I will personally respond to each trader who has expressed interest, however.
If the project proves valuable for all concerned, I'll certainly be willing to take on another trader as an educational project on the blog. Thanks again for your interest and support; I'm hopeful that this will be a unique and worthwhile experience.
Brett
The response to the project has been overwhelming, and I thank everyone who has volunteered. At this juncture I must stop accepting volunteers and spend my time responding to the many fine traders who have expressed interest. It's a highly diverse group, from beginners to pros, with many applicants coming from outside the U.S.
If I have not yet gotten back to you, please don't take this as an indication of a lack of interest. I did not plan for so many responses, and--given that I'm leaving town for two days to work with traders--I won't be making any selection until the weekend. I will personally respond to each trader who has expressed interest, however.
If the project proves valuable for all concerned, I'll certainly be willing to take on another trader as an educational project on the blog. Thanks again for your interest and support; I'm hopeful that this will be a unique and worthwhile experience.
Brett
The Most Important Step in Becoming Your Own Trading Coach
Before you read this post, I'm going to ask that you review my previous post on "The Devon Principle". It is very, very relevant to a question recently asked of me by a trader: "I know I can't afford to hire a private trading coach. What do I need to do to coach myself for success?"
The Devon Principle states that we are what we eat and that, psychologically, we are always digesting our experience. Internalizing our experience makes us who we are.
If we have negative experiences, we internalize that and develop a loss of confidence and motivation. If we have positive experiences, these become part of our outlook on ourselves and our world.
To mentor yourself, your most important step is to create positive learning experiences that will sustain your motivation, interest, and sense of efficacy.
Every trading session should involve working on a specific, doable goal and making progress toward that goal.
We can't control how markets move, so we can't control whether any single trade we make will be profitable or not. But we can control how we make trades: how we enter, how we size positions, how we exit, and how we contain losses. Having rules about all of those helps us set specific goals about the process of trading, rather than about the outcome.
The goal of your learning is to trade well, just as the goal of a pitcher is to make a good pitch. If you do that often enough, you'll win your share of outings.
But the equally important reason for setting attainable, concrete goals is that--as your own coach--you are creating the experiences that you'll be digesting. By setting yourself up for success, you build a positive identity as a trader, day by day.
Without goals, there can be no sense of attainment. Without the sense of attainment, there can't be an internalization of competence and confidence. You generate your own sense of control by--trading session by trading session--controlling your own pursuit of trading goals.
RELATED POSTS:
Becoming Your Own Trading Coach
Letting Profits Run: Becoming Your Own Coach
The Devon Principle states that we are what we eat and that, psychologically, we are always digesting our experience. Internalizing our experience makes us who we are.
If we have negative experiences, we internalize that and develop a loss of confidence and motivation. If we have positive experiences, these become part of our outlook on ourselves and our world.
To mentor yourself, your most important step is to create positive learning experiences that will sustain your motivation, interest, and sense of efficacy.
Every trading session should involve working on a specific, doable goal and making progress toward that goal.
We can't control how markets move, so we can't control whether any single trade we make will be profitable or not. But we can control how we make trades: how we enter, how we size positions, how we exit, and how we contain losses. Having rules about all of those helps us set specific goals about the process of trading, rather than about the outcome.
The goal of your learning is to trade well, just as the goal of a pitcher is to make a good pitch. If you do that often enough, you'll win your share of outings.
But the equally important reason for setting attainable, concrete goals is that--as your own coach--you are creating the experiences that you'll be digesting. By setting yourself up for success, you build a positive identity as a trader, day by day.
Without goals, there can be no sense of attainment. Without the sense of attainment, there can't be an internalization of competence and confidence. You generate your own sense of control by--trading session by trading session--controlling your own pursuit of trading goals.
RELATED POSTS:
Becoming Your Own Trading Coach
Letting Profits Run: Becoming Your Own Coach
Building Self-Efficacy With a Solution Focus
My last post identified self-efficacy as an important link between a person's goals and their ability to sustain action toward those goals. If we experience ourselves as efficacious--if we feel that we are in control of our destinies--we will be more likely to muster the motivation to do what we know is best for us.
In my co-authored book The Art and Science of Brief Psychotherapies, I wrote a chapter specific to solution-focused brief therapy (SFBT). The idea behind SFBT is that, instead of focusing on a person's problems, it is often helpful to identify strengths and build upon these. The psychologist using SFBT identifies what you're doing when you're not having problems; when you're acting in a manner more consistent with your goals. From those exceptions to problem patterns, it is possible to find solution patterns: positive modes of thought and behavior that can be duplicated in new situations.
Thus, if I'm working with a trader with discipline problems in a SFBT framework, I will review his recent trading with him and work with him to identify occasions when he *did* follow his plans and trade in control. We'll then figure out how he was able to do that and create a solution pattern from his own recent behavior. Perhaps, for instance, we'll learn that he was able to trade in a disciplined way when he traded a position reasonable for his portfolio size, took a break after losing trades, and clearly identified a market direction in his pre-opening preparations. We might then use a self-hypnosis technique to mentally rehearse these solution patterns again and again--until they become a more natural part of the trader's repertoire.
Research on SFBT suggests that the approach works because it directly improves the individual's self-efficacy. Here's what I had to say in my book chapter:
"Beyebach et al (1996) examined SFBT outcomes and found that the sole significant predictor of success was client internal locus of control, which reflects the degree to which individuals perceive that they are in control of their lives. The internal locus was positively correlated with favorable pretreatment reports of change and subsequent goal formation in counseling" (p. 96).
Pretreatment reports of change refer to partially successful efforts that the person made prior to getting professional help. By focusing individuals on what they are already doing to change and by helping them form clear, doable, positive goals, the solution-focused approach enables them to feel more efficacious, more in control of their own lives.
This, I have found, is the most effective means for helping people bridge the gap between their actions and their goals. If coaching or counseling focuses on problems and what people are doing wrong, it unwittingly reinforces the lack of efficacy. By identifying what you're already doing--even in a small way--to bring you closer to your goals and then gradually building on that, you increase your sense of control and eventually pave the way for larger goals and greater progress.
Positive focus, measurable and achievable goals: these are key to a trader's self-coaching and improved control over one's own actions.
RELATED POSTS:
A Solution-Focused Linkfest
The Most Important Question to Ask When You're in a Slump
Solution-Focused Trading
In my co-authored book The Art and Science of Brief Psychotherapies, I wrote a chapter specific to solution-focused brief therapy (SFBT). The idea behind SFBT is that, instead of focusing on a person's problems, it is often helpful to identify strengths and build upon these. The psychologist using SFBT identifies what you're doing when you're not having problems; when you're acting in a manner more consistent with your goals. From those exceptions to problem patterns, it is possible to find solution patterns: positive modes of thought and behavior that can be duplicated in new situations.
Thus, if I'm working with a trader with discipline problems in a SFBT framework, I will review his recent trading with him and work with him to identify occasions when he *did* follow his plans and trade in control. We'll then figure out how he was able to do that and create a solution pattern from his own recent behavior. Perhaps, for instance, we'll learn that he was able to trade in a disciplined way when he traded a position reasonable for his portfolio size, took a break after losing trades, and clearly identified a market direction in his pre-opening preparations. We might then use a self-hypnosis technique to mentally rehearse these solution patterns again and again--until they become a more natural part of the trader's repertoire.
Research on SFBT suggests that the approach works because it directly improves the individual's self-efficacy. Here's what I had to say in my book chapter:
"Beyebach et al (1996) examined SFBT outcomes and found that the sole significant predictor of success was client internal locus of control, which reflects the degree to which individuals perceive that they are in control of their lives. The internal locus was positively correlated with favorable pretreatment reports of change and subsequent goal formation in counseling" (p. 96).
Pretreatment reports of change refer to partially successful efforts that the person made prior to getting professional help. By focusing individuals on what they are already doing to change and by helping them form clear, doable, positive goals, the solution-focused approach enables them to feel more efficacious, more in control of their own lives.
This, I have found, is the most effective means for helping people bridge the gap between their actions and their goals. If coaching or counseling focuses on problems and what people are doing wrong, it unwittingly reinforces the lack of efficacy. By identifying what you're already doing--even in a small way--to bring you closer to your goals and then gradually building on that, you increase your sense of control and eventually pave the way for larger goals and greater progress.
Positive focus, measurable and achievable goals: these are key to a trader's self-coaching and improved control over one's own actions.
RELATED POSTS:
A Solution-Focused Linkfest
The Most Important Question to Ask When You're in a Slump
Solution-Focused Trading
Monday, May 28, 2007
Self-Efficacy and the Psychology of Consumer Debt
Popular personal finance expert Jean Chatzky calls it an epidemic and organizes self-help groups to deal with its impact. U.S. News and World Report, Newsweek, the Center for American Progress, and Fox News all use the same word to describe the situation: drowning.
Increasingly, they note, middle class Americans are drowning in debt.
Statistics from the Federal Reserve show that, from 1980 to the present, homeowners are paying an increasing percentage of their disposable income toward debt repayment. Indeed, the financial obligations ratio for the average American is at a record 19.4%. In an excellent review, Mike Shedlock notes that personal bankruptcy rates are rising among baby boomers and particularly among those above the age of 55. He refers to the situation of housing woes and rising fuel prices as a "perfect storm" of debt, with household expenses increasing and home equity not keeping pace.
To be sure, many causes of debt are unavoidable. Those without health insurance, for example, can be wiped out by expenses associated with treatment of major diseases, such as cancer. Many times, however, debt is simply a function of lifestyles that fail to balance income with expenditures. Chatzky's recent book on making money rather than excuses, for instance, covers a number of practical steps--simple reductions of regular purchases--that can meaningfully reduce a family's debt burden.
So what keeps individuals and families from taking such steps?
Consider these situations that appear quite different, but are psychologically similar:
* A man knows he needs to lose weight given his heart problems, but he continues to overeat.
* A woman vows to exercise to get in better shape, but fails to use the expensive equipment she's purchased.
* An investor knows that he should hold onto winning positions and not let losers get out of hand, yet he finds himself doing exactly the opposite.
* Arguments are killing their marriage; both members of the couple realize it and don't want a divorce, but they continue to wound one another in bitter verbal battles.
Each of these situations is one in which a person knows what to do, but cannot match their actions to their awareness. We usually associate such a lack of will with addictions, but as the above suggests--and as we see with many families in debt--the problem is much more widespread than that.
Why do we lack the will to do what is best for us?
The answer, one group of psychological researchers suggests, can be found in self-efficacy. Self-efficacy refers to the belief system of the individual: the degree to which people hold the conviction that they are *capable* of attaining their goals. A person may wish to lose weight, for example, but may not perceive that she is in control of her weight. Her belief is that "I just have a slow metabolism". Without the underlying conviction that she's in control, she won't be motivated to take the actions needed to change her situation.
Self-efficacy has been found to be associated with positive outcomes in educational and health settings, as well as athletic performance. When people believe that they *can* achieve a goal, they're more likely to initiate action toward that goal. A great example of how a lack of self-efficacy can dampen motivation can be found among abused children and spouses. Even when they have opportunities to leave their environments, they often do not act on these. They have learned--through painful experience--that they cannot control their own life outcomes.
So it is with many families facing potential bankruptcy. Their self-talk is that they're "in debt", just like they might be *in* an accident or *in* a hurricane. Such self-talk reinforces the notion that debt happens to them--not that they can influence their own financial outcomes. Similarly, the investor who hangs onto losing positions and risks going bust talks about being *in* the red, *in* losing trades, and *in* a drawdown.
Changing such self-talk requires fresh emotional experience, not just intellectual awareness. Intellectually everyone pretty much knows what they need to do to follow a budget, exit losing positions, stay in good physical condition, etc. If, however, you don't experience yourself as being in control, you can't internalize an enduring sense of self-efficacy. Building that experience of control requires at least two steps:
1) Developing a new kind of self-talk, which makes nouns like "debt" and "drawdown" into active verbs, stressing decision-making and choice. Debt is something you do, not something you passively find yourself in;
2) Cultivating a hierarchy of doable goals to create the emotional experience of being in control and seeing in one's own experience that it *is* possible to make good things happen.
In short, self-efficacy can only result from first-hand experiences of being efficacious. Unless we truly, consistently feel ourselves to be in control, we're unlikely to sustain the actions needed to achieve our goals. In my next post, I'll take a look at one immediate step people can take to generate those first-hand experiences of efficacy.
RELATED POST:
The Devon Principle
Increasingly, they note, middle class Americans are drowning in debt.
Statistics from the Federal Reserve show that, from 1980 to the present, homeowners are paying an increasing percentage of their disposable income toward debt repayment. Indeed, the financial obligations ratio for the average American is at a record 19.4%. In an excellent review, Mike Shedlock notes that personal bankruptcy rates are rising among baby boomers and particularly among those above the age of 55. He refers to the situation of housing woes and rising fuel prices as a "perfect storm" of debt, with household expenses increasing and home equity not keeping pace.
To be sure, many causes of debt are unavoidable. Those without health insurance, for example, can be wiped out by expenses associated with treatment of major diseases, such as cancer. Many times, however, debt is simply a function of lifestyles that fail to balance income with expenditures. Chatzky's recent book on making money rather than excuses, for instance, covers a number of practical steps--simple reductions of regular purchases--that can meaningfully reduce a family's debt burden.
So what keeps individuals and families from taking such steps?
Consider these situations that appear quite different, but are psychologically similar:
* A man knows he needs to lose weight given his heart problems, but he continues to overeat.
* A woman vows to exercise to get in better shape, but fails to use the expensive equipment she's purchased.
* An investor knows that he should hold onto winning positions and not let losers get out of hand, yet he finds himself doing exactly the opposite.
* Arguments are killing their marriage; both members of the couple realize it and don't want a divorce, but they continue to wound one another in bitter verbal battles.
Each of these situations is one in which a person knows what to do, but cannot match their actions to their awareness. We usually associate such a lack of will with addictions, but as the above suggests--and as we see with many families in debt--the problem is much more widespread than that.
Why do we lack the will to do what is best for us?
The answer, one group of psychological researchers suggests, can be found in self-efficacy. Self-efficacy refers to the belief system of the individual: the degree to which people hold the conviction that they are *capable* of attaining their goals. A person may wish to lose weight, for example, but may not perceive that she is in control of her weight. Her belief is that "I just have a slow metabolism". Without the underlying conviction that she's in control, she won't be motivated to take the actions needed to change her situation.
Self-efficacy has been found to be associated with positive outcomes in educational and health settings, as well as athletic performance. When people believe that they *can* achieve a goal, they're more likely to initiate action toward that goal. A great example of how a lack of self-efficacy can dampen motivation can be found among abused children and spouses. Even when they have opportunities to leave their environments, they often do not act on these. They have learned--through painful experience--that they cannot control their own life outcomes.
So it is with many families facing potential bankruptcy. Their self-talk is that they're "in debt", just like they might be *in* an accident or *in* a hurricane. Such self-talk reinforces the notion that debt happens to them--not that they can influence their own financial outcomes. Similarly, the investor who hangs onto losing positions and risks going bust talks about being *in* the red, *in* losing trades, and *in* a drawdown.
Changing such self-talk requires fresh emotional experience, not just intellectual awareness. Intellectually everyone pretty much knows what they need to do to follow a budget, exit losing positions, stay in good physical condition, etc. If, however, you don't experience yourself as being in control, you can't internalize an enduring sense of self-efficacy. Building that experience of control requires at least two steps:
1) Developing a new kind of self-talk, which makes nouns like "debt" and "drawdown" into active verbs, stressing decision-making and choice. Debt is something you do, not something you passively find yourself in;
2) Cultivating a hierarchy of doable goals to create the emotional experience of being in control and seeing in one's own experience that it *is* possible to make good things happen.
In short, self-efficacy can only result from first-hand experiences of being efficacious. Unless we truly, consistently feel ourselves to be in control, we're unlikely to sustain the actions needed to achieve our goals. In my next post, I'll take a look at one immediate step people can take to generate those first-hand experiences of efficacy.
RELATED POST:
The Devon Principle
Reading for the Long Weekend
* A Look Beneath the Market Surface - The updated Trading Psychology Weblog reviews markets, indicators, and money flows and takes a glance at the week ahead.
* Trader Coaching Project - I'll take on one trader for a month free of charge and we'll document the process on this blog. Details are on the Trader Performance page.
* Andrew Lo on Trading Psychology - Great post from the Daily Speculations site on Dr. Lo's Adaptive Market Hypothesis.
* Interesting New Charting Application - Stock Spy integrates RSS feeds directly into the charts, so you see the news and the buzz along with price, volume, and indicators.
* Margin Debt Exploding - David Korn, in his excellent newsletter, notes that, since August, margin debt has increased at a 67% annual clip. He also notes that money continues to flow into domestic and international equity funds.
* Breaking Bad Habits - Practical advice from Dr. Bruce Hong, who stresses the importance of self observation.
* Is Directional Trading the Way to Go? - Matt at C++ trader provides a thoughtful perspective on directional and non-directional trading for retail traders.
* Oil Stocks Worth a Look - I recently noted the huge money flows into energy issues. This Seeking Alpha post reports on seven issues to consider for ownership.
* Alternative Energy - InvesLogic aggregates feeds from a variety of blogs in the alternative energy space. Excellent way to generate ideas, track trends.
* Memorial Day Linkfest - The Big Picture reviews the economy and markets, including a look at the fastest growing tech firms.
* Trader Coaching Project - I'll take on one trader for a month free of charge and we'll document the process on this blog. Details are on the Trader Performance page.
* Andrew Lo on Trading Psychology - Great post from the Daily Speculations site on Dr. Lo's Adaptive Market Hypothesis.
* Interesting New Charting Application - Stock Spy integrates RSS feeds directly into the charts, so you see the news and the buzz along with price, volume, and indicators.
* Margin Debt Exploding - David Korn, in his excellent newsletter, notes that, since August, margin debt has increased at a 67% annual clip. He also notes that money continues to flow into domestic and international equity funds.
* Breaking Bad Habits - Practical advice from Dr. Bruce Hong, who stresses the importance of self observation.
* Is Directional Trading the Way to Go? - Matt at C++ trader provides a thoughtful perspective on directional and non-directional trading for retail traders.
* Oil Stocks Worth a Look - I recently noted the huge money flows into energy issues. This Seeking Alpha post reports on seven issues to consider for ownership.
* Alternative Energy - InvesLogic aggregates feeds from a variety of blogs in the alternative energy space. Excellent way to generate ideas, track trends.
* Memorial Day Linkfest - The Big Picture reviews the economy and markets, including a look at the fastest growing tech firms.
Sunday, May 27, 2007
The Trader Coaching Project
TraderFeed will be going behind the doors of a trading psychologist. I've just announced on my Trader Performance page that I will be taking on one trader for coaching completely free of charge for the period of one month. The "catch" is that the trader must agree to sharing summaries of the coaching as part of posts to TraderFeed. That will enable all readers to potentially benefit from the coaching. During the month, we'll learn about a trader and his/her challenges; how we're tackling those challenges; and the progress we make.
If you're interested in being considered as the trader for this project, check out my post to the Trader Performance page and send me an email as outlined in the instructions. Please note that I can only accept one trader at this time, but if the project goes well, I'll be happy to open it up to other traders.
My hope is that this creates a unique learning experience for all involved; thanks for your interest!
Brett
RELEVANT POSTS:
Coaching the Professional Trader
When Coaching Works, and When It Doesn't
Trading Coaches: What Works?
If you're interested in being considered as the trader for this project, check out my post to the Trader Performance page and send me an email as outlined in the instructions. Please note that I can only accept one trader at this time, but if the project goes well, I'll be happy to open it up to other traders.
My hope is that this creates a unique learning experience for all involved; thanks for your interest!
Brett
RELEVANT POSTS:
Coaching the Professional Trader
When Coaching Works, and When It Doesn't
Trading Coaches: What Works?
The Heroic Dimensions of Trading
For me, there's no better time than a long holiday weekend to step back and ask the big questions: those that deal with the meaning and significance of being a trader. These segments from my two books capture much of my sentiment on the topic.
"It is better to struggle in the service of one's dreams than to find instant success at meaningless work. The greatest joy in life, George Bernard Shaw once wrote, is being used for a purpose you recognize to be mighty. The greatest fields--those that are a calling and not a mere job--give one room to expand and develop oneself. There is only one valid reason for trading the markets, just as there is only one valid reason for being a psychologist, a dancer, or an architect: because it is your calling, the arena that best draws upon one's talents and passion for self-development." - The Psychology of Trading, p. 317.
"There are few arenas left in life where the independent individual can enact the heroic struggle...This, I believe is the eternal allure of the markets. With a reasonable stake and an online account, each person can undertake his or her own gold rush and enact the highest entrepreneurial quest. Like salmon that swim upstream to spawn, sperm that pursue the egg, and prospectors that dig for precious metal, many will be called and few chosen. It matters not. What matters is the dignity and the dimension of soul conferred by one's noblest impulses. It is not desirable to rule in hell or to serve in heaven; far preferable, to paraphrase Ayn Rand, is to fight for tomorrow's Valhalla in order to walk its halls today." - The Psychology of Trading, p. 318.
"Let us not forget what it means to be a trader. It means that I am free to own property: shares of a private company or contracts in a commodity. I can take delivery of my property and dispose of it as I wish, or I can trade it to others. My decisions are mine to make; I need not follow the dictates of those who would put other interests--those of gods, governments, or guns--above my own. If I lose, it is my loss. If I profit, the gain is mine...Without freedom, there is no trading. Trading is a celebration of economic and political freedom. Slaves are traded; they do not trade." - Enhancing Trader Performance, p. 253-4.
"What are we really developing when we train for expert performance in any domain? We develop skill and knowledge, to be sure, but we also develop more than that. We cultivate will: the ability to formulate goals and direct our actions toward reaching those goals. Every training session is a battle of will: a struggle to overcome our limitations and reach a particular performance goal...When you enhance your performance as a trader, you replace a small piece of randomness with intention. To that degree, your outcomes are self-determined. If you train yourself properly, you will become not only a successful trader, but a more self-determining human being." - Enhancing Trader Performance, p. 254-255.
RELEVANT LINKS AND QUOTES:
Ayn Rand and Objectivism
"It is better to struggle in the service of one's dreams than to find instant success at meaningless work. The greatest joy in life, George Bernard Shaw once wrote, is being used for a purpose you recognize to be mighty. The greatest fields--those that are a calling and not a mere job--give one room to expand and develop oneself. There is only one valid reason for trading the markets, just as there is only one valid reason for being a psychologist, a dancer, or an architect: because it is your calling, the arena that best draws upon one's talents and passion for self-development." - The Psychology of Trading, p. 317.
"There are few arenas left in life where the independent individual can enact the heroic struggle...This, I believe is the eternal allure of the markets. With a reasonable stake and an online account, each person can undertake his or her own gold rush and enact the highest entrepreneurial quest. Like salmon that swim upstream to spawn, sperm that pursue the egg, and prospectors that dig for precious metal, many will be called and few chosen. It matters not. What matters is the dignity and the dimension of soul conferred by one's noblest impulses. It is not desirable to rule in hell or to serve in heaven; far preferable, to paraphrase Ayn Rand, is to fight for tomorrow's Valhalla in order to walk its halls today." - The Psychology of Trading, p. 318.
"Let us not forget what it means to be a trader. It means that I am free to own property: shares of a private company or contracts in a commodity. I can take delivery of my property and dispose of it as I wish, or I can trade it to others. My decisions are mine to make; I need not follow the dictates of those who would put other interests--those of gods, governments, or guns--above my own. If I lose, it is my loss. If I profit, the gain is mine...Without freedom, there is no trading. Trading is a celebration of economic and political freedom. Slaves are traded; they do not trade." - Enhancing Trader Performance, p. 253-4.
"What are we really developing when we train for expert performance in any domain? We develop skill and knowledge, to be sure, but we also develop more than that. We cultivate will: the ability to formulate goals and direct our actions toward reaching those goals. Every training session is a battle of will: a struggle to overcome our limitations and reach a particular performance goal...When you enhance your performance as a trader, you replace a small piece of randomness with intention. To that degree, your outcomes are self-determined. If you train yourself properly, you will become not only a successful trader, but a more self-determining human being." - Enhancing Trader Performance, p. 254-255.
RELEVANT LINKS AND QUOTES:
Ayn Rand and Objectivism
"Dr. Miller says we are pessimistic because life seems like a very bad, very screwed-up film. If you ask "What the hell is wrong with the projector?" and go up to the control room, you find it's empty. You are the projectionist, and you should have been up there all the time." - Colin Wilson
"Every man builds his world in his own image. He has the power to choose, but no power to escape the necessity of choice." - Ayn RandSaturday, May 26, 2007
Energy Stocks Powering Ahead: The Geopolitics of a Market Rally
Energy stocks are attracting huge investor interest. Chevron Texaco (CVX) has risen from the mid $60 range to over $80/share just since March. Over that time, we have had exactly one day--one day!--of negative money flow in the stock. Every other day, funds have been flowing into CVX.
Exxon (XOM) has risen from the low 70s to over $80/share in that same time. We've seen only four days of money outflows from the stock since the mid-March lows.
Schlumberger (SLB) has risen from the mid $60's to about $80/share since mid March. How many days of negative money flow have we seen during that time?
None.
I'd say that's a pretty strong performance for a sector. The S&P Energy Sector ETF (XLE) has risen over 20% since mid-March, helping to underpin the strength in the large cap stocks.
A recent Congressional vote on funding the Iraq war set benchmarks for the Iraqi government needed for continued funding of the war. While most discussion of the benchmarks has focused on the achievement of democratic reforms, quelling of sectarian hostilities, and the like, a less-remarked benchmark concerns the disposition of Iraqi oil.
The Iraq Hydrocarbon Law requires a privatization of Iraqi oil to develop Iraq's untapped resources. Understandably, oil companies are reluctant to commit funds to such an effort without the protection of such a law. It has been difficult for the various factions to agree on revenue sharing, creating limbo for the proposed law--and opposition to the notion of foreign control. Each of the sectarian groups has reasons for opposing the law. There is expectation that oil and gas assets will be auctioned off within the next couple of months, however.
In the U.S., serious political opposition to the privatization of Iraqi energy assets appears minimal, given that the recent bill passed by Congress represented a Democratic compromise with the White House. When Dennis Kucinich took an hour of House time to blast the "exploitation" of Iraqi oil, his remarks went without further comment or debate.
Christopher Hitchens, on the other hand, makes a case for the Iraq Hydrocarbon Law, suggesting that the proper development and distribution of oil revenues will benefit the entire country and abolish the economic rationale for dictatorship.
The American public, seeing higher gasoline prices at the pump thanks to refining bottlenecks, is unlikely to oppose any efforts to expand energy reserves, as oil companies blame the push for biofuels for reduced refining capacity.
I don't think the U.S. would be building the world's largest embassy complex in Baghdad unless there was a solid economic rationale, whether you agree with the rationale or not. The stock market seems to agree, and investors--seeing higher energy prices and availability of what appears to be the world's second largest oil reserves--are steadily pouring money into international oil/energy companies as a result.
Exxon (XOM) has risen from the low 70s to over $80/share in that same time. We've seen only four days of money outflows from the stock since the mid-March lows.
Schlumberger (SLB) has risen from the mid $60's to about $80/share since mid March. How many days of negative money flow have we seen during that time?
None.
I'd say that's a pretty strong performance for a sector. The S&P Energy Sector ETF (XLE) has risen over 20% since mid-March, helping to underpin the strength in the large cap stocks.
A recent Congressional vote on funding the Iraq war set benchmarks for the Iraqi government needed for continued funding of the war. While most discussion of the benchmarks has focused on the achievement of democratic reforms, quelling of sectarian hostilities, and the like, a less-remarked benchmark concerns the disposition of Iraqi oil.
The Iraq Hydrocarbon Law requires a privatization of Iraqi oil to develop Iraq's untapped resources. Understandably, oil companies are reluctant to commit funds to such an effort without the protection of such a law. It has been difficult for the various factions to agree on revenue sharing, creating limbo for the proposed law--and opposition to the notion of foreign control. Each of the sectarian groups has reasons for opposing the law. There is expectation that oil and gas assets will be auctioned off within the next couple of months, however.
In the U.S., serious political opposition to the privatization of Iraqi energy assets appears minimal, given that the recent bill passed by Congress represented a Democratic compromise with the White House. When Dennis Kucinich took an hour of House time to blast the "exploitation" of Iraqi oil, his remarks went without further comment or debate.
Christopher Hitchens, on the other hand, makes a case for the Iraq Hydrocarbon Law, suggesting that the proper development and distribution of oil revenues will benefit the entire country and abolish the economic rationale for dictatorship.
The American public, seeing higher gasoline prices at the pump thanks to refining bottlenecks, is unlikely to oppose any efforts to expand energy reserves, as oil companies blame the push for biofuels for reduced refining capacity.
I don't think the U.S. would be building the world's largest embassy complex in Baghdad unless there was a solid economic rationale, whether you agree with the rationale or not. The stock market seems to agree, and investors--seeing higher energy prices and availability of what appears to be the world's second largest oil reserves--are steadily pouring money into international oil/energy companies as a result.
Money Flow Review: Stocks on the Radar
* Stock Looking Sharper? - Sharper Image (SHRP) has been quite a disappointment as an investment, as it's trading around $11/share, down from $38 in 2004. It's an interesting short-squeeze candidate, however, as Friday's Wall St. Journal reports a mammoth short position in SHRP: equivalent to 37 days worth of average trading volume. The last two trading days this week saw sharp gains in Sharper Image on much above average money flow.
* Taking Profits From the Oil Patch? - In the current environment, which stocks should be doing better than the oil refiners? Valero (VLO) is up from about $58 to $74 since the late February/early March weakness. Money flow for VLO, however, has been outright negative--dollars have been flowing out of the stock--for each of the past six trading sessions and 13 of the last 20. Large traders/investors taking profits into recent strength?
* Soft Flows at MSFT - Microsoft is another stock showing net dollar outflows of late. We've had negative money flow readings seven of the past eight trading sessions, as price has stalled in the 30s.
* NTRI Gets Expansive - NutriSystem (NTRI), featured here recently as another short-squeeze candidate, hit its highest price since January on Friday.
* Power Behind the Stock - Toshiba was another stock I featured last month; it trades on NASDAQ as TOSBF. After hitting a bull market high on 5/8, it has settled back but remains in a firm uptrend. This is an interesting play on nuclear power as an oil alternative.
* Honda Ready to Zoom Ahead? - I just purchased a Honda Fit and have to say the company got it right, with a bit of performance (for a subcompact), good gas mileage, low emissions, and a surprisingly roomy interior for the small footprint. Honda stock (HMC) is down for 2007 and has gone nowhere over the past year. Money flows have been doggedly positive, however, and the stock remains in a long-term uptrend.
* Chips Are Down for INTC? I noted a surge in Intel (INTC) money flows last month, and the stock closed at its highest price of 2007 this past Tuesday. But now money flows have been outright negative--dollars exiting the stock--for seven of the past ten trading sessions.
* Wal-Mart is Being Discounted - The stock (WMT) closed at its lowest levels since March this past week and money flows have been outright negative for 8 of the past 10 trading sessions.
* Gains Still Flowing in TTEK - I featured this stock earlier this month as a worthy play on the water-as-resource theme. The stock made a new high on Tuesday and continues to enjoy net dollar inflows. Tuesday's gain met with stiff selling and net money outflows on Wednesday, which may herald some consolidation.
* Taking Profits From the Oil Patch? - In the current environment, which stocks should be doing better than the oil refiners? Valero (VLO) is up from about $58 to $74 since the late February/early March weakness. Money flow for VLO, however, has been outright negative--dollars have been flowing out of the stock--for each of the past six trading sessions and 13 of the last 20. Large traders/investors taking profits into recent strength?
* Soft Flows at MSFT - Microsoft is another stock showing net dollar outflows of late. We've had negative money flow readings seven of the past eight trading sessions, as price has stalled in the 30s.
* NTRI Gets Expansive - NutriSystem (NTRI), featured here recently as another short-squeeze candidate, hit its highest price since January on Friday.
* Power Behind the Stock - Toshiba was another stock I featured last month; it trades on NASDAQ as TOSBF. After hitting a bull market high on 5/8, it has settled back but remains in a firm uptrend. This is an interesting play on nuclear power as an oil alternative.
* Honda Ready to Zoom Ahead? - I just purchased a Honda Fit and have to say the company got it right, with a bit of performance (for a subcompact), good gas mileage, low emissions, and a surprisingly roomy interior for the small footprint. Honda stock (HMC) is down for 2007 and has gone nowhere over the past year. Money flows have been doggedly positive, however, and the stock remains in a long-term uptrend.
* Chips Are Down for INTC? I noted a surge in Intel (INTC) money flows last month, and the stock closed at its highest price of 2007 this past Tuesday. But now money flows have been outright negative--dollars exiting the stock--for seven of the past ten trading sessions.
* Wal-Mart is Being Discounted - The stock (WMT) closed at its lowest levels since March this past week and money flows have been outright negative for 8 of the past 10 trading sessions.
* Gains Still Flowing in TTEK - I featured this stock earlier this month as a worthy play on the water-as-resource theme. The stock made a new high on Tuesday and continues to enjoy net dollar inflows. Tuesday's gain met with stiff selling and net money outflows on Wednesday, which may herald some consolidation.
Friday, May 25, 2007
Musings for a Friday
* When downside momentum is strong - My Demand/Supply Index hit a lopsided extreme on Thursday, with Demand at 23 and Supply at 210. As noted in my recent post, that means that we have about 9 times as many stocks that closed with significant downside momentum as ended with significant upside momentum. Going back to 2005 (N = 582 trading days), we've only had 7 occasions in which Supply has exceeded 200. The S&P 500 Index (SPY) was lower three days after this extreme on six of those seven occasions, with an average loss of -.57%. In other words, very strong downside momentum tends to persist in the short run before reversing. On average, it's when we see price lows on improving momentum that we look for bullish reversals.
* Excellent update on links - Trader Mike does an excellent job of updating his site with practically relevant links for traders. There are some particularly good posts in his recent updates, including thoughts re: Web 2.0 and China bubbles. And if you're looking to get a jump on long weekend reading, check out Abnormal Returns' links--particularly the interesting post on an indicator off the beaten path.
* Wickedly funny post - CXO Advisory lists the top ten guru excuses for getting the market wrong. Check out their analysis of guru calls on the market.
* Spotlight on China - Ticker Sense does a fine job tracing the "A" and "B" shares in Shanghai vs. the Yuan.
* The Personal Bankruptcy Storm - Mish has provided a detailed and eye-opening analysis; great work.
* Excellent update on links - Trader Mike does an excellent job of updating his site with practically relevant links for traders. There are some particularly good posts in his recent updates, including thoughts re: Web 2.0 and China bubbles. And if you're looking to get a jump on long weekend reading, check out Abnormal Returns' links--particularly the interesting post on an indicator off the beaten path.
* Wickedly funny post - CXO Advisory lists the top ten guru excuses for getting the market wrong. Check out their analysis of guru calls on the market.
* Spotlight on China - Ticker Sense does a fine job tracing the "A" and "B" shares in Shanghai vs. the Yuan.
* The Personal Bankruptcy Storm - Mish has provided a detailed and eye-opening analysis; great work.
Protracted Selling Pressure in the NYSE TICK
We've now seen net selling pressure over the past 20 trading sessions. In my last post, we saw a tendency for the S&P 500 Index to bounce following days of extreme selling pressure in the Cumulative Adjusted TICK measure. Above we can see the S&P 500 Index (SPY; blue line) vs. the 20-day moving average for the daily cumulative Adjusted TICK values. Note that, although we're not far off price highs--despite Thursday's decline--the 20-day Adjusted TICK is at rather oversold levels. This suggests that we've seen protracted selling pressure: something that's far more noticeable in the small cap market than in the Dow or the S&P 500 Index.
Interestingly, going back to 2005 (N = 834 trading days), when the 20-day cumulative Adjusted TICK has been below -150 (N = 71), the next ten days in SPY have averaged a subnormal gain of .07% (37 up, 34 down). That is notably weaker than the average 10-day gain of .39% (481 up, 282 down) for the remainder of the sample.
This result also fits with findings regarding my Demand/Supply Index, which hit lopsided selling extremes on Thursday. Demand closed at 23; Supply ended the day at 210. For readers unfamiliar with this measure, it means that--across the three exchanges--roughly 9 times as many issues closed below the volatility envelopes surrounding their moving averages as closed above them.
When we get such extremes in selling sentiment (TICK) and momentum (Demand/Supply), the tendency is for the decline to continue in the short run, even as downside momentum wanes. It is rare to make a low on extreme negative momentum and then turn on a dime and sustain a bullish trend. More often, we see bottoming action with further price lows and moderating Supply, TICK, and new 20-day lows among stocks. For this reason, I will look for the possibility that any bounce after the selling (per the previous post) will provide an additional opportunity for selling the market and testing recent lows.
RELATED POSTS:
Trading with the NYSE TICK - Part One
Trading with the NYSE TICK - Part Two
Identifying Sentiment Trends with NYSE TICK
When Selling Becomes Indiscriminate: What Happens Next?
On Thursday my cumulative Adjusted TICK measure gave a daily reading below -1000. This has only occurred 16 times since 2004. To achieve such a reading, we have to have persistently negative NYSE TICK readings: far below the 20 day average. That means that traders have been hitting bids across a wide range of NYSE stocks--an indiscriminate selling that affects good stocks and bad. Indeed, we saw declining stocks exceed advancers by over 2000 issues on Thursday.
When we've had cumulative Adjusted TICK readings below -1000 in a single day (N = 16), the next three days in SPY have averaged a solid gain of .58% (13 up, 3 down). That is much stronger than the average three-day gain of .10% (468 up, 376 down) for the remainder of the sample.
I will want to see evidence of waning selling pressure--and an inability of negative TICK readings to drive price to new lows--before acting on this pattern. Nevertheless, when selling has become extreme, it's generally been a good idea to look for a bounce. In my next post, I will take a somewhat longer-range perspective on the performance of the Cumulative Adjusted TICK and provide a note of caution.
When we've had cumulative Adjusted TICK readings below -1000 in a single day (N = 16), the next three days in SPY have averaged a solid gain of .58% (13 up, 3 down). That is much stronger than the average three-day gain of .10% (468 up, 376 down) for the remainder of the sample.
I will want to see evidence of waning selling pressure--and an inability of negative TICK readings to drive price to new lows--before acting on this pattern. Nevertheless, when selling has become extreme, it's generally been a good idea to look for a bounce. In my next post, I will take a somewhat longer-range perspective on the performance of the Cumulative Adjusted TICK and provide a note of caution.
Thursday, May 24, 2007
Capturing the Intraday Trend with the Cumulative Adjusted TICK
Here we see the ES futures for 5/24/07 (blue line), a one-day cumulative total of the Adjusted NYSE TICK. Recall that the Adjusted TICK is the one minute NYSE TICK minus the average TICK level over the past 20 trading sessions. When the cumulative total slopes downward, we know that we're getting above average selling interest (hitting of bids) across the NYSE stock universe. Note at point (1) that, despite the early rise in ES, we never saw above average TICK readings. That was our first clue that buyers were not aggressive in the market. We then saw above average hitting of bids and a reversal of ES, with price declining below the open.
Observe at points (2) that bounces in price were not accompanied by significant bounces in the Adjusted TICK: buying remained below average. The general rule during such occasions is to sell these bounces, as they represent short covering and not an influx of fresh buying. This principle would have kept a trader short through much of the decline.
We did get a bit of a bounce in the Adjusted TICK in midafternoon, but note at point (3) that the pattern of lower cumulative readings at price bounces reasserted itself. This led to fresh selling late in the day.
Very, very often I find that following the slope of the cumulative Adjusted TICK line keeps me on the right side of the market. My worst trades have occurred when I've bucked the trend of buying and selling interest.
RELATED POSTS:
Identifying the Trend of Sentiment With NYSE TICK
What You Can Learn From the Opening Minutes of Trading
Market Psychology and Trader Psychology: Thoughts for a Thursday
* More on Extreme Negative Sentiment - Here's a post I sent to a distribution list of traders after we hit an extreme negative level in the NYSE TICK on Wednesday:
I show that, since 2004 (N = 848 trading days), we've had 61 occasions in which there has been at least one daily NYSE TICK reading of -1100 or lower. Five days later, we've averaged a gain in SPY of .65% (43 up, 18 down). That is stronger than the average five-day gain of .19% (493 up, 355 down) for the entire sample.
It turns out that we hit another such negative extreme today. Going back to 2004, we've only had 48 occasions in which we've had back to back daily readings of less than -1000 in the NYSE TICK. Five days later, SPY has averaged an impressive gain of .83% (36 up, 12 down)--again much stronger than the average five-day gain for the sample.
* Great Research on the NYSE TICK - In his latest newsletter, Rainsford Yang has replicated my research on the Cumulative Adjusted TICK and charted it long-term to show how this indicator has consistently led market rises and declines. Rennie has graciously offered readers of TraderFeed a renewable 25% discount on a subscription to the newsletter. I'm not financially affiliated with MarketTells, and I don't benefit from subscriptions, but I can tell you that I am a paid subscriber and greatly respect Mr. Yang's work. If you're interested in the discount, just enter "traderfeed" where the subscription form asks you for a promotional code.
* Trade Ideas on the Web--Backed by Research! - Every day James Altucher is putting out value by tracking "system trades of the day" on the StockPickr site. You not only see the ideas, but how well they performed over recent market history. I continue to believe this is one of the Web's best information sources for traders and investors.
* More on the Turtles - I recently addressed some of the psychological challenges associated with investment (as opposed to short-term trading). It turns out that Michael Covel has addressed this topic on his site and will also be tackling it in a forthcoming book. I look forward to reading and reviewing that book.
* Brain Fitness - Here's an excellent collection of resources concerning brain fitness and cognitive neuroscience from SharpBrains. Once again, I have no commercial relationship with this firm, but I applaud their commitment to trader education.
* Rising Interest Rates Taking a Toll? - I find it difficult to believe it's a coincidence that the number of stocks making new 65-day highs topped out in mid-April, which is also when 10-year interest rates bottomed. Since then, rates have risen to over 4.9% intraday today--one factor that may be playing into the stock market weakness today. I am very curious to see how the market would tolerate a move above 5%.
It turns out that we hit another such negative extreme today. Going back to 2004, we've only had 48 occasions in which we've had back to back daily readings of less than -1000 in the NYSE TICK. Five days later, SPY has averaged an impressive gain of .83% (36 up, 12 down)--again much stronger than the average five-day gain for the sample.
* Great Research on the NYSE TICK - In his latest newsletter, Rainsford Yang has replicated my research on the Cumulative Adjusted TICK and charted it long-term to show how this indicator has consistently led market rises and declines. Rennie has graciously offered readers of TraderFeed a renewable 25% discount on a subscription to the newsletter. I'm not financially affiliated with MarketTells, and I don't benefit from subscriptions, but I can tell you that I am a paid subscriber and greatly respect Mr. Yang's work. If you're interested in the discount, just enter "traderfeed" where the subscription form asks you for a promotional code.
* Trade Ideas on the Web--Backed by Research! - Every day James Altucher is putting out value by tracking "system trades of the day" on the StockPickr site. You not only see the ideas, but how well they performed over recent market history. I continue to believe this is one of the Web's best information sources for traders and investors.
* More on the Turtles - I recently addressed some of the psychological challenges associated with investment (as opposed to short-term trading). It turns out that Michael Covel has addressed this topic on his site and will also be tackling it in a forthcoming book. I look forward to reading and reviewing that book.
* Brain Fitness - Here's an excellent collection of resources concerning brain fitness and cognitive neuroscience from SharpBrains. Once again, I have no commercial relationship with this firm, but I applaud their commitment to trader education.
* Rising Interest Rates Taking a Toll? - I find it difficult to believe it's a coincidence that the number of stocks making new 65-day highs topped out in mid-April, which is also when 10-year interest rates bottomed. Since then, rates have risen to over 4.9% intraday today--one factor that may be playing into the stock market weakness today. I am very curious to see how the market would tolerate a move above 5%.
The Psychology of Investing: How Investors Differ From Traders
Investment is different from short-term trading, psychologically as well as strategically. The shorter the time frame, the less time traders typically have to plan and research their trades. The intuitive, implicit recognition of patterns is a core skill for the high frequency trader. Many of the traders I have worked with in proprietary firms don't trade with a directional bias. They observe the flow of orders in the depth-of-market (DOM) display, the distribution of large transactions (buying vs. selling), and the waxing and waning of volume to frame trading ideas on the fly. As I've noted before, this rapid pattern recognition requires intensive exposure to multiple market scenarios, so that the high frequency trader literally develops a feel for market action.
The investor, on the other hand, seeks capital appreciation over a lengthy time period. There is plenty of time to research various markets and strategies, and this research is often key to the investor's success. Any investor will only see a limited number of bull and bear markets during their lifetime--not nearly enough to develop that intuitive, implicit grasp of patterns. As a result, the long-term investor must find an edge in his or her ability to identify strategies with an edge and then sustain the patience to stick with those strategies. Where the scalper is relying on implicit feel, the investor must follow conscious reason.
To understand the psychology of investing, it's helpful to look toward other areas of life in which we invest ourselves, such as relationships and careers. Can you imagine what would happen if we were to take a "trading" perspective on relationships or careers? We would set a close "stop loss" and exit the relationship or career whenever that was hit. No doubt, we'd wind up with an impoverished love and work life as a result. To sustain a romantic relationship or a successful career, we have to be able to ride the ups and the downs and remain rooted in our commitment despite difficult times.
This is equally true for the financial investor. Consider the long-term investor in stocks who was frightened out of the market during the scary drop late in February and early in March. Had the investor behaved like a trader, cut losses, and abandoned his or her strategy at that time, a great deal of opportunity would have been lost.
The experience of the Turtles suggests that it is not so easy to follow longer-term market strategies. The Turtles, recall, were given a purely mechanical system to trade, with rules governing when to enter and exit positions, how to size those positions, and how many different positions to take. Even with strategy mapped out for them neatly, the Turtles varied greatly in their returns, as recently noted in Curtis Faith's book. They could not ride out the inevitable drawdowns of the trading method.
To stick with a career, you have to believe in the value of your work; to stay with a marriage, you must remain grounded in the love that brought you to that other person. In no small measure, the successful professional or spouse relies on emotional bonds to ride out short-term adversity. The investor, unlike the trader, must bond with his or her strategies--must really believe in them and their intrinsic value. Look at the trend followers featured on Michael Covel's site: they are passionate about their method. Consider Warren Buffett or Jimmy Rogers: they truly value their (quite different) value approach to investments.
I've often heard advice from short-term traders: "Don't get married to a position." Investors, however, do enter into a kind of marriage: a marriage with their basic approach to markets. Frequency of exposure drives the rapid pattern recognition of the scalper, but it is depth of conviction that enables investors to stay their course. The key, in investing as in marriage and careers, is finding the right partner for that bonding and commitment--not just something you think can work, but something that captures your deepest beliefs; that you're willing to subordinate yourself to.
RELATED POSTS:
Guiding Principles of Trading Psychology
The Objective Basis for Subjective Knowledge
Reflections on Life and Markets
The investor, on the other hand, seeks capital appreciation over a lengthy time period. There is plenty of time to research various markets and strategies, and this research is often key to the investor's success. Any investor will only see a limited number of bull and bear markets during their lifetime--not nearly enough to develop that intuitive, implicit grasp of patterns. As a result, the long-term investor must find an edge in his or her ability to identify strategies with an edge and then sustain the patience to stick with those strategies. Where the scalper is relying on implicit feel, the investor must follow conscious reason.
To understand the psychology of investing, it's helpful to look toward other areas of life in which we invest ourselves, such as relationships and careers. Can you imagine what would happen if we were to take a "trading" perspective on relationships or careers? We would set a close "stop loss" and exit the relationship or career whenever that was hit. No doubt, we'd wind up with an impoverished love and work life as a result. To sustain a romantic relationship or a successful career, we have to be able to ride the ups and the downs and remain rooted in our commitment despite difficult times.
This is equally true for the financial investor. Consider the long-term investor in stocks who was frightened out of the market during the scary drop late in February and early in March. Had the investor behaved like a trader, cut losses, and abandoned his or her strategy at that time, a great deal of opportunity would have been lost.
The experience of the Turtles suggests that it is not so easy to follow longer-term market strategies. The Turtles, recall, were given a purely mechanical system to trade, with rules governing when to enter and exit positions, how to size those positions, and how many different positions to take. Even with strategy mapped out for them neatly, the Turtles varied greatly in their returns, as recently noted in Curtis Faith's book. They could not ride out the inevitable drawdowns of the trading method.
To stick with a career, you have to believe in the value of your work; to stay with a marriage, you must remain grounded in the love that brought you to that other person. In no small measure, the successful professional or spouse relies on emotional bonds to ride out short-term adversity. The investor, unlike the trader, must bond with his or her strategies--must really believe in them and their intrinsic value. Look at the trend followers featured on Michael Covel's site: they are passionate about their method. Consider Warren Buffett or Jimmy Rogers: they truly value their (quite different) value approach to investments.
I've often heard advice from short-term traders: "Don't get married to a position." Investors, however, do enter into a kind of marriage: a marriage with their basic approach to markets. Frequency of exposure drives the rapid pattern recognition of the scalper, but it is depth of conviction that enables investors to stay their course. The key, in investing as in marriage and careers, is finding the right partner for that bonding and commitment--not just something you think can work, but something that captures your deepest beliefs; that you're willing to subordinate yourself to.
RELATED POSTS:
Guiding Principles of Trading Psychology
The Objective Basis for Subjective Knowledge
Reflections on Life and Markets
Wednesday, May 23, 2007
Squeezing Shorts With Money Flow: A Stock Picking Strategy
When pessimism is overdone, you can benefit from short squeezes. The idea here is that, when everyone seems to be bearish on a stock, there are few sellers left. Once buying comes into the stock, the effect is amplified by short sellers fleeing their positions.
Several services help traders find promising short squeeze plays. The Squeeze Shorts blog has gotten off to a nice start. The Short Squeeze site is devoted to scanning for stocks with high short positions that are trading near important pivot levels; that are long and short candidates; etc. A recent post to the excellent StockPickr site identified a number of stocks with high short interest that also display high insider buying: a potentially powerful combination.
I decided to add to StockPickr's criteria by tracking my money flow measure (adjusted relative dollar volume flow) for one of the high short interest stocks that also display solid insider buying. NutriSystem (NTRI) has a short interest ratio of 10 and insider buying of $2.6M, according to StockPickr. It has also been added as a holding by three professional money managers.
As we can see, NTRI stock (blue line) has been trading in a range since early 2006. Its 20-day adjusted relative dollar volume flow (pink line), however, has been above its 200 day moving average (above zero on the chart) since the February/March decline. Indeed, over the past 30 trading sessions, NTRI has displayed net dollar inflows on 21 occasions--18 of which were above the 200 day moving average.
By adding money flow to the criteria of insider buying and high short interest, we can refine the short squeeze stock selection process. The fact that pros are buying NTRI, that the stock is displaying above average dollar inflows, and that there is still a very heavy short position overhanging the stock leads me to surmise that the resolution of the extended trading range will be to the upside. A portfolio of such candidates would make for a worthy strategy.
RELATED POSTS:
Overview of Relative Dollar Volume Flow Indicator
Tracking the Dollar Volume Flows Among Stocks
Midweek Stock Market Observations
* Money Flow Chugs Along - My weekend review of money flow across the S&P sectors found that dollars were still flowing into the large caps. Nothing so far this week has altered that scenario. Indeed, we've had six consecutive sessions in which dollar volume flow into the Dow 30 stocks has been above the 200-day average. Hard to sustain the downside with that kind of buying interest.
* What's Hot, What's Not - Keep an eye on PFE; dollar volume flows are up noticeably over the past three trading sessions. The money flow laggards among the Dow stocks are INTC and WMT. WMT shows net outflows for eight of the last nine sessions; INTC has shown net outflows for seven of the last eight sessions.
* Know Your Limits - Victor Niederhoffer makes a case for periodic, difficult self assessments.
* Energy Stock Recommendations and Much More - Charles Kirk opens up his Q&A for members for general viewing, with plenty of insights regarding his new stock screening.
* Support for the Russell 2000 Index - Trader Mike tracks index strength and notes the 50-day moving average support for $RUT.
* Technicals Look Healthy for this Market - Brian Shannon reviews the NASDAQ 100 and S&P 500 Index and likes what he sees.
* The Private Equity Boom is Affecting the Options Market - Adam Warner offers a nice insight into the underlying bid. See also the analysis from A Dash of Insight: how private equity is creating an underlying bid for equities.
* The Market's a BRIC House - The Big Picture notes optimistic sentiment in a recent WSJ piece and shows how the emerging markets of Brazil, Russia, India, and China have trounced the European averages and especially the U.S. equity market.
* Inverted Nifty Fifty? - Abnormal Returns notes how undervalued large caps have been making their return. Check out StockPickr for data on 10 large cap stocks rising on increasing volume.
* Saving Dessert for Last - Many thanks to Rennie Yang for his recent shout out. His Market Tells service has pointed out a number of historical trading patterns that enabled traders to benefit from the recent strength. But now that we've had eight consecutive higher highs on the weekly chart for the S&P 500 Index and nine higher weekly lows, can we expect a correction? Rennie looks at the historical evidence and finds that such consistent strength leads to further price gains going forward.
* What's Hot, What's Not - Keep an eye on PFE; dollar volume flows are up noticeably over the past three trading sessions. The money flow laggards among the Dow stocks are INTC and WMT. WMT shows net outflows for eight of the last nine sessions; INTC has shown net outflows for seven of the last eight sessions.
* Know Your Limits - Victor Niederhoffer makes a case for periodic, difficult self assessments.
* Energy Stock Recommendations and Much More - Charles Kirk opens up his Q&A for members for general viewing, with plenty of insights regarding his new stock screening.
* Support for the Russell 2000 Index - Trader Mike tracks index strength and notes the 50-day moving average support for $RUT.
* Technicals Look Healthy for this Market - Brian Shannon reviews the NASDAQ 100 and S&P 500 Index and likes what he sees.
* The Private Equity Boom is Affecting the Options Market - Adam Warner offers a nice insight into the underlying bid. See also the analysis from A Dash of Insight: how private equity is creating an underlying bid for equities.
* The Market's a BRIC House - The Big Picture notes optimistic sentiment in a recent WSJ piece and shows how the emerging markets of Brazil, Russia, India, and China have trounced the European averages and especially the U.S. equity market.
* Inverted Nifty Fifty? - Abnormal Returns notes how undervalued large caps have been making their return. Check out StockPickr for data on 10 large cap stocks rising on increasing volume.
* Saving Dessert for Last - Many thanks to Rennie Yang for his recent shout out. His Market Tells service has pointed out a number of historical trading patterns that enabled traders to benefit from the recent strength. But now that we've had eight consecutive higher highs on the weekly chart for the S&P 500 Index and nine higher weekly lows, can we expect a correction? Rennie looks at the historical evidence and finds that such consistent strength leads to further price gains going forward.
Tuesday, May 22, 2007
NYSE TICK and the Small Cap/Large Cap Relationship
The NYSE TICK tells us something about sector strength. Long time readers of this blog are familiar with my cumulative Adjusted TICK statistic. This takes the NYSE TICK (the number of stocks trading at offer minus those trading at their bid prices) and subtracts from each one minute value the average one-minute NYSE TICK reading from the prior 20 days. These values are cumulated to give a single end-of-day reading. If the cumulative Adjusted TICK is above zero, it means that we're seeing a tilt toward buying interest (lifting of offers) among the broad list of stocks. If the cumulative Adjusted TICK is below zero, it means that we have net selling sentiment (hitting of bids).
Since 2005 (N = 596 trading days), the cumulated Adjusted TICK has correlated very highly with concurrent daily price change in the S&P 500 Index (SPY; .76) and price change in the Russell 2000 Index (IWM; .80). This is why one of my most effective intraday strategies is to assess shifts in the distribution of the TICK for emerging directional moves in the indices. Shifts in the TICK, including breakouts from ranges, frequently precede or initiate short-term directional moves in the indexes.
But suppose we are interested in answering the question: should I be trading the large cap index (S&P 500 issues) or the small cap index (Russell 2000)? Or suppose we decide to craft a pairs trade in which we'll be long one of those indexes and short the other one. In both cases it turns out that the cumulative Adjusted TICK provides useful guidance.
I went back to 2005 (N = 596) and found that the cumulative Adjusted TICK correlates .60 with the difference in performance between IWM and SPY. Specifically, when the Adjusted TICK is strong, IWM is significantly more likely to outperform SPY than the reverse. When the Adjusted TICK is weak, we see underperformance of IWM relative to SPY.
In fact, when the cumulative Adjusted TICK was above zero (N = 301), IWM outperformed SPY on 212 of those occasions. When the cumulative Adjusted TICK reading was above +300 (N = 144), IWM outperformed SPY on 114 occasions, or about 80% of the time.
When, however, the cumulative Adjusted TICK was below zero (N = 295), SPY outperformed IWM on 196 of those occasions. When the cumulative Adjusted TICK reading was below -300 (N = 139), SPY outperformed IWM on 117 occasions--over 80% of the time.
A strong NYSE TICK not only tells us that there is buying interest in the market, but it's also telling us that the buying interest is extending to the broad list of stocks, including small caps. Similarly, very weak TICK readings tell us that investors are selling off the smallest of stocks along with the larger ones. In strong or weak TICK environments, traders can consider trading long or short positions in IWM or perhaps constructing pairs trades in which they are long IWM/short SPY (or the reverse in a weak TICK setting).
Note that this strategy also suggests that it could be fruitful to monitor custom TICK measures for specific market sectors. (The NeoTicker platform enables the construction of such TICK-specific measures). A range of ETF trading strategies (or pairs trades among ETFs) could follow such an effort--a worthy area to research.
RELATED READINGS:
Trading With the NYSE TICK
NYSE TICK and Short-Term Breakout Moves
Since 2005 (N = 596 trading days), the cumulated Adjusted TICK has correlated very highly with concurrent daily price change in the S&P 500 Index (SPY; .76) and price change in the Russell 2000 Index (IWM; .80). This is why one of my most effective intraday strategies is to assess shifts in the distribution of the TICK for emerging directional moves in the indices. Shifts in the TICK, including breakouts from ranges, frequently precede or initiate short-term directional moves in the indexes.
But suppose we are interested in answering the question: should I be trading the large cap index (S&P 500 issues) or the small cap index (Russell 2000)? Or suppose we decide to craft a pairs trade in which we'll be long one of those indexes and short the other one. In both cases it turns out that the cumulative Adjusted TICK provides useful guidance.
I went back to 2005 (N = 596) and found that the cumulative Adjusted TICK correlates .60 with the difference in performance between IWM and SPY. Specifically, when the Adjusted TICK is strong, IWM is significantly more likely to outperform SPY than the reverse. When the Adjusted TICK is weak, we see underperformance of IWM relative to SPY.
In fact, when the cumulative Adjusted TICK was above zero (N = 301), IWM outperformed SPY on 212 of those occasions. When the cumulative Adjusted TICK reading was above +300 (N = 144), IWM outperformed SPY on 114 occasions, or about 80% of the time.
When, however, the cumulative Adjusted TICK was below zero (N = 295), SPY outperformed IWM on 196 of those occasions. When the cumulative Adjusted TICK reading was below -300 (N = 139), SPY outperformed IWM on 117 occasions--over 80% of the time.
A strong NYSE TICK not only tells us that there is buying interest in the market, but it's also telling us that the buying interest is extending to the broad list of stocks, including small caps. Similarly, very weak TICK readings tell us that investors are selling off the smallest of stocks along with the larger ones. In strong or weak TICK environments, traders can consider trading long or short positions in IWM or perhaps constructing pairs trades in which they are long IWM/short SPY (or the reverse in a weak TICK setting).
Note that this strategy also suggests that it could be fruitful to monitor custom TICK measures for specific market sectors. (The NeoTicker platform enables the construction of such TICK-specific measures). A range of ETF trading strategies (or pairs trades among ETFs) could follow such an effort--a worthy area to research.
RELATED READINGS:
Trading With the NYSE TICK
NYSE TICK and Short-Term Breakout Moves
Buying Panic Among SPY Traders?
SPY Traders Are Jumping Into This Market. Monday's rise took the S&P 500 Index to a new all-time high. As we can see from the chart above, the recent market rise has been accompanied by quite a spike in the ratio of volume of the S&P 500 Index ETF (SPY) to NYSE Volume. In the recent past, spikes in SPY volume relative to general market volume have occurred at market lows as a function of panicky selling. To that degree, SPY traders as a whole have not looked like smart money; spikes in their participation have been a contrary indicator. This was particularly evident during the market weakness of late February/early March.
This is the first time I can recall during the bull market when we've had an elevated ratio of SPY:NYSE Volume on a market rise. It invites the perception that, just as SPY traders panicked on the downside during the Feb./Mar. weakness, they are now panicking to the upside, eager to get into a market making fresh all-time highs.
I'm watching closely to see if this, too, proves a contrary indication of sentiment.
RELATED POSTS:
NASDAQ Volume as a Sentiment Measure
Equity Option Volume and Sentiment
Mutual Fund Sentiment
Monday, May 21, 2007
Decision Making and Risk: Fascinating Research From Dr. Itiel Dror
As part of my recent post on trader psychometrics, I reviewed a number of research studies dealing with risk taking and personality. One of the happy outcomes of my search was coming across the research of Dr. Itiel Dror, who teaches at the School of Psychology at the University of Southampton in England. His work on decision making is particularly relevant to trading.
Among the interesting findings from his research:
* Time Pressure Affects Risk Taking - Under time pressure, individuals are more conservative when they face less risk, but more risk-taking at higher levels of risk.
* Emotions Affect Pattern Recognition - Increased negative emotionality led raters to identify more patterns in ambiguous situations.
* Contextual Information Affects the Judgments of Experts - When you provide leading information to experts, their subsequent judgments change to fit the prior information.
* Perception is Far From Perfection - What we perceive is greatly influenced by our mental states, the information we've already stored and organized, and the meanings we impose upon ambiguous situations.
* Primacy Effects - What we see first biases our perception and affects our subsequent performance.
The important take-away from this research is that many of the factors that influence performance--even among expert performers--are situational and not part of fixed personality traits. What we perceive and how we respond are greatly influenced by the environment. A full understanding of a trader's performance requires an appreciation of the specific situation in which the performance was embedded.
RELATED POSTS:
Inside the Trader's Brain
Finding an Objective Basis for Subjective Knowledge
Four Insightful Studies From Dr. Andrew Lo
Among the interesting findings from his research:
* Time Pressure Affects Risk Taking - Under time pressure, individuals are more conservative when they face less risk, but more risk-taking at higher levels of risk.
* Emotions Affect Pattern Recognition - Increased negative emotionality led raters to identify more patterns in ambiguous situations.
* Contextual Information Affects the Judgments of Experts - When you provide leading information to experts, their subsequent judgments change to fit the prior information.
* Perception is Far From Perfection - What we perceive is greatly influenced by our mental states, the information we've already stored and organized, and the meanings we impose upon ambiguous situations.
* Primacy Effects - What we see first biases our perception and affects our subsequent performance.
The important take-away from this research is that many of the factors that influence performance--even among expert performers--are situational and not part of fixed personality traits. What we perceive and how we respond are greatly influenced by the environment. A full understanding of a trader's performance requires an appreciation of the specific situation in which the performance was embedded.
RELATED POSTS:
Inside the Trader's Brain
Finding an Objective Basis for Subjective Knowledge
Four Insightful Studies From Dr. Andrew Lo
Assessing Trader Personality: The Role of Trader Psychometrics
Are there personality patterns common to successful traders? This is a question that interests aspiring traders and trading firms alike. The usual way of addressing the issue is to offer traders a set of pencil-and-paper questionnaires that evaluate personality traits and then see if the results correlate with trading outcomes.
There is much to be said for the questionnaire method of assessing personality and performance. Questionnaires are easy to administer and score. There are also highly reliable, valid, and standardized measures of personality traits in the psychological literature, such as the NEO PI-R based upon the work of Costa and McCrae. Research coming out of the London Business School has found that personality traits--including overconfidence and sensation-seeking--are significantly associated with trading results. This corresponds to my own, more informal, findings that high degrees of neuroticism, coupled with sensation-seeking and low conscientiousness, are associated with poor trading outcomes.
There are several potential weaknesses to the questionnaire approach, however. First, and most fundamentally, it is not at all clear how much of the variance in real world trading outcomes is accounted for by self-reported traits. My investigation with Andrew Lo's research team at MIT did not find any strong association in a sample of traders. Nor is it clear that the universe of traders is homogeneous, with a single set of optimal personality traits. Just as different personality styles are associated with specialties within medicine--psychiatry vs. surgery vs. radiology--it may well be the case that different personality patterns typify successful market makers vs. portfolio managers vs. mechanical system traders.
Equally problematic, questionnaires tend to be face valid; it is obvious to respondents what is being asked of them. This makes it easy to manipulate the results, particularly in employment settings where test-takers will provide the most socially desirable responses.
For these reasons, it can be worthwhile to supplement the use of questionnaires with measures of trader psychometrics. As David Norman of the Illinois Institute of Technology indicates, we can learn about traders from an assessment of their trading, just as we can learn about trading by asking questions of traders. Dr. Norman's Trader DNA program is an effort to collect metrics on one's trades, so that traders can identify their own patterns of successful and unsuccessful trading.
Having utilized this approach in my own work with traders, I would like to propose that trader psychometrics can reveal several important dimensions of trader personality that are useful supplements to the information gleaned from questionnaires:
1) Frequency of Trading - I propose that this is a manifestation of a trader's need for stimulation and tendency toward sensation-seeking. The trader who needs/desires to be active in the marketplace (e.g., the day-trader) displays different needs for stimulation than the long-term investor;
2) Size of Positions Relative to Portfolio Size - This is a direct measure of risk-taking vs. risk assumption;
3) Average Size of Losing Trades vs. Winning Trades - This assesses the prudence or conscientiousness of the trader in managing risk. Traders with large outliers among losing trades display a lack of control over risk.
4) Number of Different Positions and Strategies Employed - This is a measure of behavioral complexity, which in turn has been found to be associated with superior performance in a variety of work settings. Such complexity may also prove to offer a degree of insulation from changing market conditions.
The trader psychometrics address many of the shortcomings of pencil-and-paper self-report personality questionnaires. They are easily gathered by computer and need no psychological interpretation and administration. They represent objective, observable data that are not subject to subjective interpretive bias. The metrics also cannot be faked by traders.
Most important of all, however, the trader psychometrics create a process-based assessment. We can see how patterns of trading change over varying market conditions and across different markets and strategies. The research of MacCrimmon and colleagues, for example, found that risk-assumption has a very strong situational component: people who are risk-takers in one situation (personal life, for example) may be risk averse in other situations (finances). The trader psychometrics view personality as it is manifested in the specific trading context. We can detect personality at work as trading proceeds. This makes trading metrics a fine supplement to more global personality measures.
Finally, an advantage of trader psychometrics is that they can be collected by traders themselves and used to identify patterns of success and failure. For instance, traders can track their trading and learn whether they become more or less risk averse as markets become more volatile; whether they become more prudent over time; etc. In this sense, trader psychometrics are both assessment tool and learning tool.
Your personality affects your trading, but your trading also reflects your personality. A well-rounded approach to assessment looks at the trader from both angles, identifying elements of performance associated with the person and with the trading situation.
RELATED POSTS:
How Personality Affects Trading Performance
Steps Toward Becoming a Better Trader
A Personality Questionnaire for Traders
Interpreting the Personality Questionnaire
There is much to be said for the questionnaire method of assessing personality and performance. Questionnaires are easy to administer and score. There are also highly reliable, valid, and standardized measures of personality traits in the psychological literature, such as the NEO PI-R based upon the work of Costa and McCrae. Research coming out of the London Business School has found that personality traits--including overconfidence and sensation-seeking--are significantly associated with trading results. This corresponds to my own, more informal, findings that high degrees of neuroticism, coupled with sensation-seeking and low conscientiousness, are associated with poor trading outcomes.
There are several potential weaknesses to the questionnaire approach, however. First, and most fundamentally, it is not at all clear how much of the variance in real world trading outcomes is accounted for by self-reported traits. My investigation with Andrew Lo's research team at MIT did not find any strong association in a sample of traders. Nor is it clear that the universe of traders is homogeneous, with a single set of optimal personality traits. Just as different personality styles are associated with specialties within medicine--psychiatry vs. surgery vs. radiology--it may well be the case that different personality patterns typify successful market makers vs. portfolio managers vs. mechanical system traders.
Equally problematic, questionnaires tend to be face valid; it is obvious to respondents what is being asked of them. This makes it easy to manipulate the results, particularly in employment settings where test-takers will provide the most socially desirable responses.
For these reasons, it can be worthwhile to supplement the use of questionnaires with measures of trader psychometrics. As David Norman of the Illinois Institute of Technology indicates, we can learn about traders from an assessment of their trading, just as we can learn about trading by asking questions of traders. Dr. Norman's Trader DNA program is an effort to collect metrics on one's trades, so that traders can identify their own patterns of successful and unsuccessful trading.
Having utilized this approach in my own work with traders, I would like to propose that trader psychometrics can reveal several important dimensions of trader personality that are useful supplements to the information gleaned from questionnaires:
1) Frequency of Trading - I propose that this is a manifestation of a trader's need for stimulation and tendency toward sensation-seeking. The trader who needs/desires to be active in the marketplace (e.g., the day-trader) displays different needs for stimulation than the long-term investor;
2) Size of Positions Relative to Portfolio Size - This is a direct measure of risk-taking vs. risk assumption;
3) Average Size of Losing Trades vs. Winning Trades - This assesses the prudence or conscientiousness of the trader in managing risk. Traders with large outliers among losing trades display a lack of control over risk.
4) Number of Different Positions and Strategies Employed - This is a measure of behavioral complexity, which in turn has been found to be associated with superior performance in a variety of work settings. Such complexity may also prove to offer a degree of insulation from changing market conditions.
The trader psychometrics address many of the shortcomings of pencil-and-paper self-report personality questionnaires. They are easily gathered by computer and need no psychological interpretation and administration. They represent objective, observable data that are not subject to subjective interpretive bias. The metrics also cannot be faked by traders.
Most important of all, however, the trader psychometrics create a process-based assessment. We can see how patterns of trading change over varying market conditions and across different markets and strategies. The research of MacCrimmon and colleagues, for example, found that risk-assumption has a very strong situational component: people who are risk-takers in one situation (personal life, for example) may be risk averse in other situations (finances). The trader psychometrics view personality as it is manifested in the specific trading context. We can detect personality at work as trading proceeds. This makes trading metrics a fine supplement to more global personality measures.
Finally, an advantage of trader psychometrics is that they can be collected by traders themselves and used to identify patterns of success and failure. For instance, traders can track their trading and learn whether they become more or less risk averse as markets become more volatile; whether they become more prudent over time; etc. In this sense, trader psychometrics are both assessment tool and learning tool.
Your personality affects your trading, but your trading also reflects your personality. A well-rounded approach to assessment looks at the trader from both angles, identifying elements of performance associated with the person and with the trading situation.
RELATED POSTS:
How Personality Affects Trading Performance
Steps Toward Becoming a Better Trader
A Personality Questionnaire for Traders
Interpreting the Personality Questionnaire
Sunday, May 20, 2007
Weekend Reading and Market Insights
* Large Cap Strength: The updated Trading Psychology Weblog reviews the recent strength among large cap stocks and looks at where money is flowing among the S&P 500 sectors.
* Developing Creative Trade Ideas: The Trader Performance Page and my recent post on market vision represent directions I'm taking in my own research and trading. The idea is to trade themes, not just broad market movements.
* Great Weekly Review: Every weekend from Barry Ritholtz and the Big Picture's linkfests. This week's links include some insight into what happens when markets display bad breadth. See also the top ten water stocks.
* An Alternate View of Web Search: Trader Mike notes the recent interview with Jimmy Wales and wiki implications for search.
* Membership Hath Its Privileges: Charles Kirk offers a wide ranging Q&A session for members touching on such issues as what could derail the bull market, recommended software for learning technical patterns, setting trading goals, perspectives on market timing, and much more.
* Blogging the Frenzy: The Wall St. Journal MarketBeat feature does a nice job of tracking trading ideas, market developments, and posts through the day.
* More Fine Links: Abnormal Returns hits a number of fine posts, including a view on how financial stocks are turning in disparate performances.
* The Value of Moving Averages: Michael Covel shares a great perspective from Ed Seykota.
* Wrapping Up the Market Week: Larry Nusbaum offers a great collection of posts, including ETF performance.
* Chronic Stress: Dr. Hong outlines the biology of chronic stress and the implications for traders. Great new site.
* Perspectives Galore: From Misstrade, including a bicoastal view of trading.
Have a great start to your week!
Brett
* Developing Creative Trade Ideas: The Trader Performance Page and my recent post on market vision represent directions I'm taking in my own research and trading. The idea is to trade themes, not just broad market movements.
* Great Weekly Review: Every weekend from Barry Ritholtz and the Big Picture's linkfests. This week's links include some insight into what happens when markets display bad breadth. See also the top ten water stocks.
* An Alternate View of Web Search: Trader Mike notes the recent interview with Jimmy Wales and wiki implications for search.
* Membership Hath Its Privileges: Charles Kirk offers a wide ranging Q&A session for members touching on such issues as what could derail the bull market, recommended software for learning technical patterns, setting trading goals, perspectives on market timing, and much more.
* Blogging the Frenzy: The Wall St. Journal MarketBeat feature does a nice job of tracking trading ideas, market developments, and posts through the day.
* More Fine Links: Abnormal Returns hits a number of fine posts, including a view on how financial stocks are turning in disparate performances.
* The Value of Moving Averages: Michael Covel shares a great perspective from Ed Seykota.
* Wrapping Up the Market Week: Larry Nusbaum offers a great collection of posts, including ETF performance.
* Chronic Stress: Dr. Hong outlines the biology of chronic stress and the implications for traders. Great new site.
* Perspectives Galore: From Misstrade, including a bicoastal view of trading.
Have a great start to your week!
Brett
Understanding Market Themes
One of the findings that stand out in dramatic relief in my research is the relative strength of the Materials, Industrials, and Energy stocks relative to Consumer Discretionary, Consumer Staples, Financial, and Technology stocks. Above we see the relationship between the Materials sector ETF and the Technology sector ETF within the S&P 500 Index. This, I believe, represents an important thematic dimension for markets: the degree to which capital is rewarding physical vs. intellectual assets. In the late 1990s, we saw a premium according to the intellectual assets of technology. Since 2004, however, we've seen an upward trend in the relationship between hard assets and technology.One of the promising areas of money flow research is its ability to detect these themes among sectors. The usual question traders ask is whether the market is likely to rise or fall. An equally fruitful question, however, is: Which themes are likely to benefit from capital inflows? When the dollar (and returns from dollar denominated assets) are relatively weak, hard assets become attractive storehouses of value.
Market Review: The Large Caps are Living Large
Market observations for a Sunday morning (hats off to Decision Point for the Advance-Decline stats and to Barchart for the new high/low data):
* The NYSE Advance-Decline Line has been flat since mid-April and is below peaks achieved earlier in April and May, despite the rise to new price highs on Friday.
* The Advance-Decline line specific to the Dow Industrials has steadily moved to new highs through the rise; the AD Line for the S&P 500 large caps also touched a marginal new high on Friday.
* From mid-April to early May to this past Friday, the AD Line specific to the S&P 600 small cap stocks has traced out lower highs and lower lows. This pattern of lower AD highs and lower AD lows is especially noticeable in the advance-decline stats specific to the NASDAQ Composite stocks.
* The AD Line specific to the NASDAQ 100 stocks is also not confirming the Friday highs in the large caps, but is notably stronger than the AD Line for the full range of NASDAQ Composite stocks. Clearly the large cap stocks are the beneficiaries of the recent market strength.
* Among the S&P 500 sectors, the AD Lines are strongest among the Materials, Utilities, Industrials, Health Care, and especially the Energy stocks. This fits my money flow data very well. The AD Lines for Technology, Financials, Consumer Discretionary, and Consumer Staples stocks are lagging.
* Despite Friday's highs in the large cap indexes, we had 856 new 20-day highs across the NYSE, NASDAQ, and ASE on Friday against 984 new 20-day lows. Clearly the rally is quite selective at this juncture.
* We see more new high/low strength in the NYSE than in the NASDAQ Composite. On Friday, we had 432 new 20-day highs among NYSE stocks against 409 new lows. But we had 205 NASDAQ new 20-day highs against 369 new lows.
* Among stocks that trade more than 100,000 shares daily, we had 509 new 20-day highs against 467 new lows. Among those trading less than 100,000 shares daily, we had 347 new highs and 517 new 20-day lows. No matter how you slice it, the larger caps come out on top.
* Will those large caps be the ones to benefit as China diversifies the investment of its reserves in search of superior returns? Will the diversion of this capital away from fixed income lead to a rise in U.S. interest rates?
* Will China's participation in the private equity-led takeover boom accelerate the shrinkage of supply in equities, further fueling the market rise? And will China's diversification continue to lead to allocation of capital to Anything But U.S. Equities?
Lots of dynamics favoring large caps here. I'll review money flow numbers in those large caps late Sunday in the Trading Psychology Weblog.
* The NYSE Advance-Decline Line has been flat since mid-April and is below peaks achieved earlier in April and May, despite the rise to new price highs on Friday.
* The Advance-Decline line specific to the Dow Industrials has steadily moved to new highs through the rise; the AD Line for the S&P 500 large caps also touched a marginal new high on Friday.
* From mid-April to early May to this past Friday, the AD Line specific to the S&P 600 small cap stocks has traced out lower highs and lower lows. This pattern of lower AD highs and lower AD lows is especially noticeable in the advance-decline stats specific to the NASDAQ Composite stocks.
* The AD Line specific to the NASDAQ 100 stocks is also not confirming the Friday highs in the large caps, but is notably stronger than the AD Line for the full range of NASDAQ Composite stocks. Clearly the large cap stocks are the beneficiaries of the recent market strength.
* Among the S&P 500 sectors, the AD Lines are strongest among the Materials, Utilities, Industrials, Health Care, and especially the Energy stocks. This fits my money flow data very well. The AD Lines for Technology, Financials, Consumer Discretionary, and Consumer Staples stocks are lagging.
* Despite Friday's highs in the large cap indexes, we had 856 new 20-day highs across the NYSE, NASDAQ, and ASE on Friday against 984 new 20-day lows. Clearly the rally is quite selective at this juncture.
* We see more new high/low strength in the NYSE than in the NASDAQ Composite. On Friday, we had 432 new 20-day highs among NYSE stocks against 409 new lows. But we had 205 NASDAQ new 20-day highs against 369 new lows.
* Among stocks that trade more than 100,000 shares daily, we had 509 new 20-day highs against 467 new lows. Among those trading less than 100,000 shares daily, we had 347 new highs and 517 new 20-day lows. No matter how you slice it, the larger caps come out on top.
* Will those large caps be the ones to benefit as China diversifies the investment of its reserves in search of superior returns? Will the diversion of this capital away from fixed income lead to a rise in U.S. interest rates?
* Will China's participation in the private equity-led takeover boom accelerate the shrinkage of supply in equities, further fueling the market rise? And will China's diversification continue to lead to allocation of capital to Anything But U.S. Equities?
Lots of dynamics favoring large caps here. I'll review money flow numbers in those large caps late Sunday in the Trading Psychology Weblog.
Saturday, May 19, 2007
Goldman Sachs (GS): Does Money Flow Matter?
I'm building out models of individual stock performance based on historical patterns of money flow. Let's take GS, which made a new high on Friday. On a five-day basis, money flow in GS has been outright negative: investors have pulled dollars out of the stock. It turns out that the correlation between five-day price change in GS and five-day money flow is only .08. This suggests that flow represents a different variable (sentiment) from simple price change.
But does money flow matter?
Going back to 2004 (N = 845), when GS has been up more than 1% over a five-day period and money flow during that time has been negative (N = 158), the next five days in GS have averaged a gain of .73% (87 up, 71 down). When GS has been up more than 1% and money flow has been positive over the five day period, the average gain in GS over the next five sessions has been only .06% (113 up, 105 down). It thus appears that five-day returns have been subnormal when GS has been up strongly over a five-day period on positive money flow. When GS has been up strongly on negative flow, returns have not been subnormal; indeed, they're slightly stronger than the average (.54%) from 2004 to the present.
How about when GS is down over a five-day period? When GS loses ground over five sessions and money flow is negative during that time (N = 164), the next five days have returned an average of a whopping 1.60% (115 up, 49 down). That is much stronger than the average gain when GS is down over five days on positive money flow (.13%; 106 up, 85 down).
What this suggests is that sentiment, as measured by money flows, makes a difference for short-term returns in GS. When five-day money flow has been positive, the next five days in GS have returned an average of only .08% (264 up, 224 down). When five-day flows in GS have been negative, the next five days have returned an average of 1.17% (226 up, 131 down).
If you envision separate models for different stocks--some of which will show positive sentiment and some negative--you can see how a worthwhile long/short strategy might evolve. By being long the stocks with the most bullish flow patterns and short the stocks with the most bearish patterns, you can trade off sentiment and eliminate a large measure of general market (directional) risk.
RELATED POSTS:
Overview of Relative Dollar Volume Flow
Going With the Money Flow
Money Flow and Returns in the Dow Jones Industrials
But does money flow matter?
Going back to 2004 (N = 845), when GS has been up more than 1% over a five-day period and money flow during that time has been negative (N = 158), the next five days in GS have averaged a gain of .73% (87 up, 71 down). When GS has been up more than 1% and money flow has been positive over the five day period, the average gain in GS over the next five sessions has been only .06% (113 up, 105 down). It thus appears that five-day returns have been subnormal when GS has been up strongly over a five-day period on positive money flow. When GS has been up strongly on negative flow, returns have not been subnormal; indeed, they're slightly stronger than the average (.54%) from 2004 to the present.
How about when GS is down over a five-day period? When GS loses ground over five sessions and money flow is negative during that time (N = 164), the next five days have returned an average of a whopping 1.60% (115 up, 49 down). That is much stronger than the average gain when GS is down over five days on positive money flow (.13%; 106 up, 85 down).
What this suggests is that sentiment, as measured by money flows, makes a difference for short-term returns in GS. When five-day money flow has been positive, the next five days in GS have returned an average of only .08% (264 up, 224 down). When five-day flows in GS have been negative, the next five days have returned an average of 1.17% (226 up, 131 down).
If you envision separate models for different stocks--some of which will show positive sentiment and some negative--you can see how a worthwhile long/short strategy might evolve. By being long the stocks with the most bullish flow patterns and short the stocks with the most bearish patterns, you can trade off sentiment and eliminate a large measure of general market (directional) risk.
RELATED POSTS:
Overview of Relative Dollar Volume Flow
Going With the Money Flow
Money Flow and Returns in the Dow Jones Industrials
On the Value of Broad Market Vision
I had a great time on Friday talking with traders at a well-regarded financial institution. A particular treat was sharing the stage with a very successful trader who has been highlighted in financial publications. He addressed his comments to the new traders in the audience and, among other things, offered the following piece of wisdom:
"Whatever asset class you're trading, someone is trading something else against it. The more you know about that something else, the more prepared you'll be for market moves."
It was a great example of the broad market vision that I encounter among many fine traders. Like great quarterbacks, they see the entire field. Many fine trading ideas result when related markets change their relationships to one another.
If you think of it, every trade is a pairs trade. It's just that we often take the denominator--dollars--for granted. What I see in many very successful traders is that they think in denominator terms, not just numerators. They're very aware that they're trading one thing vs. another, and they frame their ideas and trades accordingly. The number of viable trade ideas rises exponentially when you think across asset classes and become free to change denominators as well as numerators.
I'll post more, with specifics, in an upcoming post.
RELATED POSTS:
What Makes a Professional Trader
The Myths of Trading Psychology
If you think of it, every trade is a pairs trade. It's just that we often take the denominator--dollars--for granted. What I see in many very successful traders is that they think in denominator terms, not just numerators. They're very aware that they're trading one thing vs. another, and they frame their ideas and trades accordingly. The number of viable trade ideas rises exponentially when you think across asset classes and become free to change denominators as well as numerators.
I'll post more, with specifics, in an upcoming post.
RELATED POSTS:
What Makes a Professional Trader
The Myths of Trading Psychology
Friday, May 18, 2007
Hybrid Trading: How Discretionary Traders Can Become More Systematic in Their Decisions
I recently finished an article for SFO Magazine with Henry Carstens, the system developer who contributed a worthy best practice for the series a while back. I continue to feel that Henry's introduction to testing trading ideas is the best article on the topic I've ever read.
For that reason, I was only too happy to write the current article with Henry. This article deals with something we call hybrid trading: the blending of discretionary and system trading styles.
If you recall, Henry worked with a blog reader and successful trader to help him extend his edge. Since that time, he has extended his ideas regarding helping discretionary traders become more systematic and consistent in their trading.
The creative idea that underlies the article is that successful traders can articulate their trading ideas and approaches to a system developer (with assurances of confidentiality, of course), who also studies the actual trades placed by the trader. From the account statements and the trader's own descriptions, the system developer identifies the rules behind the discretionary trader's trading.
Once the developer has this initial set of rules, he can then test the rules and improve upon them as part of system development. The result, for the trader, is a trading system that trades the trader's way. Many trading systems don't work for traders because they involve larger risks and drawdowns and different activity levels than are right for the trader. When a system is developed around *your* trading style, however, you're most likely to be able to use it out of the box.
The beauty of this hybrid is that you can accept or override its signals as you see fit. This enables you to see exactly how much your discretionary judgment adds to the performance of your basic rules. Moreover, you can automate your system so that you will be trading, even when you're not in front of the screen. This frees you up for other tasks and priorities, including (perhaps) developing new trading methods for other markets. Eventually, you could have a dozen computers trading just like you across different markets and time frames.
My sense is that this idea will be a particular boon to proprietary trading firms, enabling them to leverage the skill sets of their traders. A profit sharing arrangement between the trader and the firm to let a computer trade the hybrid method would prove a win-win--and it would help firms make the most of their talented traders. Too, a system developed to reflect a trader's own style could serve as a mentoring tool for beginning traders who might study under the expert trader.
I come across new ideas every week, but I have to say this strikes me as one of the most promising ones in quite a while. I'll post the link when the SFO article comes out.
RELATED POSTS:
Blending System and Discretionary Trading
Every Trader is a Trading System
For that reason, I was only too happy to write the current article with Henry. This article deals with something we call hybrid trading: the blending of discretionary and system trading styles.
If you recall, Henry worked with a blog reader and successful trader to help him extend his edge. Since that time, he has extended his ideas regarding helping discretionary traders become more systematic and consistent in their trading.
The creative idea that underlies the article is that successful traders can articulate their trading ideas and approaches to a system developer (with assurances of confidentiality, of course), who also studies the actual trades placed by the trader. From the account statements and the trader's own descriptions, the system developer identifies the rules behind the discretionary trader's trading.
Once the developer has this initial set of rules, he can then test the rules and improve upon them as part of system development. The result, for the trader, is a trading system that trades the trader's way. Many trading systems don't work for traders because they involve larger risks and drawdowns and different activity levels than are right for the trader. When a system is developed around *your* trading style, however, you're most likely to be able to use it out of the box.
The beauty of this hybrid is that you can accept or override its signals as you see fit. This enables you to see exactly how much your discretionary judgment adds to the performance of your basic rules. Moreover, you can automate your system so that you will be trading, even when you're not in front of the screen. This frees you up for other tasks and priorities, including (perhaps) developing new trading methods for other markets. Eventually, you could have a dozen computers trading just like you across different markets and time frames.
My sense is that this idea will be a particular boon to proprietary trading firms, enabling them to leverage the skill sets of their traders. A profit sharing arrangement between the trader and the firm to let a computer trade the hybrid method would prove a win-win--and it would help firms make the most of their talented traders. Too, a system developed to reflect a trader's own style could serve as a mentoring tool for beginning traders who might study under the expert trader.
I come across new ideas every week, but I have to say this strikes me as one of the most promising ones in quite a while. I'll post the link when the SFO article comes out.
RELATED POSTS:
Blending System and Discretionary Trading
Every Trader is a Trading System
Thursday, May 17, 2007
Market Notes for a Thursday
* Thursday makes the fifth consecutive trading session in which we've seen an ARMS Index below 1.0. Indeed, the five-day reading of .73 is one of the lowest readings we've had since 2005. Going back to 2005 (N = 592 trading days), we've had 97 occasions in which the five-day ARMS Index (or TRIN, as it's also known) has been below .90. Five days later, the S&P 500 Index (SPY) averaged a gain of only .07% (52 up, 45 down), much weaker than the average gain of .24% (298 up, 197 down) for the remainder of the sample. When volume is concentrated in the rising stocks over a five-day period, returns have been subnormal over the following week.
* Equity put/call ratios continue to drift lower, indicating no noticeable fear in the market despite the recent small cap weakness. Indeed, the five-day reading as of Thursday is the second lowest level since March.
* The small caps continue weak, with the Russell 2000 futures closing at their lowest level since mid-April. On Wednesday, we saw 20 new 52-week highs among S&P 600 small cap issues and 16 new annual lows! Thursday saw 21 highs against 12 lows. Hardly the stuff of roaring bull markets.
* Hats off to CXO Advisory's blog; they consistently summarize interesting research. Here CXO takes a look at companies that are good to work for and whether they're also good investments.
* The Kirk Report does a great job scouring the Web for news. The recent market watch links include James Altucher's look at 10 stocks with significant insider buying.
* Interesting new ETF from Claymore (CGW) is a way of trading companies involved in the clean water/water-as-natural-resource theme. The holdings are global, making this somewhat different from other investment alternatives.
* The scans are showing lots of NR7 patterns for Trader Mike.
* Yet another way of tapping home equity and keeping the boom going: Seeking Alpha. But Barry Ritholtz shows that housing needs more than a little stimulus.
* Equity put/call ratios continue to drift lower, indicating no noticeable fear in the market despite the recent small cap weakness. Indeed, the five-day reading as of Thursday is the second lowest level since March.
* The small caps continue weak, with the Russell 2000 futures closing at their lowest level since mid-April. On Wednesday, we saw 20 new 52-week highs among S&P 600 small cap issues and 16 new annual lows! Thursday saw 21 highs against 12 lows. Hardly the stuff of roaring bull markets.
* Hats off to CXO Advisory's blog; they consistently summarize interesting research. Here CXO takes a look at companies that are good to work for and whether they're also good investments.
* The Kirk Report does a great job scouring the Web for news. The recent market watch links include James Altucher's look at 10 stocks with significant insider buying.
* Interesting new ETF from Claymore (CGW) is a way of trading companies involved in the clean water/water-as-natural-resource theme. The holdings are global, making this somewhat different from other investment alternatives.
* The scans are showing lots of NR7 patterns for Trader Mike.
* Yet another way of tapping home equity and keeping the boom going: Seeking Alpha. But Barry Ritholtz shows that housing needs more than a little stimulus.
A Tale of Two Markets
On Wednesday, we saw a bull market high in the S&P 500 Index (SPY; blue line) and an all-time high in the Dow Jones Industrial Average. At the same time, the Russell 2000 Index chalked up a two-week low. The result is that we actually had a day in which more stocks on the NYSE, AMEX, and NASDAQ registered 65-day lows than highs (pink line) on a day in which large caps made new highs.We can see that, since April, the rally has become more selective as we've moved higher. Indeed, according to the Barchart site, Wednesday's highs were accompanied by 603 stocks making fresh 20-day highs, but 1225 making new 20-day lows!
Nor is the selectivity of the rally confined to small caps. DecisionPoint reports that only 35 S&P 500 stocks made new 52-week highs on Wednesday, down from about 90 in April. And only 6 of the Dow 30 issues made annual highs.
Many have commented on the persistence of this rally. Now, perhaps, they will also marvel at its shrinking base.
Risk Management and the Biology of Trading Psychology
Readers of this blog are probably familiar with Dr. Bruce Hong, who has graced many posts with insightful comments. He recently helped us understand how the adrenaline rush impacts trading in stressful circumstances.
I'm happy to report that Dr. Hong now has his own blog and is elaborating upon the biology of trading psychology. He offers considerable insight into the biological mechanisms of learning and how traders develop bad habits. His explanation of the role of the amygdala in learning under conditions of stress and the counterbalancing influence of the prefrontal cortex is the best, clearest account I've yet encountered.
A very important implication of Dr. Hong's work is that risk management is perhaps the preeminent tool of trading psychology. When we trade with excessive leverage, exposing our accounts to potential drastic drawdowns, we create the kind of stress-based learning that overwhelms the executive abilities of the prefrontal cortex.
There are many guides for risk management, but perhaps this psychological definition is simplest of all. You should always ensure that any loss you are likely to take in a position will not be large enough to generate an emergency response of mind and body. The size of your positions relative to the size of your portfolio will serve as a kind of magnifying glass for the stress responses of mind and body. Read Dr. Hong's posts carefully, and you'll understand why risk management is a biological--as well as psychological--trading imperative.
RELATED POSTS:
Psychological Risk Management
Self-Inflicted Problems of Trading
I'm happy to report that Dr. Hong now has his own blog and is elaborating upon the biology of trading psychology. He offers considerable insight into the biological mechanisms of learning and how traders develop bad habits. His explanation of the role of the amygdala in learning under conditions of stress and the counterbalancing influence of the prefrontal cortex is the best, clearest account I've yet encountered.
A very important implication of Dr. Hong's work is that risk management is perhaps the preeminent tool of trading psychology. When we trade with excessive leverage, exposing our accounts to potential drastic drawdowns, we create the kind of stress-based learning that overwhelms the executive abilities of the prefrontal cortex.
There are many guides for risk management, but perhaps this psychological definition is simplest of all. You should always ensure that any loss you are likely to take in a position will not be large enough to generate an emergency response of mind and body. The size of your positions relative to the size of your portfolio will serve as a kind of magnifying glass for the stress responses of mind and body. Read Dr. Hong's posts carefully, and you'll understand why risk management is a biological--as well as psychological--trading imperative.
RELATED POSTS:
Psychological Risk Management
Self-Inflicted Problems of Trading
Wednesday, May 16, 2007
Assorted Stock Market Observations
* The "stealth correction" that I noted in the Weblog is looking more corrective and less stealthy so far this week. The discrepancy in performance between the large caps and small caps continues to widen. On Tuesday, we saw 735 stocks make fresh 20-day highs across the NYSE, AMEX, and NASDAQ. We also saw 1110 stocks make new 20-day lows. That's the highest level of new lows since May 1st. We've seen below average NYSE TICK readings for 7 of the past 9 trading sessions, even as the Dow Jones Industrials have made fresh highs.
* I'm watching interest rates here. With a rise above 4.7% on Tuesday, we made a 20-day high in 10-year rates as the small cap stocks fell out of bed. Since 2005, however, rising rates have not hurt stocks. When the market has made a 20-day high in 10-year rates (N = 93), the next five days in SPY have averaged a gain of .36% (60 up, 33 down). That is stronger than the average five-day gain of .17% (277 up, 205 down) for the remainder of the days in the sample. What I'm watching for in the current market is any evidence that this pattern is changing, such that rising rates might be associated with weakness in the NYSE TICK and the small caps.
* We're seeing sector divergences in the current market. DecisionPoint notes that, among S&P 500 large cap stocks, 69% are above their 50-day moving averages, down from over 85% in late April. The proportion of S&P 600 small cap issues above their 50-day benchmarks, however, is down to 46%. Among the S&P large caps, 97% of energy stocks; 85% of industrials; 82% of materials issues; and 97% of utilities are above their 50-day averages. Only 51% of consumer staples stocks; 63% of financials; and 66% of technology stocks are above those levels. And the NASDAQ 100 stocks? Only 57% are now trading above their 50-day moving averages.
* Bounce after two days of strong selling sentiment? We've had two consecutive days in which my cumulative adjusted TICK reading has been below -500. That has occurred 16 times since 2005. Five days later, the S&P 500 Index (SPY) has been up by an average of .46% (10 up, 6 down), modestly stronger than the average five-day gain of .21% for the entire sample. To act on such a pattern, however, I need to see evidence of momentum drying up to the downside. With my Demand measure at 45 and Supply at 95 as of Tuesday's close, I'm not yet seeing that evidence.
* Yen continues to grind lower vs. the dollar. That's been facilitative of favorable stock market returns the past several years as part of the carry trade.
* Great reading - Check out the links at Abnormal Returns. Just about every article is a worthwhile read. Hats off to Abnormal Returns; they regularly scour the Web for market and industry insights.
* I'm watching interest rates here. With a rise above 4.7% on Tuesday, we made a 20-day high in 10-year rates as the small cap stocks fell out of bed. Since 2005, however, rising rates have not hurt stocks. When the market has made a 20-day high in 10-year rates (N = 93), the next five days in SPY have averaged a gain of .36% (60 up, 33 down). That is stronger than the average five-day gain of .17% (277 up, 205 down) for the remainder of the days in the sample. What I'm watching for in the current market is any evidence that this pattern is changing, such that rising rates might be associated with weakness in the NYSE TICK and the small caps.
* We're seeing sector divergences in the current market. DecisionPoint notes that, among S&P 500 large cap stocks, 69% are above their 50-day moving averages, down from over 85% in late April. The proportion of S&P 600 small cap issues above their 50-day benchmarks, however, is down to 46%. Among the S&P large caps, 97% of energy stocks; 85% of industrials; 82% of materials issues; and 97% of utilities are above their 50-day averages. Only 51% of consumer staples stocks; 63% of financials; and 66% of technology stocks are above those levels. And the NASDAQ 100 stocks? Only 57% are now trading above their 50-day moving averages.
* Bounce after two days of strong selling sentiment? We've had two consecutive days in which my cumulative adjusted TICK reading has been below -500. That has occurred 16 times since 2005. Five days later, the S&P 500 Index (SPY) has been up by an average of .46% (10 up, 6 down), modestly stronger than the average five-day gain of .21% for the entire sample. To act on such a pattern, however, I need to see evidence of momentum drying up to the downside. With my Demand measure at 45 and Supply at 95 as of Tuesday's close, I'm not yet seeing that evidence.
* Yen continues to grind lower vs. the dollar. That's been facilitative of favorable stock market returns the past several years as part of the carry trade.
* Great reading - Check out the links at Abnormal Returns. Just about every article is a worthwhile read. Hats off to Abnormal Returns; they regularly scour the Web for market and industry insights.
How to Keep a Trading Journal: Trader Perspectives
When it comes to climbing the learning curve of trading, few tools have proven as helpful to traders as journals. Properly constructed, a journal can be a device for goal setting and identifying strengths and weaknesses. Here are some worthwhile perspectives on keeping journals from trader/bloggers:
RELEVANT POST:
The Most Important Psychological Skill for Traders
- Joey Fundora, from the Downtown Trader site, offers an excellent account of how journals can aid in the cultivation of a trading edge. He explains how he utilizes the journal feature within the StockTickr program to create a forward evaluation of his trading. He makes effective use of tags to categorize his trades, enabling him to quickly identify the types of trades and markets that are working best for him. Great article.
- Trader Mike tracks his trades with a spreadsheet and offers the spreadsheet as a free download. He follows his P/L as a function of dollars risked and leaves a column for comments about each trade. This enables him to identify specific circumstances--in the market and in his trading--that were operative in the trade. Helpful tool.
- Here's a post from Charles Kirk, summarizing Doug Hirschhorn's trading journal checklist. He includes 15 items, such as news and economic events for the day, the trader's game plans, and self-evaluation. This is useful as an integration of trading and trading psychology.
- In this article from my personal site, I provide a summary of trading journal features that have worked best for the traders I've known. I stress the use of the journal to learn from good trades as well as bad ones, and the role of the journal in preparing for the upcoming trading day. I also identify specific metrics worth tracking to improve your trading.
- Here's another take on journals from Downtown Trader. He makes effective use of the "R" statistic in his journal and outlines several ways of improving the bottom line.
RELEVANT POST:
The Most Important Psychological Skill for Traders
Tuesday, May 15, 2007
Using ETFs to Develop Trading Ideas
I find specialty ETFs to be great ways of developing ideas for trading and investment. Above we see PUW (blue line), the PowerShares WilderHill Progressive Energy ETF. PUW is different from another energy ETF I have written about, PBW. Unlike PBW, PUW focuses on companies that are involved in improving the efficiency of fossil fuels, not the development of alternative fuels and technologies. PUW has outperformed PBW of late, and I like the fact that PUW draws upon a variety of styles and sectors for its holdings. Specifically, PUW consists of approximately 50% small cap stocks and about 50% growth stocks. About 28% of the companies are Industrials; 21% Energy; 16% Utilities; 12% Technology; and 12% Consumer Discretionary. I like not being locked into one style or sector when investing in a theme.Above, we can see that money flows have been very good for the most highly weighted PUW stocks. The chart summarizes the Adjusted Relative Dollar Volume Flows for five issues: TEN, ENR, USU, CCJ, and MEOH. Flows have consistently been above the zero level, meaning that the stocks are seeing dollar inflows above their 200-day averages. (Note some relative tailing off of dollar flows as we've hit recent highs in PUW. This is a pattern common to many of the market sectors and themes I track and has preceded the recent correction, particularly among the small caps. I'd like to see a pickup of flows before making a commitment to the theme).
Before I allocate capital to PUW, I will have reviewed the money flows for all 46 holdings of the fund. This will tell me which stocks within the universe are particularly strong. This may reveal subthemes within the universe--efficiency plays within utilities for instance--worthy of consideration. Too, the money flow examination might identify stocks beaten down within the theme that could represent value under accumulation. Honda and Toyota are candidates in that regard.
From the 46 stocks, we can also track new highs/lows; expansion and contraction of volume; and other indicators that would help us identify institutional accumulation of the shares. It's not enough to look at a chart of an ETF and make an investment decision. It pays to look under the hood, see if the stocks are under accumulation, and see if the number of issues participating in the ETF strength is growing or waning.
In that sense, the search for good ETFs is the beginning of a research process, not the endpoint.
RELATED POST:
Overview of the Adjusted Relative Dollar Volume Flow Indicator
Perspectives From the Pros
Always happy to share credible ideas from worthy sources; these are on my current radar:
- Victor Niederhoffer puts a piece of common wisdom to the test and finds that homebuilding weakness is not necessarily bad for the stock market.
- Between the Hedges on the implications of Chinese funds entering U.S. markets.
- What comes after free trade? Deep integration of economic relations, including regulation, along the lines of worldwide aviation: Deutsche Bank Research.
- If housing has peaked, rates will come down: Bill Gross.
- Robert Schiller/Yale research: Institutions have grown more confident we'll avoid a crash; individuals are less confident.
- On the proliferation of automated trading and implications: CPP Trader.
Thoughts on a Weak NYSE TICK and Strong Patterns
Monday's trading saw significant selling in the broad market. My cumulative adjusted NYSE TICK reading for the day was the lowest since March 13th. The "stealth correction" that I had noted in the Weblog broadened into more noticeable weakness.
Recall that I utilize the NYSE TICK as a sentiment measure reflecting the willingness of traders to execute at the market offer vs. bid across the broad range of listed stocks. I watch for shifts in the distribution of NYSE TICK readings to alert me to changes in the sentiment of large market participants. Such a shift alerted us to the downside breakout from a narrow range on Monday, and it tells us that sentiment is turning more negative on a short-term basis.
But what does it tell us if the Dow Jones Industrial Average (DIA) rises on a day in which we have significant selling sentiment?
I went back to the start of 2005 (N = 589 trading days) and found 121 occasions in which we hit an NYSE TICK reading of -1000 or less during the trading day. On only 28 of those instances did we see a flat or rising Dow on the day. Five days later, the Dow was up by an average of .92% (22 up, 6 down). That is considerably stronger than the average five-day Dow gain of .20% (346 up, 243 down) across the entire sample.
In sum, when the Dow has held up in the face of selling pressure, we've tended to see further strength in the near term. Of course, I'll need to see a drying up of negative TICK readings intraday and a holding of the Monday lows to act on this pattern. It's the kind of pattern that would lead me to book some profits intraday, but also leave a piece of the position on to catch a larger move.
The best setups are those that combine a multi-day edge with intraday confirmation; clear, conceptually grounded stops (at the Monday lows); and equally clear profit targets (the S&P highs). As any baseball batter knows, if you only swing at good pitches and take enough quality cuts at the ball, you'll eventually make contact and get your hits. With the market weak in the pre-opening action as I write, we may not get that good pitch to hit from this pattern.
But that might lead to another pattern. And an even better pitch.
Sometimes laying off the high outside stuff is the best thing a batter can do.
Recall that I utilize the NYSE TICK as a sentiment measure reflecting the willingness of traders to execute at the market offer vs. bid across the broad range of listed stocks. I watch for shifts in the distribution of NYSE TICK readings to alert me to changes in the sentiment of large market participants. Such a shift alerted us to the downside breakout from a narrow range on Monday, and it tells us that sentiment is turning more negative on a short-term basis.
But what does it tell us if the Dow Jones Industrial Average (DIA) rises on a day in which we have significant selling sentiment?
I went back to the start of 2005 (N = 589 trading days) and found 121 occasions in which we hit an NYSE TICK reading of -1000 or less during the trading day. On only 28 of those instances did we see a flat or rising Dow on the day. Five days later, the Dow was up by an average of .92% (22 up, 6 down). That is considerably stronger than the average five-day Dow gain of .20% (346 up, 243 down) across the entire sample.
In sum, when the Dow has held up in the face of selling pressure, we've tended to see further strength in the near term. Of course, I'll need to see a drying up of negative TICK readings intraday and a holding of the Monday lows to act on this pattern. It's the kind of pattern that would lead me to book some profits intraday, but also leave a piece of the position on to catch a larger move.
The best setups are those that combine a multi-day edge with intraday confirmation; clear, conceptually grounded stops (at the Monday lows); and equally clear profit targets (the S&P highs). As any baseball batter knows, if you only swing at good pitches and take enough quality cuts at the ball, you'll eventually make contact and get your hits. With the market weak in the pre-opening action as I write, we may not get that good pitch to hit from this pattern.
But that might lead to another pattern. And an even better pitch.
Sometimes laying off the high outside stuff is the best thing a batter can do.
Monday, May 14, 2007
Taking the Measure of Large Cap Stocks
The measure of a market from day to day is whether it closes near its highs or near its lows. In a bull market, intraday weakness is viewed as opportunity to add to positions. This creates a floor under stocks and enables the market to close well of its lows. Conversely, in a bear market, bounces are viewed as opportunities to lighten up on holdings or establish short positions. This leads us to close nearer to the day's lows than highs.
Where we close in relationship to the day's highs and lows tells us very simply whether buyers or sellers were viewing those prices as significantly different from fair value.
All of which brings us to the Dow Jones Industrial Average (DIA) and its trading pattern over the last 20 sessions. For 18 of those sessions, we have closed closer to the day's highs than lows. Specifically, in DIA, we've averaged a close $.26 (26 Dow points) away from the day's highs but $.66 (66 Dow points) off the day's lows.
Monday was an excellent case in point. We saw significant selling in the broad market during the day, with the NYSE TICK hitting very negative numbers repeatedly in the afternoon. By the close of trading, however, the Dow was sitting well off its day's lows and with a gain on the session.
I referred to this action as a "stealth correction" in my recent Weblog entry. Even as we see selling among small caps, traders continue to bargain hunt among large caps on weakness. Indeed, over the past 20 sessions, all but one Dow stock has displayed money flow above its 200-day moving average. Until institutions no longer view value in these stocks--as revealed by money flows and how we trade relative to daily highs and lows--it is difficult to hold short positions for anything more than an intraday trade.
Where we close in relationship to the day's highs and lows tells us very simply whether buyers or sellers were viewing those prices as significantly different from fair value.
All of which brings us to the Dow Jones Industrial Average (DIA) and its trading pattern over the last 20 sessions. For 18 of those sessions, we have closed closer to the day's highs than lows. Specifically, in DIA, we've averaged a close $.26 (26 Dow points) away from the day's highs but $.66 (66 Dow points) off the day's lows.
Monday was an excellent case in point. We saw significant selling in the broad market during the day, with the NYSE TICK hitting very negative numbers repeatedly in the afternoon. By the close of trading, however, the Dow was sitting well off its day's lows and with a gain on the session.
I referred to this action as a "stealth correction" in my recent Weblog entry. Even as we see selling among small caps, traders continue to bargain hunt among large caps on weakness. Indeed, over the past 20 sessions, all but one Dow stock has displayed money flow above its 200-day moving average. Until institutions no longer view value in these stocks--as revealed by money flows and how we trade relative to daily highs and lows--it is difficult to hold short positions for anything more than an intraday trade.
ABUSE But No Neglect: The Global Liquidity Boom in Equities
In my latest Weblog entry, I noted that the U.S. is actually at the trailing end of a liquidity boom that is inflating equity prices worldwide. Above we see EFA, the iShares ETF for the MSCI EAFE Index (Europe, Australia, Far East) and EEM, the iShares ETF for the MSCI Emerging Markets Index. Plotted with each of the ETFs is their 50-day moving average for share volume. Note the expanding participation in these markets as they have risen.
Since the start of 2006, EFA has gained 30.54%; EEM has risen 37.58%. By contrast, the S&P 500 Index (SPY) has risen a little more than 19% over that same period.
According to Charles Biderman of TrimTabs, since 2005 investors have placed $60 billion into mutual funds that focus on U.S. equities, but $300 billion into funds that primarily invest outside the U.S. The strategy has gained the acronym ABUSE: Anything But U.S. Equities.
Meanwhile, however, Biderman notes a separate dynamic to the liquidity boom: the buyout surge among private equity firms and the corporate buyback of stock. Together, these have accounted for a decrease in the total float of U.S. equities of 1.4% during the first four months of the year alone.
Rising liquidity (demand) and decreasing stock float (supply) is a potent combination for market strength, particularly if investors cease their ABUSE.
Sunday, May 13, 2007
Weekend Highlights From the Blogosphere
- The revamped Trading Psychology Weblog lays out my case for a stealth correction in a bull market.
- I've updated my resource links for traders.
- Charles Kirk works his magic with more links, including a new alternative energy ETF.
- Jeff Miller, on the difficulties of timing declines in a rising market.
- The Big Picture offers a Mother's Day linkfest, including observations about cheap debt inflating stock prices.
- CXO Advisory, with some excellent work questioning the value of options indicators.
- Stockpickr tracks stocks rising on unusual volume.
- Bespoke Investment Group tracks the various currency ETFs. See also their lists of commodity ETFs and dividend ETFs.
- Recent links from Trader Mike, including a very disruptive technology.
- Sunday links from Abnormal Returns, including why passive investing often beats active investing.
- Millionaire Now! on uranium.
TTEK: The Money and the Water are Flowing
A while back I wrote about an interesting ETF that enables traders to play the "water as natural resource" theme. Since that time, the PowerShares Water Resources ETF (PHO) has moved to new bull market highs. A component that has received particular buzz is Tetra Tech (TTEK), an environmental engineering consulting firm involved in water quality but which is also expanding into other fields, such as alternative energy. The stock was a recent Smart Money pick as one to own for the next 10 years; it was also recently mentioned in Barron's as a growth stock with potential for further appreciation. A good part of the company's appeal is its ability to help companies become more eco-friendly, although a substantial book of business is with governmental agencies.Above we can see that TTEK (blue line) broke out of a trading range on substantially above average adjusted relative dollar volume flows (pink line). Indeed, we've seen money flows above the 200 day average (red line) for 14 of the past 20 trading sessions. In this case it appears that investors are putting their money where their mouths are, keeping dollars as well as water flowing at TTEK.
RELATED POST:
Explanation of the Relative Dollar Volume Flow Measure
Saturday, May 12, 2007
Equity Option Volume and Speculative Sentiment in the Stock Market
In my recent post, we saw that stocks are climbing a wall of worry, with expanding put/call ratios, even as equity prices rise. How about total option volume, however? When we have more puts *and* more calls trading, we can reasonably assume that speculators are active in the marketplace and emotions are running strong. Conversely, very low option volume suggests more placidity among speculators.
I went back to the beginning of 2005 (N = 573 trading days) and expressed each day's equity option volume as a proportion of the prior 200 days' moving average. I then assessed how a 10-day moving average of this relative volume was related to future price change in the S&P 500 Index (SPY).
When option volume over a 10-day period was 25% or more ahead of its 200 day moving average (N = 92), the next 10 days in SPY averaged a very solid gain of .89% (66 up, 26 down). It thus appears that, when emotions are frothy among stocks, returns have been skewed to the bullish side.
When option volume over a 10-day period was below its 200 day moving average (N = 123), the next 10 days in SPY averaged an impressive gain of .85% (90 up, 33 down). Interestingly, very low emotionality among speculators has also been associated with a bullish bias.
When option volume has been average or modestly above average over a 10-day period, however (N = 358), the next 10 days have averaged a gain of only .13% (214 up, 144 down). Returns have been subnormal when emotionality among speculators has not been outstandingly high or low.
It thus appears that it's not just the directional bias of option traders, but also their willingness to participate in the marketplace that helps to define the market's speculative status.
RELATED POSTS:
Stock Margin Debt and Trading Sentiment
NASDAQ Volume and Speculative Sentiment
Emerging Market Performance and Speculative Sentiment
I went back to the beginning of 2005 (N = 573 trading days) and expressed each day's equity option volume as a proportion of the prior 200 days' moving average. I then assessed how a 10-day moving average of this relative volume was related to future price change in the S&P 500 Index (SPY).
When option volume over a 10-day period was 25% or more ahead of its 200 day moving average (N = 92), the next 10 days in SPY averaged a very solid gain of .89% (66 up, 26 down). It thus appears that, when emotions are frothy among stocks, returns have been skewed to the bullish side.
When option volume over a 10-day period was below its 200 day moving average (N = 123), the next 10 days in SPY averaged an impressive gain of .85% (90 up, 33 down). Interestingly, very low emotionality among speculators has also been associated with a bullish bias.
When option volume has been average or modestly above average over a 10-day period, however (N = 358), the next 10 days have averaged a gain of only .13% (214 up, 144 down). Returns have been subnormal when emotionality among speculators has not been outstandingly high or low.
It thus appears that it's not just the directional bias of option traders, but also their willingness to participate in the marketplace that helps to define the market's speculative status.
RELATED POSTS:
Stock Margin Debt and Trading Sentiment
NASDAQ Volume and Speculative Sentiment
Emerging Market Performance and Speculative Sentiment
The Equity Put/Call Ratio Traces a Wall of Worry
Here we see the 15-day equity put/call ratio (pink line) plotted against the S&P 500 Index (blue line) from January, 2004 to the present. Note how spikes in the options ratio have marked excellent intermediate-term buying opportunities during this period.
Perhaps even more interesting, observe how we've been riding a wall of worry during this bull market. We've been tracing out higher lows and higher highs in the equity put/call ratio. While some have referred to this market as a "bubble", it is difficult to make the case that we're seeing excesses of optimism that would be characteristic of a market peak.
With respect to the present market, we can see that troughs in the put/call ratio have tended to precede price tops during market swings. We've yet to see such a trough in the recent market, suggesting that we could have further to go on the upside during this swing.
RELATED POSTS:
Market Psychology: Why It Is Important
Assessing Market Psychology With Relative Options Indicators
A Different Way to Measure Market Sentiment
Friday, May 11, 2007
Changes to the Trading Psychology Weblog
Dear Readers,
Starting this Sunday, the Trading Psychology Weblog will join the rest of my personal site with a weekly publication schedule. This will enable me to focus on broad market themes, and it will accomodate my expanding schedule on the road working with traders.
Some of the daily indicators that had been part of the Weblog will be posted to TraderFeed, particularly when there are significant market developments. Similarly, I will be posting worthwhile blog links and resources to both sites.
The personal site will continue to post articles and reflections on trader performance. My hope is that the weekly features on that site will provide a big picture context for traders, regardless of their trading style and time frame.
Thanks for your interest and support. Look for the format changes to go into effect on Sunday!
Brett
Starting this Sunday, the Trading Psychology Weblog will join the rest of my personal site with a weekly publication schedule. This will enable me to focus on broad market themes, and it will accomodate my expanding schedule on the road working with traders.
Some of the daily indicators that had been part of the Weblog will be posted to TraderFeed, particularly when there are significant market developments. Similarly, I will be posting worthwhile blog links and resources to both sites.
The personal site will continue to post articles and reflections on trader performance. My hope is that the weekly features on that site will provide a big picture context for traders, regardless of their trading style and time frame.
Thanks for your interest and support. Look for the format changes to go into effect on Sunday!
Brett
When Trading Coaches Fail - Part Two: Stages of Change
In my last post, I mentioned the relapse problem as a major challenge for any coaching efforts. As several readers astutely pointed out, skill development and the acquisition of expertise are a function of practice. That same practice effect pertains to personal change as well. Repetition cements all learning.
There is, however, another major barrier to change that helps to account for situations in which coaching does not work. Coaches, counselors, and therapists tend to approach their work with a limited toolkit of methods to create change. In applying this restricted set of methods, they fail to recognize that the people they work with may be at very different points in the change process.
Prochaska, Norcross, and DiClemente, in their extensive research on the stages of psychological change, have found that individuals differ greatly in their readiness for change.
At the stage of precontemplation, traders are unaware of a problem and may even be in denial--much like the substance user who does not acknowledge signs of addiction. This trader may blame outside forces for problems or refuse to face problems altogether. Such traders rarely seek coaching on their own, but may be referred by their trading firms or may be nudged into help by spouses and concerned others. For this reason, the person in precontemplation does not usually have a strong motivation to change. The role of the psychologist is to help the person explore actions and consequences and move toward contemplation of change.
In the contemplation stage, there is a mixed motivation for change. The prospect of change raises a "yes, but" response. For example, I know I should exercise, but I have so little time during the day; I know my marriage isn't working, but I don't want to raise the kids myself; etc. Change, for the person in contemplation, is overwhelming, creating an internal tug of war. The psychologist's job in this stage is to help the trader develop more limited, doable, non-threatening goals that can serve as a focus for action.
Some traders enter coaching already in the next, action stage. They know they have a problem, and they are ready to work on it. They've experienced consequences from this problem and no longer want to continue acting out their old patterns. Those traders are ready for psychological techniques that facilitate focused change, such as cognitive restructuring methods or solution-focused techniques.
As mentioned in the previous article, however, initiating change is only one part of the coaching process. In the final, maintenance phase of change, traders work on holding onto those gains, rehearsing them, and making them automatic. The goal is to prevent relapse. Here, too, the role of the psychologist shifts dramatically. Instead of introducing new change methods, the coach helps the trader identify new opportunities for extending developed skills and provides copious feedback about those change efforts.
Coaches with limited repertoires (and sometimes very limited training) will equate coaching with the third, action phase of change. They come to the coaching relationship like a cavalry riding to the rescue, armed with action-oriented techniques for change. The problem is that not all traders are ready for change. If a coach tries to impose action methods on a trader in a contemplation mode, for instance, that trader will seem unmotivated and resistant to change. The problem, however, is not really one of motivation. Rather, the trader needs an exploratory process to help them develop viable goals and become ready for action. Many people drop out of their meetings with coaches and counselors because they are simply not ready for what their helper is offering: they don't feel heard or understood.
Equally problematic, the limited coach will initiate change efforts for traders, but won't have in place structured methods for preventing relapse. Ignoring the maintenance phase, the change they create is temporary; it is never truly internalized as part of an ongoing repertoire. This is a problem even with very experienced psychologists. Research shows that the outcomes of counseling and therapy are typically much better at the end of the helping process than six months or a year later. Too often, the emphasis is on generating change--not maintaining it.
A routine goal of my first meeting with a trader is to assess his or her readiness for change. If that readiness is low (precontemplation or contemplation stage), I will work in an exploratory mode to help that person see problems that might be there and begin to think through limited goals to start some action. Conversely, if the trader is in action mode, I am happy to bring out the toolkit of behavioral, cognitive, biofeedback, self-hypnosis, and solution-focused methods to work on targeted change. When a trader has already made meaningful changes, my role is to highlight these, find out how they occurred, and then extend this process to new facets of performance to reduce relapse.
In coaching as in clothes, one size does not fit all. It is important for traders to know where they stand in terms of readiness for change and find the right activities to help them move to the next phase.
RELATED POST:
Five Principles of Trading Psychology
There is, however, another major barrier to change that helps to account for situations in which coaching does not work. Coaches, counselors, and therapists tend to approach their work with a limited toolkit of methods to create change. In applying this restricted set of methods, they fail to recognize that the people they work with may be at very different points in the change process.
Prochaska, Norcross, and DiClemente, in their extensive research on the stages of psychological change, have found that individuals differ greatly in their readiness for change.
At the stage of precontemplation, traders are unaware of a problem and may even be in denial--much like the substance user who does not acknowledge signs of addiction. This trader may blame outside forces for problems or refuse to face problems altogether. Such traders rarely seek coaching on their own, but may be referred by their trading firms or may be nudged into help by spouses and concerned others. For this reason, the person in precontemplation does not usually have a strong motivation to change. The role of the psychologist is to help the person explore actions and consequences and move toward contemplation of change.
In the contemplation stage, there is a mixed motivation for change. The prospect of change raises a "yes, but" response. For example, I know I should exercise, but I have so little time during the day; I know my marriage isn't working, but I don't want to raise the kids myself; etc. Change, for the person in contemplation, is overwhelming, creating an internal tug of war. The psychologist's job in this stage is to help the trader develop more limited, doable, non-threatening goals that can serve as a focus for action.
Some traders enter coaching already in the next, action stage. They know they have a problem, and they are ready to work on it. They've experienced consequences from this problem and no longer want to continue acting out their old patterns. Those traders are ready for psychological techniques that facilitate focused change, such as cognitive restructuring methods or solution-focused techniques.
As mentioned in the previous article, however, initiating change is only one part of the coaching process. In the final, maintenance phase of change, traders work on holding onto those gains, rehearsing them, and making them automatic. The goal is to prevent relapse. Here, too, the role of the psychologist shifts dramatically. Instead of introducing new change methods, the coach helps the trader identify new opportunities for extending developed skills and provides copious feedback about those change efforts.
Coaches with limited repertoires (and sometimes very limited training) will equate coaching with the third, action phase of change. They come to the coaching relationship like a cavalry riding to the rescue, armed with action-oriented techniques for change. The problem is that not all traders are ready for change. If a coach tries to impose action methods on a trader in a contemplation mode, for instance, that trader will seem unmotivated and resistant to change. The problem, however, is not really one of motivation. Rather, the trader needs an exploratory process to help them develop viable goals and become ready for action. Many people drop out of their meetings with coaches and counselors because they are simply not ready for what their helper is offering: they don't feel heard or understood.
Equally problematic, the limited coach will initiate change efforts for traders, but won't have in place structured methods for preventing relapse. Ignoring the maintenance phase, the change they create is temporary; it is never truly internalized as part of an ongoing repertoire. This is a problem even with very experienced psychologists. Research shows that the outcomes of counseling and therapy are typically much better at the end of the helping process than six months or a year later. Too often, the emphasis is on generating change--not maintaining it.
A routine goal of my first meeting with a trader is to assess his or her readiness for change. If that readiness is low (precontemplation or contemplation stage), I will work in an exploratory mode to help that person see problems that might be there and begin to think through limited goals to start some action. Conversely, if the trader is in action mode, I am happy to bring out the toolkit of behavioral, cognitive, biofeedback, self-hypnosis, and solution-focused methods to work on targeted change. When a trader has already made meaningful changes, my role is to highlight these, find out how they occurred, and then extend this process to new facets of performance to reduce relapse.
In coaching as in clothes, one size does not fit all. It is important for traders to know where they stand in terms of readiness for change and find the right activities to help them move to the next phase.
RELATED POST:
Five Principles of Trading Psychology
Thursday, May 10, 2007
When the Coaching of Traders Doesn't Work - Part One
You don't see too many discussions of failed coaching among traders. The reality of the outcome research, however, is that, while a majority of people receiving psychological help will benefit (compared with people receiving no help or a placebo intervention), a significant proportion of those individuals will not retain their gains over a 6-12 month period. This is known as the relapse problem, and it is one of the most important reasons that the coaching of traders doesn't yield meaningful results.
We're accustomed to thinking about relapse in the context of counseling/therapy for substance use disorders and other addictive problems. Research tells us, however, that relapse rates are just as high for many other problems, from marital discord to depression. After all, how many of us have made efforts to change our patterns of eating or exercise, only to relapse into old ways?
There's a sense in which making changes is easy. The hard part is sustaining those. In a motivated state, when we're emotionally connected to the consequences of our problem patterns, we can muster the will to do things differently. Once that emotional connection is gone, however, we tend to lapse into what is most familiar.
Change is most likely to stick when we overlearn new patterns of thinking, feeling, and acting. It's when we make changes again, and again, and again across a variety of situations that those changes begin to become second nature to us. When the coaching process is too brief or intermittent, those opportunities for overlearning may be insufficient for the internalization of change. That makes it easier to fall into old patterns.
For traders serving as their own coaches, it is helpful to keep a journal of your change efforts, tracking your specific change efforts every day for at least a full month. The daily effort, repeated with consistency, will increase the odds that the changes will become an automatic part of your repertoire.
When people need help with alcohol problems, the folks at AA will encourage them to attend 90 meetings in 90 days. That's great advice for any change process. Make the change 90 times in 90 days. AA knows that "when you bring the body, the mind will change." Similarly, when you make the consistent efforts, the changes will become automatic.
RELATED POST:
Coaching the Professional Trader
We're accustomed to thinking about relapse in the context of counseling/therapy for substance use disorders and other addictive problems. Research tells us, however, that relapse rates are just as high for many other problems, from marital discord to depression. After all, how many of us have made efforts to change our patterns of eating or exercise, only to relapse into old ways?
There's a sense in which making changes is easy. The hard part is sustaining those. In a motivated state, when we're emotionally connected to the consequences of our problem patterns, we can muster the will to do things differently. Once that emotional connection is gone, however, we tend to lapse into what is most familiar.
Change is most likely to stick when we overlearn new patterns of thinking, feeling, and acting. It's when we make changes again, and again, and again across a variety of situations that those changes begin to become second nature to us. When the coaching process is too brief or intermittent, those opportunities for overlearning may be insufficient for the internalization of change. That makes it easier to fall into old patterns.
For traders serving as their own coaches, it is helpful to keep a journal of your change efforts, tracking your specific change efforts every day for at least a full month. The daily effort, repeated with consistency, will increase the odds that the changes will become an automatic part of your repertoire.
When people need help with alcohol problems, the folks at AA will encourage them to attend 90 meetings in 90 days. That's great advice for any change process. Make the change 90 times in 90 days. AA knows that "when you bring the body, the mind will change." Similarly, when you make the consistent efforts, the changes will become automatic.
RELATED POST:
Coaching the Professional Trader
A Favorite Trading Pattern
Some of my favorite morning trades are based on a reading of strength or weakness in early trading--using such tools as the NYSE TICK and Market Delta--and then handicapping the odds of taking out the previous day's high or low.
Since 2005 in the S&P 500 Index (SPY; N = 588 trading days), we've had 81 inside days. That means that over 85% of the time, the market has either taken out its prior day's high, low, or both.
Those odds are increased when markets trade on above average volume. Because volume correlates well with volatility, it is rare to see a day with above average volume also be an inside day.
For example, we had 329 days since 2005 in which volume in SPY was above the 200 day moving average. Out of those 329 days, only 29 were inside days. That means that over 90% of the time, a high volume day will not be an inside day.
Conversely, out of the 259 days that were below the 200 day moving average of volume, 52 were inside days--about 20%.
When I see a day begin with average or above average volume, I go with the assumption that we'll take out the previous day's high or low and touch either the R1 or S1 pivot level (posted daily to the Weblog). At that point, it's just a matter of following the emerging distribution of market strength or weakness in such indicators as NYSE TICK to place your bet on which extreme will be breached.
A large number of my successful trades are based on this pattern. I will be illustrating in future posts.
RELATED POSTS:
How I Trade: Handicapping the Odds of Hitting Pivot Points
What You Can Learn From the Opening Minutes of Trading
Since 2005 in the S&P 500 Index (SPY; N = 588 trading days), we've had 81 inside days. That means that over 85% of the time, the market has either taken out its prior day's high, low, or both.
Those odds are increased when markets trade on above average volume. Because volume correlates well with volatility, it is rare to see a day with above average volume also be an inside day.
For example, we had 329 days since 2005 in which volume in SPY was above the 200 day moving average. Out of those 329 days, only 29 were inside days. That means that over 90% of the time, a high volume day will not be an inside day.
Conversely, out of the 259 days that were below the 200 day moving average of volume, 52 were inside days--about 20%.
When I see a day begin with average or above average volume, I go with the assumption that we'll take out the previous day's high or low and touch either the R1 or S1 pivot level (posted daily to the Weblog). At that point, it's just a matter of following the emerging distribution of market strength or weakness in such indicators as NYSE TICK to place your bet on which extreme will be breached.
A large number of my successful trades are based on this pattern. I will be illustrating in future posts.
RELATED POSTS:
How I Trade: Handicapping the Odds of Hitting Pivot Points
What You Can Learn From the Opening Minutes of Trading
Wednesday, May 09, 2007
What Makes a Professional Trader
I'm on the road this week working with traders at several professional trading organizations. It's always an enlightening experience to see how the best traders and trading firms operate. Here are a few observations that have hit me between the eyes over the past several days:
1) Many of the best traders follow and trade a variety of markets. They go where the opportunity is. When volatility dries up in one market, they have others to turn to. The small, neophyte retail trader often becomes pigeonholed in one market and overtrades it, desperate to turn a small account into a larger one. The professional trader may have a top-down or bottom-up perspective on markets (developing ideas from big economic trends or from individual company and sector results), but they have a framework for how to think about markets. Inexperienced traders lack such a framework.
2) Many of the best traders think big--as in big picture. Because they follow multiple markets, they are aware of the relationships among these markets. This enables them to develop trade ideas that connect one market to another, capitalizing on big picture themes. Knowing how interest rate differentials around the world affect capital flows is an obvious example of that. Another example is knowing how one asset is priced relative to others to capitalize on mispricing. The novice trader trades small patterns, losing sight of the context in which those patterns occur. They lack a framework for thinking about proper and improper pricing.
3) All of the best trading firms have risk managers. They stay on top of how individual traders (and the firm as a whole) are performing. They help traders adjust their position sizes to fit their portfolio needs, and they help traders during drawdown periods. It is very difficult for individual, solo traders to fill this role for themselves. The excellent traders spend significant time and effort on risk management: they know how much they want to gain and put at risk in each trade. Small traders tend to put a far larger portion of their capital at risk with each trade than large, professional traders.
4) Many of the best traders think small--as in very reasonable profit goals. This is very interesting. I never hear the pros talking about tripling their money in a year. It's the small traders, feeling a desperate need for a kill in order to make a living, who take those kind of risks. Many of the best traders I know focus on consistency and favorable risk-adjusted returns. I essentially never hear small, retail traders focus on risk-adjusted returns. I don't think I've ever met a retail trader who knows what his or her Sharpe Ratio is, for example. I don't think most newer traders could even explain the concept of VAR.
5) Many of the best traders use psychology to amplify strengths. This is one thing that a majority of "trading coaches" don't get. They are so accustomed to working with small, retail traders that their vision becomes limited to the kinds of problems that beginners have. On average, if a person lacks discipline, emotional control, etc., they don't get hired at a good firm. The best traders do experience drawdowns, but they work on themselves to identify and build strengths, not to develop simplistic "trading plans". A great deal of what's out there labeled as "trading psychology" could be relabeled as the psychology of the beginning trader. It's not that it's useless; it's that it doesn't speak to the seasoned professional. To the extent that trading shrinks emphasize positive thinking as the key to trading success, they don't understand trading--and what it takes to generate alpha--at all.
Ultimately, whether one is a professional or an amateur is a function of their approach to their work, not their setting. It is, of course, easier to live up to professionalism when you're surrounded by professionals. The best traders I know spend significant time generating trade ideas, researching markets, and staying on top of developments world wide. The ratio of time spent in preparation to time spent actually in trading has, in my experience, been a worthwhile measure of a trader's professionalism--regardless of setting. The best traders, like the best athletes, are always working on themselves, always refining what they do. In an important sense, they don't just use psychology to improve their performance. They work on their performance as a means of extending their personal mastery.
A small trader can approach his or her craft professionally. There are few models, however, for such professionalism--particularly when many of the "gurus" themselves do not begin to approximate what the pros are doing.
1) Many of the best traders follow and trade a variety of markets. They go where the opportunity is. When volatility dries up in one market, they have others to turn to. The small, neophyte retail trader often becomes pigeonholed in one market and overtrades it, desperate to turn a small account into a larger one. The professional trader may have a top-down or bottom-up perspective on markets (developing ideas from big economic trends or from individual company and sector results), but they have a framework for how to think about markets. Inexperienced traders lack such a framework.
2) Many of the best traders think big--as in big picture. Because they follow multiple markets, they are aware of the relationships among these markets. This enables them to develop trade ideas that connect one market to another, capitalizing on big picture themes. Knowing how interest rate differentials around the world affect capital flows is an obvious example of that. Another example is knowing how one asset is priced relative to others to capitalize on mispricing. The novice trader trades small patterns, losing sight of the context in which those patterns occur. They lack a framework for thinking about proper and improper pricing.
3) All of the best trading firms have risk managers. They stay on top of how individual traders (and the firm as a whole) are performing. They help traders adjust their position sizes to fit their portfolio needs, and they help traders during drawdown periods. It is very difficult for individual, solo traders to fill this role for themselves. The excellent traders spend significant time and effort on risk management: they know how much they want to gain and put at risk in each trade. Small traders tend to put a far larger portion of their capital at risk with each trade than large, professional traders.
4) Many of the best traders think small--as in very reasonable profit goals. This is very interesting. I never hear the pros talking about tripling their money in a year. It's the small traders, feeling a desperate need for a kill in order to make a living, who take those kind of risks. Many of the best traders I know focus on consistency and favorable risk-adjusted returns. I essentially never hear small, retail traders focus on risk-adjusted returns. I don't think I've ever met a retail trader who knows what his or her Sharpe Ratio is, for example. I don't think most newer traders could even explain the concept of VAR.
5) Many of the best traders use psychology to amplify strengths. This is one thing that a majority of "trading coaches" don't get. They are so accustomed to working with small, retail traders that their vision becomes limited to the kinds of problems that beginners have. On average, if a person lacks discipline, emotional control, etc., they don't get hired at a good firm. The best traders do experience drawdowns, but they work on themselves to identify and build strengths, not to develop simplistic "trading plans". A great deal of what's out there labeled as "trading psychology" could be relabeled as the psychology of the beginning trader. It's not that it's useless; it's that it doesn't speak to the seasoned professional. To the extent that trading shrinks emphasize positive thinking as the key to trading success, they don't understand trading--and what it takes to generate alpha--at all.
Ultimately, whether one is a professional or an amateur is a function of their approach to their work, not their setting. It is, of course, easier to live up to professionalism when you're surrounded by professionals. The best traders I know spend significant time generating trade ideas, researching markets, and staying on top of developments world wide. The ratio of time spent in preparation to time spent actually in trading has, in my experience, been a worthwhile measure of a trader's professionalism--regardless of setting. The best traders, like the best athletes, are always working on themselves, always refining what they do. In an important sense, they don't just use psychology to improve their performance. They work on their performance as a means of extending their personal mastery.
A small trader can approach his or her craft professionally. There are few models, however, for such professionalism--particularly when many of the "gurus" themselves do not begin to approximate what the pros are doing.
Tuesday, May 08, 2007
Why Short-Term Traders Lose Money
Chris (fictitious example, but real trading results) is a trader of the S&P 500 market. He is disciplined and selective in his trades. He limits his trades to those that go with the longer-term and shorter-term trends. If the market is not trending in his direction, he does not trade.
Seeing a long bias to the recent market, Chris has developed a trading method that is long only. He looks at the Bollinger Bands (volatility envelopes) surrounding the 20-day moving average for the S&P 500 Index (SPY). If we close above the upper band/envelope, he buys the market on close. If we return to the area between the bands, he exits the position to limit losses. His idea is to participate in strong trending markets.
Chris averages 3 days per trade as his holding period. Over the past two years, his method has provided him with 18 trades. He has never deviated from this approach during that time.
Yesterday Chris tallied up the results from two years of trading. He was profitable on 3 trades, unprofitable on 15. He made a total of 1.34 SPY points (13.4 ES points) from his profitable trades. He lost 10.30 SPY points (100.30 ES points) from his losers. Overall, Chris lost about 90 S&P points trading long positions in a bull market with perfect market discipline and psychology.
He had an effective system--if he had traded it in reverse. Traders need to understand how markets move on *their* time frame. Much losing of money among short-term traders can be traced to the mistake made by Chris. What occurs on the longer time frame and at shorter time frames can be quite, quite different.
Seeing a long bias to the recent market, Chris has developed a trading method that is long only. He looks at the Bollinger Bands (volatility envelopes) surrounding the 20-day moving average for the S&P 500 Index (SPY). If we close above the upper band/envelope, he buys the market on close. If we return to the area between the bands, he exits the position to limit losses. His idea is to participate in strong trending markets.
Chris averages 3 days per trade as his holding period. Over the past two years, his method has provided him with 18 trades. He has never deviated from this approach during that time.
Yesterday Chris tallied up the results from two years of trading. He was profitable on 3 trades, unprofitable on 15. He made a total of 1.34 SPY points (13.4 ES points) from his profitable trades. He lost 10.30 SPY points (100.30 ES points) from his losers. Overall, Chris lost about 90 S&P points trading long positions in a bull market with perfect market discipline and psychology.
He had an effective system--if he had traded it in reverse. Traders need to understand how markets move on *their* time frame. Much losing of money among short-term traders can be traced to the mistake made by Chris. What occurs on the longer time frame and at shorter time frames can be quite, quite different.
Monday, May 07, 2007
Three Thoughts on Freud and Markets
Here are three insights from modern psychoanalytic theory and my comments to apply those to performance fields such as trading:
1) We internalize our sense of self from our significant relationship experiences. Relationships serve as a kind of psychological mirror, by which we can experience ourselves through others. If our relationships are positive and healthy, we're more apt to internalize a positive sense of self. It's only a small step from this insight to the realization that we have a relationship with *all* of our life activities. We experience ourselves through our trading: over time trading without an edge and without proper risk control virtually ensures that our trading will take a personal toll.
2) We defend ourselves against sources of anxiety. These defense mechanisms may keep us from becoming anxious, but they often are maladaptive and create problems in social and work situations. If we're feeling inadequate or vulnerable, we might defend against these feelings by jumping into trades or by avoiding markets altogether. What we do to manage our feelings often is the opposite of what we need to do to properly manage our money and positions.
3) We tend to replay conflicts in past relationships in our current relationships. These unresolved problems reappear in different situations until we find resolution. Many trading problems occur when we act out our needs for recognition and self-worth in our trades. The trader who breaks rules when trading and takes undue risk often is needing the markets to provide desired emotional experiences, not just profits. To the degree that we act out our personal issues in markets, we can't be fully focused on those markets.
A summary of Freud's view would be the dictum that those who fail to learn from history are condemned to repeat it. It is our repetitive patterns across situations of uncertainty and gain/loss that can take us away from doing what we know to be best.
1) We internalize our sense of self from our significant relationship experiences. Relationships serve as a kind of psychological mirror, by which we can experience ourselves through others. If our relationships are positive and healthy, we're more apt to internalize a positive sense of self. It's only a small step from this insight to the realization that we have a relationship with *all* of our life activities. We experience ourselves through our trading: over time trading without an edge and without proper risk control virtually ensures that our trading will take a personal toll.
2) We defend ourselves against sources of anxiety. These defense mechanisms may keep us from becoming anxious, but they often are maladaptive and create problems in social and work situations. If we're feeling inadequate or vulnerable, we might defend against these feelings by jumping into trades or by avoiding markets altogether. What we do to manage our feelings often is the opposite of what we need to do to properly manage our money and positions.
3) We tend to replay conflicts in past relationships in our current relationships. These unresolved problems reappear in different situations until we find resolution. Many trading problems occur when we act out our needs for recognition and self-worth in our trades. The trader who breaks rules when trading and takes undue risk often is needing the markets to provide desired emotional experiences, not just profits. To the degree that we act out our personal issues in markets, we can't be fully focused on those markets.
A summary of Freud's view would be the dictum that those who fail to learn from history are condemned to repeat it. It is our repetitive patterns across situations of uncertainty and gain/loss that can take us away from doing what we know to be best.
Catching Short-Term Market Transitions
During the Sunday Webinar, I made reference to some of my bread-and-butter intraday setups, which involve a sequence of events in which heavy buying (selling) dries up over time, with lower NYSE TICK highs (higher TICK lows) and with volume declining as the rise (decline) loses momentum.Above is a 3-minute chart of the ES futures vs. the NYSE TICK for the morning of 5/4/07. (Chart created in RealTick). Note that we hit a price high (black candles) a little before 10:30 AM ET on solidly positive NYSE TICK (pink lines), followed by a drop, and then by an effort to test the highs around 11:00 AM. Note the decline in volume on that test (bottom axis, black bars), and notice the much lower TICK readings on the test. Quite simply, large traders were not pushing the market higher, and we were not seeing buyers aggressively lift offers among NYSE stocks. This set the stage for subsequent selling: the buying had dried up.
Notice also how the market made a bottom around 12:30 PM, as price lows were accompanied by lower volume and higher TICK lows. This drying up of selling pressure then led to fresh buying and short covering, with a solid upside breakout in TICK. Once the selling pressure had dried up, it set the stage for bulls to romp.
These transitional patterns occur every day in the stock indexes. Like snowflakes, they have a similar structure, but no one market turnaround is identical to others. The key is noticing the dynamics among price, volume, and the sentiment of traders (TICK).
When you see one of these transitional patterns, such as selling drying up, within a larger pattern (bull trend, positive historical odds of a rise) in the same direction, that is where you're most apt to find home run trade ideas. I studied charts of stock indices and NYSE TICK every day for well over a year before I felt confident about my ability to read transitions in real time. The more you see different examples, the more sensitive you become to the nuances of the patterns. This is the real time cultivation of implicit learning, part of the skill development crucial to any trading career. By amplifying our screen experience, we can hasten our learning curves.
RELATED POSTS:
Tracking the Large Trader
The Structure of Market Reversals
When Do I Get Out of a Trade?
Webinar: Assessing Market Psychology
Sunday, May 06, 2007
More on What's Been Carrying the Market Higher
Weak dollar/yen (chart below); strong stock market (chart above). So far stocks have benefited from the weak dollar, and that's been supportive of the yen carry trade. That continues to be an intermarket relationship worth tracking closely.
Is Trading Style Hard-Wired?
Perhaps the most common assumption made by traders and trading psychologists alike is that people are capable of adapting to any market or trading methodology.
An increasing body of knowledge, however, suggests that many of the personality factors that affect decision-making under conditions of risk and uncertainty are hard-wired. Brain scans, for instance, predict who will be risk takers in gambling situations and who will be risk-averse. As one researcher bluntly puts it, "Brain activity predicts behavior."
A key element in decision-making is the brain's reactivity to loss vs. gain in decision-making. When the brain responds much more to loss than gain, individuals are far more likely to be averse to gambling. When the brain's "reward centers" respond to winning about as much as losing, the result is risk-seeking behavior. Interestingly, the brain areas that respond to winning money are the same as those that respond to cocaine or chocolate. This helps to account for the frequency of addictive behavior among gamblers--and traders.
Such individuals are not only risk-seeking, but stimulation-seeking. They have a low tolerance for boredom and use risky behavior to generate interest in their environment. Research suggests that easily bored individuals are more prone to depression and addiction than other people. Easily bored people also tend to have lower attention spans than others, increasing the odds of impulsive behavior. Such individuals would have particular difficulty adhering to trading plans and discipline.
Different brain mechanisms have been found to mediate risk-taking and risk-aversion in financial situations. A particularly interesting finding is that the dopamine reward center kicks in about two seconds prior to making a risky decision. Conversely, a brain center that is responsible for emotions of anxiety and repulsion is activated prior to suboptimal, risk-averse decisions.
We have no problem with the notion that some individuals are born with physiques that enable them to be successful in athletic contests. It is more controversial, however, to assert that some of us may be born with greater ability to make rational financial decisions than others. And there may be people with brain processes and psychological makeups who should avoid trading as assiduously as they might avoid cocaine.
It's nice to think that any trader can trade any market or methodology. The reality, however, is that we seem to be hard-wired to prefer certain levels of risk and stimulation. It may be more effective to fit trading methods to individuals than to hope to overcome hard wiring and teach a particular style to all traders.
An increasing body of knowledge, however, suggests that many of the personality factors that affect decision-making under conditions of risk and uncertainty are hard-wired. Brain scans, for instance, predict who will be risk takers in gambling situations and who will be risk-averse. As one researcher bluntly puts it, "Brain activity predicts behavior."
A key element in decision-making is the brain's reactivity to loss vs. gain in decision-making. When the brain responds much more to loss than gain, individuals are far more likely to be averse to gambling. When the brain's "reward centers" respond to winning about as much as losing, the result is risk-seeking behavior. Interestingly, the brain areas that respond to winning money are the same as those that respond to cocaine or chocolate. This helps to account for the frequency of addictive behavior among gamblers--and traders.
Such individuals are not only risk-seeking, but stimulation-seeking. They have a low tolerance for boredom and use risky behavior to generate interest in their environment. Research suggests that easily bored individuals are more prone to depression and addiction than other people. Easily bored people also tend to have lower attention spans than others, increasing the odds of impulsive behavior. Such individuals would have particular difficulty adhering to trading plans and discipline.
Different brain mechanisms have been found to mediate risk-taking and risk-aversion in financial situations. A particularly interesting finding is that the dopamine reward center kicks in about two seconds prior to making a risky decision. Conversely, a brain center that is responsible for emotions of anxiety and repulsion is activated prior to suboptimal, risk-averse decisions.
We have no problem with the notion that some individuals are born with physiques that enable them to be successful in athletic contests. It is more controversial, however, to assert that some of us may be born with greater ability to make rational financial decisions than others. And there may be people with brain processes and psychological makeups who should avoid trading as assiduously as they might avoid cocaine.
It's nice to think that any trader can trade any market or methodology. The reality, however, is that we seem to be hard-wired to prefer certain levels of risk and stimulation. It may be more effective to fit trading methods to individuals than to hope to overcome hard wiring and teach a particular style to all traders.
Saturday, May 05, 2007
Gimme the Finger, and I'll Tell You How Aggressive You Are
Recent research suggests that prenatal testosterone levels contribute to the relative sizes of fingers on the hand among men. Specifically, when testosterone levels are high, the second (index) digit of the hand tends to be small relative to the fourth (ring) finger. Thus, the finger-length ratio is correlated inversely with characteristics associated with elevated testosterone, such as aggressiveness. There is also some evidence that the ratio is predictive of aggressive behavior among females.
An important implication of this research is that much of our psychological makeup is determined by our biology. Finger lengths predict about five percent of the variance in aggressive traits, which is not trivial.
Of equal interest is the finding that the ratio of lengths between the fourth (ring) and fifth (little) fingers is related to neuroticism among both females and males. The ratio between second and fourth fingers also appears to be predictive of depression among men.
Given that aggressiveness among traders is plausibly related to risk seeking and neuroticism is related to emotional self control, it may well be that one's trading psychology is related to simple finger measurements. The ability to aggressively take controlled and prudent risk is surely an important component of trading success.
RELATED POSTS:
A Personality Test for Traders
Interpreting the Personality Questionnaire for Traders
An important implication of this research is that much of our psychological makeup is determined by our biology. Finger lengths predict about five percent of the variance in aggressive traits, which is not trivial.
Of equal interest is the finding that the ratio of lengths between the fourth (ring) and fifth (little) fingers is related to neuroticism among both females and males. The ratio between second and fourth fingers also appears to be predictive of depression among men.
Given that aggressiveness among traders is plausibly related to risk seeking and neuroticism is related to emotional self control, it may well be that one's trading psychology is related to simple finger measurements. The ability to aggressively take controlled and prudent risk is surely an important component of trading success.
RELATED POSTS:
A Personality Test for Traders
Interpreting the Personality Questionnaire for Traders
Dwindling Participation in the Recent Large Cap Rally
As the S&P 500 large cap market (blue line) has steadily risen to new highs over the past week, fewer stocks in the S&P 500 universe have participated in that move. Above I'm tracking the number of 10 day highs minus lows among 40 highly weighted S&P 500 stocks. These are evenly divided among the Materials, Industrials, Consumer Discretionary, Consumer Staples, Energy, Health Care, Financial, and Technology sectors. (See those recent sector money flow posts for the specific roster of stocks.) Note that on Friday, as we hit new highs, there were 9 stocks in the basket making 10-day highs and none making 10-day lows. By contrast, on 4/25 we had 18 fresh 10-day highs and no 10-day lows. It appears that the rally is becoming more selective.This accords with the data reported in today's Trading Psychology Weblog, which show waning new 52-week highs across several different U.S. equity markets. I don't expect the market to spiral downward from here: money flows remain solid, and we're not yet seeing stocks expanding new lows. Rather, the rally is relying on a dwindling base of strength, and that's generally led to consolidation prior to any fresh bull leg.
Friday, May 04, 2007
Stockfest: Strong Flows in MER
Here we see Merrill Lynch (MER; blue line) from January, 2006 to the present. Note that the 20-day money flows (pink line) have been on a steady rise, remaining positive throughout the entire period. We can also see patterns familiar from prior money flow posts, such as the tendency of flow rates to top and bottom ahead of price during intermediate-term swings. Observe how flow broke out to new highs just ahead of the price breakout in October, 2006. Flows also remained positive even during the sharp market correction of late February/early March.Since that time, flows have vaulted to new highs, though we're not yet seeing fresh highs in the stock price. This inefficiency tends to precede corrections; note, too, that flows have put in a momentum high. For these reasons, it would not surprise me to see consolidation in MER, even as price may move higher in the short run following the momentum peak in flows.
Stockfest: More Than a Dead CAT Bounce
My recent post found a breakout in money flow and price in VZ. Above we see a chart for Caterpillar (CAT; blue line) going back to January, 2006. Note the large drop on very negative money flow (pink line) in October, 2006. After that point, CAT price stabilized on positive money flow. Following the February bottom, notice that we saw solid upward spikes in money flow and only occasional, muted negative readings. During the late February/early May selloff, we never saw sustained negative money flow in CAT and we held well above the late 2006/early 2007 price lows.
Most recently, money flow has spiked even higher, and we're making strides toward testing the 2006 highs. The drying up of selling in CAT following the spike downward, the ability to hold lows on market weakness, and now the new dollar inflows make this a continued stock to watch.
YHOO and Money Flow on the Rise
Despite the recent sharp drop in Yahoo! stock (YHOO; blue line) taking us back below $30/share, notice that money flows (pink line) have been on the rise of late. YHOO is trading significantly higher in pre-opening trade (over $32/share), thanks to talk of a merger with Microsoft (MSFT). Let's see if money flows during the day today confirm investor optimism regarding that merger. I'll update later in the day.Update 8:55 AM CT - YHOO started the day with negative money flow readings, which actually improved (but stayed negative) through the early minutes of trade, as the stock fell about a dollar from its pre-opening highs. The improving flows as the stock dropped have led to a bounce in price, but flows remain negative and are actually deteriorating a bit as I write.
Update 2:12 PM CT - Money flow in YHOO has remained negative all day, dropping below the opening levels *prior* to the big spike down in price (which only made flows more negative). We've since bounced from this spike down, but it seems clear that--at least for today--investors are using strength in YHOO to lighten up positions. At no time during the day has buying interest exceeded selling. This strikes me as important information in determining whether to buy or fade an opening gap to the upside.
Stockfest: Money Flow Breakout in VZ
A while back I indicated that I'd be holding a stockfest, examining individual equities with interesting money flow patterns. Since then, we've looked at Toshiba, the semiconductor sector, Amazon, and the Dow 30 Industrials. I'll be covering some of the suggested stocks from readers in upcoming posts.To kick off the stockfest, here's one mentioned yesterday by a reader. As the chart above shows, Verizon (VZ; blue line) broke out of a range on elevated volume. Just as important, money flow (pink line) jumped on the rise, indicating that much of this volume can be attributed to buyers lifting offers.
We saw similar buyer aggressiveness in late 2006, leading to higher prices into early 2007. Note that, since that time, money flow has been consistently positive for VZ. Clearly, large market participants have been displaying interest in the stock.
One interesting tell leading up to the breakout: When I compute relative dollar volume flow by expressing money flow as a proportion of total volume, several spikes in relative flow on rising stock prices can be seen to precede the recent market move, most notably on 3/30 and 4/16. I continue to find that screening for jumps in money flow can help target stocks that are candidates for breakout moves.
Thursday, May 03, 2007
Sunday Morning Webinar: Submit Your Questions!
I recently mentioned that I will be doing a free, interactive two-hour Webinar on the topic of improving trading performance this Sunday morning at 7 AM CT. Here is the registration page; I'm pleased to see that we have over 170 participants signed up so far.
But here's your opportunity to help shape the Webinar: If you have specific questions about trading psychology, trading performance methods, or trading techniques, please submit them as comments to this blog post. I will do my best to address these during my presentation and/or during the interactive discussion following.
Once again, I want to thank Steven Buss for organizing this session. He's an active participant in the NeoTicker and TradeStation forums, and I greatly appreciate his dedication to trader development.
It'll be early, so bring your coffee! I look forward to seeing you on Sunday--
Brett
But here's your opportunity to help shape the Webinar: If you have specific questions about trading psychology, trading performance methods, or trading techniques, please submit them as comments to this blog post. I will do my best to address these during my presentation and/or during the interactive discussion following.
Once again, I want to thank Steven Buss for organizing this session. He's an active participant in the NeoTicker and TradeStation forums, and I greatly appreciate his dedication to trader development.
It'll be early, so bring your coffee! I look forward to seeing you on Sunday--
Brett
Intraday Patterns in the Money Flow Data
In my recent post, I illustrated a short-term trending pattern in the intraday money flow data. In Wednesday's market, I tapped Home Depot (HD; blue line) for this same pattern, as it opened higher in a mixed market (thanks to favorable housing news) and then proceeded to rise on strong money flow (red line). Around 10:30 AM ET, however, it was clear something was wrong. A few large trades lifting offers in HD had taken money flow to daily highs, but price was no longer participating. Readers will observe that this is the same inefficiency pattern that we see in the NYSE TICK data at market tops in the indexes.
From there, price moved steadily lower in HD, even as the broad market registered fresh highs. Interestingly, money flow bottomed out around 11:15 AM, well ahead of price. That is also a bottoming pattern we frequently see in the NYSE TICK, as selling pressure dries up on new price lows.
It makes sense that patterns in the money flow might mirror patterns in the NYSE TICK, as money flow is really a volume-weighted TICK measure for each individual stock. (More on how money flow is calculated can be found here).
I strongly suspect that this can be a powerful tool in the arsenal of the intraday trader of individual stocks. (Note: data from RealTick, charted in Excel).
Wednesday, May 02, 2007
Trading and the Adrenaline Rush
In today's Trading Psychology Weblog, I linked to a blog post on the topic of the "flight or fight" adrenaline response and its effect on trading. Dr. Bruce Hong, a blog reader and active trader, kindly responded to the link and offered his own, medical perspective:
I don't wish to sound critical, but your analysis is a little bit incorrect. Allow me to introduce myself. I am a physician (ER) with a great deal of experience with adrenaline and adrenaline-producing situations.
First, let's look at the biological role of adrenaline: Let's say you're walking down a path and a tiger jumps out at you. Instantly, you perceive a threat and adrenaline is released. This is a response that is AUTOMATIC and not under conscious control. The immediate response is, as you note, to prepare your body for "fight or flight". But, beyond increasing your heart rate, blood pressure, and blood flow to your muscles, IT ALSO DOES SOMETHING IN YOUR BRAIN! Namely, it shifts blood flow AWAY from the frontal lobes and to the motor cortex. After all, you don't need to do any long-term planning at this point. Either you survive - or you don't.
This response is very beneficial in acute, MILD stress. In biological terms, 'mild' means you are not having your limbs torn off or exsanguinating. Acute means lasting <5 minutes. These are biological definitions and, unless re-stimulated, that is roughly how long the "adrenaline rush" lasts.
The important thing is that we are no longer at risk for tiger attacks, but our automatic response to threat is still the same as if a tiger had just jumped out at us. And if we are in a trade, this same sequence of events still occurs. Remember, it's automatic. Now, every one is aware of the obvious physiologic responses that WE CAN FEEL. You report that this is uncomfortable - it's not. It’s just biology. It's only uncomfortable because you are sitting, trying to remain calm, AND TRYING TO MAKE GOOD DECISIONS. If you were a pro athlete, you would want this to occur during a critical point in the game, and to make quick, ‘instinctive’ moves – hence the term 'adrenaline rush'.
BUT WHAT YOU CAN'T FEEL IS THE REDISTRIBUTION OF BLOOD FLOW IN YOUR BRAIN.
And this is what destroys us as traders. Remember, blood is flowing TO the motor cortex and AWAY from the Frontal lobes (the governor or long-term assessment and planning part of the brain.) Normally, it functions as a damping mechanism to reduce or counteract the effects of emotion on our decision-making processes. It is the part of the brain that allows us to assess the long-term consequences of our actions. But because of the presence of adrenaline, we have an overwhelming URGE TO DO SOMETHING - NOW! And all our thought processes are directed to threat and elimination/avoidance of that threat. So instead of thinking things through carefully, we make abrupt, impulsive decisions.
Now, here's the take home message. There are a number of things that you can do behaviorally, but not cognitively. (Remember, the thinking brain is shut off for ~5 minutes). So, you can force yourself to wait 5 minutes, do jumping jacks to 'burn off the adrenalin', and, most importantly, use visualization BEFORE you enter the trade. You would visualize yourself entering the trade and rehearse every situation and prepare your responses to each possible event. In that way, you don't perceive a threat, but a contingent event - so you don't develop a threat response. And, if something totally unexpected happens, you would have prepared a plan, like "exit immediately" or do a quick scan of the news wires, or exit and then do a scan, etc.
BIO: Dr. Hong was trained in Internal Medicine and started his career in Geriatrics and Chronic Pain/Addiction treatment, where he learned quite a bit about the role of adrenaline in behavior. He recommends the work of Dr. Robert Sapolsky, who has worked in the area of stress, as particularly useful. Now in his 60's, Dr. Hong is transitioning toward retirement and life as a trader. He credits Woodie's CCI Club with helping him think for himself as a trader. Dr. Hong can be reached for questions at bhong 4664 at yahoo dot com (no spaces).
RELATED POSTS:
Techniques for handling performance anxiety in trading
The Most Important Psychological Skill for Traders - Part One, Part Two
I don't wish to sound critical, but your analysis is a little bit incorrect. Allow me to introduce myself. I am a physician (ER) with a great deal of experience with adrenaline and adrenaline-producing situations.
First, let's look at the biological role of adrenaline: Let's say you're walking down a path and a tiger jumps out at you. Instantly, you perceive a threat and adrenaline is released. This is a response that is AUTOMATIC and not under conscious control. The immediate response is, as you note, to prepare your body for "fight or flight". But, beyond increasing your heart rate, blood pressure, and blood flow to your muscles, IT ALSO DOES SOMETHING IN YOUR BRAIN! Namely, it shifts blood flow AWAY from the frontal lobes and to the motor cortex. After all, you don't need to do any long-term planning at this point. Either you survive - or you don't.
This response is very beneficial in acute, MILD stress. In biological terms, 'mild' means you are not having your limbs torn off or exsanguinating. Acute means lasting <5 minutes. These are biological definitions and, unless re-stimulated, that is roughly how long the "adrenaline rush" lasts.
The important thing is that we are no longer at risk for tiger attacks, but our automatic response to threat is still the same as if a tiger had just jumped out at us. And if we are in a trade, this same sequence of events still occurs. Remember, it's automatic. Now, every one is aware of the obvious physiologic responses that WE CAN FEEL. You report that this is uncomfortable - it's not. It’s just biology. It's only uncomfortable because you are sitting, trying to remain calm, AND TRYING TO MAKE GOOD DECISIONS. If you were a pro athlete, you would want this to occur during a critical point in the game, and to make quick, ‘instinctive’ moves – hence the term 'adrenaline rush'.
BUT WHAT YOU CAN'T FEEL IS THE REDISTRIBUTION OF BLOOD FLOW IN YOUR BRAIN.
And this is what destroys us as traders. Remember, blood is flowing TO the motor cortex and AWAY from the Frontal lobes (the governor or long-term assessment and planning part of the brain.) Normally, it functions as a damping mechanism to reduce or counteract the effects of emotion on our decision-making processes. It is the part of the brain that allows us to assess the long-term consequences of our actions. But because of the presence of adrenaline, we have an overwhelming URGE TO DO SOMETHING - NOW! And all our thought processes are directed to threat and elimination/avoidance of that threat. So instead of thinking things through carefully, we make abrupt, impulsive decisions.
Now, here's the take home message. There are a number of things that you can do behaviorally, but not cognitively. (Remember, the thinking brain is shut off for ~5 minutes). So, you can force yourself to wait 5 minutes, do jumping jacks to 'burn off the adrenalin', and, most importantly, use visualization BEFORE you enter the trade. You would visualize yourself entering the trade and rehearse every situation and prepare your responses to each possible event. In that way, you don't perceive a threat, but a contingent event - so you don't develop a threat response. And, if something totally unexpected happens, you would have prepared a plan, like "exit immediately" or do a quick scan of the news wires, or exit and then do a scan, etc.
BIO: Dr. Hong was trained in Internal Medicine and started his career in Geriatrics and Chronic Pain/Addiction treatment, where he learned quite a bit about the role of adrenaline in behavior. He recommends the work of Dr. Robert Sapolsky, who has worked in the area of stress, as particularly useful. Now in his 60's, Dr. Hong is transitioning toward retirement and life as a trader. He credits Woodie's CCI Club with helping him think for himself as a trader. Dr. Hong can be reached for questions at bhong 4664 at yahoo dot com (no spaces).
RELATED POSTS:
Techniques for handling performance anxiety in trading
The Most Important Psychological Skill for Traders - Part One, Part Two
Daytrading Stocks With Money Flow Patterns
Recall that the relative money flow indicator is designed to track the buying and selling preferences of large market participants. Each trade in a stock is tracked by multiplying the volume of the trade times the trade price. That gives you dollar volume. If that trade occurred on an uptick, the dollar volume is added to a cumulative total. If the trade occurred on a downtick, the dollar volume is subtracted from the total. The running total, called money flow, is very sensitive to large trades occurring at the market offer price (aggressive buyers) and at the market bid (aggressive sellers). In my relative money flow calculations, I simply express money flow as a proportion of total volume. Thus, if volume expands from period one to period two but money flow remains the same, we can see that the market is losing efficiency: it's taking more volume to create the same inflows.
Until now, all my money flow research has used end-of-day data. Here we see a chart of Citigroup stock (C) for 4/30/07, with 15-minute bars. Above the opening bars, we can see the relative dollar volume flows specific to those 15-minute periods. Let's walk through the early morning trade:
The Dow opened lower that morning, but C opened higher on positive money flow. In fact, 15 of the 30 Dow stocks traded with outright negative money flows during the first 15 minutes of the session. That C opened higher with positive flow was our first sign of relative strength.
Note what happened in the second 15-minute period. Not only did C jump higher in price; the relative flow for that period was a whopping 12.74. (As a point of reference, consider that the median relative flow for C from 2004 to the present has been 3.46). This means that large trades were very aggressive on the buy side, even though the market overall was not strong.
In the third 15-minute period of the session, volume in C jumped meaningfully, but relative flows rose even more to an eye-popping 20.06. That means that institutions are jumping into the stock (rising volume), and their participation is strongly bullish. They are willing to lift the offer price in order to get into the stock.
Notice how this bullish momentum then carried us higher over the next hour on solid dollar volume flow readings. The active trader, noting the relative strength in the stock and the very strong money flows, had plenty of opportunity to participate to the upside.
(Note: Relative flows began to wane after this period and actually turned negative during the afternoon, with the final daily reading coming in at 2.83. In a future post, I will examine reversal patterns in the money flow data).
When a stock opens higher in a down market on solid volume and with positive money flows, that should trigger an alert for the short-term trader. Large market participants are so interested in owning this stock that they're bucking the overall market. Once we then see *rising* relative flows and rising volume in the stock, we know that there is significant demand for the issue. That is the kind of scenario that lends itself to short-term trending moves.
It's a promising example of how traders can track the behavior of the market's largest participants by focusing on the opening minutes and finding a potential directional edge. More from this research to come.
Tuesday, May 01, 2007
Every Trader Is A Trading System
I interviewed system developer Michael Bryant to prepare for this post. Mike offers a free newsletter for traders that includes valuable information for those interested in trading and/or developing systems. He also offers worthwhile free downloads.
The purpose of my interview, however, was to discuss with him the latest version of his Market System Analyzer (MSA). This strikes me as a tool that could be valuable for discretionary and system traders alike.
The idea behind MSA is that you treat all trading like system trading. In that sense, every trader is a system, although they may not be systematic. Mike's way of putting it was more blunt: There *are* no discretionary traders.
By entering your trades into a program such as MSA, you can learn a great deal about your strengths and weaknesses. The program enables you to identify the position sizing that would work best for your trading, with a goal of optimizing risk and reward. The software also enables traders to identify runs of winners and losers (dependencies) and calculates detailed performance statistics on your trading. (Note: I have no commercial affiliation with the product or with Mike; nor did he solicit this mention).
My sense is that this could form a useful part of a trader portfolio that includes a journal and video playbacks of markets for review. The idea is to turn your trading into a platform for learning and development. By viewing yourself as a system and knowing how that system behaves, you're in a stronger position to optimize yourself.
Suppose, however, that you trade multiple markets. The latest version of the software (version 3) not only monitors and evaluates systems and trades, but also portfolios of systems. This would be particularly useful for discretionary traders who trade multiple instruments. You could separately evaluate your trading of each instrument and then see how each contributes to the whole of your performance.
The take-away message? You don't have to be a systems trader to be systematic about your trading.
Related Readings:
Three Steps Toward Becoming a Better Trader
Five Defining Features of Market Pros
The purpose of my interview, however, was to discuss with him the latest version of his Market System Analyzer (MSA). This strikes me as a tool that could be valuable for discretionary and system traders alike.
The idea behind MSA is that you treat all trading like system trading. In that sense, every trader is a system, although they may not be systematic. Mike's way of putting it was more blunt: There *are* no discretionary traders.
By entering your trades into a program such as MSA, you can learn a great deal about your strengths and weaknesses. The program enables you to identify the position sizing that would work best for your trading, with a goal of optimizing risk and reward. The software also enables traders to identify runs of winners and losers (dependencies) and calculates detailed performance statistics on your trading. (Note: I have no commercial affiliation with the product or with Mike; nor did he solicit this mention).
My sense is that this could form a useful part of a trader portfolio that includes a journal and video playbacks of markets for review. The idea is to turn your trading into a platform for learning and development. By viewing yourself as a system and knowing how that system behaves, you're in a stronger position to optimize yourself.
Suppose, however, that you trade multiple markets. The latest version of the software (version 3) not only monitors and evaluates systems and trades, but also portfolios of systems. This would be particularly useful for discretionary traders who trade multiple instruments. You could separately evaluate your trading of each instrument and then see how each contributes to the whole of your performance.
The take-away message? You don't have to be a systems trader to be systematic about your trading.
Related Readings:
Three Steps Toward Becoming a Better Trader
Five Defining Features of Market Pros
Coaching the Professional Trader: A Consumer's Guide
Coaching has become an institution within American business. According to a recent Harvard Management Update, 86% of companies utilize coaching to enhance the skills of their managers. Indeed, a Harvard Business Review study estimates that 1 billion dollars is spent annually on executive coaching. The article refers to the market for executive coaches as a kind of "wild west", in which "No one has yet demonstrated conclusively what qualifies an executive coach or what makes one approach to executive coaching better than another. Barriers to entry are nonexistent--many executive coaches know little about business, and some know little about coaching." Despite valiant efforts to standardize the field, such as The Executive Coaching Handbook, the plain reality is that coaching in the corporate world is a field without a firm empirical base and without uniformly recognized credentials.
This wild west applies not only to executive coaching, but the gamut of coaching in the trading world. There is a very thin literature dealing with the coaching of traders, and much of that is more applicable to the novice, retail trader than to the established professional. Much of the popular literature, for example, assumes that major goals of coaching are to help traders establish trading plans and stick to these with discipline. This simplistic notion of trading does not begin to capture the complex world of a market maker at an investment bank, who is interacting with trader colleagues, market, and sales professionals through the day. Nor does it ring true to the multimillion dollar portfolio manager at a hedge fund, who might be trading a long/short strategy based upon quantitative valuation models.
While coaching of the retail trader has tended to address the needs and interests of struggling traders, trading coaches are most often sought for professional traders who are already successful. (Many firms, in fact, only hire traders with established track records of success who already have demonstrated successful trading methods and risk management). Very often, the traders seeking coaching are looking to "take it to the next level" by expanding the size and/or scope of their operations. Others are finding that their success increasingly places them in managerial roles, for which they were not trained and which may not represent their true passion. Still others face life challenges apart from trading that might impact their performance.
If you're a professional trader or trading firm considering hiring a trading coach, what should you look for? Here's a brief checklist that might guide your initial search:
* Trader Motivation - My experience across proprietary firms, hedge funds, and investment banks is that the value of coaching is directly proportional to the trader's interest in the process. When the coaching is initiated by management (or HR) with little trader input, it rarely turns into an ongoing, useful process.
* Rapport - A large body of research in psychology suggests that change efforts are most likely to be successful when there is a positive working relationship between the parties involved. Scheduling initial, trial meetings to determine whether or not there is a solid alliance can help avoid wasting much time and energy. If rapport isn't present after a couple of meetings, it most likely won't be there.
* Content Awareness - A trading coach should know something about trading and about the kind of trading engaged in at the relevant setting. The challenges facing a high frequency trader at a prop firm and a portfolio manager at a growing hedge fund are meaningfully different. It is difficult to build a strong rapport if the coach is clueless about the trader's life work.
* A Thorough Assessment Process - Beware the coach who offers a canned program of assistance, one-size-fits-all. The coaching should be bespoke: tailored to the individual's specific needs and circumstances. This means that a thorough assessment process should precede efforts at intervention. It is invaluable, I have found, to include others in that assessment process, such as risk managers, desk managers, MDs, and others coordinating the work of traders.
* Emphasis on Limited, Measurable Goals - If there's one thing that has given coaching a bad name, it's a reliance on buzz words and psychobabble in place of validated methods directed toward measurable aims. Both coach and client should be able to verbalize their specific aims, what they will be doing to reach these, and how they'll know if they're achieved.
* Professionalism and Experience - Who is the coach ultimately working for: the client firm or the trader? How will confidentiality be handled? What feedback will be given to managers of the trading firm? If more specialized help is required (e.g., a psychiatrist), how are referrals handled? How does the initial assessment identify problems that would out outside the coach's scope of practice? An experienced, professional coach will have thought through these issues carefully.
My personal preference is for services that enable traders to become their own trading coaches, rather than dependent upon an external coach. As a helper, that takes me down the path of direct skills teaching, rather than talk counseling. Ultimately, however, what is most important is the fit between the personality and needs of the trader and the style and methods of the coach. Firms should not be hesitant to audition many prospective coaches before settling on one or more to make available to their talent.
Relevant Readings:
Performance Coaching: When It Works, When It Doesn't
Trading Coaches: What Works
Trading Mentors and Coaches: A Resource Linkfest
How Traders Can Become Their Own Coaches
This wild west applies not only to executive coaching, but the gamut of coaching in the trading world. There is a very thin literature dealing with the coaching of traders, and much of that is more applicable to the novice, retail trader than to the established professional. Much of the popular literature, for example, assumes that major goals of coaching are to help traders establish trading plans and stick to these with discipline. This simplistic notion of trading does not begin to capture the complex world of a market maker at an investment bank, who is interacting with trader colleagues, market, and sales professionals through the day. Nor does it ring true to the multimillion dollar portfolio manager at a hedge fund, who might be trading a long/short strategy based upon quantitative valuation models.
While coaching of the retail trader has tended to address the needs and interests of struggling traders, trading coaches are most often sought for professional traders who are already successful. (Many firms, in fact, only hire traders with established track records of success who already have demonstrated successful trading methods and risk management). Very often, the traders seeking coaching are looking to "take it to the next level" by expanding the size and/or scope of their operations. Others are finding that their success increasingly places them in managerial roles, for which they were not trained and which may not represent their true passion. Still others face life challenges apart from trading that might impact their performance.
If you're a professional trader or trading firm considering hiring a trading coach, what should you look for? Here's a brief checklist that might guide your initial search:
* Trader Motivation - My experience across proprietary firms, hedge funds, and investment banks is that the value of coaching is directly proportional to the trader's interest in the process. When the coaching is initiated by management (or HR) with little trader input, it rarely turns into an ongoing, useful process.
* Rapport - A large body of research in psychology suggests that change efforts are most likely to be successful when there is a positive working relationship between the parties involved. Scheduling initial, trial meetings to determine whether or not there is a solid alliance can help avoid wasting much time and energy. If rapport isn't present after a couple of meetings, it most likely won't be there.
* Content Awareness - A trading coach should know something about trading and about the kind of trading engaged in at the relevant setting. The challenges facing a high frequency trader at a prop firm and a portfolio manager at a growing hedge fund are meaningfully different. It is difficult to build a strong rapport if the coach is clueless about the trader's life work.
* A Thorough Assessment Process - Beware the coach who offers a canned program of assistance, one-size-fits-all. The coaching should be bespoke: tailored to the individual's specific needs and circumstances. This means that a thorough assessment process should precede efforts at intervention. It is invaluable, I have found, to include others in that assessment process, such as risk managers, desk managers, MDs, and others coordinating the work of traders.
* Emphasis on Limited, Measurable Goals - If there's one thing that has given coaching a bad name, it's a reliance on buzz words and psychobabble in place of validated methods directed toward measurable aims. Both coach and client should be able to verbalize their specific aims, what they will be doing to reach these, and how they'll know if they're achieved.
* Professionalism and Experience - Who is the coach ultimately working for: the client firm or the trader? How will confidentiality be handled? What feedback will be given to managers of the trading firm? If more specialized help is required (e.g., a psychiatrist), how are referrals handled? How does the initial assessment identify problems that would out outside the coach's scope of practice? An experienced, professional coach will have thought through these issues carefully.
My personal preference is for services that enable traders to become their own trading coaches, rather than dependent upon an external coach. As a helper, that takes me down the path of direct skills teaching, rather than talk counseling. Ultimately, however, what is most important is the fit between the personality and needs of the trader and the style and methods of the coach. Firms should not be hesitant to audition many prospective coaches before settling on one or more to make available to their talent.
Relevant Readings:
Performance Coaching: When It Works, When It Doesn't
Trading Coaches: What Works
Trading Mentors and Coaches: A Resource Linkfest
How Traders Can Become Their Own Coaches
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