Saturday, February 28, 2009
* Markets communicate patterns of supply and demand at all time frames; following and responding to these patterns is similar to a psychologist's following and responding to the communications of others in counseling;
* Effective trading requires an ability to listen to markets; most psychological trading problems occur when personal needs, reactions, and biases interfere with an open-minded processing of market communications;
* Markets can be understood, not only by what they do, but also by what they fail to do. A market that fails to follow an expected historical pattern, for instance, is communicating something of importance regarding current supply and demand;
* The optimal coaching of traders can be conceptualized as a supervisory process, much like the training models in psychiatry and psychology by which therapists are developed over time. This is significantly different from coaching models that are grounded in weekly individual or group talk time (therapy model) or time-limited workshops/seminars (education model).
* Because competence and expertise typically develop over years of practice and supervision across all performance fields, models of coaching that are highly time-limited and not grounded in actual trading practice are not likely to be successful in facilitating the learning/mastery process required of traders.
So, if we draw upon the structure of training programs in such fields as medicine, law, performing arts, athletics, and military, what might an optimal coaching program for traders look like?
* It would start by building a fund of knowledge - Traders who try to learn the ropes by immediately placing their capital at risk are like rock climbers who try to learn by immediately tackling the highest mountains. As I stress in my performance book, there is no "minor leagues" of trading; no exchanges where everyone participating is either inexperienced or an idiot. From day one, traders always trade against pros. For that reason, traders begin by learning about how markets operate, how they move, why they move, and how traders read their movements.
* It would teach pattern recognition before intervention - A medical student first learns pathology and introductory clinical medicine before ever working on a patient. You can't heal if you don't know the difference between health and illness. Similarly, a student of the markets needs to learn patterns of supply and demand and various structures to market days and weeks before developing and executing trading plans.
* It would emphasize mutual learning and mentorship - Observing actual trading and the decision-making of more advanced students would precede one's own real-time market activity. Just as a junior medical student follows a senior student and beginning resident (intern) around the hospital, a junior trader would observe the learning and performance of more senior traders.
* It would entail ongoing supervision and performance review - In the military, there is always an after-action review to learn from operations that have been undertaken. Similarly, the work of medical students and residents is always supervised and reviewed by experienced attending physicians. In team sports, players will often break into groups for drills that are overseen by coaches and assistant coaches, with immediate corrective efforts as needed.
* It would combine group-based learning with individualized training - Learning in groups allows students to see the mistakes (and strengths) of others and learn from those via observation. Individualized learning enables students to identify and work on strengths and weaknesses unique to them, focusing on specific performances.
* It would be affordable - The beginning levels of training, focusing on fund-of-knowledge and pattern recognition, can typically occur in large didactic settings. For example, at my medical school, the entering class was about 150 students and all students took the same introductory courses in large lecture halls. Later, the training became more individualized in clinical rotations (group based) and work with individual supervisors. By delivering material in the best possible format according to a structured curriculum, training can be educationally and cost effective.
Perhaps the best model for training and development can be found, not in medicine or athletics, but in the spiritual disciplines. Think about the learning process that occurs in monasteries, Yeshivas, ashrams, and even martial arts centers. These involve several elements that have been crucial to their long-term success:
1) They are structured as committed communities, in which everyone is both student and teacher;
2) They are led by one or more accomplished individuals who provide the community with a sense of values and direction;
3) They involve a degree of withdrawal from the everyday world to facilitate a daily commitment to learning;
4) They are not primarily commercial entities, but instead seek mutual "profit" in self-development and participation in the development of others;
5) They develop multiple leaders and teachers, encouraging diversity of learning and thereby becoming self-sustaining. This is what differentiates true learning communities from cults that focus on a single "guru" leader.
The beauty of intentional trading communities is that, in seeking self and mutual learning and development, participants also profit and prosper financially. There is no dichotomy, so often seen in present educational efforts, between the learning needs of the participants and the financial interests of the educators. This is because the participants are the educators and the educators are the participants.
At one time, the barriers to the development of intentional trading communities and training programs were technological. It is not practical for people to uproot their lives and relocate to communities that may be located across the globe. At present, however, the tools for online learning and communication make it possible to sustain communities across national boundaries and far-flung time zones and markets. All that is needed is vision, values, and a curriculum that joins participants in mutual student/mentor roles.
Friday, February 27, 2009
My new book, The Daily Trading Coach, was written explicitly as a self-help trading psychology resource for traders. It consists of 101 short "lessons", covering everything from behavioral techniques to regulate emotion to strategies for managing a trading business. Material on risk management, the use of Excel to identify historical trading patterns, and self-coaching perspectives from leading blogger/traders will be new, even to regular blog readers.
Thanks to publisher Wiley, a free sample chapter of the book is now available. The volume will be available in March and is being nicely discounted on the Amazon site. My goal was to write a highly useful guide for traders that would also be highly affordable for developing traders. I appreciate the cooperation between Amazon and Wiley in making the text available for under $30.00.
We moved sharply lower during pre-opening trading hours, breaking below the multi-day trading range. I noted in my morning Twitter comments (free subscription via RSS) that an important issue for the day was how we traded around the market's opening price.
The recency effect is a cognitive bias in which we overweight the most recent events and allow them to unduly color our future expectations. Understandably, traders caught up in the pre-opening weakness might anticipate further downside market action early in the day, particularly given the downside breakout.
At such times, I like to check my biases against actual market history. Since 2007 in the S&P 500 Index (SPY), for example, the correlation between overnight market moves and moves during the day session is only .06. In other words, these function as largely independent trading periods. Indeed, we've had 59 occurrences of SPY opening more than 1% lower than its previous day's close; the market's subsequent day session was up 27 times, down 32 times, for an average loss of -.21%. That compares with an average loss of -.06% (236 up, 247 down) for the remainder of the sample.
So, yes, particularly during a period of lower market prices, there can be downside follow through to overnight weakness. This is hardly a significant edge, however. Knowing that a different category of traders participates in the day session vs. the overnight helps us avoid the recency bias of assuming that overnight moves will continue into the day.
Recency Effects and Bloggers
With indications of needs for continuing bailout at AIG, the spotlight has turned from banks to insurance companies as potential sources of crisis. As we can see from the insurance index above ($KIX), that sector has been more than cut in half since September and is now sitting at bear market lows, below its declining 40-day VWAP (green line).
One economic factor that could turn recession into depression for millions of families would be the loss of life insurance and retirement annuity benefits that many families depend upon. With financial ratings of life insurers being cut and no clear indications of government support, this may be the unappreciated side of the current financial crisis.
Thursday, February 26, 2009
It is significant that the training process in psychiatry is a four year sequence, not including any fellowships or sub-specialty training. Similarly, those with a Ph.D . in psychology typically train for four years after college, followed by a fifth year of full-time supervised internship.
The progression of the years takes the form of "see one, do one, teach one." Beginning students of psychology and psychiatry take courses and observe others doing therapy. Their initial attempts at working with others are conducted in courses through role play, minimizing the risks of making mistkes. Only in later training do student-therapists see their own clients in training clinics, under close supervision. Still later, they help to supervise beginners, sharing their competence and growing expertise with more junior peers.
No one in the mental health field would suggest that teaching, supervision, and the development of competence (much less expertise) could take place in a matter of days or weeks. We know from studies of expertise development--from sports to chess--that the cultivation of expertise typically takes years. It is no coincidence that Olympic contenders--themselves superior athletes--continue to receive coaching and mentoring years after they developed competence in their work.
Education--in trading as in other fields--is valuable, but it is different from coordinated curricula of training. Isolated seminars, workshops, and learning experiences cannot substitute for the "crawl, walk, run" training that moves students from "see one" to "do one" to "teach one".
We commonly hear that 80% or more traders fail at their pursuit. Might that be because they lack the training structures typically available to athletes, professional soldiers, and performing artists? Yet how could such training be offered in a way that is affordable and logistically feasible? I will be addressing these significant challenges in my next post in this series.
If this analogy holds, then the ideal coaching of traders might be less like conducting a counseling session than conducting a supervision session with a therapist in training. When a psychologist learns therapy in graduate school or a psychiatrist learns it in residency training, a core part of the learning experience consists of individual and small group supervisory experiences. An experienced faculty member reviews audio or videotapes of counseling sessions with the trainees, pausing at crucial junctures to point out what was communicated, what was done well, and what was missed. Typically, the supervision concludes with specific ideas of what to pursue in the next week's session, based upon the case review.
This supervisory process sensitizes the therapist-in-training to several things: what to listen for, how to generate ideas about people's core themes and conflicts, and how to intervene effectively at the right times (when people are most ripe for change). Such listening, conceptualization, and timing skills are surprisingly similar to the challenges that active traders face. Clinical supervision is a time and labor-intensive process, not unlike apprenticeships in the trades. It is, however, a time-tested framework for teaching performance skills that cannot be acquired simply by reading textbooks.
I am not convinced that the common models for coaching traders, which structures the learning process more like counseling sessions than supervisory ones--which treats the trader more like a client than a professional in training--is the ideal one. Might it be the case that we could meaningfully improve trader success by providing traders with "clinical" supervision, grounded in market and performance review? More on this topic to come.
Wednesday, February 25, 2009
The good psychologist doesn't just listen to what is said, but also attends to what *isn't* communicated:
* A man says he's doing well, but pointedly leaves out any mention of the problems discussed the previous week;
* A woman talks about being taken advantage of by a friend, but expresses no feelings of hurt or anger;
* A person in trouble refuses to ask for help, afraid of being rejected.
Many times, it's what isn't expressed that offers the best window into the inner workings of a person.
Similarly, what *doesn't* happen in markets is often as meaningful as what does:
* After rallying solidly the previous day, the market cannot trade above its previous day's high;
* In the opening minutes of trading, even on attempted rallies, buying interest (NYSE TICK) fails to reach a single significant reading of +800 or greater;
* The market never trades above its opening price range of the first 15 minutes;
* Volume never expands on attempted rallies, as large traders don't participate in the upside.
It's often helpful to know what markets usually do, because that sensitizes you to those occasions when they behave atypically. When markets fail to provide their usual communications, they're usually communicating something important.
Social competence--or emotional intelligence--is largely a function of being able to seamlessly assimilate and respond to these state shifts. When a person lowers her voice and talks about a loss she experienced in her family, only a socially tone deaf individual would continue a prior banter. The socially competent individual picks up on both the shift in voice and the meaning of what is communicated, processes that in a personal and empathic way, and responds with concern and condolence.
Similarly, the competent trader will observe a shift in markets--a breakout from a range, a slowing down of trading--and adjust expectations and actions accordingly. The trader who enters the market with a fixed directional view and sticks with that view through minute after minute, hour after hour of contrary evidence is not unlike the bore who dominates a conversation by talking exclusively about what interests him. The emotionally intelligent person is one who talks with people, creating an intricate dance--not the person who talks at people, heedless of their reactions and communications.
Many traders don't trade with markets; they trade at them. Their failure is not simply one of communicating, but of listening. The socially skilled conversationalist does not barge into a party conversation by immediately talking. Rather, she will hold back, listen to the ongoing conversation, and then find a point to join the flow. An emotionally unintelligent trader will not first listen to markets; his job is to trade! Like a conversationalist who thinks his only job is to talk, the trader who thinks his only job is to trade will naturally operate outside of the market's rhythms. In a very real sense, he is not trading the markets, but his need to dominate markets. Little wonder such traders experience frustration when the markets don't yield to those attempts!
So often, educational efforts at trading begin with how to trade: how to recognize "setups", how to place orders, etc. That's like teaching counselors and therapists how to talk to clients before you've shown them how to listen--and what to listen for. The challenging--and fascinating--part of being a psychologist is figuring things out when you're *not* talking: letting a person's unfolding story reveal its patterns and meanings. Many an inexperienced counselor jumps the gun with advice, rather than waiting with empathic listening and figuring things out before speaking.
It sounds a bit strange, but empathic listening--the capacity to hold back, process information, not personalize it but relate to it--may well be a core competency for discretionary traders. It isn't so much emotion that derails good trading as any interference that takes us out of the flow of market conversation, leading us to react to our own impulses and feelings rather than the messages laid out in front of us.
Tuesday, February 24, 2009
When a psychologist listens to a client in therapy, he or she focuses on the flow of conversation. Attention is paid to both what is said and how it is said. For example, let's say I am talking in a friendly, informal way with someone to start a counseling session and then ask about the person's marriage. Immediately the person shifts position and posture in the chair and adopts a halting tone of voice that is very different from the tone of the previous conversation. Without even attending to *what* the person is saying, I can detect from that radical shift of posture and tone that this is not a comfortable topic and that there are issues to be explored.
These shifts occur in subtle ways and not so subtle ones in all conversations. Rate of speech, volume, inflection, gestures, the richness of language used--all of these are indicators of a person's inner world. When a person is angry (without even acknowledging it), those shifts manifest themselves as changes in muscle tension and vocal intensity. When a topic changes in a conversation and we see such shifts, we know that the topic is emotionally loaded for that individual.
Markets produce their own streams of "conversation" in the form of price and volume movements that evolve through the day. Volatility, directionality, choppiness: these are some of the market's "body language". Just as a person's tone or posture can shift over the course of a conversation in response to meanings and what they stimulate, the market will alter its patterns of movement through the day, particularly in response to news events, economic reports, rumors, and the sentiment of traders.
Much of success in short-term trading is a function of being able to read the market's body language and respond promptly and appropriately. A good conversationalist is one who picks up on nuances of meaning and responds to those in his or her own speech and mannerisms. Similarly, a good trader is attuned to market communications and responds to these flexibly.
Consider the ES futures during the early part of the trading session today (top chart). Moving in a range, they drifted away from their opening price, only to be pulled back toward it. A bit after noon, however (second chart from top), the market moved violently higher on expanded volume and significant volatility. You can see from the size of the bar and its break to new highs that this was a shift in trading pattern.
In the third chart from the top, we see the result of this shift: the market never looked back and trended higher into the afternoon: a range market had morphed into an uptrending one.
Notice how the NYSE TICK distribution (the distribution of five-minute bars around the blue zero line, bottom chart) changed from balanced to distinctly bullish prior to the breakout bar. If you look at the energy (XLE) and especially the financial (XLF) stocks, you'll also see that they broke to new daily highs ahead of the breakout. These subtle pieces of body language--the sentiment of traders, the behavior of leading sectors--are important clues to those who follow markets like a psychologist. For the trader as for the shrink, it isn't necessary to predict shifts; rather the challenge is to identify them in real time and know how to respond.
Emotional Intelligence and Trading
Above we see the flip side: the frequency of strong buying minutes in the stock market based upon one-minute readings in which the NYSE TICK hits or exceeds +1000. Once again, this is a rare reading, as it requires 1000 or more issues to trade on upticks at the same time. Only significant buying pressure from institutional participants can generate such a reading. By cumulating the strong buying minute readings over a one-day moving average period (pink line above), we can see how such sentiment has correlated with movement in the S&P 500 e-mini (ES) futures (blue line) since the start of 2009.
What we see is that the peaks in the strong buying minutes have been diminishing; with each rally, we've had fewer strong buying minutes. This suggests that institutional buying has waned, even as we've seen a pickup in institutional selling per the previous post. Note also an interesting pattern in which the frequency of strong buying minutes tends to peak ahead of price on intermediate-term market rallies.
A rising market needs significantly more strong buying minutes than strong selling ones; a falling market requires the reverse. By catching the distribution of extreme readings in NYSE TICK, we can make a reasoned assessment as to whether buying or selling sentiment are dominant, or whether they are relatively balanced.
An interesting exercise would be to take extreme readings in Market Delta (the proportion of volume traded at offer minus that traded at bid) and see if similar distributions occur in trending and non-trending markets. I hope to address this at a later juncture. In the interim, I will include observations about the distribution of NYSE TICK values in my morning real time market comments via Twitter (free subscription via RSS).
Monday, February 23, 2009
If you review this morning's Twitter comments and follow the NYSE TICK for Monday, you'll see how a weak market sustained weakness through the day and hit one price target after another. These downside trend days are notable in that they generally open near the price high for the day, move steadily lower on very weak NYSE TICK and average/above average relative volume, and stay below the day's volume-weighted average price for the vast majority of the session. Recognizing the structure of a day early in the session is a cardinal skill for short-term traders: it determines whether you fade strength/weakness or go with it by playing counter-trend bounces.
In the chart above, we take a longer-term view that illustrates the significant weakness of the current market. The dark blue line represents the S&P 500 e-mini (ES) futures during 2009; note the breakdown below the 800 level, as represented by the horizontal light blue line.
The pink line is a one-day moving average of the number of minutes that hit -1000 in the NYSE TICK. I call these "strong selling minutes". A reading of -1000 or lower means that 1000 or more stocks are trading on downticks at that moment. That represents very broad market selling pressure. Readings of -1000 or less are rare; they are almost 2 standard deviations below the median low TICK reading for all minutes since the start of October, 2008.
Another way of looking at the significance of that weakness is that the median number of strong selling minutes during a trading day is 11, with a standard deviation of 21. On Monday, we closed with 66 minutes hitting that level--more than two standard deviations away from the norm.
What is significant in the chart above is the elevation in the number of weak market minutes (i.e., minutes where we had TICK readings of -1000 or lower) as we broke the 800 level in the ES contract. That tells us that this was a significant breakdown, with broad participation to the downside. Only the selling pressure of large institutional traders can sustain such negative TICK readings. As individual traders, we want to follow the path of those that move market, not stand in the way.
As long as we see so many stocks trading on downticks, it is premature to expect a durable market rally. Recognizing this strong selling sentiment is important to staying on the right side of these downtrend days.
Last week's indicator update found sector and indicator weakness, but stressed that we were not at an oversold level and remained in a wide, choppy trading range. With the break of the 800 level in the S&P 500 Index early in the week, we moved below that range and stayed below for the week. That brought the Cumulative Demand/Supply Index (top chart) into oversold territory, though not at that -30 level that has marked recent intermediate-term market bottoms. The weakness has been broad, extending across all sectors, suggesting that the bear market remains intact as long as we stay below the prior, extended trading range mentioned above.
Another indication of the breadth of the market weakness is the expansion of stocks making fresh 20-day lows across the NYSE, NASDAQ, and ASE (middle chart). We are seeing fewer new lows on a 52-week basis than we saw late in 2008, and not all sectors have seen fresh bear market price lows. Similarly, while we were notably weak in Cumulative NYSE TICK this past week (bottom chart), we remain above the November lows. The same is true for the advance-decline lines specific to NYSE common stocks and S&P 500 issues. These divergences would become much more important in my estimation should we sustain a broad rally that keeps the S&P 500 market above its violated support at that 800 level.
As I emphasized the last couple of weeks, the peaks in the Cumulative Demand/Supply index have occurred at successively lower price highs; each rally in this bear market has failed to surmount the one previous. As long as that is the case, and especially as long as we're seeing weakening Cumulative TICK and expanding new lows, it is premature to be pounding the table on the long side.
I have posted the daily and weekly SPY target levels to Twitter (free subscription via RSS) and will update the indicators each morning prior to the market open. The market's relative volume--how current volume compares to the average volume for that particular time of day--is very helpful in gauging market volatility and the odds of hitting these targets. The relative volume norms for this week's S&P 500 e-mini market appear below:
9:00 - 199,589 (48,899)
9:30 - 152,938 (48,688)
10:00 - 136,174 (65,293)
10:30 - 117,904 (59,114)
11:00 - 104,818 (40,222)
11:30 - 90,351 (33,155)
12 N - 110,937 (37,560)
12:30 - 121,941 (46,688)
1:00 - 125,444 (58,883)
1:30 - 140,481 (61,592)
2:00 - 175,042 (50,129)
2:30 - 230,477 (84,999)
3:00 (15 min period) - 99,318 (25,438)
Sunday, February 22, 2009
We did, indeed, sustain a plurality of new lows and have moved toward the November lows on strong selling pressure. As noted in my recent post, the over 4000 new 20-day lows observed on Friday was a level of weakness seen only 11 times since late 2002.
As we look at the Technical Strength of the eight S&P 500 sectors that I follow each week--a proprietary short-term measure of trending--we can see further evidence of this broad weakness:
INDUSTRIAL: -440 (2%)
CONSUMER DISCRETIONARY: -440 (8%)
CONSUMER STAPLES: -180 (15%)
ENERGY: -440 (0%)
HEALTH CARE: -360 (31%)
FINANCIAL: -480 (1%)
TECHNOLOGY: -340 (11%)
Recall that the Technical Strength of each sector varies from -500 (very strong downtrend) to +500 (very strong uptrend), with values of -100 to +100 indicating no significant trend. As we can see, the sectors are mostly in a strongly downtrending mode, with only the defensive Consumer Staples group showing less weakness. In the recent past, such highly negative readings have represented oversold conditions that have led to short-term rallies.
When we look at the percentage of stocks in each sector closing above their 20-day moving averages (in parentheses), as noted by Decision Point, we find that all sectors show fewer than half of their components above that benchmark. Only the defensive Health Care sector shows a meaningful percentage of issues above their moving averages. The Energy sector has shown particular deterioration in the last week, and Financial issues are notably weak.
In sum, we continue to see broad market weakness, though a bounce from oversold conditions would not be surprising. It is not just the weakness, but the pattern of sector weakness--with relative strength in defensive sectors and relative weakness among economically-sensitive ones--that suggests that we have yet to turn the corner on the bear.
* Not So Preferred - I talked with a Dow Jones Newswire reporter on Friday about investor fears regarding bank nationalization. One psychological indicator of those fears is PGF, the ETF specific to preferred shares of financial institutions. As we can see from the chart above, PGF has been cut in half since the start of the year, as fears mount that preferred shareholders may recover little in any government assumption of equity.
* StockTwits - I recently began participating in the StockTwits site, which features conversations among traders who communicate via Twitter. One feature I like is the ability to filter "tweets" by stock symbol, so see what the chatter is regarding specific names.
* Trade Signals - I continue to follow Henry Carstens' mechanical trading signals via Twitter; it's interesting to see which signals do and don't fit with my own market judgments. One more piece of data for discretionary traders to integrate into their market views.
* Frugality - I found the N.Y. Times article on consumer retrenchment in Japan to be quite interesting; Iceland is seeing similar frugality, and the relative outperformance of WMT and MCD suggest that the meme has taken hold in the U.S. as well. Given that this represents a sea change in sentiment and behavior, not a fad, a number of pairs trades might follow from the theme: long the company that offers perceived value, short the company that offers perceived cachet.
* Ideal Coaching Service for Traders - The last few days I've been pondering the question of what an ideal coaching service for individual, developing traders might look like and how that might be delivered in a highly affordable way. I'll be posting ideas on the blog this coming week.
* Where Value Might Be Found - I recently posted a review of Janet Tavakoli's book that dealt with Warren Buffett's value investing. Here's a post that reviews Buffett's positions: where he is finding value in the current market.
Saturday, February 21, 2009
Interestingly, when we've had more than 4000 new 20-day lows, there has not been an intermediate-term bullish bias. Indeed, 30 days later, the S&P 500 Index (SPY) has been up 5 times and down 6, for an average loss of 3.0%.
A more interesting observation, however, is that--of the 11 occurrences of 4000 or more 20-day lows--all but one (5/10/04) has occurred since the second half of 2007. During the bull market, pullbacks led to an excess of new 20-day lows, but not such broad weakness. When markets have been broadly weak, it's been an indication of bearish trend conditions and we haven't seen a bullish edge going forward.
An interesting topic for research is whether extremely weak or strong markets differ qualitatively from normally weak or strong ones. It may well be that rising or falling tides that lift or drop all boats show greater odds of continuation, whereas less broad moves are more likely to encounter reversal.
Note: I post new 20-day highs and lows each morning before the market open via Twitter (free subscription via RSS).
The novelist philosopher Ayn Rand used to advise readers to "check their premises." A premise embedded in the trader's question above is that getting stopped out of a trade that eventually proves profitable is, indeed, a mistake.
If markets expand their volatility, it's not difficult to be stopped out of a position due to mere market noise. You may set your stop just above a trading range, and the market will move well above that point before reversing and trapping the longs.
In such an event, is it getting stopped out that is the mistake, or is the mistake not re-entering the position once it is clear that we can't sustain prices at new levels of value?
The reader is right to point out that not letting go of the feeling of having made a mistake is costly for traders. Consider the recent post on learning from losing trades. If a trader can't let go of the loss, it's difficult to stay market focused and re-enter the trade. In fact, I generally find that such trades are better risk/reward propositions on re-entry, because they have given you validation that they cannot sustain a move against you. It's difficult to see that, however, if you become self-focused at the very time you need to be market focused.
An excellent addition to any trading plan would be a "what if" scenario that spells out what would have to happen to put you back into the same trade. As any soldier knows, it is much easier to take the right actions in the heat of battle if they have been planned and rehearsed.
On the psychological side, not letting go of mistakes is an example of internal dialogues going wrong. Those who have read the Psychology of Trading book will recognize the issue from Chapter Thirteen; in addition to the techniques outlined there, the cognitive restructuring methods laid out in Chapter Eight of the Enhancing Trader Performance book can be quite helpful.
The gist of these efforts is to recognize your thought process as a conversation that you are having with yourself. Once you become aware that many of your internal conversations are actually ways of venting frustration and anger, you can consciously adopt a different tone of conversation in your self-talk. Changing your self talk is like changing any habit pattern; it requires initial effort and repetition; the payoff is that you are then freed to stay market focused at times when other traders are focused solely on themselves and their P/L.
Ultimately, the only way to let go of losing trades is to learn from them. Maybe the trade teaches you something about how the market is trading: information that can help you frame the next trade. Maybe the trade teaches you something about where you place stops and how you manage risk: that will help you avoid future losses. And maybe the trade will teach you to work on yourself and the relationship you have with you when the chips are down.
Losing trades can be the best learning experiences, but only if we're not mechanically repeating our losing psychological patterns.
Friday, February 20, 2009
The top chart (click for detail) is a three-minute chart of the ES futures. You're at the 13:12 PM CT bar and you observe that we're in a downtrend. The trend of the NYSE TICK has been down; VWAP (40-period MA) has been downtrending and price remains below the 761.75 level from which a high volume decline launched at the 11:48 AM CT bar. The market has bounced, volume has pulled back on the bounce, so you decide to sell in anticipation of at least a test of the day's lows. At 759.25, you're risking 2.50 points in hopes of making at least 6.75 points on a retouching of the day's low. Not the worst trade idea one could generate.
Now we advance one bar and we see in the bottom chart (click for detail) what happened. The market has screamed upward on volume that has more than doubled the expanded volume on the market decline. Whether it's the President reassuring the market about bank nationalization or a surprise news or earnings announcement, these rogue events are apt to occur from time to time.
You've had your stop in place and your risk/reward set, so you're blown out of the trade well before the three-minute bar is complete. It's frustrating, but hardly something that needs to ruin your day or week. You compose yourself, pull back from the screen briefly, and return to watch and size up your opportunity.
Another trader did not set a stop. He watches as the bar expands away from his entry, hoping for a pullback to break even. The market marches ten full S&P points against him before the hour is up. That can easily wipe out a day's or week's worth of effort, leaving him in a bad mental state to start next week.
A third trader sees the stop hit on expanded participation from large traders. The market is now soaring above the point where significant selling had begun, so the trader concludes that this is a major shift in demand. We've seen the day's low, he concludes. He waits for the first pullback in TICK, notes the reduced volume on the pullback, and buys the market around 765. He is rewarded with a near-immediate gain that more than offsets the loss on the first trade.
The failing trader does not set or honor stops and is left with a deteriorating position. The good trader sets a stop and limits his loss. The excellent trader extracts information from the losing trade to generate profits.
A losing trade is not necessarily a bad trade. When markets don't pay you for a good trade, they are telling you something important. It's difficult to listen, however, if you're holding the loser or consoling yourself about the loss. It's the trader who quickly accepts the loss that is able to stay market-focused, learn from the reversal, and find the next opportunity.
"At its core," Tavakoli observes, "the mortgage crisis is no more sophisticated than a schoolyard swindle, and the SEC is the principal." She effectively contrasts the imprudent use of leverage across investment banks, government sponsored enterprises, and hedge funds with the value investing philosophy of Warren Buffet, driving home the point that much of our recent economic activity has been destructive of wealth. "Price is what you pay," Buffett explained, "Value is what you get." Our recent financial system, Tavakoli asserts, has paid high prices for little value.
Her book is an excellent, readable overview and explanation of what's gone wrong and also a warning about what may be to come. She explains:
"As long as Wall Street enhances revenues with leverage to prop up kingly bonuses, as long as there are few personal consequences for CEOs (and board members and other top executives) for shoddy risk management, as long as CEOs are allowed to walk away with millions, nothing will change. The fact that shareholders are wiped out is no deterrent, and moral hazard will live on (p. 206)."
Indeed, Tavakoli maintains, we have compounded such moral hazard by putting billions of taxpayer dollars at risk in bailouts without clear, effective accountability.
To be sure, even value investing undergoes painful drawdowns during bear markets. It is only after those downdrafts that portfolios reveal the value purchased for the price. Buffett has advised that people only buy things that they'd be happy to own if markets closed down for ten years. That may well be good advice for those looking to be well positioned in the next decade; if so, the bear market will have fulfilled its function and returned wealth to its rightful owners.
Thursday, February 19, 2009
The bill indicates that "This Act may be cited as the ‘Let Wall Street Pay for Wall Street’s Bailout Act of 2009’". As many traders have pointed out, this is not at all a situation in which Wall Street would pay for its own bailout. Rather, ordinary traders who had nothing to do with the malfeasance associated with the securitization of questionable mortgages would be punished for the bailout of the offending organizations.
The bill explains that "This transfer tax would be on the sale and purchase of financial instruments such as stock, options, and futures. A quarter percent (0.25 percent) tax on financial transactions could raise approximately $150 billion a year." The net effect of taking 25 basis points out of every trade would be to put high frequency traders out of business and reduce the liquidity of markets. Capital would then flow out of the U.S. to exchanges that do not impose such taxes.
There is an online mechanism for writing your Congressional representative about this and other bills; shout out to Forex Factory for pointing that out and highlighting the issue. It may make sense to require the financial industry to recoup taxpayer bailout monies. Placing that burden on the backs of independent traders and threatening the liquidity of U.S. markets is not the way to accomplish that goal.
Days--and periods of days--where we don't hit any of these targets are range bound days. These tend to cluster, given serial correlations of volatility. Thus we'll have periods of time in which we hit one or more targets and periods of time in which we'll stay closer to daily pivot levels. Much of the skill of trading, across any time frame, is identifying when we're in a directional market environment (and thus likely to hit the price targets) or a range environment (and thus likely to oscillate around pivot levels and/or volume-weighted moving averages).
Once we define the pivot and price target levels for a particular day, we can ask some rather sophisticated questions. For instance, if we hit R3 or S3 in yesterday's trade, what are the odds of hitting the R1 or S1 level today? If we do not hit either R1 or S1 in today's trade, what are the odds that we'll have a directional move (i.e., one that hits one or more price targets) tomorrow?
Notice that, the segmentation of market moves into R1/R2/R3 and S1/S2/S3, each adjusted for that market's level of volatility, provides us with an objective measure of a day's directionality. We can then ask whether stronger up or down days (those that hit R2/S2 or beyond) are more likely to lead to reversal than days that only hit R1/S1.
Such investigations are likely to uncover trading patterns that provide a possible edge to traders. For example, did you know that the market two days from now (e.g., Monday's market) has a 43% chance of touching today's (Thursday's) pivot level? If we factor relative volume into the mix, those odds rise substantially. Knowing that we have high odds of a range market over a swing trading period could be quite valuable to both day traders and those holding overnight.
To get even more ambitious, imagine that we calculate similar pivot and price targets for various sector ETFs and stock indexes. We can then ask such questions as, "What happens when the S&P 500 Index touches R1/S1 today, but financial stocks (XLF) do not hit their R1/S1?" If a sector hits its R1 early in the trading day, what are the odds that the S&P 500 Index will follow and hit its R1 target? Do certain sectors tend to lead the S&P 500 in hitting their targets?
All of these investigations offer potential decision support for traders, and Twitter is an ideal mechanism for blasting the results of these investigations to traders in real time. More to come--
Wednesday, February 18, 2009
Once a view becomes ours, we are prone to confirmatory biases, seeking information that supports our preconception. If, however, we can formulate multiple "what-if" scenarios, we're no longer attached to any one outcome.
A directional move that cannot hit the R1 or S1 profit targets is not a trending move on a day time frame. Failure to reach the first of the targets is a characteristic of range days.
At some point in time, a directional move will look like an uptrend or downtrend day. Evidence will accumulate that the move is not being sustained. The market will return to its prior range. Instead of trading for price continuation, you'll want to trade for reversals back to a volume-weighted price average.
The transition from directional trade to range trade often begins when buying/selling pressure cannot generate new price highs/lows and incremental volume. Look at the ES trade around 9:55 AM CT. The 9 AM market was directional; it looked like the start of a trend day. By 10 AM, selling pressure (very negative TICK) could not generate fresh price lows; volume tailed off.
Switching in an hour's time from a trend view to a range view, a continuation strategy to a mean reversion strategy: That is the mental flexibility required of the active trader.
Trading Psychology Observations
Demand is an index that captures the number of NYSE, NASDAQ, and ASE stocks that close above the volatility envelopes surrounding their short-term moving averages. Supply assesses the number of those issues closing below those envelopes. The idea is that stocks with strong upside or downside momentum will close outside their envelopes. By creating an index of the number of stocks with strong and weak momentum, we gain a sense for the momentum of the stock market as a whole.
As noted in this morning's Twitter post, Supply for Tuesday closed at a very elevated figure of 234. Since late 2002, when I began assembling these data, we've only had 21 occasions in which Supply has exceeded 200. Naturally, since this is an unusual event, I wanted to see if there was any edge going forward.
Interestingly, after such a weak day, the S&P 500 Index (SPY) opened higher 16 times and lower only 5 times for an average gain of .43%. Holding the weak market overnight in anticipation of further losses has not been a winning strategy.
When we look four days out, however, the average change in SPY following a very weak momentum day has been -.38% (8 up, 13 down). In other words, on average, the market lost all of its early bounce and then some.
What this suggests is that markets often will not bottom on very weak momentum. Rather, price will tend to move lower, even as a decline loses its momentum and eventually reverses. This is a dynamic that can set up trade ideas across multiple time frames. I will be elaborating this relationship between momentum and price with the resumption of my series of "Introduction to Trading" posts.
Tuesday, February 17, 2009
9:31 AM CT- Watching closely: We need to sustain prices above their day session open w/ positive TICK distribution to get a good reversal.
This first comment came after we spiked lower in the first half hour of trading on extreme negative TICK and high volume. Such capitulation often leads to a reflex bounce, sellers are "all in" and no one is left to drive prices lower. As buyers are attracted by the low prices, short-covering contributes to the bounce. For this bounce to become a true reversal and turn the short-term trend bullish, we need to see the majority of sectors sustain prices above their opening levels, and we need to see net buying pressure (positive NYSE TICK). Gauging the participation of the sectors and the vigor of the buying interest helps us distinguish between a bear market bounce and a bullish reversal.
9:38 AM CT - Rel volume has dropped off on the attempted rally; back l8r in day.
Within a few minutes, I'm seeing that relative volume (how volume at a particular time of day compares with average volume at that time of day) is tailing off after a surge on the early selling. This is a sign that higher prices are not attracting fresh participation. Recall that volume is strongly correlated with volatility. When we're trading directionally, we want volatility to be expanding on moves in our direction. When relative volume tails off, it's one sign that the volatility winds are not at our back, which leads us to suspect that the upmove is a bear bounce, not a fresh bull move.
10:06 AM CT - Unless we can sustain positive TICK and above avg volume to upside, that 800 support will start to act as resistance.
I hadn't planned another post so soon, but I thought the point was worth reiterating. In a valid breakout move, we should not move back into the prior trading range. That means, on a downside break, that what had been support (the 800 level of the S&P 500 Index) is now resistance. We need buying pressure (TICK) and volatility (relative volume) to push us back into the range. That wasn't happening, and that observation helped set us up for weakness later in the day.
What I'm trying to do with the intraday Twitter comments is model a way of thinking about price action by synthesizing observations about ranges, market sentiment/strength, volume, and historical price patterns. Much of this thinking is based on looking at not only *what* the market is doing, but *how* it is doing it. Following Cumulative TICK, where we traded relative to VWAP, relative volume, and leading sectors (financials) all were helpful in tracking the market's weakness during the day session. Subscription to Twitter comments is free; you can also pick up the five latest "tweets" on the blog home page under "Twitter Trader".
Last week's indicator review concluded, "In sum, this is a Missouri market: I need to see the market bulls "show me" their hand by following strength with further strength." The market did not show strength, as the recent sector update noted, and we fell back to the bottom of the multi-week trading range.
As an aside, let me emphasize that everything I've been writing lately regarding identifying and trading markets that are in ranges, as well as identifying and trading breakout moves, applies to swing time frames as well as intraday ones. This is why my morning Twitter posts at the start of the trading week emphasize weekly as well as daily price targets for the S&P 500 Index. What looks like a trending move on the day time frame may be a swing within a multi-week range. Knowing what is happening at the time frame just above the one you're trading is key to framing and executing trade ideas.
Because we're at the bottom of a multi-week range, we need to see if the market will once more hold its lows, which would target a move back to the intermediate-term pivot in the mid-830s in the S&P futures or whether we sustain a breakout move to the downside to test the November bear market lows.
Despite the sector weakness mentioned above, stocks are not in an oversold position in the Cumulative Demand/Supply Index (top chart) and continue to make successive peaks in Cumulative Demand/Supply at lower price highs. This is what we'd expect in bear market mode, as noted last week. New 20-day lows have once again begun to outnumber 20-day highs (middle chart); we need to see that continue to sustain a bear leg down.
The Cumulative NYSE TICK (bottom chart) has been toppy, but remains well above its November lows; that is noteworthy. On a break of the recent support and any test of November lows, it's quite possible we'll see a divergence in the Cumulative TICK, given recent strength. A close look at the advance-decline lines specific to various market sectors (Decision Point is a good source for these data) also suggests the possibility of divergences on further market weakness. For instance, the advance-decline line specific to Dow Industrial stocks is already near bear lows, but the line for NASDAQ 100 stocks is well off those lows and near multi-week highs. The line for Financial shares is near its bear low, but the line for Health Care and Energy stocks is well off those lows and also near multi-week highs.
For now, we're in a wide trading range with choppy, volatile trading and playing that range has been the winning strategy. I will be updating indicators daily via Twitter (free subscription via RSS), along with intraday market observations, to track strength and weakness at short- and intermediate-term horizons.
Below are relative volume numbers for this coming week to tell us if participation of large traders in the ES contract is significant on market moves:
9:00 - 191,149 (46,133)
9:30 - 151,742 (50,625)
10:00 - 134,700 (68,832)
10:30 - 104,551 (62,872)
11:00 - 101,011 (42,410)
11:30 - 88,368 (32,974)
12 N - 108,429 (36,033)
12:30 - 118,164 (49,088)
1:00 - 125,444 (53,390)
1:30 - 134,227 (56,771)
2:00 - 173,159 (52,533)
2:30 - 228,664 (82,710)
3:00 (15 min period) - 93,531 (25,377)
Monday, February 16, 2009
Here are the Technical Strength readings for the eight sectors as of Friday's close. Recall that Technical Strength for each sector varies from strong downtrend (-500) to strong uptrend (+500), with values between +100 and -100 indicating no dominant trend:
INDUSTRIAL: -300 (28%)
CONSUMER DISCRETIONARY: -320 (26%)
CONSUMER STAPLES: -220 (33%)
ENERGY: -160 (53%)
HEALTH CARE: -180 (76%)
FINANCIAL: -300 (15%)
TECHNOLOGY: -60 (54%)
We can see that the short-term trends have turned bearish for the economically-sensitive sectors, such as Materials and Consumer Discretionary stocks, as well as Industrial and Financial issues. Technology has shown relative strength, as has the NASDAQ 100 Index overall.
On a somewhat longer time frame, in parentheses above, we can see the percentage of stocks in each sector that closed above their 20-day moving averages, as reported by the excellent Decision Point site. Only three of the eight sectors show more than half their stocks trading above that benchmark, compared with seven last week.
Clearly we've weakened since last week and now are testing major support in the 800 area of the S&P 500 Index. We closed Friday with new 20-day highs across the NYSE, NASDAQ, and ASE at 492; new lows were 596. As long as we cannot sustain a plurality of new highs, I expect the market to breach that 800 level and test the bear market lows of November. As always, I will be tracking new highs/lows, Demand/Supply, and the percentage of stocks above their moving averages via Twitter each morning before the market open (free subscription via RSS).
The links from the earlier post cover a variety of reasons why traders lose their discipline. There is, however, another reason why traders find it difficult to follow the plans they set: their plans aren't truly plans.
To understand this, consider the difference between plans and intentions. If I tell myself that I need to go to the gym and get into shape, that's an intention. It is not a plan. If I actually join a gym, sign up for classes, set up a schedule for exercise, and create weekly goals for how often I'll exercise and how much weight I'll lose, that is a plan.
Similarly, I might intend to take my wife on a trip that will help her get away from work stress. That is very different from actually planning the trip by discussing it, creating an itinerary, shopping for best airfares, etc.
Intentions are thoughts of future actions, often accompanied by "should". Plans require action--taking steps in the present to achieve the desired end--and they often have a social and motivational component. A business plan, for instance, is much more than intended success; it can be vital in attracting investors and key employees. Because intentions lack committed action, they are generally weaker than plans. We're likely to break a New Year's intention, but less likely to break those vacation plans once they've been formulated with a spouse.
Many traders formulate intentions for their trades and then wonder why they have veered from their "plan". When I ask to see their plan, however, there is nothing written down; nor is there anything specific that has been planned. To be sure, high frequency traders are not going to formulate detailed plans for each trade. In their case, trading rules about such matters as execution, sizing, and risk control would take the place of unique plans for each position. Often, however, I'll hear from "scalpers" that they've violated their discipline. When I ask which rules they've violated, they cannot give a ready answer.
My response is that you can't violate a discipline that isn't there to begin with. The problem is not that an excess of emotion interfered with their plans and rules. Rather, they were never sufficiently planful and rule-governed to begin with.
The single greatest way to build discipline is to turn rules and plans into commitments. That means that you have to give those rules and plans distinct life of their own. The more you think of them, look forward to them, talk them to others, write them down, grade yourself on them, reward yourself for them--the more real they become. You are most likely to abandon rules and plans that haven't been internalized as commitments.
Please check out the comment of reader Adam following the post on learning to think like the herd, but not follow the herd. You'll gain a valuable lesson in turning rules and plans into routines and commitments. Adam's observation regarding the value of checklists in high risk professions is excellent. He explains, "Trading is a matter of repeating over and over again behaviors that trap errors before they are released into the market".
Intentions aren't strong enough to trap errors. To catch the mistakes before they're released, you need the emotional force of commitments and the reliability of routines. Turning intentions into checklists and checklists into commitments is a great way to ground yourself in best trading practices.
Sunday, February 15, 2009
Today's featured site is Cara Community, hosted by Bill Cara. His week in review post is an excellent review of economic data, sector performance, bonds and yields, commodities, and more. His commentaries and community chats also bring considerable feedback from readers, often in response to his strongly held views.
My favorite sites are ones which make me look at data in new ways, think about new issues, and view old issues in new ways. I believe that's what Cara Community is trying to accomplish.
The implications for trading are enormous. Here are just a few:
1) Your success comes from knowing and accepting your strengths and limitations;
2) Your edge has to be cultivated on a continuous basis; you have to adapt to the game faster than it adapts to you;
3) You don't have to be freakishly talented to find success, but you do have to be freakishly devoted to exploiting your edge;
4) It's amazing how much you can accomplish when you are focused on the game and not ego-focused;
5) Study, study, study the numbers: Success comes from knowing who you're up against better than they know themselves.
Battier comes across as a bright, dedicated professional. Because he is such an intense student of the game, he finds opportunity where others do not. The dynamics of success aren't so different in athletics, markets, business--and life itself.
Much attention has been given to the issue of whether or not major banks are solvent. But how about the federal government? Is it solvent? Much of the answer depends upon how one accounts for assets and liabilities on the federal balance sheet. A recent article, quoted below, raises doubts about the budgetary health of the government:
"Truthfully," Williams pointed out, "there is no Social Security 'lock-box.' There are no funds held in reserve today for Social Security and Medicare obligations that are earned each year. It's only a matter of time until the public realizes that the government is truly bankrupt and no taxes are being held in reserve to pay in the future the Social Security and Medicare benefits taxpayers are earning today."
The $65.5 trillion total federal obligations under GAAP (Generally Accepted Accounting Practices) accounting not only now exceed four times the U.S. gross domestic product, or GDP, the $65.5 trillion deficit exceeds total world GDP (my emphasis).
Thus far, U.S. Treasury instruments have been viewed as safe havens, so there has been little concern over stimulus solutions that add massive debt to a debt-laden balance sheet. At some point, the appetite for expanding Treasury issuance will falter, as countries are challenged to raise their own funds and stimulate their own economies.
At that juncture, will we have rising rates in a fragile economy, adding to deflationary forces? Will the Federal Reserve need to monetize debt by aggressively purchasing Treasuries further out on the yield curve, courting significant inflation? Gold has been holding its own vis a vis other commodities and especially vis a vis non-U.S. currencies; so far, it seems to be betting that a deflation-wary Fed will choose a stagflationary path.
Saturday, February 14, 2009
1) Market opens above or below the previous day's pivot on low volume and relatively narrow breadth and TICK: Play for a move back to pivot and consider a range day, with moves oscillating around VWAP;
2) Market makes a good move on strong/weak TICK and average or above volume early in the AM and holds above/below pivot on next pullback: Play for a move to the overnight high/low and/or the previous day's high/low;
3) Market makes a move above/below its overnight high/low early in trading on strong/weak TICK and average or better volume: Play for a move to previous day's high/low and R1/S1;
4) Market makes a move above/below R1/S1 early in the day on strong/weak TICK and average or better volume: Play for a move to R2/S2;
If you are playing for a move to the next price target, pullbacks ideally should not pierce the prior level (e.g., if you have broken above the previous day's high, the next pullback should stay above the overnight high in order to play for a move to R1.)
If you are playing for a directional move up/down, price should stay above/below the day's VWAP.
If you are playing a range market, you should fade moves away from VWAP that cannot sustain upside/downside price targets.
Your entries should provide you with favorable risk/reward, so that you'll make more on a trade that reaches your target than you'll lose if you're stopped out.
My Twitter posts in real time and upcoming posts will illustrate some of these ideas in practice. The links below will orient new readers to some of the price target terminology: