Monday Market Ideas and Views

Breaking China - While the credit crisis has gotten most of the recent financial press, China's Shanghai-A Index (3-year chart above) has been steadily retracing much of its massive bull market gains. A contracting economy in China would have important ramifications for world economies (less demand for raw materials and goods) and commodities.

Quick Look at Rates - We saw more weakness in Treasury bill rates, as flight to safety continues unabated in the wake of recent Fed and central bank interventions. I see where 3-month LIBOR rates are nearly doubling the anemic 1.32% rates for 3-month T-bills. Banks continue to be risk averse in lending to one another, suggesting that added liquidity is not yet adding to confidence among institutions. Meanwhile, 10-year municipal bonds are yielding (on average) 4.05%--a 5.62% effective yield for an investor in a 28% tax bracket--vs. 10-year Treasury yields of 3.42%. Such anomalous rates--where tax-free yields are higher than taxable ones--either offer phenomenal opportunity or a frightening likelihood of municipal defaults in the wake of falling home prices and a weakening economy.

Getting Your News Fix - I try to keep readers posted on major news themes through the Twitter app. But traders need reliable sources for fast-breaking and comprehensive news. Barron's reviews some excellent resources, including the Newsflashr site that I've been using of late.

The Importance of Sleep - Sharp Brains offers an excellent post on the importance of sleep in learning and performance. Lack of sleep--including lack of proper stages of sleep--affects concentration, mood, and reaction time: all important for active traders.

Momentum Ideas That Are Losing Momentum - Abnormal Returns returns with more excellent links, including an ETF that covers the world and four momentum ideas that are getting crowded.

Expensive Puts and Calls - CXO Advisory summarizes fascinating research that suggests that informed investors bid up puts and calls ahead of stock declines and advances. Excellent website worth exploring.

A Look at Markups - Do stocks get marked up at the start of a quarter? Quantifiable Edges looks at the evidence. Another excellent site that offers more than off-the-cuff opinion.
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Indicator Review for March 31st

Last week's indicator review noted only tepid strength following the bounce off the mid-month market lows. I also noted weak money flows among the S&P 500 stock sectors (article with link to all the posts here). A close look, sector by sector, finds that defensive themes are dominating the market--not something we'd expect if we were entering a bullish market phase.

For this week's indicator review, I recalculated money flows among the Dow Industrial stocks using my own data and methodology, rather than the data from Dow Jones. My conclusion (top chart) is essentially the same: there is no evidence at this time of sustained dollar flows into stocks. Even as the market has bounced, we have stayed below the zero line, suggesting that money is flowing out of the shares of the companies that comprise the index.

We can also see (middle chart) that new 20-day highs minus lows among NASDAQ, NYSE, and ASE issues have rolled over and, as of Friday, were essentially even. This rolling over was reflected in the Cumulative NYSE TICK, which turned down on Friday after seven consecutive days of positive readings. The fact that the TICK and the new highs/lows are not plunging suggests that we're getting more of an absence of buying in the recent market than an avalanche of selling. The result has been a rather steady drift downward for much of the week.

The best one can say about the situation is that the dramatic central bank interventions have helped stopped the selling, but have not inspired sufficient confidence to sustain buying. The fact that financial shares remain market laggards does not speak well for investor confidence on the heels of those interventions.

My momentum measures have turned downward. On Friday, Demand closed the day at 38; Supply was 127. Among S&P 500 stocks, only 38% were trading above their 20-day moving averages on Friday, down from over 70% early in the week. We're seeing a bit more strength among the small caps: among the S&P 600 small cap issues, 50% are above their 20-day moving averages, down from over 75% early in the week.

Among NYSE common stocks only, we had 8 new 52-week highs on Friday and 33 new lows--the highest level of new lows of the week, but nowhere near as high as the level seen mid-month. Meanwhile, the advance-decline line for those NYSE common issues is hovering just above its bear market lows--a clear sign that broad buying has not swept the markets.

If selling does not pick up early in the week, particularly in the NYSE TICK, I would expect the market to look for a short-term bottom and enter a range mode, with last week's highs as the upper end of the range. As long as Supply exceeds Demand and stocks making new lows continue to expand, however, I will be defensive on this market. Any pickup of selling would target an important test of the mid-March lows. I will continue to update market indicators and views daily in my Twitter comments.
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The Poser Factor: A Psychologist's Take on the Presidential Election

As the Presidential election grinds along, candidates periodically whine about their media coverage. The truth of the matter, however, is that--for the most part--the Presidential hopefuls get a free ride on their questionable views.

Consider: Clinton and Obama can propose with straight faces (and an unquestioning media) that the U.S. government--yes, the same government that brought us emergency management in New Orleans and escalating budget deficits--will effectively and efficiently manage our health care system. McCain intones that the American occupation of Iraq--yes, the one that started as a liberation and now dangerously overstretches the military--should morph into ongoing, de facto colonization. Credulous reporters get their quotes right and pass along his prescriptions.

No, it's pretty difficult to raise media ire with matters of policy. Let there be an issue of character, however, and the media pwnage is palpable. The most recent case in point was Clinton's portrayal of herself under fire on the Bosnia tarmac. It wasn't just that she was lying; at that point she was a poser. You know the kind: the ones who show up with their Hot Topic t-shirts du jour and suddenly become alt-rockers, goths, metalheads, what have you. Liars can be engaging; posers are just annoying. And the media doesn't suffer annoying fools gladly.

That's why reporters turned on McCain when he suddenly courted the religious right and embraced the once-reviled Bush tax cuts. This wasn't the maverick everyone loved; it was a conservative poser--and the conservatives knew it most of all.

Bush the draft avoider lands his aircraft on a destroyer and declares "mission accomplished"? Poser. Romney the Massachusetts moderate discovers the evils of immigration? Spitzer the righteous solicits services from the human traffickers he prosecutes? Posers all; bring on the media feeding frenzy.

So perhaps it's a sign of the topsy-turvy times that Obama's recent fortunes hinge on the desire that the American public will actually see him as a poser in the Wright church: a likable unifier who only sat in the pews to build his street cred with Chicago constituents. The possibility that it's not a pose--that it's part of a larger, consistent pattern of sincere disaffection with the country--well, that is worse than annoying. Love of country, like love of a spouse, loses more than credibility when framed as incessant calls for change.

Will we elect a poser? Will we elect someone we desperately hope is a poser? Only in an environment where such questions are possible could the Republican who solicited partnership with John Kerry, then the endorsement of George Bush, ride the "straight talk express" to his party's nomination.

There's no lack of hope--or audacity--in election 2008.

The Development of Talent: Implications for Training Programs and Traders

Mad props to the Camron Systems site, which linked this phenomenal article from the NY Times on the development of talent and how elite athletes are made. I'm usually not one to gush, but this is a must-read article if you're interested in developing trading talent or in designing training programs to develop trading talent. Especially interesting is the discussion of how the brain undergoes changes (myelinization) as the result of proper training.

Discussing Spartak, an elite Russian training program for tennis players, the article explains:

If Preobrazhenskaya's approach were boiled down to one word (and it frequently was), that word would be tekhnika - technique. This is enforced by iron decree: none of her students are permitted to play in a tournament for the first three years of study. It's a notion that I don't imagine would fly with American parents, but none of the Russian parents questioned it for a second. "Technique is everything," Preobrazhenskaya told me later, smacking a table with Khrushchev-like emphasis, causing me to jump and reconsider my twinkly-grandma impression of her. "If you begin playing without technique, it is big mistake. Big, big mistake!"

So there you have it: why so many traders fail. They begin trading without technique. They try to develop their trading accounts before they've done the work to develop their brains.

Technique develops brains: the implications for the development of traders are profound.

Someday, a trading firm is going to get it and become the Spartak of the financial world.

Hats off to Camron Systems for recognizing the importance of the article.

RELATED POSTS:

Excerpt From the Trader Performance Book

Toward a Trading Curriculum

What Makes an Expert?
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Stock Sector Strength and Weakness: What It Tells Us About Sentiment

With Friday's weakness, we continue to see deterioration in the Technical Strength measure, which quantifies short-term trending behavior among individual stocks. Here's how Technical Strength is shaping up as a function of S&P 500 sector, combining the ratings from five highly weighted issues within each sector:

Materials: -80
Industrials: -120
Consumer Discretionary: -100
Consumer Staples: +320
Energy: 0
Health Care: -40
Financial: -320
Technology: -180

We once again see Financials as the weakest sector, disappointing given the recent Fed attempts at stablization. The strongest sector by far is Consumer Staples, which suggests a flight to relatively recession-resistant, defensive names. The more growth-oriented technology issues are weak.

If we look on a longer time frame among all S&P 500 stocks within the various sectors, we find that only 12% of Financial issues are trading above their 200-day moving averages and only 22% above their 50-day averages. Conversely, we're seeing 51% of Consumer Staples names trading above their 200-day benchmarks and 67% above their 50-day averages. We're also seeing greater strength among Energy shares (64% above 200-day averages; 47% above 50-day averages) than Technology issues (11% above 200-day averages; 29% above 50-day MAs) or Consumer Discretionary shares (13% above 200-day MA; 28% above 50-day MA).

Defensiveness appears to be the watchword of the day, with investors continuing to shun the Financials and preferring the safety of companies that sell Staples over those relying upon Discretionary spending.

RELATED POST:

Links to My Money Flow Analyses by Sector
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Picking Up on a Stock Market Trend

There are many ways of picking up on a stock market trend that helped identify the weakness during Friday's session. Among those that I've emphasized in recent posts, the weakness among financial issues and the persistent weakness in the NYSE TICK were two notable tells.

Another indicator worth keeping an eye on intraday is the number of advancing minus declining stocks on the NYSE ($ADD on the five-minute e-Signal chart above; bottom chart). Note how advancing stocks led decliners early in the morning, but then saw that advantage wane and then turn negative around 11 AM CT. From there, each decline in stocks added more stocks to the list of daily decliners, a sign that the market weakness was broad-based.

On another note, observe how the banking stocks ($BKX; top chart) have retraced much of their recent rally during the past several trading sessions. No doubt, Wall St. speculation regarding cutting of dividends hasn't helped. Still, if the extraordinary steps taken by the Fed were seen as taking the banks out of jeopardy, it's hard to believe we'd be seeing the current retracement. Increasingly, each day's trading is amounting to a vote of confidence in the U.S. financial system. The swings of optimism and pessimism are contributing to both intraday volatility and to the relative frequency of trend days.
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Four Indicators I'll Be Tracking Via Twitter

At the request of several readers, I'll be using morning Twitter posts to update several market indicators that I have found useful in assessing market strength and trend. These will include:

* New Highs/Lows - I particularly like to see if we have expanding or contracting new highs or lows following a period of market strength or weakness. This often signals reversal. Similarly, bursts of new highs or lows help confirm breakouts from ranges. The recent pullback in new highs was an excellent heads up for the market weakness this past week.

* % of Stocks Above Moving Average - I like this as a longer-term momentum measure and a way to assess whether stocks are gaining or losing momentum day over day. When I see divergences, I'll note the % of stocks above their MA for different indexes, such as small caps and NASDAQ issues vs. SPX stocks. This is helpful in identifying leading and lagging sectors as well.

* Demand/Supply - This is my shorter-term proprietary measure of momentum, tracking the number of stocks closing above vs. below the volatility envelopes surrounding their short-term moving averages. All NYSE, NASDAQ, and ASE issues go into this calculation. Once again, I like to see if we get more or less momentum day over day. The Cumulative Demand/Supply numbers provide excellent overbought/oversold readings and have done a fine job of tracking intermediate-term highs and lows in the past year or two.

* Technical Strength - I track 40 S&P 500 stocks that are highly weighted within eight sectors; there are five stocks per sector. The Technical Strength measure is a quantification of trending behavior in those stocks. I categorize these numbers into uptrends, neutral trends, and downtrends and examine shifts in trend day over day.

In addition to following these indicators on a daily basis, I'll also be assembling my usual weekly review of indicators on the blog over the weekends. This is a larger picture view of the markets that guides my basic strategy for the week.

For those interested in the daily review of indicators, the last five Twitter posts appear on the blog homepage. The complete set of "tweets" can be found on my Twitter page; free subscription via RSS is available there as well. I'll continue to post links of important market themes via Twitter as well as occasional market comments and a morning review of economic reports due out and how overseas markets are trading. Thanks for your continued interest.

Trading Rangebound Days and Other Resources for Friday

* Buying and Selling Sentiment on Range Days - Here's a chart of today's NYSE TICK; five minute bars and a 3-period moving average. One of the clues to a range bound market is that we'll get the moving average of the TICK oscillating around the black zero line. On the moves below the line, we end up not being able to sustain fresh price lows, and on the moves above the line, we can't sustain upside breakouts (the move around 11 AM was picture perfect: buying pressure unable to move ES to new highs for the day). The quicker we can recognize the dynamics of range days, the quicker we can adjust our expectations and be nimble in taking profits near range extremes.

* How to Test Your Trading Ideas - I see that Henry Carstens is offering his ebook on the topic free of charge. Excellent, excellent resource. I've just started looking over his Volume I of Trading Ideas; it compiles a number of good sources of inspiration. Unique opportunity to learn from a professional money manager.

* Trading Rules - While we're on the topic of generous sharing, take a look at Globetrader's excellent summary of his trading rules, complete with illustrations. Formulating rules in a structured way is a fantastic aid in controlling the trading process, rather than letting markets control you. Globetrader is one of the bloggers who truly gets it, when it comes to both trading methods and trading psychology.

* Testing Trading Assumptions - A market pullback on light volume is bullish, right? Well, Rob Hanna tests ideas like this and breaks a few myths. Here was his look at market history anticipating the current pullback. Great stuff. I also like his newsletter, which pulls together his various historical studies.

* Risk Management and Position Sizing - Ray Barros has been on a tear, with excellent posts on these topics. Great ideas from an experienced trader and mentor of traders.

* Tracking Market Research - The Research Recap site offers some nice integration of perspectives. Here's a recent overview of the airline industry and here's a look at credit card delinquencies and their relationship to unemployment.

* Bear Market Investing - FOLIOfn has developed some interesting products, enabling investors to buy and sell entire portfolios with a single order. Their recent product allows for bear market portfolio investing. The range of folios and markets covered are impressive.
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Trading Addiction Linkfest

My recent post reviewed research that suggests a link between risk-taking and addictive behavior. It's not just that an "addictive personality" will take undue risks; in addition, repeated large risk taking alters the structure and function of the brain so as to sustain addictive behavior. Many traders I've worked with never had discipline problems or out-of-control behaviors until they began frequent daytrading. When you think of traders at some firms placing 100 or more trades a day--basically one every four minutes--it's difficult to imagine that such frequent and unremitting risk/reward swings *wouldn't* affect the workings of mind and brain.

What's more, as Dr. Bruce Hong notes, is that exhausting frustration tolerance and willpower on one set of tasks appears to make us less disciplined on subsequent ones. That is how bad trading often leads to further bad trading, but also can lead to poor decision-making in other facets of life.

One of my first clues that a trader might be out of control is that he/she can't take a break from trading when he/she is losing money and can't reduce his/her risk after a series of losing days. This is very similar to the drinker who cannot stop imbibing alcohol even after the point of consequences.

If you are losing money and cannot stop yourself from trading--during a single trading day or after days of loss--I encourage you to take the hard look in the mirror at what you might be doing to your trading account, your emotions, your brain, your relationships, and your life.

Here are some posts regarding trading addiction that shed useful light--and offer helpful suggestions--regarding this painful and sensitive topic:

* When Trading Gets Out of Control

* Addictive Trading and Getting Your Life Back

* Craving Trading Highs

* Warning Signs of Trading Addiction
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Control Your Brain by Controlling Your Risk

I received an eloquent email from an excellent trader who marveled that he trades very well when he trades moderate (but still significant) size, but then trades quite poorly when he trades his maximum size. His level of risk-taking, he finds, affects his emotional experience in trading. Yesterday, when he traded moderate risk through the day, he traded consistently and made significant profits. Last week, when he maximized his risk, he violated a number of his trading rules and lost significant money.

Same trader, same trading methods--only risk levels altered his emotions, his decision-making, and his performance.

Research suggests that different areas of the brain process risk and reward. Moreover, brain activation in the face of reward tends to be more rapid than in the face of risk. Other research shows that individual differences in our patterns of brain activity are closely correlated to our risk tolerance and risk aversion. This research finds that "reward centers" in the brain become more or less active depending upon how much money can be won or lost. Significantly, these reward centers are "some of the same areas of the brain that are activated when people take cocaine, eat chocolate or look at a beautiful face."

It appears that the thrill of risk and prospect of reward "hijack" the reward centers of the brain, particularly the dopamine system. This research emphasizes that gambling affects the portions of the brain associated with "planning and forming strategies". Is it any wonder that traders report "losing discipline" as a common psychological concern?

There is a very important lesson to be learned from the trader who wrote to me: By controlling our exposure to risk and reward, we control the degree to which our brains get hijacked. Trading 100% of our risk turns planned trading into gambling; cutting risk back moderates the reactivity of our dopamine systems.

There is also another sobering conclusion: failing to moderate our risk--day after day, week after week--can make permanent changes in the brain. According to one researcher, "In people that develop problems with gambling it seems that parts of that area don't work as well as they used to." By altering the dopamine system, a normal person can turn into a gambling addict. This is an example of neuroplasticity: the ability of the brain to change structure and function as the result of experience.

By creating the right kinds of experience, we literally can shape our brains for success. By generating the wrong kinds of experience, we can turn ourselves into impaired decision-makers. The difference between right and wrong, for traders, often boils down to the amount of risk we take with the capital we have.

I try to avoid overstatement, but in my opinion, this is one of the most important topics I've ever posted to the blog. Those who read the research linked above and the posts linked below--and who heed the message of risk levels and brain function--quite literally can save their trading careers and meaningfully advance their odds of success. You can't succeed if you don't have control, and you don't have control if the reward circuitry of your brain is hijacked by the risks and rewards you're pursuing.

RELATED POSTS:

The Brain and Handling Volatile Markets

Trading and the Brain

Trading Performance and the Brain
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Using the Dow TICK ($TICKI) to Track Program Trading

A number of readers have asked me recently about tracking program trading. Program trading refers to trades in which stocks are purchased or sold in baskets either for arbitrage or for placing directional bets on sectors, themes, or the broad market. Because the Dow Jones Industrial stocks are among the market's most liquid issues, they are commonly included in baskets by institutional traders. When we see the great majority of Dow issues uptick or downtick simultaneously--giving us extreme high or low Dow TICK ($TICKI) readings--we can infer the presence of program trading. Executing the trades in the shares at the same time creates the sudden rise or drop of $TICKI to very high or low levels.

The top chart shows the first hour of trading in the June ES futures from today's market. The bottom chart shows the one-minute candlesticks for $TICKI, with a 3-minute moving average (blue line) oscillating around the neutral, zero level. The one-minute bars pretty much look like noise, but we can see from the moving average that we started the day with a distinctly negative skew to $TICKI, even as the market rallied in the opening minutes. In other words, programs were selling into the rally.

The blue line stayed mostly below the zero point as the market declined, until buy programs jumped in shortly before 9 AM CT. The market bottomed shortly thereafter and further buy programs led the ES futures higher.

Because program trades can be executed for arbitrage rather than as part of directional bets, not all rises and declines in $TICKI reflect net institutional buying or selling. Hence it's important to see how the TICK for the broad market ($TICK) and price behave when we register $TICKI extremes. It is not uncommon, as in the example above, for shifts in program trading to lead short-term turns in the stock indexes.

RELATED POST:

Dow TICK and Program Trading
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Themes and Ideas for a Tuesday Morning

* Strong Market - Monday was a strong day, with my Demand measure (index of stocks closing above the volatility envelopes surrounding their short-term moving averages) hitting 204 and Supply (index of stocks closing below their envelopes) falling to 18. That means that stocks with significant upside momentum outnumbered those with significant downside momentum by more than 10:1. It is common to see short-term follow-through price strength following such momentum. Note that my Adjusted Cumulative Demand/Supply Index (chart above) is nearing the +20 (overbought) level that has corresponded to subnormal 20-day prospective returns in SPY. Note that new 20 day highs among NASDAQ, NYSE, and ASE stocks rose to 1041 and new 20 day lows fell to 418 on Monday. That is the highest level of new highs since the end of February. I continue to lean to the long side while Demand exceeds Supply and new highs are expanding.

* Themes for the Current Market - Once again, an excellent summary of the themes out there from Abnormal Returns, including problems in the commercial paper market and a very thoughtful post about debt, external default, and inflation. This is the kind of material that's worth reading if you're looking to *understand* markets and their interconnections. See also some juicy links from Chris Perruna, including a very interesting (and accurate, IMO) look at what kinds of trading returns are impressive over a period of time.

* Great Advice - Insightful post from A Dash of Insight highlights the importance of figuring out what markets (and regulators) are *going* to do, not getting caught up in your opinions of what they *should* do. So much of what you read out there are editorials, not market analyses.
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Quiet Mind and Expanded Vision: Reflections on the Day's Trade

I'm pretty much going to let the above annotated chart of today's ES futures (click for greater detail) speak for itself. Notice how we began the day with strong buying volume, which then tailed off as the morning wore on, which led to sector non-confirmations at the late morning price highs, and which led sellers to press their advantage early in the afternoon.

Volume, TICK, price, the action of various sectors--all of these things are interrelated and tell a story.

So much opportunity is lost when traders become tunnel visioned, seeing only the market they are trading, focusing only on price.

It's about the ebb and flow of supply and demand, and only an expanded field of vision can capture those shifts.

Anxiety, frustration, greed: these narrow our field of vision. It's when we let markets speak to us that we can best appreciate their patterns. It's difficult to truly see the markets, however, when we're filling our heads with images of success and failure.

Quiet minds make for expanded vision.

RELEVANT POST:

Underconfidence, Overconfidence, and Emotion in Trading
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Quick Stock Market Update

Today's market is notable thus far in that we're seeing solid buying sentiment (NYSE TICK) and very positive money flows accompanying a multi-week upside breakout in price (see chart above). The context for this was set when we made the new bear market price lows last week, with significantly fewer NYSE common stocks making fresh 52-week lows than in January.

We need to stay above the breakout line level to sustain the intermediate-term uptrend. Given that, the next very important test of resistance would be the February price highs.
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Making the Good Trade: The Importance of Preparation

Notice the distribution of the NYSE TICK early this AM. We have been solidly above the zero line, indicating that the vast majority of NYSE issues have been trading at their offer rather than bid price. That's a clear indication of bullish sentiment among large market participants.

If you had been sitting by my side at 8:34 AM CT, just four minutes into the session, you would have heard me exclaim, "Holy Shit!" The reason was that we had a couple of sell programs hit the market and the TICK could not even hit zero. (We got as low as +210). That suggested very solid buying interest out of the gate. Given that we were near multi-week resistance (per the recent post), it suggested to me that: a) we would test that resistance; and b) we had a good shot at breaking it.

Reading these patterns of short-term buying and selling interest early in the session can help you frame hypotheses regarding market action that form the basis for solid trading ideas. Had I not been very familiar with TICK patterns within the first five minutes of trading, however, the idea and the trade would not have been possible. This is where screen time and the internalization of those market patterns become all-important. No amount of trading psychology can substitute for that kind of preparation.
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Indicator Review for March 24th

Back on March 7th, I began noticing a drying up of stocks making fresh bear market lows relative to January, noting some cracks in the foundation of the bear market. These divergences were also apparent in my last indicator review, which was waiting for stabilization among the financial stocks before aggressively taking the long side. The market did give us fresh price lows on Monday of this past week, but once again the divergences relative to January were present. With increasing Fed activism, those financial stocks rallied for the remainder of the week, posting a three-week closing high in the banking index ($BKX). Moreover, the same is true of the housing sector index ($HGX), which managed to hold above its price lows from January. As I write, the ES futures are knocking on the door of important three-week resistance around 1345 in the June contract. Are those financials leading the broad market higher?

Let's see what the indicators are saying:

New Highs/Lows - We can see from the top chart that, despite vigorous buying in the sectors hit hardest by the recent selling, new 20-day highs continue to lag new lows. Indeed, even with Thursday's price strength, we had 608 stocks across the NYSE, NASDAQ, and ASE make fresh 20-day new highs against 1391 new lows. This suggests that, at least so far, the buying is selective and not lifting the broad list of stocks significantly. We will need to see expanded new high strength--and certainly greatly diminished new lows--before we can conclude that the recent bounce is anything more than short covering. With 18 new 52-week highs and 73 new lows among NYSE common stocks on Thursday, we also saw an expansion of new lows, but we are well off the 300+ new lows registered on Monday.

Composite Money Flow - In the bottom chart, I combined the raw money flows across the 40 stocks from the eight S&P 500 sectors that I reviewed, so that we could see how total five-day money flows have been running vis a vis SPY. What we can see is that total money flow has been running below the zero line for the most part and is negative at present. This supports what we're seeing with the new high/low data: despite the recent price bounce, we're not yet seeing large influxes of funds into equities. I will be watching this indicator, along with the new highs/lows, on any test of the above-mentioned multi-week resistance in ES to handicap the odds of upside breakout vs. reversal. That's an issue that has important implications for the bear market and its longevity.

Advance-Decline Lines - The Advance-Decline Lines specific to the NYSE common stocks, SPX stocks, S&P 600 small caps, and NASDAQ 100 issues all made new lows last week and are only modestly hovering above those lows. The AD Lines specific to the eight S&P 500 sectors reviewed this past weekend for money flows also are near their bear lows; none is yet showing sustained strength.

I will post a separate analysis of the Cumulative NYSE TICK later this week. Suffice it to say that the TICK supports the findings from the three sets of indicators above: only tepid strength coming off the recent price lows. I need to see greater evidence of sustained buying interest before concluding that we've seen a turn in the recent bear market.
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WTF Among the Technology Stocks?

This is the last of eight S&P 500 sectors that I'm reviewing for money flows. The recent posts in the series include Materials, Industrials, Consumer Discretionary, Consumer Staples, Energy, Healthcare, and Financial stocks. Here we're examining five highly weighted Technology issues, with Cumulative Money Flow (top chart) and Five-Day Average Flows (bottom chart) plotted against the XLK (Technology) ETF. The five stocks included in the calculations are MSFT, INTC, IBM, CSCO, and VZ.

We can see that the Technology sector, like Financials and Healthcare, has shown recent relative weakness, breaking below its January price lows. Nevertheless, we haven't seen new lows in Cumulative Money Flow, suggesting some drying up of selling during the recent decline.

The lessened selling, however, has not translated into aggressive buying. We are only modestly off the recent price lows, and five-day money flows have remained negative. As with so many of the other sectors, we've yet to see sustained buying interest that would lead us to expect a major change of trend.
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WTF Among the Financial Stocks?

My recent posts on Money Flows have focused on the Materials, Industrials, Consumer Discretionary, Consumer Staples, Energy, and Healthcare sectors. This post examines five highly weighted issues within the Financial stock sector, tracking Cumulative Money Flow (top chart) and Five-Day average flows (bottom chart) against the XLF (Financial) ETF. The stocks included in the calculations are C, AIG, BAC, WFC, and JPM.

Like the Healthcare issues, Financials have shown recent weakness, breaking below their January lows during the latest market leg down. Observe, however, that we did not see a new low in Cumulative Money Flow, suggesting a possible drying up of selling pressure.

We've since bounced nicely off the latest lows on news of Fed intervention, but note that five-day money flows have stayed weak on the bounce. Much of market skittishness concerns the troubled financial sector; sustained dollar inflows would suggest a renewal of confidence among investors. Thus far, however, though we have seen less intense selling pressure on declines, we're not yet seeing sustained buying interest on bounces. I will be watching flows in this sector particularly closely given this dynamic.
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WTF Among the Healthcare Stocks?

Previous posts in this series have examined money flows in the Materials, Industrials, Consumer Discretionary, Consumer Staples, and Energy sectors. Here we're examining five highly weighted stocks from the healthcare sector, with Cumulative Money Flow (top chart) and Five-Day Flows (bottom chart) plotted against the Healthcare ETF, XLV. The stocks included in the analysis are PFE, JNJ, MRK, LLY, and AMGN.

Note that, unlike many of the other sectors, Healthcare shares have been quite weak during the recent market decline, dropping to new bear market lows. This weakness was preceded by steady dollar outflows from the sector: note the steady downtrend in Cumulative Money Flow. Not only is the sector weak; there are no signs at present of a sustained flow of funds into these shares.

Five-day flows have bounced a bit, but remain negative. Note how positive periods of five-day flow have not been sustained, often leading to subsequent price weakness. Of the sectors, this is one that is relatively weak, both in price performance and money flows.
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WTF Among the Energy Stocks?

In my recent posts, we've explored money flows into the Materials, Industrials, Consumer Discretionary, and Consumer Staples sectors. Now it's the turn of the Energy stocks. Above we see the Cumulative and Five-Day Flows for five highly weighted stocks within the sector, plotted against the Energy ETF, XLE. The five stocks included in the analysis are XOM, CVX, COP, SLB, and OXY.

What we see off the bat is that Energy issues have been relatively stronger than other sectors, thanks to commodity strength. Indeed, their chart looks more like the chart for the Materials sector than most of the others for this reason. Note also that the recent market weakness failed to bring XLE below its January lows. This non-confirmation, which we've observed among the other sectors as well, has played an important role in the market's very recent bounce.

That having been said, we did not see a bounce in XLE late last week, owing to the commodity selloff. Moreover, Cumulative Money Flow for the Energy stocks has been in a steady downtrend since August, 2007. Considering the historic strength in oil prices over this period, XLE performance has been muted. Indeed, it appears that money has been systematically coming out of this sector over time.

The five-day flows show that particularly little capital flowed into the sector during the bounce from the January lows. That has set up the current weakness. While the sector is range bound and the non-confirmation of the January lows was encouraging, there is not yet evidence of significant funds flowing into energy issues that would power an upside breakout.
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WTF Among the Consumer Staples Stocks?

My recent posts have tracked money flows for Consumer Discretionary stocks, Industrials issues, and Materials shares. This post takes a look at five highly weighted Consumer Staples stocks, plotting their cumulative money flows (top chart) and five-day average flows (bottom chart) against the Consumer Staples ETF, XLP. The five companies whose flows I've aggregated are PG, MO, WMT, KO, and WAG.

A pattern that we saw with the three sectors mentioned above is also apparent here: during recent market weakness, XLP failed to break below its January price lows. Note, however, that during the recent weakness, cumulative money flows for the Consumer Staples shares have been in a steady downtrend, testing bear lows. This is quite different from the flow patterns seen among the Materials and Consumer Discretionary shares, which showed reduced selling pressure during recent market declines.

Five-day flows remain weak despite a recent bounce in the sector. Clearly, despite the ability to hold the January lows, we're not seeing sustained buying interest among the Staples.
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WTF Among the Consumer Discretionary Stocks?

My last two posts tracked money flows for the Industrials stocks and for the Materials shares within the S&P 500 universe. This post takes a look at five highly weighted Consumer Discretionary stocks and plots their cumulative money flow (top chart) and five-day average flows (bottom chart) against the Consumer Discretionary ETF, XLY.

Note that, like the Industrials and Materials sectors, the Consumer Discretionary stocks have thus far held above their January lows. Observe also that cumulative money flows have held up quite well during the period of recent market (and sector) weakness, as we remain well off the money flow lows from late 2007.

Five-day flows have turned negative for the sector, but are nowhere near as intense in selling pressure as those from late 2007. While we have yet to see sustained buying interest among these shares, there does appear to be a drying up of selling pressure thus far.
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WTF Among the Industrial Stocks?

In my most recent post, I tracked the money flows in the Materials sector of the S&P 500 stock universe. Above we see the cumulative raw money flows (top chart) and five-day average flows (bottom chart) for five highly weighted industrial stocks. These are plotted against the Industrials sector ETF, XLI. The five stocks included in the calculations are GE, UPS, BA, UTX, and MMM.

Note that the flow patterns for the Industrials sector look very different from those seen among the Materials stocks. Cumulative flows have been in a steady downtrend (Friday's strength notwithstanding), indicating a flight of funds from these issues.

Five day flows are currently positive--something we haven't seen often since August, 2007--and the sector index has so far held above its price lows from January. We'll need to see sustained buying (positive flow figures), however, to conclude that the recent bounce is anything more than short covering.
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WTF Among the Materials Stocks?

In this series of posts, I ask the question, "Where's the Flow? (WTF)" for eight major sectors within the S&P 500 large cap universe.

Here I chart cumulative daily money flows (raw values; top chart) and a five-day moving average of money flow for five highly weighted stocks within the S&P 500 Materials sector. The money flow lines are plotted against the Materials ETF, XLB. The stocks included in the calculations are DD, DOW, AA, IP, and WY.

Note that five-day flows have oscillated around the zero level and tracked price reasonably well since August, 2007. We're neither seeing meaningful deterioration in money flows in this sector, nor seeing major accumulation of shares. Interestingly, we had a selloff in Materials stocks on Friday with the broad decline among commodities, but money flows were not negative on the day. This appears to be part of a broader pattern in which we're seeing higher lows in the cumulative money flow line (top chart). This may be suggesting a drying up of selling pressure within the sector.

In general, we've seen the best short-term buying opportunities in this sector when five-day flows have been negative. We are modestly positive at present. A break of the cumulative flow line above zero would suggest increased accumulation of these shares.

RELATED POST:

Money Flows for Dow Industrials Stocks
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Bond Yields as a Sentiment Gauge

Here's a weekly chart going back to the 2000 lows in the municipal bond market. We're looking at Vanguard's Intermediate-Term Tax-Exempt Fund (VWITX). According to the Vanguard site, the fund is currently yielding 3.67% on bonds with an average maturity of 7.1 years. About 87% of the holdings are rated AAA or AA. When we compare the tax-free yield of 3.67% with the yields offered on taxable certificates of deposit, the muni rate is quite attractive. Nationally, we're seeing average 5 year CD rates of 3.29%, according to Bankrate.

So what we have is one of two things:

1) A pricing anomaly that is a reflection of overblown fears of municipality vulnerability and monoline insurance fragility;

2) An accurate discounting of increased muni defaults in the face of plunging housing values, a weakening economy, reduced tax receipts, etc.

When muni rates for VWITX rose over 4% earlier this month, we saw investors snap up the attractive yields. A similar pattern occurred across the other funds I investigated. We remain well above the price lows from early March, though yields remain historically high relative to those available from Treasuries. By way of comparison, the Vanguard Intermediate Term Treasury Fund (VFITX) averages a maturity of six years and is currently yielding 2.79%.

The risk premium built into the munis is also evident among other bonds. For as close to an apples-to-apples comparison, I took a look at Vanguard's Intermediate-Term Investment-Grade Fund (VFICX). It has an average maturity of 7.8 years and over three-quarters of its holdings rated A or above. The most recent posted yield is 4.97%--again notably higher than the yields on Treasuries or bank CDs. It's interesting to note that VFICX is also trading above its recent lows, as yields over 5% found investor interest.

We saw harrowing declines in both munis (VWITX) and investment grade bonds (VFICX) in 2000, reflecting similar fears of default. Those bond markets recovered sharply well in advance of the stock market lows, reflecting reduced fears in the face of Fed easing. We're now getting significant Fed easing and bonds are off their highest yields. That has me looking for evidence of continued confidence among bond investors to see if the Fed's ministrations can help these markets turn the corner now as they did in 2000.

In that sense, these bond markets are excellent sentiment gauges. If the Fed's actions bring stability and confidence to the financial system, these yields should be very attractive and attract continued buying. If, however, we see sustained risk premia and even worsening bond prices in the face of aggressive Fed actions, then we have to look at the real possibility that these are not pricing anomalies and, instead, reflect anticipations of much worse things to come for debt issuers.

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Money Flows and Subprime Sentiment
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What Money Flows Are Telling Us About The Current Stock Market

The chart above tracks a five-day moving average of money flow across the Dow 30 Industrial stocks. Money flow is a measure of the dollar volume of trades on upticks minus the dollar volume of trades on downticks. The result shows the amount of funds flowing in and out of the market. Please note that these are raw money flow figures, not ones adjusted with respect to market volume or compared with a moving average period.

The money flow aggregated across the 30 Dow stocks correlates highly with price change for the Dow average as a whole--about .44 over the time period covered by the chart--but it is an imperfect relationship. It's when we see money flowing out of the market even during periods of price strength--and money flowing into the market during times of price weakness--that the data are most helpful. When the market peaked late in February, for example, dollar flow readings for the Dow stocks were consistently negative.

Our chart tells us two important things:

1) Money has been coming out of the market, as measured by the Dow. A cumulative line of the money flow data has a steady, negative slope.

2) Five-day peaks in money flow have tended to correspond with intermediate-term tops in the Dow during this declining period of stock prices.

Most recently, the Dow has bounced off its lows and five-day money flows have just turned positive. There is nothing yet in the readings to suggest that large amounts of funds are flowing into stocks. Rather, recent money flows into Dow stocks have been subdued, and that has me questioning the longevity and sustainability of the recent bounce.

RELEVANT POSTS:

My Previous Post on Money Flow

Money Flow and Dow Returns
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Denial as a Trading Motivation

Back in the day, I used to meet with a number of couples in counseling. Not infrequently, infidelity was a major issue bringing them to see me. In a surprising number of cases, the signs of infidelity were present long before the affair was caught. Indeed, many times there were explicit warnings from others who saw what was going on. Still, the spouse didn't want to believe the worst...made excuses...turned the other way...until evasion was no longer possible.

Denial is a powerful human motivation. We have a drive to know the world around us; less commonly appreciated is our capacity to sustain ignorance. Many times, we just don't want to know the truth, whether it's what happens in a military prison or what keeps our spouse out so late.

One particularly uncomfortable truth for traders is that their lack of profits is simply due to trading randomness. It's not a lack of discipline, a lack of trade planning, or a lack of tweaking the right indicators that create losses--all of those are relatively easy to address. No, losses are caused by trading strategies that simply do not work, and that's not so easily remedied.

It's pretty threatening to think that what you're devoting time and money to has no grounding in reality. It's much easier to simply not think about it. Like the spouse who manufactures one excuse after another in the face of a partner's erratic behavior, we construct all sorts of explanations for our shortcomings.

Or we just put the blinders on. When I started working with traders some years back, I asked them to indicate their profitability over the past year. I was shocked that most could not give me (or would not give me) a response other than a hesitant, "I'm coming close to break even." Many had simply stopped looking at their account statements. The idea of actually drilling down into their trade data and extracting information about what they were doing right and wrong was quite threatening for them.

Sadly, there are plenty of willing accomplices in this denial. Coaches eagerly assure you that "psychology" is the difference between winning and losing in markets; gurus promise you hidden market secrets that will enable you to unlock your potential; publishers crank out books on how you can succeed at trading. But no one solicits trading magazine articles, workshop presentations, or books on the topic of *lack* of edge. No one wants to hear all the first-hand stories I can tell about lives and relationships harmed and even destroyed by false hopes and promises.

That's too uncomfortable. No one can make money from it. So we don't look at it; we choose to not know. But I'm telling you truthfully: I've seen just as many lives hurt or ruined by trading as enhanced.

A while back, I was asked to submit a proposal for a workshop hosted by one of the major financial exchanges. I thought a real public service would be to present research and first-hand observations pertaining to addictive patterns among day traders: how to recognize trading addiction, and what to do about it.

The idea was shot down immediately. As it turns out, it wasn't the conference coordinator that pulled the plug, but the corporate sponsor of the event. Sponsors don't make money when people don't trade or when they trade in a more controlled fashion. People, after all, come to hear about trading as a dream, not as a nightmare.

A little while back a trader begged me to talk with him over the phone and help him with his "self-defeating" emotional patterns. In an unguarded moment, I agreed. He told me about his anger and frustration during trading and how those had led him to violate his risk management rules.

I asked the trader to give me examples of what was going on during these periods of frustration. Many of the occasions boiled down to times when he was profitable on trades, but then saw those profits reverse. I drilled down further to get examples of those trades and discovered that, even though he called himself a daytrader, many of his reversals occurred on positions held overnight. Indeed, he proudly told me his rule that limited his overnight exposure to only his most profitable daytrades.

A bit skeptical, I asked him what he based the rule on. How did he know that profitable positions intraday would become further profitable if held into the next day?

He seemed stunned that I asked. I guess we're all supposed to know that "the trend is your friend" and that you should always trade with the trend.

I quickly got on the computer, downloaded daily open-high-low-close data for the S&P 500 Index (SPY) going back a little over a year (to the start of 2007) and threw together a spreadsheet that looked at returns following up days and down days. There was no programming or advanced Excel techniques to what I did; it took all of a few minutes.

To recreate what I found: When SPY was up on the day (N = 159 trading days), the next day's open averaged a loss of -.02% (79 up, 80 down). Similarly, when SPY was up on the day, the next full trading day averaged a loss of -.13% (75 up, 84 down).

When SPY was down on the day (N = 146), the next day's open averaged a gain of .03% (86 up, 60 down). When SPY was down for the day, the next trading session as a whole averaged a gain of .11% (85 up, 61 down).

So, in other words, the trader's rule had absolutely no grounding in reality. If anything, he would have been better off fading the prior day's direction. He was becoming frustrated and angry because he was losing his profits. He was losing his profits because he was trading a setup that had no validity. Frustration wasn't causing his trading problems; his bad trading was generating (understandable) frustration.

But, for me, the eye-opener was that he had never thought to check out his rule. Even if he didn't want to crack an Excel primer and learn how to find answers for himself, he could have simply kept records of his overnight trades vs. his intraday trades and seen what was working and what wasn't.

But he didn't do that.

That's when it hit me: He didn't *want* to know.

My caller was not happy with my analysis and did not seek me out further. I didn't deliver what he wanted. He wanted a self-help psychological technique to keep him disciplined, so that his rules would make him money. He didn't want someone pointing out that his rules were invalid and that following invalid rules with discipline will simply lead to ruthless consistency in drawdowns.

As our conversation wound down, he defensively explained that he had plenty of other patterns that he traded that were valid. One of his favorites were opening gaps. Long story short, I examined the spreadsheet and told him that this, too, was coming up blank. To recapitulate, upside opening gaps led to 83 wins and 82 losses for the coming trading day; downside gaps led to 71 wins and 69 losses. There were no significant differences in the sizes of winners and losers. There was no edge there at all.

"But that's for the S&P," he said. "The gaps work for the stocks."

"Which stock would you like me to run the data on?", I asked. He said no thanks; he didn't need the data.

But the analysis wasn't the point. The point was that he was trading a belief in an edge, not an edge that he had independently validated. His entire trading strategy rested on (blind) trust in these patterns. He didn't *want* to know if the patterns were good, because that--like the spouse's actual discovery of an affair--would necessitate facing unpleasant realities and making difficult changes.

I recently started work with a trader who wrote to me in elaborate detail of recent trading losses. He immediately offered to share his account statements with me so that I could help him change what he was doing. No denial. No defensiveness. No willing blindness. Just an open kimono. I confidently predict that this trader will be successful. He's doing the hard work right now: he's facing shortcomings with eyes wide open. By owning what's worst with his trading, he'll discover the best within him.

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Tracking Market Transitions With Market Delta and NYSE TICK

In my recent post, I suggested that the relationship between the NYSE TICK and the Market Delta for a broad index provides a multidimensional view of short-term sentiment. If you click on the chart above, you'll see a nice setup from this morning's trade. The ES volume at bid vs. offer is within each of the bars in the Market Delta chart. The five-minute high and low values for NYSE TICK are in black beneath each bar.

Note how the NYSE TICK actually started drying up on the breakout move, ahead of price and Market Delta. That was an early clue that a large number of stocks weren't participating in the upmove. (Energy and materials stocks, among others, failed to confirm the highs). Once we made the new price highs at the top of the day's range, however, note how volume at offer vs. bid and NYSE TICK dried up. That provided plenty of advance warning for the retracement back into the recent range.

These transitional patterns play themselves out on multiple time frames and can be found just about every trading day.

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My Guiding Principles of Short-Term Trading
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The Breadth and Depth of Short-Term Market Sentiment

My most recent research has led me to investigate the relationship between the NYSE TICK and the Market Delta readings for a given period of time. We can think of TICK as capturing the breadth of sentiment: it tracks how many stocks are trading at their offer price vs. their bids. Market Delta, on the other hand, tracks what we might call the *depth* of sentiment: the intensity of buying (volume at offer) vs. selling (volume at bid) for any given instrument.

What I'm finding is that the relationship between the two provides useful information that is not apparent from either one by itself. For example, when we have dominant selling in the ES futures that is not matched by particularly negative NYSE TICK, this selling tends to be reversed. Conversely, trending markets tend to see the two measures traveling in unison.

From a statistical vantage point, the operative question is: What is the expectable value of NYSE TICK for a given Delta reading in ES (and vice versa)? When is the relationship between breadth and depth of buying/selling behaving normally, and when is it out of whack?

It appears to be the out-of-whack occasions that provide the most valuable signals. More to come.

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Inside Views and Perspectives for a Wednesday

* It Can't Happen Here - Hard to believe it was only 14 years ago that a prominent University of Chicago economist made the case that "no serious danger of a derivatives-induced financial collapse really exists".

* The Story Beneath the Story - What one knowledgable observer sees in today's market selloff. Meanwhile the flight to safety continues unabated: 3 month Treasury yields near .50% (!) and TIPS yield remains negative.

* What's On Investors' Minds - Bursting bubbles and vulnerable hedge funds, according to Abnormal Returns.

* Libor Perspectives - Abnormal rates have become the norm, as charted by Alea.

* Fed Bailing Out the Boat - Better than letting it sink, points out Jeff Miller.

* Choppy Action - I took a look at the trajectory of my Cumulative Demand/Supply Indicator after today's trade. Continued choppy action with lack of follow-through on rises would lead to an *overbought* condition at a much lower price level (than the prior overbought signal), and that would trigger a major sell signal for my intermediate-term trading. We're not there yet, but the concern is on the radar.
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Some Post-Rally Market Observations

* Tracking the Rally - We swung to very positive momentum on Tuesday, with my measure of Demand at 202 and Supply at 13. This means that about 16 stocks closed above their volatility envelopes for every one that closed below. Such extreme readings usually lead to follow through on the upside on a short-term basis. New 20-day highs across the NYSE, AMEX, and NASDAQ expanded to 479; new 20 day lows dropped to 943. My Technical Strength measure showed trend shifts across many of the 40 stocks that I track across eight SPX sectors. Specifically, we're now seeing 21 stocks in uptrends, 7 neutral, and 12 in downtrends. We're now seeing 53% of SPX stocks trading above their 20-day moving averages, up from just 17% on Monday. Following relative strength and weakness among the financial issues has worked well. If this rally is for real, we should see follow-through buying in this sector.

* Themes for This Market - Abnormal Returns tracks a number of current themes, including the prospects for investment banks and hedge funds and a look at a possible unwinding of a China bubble. See also the T-bills and gold theme followed by Maoxian.

* Prospects for the Rally - Trader Mike notes the lack of follow-through in recent rallies and sees the 50 day MA as the next test for the market.

* An Options Strategy for Gold - Daily Options Report explains their gold strategy and offers an observation on the BSC affair.

* Great News Summary - Between the Hedges tracks the headlines and notes greater confidence in the credit markets.
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Three Common Mistakes I'm Hearing From Traders

Here are some of the common issues that I'm hearing from traders during recent coaching sessions. Most of us can recognize ourselves in one or more of these patterns:

1) Becoming Overly Focused on P/L During Trading - Watching your profits or losses tick up and down during a trade; becoming anxious about P/L and letting P/L, not a trading plan, dictate when you get out of a trade. It's a recipe for performance anxiety. By focusing on process goals rather than P/L, you can stay grounded in good trading practices and minimize performance stresses.

2) Trading Much Larger After a Series of Winning Trades - It is common that traders become overconfident after a series of wins and decide to increase their risk by a factor of two or more. This often leads to large losing trades that wipe out much of the profit, generating frustation and discouragement. Just as it doesn't make sense to plow into a trade after a large move has already occurred, it doesn't make sense to plow into risk after a series of profitable trades.

3) Failing to Learn From Losing Trades - Traders often want to put losses behind them and not dwell on negatives. The downside is that they don't learn from their losses and thus miss opportunities to understand what's happening in markets and what they might be doing wrong. This is especially important following a series of losing trades: either you're not seeing the markets well, or you're not acting well on your perceptions. Both scenarios offer learning opportunities that can help generate profits down the line.

It's common to think of trading as a stressful occupation, but much of the stress is self-generated. By staying focused on "best practices" in trading, we minimize fear and frustration and build confidence in our development.

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Overcoming Performance Stress
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The Promises and Limits of Coaching: Lessons From College Counseling

In my recent post on how much coaching is enough to produce change, I summarized research from the dose-effect research literature. One problem with this is that the literature is primarily oriented to clinical populations: those with diagnosable disorders. Fortunately, there is one setting for applied psychology that focuses more on normal, developmental problems than clinical ones: college counseling centers.

Having worked at a college counseling center at Cornell University and then directed a student counseling service at SUNY Upstate Medical University, I can attest to the similarities between work with students in higher education and coaching of professionals in trading and other fields. In my work at Syracuse, fully two-thirds of the people seeking assistance were looking for help with such normal concerns as relationship problems, career issues, and performance-related stress. Interestingly, these are also among the most common issues that traders discuss with me. Many of the same cognitive, behavioral, and solution-focused methods that are helpful in work with students are also relevant and useful for traders.

So what can college counseling teach us about the coaching of traders? A very interesting research study conducted in 2000 summarized college counseling work with almost 1700 students across over 40 campuses. This provides a broad cross-section of schools and students. The study found that over 1000 of the students--about 60% of the sample--only attended 3 or fewer counseling visits. This is not unusual: other studies of utilization of helping services have found that the modal number of visits to a psychologist or counselor is one.

The low number of visits does not necessarily mean that the services were not helpful. Rather, the study found that almost 30% of the students reported significant improvement by the end of one session and nearly 40% by the end of the third visit. Among those who attended 10 sessions, 54.5 % reported significant improvement. The study authors suggest that this shows a dose-effect relationship among the college students: more visits produce better results. It also suggests that about half of all people in the college setting--which I believe is the best mirror for coaching settings--can benefit from short-term help. Indeed, they often vote with their feet and only attend several helping meetings.

Still, the data suggest that many people do not benefit from short-term help. On college campuses, this can include people with ongoing problems with anxiety, depression, eating disorders, and substance abuse. Similar problems can be found among traders. Of the people who attended 10 sessions, 9.1% actually deteriorated over time and 36.4% reported no change. This is a finding that is not frequently discussed among psychologists and counselors, and certainly not among coaches: some people get worse, despite best efforts at helping. This may be due to a lack of skill among helpers; a poor personality fit between helper and client; or an unusual problem that is not detected by the counselor.

My experience is that the latter is most often the case. I have met with traders who have received prior coaching (and sometimes therapy), only to find that they have a diagnosable problem that went unrecognized. Sometimes the problem is depression; sometimes it is a form of anxiety; sometimes it is an eating disorder; and sometimes it is a purely medical problem that manifests itself as emotional distress (e.g., a thyroid disorder). It is also sometimes the case that a problem is longstanding and severe and simply needs more than 10 sessions of assistance. One research study, for example, found that individuals with severe emotional disorders continue to show therapeutic responses for 25 sessions of therapy and more.

So what can we conclude from this research? Simple performance problems--especially those that are relatively recent and not severe--often require only short-term assistance. In such cases, coaching can be targeted and brief. Longer-standing problems and those that are affecting multiple areas of life--not just trading--often take more than a brief course of assistance. Generally they require a comprehensive assessment from a trained professional. Coaching holds much promise for many people, but extrapolations from the college counseling research suggest that about half of all people will not benefit from it. That's something you won't hear from helpers eager to collect your fees, but it's important for you to know if you're contemplating help.

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Coaching Yourself for Profitable Trading

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Using Trading Ranges to Frame Trade Ideas

Here's an example of a great setup from this morning's trade. It's an example of how I think about morning trading, which may be useful for some readers.

My trade idea usually begins with a "reference range". This can be the overnight range (as in the example above) or the range from the previous day's trade. As the current day unfolds, I look at several indicators to handicap the odds of either breaking out of this range or returning toward the range midpoint when we're near a range extreme:

1) NYSE TICK - I look not only at the raw values of the TICK (which indicate how many stocks are trading at their offer vs. bid price), but how the distribution of these values is shifting over time and how the values are impacting price. What was unusual in today's trade is that we started the day with negative TICK values, but could not make new price lows relative to the overnight range. This told me that selling pressure could not move the market lower and bolstered my expectation that we'd return toward the midpoint of the overnight range. As the early morning progressed, we saw an upward distribution in the NYSE TICK values (rising moving average of TICK), which indicated increased buying interest.

2) ES Volume at Bid/Offer - I read this from a Market Delta screen, and it complements the NYSE TICK quite well. In this case, it showed buyers in size lifting offers in the ES futures, even as the NYSE TICK was still giving negative readings. This suggested to me that large traders in the futures were using the downside opening gap to buy value, again leading to an expectation of a return toward the range midpoint.

3) Leading Sectors - The major leading sector for the recent market has been the financial stocks. When I saw C, GS, and LEH catch a bid in early trade, I expected the broad market to follow suit, against suggesting a return toward the range midpoint.

Because the overnight range was so large, the setup led to a nice move and gain. I was in the trade at 8:40 AM CT (bought SPY) and exited at 9:30 AM CT once we stalled near my price target.

By organizing your perception in terms of ranges and then tracking how stocks are behaving at the edges of those ranges, it's possible to anticipate breakout moves and reversion moves back into the range. A majority of my trades follow this logic.

RELEVANT POSTS:

How I Trade

Using the Opening Minutes of Trading
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Indicator Review for March 17th

* New Highs/Lows - As of Friday's close, we weren't yet seeing an expansion of fresh 20-day lows relative to last week's readings (top chart). Opening weakness on Monday should test this, and indeed pose an important test. We also still are not seeing an expansion of new lows relative to the January lows. For example, on Friday we had 36 NYSE common stocks make new 52-week highs and only 141 make new lows. Last week, we registered over 220 new annual lows among NYSE common issues, and in January we had over 700 new 52-week lows. The same pattern can be seen among SPX stocks: we had 2 new 52-week highs and 40 new lows. Last week, we saw over 70 new lows among SPX stocks; in January we had over 200 fresh annual lows. The identical pattern of dwindling lows can also be seen among the S&P 600 small cap issues. Interestingly, I don't see any commentary on this; the bearish behavior of the financial issues is getting all the press, while fewer stocks make new lows over time. Clearly these are perilous times for financial markets, and I am not holding long positions until I see stabilization among financial, housing, and other weak sectors. The bulls need to see us hold at these January lows; otherwise we could see quite a capitulation.

* Overbought/Oversold - We continue oversold in my Cumulative Demand/Supply Index (bottom chart), having hit a level last week that has tended to accompany or immediately precede intermediate-term market bottoms. Note, however, that we are tracing a pattern of lower price highs at overbought levels and lower price lows at oversold levels. This is the essence of a bear market. While we could get a rally from current oversold levels, we need to see a pattern of higher price highs at overbought levels to infer a change of trend. Shorter-term, among the 40 stocks in my basket (equally divided among 8 SPX sectors), we have 4 stocks in uptrends, 13 neutral, and 23 in downtrends. The Technical Strength Index is oversold at -1500, but above extreme oversold levels from last week.

* Momentum - We see a pattern with the momentum data very similar to the new highs/lows. Among SPX stocks, we're seeing 20% trading above their 200 day moving averages as of Friday, up from 15% last week and 13% in January. This pattern of rising % of stocks above 200-day MAs is even more noticeable among NYSE issues. Demand was 37 on Friday; Supply was 92, so short-term momentum remains bearish. Thus far we are remaining above last week's advance-decline line among NYSE common stocks (as well as NASDAQ 100 stocks and S&P 600 small caps), but that could change with weakness early this week.

All in all, we can see from the indicators that we're in a bear market mode; that we're testing the January lows; that weakness among financial stocks has been leading recent market weakness; but that there are early signs of waning new lows and waning downside momentum across the broad market. Taking day-to-day market cues from the financials has been a winning strategy, and I plan to stick with that. I am reluctant to chase new price lows, however, in the face of non-confirming new lows and momentum--particularly if we see stabilization among the financials (which would have me nibbling on the long side).

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Last Week's Indicator Update
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Stock Market Fears Grounded in a Stark Reality

Last week it was a $70 stock; today it was purchased by JPM for $2 a share. That is how quickly things unraveled for Bear Stearns (BSC). In the face of such utter annihilation of wealth, it's understandable that markets are fearful and volatile to start the week. Note that the VIX is once again above 30, on track to spike higher should the overnight weakness spill over to tomorrow's trading session.

Plunging Stocks, Plunging Dollar: Updates Via Twitter

I pulled the bottom chart off my screen a few minutes ago to show you how things are shaping up in an unusual start to the trading week. We've already declined over 30 ES points from the highs following the Fed's announcement of a discount rate cut, with volatility very unusual for overnight trade. Japan is down over 3%, and the dollar is absolutely plunging versus the yen (top chart) and euro (middle chart). Meanwhile, we are not only breaking below Friday's stock market lows, but also challenging the important lows from January. This is a very dangerous market, given the dynamics of plunging rates (2 year Treasuries at 1.35%; 10 year @ 3.37%) and plunging dollar. I will update market observations via Twitter. The last five Twitter "tweets" appear on the blog home page; the full set are on my Twitter page. Interested traders can subscribe (no cost, of course) via RSS; see my Twitter page.

Global Returns Year-to-Date: The Emerging Markets Decoupled

Here we see year-to-date returns for a number of global markets, including the U.S. (SPY); Australia (EWA); Canada (EWC); Germany (EWG); Hong Kong (EWH); Japan (EWJ); Brazil (EWZ); South Africa (EZA); and China (FXI).

Note that returns have been negative across the board, with resource rich Brazil, Canada, South Africa, and Russia (not shown) faring far better than resource consumers in Asia.

Note also that the strongest emerging markets (China, Hong Kong) are now leading the downside, nearly doubling the losses in the U.S.

Perhaps most notably, we now see that the once seemingly monolithic "emerging markets" have decoupled, with Brazil and Russia outperforming the world and China dramatically underperforming.

Weekend Perspectives and Ideas

* More Weak Dollar - Remember when the yen was the world's weak currency? It's been on a recent tear vs. the U.S. dollar (above). Indeed, just about every major currency has fared well vs. the dollar, as the Bernanke Fed pursues quantitative rate easing in the face of bank and credit market challenges. The two-year yield on U.S. Treasury debt is 1.48%. Compare that with 6.31% in Australia; 13.06% in Brazil; 3.08% in Germany; and 3.82% in the U.K. and you can see why global investors may not be attracted to the USD. Even the yen, yielding a paltry .57% for its 2 year government debt, is relatively attractive, given perceptions of the U.S. economy and continued difficulties within the U.S. financial system.

* Bursting Bubbles - Flight delays from Florida to Chicago gave me an opportunity to read "Greenspan's Bubbles" by Bill Fleckenstein (McGraw Hill, 2008). The book questions Greenspan as an economic forecaster and then takes readers on a review of Fed policy and consequences from 1995 through the present. An interesting subtext to the author's argument is the misplaced optimism (exuberance) placed on progress, whether it's the productivity/technology revolution ("the New Economy") or financial engineering. It's an easy, short read and an illuminating context for the current unwinding of the housing market and related debt instruments.

* Bears Out in Force - Excellent, excellent summary of sentiment data from Trader's Narrative. We are seeing historic levels of bearishness from a variety of indicators. See also the post from A Dash of Insight: No one is bullish.

* Tracking Your Performance - I see that Trader DNA has developed some new tools for futures traders to track and analyze their performance, including a Web-based service. They've also compiled a number of performance-related articles, including several of mine.

* Hot Industry - Brain fitness is seen as a hot industry going forward, with applications for both clinical and normal populations. I believe we'll see greater application of these tools in trading environments going forward.

* Excellent Quote - Trader Mike offers an excellent observation from Art Cashin. So many traders have come of age in the last few years when we've had lower volatility and a bullish trend. That includes many prop and fund traders. As a result, we seem to swing from unbridled optimism to the depths of fear and despair and back again.

* Falsified Data - Barry Ritholtz offers a hard-hitting critique of the CPI numbers.

* Bearish Stearns - Here's a nice mashup of perspectives on the BSC situation from Research Recap.

* Emerging Strategies - Richard Wilson offers his views of up-and-coming hedge fund strategies. Here's his listing of hedge fund website resources.
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Formatting Your Trading Journal for Success

My recent posts have focused on using journals to improve trading. Everyone has a journal format that (one hopes) works best for them. Here I'll suggest a format that I find particularly useful.

The reason I'm offering the suggestion is that I continue to find that traders use journals in ways that are less than constructive. The greatest mistakes in journaling, I find, are:

1) Lack of Specifics - The journal contains vague, general intentions such as, "I need to trade less aggressively", without any indication of how the trader will accomplish this. If the intent is to trade less aggressively, then the journal should create a specific goal. An example from my own trading would be: "I'll enter positions with one unit and scale in with a second unit on the first pullback in NYSE TICK when my position is profitable." Notice how this makes the general intention so much more concrete. Now I have something constructive to implement and can grade myself on the implementation. If I only say, "I need to trade less aggressively", that's not goal-setting. That's Monday-morning quarterbacking, or me just wagging my finger at myself. Self-criticism by itself never improved anyone: it's self-criticism followed by constructive problem solving that does the trick.

2) Focus on Negatives - The worst journals are the ones that simply vent fear or frustration. They recite every bad or missed trade, everything that went wrong during the day. Not only is there an absence of constructive suggestions for improvement, but there is also an absence of ideas re: what the trader has done right. The idea is to learn from what you do right, not just what you do wrong. Indeed, focusing on strengths will enhance motivation and the sense of competence and efficacy. By staying exclusively problem-focused, it's all too easy to drain motivation and optimism.

So, how can we improve the above in a format for a trading journal?

My suggestion is starting the journal with a listing of your specific goal(s) for that trading day.
Those goals should be: a) chosen from your previous day's or week's trading; and b) taken from your trading rules. The goal should be either to improve a mistake you made, or to build upon something you did right. The goal should state specifically what you expect yourself to do during the coming day, so that you can rehearse the goal in your mind before the market opens and so that you can evaluate how you performed on the goal at the end of the day.

Notice that, before creating the journal, it's important to write out your trading rules in advance: everything that you want to follow to trade well. You can't hold yourself accountable for a rule that you don't create; that's perfectionism, and it's not helpful either. Rules should clearly state how you want to size positions, enter them, exit them, set stops, set exits, scale in and out of trades, etc. Your journal will track how well you follow these rules, not just whether you make money or not.

So you start with rules, notice when you do a particularly good or poor job following the rules, and then set goals for the next day based on the good or poor performance. The journal entry then gives yourself a grade at the end of the day for how well you performed on your goals and why you earned that grade. Include your daily P/L with your grade, so that you can quickly see how your performance rises and falls with your grades.

The journal keeps you constructive, keeps you learning, and keeps you working on the things that are most important. It is not a tool for simply rehashing the day or voicing your feelings; it is your tool for self-development: your means for coaching yourself.

RELEVANT POST:

When Coaching Works and Doesn't Work
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Using Trading Journals to Identify and Change Your Patterns

In my last post, we took a look at trading journals and how those can be used to improve performance. The report card format for journaling is particularly helpful for goal-setting, tracking progress, and recognizing patterns in our own trading. In this post, I'll review some of the patterns that most often appear across journal entries--and that are important to work on.

1) Patterns of Negative Self-Talk: These occur during frustrated moments in markets. We miss a trade, a trade blows through our stop, we give back our money on the day: all of these create frustration. This frustration then triggers an anger response that we direct toward ourselves. For example, we might find ourself saying, "Here it goes again! Other people are killing these markets, and I can't get it going." At that point, your frustration is no longer about the specific trade or market event, but is directed to *you as a person*. Trading should be about trading; not about you. After all, you wouldn't be boasting and crowing in the journal if the trade went your way. If you wouldn't like to hear your message coming from someone else (imagine your buddy at the workstation next to yours saying, "Whoa, dude, other people are killing these markets, and you can't get it going!") and if you wouldn't be speaking that way to your trading buddy, then you shouldn't be speaking that way to yourself. Interrupting that negative self-talk and turning your frustration toward a constructive kick in the pants ("C'mon, Brett, you know you shouldn't be trading so large in the chopfest. Let's stick with the rules!") can be very helpful in preventing frustration from snowballing.

2) Patterns of Impulsivity - Out of excitement, boredom, desire to regain profits, or overconfidence, you find yourself trading too frequently or with too much size. This, in turn, leads to uneven performance and outsized trading losses, which then produce discouragement. Many traders keep their goals--and their trading rules--taped to their screens; this helps keep them in the forebrain as a check on impulsivity. One trader I worked with actually had a brief checklist that he had to check off before placing any trade. This prevented him from acting hastily. If you can figure out the triggers that make you impulsive (sometimes these are winning trades, where you start playing with "house money"), you have a good chance to put on the brakes before you act on impulse.

3) Patterns of Fear - Particularly after losses, but sometimes after making money and being afraid of losing it, traders fail to act on good signals or do not size their trades adequately. The result is missed opportunity. Often this occurs if the trader is engaging in "catastrophizing": making a normal potential loss into something much larger. Worry, physical tension, and feelings of nervousness are great clues to track in a journal. Once you recognize your fear patterns, you can take some deep breaths, calm yourself, and focus on assessing opportunity (and focus on those trading rules). One way of breaking overwhelming fear after large losses is just to put on some small trades when your signals are good and get your rhythm and confidence back. Then you ramp back up to normal size in a gradual, but steady manner. Playing defense is not giving into fear: having rules about risk control and hanging onto a day's profits can help you distinguish the two.

Once you notice your patterns, it's easier to construct specific goals for the next day's and week's trade. The overarching goal is changing your patterns: controlling how you think and feel rather than having them control you. It's difficult to imagine changing your patterns if you're not aware of them in the first place!

RELEVANT POSTS:

Using Emotion to Change Emotion

Some 2007 Posts on Trading and Emotions
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Using Trading Journals to Improve Trading Performance

I've begun working with a small group of individual traders at proprietary trading firms using daily online journals as a foundation for our work. In this post, I'll describe one useful format for such journals and how they can useful for self-improvement as well.

We know from research in psychology that goal-settting is an effective tool for performance development. Goals should be:

1) Challenging, but attainable;
2) Limited in number
3) Accompanied by regular feedback to cement learning and tailor new goals.

A journal format that I like translates each goal into a "subject" in a "report card". For frequent traders (i.e., those who trade intraday and/or every day), a single grade at the end of the day (A, B, C, D, F) indicates the degree to which the goal was met that day. Beside each grade go comments and observations that explain why the grade was given. Ideally, these comments should include what was happening in markets (and trading) at the time; what was going on in terms of the trader's thoughts and feelings; and what the trading outcomes were.

An advantage of this format is that it places equal emphasis upon the identification and assessment of strengths (the "A" grades) as weaknesses (the "F" grades). It focuses traders on the most relevant areas for improvement and easily leads to new goal setting for the following day when a poor grade is received in a particular area.

Traders I work with email me the journal/report cards daily and I provide daily email feedback. We then "meet" weekly by phone to review the week, learn from recent efforts, and set overarching goals for the next week. By utilizing the online medium for coaching, we minimize time and expense and achieve much of the advantages of having a full-time personal coach.

This regularity of contact is especially useful in ensuring that problem patterns are identified quickly and do not snowball. The money saved in drawdowns as a result is significant. The report cards are also helpful in focusing traders on their strengths, so that they can take maximum advantage of what they're doing right.

I use a variation of this report card format myself and have found it helpful for my own development as a trader. The key to using it for oneself is setting regular time aside to review the card, identify specific goals and actions for improvement, and then tracking those efforts at change the next day--repeating this process through the week. My experience is that one can achieve a compounding of learning with such active review.

It's also possible to connect with peers for mutual mentoring by sharing online journals/report cards. This is one of the advantages of such social networking platforms for traders as Stocktickr. Like going to the gym with a buddy to keep each other focused and motivated, collaborating on journals can be a great way to build advantages of a trading group even when trading independently.

RELEVANT POSTS:

Trader Perspectives on Keeping a Journal

Turning Setbacks Into Goals
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Tracking the NYSE TICK and Other Wednesday Thoughts

Tracking the TICK: Several traders have emailed and asked about easy ways to track the distribution of the NYSE TICK, which (as I mentioned yesterday) caught the afternoon rally quite nicely. One simple method (top chart) is to create a moving average of the TICK (mine is a ten-period average of five-minute bars) and then track: a) whether the average is dominantly above or below the zero (black) line; and b) whether the average is upwardly, downwardly, or non-sloping. We can see how the blue TICK MA line stayed positive (and upward sloping) for most the afternoon.

Double Bottom?: The Banking Index ($BKX; bottom chart), for all the woes of the financial sector, could not make new lows during the recent market weakness, creating a nice double bottom pattern. We're now rallying very sharply off that bottom. Headlines feature scary bank news, but markets are forward-looking and may be indicating a degree of stabilization. The key will be the ability of some of these troubled investment banks and broker/dealers to hold their recent lows.

The Next Bubble? - Check out links from Abnormal Returns, especially re: how the next bubble has to be large enough to rescue us from this one. Also note the post on generating superior returns by pursuing hot anomalies in markets.

Brief Observation - When people heatedly challenge your views on markets, but offer no evidence or analytical reasoning to back their arguments, you know that theirs is a defensive reaction. At some level they know they're wrong, and they're feeling threatened. It's one of the best market tells I've found, which is why I never discourage nasty emails and blog comments.
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How Much Coaching is Enough: A Look at the Dose-Effect Relationship in Counseling and Psychotherapy

Those who engage in "coaching"--whether it be "life coaching", "executive coaching", or the coaching of traders in financial markets--are quick to point out that they do not engage in counseling or psychotherapy. This is understandable, as most coaches lack training in these fields. (How they can adequately distinguish those who need clinical vs. coaching services without such training is a question we'll leave to another day). Still, it is not clear that the interpersonal helping processes that are part of effective coaching are any different from those that typify effective counseling. Both are verbal, interpersonal vehicles for effecting targeted changes in thought, feeling, and behavior. Both begin with an initial assessment and progress through the development of a plan and the introduction of helping methods. Structurally, coaching and counseling are identical.

This similarity suggests that issues that have long interested counselors and psychotherapists are relevant to coaches. One of these is the dose-effect relationship: how much coaching is needed on average to achieve a particular change? Fortunately there is a rich research literature in this area that is relevant to coaches and those who purchase their services. In this and subsequent posts, I will explore the implications of this research.

My review of this literature back in 1994 found that the dose-effect relationship in the helping fields is a function of many different factors, including the following:

* Severity, Duration, and Complexity of Presenting Problems - On average, it takes longer to achieve a given level of benefit for people with severe problems (those that greatly impair functioning), chronic problems (those with longstanding concerns), and complex problems (those that manifest themselves in multiple, interacting ways).

* Nature of the Changes Sought - On average, changes in mood and attitude are achieved earlier than changes in actual functioning. With good coaching, for instance, a trader will start to feel better about his work before he actually starts to trade and perform better.

* Motivation and Involvement of the Person Being Helped - On average, those who are more motivated for change and who are more highly involved in the helping process achieve gains more quickly than those who are ambivalent about change or who are less engaged in change efforts.

* Readiness for Change - On average, those who clearly identify specific changes they wish to make and are ready to take action on those benefit from assistance more rapidly than those who need time to explore their thoughts, feelings, and behaviors and come to greater self-understanding prior to formulating targeted goals.

* Duration of Changes Sought - On average, changes can be initiated in a relatively brief time span, but it takes a greater dose of helping to achieve changes that will be longstanding. This is because of the phenomenon of relapse: if helping is too brief, changes aren't truly internalized and the risk of relapse increases significantly.

Research by Kenneth Howard and colleagues conducted in the mid-1980s--and later replicated by a variety of investigators--found that about half of all people seeking assistance in therapy achieve their gains within eight sessions. Once again, these favorable short-term outcomes were more common among those with less severe and less chronic problems than among those with pervasive and longstanding concerns. Indeed, when we look just at people with relatively mild and recent presenting complaints, the number achieving significant change within eight sessions soars to 75%. It is precisely for this reason that we should expect coaching to be an ideal medium for brief change, as coaching is explicitly aimed at non-clinical populations.

What this research suggests is that, if coaching is truly appropriate for an individual, it should be able to proceed in a relatively brief manner to achieve targeted changes. Long-term coaching may be as much an indication of practitioner shortcomings (or client dependency) as practical necessity.

One variable not commonly addressed in this research is the competence of the person providing helping services. An interesting recent study conducted at a training clinic (and therefore utilizing less experienced helpers) found an attenuated dose-effect curve overall: it took more sessions to achieve a given level of average benefit. An earlier investigation at a training clinic found that only 22% of clients achieved significant gains after 8 sessions, compared to the 50% reported in the literature. The first study also found reliable differences among helpers: some just seemed to yield better outcomes than others. It may well be that training and experience (as well as helping skill) enable helpers to more quickly establish good working relationships with others; target problem areas; and introduce methods for addressing these areas.

This is an important research finding, given the lack of substantive credentialing and experience among many who hold themselves out as coaches. With coaches as with traders, skill and experience appear to make a significant difference in generating outcomes.

RELATED POST:

Coaching the Professional Trader
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Stock Market Divergences and Other Pattern Recognition Themes for Tuesday

* Catching Divergences - I've recently been posting on the topic of market themes and divergence patterns. Today's trade provided a great example. Note the double bottom in the ES futures (top chart, blue arrow), as the index made a marginal new price low for the regular trading session. The NYSE TICK (bottom chart, blue arrow), however, showed distinctly less selling at the fresh price low. Indeed, that second low in ES was not confirmed by price lows in the Russell futures, the banking stocks ($BKX), or the Dow Industrials (DIA). Once the market rebounded from the divergence, the TICK began a positive shift in distribution (note the rising blue moving average line in the second chart), which helped keep traders on the right side of the market, participating in the major bear *pwnage. (Note: it's really the same pattern--just at a larger time scale--that I noted in the recent post on the bear market).

* Preparing for the Rally - Check out this great post from Charles Kirk, particularly the good questions to ask about the positions you're holding.

* Rally or Just Short Covering? - Trader Mike notes the Fed catalyst and asks the important question as to whether the initial short covering could attract the participation of bulls. The ability of the market to catch a second wind after the initial rally led to profit taking was a positive sign for bulls.

* Identifying Your Own Patterns - When you know your own patterns as a trader, you're more able to catch and modify them. Check out this excellent post from Ray Barros on "the power of questions" to identify our patterns.

* More Pattern Recognition - Check out the chart-based pattern recognition post on the Afraid to Trade blog that captured the day's action. And, for a different pattern that has worked exceedingly well, check out Kevin's post on the yen's relationship to the stock market.

* Questioning a Pattern - The Quantifiable Edges blog takes a historical look at divergence patterns in the new high/low data.

* An Online Newspaper - The Newsflashr site that I linked in a recent post was just featured in an article in the Boston Globe. Very useful service, IMO, for catching patterns in global news.
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An Oversold Stock Market Amidst a Crisis of Confidence

We've hit oversold levels (below -30) in my Adjusted Demand/Supply Index; as mentioned earlier, these levels have been associated with favorable returns 20 days out and overbought readings (above +20) have provided a nice heads-up for subnormal returns over that span. I generally act on these readings when we see a pattern of waning new highs in an overbought market and dwindling new lows in an oversold one. The new high/new low picture was mixed on Monday, with 20-day new lows across the NYSE, NASDAQ, and ASE exceeding the Friday level (223 new highs and 3318 new lows on Monday vs. 224 highs and 3150 lows on Friday), but 52-week new lows among NYSE common stocks, SPX stocks, and NDX stocks dropping from Friday to Monday.

Meanwhile, the crisis of confidence among financial issues continued unabated on Monday, which is one of those themes I've been tracking for overall market direction. The Cumulative NYSE TICK, which has been dreadfully weak of late, continued so on Monday--another useful gauge of daily market direction--no doubt reflecting sentiment among traders, who are seeing daily new lows among such stocks as GS, FNM, C, BSC, and MER. A look at the longer-term charts of these issues is truly harrowing: FNM has gone from about 70 in August, 2007 to under 20 on Monday; MER has been cut in half since June; and C has gone from 54 to under 20 in that same time period. Moreover, the rate of damage has been accelerating: C has moved from 26 to under 20 within the last two weeks; FNM has gone from about 30 to under 20; and MER has moved from 55 to 43 in that same span.

Nor has weakness been limited to financial shares. Among the 40 stocks in my basket (equally divided among 8 sectors from the S&P 500 Index), my measure of Technical Strength (short-term trending) is also at highly oversold levels that have typified recent intermediate-term market lows. Two of the stocks qualify as trading in uptrends, five are neutral, and 33 are in downtrends. The overall Technical Strength Index, at -2160, is near levels reached at the January market lows.

As the recent post emphasized, the selling extremes we've been seeing (such as those 3318 new 20-day lows) are consistent with a momentum low in the stock market (which tends to precede price lows), but to enjoy more than a bullish bout of short covering, we need to see confidence enter the financial sector and buying sentiment return to stocks overall (an upward sloping Cumulative NYSE TICK). I'll continue to watch those two tells for day-to-day market direction, even as I stay alert for evidence of dwindling new lows at these oversold levels and a potential market rebound.
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Why Financial Crises Are Inevitable

Thanks to a reader for passing along this hard-hitting and insightful post from Paul Wilmott. He makes the argument that we will have periods of wild market volatility for no fundamental economic reasons. He explains:

"Banks and hedge funds are in control of a ridiculous amount of the world’s wealth. They also trade irresponsibly large quantities of complex derivatives. They slavishly and unimaginatively copy each other, all holding similar positions. These contracts are then dynamically hedged by buying and selling shares according to mathematical formulae. This can and does exacerbate the volatility of the underlying."

He also points out that too much money will always chase too few products because large, undiversified bets with other people's money will always provide the most tempting returns for money managers.

In this vein, I highly recommend Richard Bookstaber's text "A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation" (Wiley, 2007). In his concluding chapter, entitled "Built to Crash?", he observes:

"...the positive effects of innovation come a a price. Innovation increases complexity. Many innovative instruments are in the form of derivatives with conditional and nonlinear payoffs. When a market dislocation arises, it is difficult to know how the prices of these instruments will react. Innovation and mechanical efficiency have also increased complexity by pushing markets to become more interconnected...The combination of tight coupling and complexity is a formula for normal accidents--accidents that are all but inevitable as a result of the structure of the system." (p. 255-256).

This line of reasoning has powerful implications for risk management. We tend to think of risk in terms of standard deviations and normal distributions. Financial systems, however, possess fat tails of returns--and increasing complexity may only increase this "fatness". We can calculate the historical odds of a market crash, but will such models accurately capture risk in systems of increasingly tight coupling?

Paul Wilmott concludes:

Banks and hedge funds employ mathematicians with no financial-market experience to build models that no one is testing scientifically for use in situations where they were not intended by traders who don’t understand them. And people are surprised by the losses!

If sophisticated mathematical models can't capture risk and complexity, can we expect the gut hunches of discretionary traders to do better? There's a lesson in all this, and it seems to be: The odds of catastrophic financial outcomes are greater than we estimate. Even when we think we're diversified, the tight coupling of complex, interwoven financial systems ensures that, at times of stress, correlations will tend toward one or minus-one.

Looking for more reading on complexity and how we are "fooled by randomness"? Check out Nassim Taleb's website and this excellent summary of his ideas. They provide a sobering perspective on how we don't really know what we don't know.

Indicator Update for March 10th

This will update my recent post on the market indicators and some of the conclusions from that review. Blogger is not allowing me to post charts, so please excuse their absence.

* New Highs/Lows - Friday we saw levels of new lows consistent with recent momentum lows in markets. There were 224 new 20-day highs against 3150 new lows. We also saw 97 new 65-day highs across the NYSE, NASDAQ, and ASE, against 1225 new lows. This represents significant weakness, but so far remains below the level of new lows registered in January. Similarly, if we just look at the common stocks traded on the NYSE, we had 7 new 52-week highs, but 246 new lows. Note that 52-week new lows in January swelled to over 700. Among S&P 600 small caps, Friday had 2 new 52-week highs and 80 new lows. (January's new lows exceeded 200). And finally, among the S&P 500 large caps, we had no new highs and 73 fresh annual lows. (January's new lows also exceeded 200). Long story short, there are divergences in the high/low data that make me question the downside from here.

* Sentiment - As my recent post indicated, sentiment is quite bearish and is beginning to hit levels associated with recent market bottoms. Shorter-term, we continue to see weakness in the NYSE TICK, with the cumulative line in a clear downtrend. I need to see evidence of buying interest in the TICK before aggressively pursuing the upside in this market. Seven of the last eight trading sessions have seen net selling in the Cumulative Adjusted TICK; my breakdown of buying vs. selling interest shows overwhelmingly above average selling pressure during that time. The coast is not clear for bulls unless and until this selling pressure abates and we see evidence of above-average buying (which has occurred only once in the past eight sessions).

* Overbought/Oversold - My Cumulative Demand/Supply indicator is a hair breadth away from the -30 level that has typified recent bottoms in the stock market. Supply has exceeded demand for six of the past seven trading sessions, which shows unusual sustained selling activity. (Recall that Supply and Demand are indexes of the number of stocks closing below vs. above the volatility envelopes surrounding their moving averages). Longer-term, we have 18% of SPX stocks trading above their 200-day moving averages and 14% trading above their 50-day moving averages--quite oversold, but still above the very low levels registered in January(14% and 8%, respectively).

* Advance-Decline Lines - We're seeing new lows in the AD Lines for NYSE common stocks and for NASDAQ 100 stocks, S&P 500 stocks, and S&P 600 stocks. It is clearly premature to be aggressively buying the market while this indicator remains in a downtrend across the board.

In sum, we're seeing levels in the indicators consistent with momentum market lows. Price lows can occur beneath such momentum lows, so it is not at all inconceivable that we could see more downside in the days to come. Indeed, recent activity has been skewed solidly to the downside, making bottom-fishing dangerous. Still, for the first time in this bear market, we're seeing divergences in the data even amidst the selling pressure and bearish sentiment. That has me questioning the longer-term viability of the downside.
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Stock Market Sentiment: What the Relative Equity Put/Call Ratio is Telling Us

As the chart above indicates, rises in the relative equity put/call ratio (which I operationalize as the 10-day equity put/call volume ratio divided by the 200-day ratio) have been reliably associated with market bottoms since 2004. On Friday, we saw the 10-day ratio exceed the 200-day ratio by over 20%.

Since 2004 (N = 1033 trading days), we've had 129 occasions in which the relative put/call ratio has met or exceeded the 20% threshold. Twenty days later, the S&P 500 Index (SPY) has been up by an average of 2.22% (103 up, 26 down), much stronger than the average 20-day gain of .11% (537 up, 367 down) for the remainder of the sample.

More broadly, when the relative equity put/call ratio has been above 1.0 (meaning that we're seeing more puts traded relative to calls over the past 10 days compared to the past 200 days), the next 20 trading days in SPY have averaged a gain of .84%. When the relative ratio has been below 1.0, the next 20 days in SPY have averaged a loss of -.31%.

While it is certainly possible for the market to get weaker in the short run even when the ratio has exceeded 1.20 (50 of the 129 occasions were down after five trading days), it's generally paid to fade extremes in the relative equity put/call ratio.

RELATED POSTS:

What We Can Learn From the Equity Put/Call Ratio

What to Expect When Equity Options Traders are Bearish
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More Insight Into How to Lose at Trading

In my August post on how to lose at trading the stock market, I examined what happened if a trader bought strength in a technical indicator and sold weakness. The result was consistent losing. Doing what seems obvious in the stock market, to paraphrase Joseph Granville, is obviously wrong.

Let's take a different approach to the issue. Suppose I want to make sure that a rising market is truly in an uptrend and not just making a random bounce. Similarly, I want to ensure that a downtrend is significant before I jump on board. So I construct an indicator that will tell me when a move is significant vs. random.

Specifically, I take a 20-day moving average of the S&P 500 Index (SPY) and calculate Bollinger Bands (a volatility envelope) above and below the average. The bands are set for two standard deviations of price movement. Thus, if the market closes above the upper band, that means that it has made a statistically significant move above its average. If it closes below the band, that means that the market has moved significantly below its average.

The strategy is to not assume a trend is in place until the market has moved significantly--not just randomly--in a directional fashion.

So how does such a strategy fare? Let's update a post from last May.

Over the last three years, buying closes above the 20-day bands and selling closes below the bands has given us 14 winning trades and 29 losers in SPY for a net loss of 20 points (the equivalent of 200 S&P cash or futures points). The average gain for winning trades was .48 point in SPY. The average size of losers was .31 point. The setup captures larger winners than losers on average, but cannot make money because there are so many more losing trades than winners.

Of the 43 trades, 25 were long and 18 were short. Among the long trades, there were 11 winners and 14 losers. Of the 18 short trades, only 3 were winners and 15 were losers.

The superior performance on long trades suggests that, when this setup works, it captures the longer-term trend in the market. Interestingly in this regard, all three winning short trades have occurred since July of 2007, which is when the current bear market began. When the setup trades against the market's longer-term trend, the results are abysmal.

So what does this tell us? If we wait for a trend to become "significant" and obvious, it is too late. There is no systematic edge chasing a move that has already closed outside a volatility envelope. Indeed, to repeat a conclusion from my earlier post, pursuing a countertrend move outside the envelope has such a poor track record that it is promising.

The best way to lose at trading is to go with the obvious. I've argued in the past that the market is rigged against human nature: it is easy to lose money buying in an uptrend, and it is easy to lose money buying strength and selling weakness. Success comes to traders only when they overcome normal human biases.
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Weekend Links: Volume Two

* A Dash of Credit Market Insight - A Dash of Insight takes a look at the divergence between earnings expectations for stocks and messages from the credit markets. See also the ETFs currently recommended by their model.

* A Test of Technical Analysis - CXO Advisory reports on a study of over 7800 technical analysis rules applied to long-term Dow Jones Industrial Average data and finds room for skepticism.

* Where Jobs Are Being Lost - Calculated Risk looks at the data and the toll being taken by the housing slowdown.

* What If the Fed *Doesn't* Go 75 bps? - Econobrowser looks at implications for commodities.

* Finding Yield - Retail investors are jumping into municipal bonds, attracted by yields favorable compared with taxables, according to Accrued Interest.

* It's Who You Know That Counts - Research Recap reports on a very surprising predictor of analyst accuracy with stock recommendations.

* Next We'll Get Rid of Bars on Charts - StockTickr finds an unusual aid to trading that makes a good amount of psychological sense.
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Trading by Patterns and Themes

We had a great setup this afternoon that followed the post on themes quite nicely. We saw weakness in the morning, a sharp rally, then a new low in the ES futures (top chart) that was not confirmed by the Russell 2000 Index (middle chart) or by the NYSE advancing minus declining stocks (bottom chart). It's those moves to new lows that can't attract the broad participation of the market that are most likely to reverse, generating a move to at least the midpoint of the day's range. That's been especially true of moves that cannot attract the participation of the financial stocks, which have been a particular bellwether of late. Like the Russells, the financial sector (XLF) and bank stocks ($BKX) held above their morning lows on the afternoon decline.
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Friday Trading Links - Volume One

* Good Sentiment Observation - I see Trader Mike is noticing hits on his site coming from traders of inverse ETFs. Very nice potential sentiment tell. Put/call ratios have been very high this week; I'll post on that over the weekend.

* Preparation for the Trading Day - Meanwhile, in case you haven't noticed, Mike posts both swing trade candidates and daily stock names for his watchlist; very useful for active traders. Here's a link to his swing trading rules. Charles Kirk also features a pre-opening list of gainers and losers, with chart links. (Note the wide range of topics Kirk is addressing with members of his site; looks great). More preparation for the day is offered by Alpha Trends, which summarizes technical themes and trading ideas in a useful video format. Excellent resources.

* Peer Effects - Very interesting idea from Abnormal Returns that pertains to trading firms as well as blogs: excellence among peers make us better. Check out the recent links at Abnormal Returns, including posts on worrisome credit spreads.

* Weakening Trend - The Big Picture charts the weakening jobs picture and the troubling picture with home equity.

* Best of Chris - Chris Perruna links his top 20 posts: good weekend reading here.

* Fascinating Indicator - VIX and More tracks the SPX:VIX ratio and finds a possible turn in the tide.
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Potential Fissures in the Bear Market Foundation

I'll be posting my full indicator review this weekend; here's last week's review for reference. We're getting into the area where we're testing closing price lows from January; whether those levels can hold or not is the crucial question facing traders in coming days.

Thursday we saw 317 new 20-day highs and 2268 new lows across the NYSE, NASDAQ, and ASE. A little further out, we have 128 new 65-day highs against 914 lows. Compare this with the 3943 new 65-day lows at the January lows, and you can see that most stocks have not exceeded those lows. Going still further out and looking only at common stocks that trade on the NYSE, we see that, on Thursday, we had 13 new 52-week highs and 181 new lows. That is the highest level of new lows since the January bottom, but note that at that prior bottom we had 700 new lows among NYSE common issues. Indeed, we're seeing many fewer new lows now than January across all major exchanges and indexes.

Meanwhile, we're getting oversold. Among S&P 500 stocks, we are again seeing less than 20% of stocks trading above their 50-day moving averages, which has marked recent intermediate-term lows. Interestingly, we're seeing 22% of SPX stocks trading above their 200-day moving average, which is above the 14% level seen in January--another potential divergence.

On the bearish side, we're seeing new Advance-Decline lows for NYSE common stocks and S&P 600 small caps, but not yet for SPX stocks.

To be sure, stocks are still weak; they could get weaker and still maintain these divergences. My Demand figure closed at 20 on Thursday, with Supply at 139. That means 7 times more stocks are trading below the volatility envelopes surrounding their moving averages as trading above them. Still, my Cumulative Demand/Supply indicator, which has done a superlative job of tracking intermediate-term highs and lows in recent months, is nearing a buy signal at -23.

All in all it's prudent to wait for signs of growing strength in the indicators before making major commitments to the upside. And I'll want to see some indications of confidence in financial stocks and credit markets before putting considerable risk on the long side.

But make no mistake about it: the bearishness is thick. We've had put volume exceeding call volume for equities for five consecutive sessions. The traffic on my website has once again swelled, as at the March, August, and January lows. Back in July, when stock indexes were near their highs, the indicators were showing cracks in the bull market foundation. Now we're seeing potential fissures on the bear side. That has me still quite cautious, but ready to pounce if and when the bears are forced to cover their quite exposed backsides.
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Insights Into Human Greatness

"It was during this period that I realised I had discovered one of the secrets of human existence: if I maintained a high level of inner pressure, and declined to allow my mind to collapse into tiredness or boredom, everything went well. When I didn't, they went badly. The major problem of human beings is a tendency to allow our energies to leak. And as soon as they leak, consciousness is dimmed, and we become subject to accident."

Colin Wilson
Dreaming to Some Purpose
p. 17


“Without struggle, no progress and no result. Every breaking of habit produces a change in the machine.”

"The evolution of man is the evolution of his consciousness, and "consciousness" cannot evolve unconsciously. The evolution of man is the evolution of his will, and "will" cannot evolve involuntarily. The evolution of man is the evolution of his power of doing, and "doing" cannot be the result of things which "happen."

G. I. Gurdjieff


"Divide in yourself the mechanical from the conscious, see how little there is of the conscious, how seldom it works, and how strong is the mechanical - mechanical attitudes, mechanical intentions, mechanical thoughts, mechanical desires."

P. D. Ouspensky


“We fear to know the fearsome and unsavory aspects of ourselves, but we fear even more to know the godlike in ourselves”

Abraham Maslow


"Anyone who fights for the future lives in it today."

“Achievement of your happiness is the only moral purpose of your life, and that happiness, not pain or mindless self-indulgence, is the proof of your moral integrity, since it is the proof and the result of your loyalty to the achievement of your values.”

Ayn Rand

Four Ways to Find Themes in the Stock Market

In my recent post, I talked about the importance of finding themes in the stock market and how those themes can be useful in identifying turning points. But how does a trader find themes? How can an active trader stay focused on his or her market and yet keep vision broad enough to detect the thematic shifts that occur when trends change? Here are three ways to find stock market themes that I've observed among the traders I've worked with--and that I have therefore modeled in my own trading:

1) Make News Part of Your Daily Preparation - I cannot emphasize this highly enough: if you know what large market participants are tracking, you can anticipate their behavior. This means following the news that they follow. Many times breaking news stories can be useful in identifying themes early. For instance, I quickly picked up on U.S. jawboning of OPEC and tensions between Venezuela and Columbia as items that could affect the oil markets (and therefore that stock sector). There's a reason portfolio managers keep a Bloomberg news ticker on their screens, even though they are not necessarily frequent traders: they want to catch trends and ideas as those unfold. I like the Bloomberg web site, which categorizes stories by region and asset class. A particularly useful application is the Newsflashr site, which taps directly into the world's major news feeds and automatically updates and sorts news as it is disseminated. The news feeds are truly global, and a handy "cloud" at the side of the page helps you find hot news topics. I just clicked on the "business" section of the site and, scrolling down the page, found the five top themes in the recent news, along with links that are accompanied by Alexa ratings for those news sources (if you want to focus on the most popular news outlets). Over time, you can see how these news themes shift, giving you a feel for what might be influencing portfolio managers.

2) Track Market Commentary - The blogosphere is especially useful as a way of taking the pulse of market opinion. Here the key is to focus on the most credible bloggers who themselves possess market expertise and/or manage money. Many of these well-informed sources can be found via the Seeking Alpha site, which regularly updates its content. Especially useful is the categorization of Seeking Alpha posts by region (U.S. markets, Global) and market (ETFs, Sectors). This makes it easy to scan posts on particular topics and look for your favorite commentators. Alternatively, you can track the Seeking Alpha page specific to each commentator and bookmark their contributions (here's my page, for example). Want to catch commentary from traders themselves? The Instant Bull site (from the creators of Newsflashr) pulls posts from market message boards and categorizes by topic, so that you can get a feel for trader "buzz". This is especially helpful when tracking themes relevant to specific stock names. Although it's subjective, I find that tracking commentary overall can be a useful contrary indicator: when the buzz on a theme becomes too dominant, we're often ready for a near-term reversal.

3) Track Markets and Asset Classes Other Than Your Own - My trading screen typically tracks the NQ, ER2, and ES futures on a one-minute basis, so that I can see if small cap and NASDAQ stocks are confirming moves in my primary market (the S&P 500 Index). As my earlier post emphasized, I also keep an eye on 5-minute charts of the various S&P 500 sectors, so that I can identify divergences that emerge during the day session. I also periodically look at charts of asset classes that affect the stock market, including currencies (yen is a favorite), interest rates (yield curve as well as rates for specific Treasury instruments), and commodities (oil, gold). Many times, these intermarket relationships provide overall clues as to whether market participants are mostly risk-seeking or risk-averse, which typically translates into bullishness or bearishness regarding stocks. I also like to track international markets--particularly during pre-opening hours--to get a feel for how markets are processing global news. It's important to have a data provider that can give you global market information on a real-time basis. Very often, you'll see a shift in a correlated market or sector (e.g., interest rates, yen, financial stocks) seconds before a corresponding shift occurs in the stock indexes. Those are useful "tells" for the short-term trader.

4) Track Economic Indicators and Expectations - You'd be surprised how many active traders don't know the economic news reports scheduled for the day or their significance. They blithely trade in the morning, only to get "run over" when a news reaction creates a violent short-term movement. Many traders listen to the financial news channels on TV simply to hear breaking economic reports; websites such as Briefing.com and Bloomberg are also useful in identifying which reports are scheduled during the day and what the expectations are. Very many times, you can identify when the stock market is in a trending mode vs. a range mode simply by observing how stocks (as well as interest rates and currencies) behave once an economic report comes out. If the report cannot move rates or currencies out of trading ranges, it's much more likely that any initial reaction in stocks will be reversed. The same is true for Fed announcements. Knowing ranges in the major asset classes and seeing how markets behave relative to those ranges when economic news hits is one of the most useful theme-builders for morning trading in the U.S., I find.

In my Twitter posts, I try to identify major themes affecting markets and provide a heads up for economic reports, as well as market indicators. Every trader, however, depending on market and time frame, has to find user-friendly ways of detecting market themes of greatest relevance. Many, many traders grow frustrated and trade poorly because they don't see market moves coming. They are so busy watching their market that they don't see the themes shifting around them. In trading it helps to have binoculars as well as a microscope. The big moves are dictated by the big picture, and that picture is always changing.

RELEVANT POST:

Why Your Trading Isn't Working Out
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Cross-Talk: Once You Own It, It Owns You

Dr. Richard Peterson, in a recent post, provided an excellent example of the endowment effect: how we lose our objectivity once we take ownership of an asset. He brought pens to a seminar, but only had enough for half the audience. He then asked the group that received the pens to indicate how much they'd be willing to sell them to those who did not receive them. He also asked the group without pens how much they'd be willing to spend for one of the pens. The audience members without pens were willing to spend an average of $1.35 for a pen (which is close to the pen's intrinsic value), but the members who received pens insisted on a selling price averaging $8.80.

Once the audience members owned the pens and considered them their own, they systematically overvalued the pens' worth. Similarly, once we take a position in the market, it becomes *our* position and we value it simply because we have made it our own. That makes it extremely difficult to take a loss on our position, even when that is what our trading plans call for.

It's a bit like houses in the current weak housing market: many owners are unwilling to reduce the selling prices of their properties because they value their homes too much. Once we own the asset, it can own us by coloring our perceptions and actions.

I've noticed over the years that, when I'm trading well, my eye is on the stop-loss points for my positions, not on the potential price targets and profits. Explicitly spelling out how much I'm willing to lose on an idea and then staying focused on that scenario forces me to accept the possibility of loss, rather than fight it. It is a psychological trick that keeps me from getting married to my idea. By the time I put the position on, I'm already mentally prepared for it to fail.

That might sound like twisted logic to some: how can you feel confident about trading if your focus is on losing? But confidence doesn't simply come from winning; it comes from knowing that you can handle losing. By embracing the possibility of loss, we make sure that when we own a position, it won't end up owning us.

RELEVANT POST:

Psychological Risk Management
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Thinking in Themes

When we think of trading "themes" in the markets, we naturally think of portfolio managers and longer-term investors: those who trade fundamentals and relationships among asset classes. But there is much to be said for theme-based thinking among shorter-term market participants as well.

In my recent post, I emphasized the importance of confirmations between movements of an index (such as the S&P 500 Index futures, above) and the movements of component sectors (such as the S&P 500 Index financial stocks, XLF, below). As you can see from the charts, the financial stocks (like the consumer staples, healthcare, and utilities sectors) did not confirm the 13:00 PM CT low in the ES contract. That led to a sharp reversal shortly thereafter, as selling pressure could not sustain a broad market decline.

But there's another way of thinking about this pattern. We know from the news (and my recent Twitter posts) that weakness among financial issues has been a major market theme. When sellers have aggressively pushed these stocks lower, the broad market has generally followed. In that sense, the financial stocks have been an excellent barometer for stock market sentiment, especially around risk-assumption and risk-aversion.

When we have a low in the broad index that is *not* confirmed by a bellwether sector, the market is telling us that--at least in the short run--the market theme is not operative. Despite the price lows in ES, there is some relative risk appetite among the weakest stocks, the most vulnerable sector. This is very important market information.

Knowing the market bellwethers at any given time and tracking their performance vis a vis the broad averages is a kind of thematic thinking that can lead to excellent intraday trade ideas. For the trader looking at the ES contract only, the afternoon rally came out of the blue. The thematic trader, however, saw the divergence and was not surprised by the reversal.

RELEVANT POST:

Trading by Intermarket Themes
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Tuesday Ramblings From Brett

Hi All,

I've spent the last two hours answering emails from readers and traders. Amazing how much is going on. Having come back from visits to trading firms in the UK recently, on the docket the next few weeks are trips to meet with traders in Chicago, NY, CT, FL, and MA. What that tells you is that current market conditions are challenging even for experienced, professional traders. With volatility up, correlations among markets high, and plenty of violent countertrend moves, it's a time to preserve capital as well as pursue opportunity. I met with quite a few traders today in Chicago, and the best ones are picking their spots and being patient. When there's good movement in markets, you don't have to press to make things happen.

I also had an excellent meeting with my editor at Wiley, and it looks as though we have a very early January, 2009 publication date for my new book. This one will be a very practical guide for traders that outlines literally hundreds of exercises and techniques that traders can use to help themselves with both the psychological and performance aspects of trading. Many thanks to those who expressed interest in contributing to the new book. Incorporating ideas and techniques from others will make the book far more well-rounded than if I were the only one sharing resources.

Here's an idea that I'd like some feedback on in the comments section, if you're so moved: Remember the "Trading Coach Project" I did with "Trader C", in which I provided over a month of free coaching in return for the right to post our work on the blog? I'm thinking of extending the project to an entire trading firm. I would work for a month or so with the traders at the firm free of charge, and they--in return--would allow me to share information about the coaching with readers. It would be a rare look inside a professional trading firm: what they do, how they do it, and how they work on themselves. Any thoughts?

As always, thanks for the interest; it's much appreciated--

Brett

Training for Traders at Proprietary Trading Firms

I've been receiving an above-average number of email inquiries from people wishing to join training programs at proprietary trading firms. Although I don't maintain a referral list of such programs (the Education Department of the Chicago Mercantile Exchange has a list of member prop firms; they're a useful source of education and information), I can give you an idea of what to look for during your search.

First let's review terminology: A proprietary trading group is a group of traders that trades the capital of the firm. The firm puts up the trading capital and provides risk management, computer (IT) support, office space, and brokerage arrangements. This is in contrast with a trading arcade, which provides office space, computer support, and brokerage, but does not provide trading capital. It is a group environment for trading your own money.

A proprietary group typically generates its income from a split of trading profits, as well as by charging fees for overhead ("desk fees") and commissions. An arcade often acts as broker and makes its money from fees and commissions, but--because the trader is trading his/her own capital--does not typically take a large share of trading profits.

As a rule, firms that generate more of their own income from a split of trading profits have a greater vested interest in providing traders with ongoing training. After all, if the traders succeed, they succeed as a firm. When a firm is making most of their money from commissions, they'll generate income whether traders are profitable or not. They have less of an incentive to provide ongoing training.

Most prop firms and arcades are small operations when compared with investment banks and hedge funds. Rarely can they afford full-time staff dedicated to training. This is not necessarily out of a lack of interest in training; it's a simple economic reality. New traders trade small, and even with training, a high percentage of new traders do not succeed in the long run. It is very challenging to make a dedicated training program pay for itself.

As a result, much training at prop firms is either informal--the result of connecting with a senior trader and obtaining advice and mentoring--or is limited to several-week courses that precede live trading. Of course, it's too much to expect that a several week course could lead one to trading proficiency. Mostly the courses teach traders the basics, such as how to use the trading platform, how to manage risk, etc. It's the follow-up to the course work that is all-important.

So here are a few things to look for if you're interested in a proprietary trading firm:

* Is there a person (or persons) at the firm who take a dedicated interest in training and actively participate in mentoring new traders?

* Is there an actual training course or program that precedes live trading?

* Is the trading firm invested in training? Do they obtain a significant share of their income from splitting profits with traders?

* Does the trading firm enable you to practice trading in simulation mode prior to going live? Is someone available to provide feedback about simulated trading?

* Does the trading firm demonstrate and explain specific trading methods/setups and provide tools for identifying and trading these?

Here's an example: I'm currently working with a firm (*please* do not ask me for the name; all firms I work with are entitled to anonymity) in which the head traders share their trades with the new traders in real time. This provides valuable ongoing modeling and education. They don't have a formal course, but instead embed training into each trading day. That's the kind of commitment you want to see from a trading firm.

Of course, you'll have to match that commitment with your own. Stated motivation is not enough. I strongly, strongly recommend that traders trade in simulation mode and live (with small size) on their own prior to trying to join any prop firm. There is a great deal you can learn on your own and with online resources (including blogs and live trading rooms) and books. If you can demonstrate a favorable learning curve to a prop firm, you will be someone they want to train. For more advice on joining a prop firm, check out this post.

RELEVANT POST:

How Can I Join a Trading Firm?
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Using Stock Sector ETFs to Identify Short-Term Market Reversals

As you can see from the chart of the ES futures above, the market made a marginal low for the day at the second blue arrow before retracing much of the day's range. My research finds that, when stock indexes make relative highs or lows that are not confirmed by a significant number of the index components, the odds of reversal are greatly enhanced.

With the ES, an easy way to check on the behavior of index components is to track the S&P 500 sector ETFs, most of which are quite actively traded. The new lows in the afternoon in ES were confirmed by new lows in the energy sector (XLE); technology sector (XLK); and a very marginal new low in the materials sector (XLB). The new lows were not confirmed by the important financial sector (XLF); industrials (XLI); consumer discretionary sector (XLY); consumer staples (XLP) ; or (narrowly) healthcare (XLV).

In general, when half or more of sectors or stocks are not confirming a move, that's when you want to be on the lookout for reversal. In practice that means that short-term traders need to be watching more than the cap-weighted index they're trading, as a few highly weighted stocks can paint a misleading price picture on the screen.

RELEVANT POSTS:

Using Intraday New Highs/Lows to Gauge Market Trends

What We Can Learn From New Highs/Lows
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A Daytrading Pattern With the NYSE TICK

As long-time readers know, one of the market indications I follow is the distribution of the NYSE TICK as that unfolds during the day. This morning provided a particularly good illustration of a short-term pattern that I find especially useful: a series of rising bottoms in the TICK, suggesting that selling pressure is drying up over time. Once we see price moving to relative highs from one TICK peak to the next, those successive drops in the TICK become nice entry points on the long side. The price lows at recent TICK bottoms also provide a natural stop loss point for the quick daytrade.
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Following the Financial Stocks

The banks continue to underperform, and GS has moved to a new low this AM. If institutional investors don't have confidence in the financial system and are aggressively selling these shares, it's difficult to imagine sustaining a bull move in stocks. Indeed, short-term traders have done well by playing off relative strength and weakness in the financial sector, as these stocks are capturing the hopes and fears of large market participants.
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Indicator Update for March 3rd

In my last indicator update, I concluded that, "All in all, the evidence is suggesting an absence of bullish interest, as observed in the NYSE TICK, the weak new highs/lows, weak momentum, and tepid AD Lines." This past week, not much has changed that assessment.

* New Highs/Lows - We can see from the top chart that new 20 day lows vs. highs have continued to expand, with 395 NYSE, NASDAQ, and ASE stocks making fresh highs and 1665 making new lows. As long as new lows are expanding, it is premature to be bottom-fishing for anything other than a short-term trade. At a wider time frame, we had 15 NYSE common stocks register fresh 52-week highs on Friday, against 99 new lows. The latter is the highest number of new lows since the January bottom. Among S&P 500 stocks, we had no annual highs on Friday against 26 new lows; among S&P 600 small cap issues, we had 2 new 52-week highs and 37 new lows. All in all, we're seeing a deterioration of strength, though new lows are well off their very expanded levels from late January.

* Cumulative Adjusted TICK Line - Note from the second chart above how the recent market bounce was not at all confirmed by our Cumulative Adjusted TICK Line, suggesting that bullish participation was waning. Since then, we've broken to new lows in the Line, confirming what we're seeing among the new highs/lows. We need to see bullish sentiment sustained before we can put in a durable market bottom. The TICK Line bounce from the January lows was impressive, but has since faded. My readings from Thursday and Friday suggest both an absence of buyers (low positive TICK readings) and an excess of selling pressure (extreme negative TICK readings).

* Overbought/Oversold - The bottom chart tracks the cumulative line for my Demand/Supply Indicator, which has been a very good overbought/oversold measure of late. We see deterioration in the cumulative line in keeping with the new highs/lows and TICK, as we've entered oversold territory. Note that readings below -30 have typified recent market lows on a short-to-intermediate term basis; we're currently around -10.

* Advance/Decline Lines - The AD Line for NYSE common stocks remains above its January lows, though not by much. The same is true for the AD Line specific to S&P 500 and NASDAQ 100 stocks, but we're seeing marginal new lows in the AD Line for the S&P 600 small caps and the broad NASDAQ Composite. This is telling us that small caps have resumed weakness relative to large caps. All of these lines are in downtrends longer-term.

* Momentum - Among S&P 500 stocks, we're seeing 24% trading above their 50-day moving averages, a significant deterioration from the 55% at the recent market peak. Similarly, we're seeing 29% of S&P 600 small cap stocks trading above their 50-day MAs, down from 51% recently. My Demand/Supply measure of short-term momentum was very weak on Friday, with Demand at 24 and Supply at 228. It is not at all unusual for momentum to hit extremes before we see actual price highs or lows for a market move.

All in all, we continue to see deterioration in the indicators and a possible test of the January lows in the making. I am not inclined to buy this market until we see definitive evidence of greater buying interest, momentum, and strength.
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Cross-Talk: The Challenge of Hiring Successful Traders

I noticed that Barry Ritholtz recently linked my post on expertise. This is a topic of tremendous relevance to professional trading firms that face the challenge of hiring successful traders.

A number of trading firms that work with me begin by asking my help for their traders, but then expand the scope of our collaboration to aid with the hiring process itself. The simple economic reality is that it is much cheaper to hire the right people than to hire struggling traders who require extensive support and risk management.

Hiring successful traders is more of a challenge than one might think. Partly this is because we don't have a great deal of research to draw upon to predict trading success from failure. Often, trading firms make the (flawed) assumption that success is a function of personality traits, leading them to seek people with the "right" interests and characteristics. Even a cursory overview of successful traders at any firm, however, reveals considerable diversity in personality features.

My personal experience across trading firms is that there is no holy grail of right traits that generate success, but the presence of certain characteristics can almost certainly ensure failure. Across dozens of trading firms, I don't think I've ever encountered a successful trader who displayed a high degree of neuroticism (tendency toward negative emotion) and a low degree of traits related to risk-taking.

A different approach to hiring successful traders is to focus on expertise, rather than personality. That is, we look for talents and skills that are predictive of success for particular kinds of trading. An interesting article identifies five facets of expertise:

* Experts rely on experience to guide them, rather than explicit rules;
* Experts perform tasks automatically, rather than through (self-) conscious effort;
* Experts display significant efficiencies in processing information;
* Experts possess multiple strategies for dealing with challenging situations;
* Experts approach problems more flexibly than beginners, relying more heavily upon intuition.

As I indicate in an article from a few years back, much of expertise is the result of implicit learning. The expert trader is one who has experienced so many markets and market patterns that their response to these (and anticipation of these) becomes second nature. If a trader has career promise, he or she should show evidence of a learning curve that is consistent with expertise development. Instead of screening prospective traders for personality alone, trading firms should "get under the hood" and investigate a trader's actual trading statements and knowledge base for signs of growth and development.

The research I summarized in my book on performance is unequivocal: Those who develop expertise are immersed in their work--and in working on themselves as performers. There is a qualitative difference between the learning of the competent performer and the learning of the expert, and the difference can be traced to the nature and degree of the developing expert's immersion in his or her craft.

We tend to make decisions based upon the information that is most readily available. Casual impressions from interviews and simple personality observations thus dominate the hiring landscape. To delve deeper into developing expertise takes a kind of expertise itself, which perhaps is the reason even very sophisticated trading organizations rely on relatively primitive hiring practices.

RELEVANT POST:

A Look at a World-Class Trader
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Abandoning the U.S. Dollar: A Look at World Interest Rates

Suppose we have a savings account at a bank that is paying 2%. Just down the road are banks offering 4% and 6% for identical accounts. What are we likely to do? All things being equal, we'll pull money from our bank and seek the higher returns of competitor institutions.

So it is in the world money markets. Take a look at government interest rates around the world as of Friday:

THREE MONTH (TWO YEAR) RATES:

U.S. - 1.84% (1.62%)
U.K. - 5.2% (4.07%)
Japan - .57% (.56%)
Germany - 3.96% (3.16%)
Brazil - 11.8% (12.46%)
Australia - (6.72%)

So we have six banks, called U.S., U.K., Japan, Germany, Brazil, and Australia. In a relatively short period of time, the U.S. bank has cut its interest rates to dollar holders to become more like Japan than Europe or Brazil. From that perspective, it's not surprising that dollar holders have fled the currency in favor of the alternatives. After all, why not sell low-yielding dollars in favor of higher yielding currencies and invest in resource-rich areas such as Brazil and Australia--particularly when the management of the U.S. bank is signaling even lower rates ahead?

RELATED POST:

Identifying Market Themes
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Musical Interlude #2

The cats and I are up early as usual, and it's a writing day today as I add another chapter to the new book. While the rest of the family sleeps, I thought I'd post what we're listening to as a follow up to the recent musical interlude:

* VNV Nation - Illusion: "The world is just illusion, trying to change you." (Doll Face video from Andy Huang).

* Assemblage 23 - Drive: "Sometimes I drive to run from all my demons."

* Cruxshadows - Birthday: "So look at your life: who do you want to be before you die...you haven't got forever."

* The Arcade Fire - No Cars Go: "Between the click of the light and the start of the dream."

* London After Midnight - Sacrifice: "Darkness...it's all I want to see."

* Eisbrecher - Ohne Dich: "What is the sun without your light?"

* Morrissey - I Have Forgiven Jesus: "I carried my heart in my hands, do you understand?"
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UltraShort ETFs as a Sentiment Gauge

In my last post, I mentioned that volume has been exploding in such UltraShort ETFs as QID, which takes a double-sized short position in the NASDAQ 100 Index.

Because QID (and its S&P 500 Index equivalent, SDS) expresses an aggressive bearish opinion on the market, it might be ideally suited to serve as a sentiment gauge. A look at the trade data finds that at recent market bottoms, such as March, 2007; August, 2007; and January, 2008, daily QID volume has expanded to twice or more of its average trading volume. That is, traders seem to become most aggressively bearish just as markets are making an intermediate-term low.

It's in that vein that I note, with Friday's stiff decline, that trading volume in QID did not show any expansion. Indeed, it was slightly below its 20-day moving average. It's when the ultra bears become ultra bearish that I will be most likely to look for a meaningful market bottom.

RELEVANT POSTS:

NASDAQ Volume and Sentiment

Sentiment and the Last Hour of Trading
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Identifying Market Themes From ETF Performance and Volume

A very nice set of ETF resources can be found on the Morningstar site, which tracks the returns of ETFs over 1 month, 3 month, 1 year, 3 year, and year-to-date time frames and ranks the ETFs by trading volume. A particularly unique feature identifies ETFs relative to their "fair value", so that investors can identify undervalued opportunities. A screener also helps traders identify ETFs by their investment style, returns, and expense ratios.

When we look at ETF performance and volume, we can gain some insight into hot market themes. Not surprisingly, ETF daily volume is dominated by the SPY and QQQQ instruments for the S&P 500 Index and NASDAQ 100 Index, respectively. After that, it gets interesting. The third most popular ETF as of Thursday's trade was the S&P 500 Index financial stock sector ETF, XLF. It is down over 11% over the past month, compared to SPY, which is only down 2.58% over that same period. The high volume decline suggests widespread pessimism about this sector, despite Fed (and sovereign wealth fund) attempts at relief.

Fourth and sixth in volume are the UltraShort vehicles for the QQQQ (QID) and SPY (SDS). These enable traders to take double-size short positions on the indexes, and thus are instruments favored by very bearish participants. Since the start of 2007, 20-day volume in QID, for example, has expanded over 10 times. Once again this speaks to the pessimism of market participants--and their desire for leverage, a theme I'll be touching upon in my next post.

Significantly, we have ETFs representing market indexes from Japan (EWJ), Emerging Markets (EEM), Brazil (EWZ), EAFE (EFA), and Taiwan (EWT), and Hong Kong (EWH) in the top 20 volume list--a strong indication of the degree to which investors and traders are taking a global perspective on markets and diversifying beyond the U.S. It is interesting to see the Brazil ETF at #9 in volume, given that it is up over 9% in the past month--a clear outperformer relative to U.S., Asian, and European bourses.

Finally, also within the top 20 ETFs for volume are instruments for S&P 500 energy stocks (XLE), S&P 500 materials stocks (XLB), and gold (GLD). This is a clear reflection of the flow of money into commodities and commodity-related issues. All three are up on a one-month basis, a notable contrast to the broad indexes, which are all lower over that period.

The above, of course, is a static view of volume and performance. It is the flow of funds in and out of ETFs that help us identify sectors and themes gaining favor. By tracking these statistics over time, we can follow in the footsteps of institutional investors and ride important market trends.

RELEVANT POST:

Tracking the Stock Market's Largest Traders
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