* Have we put in a durable bottom in stocks? - I've been writing for a while about the drying up of stocks making new lows as we tested the January lows in March. Since that time, we've bounced nicely and are hugging that major resistance area around 1400 in the S&P 500 Index. I've also noted of late that the recent market strength has been accompanied by waning participation to the upside and uneven sector performance. We need to see the broad range of stocks in gear to the upside to confirm that this is more than just a catch-up move of beaten down stocks, sectors, and asset classes at the expense of first-quarter winners. I'll be looking to see if the Fed announcement can generate the rising tide that lifts all boats. Conventional wisdom has stocks selling off at the prospect that the Fed may be finished with its easing; less conventional wisdom (which I prefer) suggests that such a shift in Fed policy might be seen as a vote of confidence in credit markets and the economy.
* Will deflation or inflation concerns rule the markets? - Watch the fixed income markets in the wake of the Fed announcement. Will we see the risk-averse flight to quality, with rising Treasury prices and falling yields? Or will we see money continue to move from safety toward riskier assets, as has occurred this past week, with Treasury rates rising and yield spreads narrowing vs. mortgage-backed and high yield debt? The Fed may well offer a balanced perspective in their statement to preserve flexibility at future meetings, but the bond markets will tip us off to the market's interpretation of Fed priorities. Conventional wisdom is still focused on weak housing, and even the taxi cab driver seems to know about LIBOR. Less conventional wisdom is focused on the breakout moves we've already seen in yield spreads.
* Will sector themes mirror confidence or lack of confidence in the economy? - I've mentioned at numerous points over the past few months the importance of the financial sector and especially the bank stocks. With Citi's recent move for further cash infusion, those stocks have seen a recent resumption of weakness. Keep an eye on them in the wake of the Fed announcement. It is very difficult for me to believe that we'll sustain a bull move without confidence in the banks. But I'm aware that conventional wisdom is also focused on financials; less conventional wisdom also sees the influx of funds into consumer discretionary stocks vs. staples at the same time that commodities have been falling and the U.S. dollar has shown a bit of strength. I'll be watching the latter trends carefully as a barometer of nascent economic confidence.
Themes and transitions among themes reflect the flows of funds within and across asset classes. Even short-term traders can benefit from standing back and seeing where capital is flowing and why. The upcoming Fed meeting should prove instructive in this regard.
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Wednesday, April 30, 2008
Tuesday, April 29, 2008
Thematic Shifts Among Stock Market Sectors
Going into tomorrow's Fed announcement, we've seen significant changes in sector themes. Many of the sectors that were most beaten down during the market's selloff are now performing well. Interestingly, this has occurred at the same time that Treasuries--which had been strong during the selloff with the flight to quality--have sold off. It appears that we have been making a gradual shift toward risk-taking among stocks. This has helped the consumer discretionary, financial, and technology stocks in particular.
Below are the eight S&P 500 sectors that I track closely, along with their Technical Strength reading (a measure of short-to-intermediate term trending) and the percentage of stocks within the sector trading above their 50-day moving averages:
Materials (XLB): -60 (54%)
Industrials (XLI): +140 (77%)
Consumer Discretionary (XLY): +360 (70%)
Consumer Staples (XLP): -120 (59%)
Energy (XLE): +240 (81%)
Health Care (XLV): -200 (51%)
Financial (XLF): +220 (65%)
Technology (XLK): +260 (70%)
Some of the sectors that had been strongest during the market weakness (Consumer Staples, Materials) have been weak of late. Consumer Discretionary shares, which had suffered with recession fears, have bounced back dramatically.
I will be watching to see how the Fed meeting affects these potentially important thematic shifts.
RELEVANT POST:
Sector Money Flows
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Below are the eight S&P 500 sectors that I track closely, along with their Technical Strength reading (a measure of short-to-intermediate term trending) and the percentage of stocks within the sector trading above their 50-day moving averages:
Materials (XLB): -60 (54%)
Industrials (XLI): +140 (77%)
Consumer Discretionary (XLY): +360 (70%)
Consumer Staples (XLP): -120 (59%)
Energy (XLE): +240 (81%)
Health Care (XLV): -200 (51%)
Financial (XLF): +220 (65%)
Technology (XLK): +260 (70%)
Some of the sectors that had been strongest during the market weakness (Consumer Staples, Materials) have been weak of late. Consumer Discretionary shares, which had suffered with recession fears, have bounced back dramatically.
I will be watching to see how the Fed meeting affects these potentially important thematic shifts.
RELEVANT POST:
Sector Money Flows
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The Perils of Achievement Motivation: When Traders Press Too Hard to Win
A deadly pattern among some of the best traders is to channel achievement motivation into trading *more*.
The best traders do have a strong achievement motivation and work quite hard at their craft. That achievement drive makes them hate losing. Their impulse is to go for the jugular; they want to not only achieve, but achieve *more*.
This drive can be a trader's greatest weakness, however. It can lead to stubborness in taking losses, leading to outsized losses. It can also lead to overtrading, as the driven trader attempts to *make* things happen. That is a particular recipe for disaster on slow, narrow days such as yesterday, when it's easy to get chopped up jumping aboard seeming trending moves.
The net result is that *pressing* to achieve can take the trader out of his or her game. It subverts risk management by leading the trader to trade too large, without careful attention to stop loss points. It also interferes with decision-making by leading the trader to take trades without an objective edge.
A good analogy is the fighter who goes for the knockout on every punch, leaving himself wide open to jabs and punches from the opponent. When the boxer is *too* aggressive, defensive skills go out the window. So it is with the trader.
Another analogy is the soldier in the battlefield. Too hyped up and too aggressive, he may charge out of his foxhole and make himself an easy target for the enemy. Sometimes the best strategy is to maintain control and pick off the enemy sniper-style.
How can you know if this is a problem for you? If you keep metrics of your trading results, you'll see that the average size of your losing trades exceeds the average size of the winners. You'll see that your biggest losing days are ones in which you trade most often and with largest size, particularly when the market was showing no special opportunity. You'll also know by your state of mind: traders who *press* to win typically experience high degrees of frustration when the profits don't come quickly.
If these are concerns for you, self-control strategies such as meditation and biofeedback can be tremendously helpful. How to use such strategies will be the focus of my next post.
RELATED POSTS:
The Most Important Skill Traders Need
Biofeedback for Performance
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The best traders do have a strong achievement motivation and work quite hard at their craft. That achievement drive makes them hate losing. Their impulse is to go for the jugular; they want to not only achieve, but achieve *more*.
This drive can be a trader's greatest weakness, however. It can lead to stubborness in taking losses, leading to outsized losses. It can also lead to overtrading, as the driven trader attempts to *make* things happen. That is a particular recipe for disaster on slow, narrow days such as yesterday, when it's easy to get chopped up jumping aboard seeming trending moves.
The net result is that *pressing* to achieve can take the trader out of his or her game. It subverts risk management by leading the trader to trade too large, without careful attention to stop loss points. It also interferes with decision-making by leading the trader to take trades without an objective edge.
A good analogy is the fighter who goes for the knockout on every punch, leaving himself wide open to jabs and punches from the opponent. When the boxer is *too* aggressive, defensive skills go out the window. So it is with the trader.
Another analogy is the soldier in the battlefield. Too hyped up and too aggressive, he may charge out of his foxhole and make himself an easy target for the enemy. Sometimes the best strategy is to maintain control and pick off the enemy sniper-style.
How can you know if this is a problem for you? If you keep metrics of your trading results, you'll see that the average size of your losing trades exceeds the average size of the winners. You'll see that your biggest losing days are ones in which you trade most often and with largest size, particularly when the market was showing no special opportunity. You'll also know by your state of mind: traders who *press* to win typically experience high degrees of frustration when the profits don't come quickly.
If these are concerns for you, self-control strategies such as meditation and biofeedback can be tremendously helpful. How to use such strategies will be the focus of my next post.
RELATED POSTS:
The Most Important Skill Traders Need
Biofeedback for Performance
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Monday, April 28, 2008
Musings for a Monday
* Lack of Follow Through - A number of traders have mentioned to me how difficult they've found the trading over the last several months. It's almost as if each day has its own theme and pattern, with little follow through from one day to the next. I took a look at the daily money flow figures for the 80 S&P stocks across the eight sectors, as posted earlier today. Just looking at the data since the beginning of November (N = 120 trading days), it turns out that when money flows have been positive on the day, the next day in SPY has averaged a loss of -.42% (12 up, 22 down). When money flows have been especially negative on the day, the next day in SPY has averaged a gain of .34% (16 up, 13 down). Moderately negative money flows on the day have led to very flat performance. When we get solid buying in stocks, it's tended to not follow through, but when we've had strong selling among stocks, it too has tended to reverse. Not an easy market for short-term trend followers.
* Advance-Decline Perspectives - The excellent chart above from Decision Point shows the advance-decline line specific to common stocks only within the NYSE universe. This is a great representation of the strength and weakness within the broad market. Note that the AD line has gone nowhere of late, even as price has ground higher. This fits with the observations from the recent indicator review, which noted diminished participation during recent market strength. I find Decision Point's coverage of indexes and sectors quite helpful, with indicators not found elsewhere.
* Worth Reading - The Kirk Report links many interesting themes, including solar stocks that look good; quite a list of trading tips; and a useful ETF performance tracker. Also check out the links from Abnormal Returns, including an interesting study that shows how past positive experience (reinforcement) affects future investment decisions.
* Web 3.0? - Fascinating article on how information from blogs and other sources is being aggregated in real time to create a new kind of news.
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Indicator Review for April 28th
This is the 1500th post to the TraderFeed blog, going back to December, 2005. Three of the past four months have hit high water marks for numbers of visits to the site. Add those 1500 posts to nearly 2500 Twitter "tweets" and the information starts to add up! I want to thank readers for their continued interest and support.
Last week's indicator review noted signs of market strength, but also some concerns on the horizon with respect to money flows into Dow stocks and the cumulative NYSE TICK. This week features much of the same, but with a few more cautionary notes regarding the price strength.
The top chart requires some explaining. I recently posted money flows from the ten most highly weighted stocks within eight S&P sectors: financial, consumer discretionary, energy, consumer staples, technology, materials, industrials, and health care. I combined the money flows from those 80 stocks (the specific issues are identified in the sector posts) to arrive at an estimate of money flows into and out of the S&P 500 Index.
If you review those sector posts, you can see that there are wide variations of money flow from sector to sector. That tells us that we are not seeing money being put to work in the market in a broad-based fashion. Across the sectors, however, selling pressure (money outflow) has been waning, which you can see in the top chart from the rising lows in the five-day flow figures. Moreover, since the start of April, we have seen rather consistent flows into the S&P 500 stocks. To this point, flows are confirming the price highs that we've been seeing, but there are notable laggards among sectors--hardly a vigorous bull move.
This selective nature of the recent price strength can be observed in the new high/new low data (middle chart). Note that, during the recent move to price highs in SPY, new 20-day highs minus lows have been lagging. Moreover, this non-confirmation continues to show up in our cumulative NYSE TICK measure (bottom chart). Last week's indicator review highlighted the importance of the 1400 area as long-term resistance in the S&P 500 Index. If we are to sustain a break above that level, we need to see indications of expanding participation in the strength. While we *are* seeing expanded money flows across the sectors, the variability from sector to sector; the lagging number of stocks registering new highs; and the lagging cumulative TICK give this bull move something of a yellow caution light.
Here's a quick look at other indicators and what we might glean from them:
* Treasury interest rates have risen sharply in the past week, especially at the short end. There is growing speculation that the Fed may pause after one final interest rate cut this week. This is dollar supportive, but it also suggests that market participants are weighing the possibility that we're dealing with a normal recessionary economy, not a deflationary one requiring Japanese-style quantitative easing. It also indicates a much reduced need for the flight-to-safety trade, which frees capital for stocks.
* My Cumulative Demand/Supply measure, which has nicely tracked intermediate-term market peaks and valleys, is moderately overbought at a reading of +22. Readings of +30 and above have corresponded to 20-day periods of subnormal performance in the S&P 500 Index. We hit that +30 level back on April 18th. Interestingly, the recent price highs in SPY have occurred at lower levels in the Cumulative DSI, suggesting once again that fewer stocks have been displaying strong upside momentum as we've moved to the 1400 level in the June ES contract.
* We're seeing a continued expansion of stocks trading above their 200-day moving average. Among the S&P 500 issues, 46% are now above their 200-day averages, the highest level of 2008. That proportion is 39% for S&P 600 small cap issues, which have lagged a bit recently.
* Friday saw 51 new 52-week highs among NYSE common stocks and 23 new annual lows. That is significantly less than the over 100 new 52-week highs registered the prior week. I'm watching this closely; we need to see expanding new highs if the bull move is to be sustained.
* We continue to see technical strength within my basket of 40 stocks, with 27 issues trading in uptrends, 4 neutral, and 9 in downtrends. This is down from last week's peak, but still robust.
The bottom line is that we *are* seeing reduced selling in stocks and selective increased buying. How selective the buying remains--or how it can broaden out from here--will tell the story of whether we fall back into the multi-month trading range or sustain an intermediate-term move to new highs.
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Sunday, April 27, 2008
Money Flows Into the Materials, Industrials, and Health Care Sectors
My recent posts have examined money flows into the energy, technology, and consumer staples stocks as well as the consumer discretionary and financial sectors. (The latter post includes a detailed explanation of the money flow measure).
In this post, we take a look at five-day money flows plotted against the materials (XLB; top chart), industrials (XLI; middle chart), and health care (XLV; bottom chart) ETFs, which track the sector components of the S&P 500 large cap stock universe.
As with the earlier posts, I've taken the ten stocks most highly weighted within those ETFs to estimate sector money flows. Those stocks are as follows:
Materials: MON, DD, FCX, DOW, AA, PX, APD, NEM, NUE, X
Industrials: GE, UPS, UTX, BA, MMM, CAT, HON, EMR, DE, GD
Health Care: JNJ, PFE, MRK, ABT, WYE, MDT, LLY, GILD, AMGN, UNH
We can see from the top chart that, unlike the other sectors, funds have been consistently flowing into the materials sector, as the five-day average has spent much of its time above the zero line separating inflows from outflows. Note, however, that the most recent readings have been rather tepid. When XLB hit new price highs two weeks ago, money flows were lagging. When we had selling in the commodities last week, flows turned negative. This appears to be part of a shift out of the hot commodities stocks and into more beaten down areas, such as financials and consumer discretionaries.
Money flows for the industrials sector trace a pattern we've noted before: waning selling pressure since the January highs and net inflows since early April. As XLI has tested recent price highs this past week, money flow hit new highs before trailing off late in the week. The pattern of higher lows and higher highs in the five-day flow numbers suggests that investors have been putting money to work in this area.
Finally we have the weakest of the sectors: health care. Observe that, as the broad market has rallied of late, XLV has barely participated. Money flows have been rather consistently negative as well. We saw some inflows early this past week, but those have hardly been impressive. It is quite likely that investors, noting the health care reform ideas advanced by the Presidential candidates, are not aggressively dedicating capital to this sector.
Once again we can see how the flow of funds in and out of sectors captures important market themes. This is a promising measure of sentiment that I'll be covering in greater detail in the future.
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Money Flows Into the Energy, Consumer Staples, and Technology Sectors
My recent posts have tracked money flows to the consumer discretionary and financial sectors (see the latter post for an explanation of the money flow measure). Above we see five-day average money flow for the energy, consumer staples, and technology sectors plotted against their respective ETFs: XLE, XLP, and XLK.As with the earlier posts, I drew upon the ten most highly weighted stocks within each of those sector ETFs to estimate overall sector money flows. The stocks chosen were:
Energy: XON, CVX, COP, SLB, OXY, DVN, RIG, APA, XTO, HAL
Consumer Staples: PG, WMT, PM, KO, CVS, PEP, KFT, MO, CL, WAG
Technology: T, MSFT, CSCO, IBM, AAPL, INTC, HPQ, GOOG, VZ, ORCL
We can see from the top chart of the energy sector that the sector has been quite strong in terms of price action, following the strength of oil overall, but that money flows have been lagging. We've seen net inflows since the start of April--a pattern also noted among the financial and consumer discretionary shares--but those inflows have been modest. Indeed, with some selling in the energy markets this past week, flows actually turned negative among the energy issues of late. It's clear from the chart that selling pressure (outflows) has dried up since the January lows (another pattern we noticed in the prior two sectors reviewed), but we've yet to see investors devote funds aggressively to the sector.
The consumer staples sector (middle chart) gives us a different look altogether. Significant outflows from the sector have been seen even following the January lows--a possible result of a shift of priorities among investors from a more risk-averse stance to a more risk-seeking one (something we've seen of late in the Treasury market). Price of the sector ETF has lagged of late, and we are having trouble sustaining any kind of inflows to the sector.
The technology sector (bottom chart) shows particular strength, as outflows have been moderating since November, 2007 and inflows have recently hit new highs. Once again, this may reflect a shift in investor sentiment from a more defensive stance toward one that favors growth-oriented names, such as those found within the XLK universe. We're seeing multi-month price highs in XLK, and those are confirmed by money flow strength.
From this comparison, we can see how a sector-by-sector examination of money flows can provide us with insights into themes pursued by traders and investors. Because large transactions dominate the money flow figures, the sentiment of institutional traders is nicely tracked by the money flow measure.
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A Few Sites to Check Out
Video Reviews of Market Action - Those of you who enjoy Brian Shannon's work may have noticed that Blogger shut down his site as part of a review process concerning possible "spam blogs". This once happened to me and can take quite a few days to remedy. In the interim, you can find Brian's review of Friday action--and his other posts--at this blog URL.
Drinking From a Fire Hydrant - If you want to immerse yourself in market data and information--including much of the information most relevant to hedge fund portfolio managers--then check out the Between the Hedges site. Gary reviews his portfolio performance and gives his perspective on the markets. He also links a tremendous amount of news and market data. Fantastic site and resource.
Understanding Volatility - The VIX and More site does contain valuable trading information regarding the VIX (the topic of my next post), but there is More indeed. Bill has been covering the topic of implied volatility, including sector-specific implied volatility. Using options markets to understand sentiment in the broad stock market is quite helpful, and there are some gems in this site.
Mentorship Blog - Ray Barros is one of the very few trading coaches/mentors who actively trades and follows markets--and who freely shares his perspectives on markets and trading. His Trading Success blog contains a number of worthwhile lessons, including this one on trading and new experiences.
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Drinking From a Fire Hydrant - If you want to immerse yourself in market data and information--including much of the information most relevant to hedge fund portfolio managers--then check out the Between the Hedges site. Gary reviews his portfolio performance and gives his perspective on the markets. He also links a tremendous amount of news and market data. Fantastic site and resource.
Understanding Volatility - The VIX and More site does contain valuable trading information regarding the VIX (the topic of my next post), but there is More indeed. Bill has been covering the topic of implied volatility, including sector-specific implied volatility. Using options markets to understand sentiment in the broad stock market is quite helpful, and there are some gems in this site.
Mentorship Blog - Ray Barros is one of the very few trading coaches/mentors who actively trades and follows markets--and who freely shares his perspectives on markets and trading. His Trading Success blog contains a number of worthwhile lessons, including this one on trading and new experiences.
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Saturday, April 26, 2008
Money Flow Into the Consumer Discretionary Sector
My last post took a look at money flows within the financial sector of the S&P 500 large cap stock universe. (See that post for an explanation of money flow and how it is calculated).
The financial sector is especially important to market sentiment, given the concerns we've had over bank losses and credit quality.
A second sector I'm following closely is the consumer discretionary stocks, which are sensitive to consumer behavior--and hence the impact of recession. If the stock market is looking past recession to a recovery, we should see inflows of capital to the consumer discretionary area. If the market is anticipating deepening and more prolonged recession, however, we should see outflows from these shares.
The chart above depicts five-day money flows vs. the XLY (consumer discretionary) sector ETF. The flows are based upon the ten most highly weighted stocks within XLY. These are: MCD, DIS, CMCSK, TWX, HD, NWS, TGT, LOW, NKE, and VIA.B.
We can see a pattern in the money flows for consumer discretionary issues that is similar to the one we observed with financials and with the Dow Industrials stocks overall. Going into the January lows, we saw consistent outflows from the consumer discretionary sector and then sustained buying during late January and February. Outflows diminished with the March lows and, since early April, we've seen resumed inflows to the sector.
This pattern of waning selling sentiment since the January lows is confirmed by new high-new low data for the stock market overall and by my work on the Cumulative NYSE TICK. It is fair to say that the various measures taken to assist the economy, from rate cuts to infusions of capital into banks and fiscal stimulus, have stemmed selling pressure in the market.
It is also clear, however, that these measures have not generated significant inflows into stocks. While we've seen net inflows to the consumer discretionary area since the start of April, the most recent price strength in the sector has not been accompanied by meaningful dollar flows. The February rally in XLY failed when price highs late in the month came on diminished capital inflows. A similar pattern may be showing up during April's market. XLY has moved to new price highs, but money flows to the sector are lagging.
It is one thing to see a drying up of selling; it's another to sustain buying. So far we've seen a notable decrease in selling manifested across several sentiment measures. Buying sentiment, on the other hand, remains muted of late--something we will need to track as we trade at an important area of long-term price resistance in the broad market.
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Money Flow Into the Financial Sector
Money flow is a measure of the dollar volume that is moving into or out of individual equities. When a stock trades on an uptick, the price of the trade times the volume of that trade (i.e., the dollar volume) is added to a cumulative total. When the stock trades on a downtick, the dollar volume is subtracted from the total. By the end of the day, if the total (i.e., daily money flow) is positive, it means that dollars have been flowing into the stock--there has been net buying interest. If the total is negative, then money has been flowing out of the stock, suggesting net selling interest.
If we aggregate the daily money flow figures for individual stocks, we can make inferences as to the money flowing into and out of particular sectors and even the broad market. This is why I track money flows for the 30 Dow Industrial stocks. By examining flows from sector to sector, we can gain a more refined perspective on how funds are flowing *within* the stock market. This is invaluable information for stock pickers.
Note that we can view money flow as a sentiment measure, not unlike the NYSE TICK and Market Delta measures emphasized in the recent webinar. We're using activity at the market bid to indicate an aggressiveness among sellers and activity at the market offer to indicate initiating interest among buyers. By aggregating this behavior over the course of a day and then examining the flow of funds across days, we can detect shifts in sentiment toward stocks and sectors.
With that in mind, we can see from the above chart the financial sector of the S&P 500 Index (XLF) plotted against a five-day moving average of money flows for the ten stocks most highly weighted in XLF. Those stocks are: BAC, C, JPM, AIG, WFC, GS, WB, USB, AXP, and MS. The chart is constructed in Excel from data derived from Townsend's Real Tick platform.
As with the earlier post on money flow with the Dow stocks, we can draw two conclusions with respect to the financial sector:
1) Outflows have been waning since the January market low;
2) We have not seen massive dollar inflows into the sector.
To be sure, we *have* seen net dollar inflows into the financial shares since the start of April. These inflows, however, are not as great as those we saw at sector bounces in November, 2007 and late January, 2008. The good news is that steps taken by central banks and recapitalization efforts by banks have stemmed selling within the financial sector. The bad news is that those developments have not, as yet, led to broad-based buying of financial shares.
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Friday, April 25, 2008
Archived Webinar on Reading Market Psychology
Thanks to Bill and Trevor for quickly posting links to Thursday's Webinar on the IOAMT site and the Market Delta site. There are a few skips in the audio and you can tell that I'm not entirely past my laryngitis, but otherwise the archived session should be pretty intelligible.
I noticed that the detail in the charts that I displayed is a bit fuzzy in the archived playback, so I've posted the charts above. If you click on those, you'll see plenty of detail.
If you have any questions about the Webinar content, feel free to post them as comments to this blog post and I'll answer to the best of my ability.
I appreciate the interest--
Brett
Anticipating Reversals by Tracking Participation in Stock Index Moves
I want to thank everyone who attended the Webinar after the close yesterday. We had over 200 traders in the room; I hope they found the review of short-term sentiment measures and trading setups helpful. When the link for the archived Webinar is posted, I will point readers to it. Thanks to Bill of IOAMT and Trevor of Market Delta for hosting the program and making the archive available.
The Webinar focused on short-term sentiment measures: NYSE TICK and Market Delta. Another element that I find important in trading is participation. Participation refers to the proportion of stocks within a sector or index that are participating in a move when we reach new price highs or lows in that sector or index.
Many times an index will make new highs or lows simply because a relative handful of highly weighted issues are dominating the move. When a significant portion of issues are not participating in a rise or fall, that move is more likely to reverse. This is a principle that I find helpful across multiple time frames. That is why I monitor 20-day new highs and lows in my Twitter comments and in my weekly indicator reviews; it's also why I like to keep tabs on individual stocks and sectors intraday.
Very often, market reversals of direction are preceded by waning participation in moves.
Above we can see that principle illustrated in yesterday's market action in the Dow Jones Industrial Average (DIA) and the 30 Dow stocks. The chart tracks the number of Dow issues making fresh two-hour price highs minus those making two-hour lows; that number is updated every five minutes. Only closing five-minute prices are used for the calculation.
Early in the morning, the Dow moved lower, bounced a bit, and then moved to a new price low for the day. That price low did not show an expansion in the number of component stocks registering fresh new lows. That was a warning that the decline was running out of steam.
As the market reversed, new highs steadily expanded, which kept traders in the trending move. Note, however, that the fresh price highs around 2 PM ET were not confirmed by the new highs. This deterioration was a nice tell for the selloff late in the day: the rise was running out of steam. Waning participation preceded reversal.
It is not necessary to monitor all stocks within an index to track participation. Tracking individual sector ETFs can be a useful strategy as well. In general, if I see multiple S&P 500 sectors not participating in a move to new highs or lows in the ES contract, I will be likely to take profits if I'm riding that move, and I'll be likely to look for spots to fade the move. Combining assessments of participation (new highs/lows) with readings of shifts in sentiment (TICK, Market Delta) can be very effective in identifying directional changes in the indexes.
RELEVANT POSTS:
Detecting Participation in Breakout Moves
Participation: A Key Market Variable
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Thursday, April 24, 2008
Money Flows Into the Stock Market and What They're Telling Us
Quick review: dollar volume flows take every trade in every stock (in this case in the Dow Industrials) and multiply the price of the trade times the volume of the trade. If the trade occurred on an uptick, the dollar volume is added to a cumulative sum. If the trade occurred on a downtick, the dollar volume is subtracted from the sum. I then add the figures for all 30 Dow stocks to arrive at an estimate of dollar inflows and outflows for the broad large cap market. A positive figure for this money flow indicates capital being put to work in stocks. A negative figure suggests capital being withdrawn from stocks.
In the chart above, we see dollar volume flows into the Dow Jones Industrial stocks (pink line) plotted against the Dow Jones Industrial Average (DIA). Two immediate findings stand out from the chart:
1) Since the January lows, outflows from the Dow stocks have moderated;
2) Since the March lows, we have not been able to sustain significant inflows.
As we can see from the light blue line representing zero inflow/outflow, the five-day average of money flows is only slightly positive at present--and that was due to one solid day of inflows. After some sharp inflows following the January lows, we simply have not been able to keep money coming into the Dow issues.
The result of this has been a stalling of the market rise that began with the March lows. That stalling is visible in a number of the current market indicators. On Wednesday, for instance, we had 780 NYSE, NASDAQ, and ASE issues make fresh 20-day highs, but 723 register new lows. My measure of technical strength across the 40 stocks in my basket, drawn equally from eight S&P 500 sectors, shows 22 stocks in uptrends, 8 neutral, and 10 in downtrends. Three of the ten stocks in downtrends are from the banking sector, which continues to generate credit-related concerns.
Where does this leave us? Selling appears to be drying up, but we are also not seeing buyers flock into the current market. This dynamic is also apparent in the Cumulative NYSE TICK indicator, which has been weak of late. Given this indecision, the market may just remain in its longer-term range bound mode until it receives guidance next week from the Fed meeting.
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Wednesday, April 23, 2008
Webinar Update and a Few Wednesday Notes
* Tomorrow's Webinar - Here's the link for registering for tomorrow's Webinar, held after the market close and sponsored by the Institute for Auction Market Theory. Quite a few people have written to me, asking if the Webinar would be archived for those who aren't able to attend the event live. This is always my preference, especially in deference to those in Europe and Asia who are likely to find the time inconvenient. I just received word that the session *will* be archived; I'll post details once the link is up.
* A Portfolio of Blogs - Thanks to the Currency Trading site for this rundown of top trading blogs in various categories. There are quite a few I'm not familiar with and will check out as a result.
* Many Thanks to Readers - Who have forwarded links to interesting articles to me recently. I try my best to scour the Web (though Kirk leaves me in the dust!), but can't possibly get to everything. If you happen across an article about trading psychology or markets that is unique and informative, do send me the link at the email address posted in the "About Me" section of the blog. Also, if you know of unique trading websites and blogs, trading software, or other tools of value to traders, do pass those along to me. I keep the blog non-commercial, but always enjoy passing along resources to traders.
* Lots of Talk - About how interbank loan rate problems may impact the Fed. See also the LIBOR woes entry in the WSJ's Real Time Economics blog. Meanwhile, downgrades of subprime debt continue...and continue to weigh on markets. Hat tip to Barry Ritholtz for highlighting this informative piece on how the subprime situation developed.
* More Consumer Woes and Impact - Mish tracks soaring credit card losses and Calculated Risk updates estimates of housing losses.
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* A Portfolio of Blogs - Thanks to the Currency Trading site for this rundown of top trading blogs in various categories. There are quite a few I'm not familiar with and will check out as a result.
* Many Thanks to Readers - Who have forwarded links to interesting articles to me recently. I try my best to scour the Web (though Kirk leaves me in the dust!), but can't possibly get to everything. If you happen across an article about trading psychology or markets that is unique and informative, do send me the link at the email address posted in the "About Me" section of the blog. Also, if you know of unique trading websites and blogs, trading software, or other tools of value to traders, do pass those along to me. I keep the blog non-commercial, but always enjoy passing along resources to traders.
* Lots of Talk - About how interbank loan rate problems may impact the Fed. See also the LIBOR woes entry in the WSJ's Real Time Economics blog. Meanwhile, downgrades of subprime debt continue...and continue to weigh on markets. Hat tip to Barry Ritholtz for highlighting this informative piece on how the subprime situation developed.
* More Consumer Woes and Impact - Mish tracks soaring credit card losses and Calculated Risk updates estimates of housing losses.
.
Reading Stock Market Psychology
If you click the chart above, you'll see my annotations of the pre-opening Market Delta chart for the June ES contract. The point I want to emphasize is that reading the psychology of the market *before* the open is excellent preparation for the trading day.
First, a little orientation about the chart. We see price on the left and right vertical (Y) axes. At the left is the "Delta" at that price: the number of contracts that have been transacted at the market offer minus those transacted at the bid. When the color is green and the number beside price is more positive, it means that we have greater buying interest at that price. When the color is red and the number next to price at the left is more negative, it means that we have greater selling interest at that price.
So, along that left-hand Y-axis, we're seeing demand and supply at each market price. As the annotation at left indicates, we're seeing supply swamp demand as prices move lower: the numbers become *more* negative. Selling is not drying up as we move lower. Lower prices are attracting more sellers. This is what drives short-term market trends.
Along the X-axis, we have two sets of numbers. The top is total volume for the bar period (in this case 30 minutes). The bottom number is the Delta at that *time*. This shows us the net number of contracts transacted at the market offer minus bid over each half-hour period.
If we want to see how demand and supply are distributed *within* the bar period, we look to the numbers within the bar. The first is the volume transacted at that time and price at the market bid. The second is the volume transacted at that time and price at the market offer. When volume at bid exceeds volume at offer, that portion of the bar becomes red. When volume at offer exceeds that at bid, that portion of the bar becomes green. The mix of red and green within the bar--and from bar to bar--shows how market psychology, the shift of sentiment among buyers and sellers, evolves over time.
This view of changing market psychology within time periods and from one period to the next is especially powerful when correlated with total market volume. We can see this from the way the market topped out early in the morning. Note that during the period from 2:30 to 4:30 AM CT, the market was moving higher, but then stalled out in total volume (X axis, top number) and stalled out in the proportion of volume within each period dominated by buyers vs. sellers (less green than red). This stalling out of a market rise brought out the sellers, who then piled into the market during the 6:00 AM bar.
Once volume picked up dramatically during the selling, the bounce in the next bar was feeble, both in terms of price (amount of retracement of the recent decline) and in terms of volume transacted at offer vs. bid (very little green). This set us up for continuation of the downside move and a resumption of control by the bears.
During my Thursday Webinar, I'll have much more to say about reading market psychology. Every day in the market is an auction, and the price and volume figures reveal to us the relative interest of buyers and sellers in this auction. By understanding the dynamics of the auction prior to the market open, we can formulate hypotheses about the coming morning trade and become alert to any shifts that might occur in market sentiment.
RELEVANT POSTS:
Stock Market Reversals
Tracking Market Transitions
Breakout Trades
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Tuesday, April 22, 2008
Free Webinar This Thursday
Dear Readers,
I'm pleased to announce that, after the stock market close this Thursday (3:30 PM CT), I will be offering a free Webinar on the topic of "Reading the Psychology of the Market" hosted by Bill Duryea and the Institute of Auction Market Theory (IOAMT). I'll be delivering the session from the Chicago Board of Trade offices of Trevor Harnett, the developer of Market Delta, who will assist with the program. Access to the Webinar will be available to those who sign up for a free five-day trial membership to Bill's real-time trading room. It's a great opportunity to experience trading education in real time. During the trial period, as part of the trading room, Trevor will be conducting free educational programming regarding the use of Market Delta. Please note that he is also offering a free 30-day subscription to Market Delta--an excellent opportunity to kick the tires and see how the program works across different market conditions.
Before I launch into a description of the session, just a few disclaimers: I have no commercial ties to IOAMT or Market Delta and have insisted on receiving no compensation for the Webinar. Bill and Trevor offer services that I feel are of value to traders, so I'm happy to support their efforts. I've been a Market Delta subscriber for years and have found it to be a useful tool in reading volume/sentiment patterns in the market. A number of traders have reported positive things to me about the real-time trading room run by Bill--particularly his integration of Market Profile, Market Delta, and intraday trading principles. From my end, the Webinar is a vehicle for offering quality education to traders; I don't use it to solicit business personally, and I don't receive any compensation or consideration from IOAMT or Market Delta for my participation.
It's a shame I have to offer such disclaimers, but it's in response to the crass commercialism that dominates offerings in "trader education". So many programs are little more than infomercials. The Thursday Webinar will not be an infomercial!
The Webinar will run 1 hour in length, with time for questions/answers at the end. The focus will be on the psychology of the market--reading supply and demand as they unfold during the trading day--not so much on the psychology of traders themselves. Among the topics I'll touch upon are reading patterns across indexes and patterns in the NYSE TICK and Market Delta.
I have found--personally and in my work with developing traders--that Market Profile is an excellent conceptual framework for understanding what markets are doing and why. It's also a practical framework for thinking about price and volume relationships and when market moves are likely to extend vs. retrace. The integration of very short-term supply/demand analysis from Market Delta alongside the longer-term analysis of value from Market Profile yields many sound trading ideas and plans. The idea is to know *what* to do, but also *why* to do it. That yields mastery.
Look forward to seeing you on Thursday! As always, thanks for your interest--
Brett
.
I'm pleased to announce that, after the stock market close this Thursday (3:30 PM CT), I will be offering a free Webinar on the topic of "Reading the Psychology of the Market" hosted by Bill Duryea and the Institute of Auction Market Theory (IOAMT). I'll be delivering the session from the Chicago Board of Trade offices of Trevor Harnett, the developer of Market Delta, who will assist with the program. Access to the Webinar will be available to those who sign up for a free five-day trial membership to Bill's real-time trading room. It's a great opportunity to experience trading education in real time. During the trial period, as part of the trading room, Trevor will be conducting free educational programming regarding the use of Market Delta. Please note that he is also offering a free 30-day subscription to Market Delta--an excellent opportunity to kick the tires and see how the program works across different market conditions.
Before I launch into a description of the session, just a few disclaimers: I have no commercial ties to IOAMT or Market Delta and have insisted on receiving no compensation for the Webinar. Bill and Trevor offer services that I feel are of value to traders, so I'm happy to support their efforts. I've been a Market Delta subscriber for years and have found it to be a useful tool in reading volume/sentiment patterns in the market. A number of traders have reported positive things to me about the real-time trading room run by Bill--particularly his integration of Market Profile, Market Delta, and intraday trading principles. From my end, the Webinar is a vehicle for offering quality education to traders; I don't use it to solicit business personally, and I don't receive any compensation or consideration from IOAMT or Market Delta for my participation.
It's a shame I have to offer such disclaimers, but it's in response to the crass commercialism that dominates offerings in "trader education". So many programs are little more than infomercials. The Thursday Webinar will not be an infomercial!
The Webinar will run 1 hour in length, with time for questions/answers at the end. The focus will be on the psychology of the market--reading supply and demand as they unfold during the trading day--not so much on the psychology of traders themselves. Among the topics I'll touch upon are reading patterns across indexes and patterns in the NYSE TICK and Market Delta.
I have found--personally and in my work with developing traders--that Market Profile is an excellent conceptual framework for understanding what markets are doing and why. It's also a practical framework for thinking about price and volume relationships and when market moves are likely to extend vs. retrace. The integration of very short-term supply/demand analysis from Market Delta alongside the longer-term analysis of value from Market Profile yields many sound trading ideas and plans. The idea is to know *what* to do, but also *why* to do it. That yields mastery.
Look forward to seeing you on Thursday! As always, thanks for your interest--
Brett
.
Perspectives and Themes for Tuesday Morning
* Banks Continue to Struggle - While we recently hit multi-month highs in the number of stocks trading at fresh 65-day highs, banking stocks ($BKX) remain solidly lodged within their February-March trading range. As I noted in recent Twitter posts, both the Bank of England and the ECB have expressed continued concerns over banks and the credit crisis. I'm not sure the banks need to lead any market rally, but their failure to participate is concerning.
* The Virtues of System Trading - Bill Rempel offers some valuable elaborations to my recent trading psychology post by pointing to the strengths of developing and trading systems. Readers know that I am a discretionary trader, but I can vouch for the successes of those who develop and tweak systems that adapt to changing market conditions. Bill's point regarding the value of trading multiple systems that perform under varying regimes is excellent.
* It's Not Just Markets That Follow Seasonal Patterns - Thanks also to a reader for pointing me to the research of Dr. Richard Wiseman and this very interesting study of how personality patterns--including the perception of being lucky!--are related to the seasons of one's birth. Given the relationship between seasonality and mood, including the phenomenon of seasonal affective disorder, the findings aren't so far-fetched.
* Scenario Planning as a Guide to Action - Ray Barros continues to offer excellent guidance for traders, including this perspective on scenario planning. See also his scenario creation for discretionary traders.
* Valuable Perspectives - Trader Mike's recent links highlight discussions of stop-losses and algorithmic trading. From Abnormal Returns, we get some very interesting views, including a look at commodities and bond yields and how seasons affect the VIX.
* Can Positive Thinking Be Irresponsible? - Thanks to a reader for bringing this research report to my attention, highlighting how people edit their memories of past outcomes to justify continued gambling. It's much harder to engage in such distortion when you're tracking your trades and P/L in a journal (which may be one reason traders don't maintain journals).
* Comprehensive Psychiatry Textbook - Just received my copy of the mammoth fifth edition of the Textbook of Psychiatry from American Psychiatric Publishing, the publishing arm of the American Psychiatric Association. With over 1700 pages, the volume features chapters from recognized experts on topics ranging from psychiatric disorders to treatments and the needs of special populations. My chapter deals with brief therapies, including the approaches to short-term work that I utilize with traders.
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Monday, April 21, 2008
Why Every Trader Should Be An Investor
I find two things striking about a large number of active traders:
1) They're not prepared for failure - If trading doesn't work out for them, they don't have clear backup plans (and trading doesn't naturally lead to other careers);
2) They're not prepared for success - If trading does work out for them, how will they accumulate wealth over time and ensure their financial future?
In some ways, the latter problem is just as acute as the first. Making money, holding onto money, and accumulating wealth are very different things. Just because traders make money doesn't mean they know how to deploy that money wisely to build wealth. Indeed, I've seen many sad outcomes among those who have retained a trading mindset with respect to financial planning.
If traders are going to build a financial future, they need to think like investors. And that's not easy to do, when all your financial decision-making has been on the short term.
Fortunately, there are some valuable resources available to help traders make the transition to becoming personal money managers. Here are a few that have come to my attention of late:
1) The Disciplined Investor by Andrew Horowitz - This very accessible book is excellent for those needing an investment primer. Horowitz doesn't cover the full gamut of financial planning (insurance, estate planning, wills), but rather focuses on the range of wealth enhancement and wealth preservation opportunities via stock market investing, mutual funds, and annuities. He begins with "creating a discipline", offers background on quantitative, technical, and fundamental investment strategies, and launches into important material on risk management. It's clearly written and not at all intimidating for investment newbies. Andrew also maintains a blog and conducts frequent podcasts on investment themes.
2) Create Your Own ETF Hedge Fund by David Fry - This is a valuable introduction to the world of exchange-traded funds (ETFs), which are rapidly putting a variety of investment options--from bonds to stocks to currencies and commodities--in the hands of traders. Fry is the founder of the ETF Digest site, which tracks various ETF portfolios and includes weekly podcasts related to investment in ETFs. Fry's central thesis is that individual investors can replicate common and successful hedge fund strategies, from long/short equities to profiting from global macro themes. At the end of the book, he offers sample portfolios designed to meet a variety of investor needs. The book is very practical and quite clearly written.
3) The ETF Book by Richard A. Ferri - Ferri's book is a detailed look at the exchange-traded fund universe, covering various styles and choices among ETFs and then examining portfolio management options for ETF investors. A particularly worthwhile segment of the text applies different ETF strategies to investors in various phases of their life cycle. Ferri covers both passive and active portfolio strategies and offers clear, illustrative sample portfolios. If you're ever wondering which ETFs are available for particular kinds of investment, this book pretty well covers the gamut in a way that is not overly technical. Ferri has also written on asset allocation--an extremely important theme among investors.
What are some general lessons from these books that traders can draw upon in becoming more astute investors? These come to mind:
* You can't invest what you don't save - An investment plan starts with a cogent savings plan.
* Know your objectives - It's important to get a return on your capital, and it's important to ensure the return *of* your capital. Your investment strategy should be tailored to your risk tolerance, and that should reflect where you're at with respect to child bearing, retirement, etc.
* Know your alternatives - With a vast array of mutual funds, annuities, and exchange-traded funds, there are many ways of investing nationally, internationally, in stocks, and in other asset classes.
* Diversify, diversify, diversify - Even the greatest investments (think residential real estate of the last decade, or equities in China) can lose money quickly. Placing eggs in many baskets and ensuring that those baskets are not highly correlated in returns produces superior risk-adjusted returns over time.
You work for your profits; it's important to ensure that they work for you. The average savings rate in the U.S. has recently become negative; people are spending more than they earn. They have assumed that the rising values of their homes would fund their retirements. With the recent housing decline, that assumption will be called into question for quite a few of those folks. For them, retirement is a potential train wreck on the horizon.
That doesn't have to be you. Saving money and making it work for you in a carefully planned manner can ensure that earnings today become tomorrow's wealth of a lifetime.
.
1) They're not prepared for failure - If trading doesn't work out for them, they don't have clear backup plans (and trading doesn't naturally lead to other careers);
2) They're not prepared for success - If trading does work out for them, how will they accumulate wealth over time and ensure their financial future?
In some ways, the latter problem is just as acute as the first. Making money, holding onto money, and accumulating wealth are very different things. Just because traders make money doesn't mean they know how to deploy that money wisely to build wealth. Indeed, I've seen many sad outcomes among those who have retained a trading mindset with respect to financial planning.
If traders are going to build a financial future, they need to think like investors. And that's not easy to do, when all your financial decision-making has been on the short term.
Fortunately, there are some valuable resources available to help traders make the transition to becoming personal money managers. Here are a few that have come to my attention of late:
1) The Disciplined Investor by Andrew Horowitz - This very accessible book is excellent for those needing an investment primer. Horowitz doesn't cover the full gamut of financial planning (insurance, estate planning, wills), but rather focuses on the range of wealth enhancement and wealth preservation opportunities via stock market investing, mutual funds, and annuities. He begins with "creating a discipline", offers background on quantitative, technical, and fundamental investment strategies, and launches into important material on risk management. It's clearly written and not at all intimidating for investment newbies. Andrew also maintains a blog and conducts frequent podcasts on investment themes.
2) Create Your Own ETF Hedge Fund by David Fry - This is a valuable introduction to the world of exchange-traded funds (ETFs), which are rapidly putting a variety of investment options--from bonds to stocks to currencies and commodities--in the hands of traders. Fry is the founder of the ETF Digest site, which tracks various ETF portfolios and includes weekly podcasts related to investment in ETFs. Fry's central thesis is that individual investors can replicate common and successful hedge fund strategies, from long/short equities to profiting from global macro themes. At the end of the book, he offers sample portfolios designed to meet a variety of investor needs. The book is very practical and quite clearly written.
3) The ETF Book by Richard A. Ferri - Ferri's book is a detailed look at the exchange-traded fund universe, covering various styles and choices among ETFs and then examining portfolio management options for ETF investors. A particularly worthwhile segment of the text applies different ETF strategies to investors in various phases of their life cycle. Ferri covers both passive and active portfolio strategies and offers clear, illustrative sample portfolios. If you're ever wondering which ETFs are available for particular kinds of investment, this book pretty well covers the gamut in a way that is not overly technical. Ferri has also written on asset allocation--an extremely important theme among investors.
What are some general lessons from these books that traders can draw upon in becoming more astute investors? These come to mind:
* You can't invest what you don't save - An investment plan starts with a cogent savings plan.
* Know your objectives - It's important to get a return on your capital, and it's important to ensure the return *of* your capital. Your investment strategy should be tailored to your risk tolerance, and that should reflect where you're at with respect to child bearing, retirement, etc.
* Know your alternatives - With a vast array of mutual funds, annuities, and exchange-traded funds, there are many ways of investing nationally, internationally, in stocks, and in other asset classes.
* Diversify, diversify, diversify - Even the greatest investments (think residential real estate of the last decade, or equities in China) can lose money quickly. Placing eggs in many baskets and ensuring that those baskets are not highly correlated in returns produces superior risk-adjusted returns over time.
You work for your profits; it's important to ensure that they work for you. The average savings rate in the U.S. has recently become negative; people are spending more than they earn. They have assumed that the rising values of their homes would fund their retirements. With the recent housing decline, that assumption will be called into question for quite a few of those folks. For them, retirement is a potential train wreck on the horizon.
That doesn't have to be you. Saving money and making it work for you in a carefully planned manner can ensure that earnings today become tomorrow's wealth of a lifetime.
.
Indicator Review for April 21st
Last week's indicator review noted short-term weakness, but a longer-term pattern of market strength. With the drying up of selling early in the week, we saw buyers return to the market and push the major averages above long-term resistance. The number of stocks registering fresh 20-day highs moved higher, but did not expand above levels from early this month (middle chart), but we did see a significant expansion of stocks making fresh 65-day highs. The reduced number of new lows during market weakness and the expansion of new highs suggests that the market has been gaining strength.
That having been said, I can't say the picture is entirely rosy for the bulls. The Cumulative Demand/Supply Index (top chart) has touched an overbought level (+30), which has corresponded to subnormal price gains 20 days out. In a market gaining strength, that doesn't necessarily mean we'll see a major price reversal, but it does often lead to a period of consolidation and choppiness.
A little more concerning is the relative weakness of the Cumulative NYSE TICK line, which is not confirming its early April highs to this point (bottom chart). A similar picture is painted by my work on money flows into Dow Jones Industrial stocks. While Friday gave us the highest dollar inflows of 2008, the five-day flows are only barely positive. I will be watching the TICK line and dollar flows very carefully. A retreat from current levels and a price move of the major stock indexes back into their long-term trading range would call this past week's bull move into question and, indeed, target a return to the midpoint of that range.
Other indicators generally confirm the bullish action from the past week. As I mentioned in a recent Twitter post, we're now seeing 68% of SPX stocks trading above their 50-day moving averages, up from a little over 40% last week and 10% at the March bottom. We have to go back to October, 2007 to find a stronger reading. Similar readings are found among the broad list of NYSE stocks.
Furthermore, the advance-decline lines specific to the NYSE common stocks and the SPX stocks held their March lows last week and now have moved to multi-week highs. Also hitting multi-week highs is my measure of technical strength, with 3/4 of all stocks in my basket now trading in uptrends.
The all-important trading issue is whether the break above long-term resistance was genuine or whether it will turn out to be a false breakout trapping the bulls. While a good deal of evidence suggests that the move is for real, those on the sidelines may want to look for continued strength in the NYSE TICK and the money flow numbers before chasing price highs in a market that's becoming overbought.
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Sunday, April 20, 2008
Becoming Your Own Trading Coach: A Case Study
Yo, check it out, as Randy Jackson would say:
A young, developing trader emails me about his performance on Friday. The market gapped open strongly to the upside and he immediately found lagging stocks to short. I can only guess that his reasoning was based on the supposition that "gaps tend to fill", so that he'd benefit when the weakest of the stocks retreat with the broad market.
Lost, of course, was the fact that this was a very large upside gap, very broadly distributed across a range of sectors and issues. If our young trader had actually made a historical study of such very strong opens, he might have been less inclined to swim against the tide. And that 's not even taking into consideration that the market was breaking out of a long-term zone of price resistance.
So, OK, the young trader begins his day on a boneheaded note, at least in my book. His shorts start out profitable and then give back their gains, presumably as the broad market is roaring ahead. What happens now?
This is where our young, developing trader shows that he will someday be an old, experienced trader. He describes a rule he had set for himself, "If a position immediately went against me, if after one hour it was still a loser and not yet at my loss goal, then I would get out and move to the next trade." In other words, he doesn't wait for the position to put him deeply under water and he doesn't fight the market and add to his position out of frustration. He just moves on to the next trade.
But, as Randy would say, this is where our trader is hot: His "next trade" involved buying calls. Our young, developing trader flipped his position and aligned himself with the market direction. He took the time to reassess and then found opportunity based on what the market was doing, not based on what he thought the market *should* do. By 9 AM, he had turned his head around, setting up a profitable and successful trading day.
Compare our young trader with others who wrote to me after fading the market all day Friday. Their refrain was that the market *shouldn't* be rallying because economic fundamentals are so bad, earnings are so weak, etc. They were so locked into their opinions and scenarios that they couldn't see the lopsided nature of the day's trade.
Hey, we're all going to lose forest for trees and make some boneheaded calls. I could regale you with dozens of my own. What sets apart the traders with longevity is the ability to quickly recognize these mistakes and make mid-course corrections.
To have a strong enough ego to aggressively take on risk when you feel conviction about an idea, but also to have enough lack of ego to let go of those ideas when they're not working: that's a huge part of success and the mindset of an expert trader.
Oh, and by the way, our young trader concluded the email by emphasizing other mistakes he had made and wanted to work on next week. He's only been a trader for a few months and already he's coaching himself and preparing to put me out of a job.
I love that kind of unemployment. It keeps me well employed.
RELATED POSTS:
Becoming Your Own Trading Coach
Letting Profits Run by Coaching Yourself
Programming Your Experience as a Trader
.
A young, developing trader emails me about his performance on Friday. The market gapped open strongly to the upside and he immediately found lagging stocks to short. I can only guess that his reasoning was based on the supposition that "gaps tend to fill", so that he'd benefit when the weakest of the stocks retreat with the broad market.
Lost, of course, was the fact that this was a very large upside gap, very broadly distributed across a range of sectors and issues. If our young trader had actually made a historical study of such very strong opens, he might have been less inclined to swim against the tide. And that 's not even taking into consideration that the market was breaking out of a long-term zone of price resistance.
So, OK, the young trader begins his day on a boneheaded note, at least in my book. His shorts start out profitable and then give back their gains, presumably as the broad market is roaring ahead. What happens now?
This is where our young, developing trader shows that he will someday be an old, experienced trader. He describes a rule he had set for himself, "If a position immediately went against me, if after one hour it was still a loser and not yet at my loss goal, then I would get out and move to the next trade." In other words, he doesn't wait for the position to put him deeply under water and he doesn't fight the market and add to his position out of frustration. He just moves on to the next trade.
But, as Randy would say, this is where our trader is hot: His "next trade" involved buying calls. Our young, developing trader flipped his position and aligned himself with the market direction. He took the time to reassess and then found opportunity based on what the market was doing, not based on what he thought the market *should* do. By 9 AM, he had turned his head around, setting up a profitable and successful trading day.
Compare our young trader with others who wrote to me after fading the market all day Friday. Their refrain was that the market *shouldn't* be rallying because economic fundamentals are so bad, earnings are so weak, etc. They were so locked into their opinions and scenarios that they couldn't see the lopsided nature of the day's trade.
Hey, we're all going to lose forest for trees and make some boneheaded calls. I could regale you with dozens of my own. What sets apart the traders with longevity is the ability to quickly recognize these mistakes and make mid-course corrections.
To have a strong enough ego to aggressively take on risk when you feel conviction about an idea, but also to have enough lack of ego to let go of those ideas when they're not working: that's a huge part of success and the mindset of an expert trader.
Oh, and by the way, our young trader concluded the email by emphasizing other mistakes he had made and wanted to work on next week. He's only been a trader for a few months and already he's coaching himself and preparing to put me out of a job.
I love that kind of unemployment. It keeps me well employed.
RELATED POSTS:
Becoming Your Own Trading Coach
Letting Profits Run by Coaching Yourself
Programming Your Experience as a Trader
.
Saturday, April 19, 2008
A Few Trading Psychology Observations
* From working with developing traders, I'd say that 90% don't/can't sustain the process of keeping a substantive journal. Among the group that does journal, well over 90% of the entries are about themselves and their P/L. I almost never see journal entries devoted to figuring out markets.
* A sizable proportion of traders who have been having problems are trading methods and patterns that used to work, but are no longer operative. The inability to change with changing markets affects traders intraday (when volume/volatility/trend patterns shift) and over longer time frames (when intermarket patterns shift).
* It's a common observation that traders fail because they don't stick to their plans. My experience is different. Traders develop plans and trade patterns that simply don't work; they're based on randomness. When the patterns don't work, traders become frustrated and abandon their plans. So it looks like lack of discipline causes trading failure. But planning doesn't create success; sound planning does. Sticking to plans based on randomness is no virtue.
* I mentioned in my book an important law of performance: In every performance field of note--from Olympic athletics to Broadway--performers spend more time in practice than in formal performance. That is how expertise develops. The ratio of "practice" time (time spent on markets outside of trading) to trading time is a worthwhile indicator of a trader's prospective success.
* Among the predictors of trading success, a "passion for trading" is grossly overrated. The successful traders have a passion for markets, which is very different from a passion for trading. Indeed, a passion for trading in the absence of passion for markets is a fair definition of addiction.
* Some traders habitually look for tops in a rising market and bottoms in a falling one. There's much to be said for countertrend methods, but not when the need to be right exceeds the need to make money.
* An underrated element in trading success is mental flexibility: the ability to shift views and perceptions as new data enter the marketplace. It takes a certain lack of ego to form a strong view and then modify it in the face of new evidence.
* A trader I spoke with recently told me he was going to trade more aggressively by putting on more trades. Trading more frequently is not necessarily trading more aggressively, and it certainly isn't necessarily trading prudently. Trading more aggressively means allocating more risk capital to particular (sound) trade ideas. A considerable portion of traders would benefit from trading less frequently *and* more aggressively.
* Nice litmus test for any website devoted to trading education, coaching, and the like: If the site spends more time promoting the person than promoting ideas, you have a good sense for the site's priorities. Caveat emptor.
* Many traders fail because they're focused on what the market *should* be doing, rather than on what it *is* doing. The stock market leads, not follows, economic fundamentals. Some of the best investment opportunities occur when markets are looking past news, positive or negative.
* Success in trading requires the capacity for personal investment. Too many traders close out their efforts, along with their positions, at the end of the day.
RELEVANT POSTS:
What Trading Teaches Us About Life
Three Steps Toward Trading Improvement
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* A sizable proportion of traders who have been having problems are trading methods and patterns that used to work, but are no longer operative. The inability to change with changing markets affects traders intraday (when volume/volatility/trend patterns shift) and over longer time frames (when intermarket patterns shift).
* It's a common observation that traders fail because they don't stick to their plans. My experience is different. Traders develop plans and trade patterns that simply don't work; they're based on randomness. When the patterns don't work, traders become frustrated and abandon their plans. So it looks like lack of discipline causes trading failure. But planning doesn't create success; sound planning does. Sticking to plans based on randomness is no virtue.
* I mentioned in my book an important law of performance: In every performance field of note--from Olympic athletics to Broadway--performers spend more time in practice than in formal performance. That is how expertise develops. The ratio of "practice" time (time spent on markets outside of trading) to trading time is a worthwhile indicator of a trader's prospective success.
* Among the predictors of trading success, a "passion for trading" is grossly overrated. The successful traders have a passion for markets, which is very different from a passion for trading. Indeed, a passion for trading in the absence of passion for markets is a fair definition of addiction.
* Some traders habitually look for tops in a rising market and bottoms in a falling one. There's much to be said for countertrend methods, but not when the need to be right exceeds the need to make money.
* An underrated element in trading success is mental flexibility: the ability to shift views and perceptions as new data enter the marketplace. It takes a certain lack of ego to form a strong view and then modify it in the face of new evidence.
* A trader I spoke with recently told me he was going to trade more aggressively by putting on more trades. Trading more frequently is not necessarily trading more aggressively, and it certainly isn't necessarily trading prudently. Trading more aggressively means allocating more risk capital to particular (sound) trade ideas. A considerable portion of traders would benefit from trading less frequently *and* more aggressively.
* Nice litmus test for any website devoted to trading education, coaching, and the like: If the site spends more time promoting the person than promoting ideas, you have a good sense for the site's priorities. Caveat emptor.
* Many traders fail because they're focused on what the market *should* be doing, rather than on what it *is* doing. The stock market leads, not follows, economic fundamentals. Some of the best investment opportunities occur when markets are looking past news, positive or negative.
* Success in trading requires the capacity for personal investment. Too many traders close out their efforts, along with their positions, at the end of the day.
RELEVANT POSTS:
What Trading Teaches Us About Life
Three Steps Toward Trading Improvement
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Friday, April 18, 2008
Using a Basket of Stocks to Track the Stock Market
A few traders have emailed me, asking me to republish the names of the 40 stocks in my basket that I follow for technical strength. The 40 issues are evenly divided among eight S&P 500 sectors: Materials (XLB), Industrials (XLI), Consumer Discretionary (XLY), Consumer Staples (XLP), Energy (XLE), Health Care (XLV), Financials (XLF), and Technology (XLK). I chose the five stocks from each of the eight sectors, because they were among the most highly weighted issues within the sector ETFs.
I have found this basket of stocks to be invaluable. They tell me when sectors are moving in unison vs. traveling their own way--an issue relevant to the type of market we're in. The basket also helps me identify market themes: which sectors are leading and lagging. On an intraday basis, I use the 40 stocks to identify which stocks are making new short-term highs and lows as the broad market is making fresh price highs or lows. This is quite helpful in handicapping the odds of the move continuing vs. reversing.
Here are the stock symbols for the basket, arranged by sector:
In terms of technical strength, to wrap up the week, we find that 30 stocks in the basket are now trading in uptrends, 5 are neutral, and 5 are in downtrends. The rally has been broadening out to more stocks and sectors, which has been a very useful tell for trend followers. Not all trends are your friend, but the ones that gain strength as they progress are worth riding! The basket of stocks helps identify when trends are gaining and losing strength.
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I have found this basket of stocks to be invaluable. They tell me when sectors are moving in unison vs. traveling their own way--an issue relevant to the type of market we're in. The basket also helps me identify market themes: which sectors are leading and lagging. On an intraday basis, I use the 40 stocks to identify which stocks are making new short-term highs and lows as the broad market is making fresh price highs or lows. This is quite helpful in handicapping the odds of the move continuing vs. reversing.
Here are the stock symbols for the basket, arranged by sector:
Materials - DD, DOW, AA, IP, WY
Industrials - GE, UPS, BA, UTX, MMM
Consumer Discretionary - CMCSK, TWX, HD, DIS, MCD
Consumer Staples - PG, MO, WMT, KO, WAG
Energy - XOM, CVX, COP, SLB, OXY
Health Care - PFE, JNJ, MRK, LLY, AMGN
Financials - C, AIG, BAC, WFC, JPM
Technology - MSFT, INTC, IBM, CSCO, VZ
Industrials - GE, UPS, BA, UTX, MMM
Consumer Discretionary - CMCSK, TWX, HD, DIS, MCD
Consumer Staples - PG, MO, WMT, KO, WAG
Energy - XOM, CVX, COP, SLB, OXY
Health Care - PFE, JNJ, MRK, LLY, AMGN
Financials - C, AIG, BAC, WFC, JPM
Technology - MSFT, INTC, IBM, CSCO, VZ
In terms of technical strength, to wrap up the week, we find that 30 stocks in the basket are now trading in uptrends, 5 are neutral, and 5 are in downtrends. The rally has been broadening out to more stocks and sectors, which has been a very useful tell for trend followers. Not all trends are your friend, but the ones that gain strength as they progress are worth riding! The basket of stocks helps identify when trends are gaining and losing strength.
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Bandwagon Effects in the Stock Market
A little while back I posted about the increasing number of one-sided days in the stock market and how those are affecting traders. Yesterday I noticed another kind of one-sidedness: seven of the last nine trading sessions in the S&P 500 Index ($SPX) have closed either in the top or bottom quarter of their day's range.
This led me to examine more broadly the issue of how often stock indexes close near their day's highs or lows. If we divide each day's range into quartiles, then we would assume, over time, that a chance distribution would put 50% of market closes in the top or bottom quarter of the day's range and 50% in the middle two quarters.
That is not what we see in the data, however. Since July, 2007, two-thirds of all trading days closed either in the day's top or bottom quarter: 132 out of 200 days, to be precise. From January, 2000 through June, 2007, that ratio was 61% (385 out of 627 days).
If we tighten the criteria and divide each day's range into deciles, we can observe how often the market closes in the top or bottom 10% of its daily range. One would expect, by chance, that this would occur 20% of the time. Since July, 2007, however, it has occurred 77 out of 200 days: 38% of all occasions. From 2000 through June, 2006, we closed in either the top or bottom 10% of the daily range in $SPX 209 out of 627 days, or 33% of the time.
What we are seeing is that markets are closing near their day's highs or lows more frequently than we would expect by chance. This may reflect a bandwagon effect, in which traders and investors observe market movements during the day and don't want to miss out on them. This would lead them to buy rising markets and sell falling ones, creating late day strength or weakness. Regret and the fear of missing out on a market move would lead to increased trending behavior as the day progresses, creating a kind of one-sidedness to the trade.
This bandwagon effect, exaggerating market movements late in the day, tends to be unwound the next day. Going back to 2000 (N = 2082 trading days), we find the following average next day changes in $SPX as a function of the location of the prior day's close:
What this suggests is that, once a bandwagon starts during the day, it tends to persist into the close. Fading one-sided days, particularly of late, has not been a fruitful endeavor for traders. Expecting bandwagons to persist into the next day's trade, however, has also not been profitable. It appears that traders segment their performance day by day, perhaps jumping aboard trends in an effort to finish their days on winning notes. By the close of the next day, however, any such bandwagon effect has been erased.
RELATED POSTS:
Why It's Difficult to be a Trend Follower
Markets and Trending
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This led me to examine more broadly the issue of how often stock indexes close near their day's highs or lows. If we divide each day's range into quartiles, then we would assume, over time, that a chance distribution would put 50% of market closes in the top or bottom quarter of the day's range and 50% in the middle two quarters.
That is not what we see in the data, however. Since July, 2007, two-thirds of all trading days closed either in the day's top or bottom quarter: 132 out of 200 days, to be precise. From January, 2000 through June, 2007, that ratio was 61% (385 out of 627 days).
If we tighten the criteria and divide each day's range into deciles, we can observe how often the market closes in the top or bottom 10% of its daily range. One would expect, by chance, that this would occur 20% of the time. Since July, 2007, however, it has occurred 77 out of 200 days: 38% of all occasions. From 2000 through June, 2006, we closed in either the top or bottom 10% of the daily range in $SPX 209 out of 627 days, or 33% of the time.
What we are seeing is that markets are closing near their day's highs or lows more frequently than we would expect by chance. This may reflect a bandwagon effect, in which traders and investors observe market movements during the day and don't want to miss out on them. This would lead them to buy rising markets and sell falling ones, creating late day strength or weakness. Regret and the fear of missing out on a market move would lead to increased trending behavior as the day progresses, creating a kind of one-sidedness to the trade.
This bandwagon effect, exaggerating market movements late in the day, tends to be unwound the next day. Going back to 2000 (N = 2082 trading days), we find the following average next day changes in $SPX as a function of the location of the prior day's close:
Prior Day Closes in Top Quarter of Range (N = 727): -.06% (343 up, 384 down)
Prior Day Closes in Middle Two Quarters of Range (N = 743): -.02% (381 up, 362 down)
Prior Day Closes in Bottom Quarter of Range (N = 612): .11% (357 up, 255 down)
Prior Day Closes in Middle Two Quarters of Range (N = 743): -.02% (381 up, 362 down)
Prior Day Closes in Bottom Quarter of Range (N = 612): .11% (357 up, 255 down)
What this suggests is that, once a bandwagon starts during the day, it tends to persist into the close. Fading one-sided days, particularly of late, has not been a fruitful endeavor for traders. Expecting bandwagons to persist into the next day's trade, however, has also not been profitable. It appears that traders segment their performance day by day, perhaps jumping aboard trends in an effort to finish their days on winning notes. By the close of the next day, however, any such bandwagon effect has been erased.
RELATED POSTS:
Why It's Difficult to be a Trend Follower
Markets and Trending
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Thursday, April 17, 2008
Catching Up on a Thursday
* After a Strong Momentum Day - Wednesday was a particularly strong momentum day, as my measure of Demand (reflecting the number of issues closing above the volatility envelopes surrounding their short-term moving averages) exceeded Supply (those closing below their envelopes) by more than 8:1. I went back to September, 2002 (when I first began collecting these data; N = 1384 trading days) and found only 28 occasions when Demand exceeded Supply by more than 8:1. Interestingly, there was no directional edge the next trading day, but ten days later, the S&P 500 Index (SPY) averaged a gain of 1.01% (22 up, 6 down), much stronger than the average ten-day gain of .33% (805 up, 551 down) for the remainder of the sample.
* After Hours Volatility - Brian Shannon tracks the action in GOOG and its impact on the NASDAQ 100 Index. I just received an advance copy of Brian's new book and will provide an overview shortly. It deals with using technical analysis across multiple time frames, something Brian illustrates well in the videos on his site.
* Great New Site - While we're on the topic of GOOG, here's the stock's page in the iStockAnalyst site. There's a wealth of information in one place, including rankings on technical, fundamental, performance, and sector criteria; latest news; analyst ratings; and much more. Very promising research tool.
* A Portfolio of Blogs - Financial Philosopher identifies his favorite sites, including self-improvement and philosophy blogs I wasn't familiar with.
* Agricultural Boom - Research Recap examines evidence that high agricultural prices are likely to persist, given structural changes in population growth among emerging economies and the use of food crops for biofuels.
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* After Hours Volatility - Brian Shannon tracks the action in GOOG and its impact on the NASDAQ 100 Index. I just received an advance copy of Brian's new book and will provide an overview shortly. It deals with using technical analysis across multiple time frames, something Brian illustrates well in the videos on his site.
* Great New Site - While we're on the topic of GOOG, here's the stock's page in the iStockAnalyst site. There's a wealth of information in one place, including rankings on technical, fundamental, performance, and sector criteria; latest news; analyst ratings; and much more. Very promising research tool.
* A Portfolio of Blogs - Financial Philosopher identifies his favorite sites, including self-improvement and philosophy blogs I wasn't familiar with.
* Agricultural Boom - Research Recap examines evidence that high agricultural prices are likely to persist, given structural changes in population growth among emerging economies and the use of food crops for biofuels.
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Volume in the Stock Index Futures Market - Part Two
In my recent post, I suggested that a key to understanding the character of a market day was tracking the volume patterns within that day. Specifically, if volume is running significantly above normal, it means that institutional participants are active in the marketplace. This tends to bring greater price volatility and increased likelihood of breakout and trending moves--especially when we see similar moves in related markets (interest rates, currencies, commodities, etc.).
The chart above is quite informative. It goes back 24 trading days (to the first day when the June ES futures contract became the front month) and identifies the median volume and high-low price range (in percentage change) for each 15-minute period through the day. We can clearly see the smile pattern in the data: the tendency for early morning and late afternoon periods to trade with greater volume and price movements than periods midday. Indeed, price movement early and late in the day is easily 50-70% greater than midday. This suggests that uniform rules for placement of stops and price targets are bound to fail: the market is not uniform intraday.
Nor is the market uniform from day to day. These are median values, but the values for each individual day vary widely. Wednesday's trade was a great example: some 15-minute periods during the day traded at near-median volume and even lower than median price movement. Other periods were greatly expanded from the norms charted. Those were the periods contributing to the day's trending movement. Institutional traders are not necessarily active in every time period--they're not daytraders. But when we see that they are active at key junctures (during price breakouts, in response to movements in rates or currencies), it underscores the significance of moves that occur as a result.
Below are the data for the chart. Note that the time periods are U.S. Eastern time; fifteen-minute segments starting at the time noted. I use these data to tell me when volume is running above and below average and, hence, when I can expect more or less price movement. As mentioned earlier, this is invaluable in deciding when to take profits aggressively vs. (as Wednesday) let profits run.
| Time | Volume | Range |
| 9:30 | 107300 | 0.388 |
| 9:45 | 85008 | 0.342 |
| 10:00 | 91522 | 0.348 |
| 10:15 | 71411 | 0.314 |
| 10:30 | 81151 | 0.34 |
| 10:45 | 73599 | 0.315 |
| 11:00 | 60560 | 0.263 |
| 11:15 | 50261 | 0.296 |
| 11:30 | 53194 | 0.277 |
| 11:45 | 46481 | 0.242 |
| 12:00 | 35930 | 0.232 |
| 12:15 | 40276 | 0.235 |
| 12:30 | 39703 | 0.233 |
| 12:45 | 36437 | 0.24 |
| 13:00 | 38134 | 0.224 |
| 13:15 | 31076 | 0.193 |
| 13:30 | 39797 | 0.247 |
| 13:45 | 35313 | 0.19 |
| 14:00 | 47716 | 0.29 |
| 14:15 | 50910 | 0.248 |
| 14:30 | 50096 | 0.297 |
| 14:45 | 56285 | 0.344 |
| 15:00 | 57959 | 0.32 |
| 15:15 | 53862 | 0.33 |
| 15:30 | 68613 | 0.365 |
| 15:45 | 93226 | 0.311 |
| 16:00 | 71828 | 0.284 |
RELATED POSTS:
What Every Short-Term Trader Should Know
Finding Opportunity in the Stock Market
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Wednesday, April 16, 2008
Have We Put in a Stock Market Bottom?
Above is a daily chart of the S&P 500 Index (SPY) with the number of NYSE, ASE, and NASDAQ stocks making new 65-day lows printed below the relevant bars and the number making fresh 65-day highs printed above. You can see the pattern of dwindling new lows and, recently, expanding new highs. After pulling back and holding support, the market is in rally mode today. An expansion of new 65-day highs above the 480 level registered on 4/7 would confirm that we have, indeed, put in an intermediate-term bottom in stocks. A return to the trading range of the past several days would obviously invalidate today's breakout move.
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Volume in the Stock Index Futures Market - Part One
My recent post offered a simple tool for active traders who were having difficulty getting a handle on the character of the evolving trading day. This two-part series will outline a different set of tools for the same purpose, based on market volume. The core idea is that how the market will trade is a function of who is participating in the marketplace. If large, institutional traders are active, we will tend to see greater price volatility and larger market moves per unit of time. If those institutional traders are not active, the market is more likely to be quiet, with low volatility and smaller moves per time unit.
Those large traders are trading directionally, many times keying off fundamental dynamics (news, earnings reports, economic reports) and intermarket dynamics (shifts in interest rates, currencies, commodities). It's when these related markets are moving actively that we're more likely to revaluations of stocks, and hence greater institutional participation (volume). When news is relatively absent and those related markets are not undergoing shifts in their value areas (to use a Market Profile term), it is less likely that stocks will be revalued. That keeps volume in shares low and price action quiet.
A large part of understanding the character of the market day, then, is seeing what is happening in those related markets and seeing how stocks are trading relative to expectations regarding economic news, earnings reports, and the like.
Another way of capturing the character of the market day is to directly measure volume and compare it to the median volume for that particular time period over a lookback period. My research has found that, when this relative volume is elevated (i.e., when we're trading higher volume than normal in a particular time frame), the added volume almost exclusively comes from transactions of 50 contracts or larger in the S&P e-mini futures (ES contract). Clearly, those trades are not coming from small retail traders. Rather, it is the professional trader who is more active in the market when volume is elevated. The increased volume is the footprint that tells you *who* is in the market at the time.
For purposes of illustration, I went back to March 13th (when the June ES contract became active) and broke down each trading day into nine 45-minute segments. The correlation between the volume of the 45-minute period and the high-low price range for that period was a considerable .83. To give but one example, when the volume of the 45-minute period was above 170,000 contracts (N = 105), the price range for the period averaged .78%. When the volume was below that level (N = 102), the price ranged averaged only .42%. On average, price movement was nearly twice as high during busy periods as during slow ones.
Interestingly, 14 of the 20 highest volume periods occurred during the first or last 45-minute trading segment of the day. Conversely, 17 of the 20 lowest volume periods occurred during the midday periods from 11:45 AM ET to 2 PM ET. That tells us that *who* is in the marketplace changes significantly over the course of the market day. An active trader needs to have different anticipations of price movement early and late in the day compared with midday.
Finally, on a daily basis over the March 13th-present period, daily price range correlates a whopping .86% with daily ES contract volume. When the ES volume has been over 1,800,000 contracts (N = 12), the daily price range has averaged 3.16%. When the volume has been below that level (N = 11), the daily price range has averaged only 1.43%.
Clearly this has important implications for how traders manage trades. In a busier, more volatile market, it makes sense to place stops wider and to let profits run further (i.e., to place profit targets further from good entry points). In slow markets, it makes sense to keep stops tight and take profits aggressively, as these are less likely to run.
Who is in the market dictates how you should trade that market. That varies from one day to the next, and it varies from one time of day to another. I cannot think of a more important lesson for developing active traders.
RELATED POST:
Intraday Volume Patterns and Volatility
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Those large traders are trading directionally, many times keying off fundamental dynamics (news, earnings reports, economic reports) and intermarket dynamics (shifts in interest rates, currencies, commodities). It's when these related markets are moving actively that we're more likely to revaluations of stocks, and hence greater institutional participation (volume). When news is relatively absent and those related markets are not undergoing shifts in their value areas (to use a Market Profile term), it is less likely that stocks will be revalued. That keeps volume in shares low and price action quiet.
A large part of understanding the character of the market day, then, is seeing what is happening in those related markets and seeing how stocks are trading relative to expectations regarding economic news, earnings reports, and the like.
Another way of capturing the character of the market day is to directly measure volume and compare it to the median volume for that particular time period over a lookback period. My research has found that, when this relative volume is elevated (i.e., when we're trading higher volume than normal in a particular time frame), the added volume almost exclusively comes from transactions of 50 contracts or larger in the S&P e-mini futures (ES contract). Clearly, those trades are not coming from small retail traders. Rather, it is the professional trader who is more active in the market when volume is elevated. The increased volume is the footprint that tells you *who* is in the market at the time.
For purposes of illustration, I went back to March 13th (when the June ES contract became active) and broke down each trading day into nine 45-minute segments. The correlation between the volume of the 45-minute period and the high-low price range for that period was a considerable .83. To give but one example, when the volume of the 45-minute period was above 170,000 contracts (N = 105), the price range for the period averaged .78%. When the volume was below that level (N = 102), the price ranged averaged only .42%. On average, price movement was nearly twice as high during busy periods as during slow ones.
Interestingly, 14 of the 20 highest volume periods occurred during the first or last 45-minute trading segment of the day. Conversely, 17 of the 20 lowest volume periods occurred during the midday periods from 11:45 AM ET to 2 PM ET. That tells us that *who* is in the marketplace changes significantly over the course of the market day. An active trader needs to have different anticipations of price movement early and late in the day compared with midday.
Finally, on a daily basis over the March 13th-present period, daily price range correlates a whopping .86% with daily ES contract volume. When the ES volume has been over 1,800,000 contracts (N = 12), the daily price range has averaged 3.16%. When the volume has been below that level (N = 11), the daily price range has averaged only 1.43%.
Clearly this has important implications for how traders manage trades. In a busier, more volatile market, it makes sense to place stops wider and to let profits run further (i.e., to place profit targets further from good entry points). In slow markets, it makes sense to keep stops tight and take profits aggressively, as these are less likely to run.
Who is in the market dictates how you should trade that market. That varies from one day to the next, and it varies from one time of day to another. I cannot think of a more important lesson for developing active traders.
RELATED POST:
Intraday Volume Patterns and Volatility
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Tuesday, April 15, 2008
Sector Correlations as a Decision Support Tool for Active Traders
I've spoken with a number of intraday traders who have difficulty judging the daily market environment in which they're operating. Is this a busy, volatile day, or a slow, non-volatile one? Is this a range day, or a trending one? Of course, none of us can know the future with certainty and, at any point in the day, markets can shift gears. Still, making as accurate an assessment of market conditions as possible is extremely helpful in knowing where to place profit targets (nearer in slow, range markets) and stops (wider in volatile markets). Understanding the character of a market day is also very helpful in the decision of whether to let profits run vs. book them in a more opportunistic fashion.
Above is one of my analytical tools that helps me identify market conditions as they're evolving. The blue line is the S&P 500 Index (SPY) at 15-minute intervals. As we can see, over the two day period charted, we have been quite rangebound.
The pink line represents the correlation among four key S&P 500 sectors: financials (XLF), energy (XLE), consumer discretionaries (XLY) and consumer staples (XLP). I calculate the correlation of each sector with every other sector over a moving one-day period (26 15-minute periods) and then plot the average of those correlations. Historically, this average correlation among sectors is .53. When we see the correlation significantly higher than .53, it suggests that the different sectors are moving very much in tandem intraday. When we see the correlation significantly lower than .53, it suggests that the different sectors are not moving in unison.
Why is this important? In a trending market, the sectors tend to move in harmony. Strong uptrends or downtrends tend to move all sectors. Conversely, as markets become transitional and rangebound, sectors tend to move their separate ways, with stronger ones showing relative strength and weaker ones lagging. So, as a rule, when I see a correlation among sectors that is high and rising, I view the current environment as trending. When I see a correlation among sectors that is low and falling, I view the trading environment as rangebound. When the correlation is low and rising, I entertain the possibility that a trending move is in the making. When the correlation is high and falling, I consider the possibility that a trending market may turn transitional and rangebound.
As you can see from the chart above, the low, falling correlation has been an excellent tell over the past two days for the market's range behavior. This was very helpful in terms of avoiding bad trades (not buying range highs or selling lows) and considering some good ones (fading moves to range extremes). The low correlation has also been useful in suggesting that market moves are unlikely to extend, making it particularly important to book profits when they're available.
The above chart was created in a matter of minutes in Excel using data from a real-time data feed. No special software or programming expertise was needed. I have found such decision support tools invaluable in my own trading. They do not take the trader away from the screen for lengthy periods of time and very much help in preparing the trader for the coming day.
RELATED POST:
Anticipating Market Volatility (see also the links at the end of that post)
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Overnight and Daytime Market Regimes
The charts above decompose the S&P 500 Index (SPY) and 10-year Treasury rates ($TNX) into two components: changes that occur from close to open (overnight) and those that occur from open to close (day). For purposes of comparison, the charts are set to an arbitrary index value of 100 on 12/31/04. It doesn't take much analysis to see that the overnight and day markets behave quite differently. In fact, the correlation between overnight price changes and subsequent day changes is -.05 for SPY and .03 for $TNX. These, in essence, are separate markets.
The top chart illustrates how much of the stock market's bullish trend since 2005 has been a function of overnight price change. Indeed, a pure daytrader experienced none of the benefits of this bull run. To be sure, overnight exposure brings its risks, but closing positions at day's end also has greatly dampened reward.
Notice how, for the most part, interest rate changes have been much more pronounced during the day session compared with overnight: swings up and down tend to be larger. A good part of the trending behavior in rates has occurred during the day--at least until recently.
Which gets us to one of the most interesting aspects of this exercise. Until January of this year, much of the drop in stock prices since mid-2007 occurred during the day session. Similarly, much of the fall in interest rates (flight to quality) also occurred during the day. Since January, however, the day behavior of stocks has been relatively muted--as has been the day behavior of rates. Instead, we've seen pronounced overnight weakness in both stocks and rates since January.
This shift in regimes may be quite meaningful, reflecting a thematic shift in the markets. Much of the drop in shares and rates from mid-2007 through the January lows was a function of credit fears, whose epicenter has been in the U.S. Since January, however, U.S. stocks and rates have been responding increasingly to global recession fears, weakness in global share prices (across Asia most notably), and preopening economic and earnings reports related to recession.
It's interesting that the number of common stocks on the NYSE making fresh 52-week lows hit their highest level in January at exactly the time this overnight/day regime shifted. I believe that January low represents a pivotal point at which markets shifted their focus, such that overnight events--and the global economic picture--are now weighing more heavily on stocks.
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RELEVANT POSTS:
Are Technical Indicators Relevant for Daytraders?
How to Lose Money Buying in an Uptrend
The Multiple Personality of the Stock Market
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Monday, April 14, 2008
Perspectives to Start the Market Week
* Yet Another Longer-Term Perspective - I recently offered a long-term perspective based on the percentage of NYSE stocks trading above their 200-day moving averages. Here's a different take on the issue. In January and March of this year, as markets hit their lows, the S&P 500 Index ($SPX) moved more than 10% below its 200-day simple moving average. I went back all the way to 1960 (N = 11962 trading days) and found 667 occasions in which $SPX was more than 10% below its 200-day MA. When we look 200 days later, $SPX was up 525 times, down 142 times, for an average gain of 13.51%. That compares very favorably with the average 200-day gain of 6.05% (8017 up, 3268 down) for the remainder of the sample. Of course, that's not to say that a weak market can't get weaker: in 1974, 1987, and 2002, $SPX went more than 20% below its 200-day MA before righting itself. Interestingly, there have only been 78 days in the entire period from 1960-present in which $SPX has been more than 20% below its 200-day moving average. The market finished stronger 200-days later on 76 of those 78 occasions.
* Interesting Fed Perspectives - The Big Picture takes a look at Greenspan, Bernanke, and Friedman and the use of the printing press to work our way out of deflation. For more on Fed perspective, check out the updated links at Trader Mike's site and several excellent links at Abnormal Returns.
* Profile of a Stock Picker - Charles Kirk interviews a winning stock picker and takes a look at what makes him tick. While we're on the topic of stock picking, check out the fruits of Chris Perruna's recent research.
* Declines in a Consolidating Market - Quantifiable Edges examines what tends to happen when markets drop during a non-trending period.
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* Interesting Fed Perspectives - The Big Picture takes a look at Greenspan, Bernanke, and Friedman and the use of the printing press to work our way out of deflation. For more on Fed perspective, check out the updated links at Trader Mike's site and several excellent links at Abnormal Returns.
* Profile of a Stock Picker - Charles Kirk interviews a winning stock picker and takes a look at what makes him tick. While we're on the topic of stock picking, check out the fruits of Chris Perruna's recent research.
* Declines in a Consolidating Market - Quantifiable Edges examines what tends to happen when markets drop during a non-trending period.
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Indicator Review for April 14th
Last week's indicator review noted significant buying pressure among stocks as we approached important resistance near 1400 in the S&P 500 futures contract. That post further observed some potential negatives on the horizon--weak advance-decline lines, an overbought market condition, and worrisome credit spreads--but anticipated a breach of the overhead resistance, given the market's apparent double bottom. "What would change my mind from this scenario," I explained, "would be reversals of the dynamics we're currently seeing in NYSE TICK, money flows, and the expansion of stocks making new highs. Particularly worrisome would be an expansion in the number of stocks making fresh 20-day lows."
Well, guess what? As we see from the bottom chart, the cumulative NYSE TICK did indeed roll over, as we failed to sustain the test of the important resistance area. Stocks fell back last week, ending Friday on a particularly weak note. New 20-day lows expanded through the week, with a Friday reading of 450 new highs and 545 new lows. My five-day indicator of money flows into the Dow Industrials stocks turned positive with the market's rally, but fell to a modest negative level by the end of the week. Those weak advance-decline lines weakened even further, making new bear lows across several sectors and, for the broad market (NYSE common stocks), is now near bear lows. Moreover, my measure of technical strength stalled out early in the week and intermarket themes associated with stock market weakness reasserted themselves.
So where does that leave us? My cumulative Demand/Supply indicator, which has done a terrific job of identifying recent short-term market tops and bottoms, is back in neutral territory. Given the recent expansion of stocks making new lows, the declining NYSE TICK line, and the weak advance-decline performance, the best we can say is that we are trapped in a trading range between that resistance near 1400 in the ES contract and the March price lows. A retest of those lows is not at all out of the question, particularly if we continue to see further weakening among these indicators. I'll be updating the indicators daily in my Twitter posts to keep readers up to speed.
It is not at all clear to me that the current weakness will bring a new bear market leg. The number of stocks registering fresh 52-week lows has been drying up since January. For example, among NYSE common stocks, we had over 700 new lows in January, but only a little more than 300 new lows at the March price lows. This past Friday, we had 19 annual new highs among NYSE common issues and only 42 lows. That cumulative NYSE TICK line shown above has indeed turned down, but is very well off its March lows. In the past, that has set us up for divergences and reversals of tests of trading ranges. Should we fail to sustain a move below the March lows, I believe we could see some real opportunity to the upside, given the market's historic oversold condition.
As long as the indicators continue to weaken, I remain defensive. I think it's fair to say that I'm cautiously bearish on a day-to-day basis and cautiously bullish on a longer-term basis. How we resolve the aforementioned trading range will have significant implications for stocks and the broader economy.
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Sunday, April 13, 2008
Is Market Weakness Offering Opportunity? A Long-Term Perspective on Stocks
With a major shout-out to Decision Point, here's a long-term perspective on the NYSE Composite Index ($NYA), which is a pretty good reflection of the broad stock market. The top panel shows price movement in $NYA, and the bottom panel shows the percentage of NYSE issues trading above their 200-day moving averages. I labeled the points at which we moved below 20% in the indicator. As you can see, those points captured major market bottoms in December, 1987; October, 1990; December, 1994; October, 1998; October, 2002; and most recently in January, 2008.
The percentage of stocks trading above their long-term moving averages is not a bad indicator of "overbought" and "oversold". If you think about it, we can define a bull market as one in which we see successive overbought and oversold levels at higher prices. A bear market is one in which we see successive overbought and oversold levels at lower prices.
I'm well aware of the market's short-term weakness, and I'll be commenting upon it in tomorrow morning's indicator update. But I wanted to pull up this longer-term perspective because, unless my eyesight is failing me, $NYA remains in one helluva bullish configuration. For all the sky-is-falling worries about housing, weak dollar, national debt, and toxic credit, we remain far above our 2002 lows and less than 15% off all-time highs.
Now maybe this time is different, and maybe the sky will fall. If so, my shorter-term indicators will pick up the expanding number of stocks making new lows; the sustained weakness in cumulative TICK, money flows; etc. But we've seen dwindling new lows since January, and the percentage of NYSE issues above their 200-day moving averages has been on the rise since then--even as we made price lows in March. If we cannot sustain the recent weakness and decisively take out the March lows, I will approach the long-term the way I approach short-term trading, entering an established trend on a pullback.
RELATED POST:
Getting Close to a Bottom?
Cracks in the Bear Foundation
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Two Stock Market Sector Ratios I'm Watching Closely
The above charts represent price ratios between pairs of sector ETFs within the S&P 500 universe. Each represents a theme that I consider to be a driver of the recent bear market. Accordingly, I am watching these ratios (and themes) for indications of a continuation vs. reversal of bear market dynamics.
The first theme (top chart) represents the price ratio between the Materials ETF (XLB) and the Financials ETF (XLF). It depicts the relative valuation of physical assets--raw materials--to financial assets. In a weak dollar environment, as well as an environment of low confidence in the banking sector, raw materials should be more attractive than financials. A reversal of this ratio would suggest that the dynamics underpinning the weak dollar (expectations of further interest rate cuts by the Fed; lack of G-7 action toward a stronger dollar; recessionary expectations; fear of bank failures) were shifting.
The second theme (bottom chart) represents the price ratio between the Consumer Staples ETF (XLP) and the Consumer Discretionary ETF (XLY). It depicts the relative valuation of defensive stocks--those traditionally deemed relatively recession-proof--vs. those that are more vulnerable to contractions in consumer spending. In a recessionary environment, Staples should outperform Discretionaries as investors flee to sectors representing relative safety. A reversal of this ratio would suggest that the dynamics underpinning the recession (weak housing market; weak consumer confidence; weak employment market) were shifting.
What we see clearly in both charts is that, since mid-2007 (the period recently highlighted as one of changing intermarket dynamics), these ratios accelerated significantly as the stock market sold off. The XLB:XLF ratio topped out in mid-March (when the stock market made its price lows), pulled back sharply, and has since been clawing its way back toward its highs as stocks have fallen back. The XLP:XLY ratio topped out in early January (when the number of stocks making new 52-week lows maxxed out), dropped back sharply, and has bounced back in a choppy manner since then.
Both of these ratios capture something of the psychology of the current stock market. A move to new highs would suggest that the psychological drivers of the recent bear market are intact. A failure to advance to new highs, even as the number of stocks registering fresh 52-week lows is dwindling, would have me questioning the bear's longevity.
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Saturday, April 12, 2008
Five Lessons Traders Can Learn From American Idol
* It's a Marathon, Not a Sprint: You don't have to finish #1 to have a very successful career, and some top finishers have short-lived careers. Check out Chris Daughtry.
* Many Are Called, Few Are Chosen: For every Idol, there are many deluded wannabees. Know your strengths, and go with them.
* Be Yourself: Much of success comes from picking the right song (market, trading style) and making it your own, rather than mimicking others. Check out David Cook.
* It Takes More Than Dreams: Some of the worst tryouts are contestants with the loftiest dreams. Without talent and skill, dreams are mere fantasies.
* Listen to Feedback: The verdicts of the markets may sound more like Simon than Paula, but they provide important information for the next performance.
RELATED POST:
Ten Lessons I've Learned From Traders
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* Many Are Called, Few Are Chosen: For every Idol, there are many deluded wannabees. Know your strengths, and go with them.
* Be Yourself: Much of success comes from picking the right song (market, trading style) and making it your own, rather than mimicking others. Check out David Cook.
* It Takes More Than Dreams: Some of the worst tryouts are contestants with the loftiest dreams. Without talent and skill, dreams are mere fantasies.
* Listen to Feedback: The verdicts of the markets may sound more like Simon than Paula, but they provide important information for the next performance.
RELATED POST:
Ten Lessons I've Learned From Traders
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How Markets and Intermarket Relationships Have Changed Since Mid-2007
One of the great dividing points between experienced, successful market participants and amateurs is that the former realize that markets are continuously changing. They make active attempts to identify and adapt to these changes. Amateurs look for fixed patterns across all markets and all periods of time. For them, financial markets are relatively static entities.
This post illustrates how markets do, indeed, change over time. The chart above tracks volatility--the median price movement--for equities (S&P 500 Index, SPY) and interest rates (10-year Treasury rates, $TNX) both during the overnight period (close to open) and during the day period (open to close). Note that we're looking at the absolute size of movements--pure volatility--not the directionality of those moves.
What you can see is that the volatility of those movements has expanded significantly since mid-2007. In each case, the red bar is quite a bit higher than the blue bar, meaning that volatility since July, 2007 has increased for both stock price movements and the movement of interest rates. Indeed, for the most part, the movements lately have been twice as large since July, 2007 as they were from 2006 through June, 2007.
But it's not only the *size* of these movements that has changed dramatically. The relationship between stock price movements and the movements of interest rates has also shifted meaningfully. Below, here are the correlations between equity and rate movements:
Overnight, 2006 - Mid 2007: .16
Overnight, Mid 2007 - Present: .45
Day Session, 2006 - Mid 2007: .09
Day Session, Mid 2007 - Present: .40
In other words, the size of movements in equities are rates were relatively uncorrelated from 2006 through mid-2007. Since mid-2007, however, the size of those movements has been significantly more correlated: when we see big moves in one, we tend to see large moves in the other.
And, of course, when we look at the directionality of those movements, we see greater correlation during the recent period as well. In past periods, falling interest rates (rising Treasury prices) have been associated with bullish movements in stocks, as reduced rates have spurred lending and economic activity. Since mid-2007, however, Treasuries have acted as a safe haven when there has been uncertainty about stocks and the economy. As a result, we've seen a tight correlation between falling yields and falling stock prices.
Specifically, the correlation between end-of-day changes in SPY and $TNX was -.03 from 2006 through mid-2007. Since mid-2007, that correlation has soared to .56.
Volatility has changed, intermarket relationships have changed. We've also seen dramatic changes in trending over these time periods, across bonds, commodities, currencies, and stocks. Identifying and understanding these shifts is essential to successful investment and portfolio management. I would also argue that, on a day-to-day basis, it's also invaluable for intraday and swing traders.
RELATED POST:
Intermarket Relations
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Friday, April 11, 2008
Tracking the Impact of Recession Fears on the Stock Market
* Advance-Decline Weakness - The above three charts from the excellent Decision Point site show how we are testing bear market lows in the advance-decline lines specific to S&P 500 stocks (top chart), NASDAQ 100 stocks (middle chart), and Dow 30 Industrials (bottom chart). The themes of weakness noted recently continued through week's end.
* Sector Deterioration - My recent review of sector strength and weakness found strength confined to a very limited portion of the S&P 500 universe. In the last two weeks, the percentage of Consumer Discretionary stocks trading above their 50-day moving averages has plunged from over 70% to 30%. The corresponding percentage for Financial stocks has dropped from 65% to 28%. Meanwhile, we're still seeing 59% of Consumer Staples stocks trading above their 50-day averages, as money flows continue to reflect defensiveness and fears of recession.
* New Flight to Safety? - I've been watching the tax-free bond funds of late, largely because I committed a chunk of long-term portfolio money toward those. Interestingly, when we had stock market selloffs in August and March, there were selloffs among tax-free bonds, reflecting fears of default. During the recent stock market weakness, however, a number of tax-free funds have been making six-week price highs. We're also seeing some strength carry through to investment-grade corporates. Even as we price in recession, we may be discounting the probability of Armageddon.
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An Effective Technique for Preventing Frustration and Its Effects on Trading
The first post in this series dealt with stilling the negative thoughts that are triggered by trading-related frustrations. The second post outlined three steps for breaking patterns of frustration as they're occurring. In this final post in the series, I will describe my personal favorite among the strategies for dealing with frustration, one that I use extensively myself as well as with traders I coach. The appeal of this methodology is that it is preventive: it is designed to head off frustration before it occurs.
To understand the method, let's take a simple, practical example. Suppose you find traffic jams to be especially frustrating. You often lose your cool during periods of traffic delay, ruining your mood for the remaining morning or afternoon. How could you prevent this from occurring?
Telling yourself to not overreact doesn't work: emotions are amazingly refractory to such willpower efforts. Interestingly, the best approach is to actively *plan* for the very frustration you hate. If, say, you *knew* you were going to be delayed in your commute due to a snowstorm, you could prepare in advance. You might bring extra music, snacks for the car, or an audiobook for listening. You might plan out conference calls you can make from the road while you're stuck in traffic. Once you are actually sitting in the traffic, you find that it's not so frustrating: you are prepared--and that takes the emotion out of the event.
Let's take a step back and examine the causes of frustration. We become frustrated when we have a goal or purpose in mind and when this objective is hindered by forces beyond our control. Thus, we might be frustrated by an airline delay when we're in a hurry to a business meeting, or we might be frustrated when we're looking forward to a good night's sleep, but are kept awake by noise outside our window.
Frustration hits us when we experience these impediments as *threats*. The airline delay might be a mere annoyance if we're not in a rush to an important event. If, say, that event were a crucial job interview, we could be frustrated indeed.
When a trader emotionally accepts losing as part of the business, loss is not so threatening. With proper money management, it can be contained and need not pose more than an annoyance. But if a trader *needs* to make money--perhaps because of perfectionism, or perhaps because of dire financial circumstance--then normal loss might be experienced as unusual frustration. It's the overriding *need* to make money that sets the trader up for acute frustration.
As in the above example of anticipating the traffic delay, we can anticipate losses and prepare accordingly. For example, let's say I'm preparing myself for a potential reversion to a mean trading price as we're trading near the bottom of a multi-day range. I know that, as we approach the lower end of that range, that we'll either get the anticipated reversion, or we'll see a downside breakout. Either way, there will be a good trade in the offing.
Before the market opens, I seat myself comfortably and breathe deeply, slowly, and rhythmically, focusing my attention on relaxing music playing through headphones. Once I'm calm and focused, I walk myself through the anticipated trade, imagining in detail how the market trades near the bottom of its range and bounces higher, how I wait for the first pullback from that bounce, and then how I enter with my long position to capitalize on the return to the average trading price within that range. It's as if I'm watching a movie, visualizing vividly myself executing the trade idea.
Then, however, I include the frustrating event in the visualization: I vividly image the market reversing and trading weaker, with volume now hitting the market bid. I imagine myself feeling frustrated that my trade hasn't followed through, and I visualize myself stopping the trade out once we trade below the point at which the above-mentioned bounce began. Then, I further visualize waiting for a fresh downthrust (confirming the weakness) and immediately entering the market on the short side on the first bounce, flipping my position to capitalize on the downside breakout. That is my preparation for the frustration, just like the preparation of the driver who knows he'll be stuck in traffic in a snowstorm. Instead of viewing it as threat, I'm mentally rehearsing it as opportunity. The stopped out "reversion" trade tells me that we're not going to stay rangebound. Instead of focusing on the loss, I stress the information gathered from the loss and prepare in advance to flip my position.
As with the earlier exercises, this exercise requires repetition and the willingness to take time each morning to prepare for frustrations with vivid scenarios. Readers of my book on trader performance will recognize this approach as a variation of the exposure methods I described in the chapter on behavioral techniques for change. My experience is that traders can learn these methods for themselves as part of becoming their own trading coaches. My upcoming book will describe this in considerable detail. The key is embracing frustration by anticipating it and turning it into opportunity. That removes the threat from emotional triggers, enhancing a trader's self-control.
RELATED POSTS:
Overcoming Anxiety
Consumer's Guide to Coaching Traders
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To understand the method, let's take a simple, practical example. Suppose you find traffic jams to be especially frustrating. You often lose your cool during periods of traffic delay, ruining your mood for the remaining morning or afternoon. How could you prevent this from occurring?
Telling yourself to not overreact doesn't work: emotions are amazingly refractory to such willpower efforts. Interestingly, the best approach is to actively *plan* for the very frustration you hate. If, say, you *knew* you were going to be delayed in your commute due to a snowstorm, you could prepare in advance. You might bring extra music, snacks for the car, or an audiobook for listening. You might plan out conference calls you can make from the road while you're stuck in traffic. Once you are actually sitting in the traffic, you find that it's not so frustrating: you are prepared--and that takes the emotion out of the event.
Let's take a step back and examine the causes of frustration. We become frustrated when we have a goal or purpose in mind and when this objective is hindered by forces beyond our control. Thus, we might be frustrated by an airline delay when we're in a hurry to a business meeting, or we might be frustrated when we're looking forward to a good night's sleep, but are kept awake by noise outside our window.
Frustration hits us when we experience these impediments as *threats*. The airline delay might be a mere annoyance if we're not in a rush to an important event. If, say, that event were a crucial job interview, we could be frustrated indeed.
When a trader emotionally accepts losing as part of the business, loss is not so threatening. With proper money management, it can be contained and need not pose more than an annoyance. But if a trader *needs* to make money--perhaps because of perfectionism, or perhaps because of dire financial circumstance--then normal loss might be experienced as unusual frustration. It's the overriding *need* to make money that sets the trader up for acute frustration.
As in the above example of anticipating the traffic delay, we can anticipate losses and prepare accordingly. For example, let's say I'm preparing myself for a potential reversion to a mean trading price as we're trading near the bottom of a multi-day range. I know that, as we approach the lower end of that range, that we'll either get the anticipated reversion, or we'll see a downside breakout. Either way, there will be a good trade in the offing.
Before the market opens, I seat myself comfortably and breathe deeply, slowly, and rhythmically, focusing my attention on relaxing music playing through headphones. Once I'm calm and focused, I walk myself through the anticipated trade, imagining in detail how the market trades near the bottom of its range and bounces higher, how I wait for the first pullback from that bounce, and then how I enter with my long position to capitalize on the return to the average trading price within that range. It's as if I'm watching a movie, visualizing vividly myself executing the trade idea.
Then, however, I include the frustrating event in the visualization: I vividly image the market reversing and trading weaker, with volume now hitting the market bid. I imagine myself feeling frustrated that my trade hasn't followed through, and I visualize myself stopping the trade out once we trade below the point at which the above-mentioned bounce began. Then, I further visualize waiting for a fresh downthrust (confirming the weakness) and immediately entering the market on the short side on the first bounce, flipping my position to capitalize on the downside breakout. That is my preparation for the frustration, just like the preparation of the driver who knows he'll be stuck in traffic in a snowstorm. Instead of viewing it as threat, I'm mentally rehearsing it as opportunity. The stopped out "reversion" trade tells me that we're not going to stay rangebound. Instead of focusing on the loss, I stress the information gathered from the loss and prepare in advance to flip my position.
As with the earlier exercises, this exercise requires repetition and the willingness to take time each morning to prepare for frustrations with vivid scenarios. Readers of my book on trader performance will recognize this approach as a variation of the exposure methods I described in the chapter on behavioral techniques for change. My experience is that traders can learn these methods for themselves as part of becoming their own trading coaches. My upcoming book will describe this in considerable detail. The key is embracing frustration by anticipating it and turning it into opportunity. That removes the threat from emotional triggers, enhancing a trader's self-control.
RELATED POSTS:
Overcoming Anxiety
Consumer's Guide to Coaching Traders
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Thursday, April 10, 2008
A Few Thursday Thoughts
* Tracking Adverse Excursions - This is an excellent post worth thinking about. Henry Carstens has tracked the average amount a position taken at the market close will move against you by the close of the next day. You'll see why the current market has been challenging for traders and investors alike.
* Imminent? - A number of observers are predicting Middle East war. See also this perspective from Stratfor.
* Economic Realignment? - Given the new oil and gas boom in such places as the Dakotas and Western Pennsylvania, as well as a farming boom worldwide, the commodity bull market is creating a new set of economic winners and losers, as well as a new set of winners in the stock market.
* Commodities in a Weak Economy - One analyst sees weakness among industrial commodities, but strength among those linked to the US dollar.
* Thanks - To those who have passed along congratulations regarding the recent Business Week accolades.
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* Imminent? - A number of observers are predicting Middle East war. See also this perspective from Stratfor.
* Economic Realignment? - Given the new oil and gas boom in such places as the Dakotas and Western Pennsylvania, as well as a farming boom worldwide, the commodity bull market is creating a new set of economic winners and losers, as well as a new set of winners in the stock market.
* Commodities in a Weak Economy - One analyst sees weakness among industrial commodities, but strength among those linked to the US dollar.
* Thanks - To those who have passed along congratulations regarding the recent Business Week accolades.
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Currencies, Interest Rates, and Stocks: It's All One Market
* Intermarket Relationships - The ES futures (top) and Yen (middle) charts look like mirror images. As the yen has strengthened vs. the US dollar, stocks have weakened. This relationship is carrying forward this morning as I write and provided some nice intraday tells regarding market direction on Wednesday. Similar tells have been evident in 10-year Treasury yields (bottom chart), which have paralleled stock moves of late. When there is a flight from stocks, we see a flight to quality in Treasuries (rising prices, falling yields). Not shown is the euro vs. the dollar, which is moving to new highs this morning. The falling U.S. dollar has not been helping stocks, as interest rate gaps among countries continue to weigh on the currency. By way of comparison, two-year rates are down to 1.73% in the U.S., but are 3.93% in the U.K.; 3.44% in Germany; and 6.18% in Australia--even as the Fed is expected to ease rates further. The charts show different asset classes but, in times of fear, these trade as one market--which suggests that intermarket correlations are not a bad measure of investor psychology.
* One of My Better Posts - This one came in handy on Wednesday and very much supports the above intermarket observations.
* A Word of Thanks - I've received a number of positive emails about the Twitter posts, which link daily themes in markets and summarize market indicators. My goal has been to create a blog within a blog via Twitter, and the rising number of people subscribing suggests that this has been useful. For those new to the blog, the last five Twitter "tweets" appear on the blog; the entire list appears on my Twitter page.
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Wednesday, April 09, 2008
Quick Market Update
* Broken Support - The NQ futures were the first to break below multi-day support on Wednesday, as consistent selling sentiment (NYSE TICK) and weakness in the financial sector eventually led the entire market lower. The shrinkage in stocks registering new highs as we approached the 1400 area of resistance in the ES futures and the loss of upside momentum among stocks--both noted in the Tuesday post--anticipated this breakdown. Now we're seeing an expansion of stocks making fresh 20-day lows amidst continued negative momentum. A rundown of Wednesday's indicators will be posted to tomorrow's Twitter comments.
* Deterioration of Technical Strength - Among the stocks in my basket of S&P 500 issues evenly selected from eight sectors, we're now seeing only 16 in uptrends, 9 neutral, and 15 in downtrends. Energy issues continue to shine, given strong oil prices. If you take those shares out of the mix, however, you see that strength is difficult to find among the sectors.
* Tale of Three Markets - We're seeing bull market highs for the Advance-Decline line specific to the S&P 500 energy stocks that comprise XLE. We're also seeing fresh bear market lows for the Advance-Decline line specific to the S&P 500 financial stocks that make up XLF. It's not a good sign that the AD Line specific to the S&P 500 consumer discretionary stocks that comprise XLY has also made a bear market low as of Wednesday. If we were on the verge of an economic turnaround thanks to central bank and government intervention, one would think that the lines would be moving higher in unison, in anticipation.
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Market Review and Resources for Wednesday
* Banks Continue to Lag - Here we see a chart of the S&P 500 Index ($SPX; top chart) since the mid-March bottom. Beneath it is the equivalent chart for the banking sector ($BKX). Whereas the large cap market overall has vaulted above its 3/24 highs, the banks have not. Moreover, the large caps have only retraced a modest portion of their early April rally, but the banks have retraced about 50%. As my recent post indicated, the strongest sectors of late have been energy and materials--a reflection of weak dollar and strong commodities. That's not a theme that is a good foundation for a sustained bull move in stocks. The 1400 area remains important resistance for the ES futures; I don't think we'll sustain an upside breakout unless something ignites these banks.
* More on Mind and Body - An interesting research report links depression as a causal factor in Alzheimer's Disease. As some of the links I posted recently indicate, depression is also implicated in heart disease--and negative patterns of thinking are implicated in the genesis of depression. It's not too difficult to connect the dots and see fascinating patterns between how we think, how we feel, and how healthy we are. The exercises from my recent post (and the one from my upcoming post) might be helpful for more than trading alone.
* Establishing a Track Record - I see Rob Hanna's trade ideas from his tested historical patterns have performed nicely. Rob generously shares many of his patterns in his blog. If you didn't catch my Twitter link to his pattern post, it's worthy of study. And, while we're on the topic, Rennie Yang maintains a continuous track record for his "trend catcher" system and provides intraday alerts of signals. That system recent moved to new equity curve highs, amidst an increasing incidence of trend days. Excellent resources; you have to admire newsletter writers that test their ideas in advance and then track their performance in real time.
* Gaming Stocks Ahead of Earnings Reports - Kirk takes a look at issues that make his stock screening cut and then examines their earnings report patterns and expectations prior to announcements. This could be a nice way to play behavioral finance biases associated with underreactions to surprise news events. While you're at it, check out The Kirk Report's interview with economist and contrarian Irwin Yamamoto. His outlook on housing, consumer debt, and the Dow is sobering.
* Not Shorting a Dull Market - Trader Mike notes a short-term sell signal, but he's holding off until he sees volume confirming the intentions of sellers. So far, we've seen dwindling new 20-day highs among stocks in recent days, but no expansion of 20-day lows. It's the latter that would turn me bearish on this market.
* Going for the Yield - Anyone looking to park money relatively safely and achieve any kind of real returns has to be disappointed with the yields available for Treasury instruments and bank certificates of deposit. With baby boomers fearful of returns from stocks and real estate, it's only a matter of time before they swarm to AAA-rated tax-free yields that continue to exceed the aforementioned taxable rates. The Vanguard funds (intermediate-term: VWITX; long-term: VILPX) are ones I've been nibbling at, given low management fees and good diversification among AA and AAA-rated issues. Also on the radar are investment-grade corporate bonds, with long-term instruments pushing a 6% yield (VWESX). Not all safe bond funds are safe, however; check out the links at Abnormal Returns.
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Tuesday, April 08, 2008
A Quick Look at Technical Strength
The stock market's rally has stalled out as we've approached the resistance area emphasized in the most recent indicator update. Short-term momentum has turned negative, with Demand (an index of stocks closing above the volatility envelopes surrounding their moving averages) finishing Tuesday at 21 and Supply (an index of those closing below their envelopes) at 81. Stocks making fresh 20-day highs dropped to 706; new lows were 236. By contrast, we were seeing over 1900 fresh 20-day highs at the middle of last week.
So which sectors are strong and weak in technical strength? My measure of short-term trending across 40 stocks (five from eight S&P 500 sectors) looks like this:
Materials: +240
Industrials: +60
Consumer Discretionary: +140
Consumer Staples: +200
Energy: +360
Health Care: +40
Financial: +40
Technology: -80
Once again, those commodities/weak dollar themes of Materials and Energy continue to lead the stock market, whereas growth themes (Technology, Discretionary) somewhat underperform defensive themes (Staples). I find the lack of follow-through in relative strength among the Financials particularly concerning and strongly suspect that, if we're going to sustain a break above the 1400 SPX resistance, the strength will need to come from confidence among those Financial shares.
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So which sectors are strong and weak in technical strength? My measure of short-term trending across 40 stocks (five from eight S&P 500 sectors) looks like this:
Materials: +240
Industrials: +60
Consumer Discretionary: +140
Consumer Staples: +200
Energy: +360
Health Care: +40
Financial: +40
Technology: -80
Once again, those commodities/weak dollar themes of Materials and Energy continue to lead the stock market, whereas growth themes (Technology, Discretionary) somewhat underperform defensive themes (Staples). I find the lack of follow-through in relative strength among the Financials particularly concerning and strongly suspect that, if we're going to sustain a break above the 1400 SPX resistance, the strength will need to come from confidence among those Financial shares.
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Three Steps for Breaking Patterns of Frustration in Trading
In my recent post, I recounted the example of Rick and the frustrated thoughts that were interfering with his trading decisions. A major idea from that post was that Rick's thought and behavior patterns were not really overreactions (as he thought they were); nor were they signs that he was "crazy" or "immature" (also things he called himself). Rather, Rick's patterns represented conflicts from his past that were triggered by events in the present, setting off old (and out of date) ways of thinking and behaving.
Research that I recently cited finds that "willpower" is much like physical energy: it can be depleted with effort. When we expend effort on following markets and containing emotions, our reserves of self-control dwindle. This, in turn, leaves us ever more vulnerable to those situations in which present events trigger automatic thoughts and actions from the past.
It is for this reason that "controlling" or fighting emotions is not helpful for the trader. Even if we succeed in keeping a lid on feelings, we take ourselves out of that performance "zone" in which we'll make our best decisions. Only by removing ourselves from the trigger situation and putting ourselves in a different physical and emotional state can we short-circuit the negative patterns (make them less automatic) and enable ourselves to re-enter that decision-making "zone".
So let's break this down: the first steps in changing negative, automatic patterns are threefold:
1) Recognizing the triggers for our patterns - Typically, there are a limited number of situations that set us off. For Rick, for example, a trigger situation was one in which the market moved suddenly against him. This set off feelings of frustration, which then triggered self-talk about markets were "rigged" by the "big guys". Those thoughts, in turn, triggered efforts to fight the big guys, leading Rick to double down on his now-losing trades. This sequence can occur relatively quickly, but notice how there are many points at which Rick could interrupt the cycle. One technique I've found consistently useful is having traders keep a journal in which they look back on periods of frustration and identify the triggers. Reviewing this journal helps us become more aware of--and sensitive to--our triggers. This brings us to our second step.
2) Recognizing that the patterns are occurring - This means monitoring your state of mind and your physical state at regular intervals during the trading day. One tool I've used with traders is a simple picture of a thermometer, in which traders can fill in the time of day and their "stress temperature". The idea is to recognize frustration *before* it triggers ongoing, negative, automatic patterns of thought and behavior. (One trader I worked with stayed hooked up to a biofeedback unit while trading for this very purpose. He stopped trading temporarily when he exited the "zone" to a significant degree). The idea is to generate a mental red flag when we recognize that frustration has been triggered. A journal can be helpful here, as well. In this case, the entries would be in real time: How am I feeling right now? What am I thinking? What is the state of my body? Such a journal strengthens our ability to act as an observer of our patterns, reducing the likelihood that we will become lost in them. This, in turn, brings us to our third step.
3) Taking the break from trading and entering a new state - Once you exit the situation that is triggering frustration, you can engage in an activity that greatly shifts your physical state. The odds are good that this will also move you to a different cognitive and emotional state. A quick round of active exercise (such as jogging on a treadmill, calisthenics, or push-ups and sit-ups) can work very well. Conversely, you may find it more effective to listen to very quieting music and then perform a meditation exercise: vividly imagining yourself in a peaceful location while you rhythmically breathe very deeply and slowly for a few minutes. If you use biofeedback, this would be the time to engage in one of the biofeedback routines. One unit I use, for example, (em-Wave) includes on-screen "games" in which you keep a balloon aloft by staying "in the zone". The idea would be to only return to the trading station once you've kept the balloon aloft for a few minutes. That completely short-circuits the negative behavior pattern. It will take some creative experimentation to find the specific activities that work best for you in shifting your state. In many cases, just taking a break, putting on some music, getting a bite to eat, and walking around are enough for me to clear my head and start fresh.
Notice that the most important step in the above is the decision that a trader makes to not buy into the frustration and the resulting negative self-talk. The market is not the problem. Other traders are not the problem. "My terrible luck" is not the problem. The problem is buying into negative thinking and letting it control trading decisions. That is why the most important step of change of all is the decision to actively fight these automatic patterns. They--not you, not trading--are the problem. Once they're triggered, your sole priority is to interrupt them and prevent them from controlling your behavior. With each interruption, you distance yourself from the patterns and make it easier the next time to extricate yourself from them.
If you find that you cannot identify the triggers and recognize them as they're occurring, you may want to try some of the techniques highlighted in the two chapters in the Enhancing Trader Performance book devoted to cognitive and behavioral methods. I wrote these chapters specifically as self-help mini-manuals for traders. If you find that even self-help methods are not working for you, that's the time to consider professional assistance. Here's a reputable website that offers referrals of licensed professionals in various geographic areas.
That having been said, my experience is that the most common reason that self-help methods don't work is that traders don't stick to them. Patterns that have been acquired over a period of years and reinforced by years of repetition will not go away simply by talking with a coach or trying an exercise a few times. If traders faithfully carried out the three steps above every day for a month, I'd expect to see significant progress in the vast majority of situations. What happens, however, is that traders don't see progress after a few days and give up. It's not the time with a coach or counselor that generates change--it's the consistency of hands-on efforts day in and day out to interrupt and change our patterns.
For my last post in this series, I will outline a specific routine that I use to work on myself. It will illustrate a different aspect of working on changing our automatic patterns: preventing them from occurring in the first place.
RELATED POSTS:
Brief Therapy Techniques for Traders
A Framework for Rapid Behavior Change
Solution-Focused Change
.
Research that I recently cited finds that "willpower" is much like physical energy: it can be depleted with effort. When we expend effort on following markets and containing emotions, our reserves of self-control dwindle. This, in turn, leaves us ever more vulnerable to those situations in which present events trigger automatic thoughts and actions from the past.
It is for this reason that "controlling" or fighting emotions is not helpful for the trader. Even if we succeed in keeping a lid on feelings, we take ourselves out of that performance "zone" in which we'll make our best decisions. Only by removing ourselves from the trigger situation and putting ourselves in a different physical and emotional state can we short-circuit the negative patterns (make them less automatic) and enable ourselves to re-enter that decision-making "zone".
So let's break this down: the first steps in changing negative, automatic patterns are threefold:
1) Recognizing the triggers for our patterns - Typically, there are a limited number of situations that set us off. For Rick, for example, a trigger situation was one in which the market moved suddenly against him. This set off feelings of frustration, which then triggered self-talk about markets were "rigged" by the "big guys". Those thoughts, in turn, triggered efforts to fight the big guys, leading Rick to double down on his now-losing trades. This sequence can occur relatively quickly, but notice how there are many points at which Rick could interrupt the cycle. One technique I've found consistently useful is having traders keep a journal in which they look back on periods of frustration and identify the triggers. Reviewing this journal helps us become more aware of--and sensitive to--our triggers. This brings us to our second step.
2) Recognizing that the patterns are occurring - This means monitoring your state of mind and your physical state at regular intervals during the trading day. One tool I've used with traders is a simple picture of a thermometer, in which traders can fill in the time of day and their "stress temperature". The idea is to recognize frustration *before* it triggers ongoing, negative, automatic patterns of thought and behavior. (One trader I worked with stayed hooked up to a biofeedback unit while trading for this very purpose. He stopped trading temporarily when he exited the "zone" to a significant degree). The idea is to generate a mental red flag when we recognize that frustration has been triggered. A journal can be helpful here, as well. In this case, the entries would be in real time: How am I feeling right now? What am I thinking? What is the state of my body? Such a journal strengthens our ability to act as an observer of our patterns, reducing the likelihood that we will become lost in them. This, in turn, brings us to our third step.
3) Taking the break from trading and entering a new state - Once you exit the situation that is triggering frustration, you can engage in an activity that greatly shifts your physical state. The odds are good that this will also move you to a different cognitive and emotional state. A quick round of active exercise (such as jogging on a treadmill, calisthenics, or push-ups and sit-ups) can work very well. Conversely, you may find it more effective to listen to very quieting music and then perform a meditation exercise: vividly imagining yourself in a peaceful location while you rhythmically breathe very deeply and slowly for a few minutes. If you use biofeedback, this would be the time to engage in one of the biofeedback routines. One unit I use, for example, (em-Wave) includes on-screen "games" in which you keep a balloon aloft by staying "in the zone". The idea would be to only return to the trading station once you've kept the balloon aloft for a few minutes. That completely short-circuits the negative behavior pattern. It will take some creative experimentation to find the specific activities that work best for you in shifting your state. In many cases, just taking a break, putting on some music, getting a bite to eat, and walking around are enough for me to clear my head and start fresh.
Notice that the most important step in the above is the decision that a trader makes to not buy into the frustration and the resulting negative self-talk. The market is not the problem. Other traders are not the problem. "My terrible luck" is not the problem. The problem is buying into negative thinking and letting it control trading decisions. That is why the most important step of change of all is the decision to actively fight these automatic patterns. They--not you, not trading--are the problem. Once they're triggered, your sole priority is to interrupt them and prevent them from controlling your behavior. With each interruption, you distance yourself from the patterns and make it easier the next time to extricate yourself from them.
If you find that you cannot identify the triggers and recognize them as they're occurring, you may want to try some of the techniques highlighted in the two chapters in the Enhancing Trader Performance book devoted to cognitive and behavioral methods. I wrote these chapters specifically as self-help mini-manuals for traders. If you find that even self-help methods are not working for you, that's the time to consider professional assistance. Here's a reputable website that offers referrals of licensed professionals in various geographic areas.
That having been said, my experience is that the most common reason that self-help methods don't work is that traders don't stick to them. Patterns that have been acquired over a period of years and reinforced by years of repetition will not go away simply by talking with a coach or trying an exercise a few times. If traders faithfully carried out the three steps above every day for a month, I'd expect to see significant progress in the vast majority of situations. What happens, however, is that traders don't see progress after a few days and give up. It's not the time with a coach or counselor that generates change--it's the consistency of hands-on efforts day in and day out to interrupt and change our patterns.
For my last post in this series, I will outline a specific routine that I use to work on myself. It will illustrate a different aspect of working on changing our automatic patterns: preventing them from occurring in the first place.
RELATED POSTS:
Brief Therapy Techniques for Traders
A Framework for Rapid Behavior Change
Solution-Focused Change
.
Monday, April 07, 2008
Markets and Minds for a Monday
* Sector Strength - The above chart shows how stock sector ETFs have fared since the January and March market bottoms. Interestingly, Materials (XLB) and Energy (XLE) are strong performers since the January lows, but have not been so dominant since the March lows. Conversely, Financials (XLF) have moved only modestly since the January lows, but are leaders in the recent period since the March bottom. Homebuilders (XHB) show up strong since both bottom periods. The most recent rally has been led by beaten down sectors, as investors are showing less fear and more optimism regarding housing and banks. Health Care (XLV) has been something of a laggard, perhaps anticipating challenges following the upcoming election.
* Building Willpower - Thanks to a reader for passing along this research perspective on how to build self-control and willpower. That is exactly what biofeedback and meditation are all about. An interesting implication, supported by research, is that efforts to contain our emotions deplete our reserves of self-control. This could be one way that emotional arousal is connected to poor trading performance, as our efforts as self-containment leave us less capable of making disciplined efforts.
* Health and Emotions - Research conducted at Duke University suggests that, individually, depression, anxiety, and anger are positively correlated as traits with the risk for heart disease. When those exist in combination, however, the risk of heart disease rises dramatically. This suggests that the overarching trait of "neuroticism"--the tendency to experience negative emotion--may bring more than just psychological consequences. Indeed, hostility may be more predictive of heart disease than such risk factors as smoking and cholesterol. It appears that the combination of hostility and depression elevates inflammatory proteins in the blood. Moreover, hostility and negative patterns of thinking are directly associated with the risk of depression. How we think thus can affect how we feel, but also how healthy we'll ultimately be.
RELATED POST:
Negative Thoughts and Trading
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Tracking a Flight From Safety
Clawing Back? - After a harrowing decline from 40 down to 16 during 2007, the Homebuilders ETF (XHB) failed to make new lows when the major averages hit new lows in March. Since their lows, the group has risen 50% and is making new year-to-date highs.
Buying Surge - If today holds up, it will represent the 16th day out of the last 19 in which the Adjusted NYSE TICK has been positive on the day. What that means is that, across the broad universe of NYSE stocks, large traders are dominantly lifting offers rather than hitting bids. A similar pattern holds true for the Dow TICK (TIKI) as well. The chart from my recent indicator review clearly shows the consistent pattern of buying.
Flight From Safety - Two-year Treasury notes, which captured well investors' flight to safety, dropped to a yield below 1.3% in March and now, with quite a drop today in bonds, are pushing a 2% yield. It's not difficult to surmise that the money that had found safe haven in Treasuries are being put to work in stocks, given the dynamics of the TICK noted above. Financial issues, so far today, have once again led the upside.
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Two Early Morning Themes to Start the Week
* Knocking at the Door of Long-Term Resistance - This chart of the June ES futures is annotated with the number of NYSE, NASDAQ, and ASE stocks making fresh 65 day highs (green numbers) and lows (red numbers). You can see that we had many fewer lows on the market's second dip down and, this past week, new highs have expanded. A breakout above the 1400-area resistance on an increased number of stocks making new highs would be a bullish development for this market. The market has behaved well since registering an overbought signal in my Cumulative Demand/Supply Indicator; that tends to occur during strong bull legs in the market. We need to see an expansion of Wednesday's level of 455 new 65-day highs to keep the rally going.
* Drumbeats of War? - The report from Debka suggests that the U.S. and Israel are coordinating a pending military action against Iran. This source has been wrong before on the Iran issue. Still, this report from Britain perked up some ears, especially given recent Israeli decisions to distribute gas masks to the population amidst week-long civil defense drills.
* A Note of Thanks - Shout out to Business Week for its recognition of Trader Feed as one of the top financial blogs.
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Sunday, April 06, 2008
Indicator Review for April 7th
Since bottoming on March 10th, buying interest in stocks has remained quite high, as we can see from the chart of the Cumulative Adjusted NYSE TICK above. I had noted in last week's review that money flows were not impressive despite the rally off the price lows. This changed with Tuesday's rally, which brought significant buying across a broad range of stocks. By Wednesday, we had 455 NYSE, NASDAQ, and ASE issues making fresh 65-day highs, the highest level of 2008. Moreover, the stocks in my basket of S&P 500 issues, which are evenly divided among eight sectors, moved solidly into uptrends, as noted by my Twitter posts this past week. The charts from my Friday post show how we made a double bottom in the major averages with an important non-confirmation from the new 52-week lows. That has been followed by a pickup in the proportion of stocks trading above their moving averages, as well as by the expansion in the number of stocks making new highs.
Does this mean that we've finished a bear market and are now in bull mode? Not necessarily. The 1400 region in the S&P 500 Index represents important resistance, and--as noted recently--we're quite overbought. The Advance-Decline lines for the NYSE common stocks and S&P 500 issues do not look healthy; they've budged only moderately from their bear lows. Yield spreads--corporate and municipal vs. Treasuries, for example--and interbank loan rates still suggest a healthy measure of risk aversion.
Still, I have to go with the indicators and, for now, they're suggesting that we've put in a double bottom and should enjoy an intermediate-term advance. My expectation is that this should take us above the 1400 resistance and flush out the bears. What would change my mind from this scenario would be reversals of the dynamics we're currently seeing in NYSE TICK, money flows, and the expansion of stocks making new highs. Particularly worrisome would be an expansion in the number of stocks making fresh 20-day lows. If we're to enjoy an intermediate-term advance, I'd expect that number to remain below the 547 new 20-day lows registered on 3/28.
Those financial issues have continued to exercise leadership on an intraday basis, as they capture relative confidence and lack of confidence in the financial system. I will be watching them, as well as how well price holds up on any consolidation from this overbought level, to handicap the odds of our breaking above that 1400 region in SPX.
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What Are You Doing Between Trades?
I want to thank readers for excellent comments and perspectives on my recent post that addressed the question of why trading is so difficult. In particular, I thought that Charles and Ziad identified a most important issue: the trader's engagement with markets *between* trades.
To take a step back, if I were asked the question, "What makes trading so difficult?", my response would echo Victor Niederhoffer: "Trading is difficult because of the ever-changing nature of market patterns".
In statistical terms, this is called nonstationarity; in my previous writings I described it as playing blackjack when the number of decks in the "shoe" periodically changes. You the card counter are keeping track of the number of picture cards dealt, not knowing that the supply of picture cards has just increased multi-fold.
Similarly, from one time period to the next, market patterns can change: we can see altered patterns of trending and altered patterns of volatility. This occurs within the day--the market's behavior is different in morning than midday--and across days, weeks, months, and years. (We currently are experiencing far more volatility than a couple of years ago).
A nice example of Niederhoffer's "ever-changing cycles" is the recent shift in one-sided days that I wrote about. When we get such shifts, traders who internalized the previous patterns (and, in this case, fade opening strength or weakness) become caught in the new patterns and lose money. This is a major cause of frustration in trading, and it is a major reason that successful traders can rather quickly become unsuccessful ones.
It is because of these changing cycles that traders need to stay actively engaged with markets *between* trades. At any time, trends can reverse, breakouts can occur, markets can become quiet, etc. Only by following the market's emerging patterns can traders hope to adapt to them and eventually profit. Charles provided an excellent example in his comment to the post: because he is actively figuring out what the market is doing, he avoids what I called the "fireman" syndrome among traders, in which periods of boredom oscillate with periods of intense emotion and action.
Ziad makes the valuable point that one does not need to approach the markets quantitatively to stay actively engaged. In my own trading, for example, I stay engaged by watching unfolding sentiment (NYSE TICK, Market Delta), seeing how price and volume behave at the edges of market ranges, and by seeing how markets correlated to my own are behaving. The time between trades is never boring, because my interest is captured by reading the emerging market patterns.
Herein lies the problem beneath the fireman syndrome: If the trader is more interested in trading than in understanding markets, the period between trades will not be productive. That period will either be boring (which will incite overtrading), or it will be dominated by negative thinking about recent performance (which will color future decision making).
This is why structuring one's time between trades with processes to examine markets--and to examine oneself, when needed--is very helpful for trading. The mind, like nature, abhors a vacuum. If we aren't prepared with constructive activities between trades, the mind will latch onto non-constructive ones.
I strongly suspect that a reliable way to identify a good trader is to observe what he or she is doing *between* trades.
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To take a step back, if I were asked the question, "What makes trading so difficult?", my response would echo Victor Niederhoffer: "Trading is difficult because of the ever-changing nature of market patterns".
In statistical terms, this is called nonstationarity; in my previous writings I described it as playing blackjack when the number of decks in the "shoe" periodically changes. You the card counter are keeping track of the number of picture cards dealt, not knowing that the supply of picture cards has just increased multi-fold.
Similarly, from one time period to the next, market patterns can change: we can see altered patterns of trending and altered patterns of volatility. This occurs within the day--the market's behavior is different in morning than midday--and across days, weeks, months, and years. (We currently are experiencing far more volatility than a couple of years ago).
A nice example of Niederhoffer's "ever-changing cycles" is the recent shift in one-sided days that I wrote about. When we get such shifts, traders who internalized the previous patterns (and, in this case, fade opening strength or weakness) become caught in the new patterns and lose money. This is a major cause of frustration in trading, and it is a major reason that successful traders can rather quickly become unsuccessful ones.
It is because of these changing cycles that traders need to stay actively engaged with markets *between* trades. At any time, trends can reverse, breakouts can occur, markets can become quiet, etc. Only by following the market's emerging patterns can traders hope to adapt to them and eventually profit. Charles provided an excellent example in his comment to the post: because he is actively figuring out what the market is doing, he avoids what I called the "fireman" syndrome among traders, in which periods of boredom oscillate with periods of intense emotion and action.
Ziad makes the valuable point that one does not need to approach the markets quantitatively to stay actively engaged. In my own trading, for example, I stay engaged by watching unfolding sentiment (NYSE TICK, Market Delta), seeing how price and volume behave at the edges of market ranges, and by seeing how markets correlated to my own are behaving. The time between trades is never boring, because my interest is captured by reading the emerging market patterns.
Herein lies the problem beneath the fireman syndrome: If the trader is more interested in trading than in understanding markets, the period between trades will not be productive. That period will either be boring (which will incite overtrading), or it will be dominated by negative thinking about recent performance (which will color future decision making).
This is why structuring one's time between trades with processes to examine markets--and to examine oneself, when needed--is very helpful for trading. The mind, like nature, abhors a vacuum. If we aren't prepared with constructive activities between trades, the mind will latch onto non-constructive ones.
I strongly suspect that a reliable way to identify a good trader is to observe what he or she is doing *between* trades.
.
Saturday, April 05, 2008
A Few Weekend Views
* Overbought - We can see from the above chart that my Adjusted Cumulative Demand/Supply Index--a measure that compares the current Demand/Supply reading to its long-term moving average--is quite overbought. In my research, on average this has led to subnormal returns 20 days out. To be sure, a market can stay overbought for awhile; it's when we see the overbought readings also correspond to a period of rising 20-day new lows that stocks are most vulnerable to correction. So far, new 20-day highs have held up well (Friday showed 1630 new 20-day highs against 237 lows) and new lows have steadily contracted.
* Interview - Many thanks to the ATB Finance site in France for publishing this English-language interview with me on trading psychology and performance.
* Performance and Self-Perception - Thanks also to an alert reader who passed along this very interesting article on how our stereotyped thinking about ourselves affects our performance.
* Looking for Trend Days - On the heels of my recent post, Ray Barros shared some ways that he identifies trending days in the stock market.
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Cross-Talk: Why Trading Is So Difficult
Trader's Narrative recently posted an excellent piece on "Why Is Trading So Difficult?" The gist of the post is that, while trading is simple on the surface--it amounts to either buying or selling--it is psychologically difficult, because it requires the ability to meld patience and the tolerance of boredom with the ability to act swiftly and decisively during periods of "adrenaline induced action". I hereby dub this the "fireman's view of trading", as it portrays the trader like the firefighter in the station, sitting around for long periods of time playing cards and washing the trucks, and then suddenly responding to five-alarm events.
There is truth in this portrayal, of course. Trading does require the ability to restrain oneself from acting, just as it requires action in the face of risk and reward. Babak's point that traders need to be both serene and patient as well as decisive--able to analyze as well as act--is well taken. It is possible to be both overly analytical and indecisive or overly impulsive and out of control.
Yet, there are myths embedded in the "trading is simple, but psychologically difficult" formulation.
The idea that trading is easy--that it consists of either buying up markets, selling down ones, or playing for countertrend bounces--is a bit like saying that surgery amounts to either reshaping things, pulling them out, or replacing them. Any skill can be simplified via surface description, and it is precisely such surface description (and the ease of opening an account and trading, as Babak notes) that lures the unwary and unprepared into trading.
Of course, the entire idea that trading is about profiting from directional movement is a gross simplification shared by many traders. Take the example of an energy trader who notices that markets are deviating from historical norms and puts on a complex position of futures and swaps to capture a reversion to those norms. Such a "relative value" trade is anything but simple, as it requires accurate modeling of current markets vis a vis those historical norms. Much stock trading, in fact, is not directional, but rather an attempt to capture abnormal deviations between pairs of stocks or between markets.
It is the very simplification that trading is all about catching directional moves that helps make trading so difficult. The directional trader enters a very crowded space in which market inefficiencies are ruthlessly arbed away. It's when the trader examines more complex relationships--let's say the relationship between fixed income and currency movements and valuations among housing futures--that unexploited patterns are more likely to appear. Perhaps New York real estate will perform better than, say, Chicago properties if reduced interest rates and a falling dollar bring more overseas buying.
This idea that opportunity is to be found among more complex market relationships also changes the trading game psychologically. It is relatively difficult to find a hedge fund portfolio manager who would subscribe to the fireman's view of trading. The reason for this is that the time spent between placing trades is anything but boring. This is the time when you figure out those market relationships, developing/updating your models, assessing deviations from those, and constructing proper hedges following relative value movements. In fact, the actual act of trading is so diminished in importance at many institutions that portfolio managers don't even place trades. Rather, they call in the orders to execution desks, so that they are freed to continue their "real" work: figuring out market themes.
What makes trading difficult is the fact that, for many traders, the time between trades is dead time. Such inactivity--mentally--is what creates the boredom. Locked into a simplistic view of trading, traders perceive nothing to do when markets are providing setups for trades. They don't see their job as figuring out markets--in fact, the entire concept of "figuring out" may be discarded as overanalysis. Instead, they wait for trades like firemen wait for alarms to sound. But where the fireman engages in decisive physical action in the face of adrenaline pumping, the trader has no such outlets. Adrenaline pumping itself becomes a factor that interferes with sound decision-making and trading performance.
So what makes trading difficult is a fundamental misunderstanding of trading. Once a trader views placing trades as a simple matter of anticipating direction and the goal of trading as placing trades, he or she is locked into a perspective in which the goal is action and the challenge is the boredom of inaction. This brings trading perilously close to gambling. It is also not how the best bank traders and portfolio managers operate. Their more elaborated views of markets and trades means that the time between trades is when the real work is done; such time is intrinsically interesting and rewarding.
Consider an analogy: relationships would be difficult if we viewed sexual relations as the overarching goal and purpose. Everything else--the time between escapades in bed, from conversing to sharing experiences--would be boring and difficult to tolerate. To someone who viewed relationships in terms of intimacy, however, those times outside the bedroom would be the heart and soul of encountering the other person--what makes the physical relations *meaningful*.
Trading is not difficult because it blends action and inaction. It is difficult when we view trading through the lenses of firemen, creating both adrenaline spikes and boring interludes.
RELATED POST:
Three Market Idiots
.
There is truth in this portrayal, of course. Trading does require the ability to restrain oneself from acting, just as it requires action in the face of risk and reward. Babak's point that traders need to be both serene and patient as well as decisive--able to analyze as well as act--is well taken. It is possible to be both overly analytical and indecisive or overly impulsive and out of control.
Yet, there are myths embedded in the "trading is simple, but psychologically difficult" formulation.
The idea that trading is easy--that it consists of either buying up markets, selling down ones, or playing for countertrend bounces--is a bit like saying that surgery amounts to either reshaping things, pulling them out, or replacing them. Any skill can be simplified via surface description, and it is precisely such surface description (and the ease of opening an account and trading, as Babak notes) that lures the unwary and unprepared into trading.
Of course, the entire idea that trading is about profiting from directional movement is a gross simplification shared by many traders. Take the example of an energy trader who notices that markets are deviating from historical norms and puts on a complex position of futures and swaps to capture a reversion to those norms. Such a "relative value" trade is anything but simple, as it requires accurate modeling of current markets vis a vis those historical norms. Much stock trading, in fact, is not directional, but rather an attempt to capture abnormal deviations between pairs of stocks or between markets.
It is the very simplification that trading is all about catching directional moves that helps make trading so difficult. The directional trader enters a very crowded space in which market inefficiencies are ruthlessly arbed away. It's when the trader examines more complex relationships--let's say the relationship between fixed income and currency movements and valuations among housing futures--that unexploited patterns are more likely to appear. Perhaps New York real estate will perform better than, say, Chicago properties if reduced interest rates and a falling dollar bring more overseas buying.
This idea that opportunity is to be found among more complex market relationships also changes the trading game psychologically. It is relatively difficult to find a hedge fund portfolio manager who would subscribe to the fireman's view of trading. The reason for this is that the time spent between placing trades is anything but boring. This is the time when you figure out those market relationships, developing/updating your models, assessing deviations from those, and constructing proper hedges following relative value movements. In fact, the actual act of trading is so diminished in importance at many institutions that portfolio managers don't even place trades. Rather, they call in the orders to execution desks, so that they are freed to continue their "real" work: figuring out market themes.
What makes trading difficult is the fact that, for many traders, the time between trades is dead time. Such inactivity--mentally--is what creates the boredom. Locked into a simplistic view of trading, traders perceive nothing to do when markets are providing setups for trades. They don't see their job as figuring out markets--in fact, the entire concept of "figuring out" may be discarded as overanalysis. Instead, they wait for trades like firemen wait for alarms to sound. But where the fireman engages in decisive physical action in the face of adrenaline pumping, the trader has no such outlets. Adrenaline pumping itself becomes a factor that interferes with sound decision-making and trading performance.
So what makes trading difficult is a fundamental misunderstanding of trading. Once a trader views placing trades as a simple matter of anticipating direction and the goal of trading as placing trades, he or she is locked into a perspective in which the goal is action and the challenge is the boredom of inaction. This brings trading perilously close to gambling. It is also not how the best bank traders and portfolio managers operate. Their more elaborated views of markets and trades means that the time between trades is when the real work is done; such time is intrinsically interesting and rewarding.
Consider an analogy: relationships would be difficult if we viewed sexual relations as the overarching goal and purpose. Everything else--the time between escapades in bed, from conversing to sharing experiences--would be boring and difficult to tolerate. To someone who viewed relationships in terms of intimacy, however, those times outside the bedroom would be the heart and soul of encountering the other person--what makes the physical relations *meaningful*.
Trading is not difficult because it blends action and inaction. It is difficult when we view trading through the lenses of firemen, creating both adrenaline spikes and boring interludes.
RELATED POST:
Three Market Idiots
.
Friday, April 04, 2008
One-Sided Days in the Stock Market
I've heard from a number of intraday traders who have been performing quite poorly during very strong or very weak market days. Interestingly, most of them have also been underperforming overall. My take on that is that the stock market has been featuring more one-sided days, in which stocks generally trend higher or lower intraday--a kind of herd effect. We would expect intraday traders who fade early market moves to suffer on these one-sided days, and we would expect their overall performance to suffer if these one-sided days are more frequent now than in the past.
So let's do what too few traders do and actually look at market data.
I examined the number of days in which advancing stocks outnumbered declining issues by more than 3:1 and those days in which decliners led advancers by more than 3:1 across all NYSE issues. These are relatively one-sided days: the vast majority of issues are either rising or declining. From 2002 through the end of 2006 (N = 1259 trading days), we had 101 such one-sided days. That's a little less than 9% of all occasions.
Since 2007 (N = 315 trading days), we've had 74 one-sided days. That's almost 25% of the total. In other words, since 2007, the proportion of one-sided days has increased dramatically.
The reason for this, I believe, is that large money managers (such as hedge funds) are increasingly managing their portfolios on an intraday basis. When they see risk aversion themes kicking into markets, they dump stocks; when they see risk-seeking, they snap up shares. This creates intraday herd effects that don't necessarily carry over to the next day's trade.
What that means is that skilled intraday traders need to distinguish between early strength and weakness that represents movements of the herd and early strength and weakness that is part of normal, random drift (and hence likely to reverse). Tracking risk-aversion and risk-seeking themes in fixed income and currency markets; tracking trader sentiment with tools such as NYSE TICK; and tracking intraday market breadth (and its trend) are useful in this regard.
RELEVANT POSTS:
NYSE TICK and Intraday Trend
Intraday Trend and Sentiment
.
So let's do what too few traders do and actually look at market data.
I examined the number of days in which advancing stocks outnumbered declining issues by more than 3:1 and those days in which decliners led advancers by more than 3:1 across all NYSE issues. These are relatively one-sided days: the vast majority of issues are either rising or declining. From 2002 through the end of 2006 (N = 1259 trading days), we had 101 such one-sided days. That's a little less than 9% of all occasions.
Since 2007 (N = 315 trading days), we've had 74 one-sided days. That's almost 25% of the total. In other words, since 2007, the proportion of one-sided days has increased dramatically.
The reason for this, I believe, is that large money managers (such as hedge funds) are increasingly managing their portfolios on an intraday basis. When they see risk aversion themes kicking into markets, they dump stocks; when they see risk-seeking, they snap up shares. This creates intraday herd effects that don't necessarily carry over to the next day's trade.
What that means is that skilled intraday traders need to distinguish between early strength and weakness that represents movements of the herd and early strength and weakness that is part of normal, random drift (and hence likely to reverse). Tracking risk-aversion and risk-seeking themes in fixed income and currency markets; tracking trader sentiment with tools such as NYSE TICK; and tracking intraday market breadth (and its trend) are useful in this regard.
RELEVANT POSTS:
NYSE TICK and Intraday Trend
Intraday Trend and Sentiment
.
Themes and Thoughts for Friday
Tracking a Bottoming Process - These charts from the very useful Decision Point site show how we've been making an intermediate-term bottom in stocks. The top chart shows that, as we dipped a second time in the NYSE Composite in March, the number of common stocks registering new 52-week lows contracted meaningfully. The bottom chart shows that the percentage of NYSE stocks closing above their 200-day moving averages went below 20% in both January and March and is now on an upswing. With Tuesday's rally, money finally began flowing into shares in a significant way. We're now registering overbought in my Cumulative Demand/Supply indicator (Demand and Supply are tracked daily in my Twitter posts), so a period of consolidation following the market strength would not be surprising.
Stocks With Energy to Spare - It's very interesting to see that over 27% of the stocks showing up on Charles Kirk's screens are energy issues. The energy and materials themes have been quite durable, even through the period of market weakness, as the falling dollar, rising commodities, and anticipation of continued long-term demand from emerging nations provide solid fundamental support. See also some of the themes tracked in Kirk's recent links, including gold and utilities.
Visualizing the Market - Shout out to Trader Mike, who dug up this very worthwhile heat map of sectors and asset classes. At a glance, you can see what's weak and strong and infer some of the themes in the market. Great concept.
More Good Reading - Abnormal Returns finds more interesting themes, including a possible bottoming of interest rates, what unemployment claims are telling us, and alternative investments.
Who Makes It - There's a very accurate predictor of trader success I've found as a trading coach. The successful ones work as hard at figuring out and understanding markets as I do. If I work quite a bit harder at the markets than the traders I'm coaching, they're not going to make it. I suspect that's true of players and coaches in sports as well.
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Thursday, April 03, 2008
Frustrated Trading: Stilling the Negative Thoughts in Your Head
One of the most disruptive emotional influences in trading occurs when normal, expectable frustrations encountered during the trading day trigger longstanding, habitual patterns of negative thought. At that point, as cognitive therapists emphasize, the negative thoughts follow a well-worn—and automatic—path, adding frustration to frustration. This is particularly damaging to trading for two reasons: 1) it prevents traders from constructively addressing the original, market-related sources of frustration; and 2) it escalates frustration to the point where it impedes future decision-making.
Take the example of Rick, an active intraday trader, who grew up in a family dominated by conflict and fighting. Hit and yelled at frequently as a child, he developed resentments toward authority figures that continued during his schooling. He likes to champion the underdog and often complains that “big guys”—those with power and influence in business and government—take advantage of the “little guy”. When he is trading, Rick can be very focused on his markets and keen in his observations. Every so often, however, his markets will move suddenly on news items, rumors, or large institutional (program) trades. That becomes his trigger: the market event that sets off his negative thought patterns.
When the market moves suddenly and sharply against Rick, his first reaction is anger and frustration. Automatic thoughts rush into his head: “I can’t believe this is happening again” and “I can’t believe how unlucky I am.” Although he voices these thoughts in a frustrated and often sarcastic tone, there is no doubting his sadness. He experiences himself as a victim of the market’s adverse movement. He has become the “little guy” hurt by the “big guys”, just as he was hurt during his childhood.
As the market moves further against him, Rick makes the transition from frustration to outright anger. He raises his voice, exclaiming that he can’t believe how unfair and “rigged” the markets are. He declares that it’s impossible to make money; the markets cheat the “little guy”. Eager to lash out at the big guys who are “taking my money”, Rick fights the trend and doubles down on his now-losing position. He rebels against the “big guys” just as he did against his parents, teachers, and bosses. The market, however, doesn’t listen and doesn’t care. It grinds Rick’s oversized position into a major loss, leaving him feeling saddened, defeated, and shocked at his own lack of “discipline”.
Rick vows to do a better job of keeping his cool and following his risk rules and, for a while, he keeps a lid on his frustrations. Inevitably, however, one of those market moves is likely to once again go against his position, and his thoughts and feelings return. It’s as if his brain is taken over by an alien influence—one deeply rooted in his past.
The important thing for Rick to recognize is that he is not simply reacting to the markets; his emotional reactions are colored—and exaggerated by—his past. In fact, this is a useful psychological principle: there are no emotional overreactions to events, only reactions that mix the past with the present.
At the time Rick is finding his negative, automatic thoughts triggered, he is not aware that this is a function of the past intruding into the present. He doesn’t see that he is transferring his anger and hurt toward his father (the first “big guy” who hurt him when he was a “little guy”) to the markets. Because he isn’t aware of this connection, he winds up repeating it again and again in a destructive fashion.
Many, many times, the “overreactions” of traders are reflections of unresolved issues from the past intruding into the present.
In coming posts, I will explore ways of coming to terms with these patterns and isolating them from trading decisions. The first step, however, is for traders to recognize when their frustrations are boiling over—and to stop trading at that time. Above all else, do no harm is the principle. If you felt your car was not responding properly to your driving maneuvers, you wouldn’t keep driving, and you certainly wouldn’t speed up! So why keep trading when your mind is not responding to your planning and reasoning, and why especially trade more aggressively?
This is very important: developing the ability to stop yourself. By itself, it will not solve the problems from the past, but it will drive a wedge between you and your negative, automatic thoughts. You may not be able to stop the thoughts right away, but you can ensure that they don’t control your behaviors. All you need is a rule that you follow religiously that says: once you start yelling, swearing, pounding the table, clenching up, or talking negatively at the screen, you take a break until you’re calm. That’s it. You can choose to trade or not trade when you’re in or out of the zone.
You’ll be surprised how taking a break will help you still the voices in your head, regain your composure, and build your sense of self control. A few minutes of slow, deep breathing and focused concentration perform miracles in this regard. (I find biofeedback especially useful in this regard, as it tells you precisely when you're re-entered the zone). Many more traders would be successful if they only traded when they were in the right state of mind.
RELEVANT POSTS:Therapy for the Mentally Well
Emotional Intelligence and Trading
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Wednesday, April 02, 2008
Catching Trend Days in the Stock Market
I received an unusual number of frustrated emails from traders after yesterday's strong trend day. All of these were daytraders, and all were not able to capitalize on the trend day. Frustration over missed opportunity led to attempts to make up for the deficient performance, which then worked against them and created losses. What to do about such a situation?
First off, let's get expectations right: daytraders, on average, will tend to underperform on trend days. The buy and hold trader will, on average, milk more of the move than someone who tries to enter and exit many times in a one-way market. In addition, many trend markets start strong, meaning that daytraders who wait for an indication of direction for the day will generally enter the move once it's under way. That's tough, especially when the trend day follows some choppy, range days. The intraday trader who gets frustrated because he/she doesn't catch the entire move is probably feeling as much frustration from perfectionism as from market action per se.
(One common version of perfectionism: waiting for the trending market to pull back before participating in the move. By definition, trending markets are not going to give sizable pullbacks; they tend to be one-way markets. This doesn't mean you have to buy highs and sell lows on such days; it simply means you redefine the notion of pullback. In my trading, I use pull backs to negative NYSE TICK as one guide).
Second, let's recognize that catching trend days is essential to success in the recent market. I notice that Rennie Yang of Market Tells points out that we've had more such days in the past year than in the past decade. Fighting such one-sided markets is a recipe for losing. In such a situation, frustration is a completely appropriate response, speaking to the need to identify trending moves as early in the day as possible. Focusing on frustration as the problem misses the reason for the frustration in the first place: the difficulty making early identification of trending moves.
One way I like to channel this frustration is toward studying the characteristics of the kind of trading day I'm trying to master. By studying many examples of trend days, you can find common features and learn to identify and act upon those in real time. Here are some features to look at:
1) Breakouts from short-term ranges (overnight range, previous day's range, multi-day range, opening range) on strong volume;
2) Persistently strong NYSE TICK (note that we didn't get a -500 reading until almost noon CT on Tuesday);
3) Persistently skewed volume at offer vs. bid for ES futures (This shows up nicely on a Market Delta chart; the cumulative Delta moves steadily higher, as large traders keep lifting offers);
4) Strength in market's leading sectors (Note how, once again, financials led the way for the broad market on Tuesday);
5) Confirmation from correlated markets (Note the upswing in interest rates/decline of bond prices as the flight to quality unwound; the Yen weakness);
6) Extreme readings in the day's advance-decline readings and TRIN.
Because trend days open near their lows (highs) and close near their highs (lows), you're generally safe entering on pullbacks in NYSE TICK. Entries after relatively flat price corrections often work well also.
But nothing substitutes for studying these markets and internalizing their distinctive features. The best treatment for frustration is prevention.
RELEVANT POSTS:
Catching Market Breakouts
Identifying Breakout Moves
.
First off, let's get expectations right: daytraders, on average, will tend to underperform on trend days. The buy and hold trader will, on average, milk more of the move than someone who tries to enter and exit many times in a one-way market. In addition, many trend markets start strong, meaning that daytraders who wait for an indication of direction for the day will generally enter the move once it's under way. That's tough, especially when the trend day follows some choppy, range days. The intraday trader who gets frustrated because he/she doesn't catch the entire move is probably feeling as much frustration from perfectionism as from market action per se.
(One common version of perfectionism: waiting for the trending market to pull back before participating in the move. By definition, trending markets are not going to give sizable pullbacks; they tend to be one-way markets. This doesn't mean you have to buy highs and sell lows on such days; it simply means you redefine the notion of pullback. In my trading, I use pull backs to negative NYSE TICK as one guide).
Second, let's recognize that catching trend days is essential to success in the recent market. I notice that Rennie Yang of Market Tells points out that we've had more such days in the past year than in the past decade. Fighting such one-sided markets is a recipe for losing. In such a situation, frustration is a completely appropriate response, speaking to the need to identify trending moves as early in the day as possible. Focusing on frustration as the problem misses the reason for the frustration in the first place: the difficulty making early identification of trending moves.
One way I like to channel this frustration is toward studying the characteristics of the kind of trading day I'm trying to master. By studying many examples of trend days, you can find common features and learn to identify and act upon those in real time. Here are some features to look at:
1) Breakouts from short-term ranges (overnight range, previous day's range, multi-day range, opening range) on strong volume;
2) Persistently strong NYSE TICK (note that we didn't get a -500 reading until almost noon CT on Tuesday);
3) Persistently skewed volume at offer vs. bid for ES futures (This shows up nicely on a Market Delta chart; the cumulative Delta moves steadily higher, as large traders keep lifting offers);
4) Strength in market's leading sectors (Note how, once again, financials led the way for the broad market on Tuesday);
5) Confirmation from correlated markets (Note the upswing in interest rates/decline of bond prices as the flight to quality unwound; the Yen weakness);
6) Extreme readings in the day's advance-decline readings and TRIN.
Because trend days open near their lows (highs) and close near their highs (lows), you're generally safe entering on pullbacks in NYSE TICK. Entries after relatively flat price corrections often work well also.
But nothing substitutes for studying these markets and internalizing their distinctive features. The best treatment for frustration is prevention.
RELEVANT POSTS:
Catching Market Breakouts
Identifying Breakout Moves
.
Tuesday, April 01, 2008
Opening Intermarket Patterns For Stock Market Daytraders
Two of the intermarket relationships that I follow closely to help frame intraday trades are interest rates on Treasury bills/notes and the behavior of financial stocks. When rates come down in Treasuries (i.e., when there is demand for Treasuries and higher prices), it means that investors are in a relatively risk-averse mindset. That often carries forward to stocks.
The second relationship is the relative strength and weakness of shares in the financial sector, including banks and brokers. When these stocks are weak, it means that investors are expressing doubts about the viability of the financial system, and that also often carries forward to stocks.
I went back to the start of 2007 (N = 312 trading days) to capture relationships in the recent market. When yields on the 10-year Treasury note ($TNX) have opened with a decline of more than half a percent, the day's trading session in the S&P 500 Index (SPY, open to close) has averaged a loss of -.17% (31 up, 46 down). By contrast, when yields have opened stronger than that, the coming day's trade in SPY has averaged a gain of .02% (125 up, 110 down). This is a simple example of how fixed income markets help set the tone for the coming day's stock market trade.
Do other intermarket relationships affect the day's performance among stocks? Also going back to the start of 2007, I found that when gold (GLD) opens down by more than .40%, SPY averages a gain of .18% (36 up, 26 down) for that day's trading session (open to close). Conversely, when gold opens stronger than that, the coming day in SPY averages a loss of -.08% (120 up, 130 down). Weak gold, which implies a strong U.S. dollar, appears to set a bullish tone for stocks in the coming day's trade.
I next examined the opening performance of financial stocks (XLF) vs. the day's performance of SPY. When XLF has opened down by half a percent or more, the day session in SPY has averaged a loss of -.08% (30 up, 41 down). On the other hand, when XLF has opened stronger than that, SPY has averaged a loss of -.01% (126 up, 115 down). This makes sense, given the dynamic described above: when investors and traders are showing less confidence in the financial system, their pessimism tends to spill over to the coming day's trading.
Finally, I took a look at the opening performance of energy stocks (XLE) vs. the day's performance of SPY. When XLE has opened down by .60% or more, the coming day session in SPY (open to close) has averaged a gain of .10% (29 up, 28 down). When XLE has opened stronger than that, SPY has averaged a loss of -.06% during the coming day's trade (127 up, 128 down). A weak XLE implies weak oil prices, which are helpful to economic growth and stocks overall. A more robust relationship might be found by examining oil prices themselves.
These are far from perfect relationships, but they are indicative and have informed my intraday trading. When these relationships occur in combination and in the context of multi-day patterns, they are especially helpful (something I encourage readers to research). By understanding the optimism and pessimism of large market participants regarding interest rates, commodities, and financials, we can make inferences about their likely behavior toward equities.
RELATED POSTS:
Trading by Regimes
Oil Prices and Stocks
Interest Rates and Stocks
.
The second relationship is the relative strength and weakness of shares in the financial sector, including banks and brokers. When these stocks are weak, it means that investors are expressing doubts about the viability of the financial system, and that also often carries forward to stocks.
I went back to the start of 2007 (N = 312 trading days) to capture relationships in the recent market. When yields on the 10-year Treasury note ($TNX) have opened with a decline of more than half a percent, the day's trading session in the S&P 500 Index (SPY, open to close) has averaged a loss of -.17% (31 up, 46 down). By contrast, when yields have opened stronger than that, the coming day's trade in SPY has averaged a gain of .02% (125 up, 110 down). This is a simple example of how fixed income markets help set the tone for the coming day's stock market trade.
Do other intermarket relationships affect the day's performance among stocks? Also going back to the start of 2007, I found that when gold (GLD) opens down by more than .40%, SPY averages a gain of .18% (36 up, 26 down) for that day's trading session (open to close). Conversely, when gold opens stronger than that, the coming day in SPY averages a loss of -.08% (120 up, 130 down). Weak gold, which implies a strong U.S. dollar, appears to set a bullish tone for stocks in the coming day's trade.
I next examined the opening performance of financial stocks (XLF) vs. the day's performance of SPY. When XLF has opened down by half a percent or more, the day session in SPY has averaged a loss of -.08% (30 up, 41 down). On the other hand, when XLF has opened stronger than that, SPY has averaged a loss of -.01% (126 up, 115 down). This makes sense, given the dynamic described above: when investors and traders are showing less confidence in the financial system, their pessimism tends to spill over to the coming day's trading.
Finally, I took a look at the opening performance of energy stocks (XLE) vs. the day's performance of SPY. When XLE has opened down by .60% or more, the coming day session in SPY (open to close) has averaged a gain of .10% (29 up, 28 down). When XLE has opened stronger than that, SPY has averaged a loss of -.06% during the coming day's trade (127 up, 128 down). A weak XLE implies weak oil prices, which are helpful to economic growth and stocks overall. A more robust relationship might be found by examining oil prices themselves.
These are far from perfect relationships, but they are indicative and have informed my intraday trading. When these relationships occur in combination and in the context of multi-day patterns, they are especially helpful (something I encourage readers to research). By understanding the optimism and pessimism of large market participants regarding interest rates, commodities, and financials, we can make inferences about their likely behavior toward equities.
RELATED POSTS:
Trading by Regimes
Oil Prices and Stocks
Interest Rates and Stocks
.
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