Monday, December 31, 2007

Heads Up Regarding Twitter Trader

Once again I want to wish readers the happiest, healthiest, and most successful of New Years. During 2008, I'll be making greater use of the Twitter application, sending out frequent mini-posts that include links to readings around the Web and blogosphere. I'll also be adding to Twitter Trader more regular postings of standard and proprietary market indicators and what they're telling us about market action. Over time, the Twitter Trader app will begin to approximate an on-the-fly trading newsletter.

As always, the latest five Twitter postings ("tweets") will appear on the TraderFeed home page; the full set of posts can be accessed via my Twitter page or by setting up a subscription to the Twitter page via RSS for automatic updating of tweets.

Happy New Year!


Coaching Yourself for Profitable Trading Performance in 2008

In my recent post, I mentioned that there is a considerable overlap between coaching and the short-term approaches to behavior change known as brief therapy. Many traders try to make accelerated changes in their cognitive, behavioral, and emotional patterns without understanding how such changes can be made and sustained. Indeed, few of the professional trading coaches that I've met seem to be aware of the brief therapy literature and the extensive research on change and how it occurs.

So how can you use this growing area of research and practice to aid your progress in 2008? Here are a few findings from the brief therapy world and their implications for coaching yourself to successful trading performance:

1) Keep It Focused - The research is unequivocal: focused efforts at change are more likely to occur--and more likely to occur in a relatively brief time frame--than efforts to change many things at one time. Establishing and maintaining a change focus is perhaps the single most important thing one can do to ensure that efforts at improvement will pay off. The focus should be grounded in a thorough assessment of the problems to be addressed and the strengths to be built upon. Many times traders assume that their problem is one thing or another, when in fact they haven't really drilled down into their trade data to identify what, specifically, they're doing right or wrong. Working on something broad and vague, such as "discipline", is not a focus. Focused changes should identify specific things to do differently and concrete steps to make a difference.

2) Keep It Consistent - Research into short-term change finds that involvement in the change process--consistent efforts over time--is associated with success. Traders who work on their trading in a structured, daily fashion are much more likely to benefit from coaching than those who limit their change efforts to weekly or monthly reviews. The goal of all short-term change is to create new, positive habit patterns. It is impossible to create those patterns without regularity: doing new things so consistently that they become part of the self.

3) Keep It Doable - Success breeds optimism, motivation, and further efforts at success. Effective change efforts create a virtuous cycle of continuous improvement. If goals for change are too difficult, they will create only frustration and discouragement. It is better to start small and ensure success than to try to make the most complex changes all at once. If you're working on entering or exiting trades differently, just try it for a single day and see how it goes. Then modify the goal for the next day. By focusing on the next day's trade, you keep goals concrete and doable.

In general, I would say that traders tend to overweight the importance of psychology in their results and underweight trading mechanics: how they execute trade ideas (getting good entry prices, not chasing moves; ensuring that each trade has a favorable reward-to-risk profile) and how they set and follow criteria for exiting trades (price targets as well as stop losses). To be sure, psychological factors can interfere with the implementation of those mechanics, but many traders simply lack sound rules for entering and exiting positions and instead make decisions impulsively, on the fly.

A review of one's own best trades can be very effective in identifying one's own "best practices" regarding trading mechanics. Those best practices can then be translated into focused, doable goals that are pursued with consistency.

Best of luck in your development in 2008. The posts below may be of additional help in your self-coaching efforts.


Predicting Coaching Success

Coaching and Mentorship Resources for Traders

Why Coaching Doesn't Work - Part One

Why Coaching Doesn't Work - Part Two

Coaching the Professional Trader

Sunday, December 30, 2007

Signs of Stock Market Weakness

* Continued Weakness in Cumulative TICK - My Cumulative TICK line has been showing notable weakness during the recent bounce and the last couple of days of pullback. This leads me to suspect that we're putting in a lower high in ES and could be testing the lows from earlier in the month. My indicators that treat buying and selling interest as separate variables show significantly below average buying interest all four trading days last week. During the last two sessions of the week, selling interest was pretty average relative to the prior 30 trading sessions. In short, buyers have been on strike. Tough to mount a rally when that happens.

* Weakening New High/Low Numbers - We've seen weaker numbers for 20-day new highs/lows over the past three trading sessions. On Friday, we had 509 new 20-day highs, against 903 new lows. Demand/Supply momentum numbers have also been negative the past two trading sessions. Among NYSE common stocks, we had 31 new 52-week highs against 87 new lows--the highest number of new lows in five trading sessions. We see a similar pattern among the S&P 600 small caps, where we had 6 new 52-week highs against 26 new lows, and among the S&P 500 large caps, where there were 12 annual new highs and 28 new lows.

* Technical Strength - Among my basket of 40 S&P 500 stocks highly weighted across eight sectors, we have 13 stocks qualifying as technically strong, 9 as neutral, and 18 as weak. That 's a considerable deterioration from earlier in the week. The Technical Strength Index closed on Friday at -400, which means that we've shifted from a preponderance of stocks in uptrends to a modest plurality in downtrends. The technical strength situation--and quite likely the S&P 500 Index as a whole--would be much weaker would it not be for the energy sector, which is contributing almost all the strength at present. Without those energy issues, we definitely have a majority of sectors in downtrends--even among the large caps. Note how we were seeing far greater strength on Wednesday.

New Highs and Lows Among the Largest Caps

A click on the chart above will give a larger picture of 10-day new highs minus lows for the basket of 40 stocks that track eight major sectors within the S&P 500 universe. An interesting aspect of the chart is that we have been spending the majority of time since July with new highs outnumbering new lows. We've seen several occasions in which new highs have outnumbered new lows by 20 or more issues, but have not seen new lows outnumber new highs by such a margin.

This observation fits with my advance-decline line findings for the 40 stocks, which recently hit a bull market high. While many sectors have been in an outright bear market and the large cap indexes have been in a wide range through much of 2007, the largest of the large caps (which include many of these 40 issues) have not been in a bear market at all. Indeed, sectors such as Consumer Staples and Energy have remained quite strong, even as Financials and Consumer Discretionary issues have lagged.

I am watching carefully to see if we are peaking at present at lower price highs and with fewer of these mega-cap issues making fresh 10-day highs. If that is the case, I would expect the S&P 500 Index (SPY) to test the lows on this chart. I would also expect weakness to finally catch up to the basket of stocks and begin giving us readings of -20 and below for the new high/low balance. In an upcoming post, I will update technical strength and sector performance within the basket.


My Recent Indicator Review

Saturday, December 29, 2007

A Look at Short-Term Trending: Power Measure

My Power Measure began as a moving correlation function relating price change to volume and volatility. The goal was to capture "trendiness" as a variable. I've since refined the measure (recalibrated and smoothed it) and extended it to a variety of time frames. I've found that some of the best trading opportunities occur when we see concurrent shifts in trendiness at multiple time frames.

Trends at larger time frames can be detected by noting trendiness peaks at lower price highs (downtrend) and trendiness valleys at higher price lows (uptrend). While the specifics of the latest iteration of this indicator remain proprietary at this juncture, the key idea is quite replicable: to identify occasions in which volatility is expanding in the direction of a price move. Moving correlations are excellent ways to capture this dynamic graphically.

Expanding One's Trading Framework: Building on Strengths

I've written before on my basic framework for trading. I calculate various price targets, including the prior day's high, low, and average points as well as the R1 and S1 pivot points, and then handicap the odds of hitting those levels as the day unfolds. My major tools for handicapping those odds are relative volume (how volume compares to a 20-day average), the adjusted NYSE TICK (how TICK compares to its 20-day average), and Market Delta (volume transacted at market bid vs. offer).

This framework has proven sufficiently successful that I am experimenting with rolling it out to longer time frames. What this means is that, instead of using the prior day as the basis for calculation of the price targets, I will calculate the targets associated with any N-day lookback period. A simple example would be to calculate the price targets based on weekly bars rather than daily ones and use the indicators (as well as other ones, such as advances/declines for common stocks only) to handicap the odds of hitting those targets over the next five trading sessions.

Time is completely malleable in this framework. You can create bars and targets based on 45-minute periods, 3-day periods, or monthly periods--and everything in-between. The swing trades boil down to making bets on which of the price targets will be hit first based upon unfolding price action and volatility. By trading periods of very different lengths, it is possible to diversify bets even as you might be trading highly correlated instruments.

When developing new trading frameworks, it is important that these not only build on existing strengths, but also match your own needs and interests in the markets. My personal trading takes place entirely during AM hours, as I wish to free my days for writing, work with traders, and family life. I know from experience that sitting in front of a screen all day every day leaves many of my needs and interests unfulfilled.

By expanding the trading framework to an N-day level, decision-making and placing of orders can take place during the morning hours, even as the trades may last several days. This leverages a trading method without requiring additional screen time. It also keeps the number of trades I place down to a manageable number, minimizing commission overhead and allowing trades to be well-planned and thought through.

That, in a nutshell, is my trading project for 2008.

Friday, December 28, 2007

Handbook of Clinical Psychology, Brief Therapy, and Coaching

I just received my copy of the 2008 Handbook of Clinical Psychology, a two volume reference set that covers the major topics in adult and child psychology, respectively. The first volume, covering adult psychology, consists of 33 chapters that tackle such topics as psychological assessment, research on temperament and personality, studies of psychological change processes, health psychology, and various approaches to therapy. While the reference volume is hardly light reading, it effectively summarizes a wide range of research and practice within psychology. I'll be referring to a few of the chapters in upcoming posts, as I apply the material to trading and human performance.

My own chapter in the Handbook covers the topic of "brief therapy". One of the topics I cover in the chapter is the thorny issue of who can benefit from short-term change approaches. It turns out that the effectiveness of brief interventions is partly a function of the person receiving help (their motivation and readiness for change, their lack of severe and chronic problems) and partly a function of the methods used to promote change (active, experiential, focused). The chapter is relevant to the trading arena because much of what goes under the rubric of "coaching" is actually efforts at short-term emotional and behavioral change.

That means that the issue of who can benefit from brief therapy is not so different from the question of who can benefit from performance coaching, including the coaching of traders. In an upcoming post, I'll draw upon my chapter to offer some guidelines for effective coaching.


A Consumer's Guide to the Coaching of Traders

The Brain's Role in Trading Performance

Consider the following behaviors:

* Planning, setting goals, and initiating action
* Monitoring outcomes and adapting to errors
* Mental effort in pursuing difficult goals
* Motivation, willingness to engage in action
* Regulating emotional impulses
* Active thinking
* Sustained attention in the face of distraction
* Decision-making, switching attention and changing strategies
* Planning and sequencing actions
* Resolving competition between plans

These sound like a veritable who's who of sound trading behaviors. In fact, however, they have been taken from a list of common functions of the brain's prefrontal cortex provided by Elkhonon Goldberg and Dmitri Bougakov in their chapter "Goals, Executive Control, and Action", which is part of an excellent overview text on the brain called Cognition, Brain, and Consciousness and edited by Bernard J. Baars and Nicole M. Cage.

The brain's frontal lobes are involved in impulse control, judgment, and the planning, coordinating, and executing of behavioral plans. Among frontal lobe disorders are schizophrenia, dementia, and attention-deficit disorders. When individuals fail to live up to their New Year's resolutions and other intentions, we commonly attribute their failure to a lack of motivation. Research, however, finds that the ability to follow up on such plans is significantly related to frontal lobe performance on neuropsychological tests. It may well be that traders who have problems with following trading rules have much broader neuropsychological deficits, not merely temporary lapses in motivation or discipline.

Dr. Goldberg, co-author of the aforementioned chapter, suggests that engaging in tasks that require use of the frontal lobes may in fact strength their function. This has profound implications for the treatment of dementia and attention deficits and may also play an important role in improving performance at such cognitive tasks as trading.

Interestingly, the research cited in Dr. Goldberg's chapter indicates that the prefrontal cortex is most involved in tasks that involve novelty. Familiar tasks that are routine do not require the same kind of attention, concentration, planning, and judgment. It may well be that tackling new, unfamiliar challenges is most stimulating to brain development, whereas routine (consider the lifestyles of many retired people) is least likely to enhance cognitive functioning.

This strikes me as one of the exciting frontiers of performance psychology.


Inside the Trader's Brain

Finding the Zone

Biofeedback for Performance Enhancement

Lessons From Neuroeconomics

Thursday, December 27, 2007

Bearish Stock Sentiment and Other Ideas for Thursday

* Bearish Sentiment on the Day - In a number of past posts, I've emphasized the value of the NYSE TICK as a measure of trader sentiment. This is because the TICK captures the moment to moment decision-making of traders to execute trades at the market offer vs. the bid. When a preponderance of stocks are transacting at the offer, we know that buyers are willing to pay up to own those issues. Conversely, when stocks are transacting at their bid prices, we know that sellers are sufficiently aggressive as to accept the bid price to get out of those issues. By cumulating the NYSE TICK values over the course of the day, we can detect the trend of sentiment. Notice how the weak day on Thursday was accompanied by consistent transacting of stocks at the market bid, leading to a downsloping cumulative TICK line. This helped keep short-term traders on the sell side through the day.

* Revising Beliefs - Traders need to have strong beliefs to enter and stay with trades, but they also need to be able to revise those beliefs to exit trades when necessary. Dr. Bruce Hong offers insight into changes of beliefs and behaviors.

* ETF Forecast - ETF Trends offers their predictions for 2008, including an interesting view of ETFs of ETFs.

* Link Update - Trader Mike once again finds worthwhile topics in his link updates, including business planning for traders and best blogs of 2007.

* Perspective on VIX Futures - Adam offers cautionary insights into a complex product.

* Top Stocks of 2007 - Chris Perruna looks back at the stocks most actively covered on his blog and finds a number of trending issues.

* Canadian Oil Sands and More - Larry Nusbaum offers a range of perspectives and links including a site that is a mini-Bloomberg.

* Global Liquidity - This interesting blog offers an unusual and very insightful 2007 review including thoughts re: checks and balances.

Living the Purposeful Life: A Formula for Well-Being

A very interesting chapter in the book "Well-Being: The Foundations of Hedonic Psychology" begins with an intriguing title: Life Task Participation and Well-Being: The Importance of Taking Part in Daily Life". The authors, Nancy Cantor and Catherine A. Sanderson, advance the thesis that "sustained participation in personally and culturally valued tasks that change across the life course enhances well-being".

Not all life activities contribute to emotional well-being, the authors note. Rather, "well-being should be enhanced when individuals are able to pursue their distinct personal goals in ways that are intrinsically valued and autonomously chosen, approached at a feasible level, and facilitated in their daily life context".

The important contributor to well-being identified by this research appears to be purposeful activity. Note that purposeful activity can be work-related, but doesn't need to be. For example, writing a song, taking a vacation to a new area of the world, or working out in a gym all could be considered leisure activities, but they are goal-driven. Other activities might even be work-related, but not directly purposeful (many meetings scheduled within businesses!).

One's overall well-being appears to be related to the proportion of time and effort devoted to activity with a distinct purpose. Interestingly, research cited by the authors also suggests that physical well-being is also enhanced by goal-directed activity. This helps to explain why depression is so debilitating: the lack of energy and optimism make it difficult to initiate meaningful activity, which in turn fuels a loss of well-being. Similarly, retirement can be very challenging for individuals who find that old age brings a paucity of purpose-driven activities.

The authors emphasize that resources are essential to sustaining the task participation that underlies well-being. These include monetary resources as well as physical ones (health) and social ones. One formula for emotional success appears to be the ability to deploy an array of resources in one's life toward consistently meaningful activities.

I like the phrase in the article title: "the importance of taking part in daily life". The successful traders I've known definitely take part in daily life and indeed engage in goal-directed activities apart from their trading. This helps sustain a high level of well-being that provides energy and optimism across their career. Where trading is a sole obsession for a trader--an existential and emotional poverty often justified by the empty phrase "passion"--it is very common to find a lack of energy and optimism, especially during times of loss, drawdown, and flat performance.

There's much to be said for kicking back, relaxing, being a couch potato, and getting rest. If the authors are correct, however, this may be necessary to a balanced life, but not sufficient. It's the presence and pursuit of goals--personally chosen, challenging but doable, and changing across the lifespan--that recharges our emotional batteries. It is not enough to minimize stress and distress: high levels of well-being facilitate learning, memory, concentration, and ultimately performance.


The Importance of Well-Being

Goal Setting: What Works

Wednesday, December 26, 2007

Virtual Trading Groups: Getting to the Next Level

One of the most common concerns I hear from traders is difficulty "getting to the next level". Many have a sense that they've made progress, but can't quite take that next step toward consistent, significant profitability.

A tremendous advantage of trading within a firm is that you have multiple potential role models for getting to that next level. Within trading firms, you have colleagues who can discuss ideas with you, help keep you positive and motivated during dry spells, and inspire you to greater accomplishment.

Within a firm, also, you get regular feedback on your performance, assistance with risk management, and recognition for accomplishment.

All of these things are lacking for most independent traders.

I do not trade for a firm, but my work as a trading coach/psychologist brings me in contact with many traders and trading institutions. I cannot tell you how much I've learned simply by being around experienced, skilled traders. In such environments, you cannot help but absorb some of their knowledge and wisdom.

Does one need to actually join a trading organization, however, to benefit from group interactions with other traders? The popularity of chat rooms and Web 2.0 trading communities suggests that independent traders are using the online medium to create "groupness" and some of the advantages of affiliation with other traders.

But why not carry that forward yet another step and create actual virtual trading groups? Certainly the technology is readily available (instant messaging, Twitter, online conferencing) to facilitate interactions between and among traders in real time. If a truly committed band of traders decided to openly share ideas and trades, learning from mutual successes and setbacks, the gains in performance for the whole could be far greater than anything that might be achieved in isolation.

Such virtual trading groups would not require investments of capital or added risk. The only demand would be complete and total openness with trades, trade ideas, and trading results--and a willingness to both learn and facilitate the learning of teammates.

To be sure, such groups would require the right kinds of participants: ones sufficiently experienced to offer value to others, ones sufficiently committed to putting time and effort into learning, and--perhaps most of all--ones sufficiently secure to maintain an open kimono and share all the successes, failures, lessons, and letdowns.

A while ago, I conducted real-time postings of market observations, including my own trade ideas and trades. I then hit upon the idea of offering readers the opportunity to take turns leading these sessions via the blog, so that we could all benefit from multiple role models, myself included. Between 2000 and 3000 unique visitors access TraderFeed daily. How many responses do you think I got to lead even just one trading session by posting real time comments?


Given that result, it's perhaps not so surprising that we don't see more virtual trading groups.

The most painful part of my training as a clinical psychologist was having to play tapes of my sessions for my supervisors. Every mistake, every missed opportunity was laid bare; there was no escape. In group supervision, getting a student to volunteer their tapes was torture. After initial hesitance, I pushed myself to volunteer; the worse the session, the more I forced myself to put it out there for learning.

That's what it took for me to get to the next level as a psychologist.

And that, I suspect, is why so few traders make it to that next level.


Performance and Profitability

A Post-Holiday Stock Market Review

* Continuing to See Strength - We saw fewer new highs and fewer new lows on Monday, not so unusual for a shortened pre-holiday session. There were 969 issues making fresh 20-day highs and 429 new lows. We had 55% of S&P 500 issues closing above their 50-day moving averages, up from 50% the day before. Momentum continued to be favorable, with Demand at 109 and Supply at 20. That means that Monday saw five times as many stocks closing above the volatility envelopes surrounding their short-term moving averages as closing below them.

* Technical Strength - Technical Strength has also been rising among my basket of 40 issues distributed across the eight S&P sectors. 23 issues closed Monday in uptrends, 11 neutral, and 6 in downtrends. The Technical Strength Index finished at +1220, a sizable improvement from recent readings.

* Advance-Decline Lines - The A/D Line specific to common stocks only traded on the NYSE has moved above its early December high after failing earlier to pierce its November low. We still remain below the A/D peak of October, however, which in turn was below the peak in July. The Dow 30 stocks hit a new bull market high in their A/D line. We've seen recent strength in the A/D line specific to the S&P 600 small caps--it's moved slightly above its early December peak--but it remains well below its October and July highs.

* Perspective on the Fed - This thoughtful piece from David Merkel, along with its accompanying links, highlights what the Fed has been doing, why, and implications.

Tuesday, December 25, 2007

Happy Holidays!

This is to express my thanks to readers and my wishes for a very happy 2008!



Christmas Readings Across the Blogosphere

* Interest Rates and Stocks - As the charts above indicate, interest rates on the 10-year Treasuries and stock prices in the S&P 500 futures have moved pretty well in lockstep since October. This suggests that, so far, stocks have been responding more to themes of economic strength/weakness than to inflation themes.

* Online Trading Journal - This strikes me as far more effective than a static paper journal. The StockTickr service enables traders to categorize their trades and see what's working and what's not. See also their blog, including interviews with traders and trading coaches.

* Insider's Look at the Mortgage Crisis - I've been using the Twitter app to link readings that highlight market themes and influences; this article on the dimensions of the mortgage problem was one of the posts I think is especially worth highlighting. The latest five Twitter "tweets" appear on the TraderFeed blog page under "Twitter Trader". You can also subscribe to the Twitter page via RSS if you'd like the updates to come directly to your feed reader.

* Mixed Economic Signals - The Calculated Risk site does a great job of tracking credit markets and economic themes. It appears we're seeing increasing consumer credit card problems even as economic data for the fourth quarter looks strong. Mish sees the credit card data as part of a larger, deflationary picture.

* Yield Spreads, Odds of Recession, and a Possible Shakeout Among ETFs - Lots of good topics covered in the recent links posted by Abnormal Returns.

* Buying Beaten Down Issues - StockPickr tracks some recent selections from Bill Miller, including homebuilders and financial stocks. Here's an insightful post from Accrued Interest on the dangers of buying value when the good stocks are being punished with the bad.

* Holiday Sales - Barry Ritholtz finds the holiday sales picture to be mixed at best. See also his skeptical take on the recent consumer spending data.

* Chances of Recession - This one also from Calculated Risk, with a link to an informative analysis by Paul Kasriel.

* Sign of Desperation? - Bespoke Investment Group on the terms of the Merrill Lynch cash infusion.

* The Limits of Statistics - A fine overview of the Nassim Taleb text, The Black Swan, from the CXO Advisory Blog. It illustrates how conventional statistical analyses can mislead investors.

Monday, December 24, 2007

What's Strong, What's Weak: A Look at Stock Sectors

* Neutral Reading on Technical Strength - My basket of 40 stocks is showing 14 issues with technical strength (a quantitative measure of trending), 14 neutral, and 12 weak. The Technical Strength Index now reads +420 following Friday's rise. While this is a jump from readings earlier in the month, it suggests that the majority of stocks are not yet trading in short-term uptrends. I will be watching the neutral issues carefully to see if the upmove broadens out. These neutral issues include IP, GE, UPS, MMM, DIS, WMT, KO, SLB, MRK, LLY, AIG, JPM, and VZ.

* Sector Strength and Weakness - Here's how the Technical Strength scores look on a sector-by-sector basis:

Materials: -20
Industrials: +40
Consumer Discretionary: -80
Consumer Staples: +220
Energy: +280
Health Care: -40
Financial: -240
Technology: +260

Note how strength is limited thus far to three of the sectors. The weakness among Financials is notable given the attention given to this sector, with central bank interventions and bailouts from sovereign wealth funds.

* Yet Another Measure of Sector Strength - We now have 50% of S&P 500 stocks trading above their 50-day moving averages. That is up from 20% in late November. Here is how the percentage of stocks trading above their 50-day moving averages breaks down by sector:

Materials: 52%
Industrials: 56%
Consumer Discretionary: 29%
Consumer Staples: 67%
Energy: 85%
Health Care: 62%
Financial: 29%
Technology: 45%

Recession-resistant sectors (consumer staples and health care) show greater strength, along with energy. Sectors affected by the credit and housing crises (consumer discretionary and financial) continue to show greatest weakness. This is far from a monolithic market.

* Pocket of Strength - The Trading Psychology Weblog update and my latest post to the Trader Performance page illustrate why I was less than overwhelmed with Friday's rise. Still, the interest in small caps was impressive. We registered 32 new 52-week highs among S&P 600 small cap issues on Friday, the highest in a couple of months. Overall, however, we continue to see declining new highs from October to November to December across the major sectors and markets.


Mid-Week Sector Strength Readings

Sunday, December 23, 2007

Self-Efficacy, Physical Exercise, and Goal Attainment

A wide range of research finds that physical exercise that improves aerobic conditioning improves both mood and self-esteem. Such exercise also has distinctive health benefits and helps reduce state anxiety and other forms of emotional distress.

One study, however, suggests that the link between aerobic conditioning and psychological well-being is due to a placebo effect: subjects who are specifically told that their exercise will help their psychological state show much greater improvements in well-being than those going through the same program and not told of the link.

An interpretation of this latter finding is that improvements in self-efficacy, not just aerobic conditioning per se, might be responsible for the link between exercise and psychological well-being. Research suggests that beliefs about the health benefits of exercise are often responsible for people starting their workout routines, but that improvements in self-efficacy are responsible for *continuing* these routines.

Self-efficacy--the belief that one is capable of engaging in positive actions and reaching desired goals--may thus be important to sustaining an exercise regime, but may also be the result of such routines. This creates a virtuous circle, in which efficacious actions enhance the sense of efficacy, which, in turn, fuel further goal-oriented behavior.

These research results hold a number of implications. First, it may be fruitless to engage in coaching and counseling efforts if one is lacking the basic self-efficacy beliefs needed to sustain goal-directed action. Stated otherwise, it may be important to first improve self-efficacy beliefs with immediate, emotionally-impactful experiences of efficacy before tackling larger life goals. Does it really make sense, for example, to help someone improve their trading discipline when, in fact, that person does not possess the self-efficacy needed to sustain personal discipline in other aspects of life?

Another, subtle implication is that programs designed to enhance self-efficacy in one arena may spill over and fuel self-efficacy in other areas of life. A sustained exercise program, for instance, may fuel the self-efficacy needed to tackle changes in one's relationship life or trading. Nothing so promotes goal-seeking as goal attainment: by tackling goals in a variety of life areas, a more general sense of self-efficacy--impelling further achievement--may result.


Self-Efficacy and Consumer Debt

Building Self-Efficacy With a Solution Focus

Self-Evaluation and Success

Saturday, December 22, 2007

Returns Following Surges in New Lows

In the last post, we looked at returns in the S&P 500 Index following surges in the number of stocks making short-term highs. Now we'll look at surges in the number of stocks making new short-term lows and see if those affect returns over 5 and 20-day horizons.

Going back to 2004 (N = 981 trading days), we have 55 occasions in which the net number of new five-day lows minus new highs among the 40 stocks in my basket has been 25 or greater. Five days later, the S&P 500 Index (SPY) is up by an average of .86% (42 up, 13 down)--much stronger than the average five-day gain of .10% (513 up, 413 down).

When we look 20 days out, we see continued outperformance following surges in the number of stocks making new five-day lows. Twenty days later, the average gain in SPY is a very healthy 2.04% (45 up, 10 down), much stronger than the average 20-day gain of .48% (581 up, 345 down) for the remainder of the sample.

This makes conceptual sense. When traders panic and sell stocks indiscriminately across sectors, this marks a period of maximum bearishness. With no more bears available to sell, short-covering aids value-oriented buyers and we see favorable prospective returns.

Putting together the findings from this post and the last one, we can see that, on a 20-day horizon, returns have been best when a plurality of stocks are simultaneously making new highs or new lows. When they are making fresh highs, momentum tends to carry them further before there is a major correction. When they're making fresh lows, reversal effects occur more quickly--at five and 20-day horizons.

Understanding these patterns helps short-term traders make decisions regarding trading vs. fading market strength and weakness.


Falling Markets and New Lows

When New Lows are High

Returns Following Surges in Short-Term New Highs

Above we can see a chart tracking the S&P 500 Index (SPY) versus the net number of stocks in my basket that make closing five-day highs minus lows. With Friday's strong up move, we saw a surge in short-term new highs among the issues in the 40-stock basket. (See this post for a listing of the stocks included in the basket).

Going back to 2004 (N = 981 trading days), I found 47 occasions in which the net number of five-day new highs minus lows within the basket was 25 or greater. Five days later, the average change in SPY was -.05% (23 up, 24 down). That is notably weaker than the five-day average change of .15% (532 up, 402 down) for the remainder of the sample.

Interestingly, however, when we look 20 days out, we get a different picture. After a surge in five-day new highs, SPY averages a gain of .81% (31 up, 16 down), which is actually stronger than the average 20-day gain for the remainder of the sample (.56%; 595 up, 339 down). It thus appears that, after a surge in new highs, we've tended to see some consolidation of those gains in the near term, which has led to underperformance over the next five trading sessions. This consolidation has, however, been a buying opportunity on average over the next three weeks as the burst of strength has been followed by further strength.

In my next post, we'll look at short-term bursts of new lows and what they have brought in terms of five and twenty-day returns.


Using Intraday New Highs/Lows to Anticipate Market Turns

Friday, December 21, 2007

More Market Views to Start the Weekend

* Shrinking Volatility - VIX and More offers some valuable enlightenment re: the recent drop in VIX.

* Should You Play Bubbles? - CXO Advisory, with an excellent summary of research on whether it pays to trade or fade bubble rises in the markets.

* Trading IPO Opportunities in China - Chris Perruna offers the latest opportunity to come down the pike.

* Link Shopping - Adam Warner has been shopping the blogosphere and has come up with a bagful of worthy links, including several more VIX perspectives.

* Time to Stop Feeding on Monsanto? - Excellent analysis from 10-Q Detective questions the valuation.

* Fading the Gap and Trading the U-Turn - Corey does a nice job of illustrating some intraday trading patterns.

* Excellent Quote - This one from Jon Hilsenrath in the Thursday WSJ: "Think of a bicycle with a broken chain. You can use lots of oil to grease the chain, but you can't make the bicycle move again until the chain is repaired. The chain that links borrowers and lenders in the mortgage market looks broken. And it's probably going to take a lot more than the grease of easier money to fix it."

Market Themes and Patterns for a Friday

* Playing a Bit of Catch Up - The market has been giving some interesting readings over the last several days. Small cap stocks, which had been lagging, have recently outperformed their larger counterparts. We now see a relatively even percentage of large caps (38%) and small caps (35%) trading above their 50-day moving averages. We've also seen renewed interest in the NASDAQ 100 issues, 43% of which are now trading above their 50-day benchmark. We have 53% of Dow Industrial stocks trading above their averages, but that number has hardly budged in the last few trading sessions. Rather, we've seen some catch up from those other sectors.

* Not a Robust Rise So Far - We have some good overnight strength this morning on the heels of strong international markets, so I'll be looking to see if that broadly lifts stocks today. One measure I'll be following is the Cumulative Adjusted NYSE TICK, which has actually been negative during this recent market bounce. That bias in selling sentiment has shown up in other measures as well, including tepid advance-decline numbers and persistent high levels in the number of stocks making fresh 20-day lows. On Thursday we saw 480 stocks make 20-day highs, but also 1262 register new 20-day lows. Momentum figures were good for Thursday (Demand was 101, Supply 48) and that seems to be carrying forward this AM. We need to be seeing rising numbers of stocks making new highs, but also fewer stocks making new lows. If we just look at common stocks traded on the NYSE, new lows actually increased on Thursday over Wednesday.

* Carry Trade Comeback - Some chatter this AM regarding economic weakness in Japan and prospects for an interest rate cut. That has renewed interest in the carry trade, with the Yen hovering at multiday lows. The recent decline has also corresponded to this morning's bounce in stocks, so it's a theme I'm tracking.

* Checking Out the Blogosphere - Trader Mike's link update includes some very interesting perspectives on daytrading and subprime implosion, plus an interview with a trading coach. Abnormal Returns weighs in with views on counterparty risk--a major bank concern right now--and rising volatility in equities.

* Historical Trading Patterns - Bespoke Investment Group finds a bearish pattern when the 50 day MA crosses the 200 day MA and also looks at bullish seasonal trends from Christmas to New Year. Trader's Narrative finds a pattern in the market's new highs and lows that has worked out well lately. My recent post found subnormal returns following market dips during periods of falling volatility.

* Training the Brain - Sharp Brains offers an interview perspective on cognitive fitness, including its relationship to physical fitness. See also 10 habits of effective brains.

* Market Direction and Volume - Ray Barros offers worthwhile views from Wyckoff and Market Delta.

Thursday, December 20, 2007

Stocks Down, Option Volatility (VIX) Down: What Happens Next

Interestingly, over the past five trading sessions, the S&P 500 Index ($SPX) has been down about 1.9%, but the VIX has also been down 8.8%. I went back to the start of 2004 (N = 995 trading days) and found that the average VIX change when the five-day $SPX has been down more than 1% has been +16.46%. We've only had six occasions during that time in which $SPX has been down more than 1% over a five-day period and VIX has also been down. The S&P 500 Index was lower five days later on four of those six occasions, for an average loss of -.77%.

Indeed, when $SPX has been down more than 1% over a five-day period and VIX has been up less than 4% during that same time (N = 29), the S&P 500 Index has been higher only 7 times and lower 22 times over the next five trading days (average loss = -.84%). When stocks have been lower but options participants are displaying relative complacency, short-term returns have been subnormal.


* VIX and Daytrading Opportunity

* Volatility of the VIX

Macro Themes for a Thursday

* Central Bank Cross-Currents - Very interesting dynamics among the central banks. China is raising interest rates to fight inflation; the ECB is dismissing calls for lower rates also due to inflation concerns, but faces pressure to reduce rates in the face of economic slowdown. Inflation is on the rise in Brazil, where rates have been kept steady after a lengthy period of easing. The BOJ has refrained from raising rates due to signs of economic slowdown. The markets are anticipating a Fed interest rate cut on Jan. 30th (86% odds), but 10-yr yields have been staying above 4% due to inflation concerns in the U.S. Meanwhile, I'm looking to the commodity markets for indications of whether the economic slowdown meme might be trumping concerns over inflation.

* Currency Cross-Currents - As stocks have bounced from their November lows, we've also seen a dollar bounce vs. Yen and Euro despite those recent nasty inflation figures in the U.S. Ironically, in a global slowdown scenario--particularly one in which growth is more threatened in Japan and Europe than in the U.S. due, in part, to overseas credit concerns--the dollar could wind up as a safer haven despite the multitude of dollar concerns. A U.S. slowdown appears to be hurting Asian issues, adding to those international credit concerns. Concerns over an overvalued Euro could lead to renewed interest in dollar-based assets.

* Misunderstanding the Fed and ECB: A Dash of Insight has several excellent posts on how investors lack an understanding of LIBOR and how the Fed and ECB are not out of touch with financial markets, despite concerns over the pace of their response to credit concerns.

* Tough to Be Rich - Barry Ritholtz chronicles the high cost of living well, as inflation hits the upper end of the economic spectrum.

Wednesday, December 19, 2007

Greatness, Happiness, and Performance: What Contributes to Success

What It Takes To Be An Elite Performer: It's not something you're born with; greatness develops over time. Intensive skill rehearsal is a major component. I've gotten pretty good at identifying who will succeed in a trading career and who won't. The successes are those that work intensively on their trading--when they're making money.

Intelligence: Researcher Dean Keith Simonton hits it on the head: "My view of intelligence is basically a Darwinian one. It's based on sort of the old Functionalist notion that goes way back to Francis Galton, that says that there are a certain set of cognitive capacities that enable an individual to adapt and thrive in any given environment they find themselves in, and those cognitive capacities include things like memory and retrieval, and problem solving and so forth. There's a cluster of cognitive abilities that lead to successful adaptation to a wide range of environments." Successful traders are intelligent in Simonton's sense. They don't just master one pattern or market environment, but adapt to changing market conditions and thus build a career.

Well-Being: Historically, psychologists have spent more time and effort studying dysfunction than positive emotion. Recent studies have utilized a range of methods for evaluating the positive emotional states that people experience. One of the most interesting findings is that of adaptation: when people have good things happen to them (such as winning a lottery or getting a new home or job), they quickly adapt to the new circumstance and wind up with the same overall level of well-being that they experienced before. Similarly, people can experience sizable setbacks, including even the loss of a limb, and return to their prior level of well-being once they've adapted to the change. This helps explain the persistent motivation of successful traders. In an important sense, they never totally feel satisfied with their performance and wealth--they adapt to their new levels of profitability and return to their prior levels of well-being--so they're always trying to accomplish more and reach new levels.

What Makes You Happy: Research suggests that your base of comparison is an important element in your happiness. If you compare yourself to a reference group that makes your accomplishments seem small, you're more likely to be unhappy than if you have more realistic criteria for evaluating your performance. By comparing your current performance to your past, you can focus on the process on making improvements and manage your own well-being. Why is this important? Research finds that happy people are more likely to be successful.


Self-Confidence and Performance

What We Can Learn From Sport Psychology

Transforming Stress Into Well-Being

Technical Strength Update, Sector by Sector

As I've described before, my measure of Technical Strength is a quantification of trending behavior over a short-to-intermediate time frame. I track 40 stocks within eight S&P 500 sectors to get a sense for the technical strength of the large cap market as a whole and the individual sectors. Here's how we're looking as of Tuesday, 12/18:

Materials: -340
Industrials: -240
Consumer Discretionary: -140
Consumer Staples: -120
Energy: -140
Health Care: -80
Financials: -380
Technology: -100

Technical Strength Index: -1540 (3 stocks technically strong, 11 neutral, 26 weak).

We see financial issues once again bringing up the rear, suggesting that credit concerns have not abated. What we also see is that weakness has spread to all the sectors, something we haven't seen in quite a while. Even the formerly strong consumer staples sector, which has been acting as a haven due to recession concerns, has turned negative. Interestingly, one of the stronger sectors during 2007, the materials shares, has turned quite bearish, also perhaps reflecting anticipated reduced demand due to economic slowdown.

Another way of tracking sector strength and weakness is to take a look at the S&P 500 stocks within each sector and create daily advance-decline lines specific to those sectors. What we find is that the AD line is in a consistent downtrend for Consumer Discretionary and Financial issues, an uptrend for Consumer Staples and Energy shares, and range bound for the other sectors. Interestingly, Technology stocks are hovering near their AD lows for the past several months despite being a strong sector through much of 2007.

In sum, we see a very mixed picture, but one in which even the strongest sectors are seeing some downside pressure due to concerns over economic weakness. The last two days, we've seen 20-day lows across the NYSE, NASDAQ, and AMEX exceed 1700 and the Banking Index ($BKX) touch an intraday low for the year. Until we see some signs that measures from the Fed and Treasury are renewing confidence in the financial sector, I am not quick to be buying this market, particularly when we see sector performance deteriorating.


Sector Performance Turns Negative

Tuesday, December 18, 2007

Three Predictors of Coaching Success

When a trader or trading firm hires a coach, there is a significant investment of time, effort, and (often) money. Coaches are generally sought when trading results are substandard, which means that time is at a premium. Hiring the wrong coach or seeking the wrong goals with the right coach is thus more than a missed opportunity. It can dig traders further into a hole and reduce the odds of eventual success.

So how do we know if coaching will be helpful to a trader? The psychology research on change processes in counseling and therapy, as well as my own experience across a variety of trading settings, suggest three predictors of coaching success:

1) Relationship Between Coach and Trader - It's the quality of the relationship that often gets people through the inevitable "two steps forward, one step back" frustrations of change. In a good helping relationship, the coach sees the trader's potential, demonstrates a concrete understanding and empathy for the trader's situation, and is seen by the trader as both caring and competent. Very often, I find, the good helping relationship is one that transcends the pure business relationship. Every trader I work with gets my email address and home phone number; I do not charge for those contacts and, indeed, strongly encourage those. It's one way of demonstrating that my level of commitment will match that of the trader. Too, when traders make significant progress, I get excited; it's a real rush for me. I think traders can sense that. They know when a coach is emotionally invested in their success. If the coaching relationship lacks that commitment and spark, the odds of it being successful are meaningfully reduced.

2) Readiness For Change - Research in psychology finds that change is most likely to occur when people are prepared to take actions necessary to make changes. Many times, traders are aware of problems but don't know what to do--or aren't emotionally prepared to take action--to change those problems. A good example is a trader who might need to alter his trading style to adapt to changing market conditions. He might be reluctant to tackle the uncertainty of remaking his trading, which will necessarily extend the length of time it takes to make changes. The traders who are most ready to make changes are often those who are in some discomfort and who have tried all the easy fixes. They are prepared to do what it takes to turn things around. If you're seeking a coach and aren't ready to work on yourself every day and week, you might be best off saving time and money and waiting until the readiness is higher.

3) Involvement In Change - When I reviewed the research literature on change in counseling and therapy some years back, the brief conclusion that I came to is that "talk is cheap". Coaching needs to be more than talk: it needs to produce new skills and new experiences. Good coaching is hands on and goal-focused; it targets specific areas for change and introduces concrete strategies for accomplishing those changes. Too often, coaching talks about trading rather than works directly on trading. Some of my best work has occurred while I was watching a trader trade and could make very specific suggestions about improvements. That made the change work very immediate and involving. The more emotionally and behaviorally involved a trader is in the change process, the more successful that process is likely to be.

One interesting study found that, if positive changes and a solid relationship had not materialized by the third meeting, the counseling was unlikely to be successful--ever. Within a short time, you should have a good feel for the quality of the working relationship, the specific goals you'd be working on, and the concrete ways you'll be tackling those. Within those first few meetings, you should already be feeling that you're on a promising path. If you don't experience all the above with a new trading coach, treat the coaching like a trade and quickly exit the losers.


A Consumer Guide to Coaching

When Coaching Works--and Doesn't

A Buying/Selling Index, Sentiment, and Other Ideas for Tuesday

* Buying/Selling Index - In my recent post, I mentioned research that treats buying and selling as independent variables. My first stab at this research has been with the NYSE TICK, breaking uptick and downtick readings into separate categories for analysis. By doing this, we find that Monday's action was over one standard deviation below the 30-day median in buying activity and about .8 SD above the median in selling. Compared with the decline in November, the recent drop has been more about weak buying than strong selling, though selling has certainly exceeded buying for the last five trading sessions.

* Blog Traffic Indicator - I wrote earlier about how traffic on this blog has tended to expand during periods of market weakness. August and November were the strongest traffic months of the year, for example, and the days of the market lows were the most trafficked days. Uncertainty seems to lead to a seeking of information across the blogosphere. So I find it interesting that traffic has not expanded over the past five days of weakness. On the contrary, traffic is more similar to the patterns seen at the October and recent December market highs.

* Problems With Self Report - People are not especially good self-observers, which causes problems for surveys. For example, 80-90% of people will rate themselves as "above average" across a whole range of virtues. (Perhaps they are all progeny of Lake Wobegon residents). So it's in that vein that Barry Ritholtz finds that bullish retail survey data have not translated into robust retail activity. What we say and what we do can be quite different.

* Trading More Profitably - Trade Ideas asks for some guidelines from two experienced traders. Turning "best practices" into firm rules that can be made explicit and rehearsed is a valuable meta-strategy for success.

* Current Market Themes - Abnormal Returns finds a number of themes in the market, including the meltdown of quant funds and strong performance of growth stocks; problems with bond insurers and systemic risks; and negative real interest rates.

* Opening Gaps - Trader Mike notes that cash indexes do not accurately reflect opening gaps; a better picture is obtained from futures. This is very relevant to testing out trading systems that might, for example, buy or sell at the market open.

* Best Posts - Charles Kirk has archived his best posts from previous years. Year end is a great time to reflect on personal bests, step back, reassess, set goals, and revitalize for the new year. It's also a great time to view and review fresh ideas. I'll be listing "best of 2007" TraderFeed posts during the last week of the year.

Monday, December 17, 2007

Gauging Market Strength and Weakness: Buying and Selling Events as Independent Variables

Most of what we look at is the summing or averaging of buying and selling events. Price moves higher during a given time period, and it moves lower at other periods. Bar charts sum these price movements over a longer period to show us overall price movement and change. Similarly, we sum buying and selling events via such indicators as advance-decline lines, NYSE TICK, moving averages, and oscillators.

Suppose, however, we adopt a different framework and view buying and selling events as orthogonal. Instead of summing and averaging them, we treat them as independent variables. Thus, for instance, any given time period might display very strong buying *and* very strong selling; very weak buying *and* very weak selling; or any permutation thereof.

Once we conceptually separate strong/weak buying from strong/weak selling, we're then in a position to ask interesting empirical questions:

* Do weak/strong buying days have different implications for future price change than weak/strong selling days?

* Do particular combinations of buying/selling levels identify trending days?

* Can we profile average levels of buying/selling at various times of day to gauge the market's current strength/weakness?

* Do topping markets show early signs of reduced buying and bottoming markets show early signs of reduced selling?

I'm just in the early phases of this research, but results to date look promising. I hope to have concrete results to report by year's end, resulting in a useful and unique market indicator.


Trend and Trajectory

Sentiment Trends

Ray Barros on The Nature of Trends

Ray Barros is a trading mentor I both respect and admire. He is a successful trader and a teacher, intensively sharing his methods with students. Indeed, he only mentors a small number of students at one time to ensure hands-on skills-building. His Trading Success Blog covers a wide range of topics, including exit strategies, psychology, and buy/sell zones.

Now we have a new book from Ray, entitled The Nature of Trends. He made it clear in his introduction that one goal that has yet eluded him is the leaving of a legacy. By sharing many of his methods and ways of viewing markets, Ray takes a large step toward that goal.

Ray's book begins with a definition of trends and an emphasis upon the importance of understanding trending and non-trending on multiple time frames. His understanding is grounded in Market Profile, but includes an extensive discussion of chart and wave patterns. In this, his methods are highly visual. He uses diagrams and chart/examples to illustrate his points, as he moves from trends to discussions of trend changes and the impact of time frames.

Later in the text, Ray presents his ideas on entries and trade management, followed by risk management and trading psychology. He concludes with a section on swing patterns, which clearly is his love as a teacher and trader. I particularly like the structured questions that he lays out as a template for studying markets and enhancing one's learning curve.

I found Ray's book to be well-written and very well organized, but I can't say it's a casual read. Many of the patterns involved careful labeling and understanding within the context of the previous material. My sense is that such an approach requires considerable market observation and study, so that these patterns can stand out clearly. Their advantage is that they help organize traders' thoughts regarding trending and rangebound markets at specific, well-defined time frames. In short, this is a book to be studied, not skimmed. Those who know me well will know that this is a compliment, as well as a warning to grail-seekers.

I believe this book is of greatest potential benefit for those who trade visual/chart patterns and who wish to greatly tighten and structure their trade selection and management. While Ray's presentation is not statistical, it is far more systematic than most presentations of chart-based trading. It helps a trader turn pattern recognition into trading rules, and that aids discipline and consistency.

And, by the way, if you're interested in book reviews, the Value Blog Review has some excellent ones. I receive many, many books from publishers and authors for review purposes and will be passing along thoughts about my favorites from time to time. (Disclaimer: I do not accept promotional consideration or compensation from any authors or publishers with respect to anything mentioned or reviewed herein.)


Book Review: Markets in Profile

Sunday, December 16, 2007

What Investment Style and 2007 Returns Tell us About Stock Market Sentiment

In recent posts, we've seen how 2007 returns have varied widely as a function of sector and international market exposure. Now we turn to investment style, where we see equally dramatic differences in returns.

Here are year-to-date percentage returns for the i-Shares Russell 1000 (Large Cap) and 2000 (Small Cap) growth and value ETFs:

Large Cap Growth (IWF): 11.12%
Large Cap Value (IWD): -2.46%
Small Cap Growth (IWO): 4.70%
Small Cap Value (IWN): -12.69%

We can see that style has been the difference between quite a profitable year and quite a losing one. Large caps have handily outpaced small caps and growth has trounced value.

If we look at returns since the October market top, we see a similar pattern:

Large Cap Growth (IWF): -3.18%
Large Cap Value (IWD): -8.52%
Small Cap Growth (IWO): -9.01%
Small Cap Value (IWN): -13.01%

Here we can see that small caps and value are behaving as though we're in the midst of a bear market. Large caps and growth act more in a corrective mode. As the odds of recession have grown and credit concerns have not diminished, large cap growth has been a haven for those seeking stability and earnings. Even in the last week, the loss in large cap growth was less than half that in small cap value. Such a defensive mindset does not speak well for overall market sentiment.


Shift in the Style Box

Saturday, December 15, 2007

International Returns for 2007: The Impact of Where You Invest

What we saw in my last post is that U.S. investor performance for 2007 was highly dependent upon the sectors one chose. Financial stocks and consumer discretionary issues posted double-digit losses on the year; energy and materials stocks yielded double-digit gains.

Above we can see that returns have also been highly dependent on where one was invested. The cash S&P 500 Index, as a proxy for U.S. returns, is up about 3.5% on the year. The DAX in Germany, however, has returned about 20.5% over that same period. The year-to-date returns in London's FTSE were only 2.83%, but we saw an eye-popping return of 38% from Hong Kong's Hang Seng Index. Bringing up the rear was Japan's Nikkei, down almost 10% on the year.

What you invest in (sectors) and where you invest (world markets) are every bit as important to performance as when you invest (timing). In my next post, we'll look at the impact of investment style on 2007 returns.

Meanwhile, I note that, since the S&P 500 market top in October, we've lost about 6% in the U.S. index; 1% in the DAX; 5% in the FTSE; 4.5% in the Hang Seng; and 10% in the Nikkei. Offhand, it appears that countries with the weaker currencies and lower interest rates have been lagging their peers recently and during much of the year.

Stock Sector Performance: A Mixed Bag Turns Negative

Here are some of the major stock sectors within the S&P 500 universe and their performance during two time periods: 2007 to date and (since the October market top). All values are expressed as percentage changes:

S&P 500 Index, SPY: 3.92 (-5.95)
Materials, XLB: 20.54 (-3.54)
Industrials, XLI: 12.71 (-5.82)
Consumer Discretionary, XLY: -13.32 (-12.41)
Consumer Staples, XLP: 11.10 (3.72)
Energy, XLE: 30.39 (.79)
Health Care, XLV: 6.60 (-1.65)
Financial, XLF: -20.11 (-17.79)
Technology, XLK: 15.05 (-3.22)

What we find is quite a mixed bag: soaring performance over the course of the year from energy and materials and horrendous performance from financial and consumer discretionary shares. Since the October market top, it's been more of the same: very weak financials and consumer discretionaries and relatively strong consumer staples and energy.

Sectors that benefit from the weak dollar and that are perceived as recession resistant have been among the winners. Sectors affected by housing and credit crises have been among the big losers.

This past week here's how our sectors have shaped up:

S&P 500 Index, SPY: -2.48
Materials, XLB: -2.46
Industrials, XLI: -2.08
Consumer Discretionary, XLY: -4.73
Consumer Staples, XLP: -1.49
Energy, XLE: .35
Health Care, XLV: -2.86
Financial, XLF: -5.93
Technology, XLK: -.52

Financials and consumer discretionary shares continue to lead the downside, suggesting that the Fed's actions and those of the Treasury have not been sufficient to ease those housing and credit concerns. For the most part, however, the other sectors turned tail and went south as well. I found the end of week performance particularly interesting in that the weak Yen was no longer correlated with either falling bond yields or rising stock prices. The carry trade wasn't carrying the stock market higher, and that--along with expanding sector weakness--caught my attention.


Carry Trade Carries Stocks

A Recent Look at the Sectors

Friday, December 14, 2007

More on the Stock Market's Multiple Personality

In my last post, we saw how much of the stock market's strength was attributable to the first hour of trading. The first hour data, however, really includes two components: overnight action and trading during the first 60 minutes of a session.

In the chart above, we look at the S&P 500 Index (SPY; yellow line) and the changes during 2007 that are attributable to the overnight session (blue line) and the day session (pink line).

What we find is that the S&P 500 Index has been broadly range bound through most the year. This overall performance masks quite a difference, however, between the day and night sessions. The overnight action has had a distinctly bullish leaning; the day session has lost money over time. Indeed, we've gained the equivalent of about 158 S&P 500 Index points during the overnight hours and lost the equivalent of 102 points during day hours!

The correlation between price changes during the overnight and day hours has been about .17 during 2007, suggesting that less than 3% of the variance in price change is shared between the two. In essence, these behave as separate markets. Indeed, all of the gains in the S&P 500 Index since the start of 2006 are attributable to overnight action. Daytraders may limit their risk with intraday trading, but they have also missed out on much of the bull market's reward.


The Multiple Personality of the Market

Daytraders' Challenge: Stock Market Performance by Time of Day

Many times short-term traders struggle because they don't realize how their market is trading at the times of day in which they are active.

Here we see the Dow Jones Industrial Average for 2007 broken down by time of day performance. The blue line represents the cumulative performance of the first hour of trading; the pink line is the performance for the middle hours (end of first hour to beginning of the last hour); and the yellow line is the performance for the final hour of trading.

What we can see is that these seem to be different markets. Indeed, the daily correlations among the three range from .12 to .18, suggesting that what the market does during one time period is only very weakly related to what it will do in the next one.

Moreover, we can see that essentially all of the market's upward trend has taken place during the first hour of trading. The first hour has accounted for about 1116 points of gain during 2007; the middle hours have lost about 780 points; and the last hour has gained about 719 points. What that means is that daytraders who sit out the first hour of trading have not, as a whole, benefited from the upward market trend. Indeed, there has been something of a downward trend to the market's middle hours.

We can see that, during the market's recent weakness, there has been relatively little selling in the last hour. Much of the market's bounce from November lows has occurred during the first hour--and most likely during overnight action in response to strength in Asia and Europe. Too often, short-term traders look at a daily chart and try to go with a trend, not realizing that the trend may not pertain to the hours of day in which they're trading.


Stock Market Performance by Hour of Day

Thursday, December 13, 2007

Spikes in the Equity Put/Call Ratio: A Signal With an Impressive Track Record

Here we see the daily action since the start of 2007; the pink line is an adjusted, relative put/call ratio, and the blue line is the Dow Jones Industrial Average (cash close).
The adjusted put/call ratio is the five-day equity put-call ratio divided by the 50-day equity put-call ratio. We can see in the chart above how spikes in this adjusted ratio--occasions in which the five-day put/call ratio soars above the 50-day average--have corresponded to intermediate-term market lows.

I went back to 1998 (N = 2483 trading days) and computed the daily adjusted ratio and what happened in the Dow 20 days later. We had 188 occasions in which the adjusted put/call ratio was above 1.20 (meaning that the five-day put/call ratio exceeded the 50-day ratio by more than 20%). Twenty days later, the Dow averaged a whopping gain of 2.28% (143 up, 45 down). That is much stronger than the average 20-day gain of .39% (1346 up, 949 down) for the remainder of the sample.

I find these results impressive, as they cover a number of bull and bear market conditions. Spikes in the equity put/call ratio have been excellent signals over the past year, but have a much longer track record of success.


Equity and Index Put/Call Ratios

VIX and Put/Call Ratio

Using Short-Term Sentiment to Avoid Market Head Fakes

The most basic unit of sentiment for the short-term trader is whether a given trade occurs at the market bid or the offer. When a trade occurs at the bid price, it means that a seller was willing to give up the edge in order to exit his or her position. Similarly, when a transaction occurs at the offer price, it means that a buyer was willing to pay up in order to enter the market.

Over time, by correlating the size of trades with their location within the bid-offer matrix, we can detect how large traders are leaning: to the buy or sell side. This is the concept that underlies the Market Delta program. Similarly, by observing how many stocks at one time are trading at their offer vs. bid price, we can see if the broad market is tilted toward buyers or sellers. This is the logic underlying the NYSE TICK measure.

By cumulating the volume at offer vs. bid over the course of the day and by cumulating the NYSE TICK values through the course of a market session, we can see how market sentiment is shifting over time.

When we rose sharply yesterday in response to the Fed announcement of coordinated action, the market looked very bullish. As Rennie Yang observed in his excellent Market Tells newsletter, however, the NYSE TICK action was telling a different story. Relative to the 20-day average, we were actually seeing reduced buying interest. The TICK told us that traders were selling into the strength, which ended up being a great market tell.

I like to sit out the first 15 or so minutes of price action and see how the Market Delta and TICK are unfolding. Rennie uses extreme TICK action to anticipate a trend day; his trend-catcher strategy has performed admirably of late. By watching the sentiment underneath price action we gain valuable short term information that keeps us out of head fake markets.


Using Market Delta in Trading