Monday, March 28, 2016

Trading Notes For The Week Of March 28, 2016

Friday, April 1st

Top 20 people to follow on Stock Twits and Twitter for great market content.  Of course, Ivaylo is too modest to include himself, so I'll nominate him here both for his blog content and his books

*  We've pulled back from recent highs, as my measures of realized event time volatility continue lower--a situation that, in the past, has been associated with subnormal forward returns.  Stocks making new monthly highs across all exchanges declined from 1221 to 822; monthly lows ticked up from 106 to 137.  So it's hard to say that we have weak breadth.  As noted yesterday, my measure of upticks vs. downticks has continued positive.  Yesterday was positive, but total institutional participation contracted to the lowest level since the rally began.  Again, this has been associated historically with subnormal returns.  Institutional participation is a measure of total upticks and downticks across all NYSE shares (not volume traded).  The low volume and volatility make me not particularly bullish; the absence of new lows and downticks make me not particularly bearish.

*  My cycle measure continues in positive territory but off its highs.  Many of my breadth measures look this way:  positive, but off their peaks.  Note how we've stayed positive for much longer than during recent cycles--again a tell that this has been more than a bear market rally or even a bounce higher in a range market. 

*  Are there microtrends within the market and are these tradeable?  Hell, I have no idea, but I'm researching it.  Will let you know what I find.  This will be a purely systematic implementation.  My other research project is identifying longer term cycles in the stock market, with data going back to 1980.  This is based on a unique implementation of the event time concept.  Basing event time on volume doesn't work because of the secular differences in volume over the period of decades.  If you're not innovating, you're stagnating.  Too many traders pat themselves on the back for doing the same thing again and again and calling it discipline.  A disciplined implementation of an outmoded approach will lose money with admirable consistency.

*  If you look at stocks outside the U.S., such as the EFA ETF, the longer-term picture is pretty unimpressive.  It is not clear to me that negative rates are having the desired impact overseas.  If this is the case, we could see more aggressive central bank stimulation of economies, particularly if those indicators of deflation--strengthening currencies, weakening commodities, etc.--become more problematic.  

Thursday, March 31st

*  Is the housing market strong or weak?  See It Market notes mixed signals amidst supply constraints.

*  Oil and commodities overall (DBC) have been lagging stock price gains recently; keeping an eye on that relationship.  I'm also noticing high yield bonds (JNK) lagging recent price gains in stocks.  These relationships were key during the period of market weakness.

*  Stocks rallied nicely early yesterday, again posting fresh rally highs before pulling back.  Breadth once again expanded, with over 1000 stocks across all exchanges posting fresh monthly highs.  My measure of upticks vs. downticks continued quite strong; below we can see a 10-day moving average.  As mentioned before, volume has not been impressive, but the volume traded has been quite skewed toward the buyers:

*  One of my pure volatility measures continues at levels more consistent with market highs than lows.  Note VIX now trading a bit above 13.  This has the potential to significantly constrain directional movement across all time frames.  There is less volume traded, *and* each unit of volume moves price less.

*  Note the continued strength of liquid, high quality corporate bonds (LQD).  In a world of low and even negative rates, any yield becomes a safe haven.  Hence the environment in which stocks and bonds have been jointly outperforming (the risk parity trade).

Wednesday, March 30th

*  New Trader U highlights 22 bad trading habits.  Notice how many of them boil down to not being rule-governed, where the rules reflect trading strengths and identified best trading practices.  That suggests that traders are suffering, not just because they don't study markets, but because they haven't truly studied their own performance.

*  Stocks liked the statements of the Fed chair and that has lifted us to a new high for this rally.  Interestingly, across all stocks on all exchanges, three month new highs versus lows are lagging their peak from a couple of weeks ago (see below).  Among SPX shares, however, fresh 100-day highs vs. lows did hit a marginal new peak.  I would become concerned about the uptrend if stocks making fresh new lows were to expand from here.

*  Once again, we saw buying pressure completely dominate selling pressure via the uptick/downtick measures.  This lifted the cumulative uptick/downtick measure to new highs (see below).  As noted yesterday, volume has not been stellar (though it picked up yesterday), but what volume has been there has been strongly skewed to the buyers and that has been associated historically with favorable near-term returns (upside momentum).

Tuesday, March 29th

*  How can you find trade opportunities that others miss?  Here is a process that can help you become better at perceiving opportunity.

*  Meh.  Volume has been quite lackluster, and that is more typical of market tops than bottoms.  We remain in relatively oversold territory on my swing measures and my measures of upticks vs. downticks remain strong.  So my base case remains a continued move higher, but I can't say I'm particularly impressed with recent action.  Financial and energy shares have been relatively weak and I continue to keep an eye on small caps.  Perhaps month end/quarter end flows will bring some life to the market.  Stocks making fresh monthly highs did uptick yesterday and I'm not seeing an influx of selling at all.  Of the (low) volume present yesterday, buyers were dominant.

*  Put/call ratios were low yesterday; shares outstanding for SPY have been modestly elevated.  Bears are relatively absent.

*  We're working off quite an overbought level, per the intermediate-term strength chart below, which tracks the number of SPX shares making new highs vs. lows on multiple time frames.  To the extent that we can do so with minimal price damage, it is supportive to the bulls.

Monday, March 28th

*  In case you missed, here's my latest podcast; thanks to Chat With Traders.

*  We've bounced from a swing oversold level and, as we can see below, are not yet at an overbought level.

*  Buying interest hit a new rally high with this most recent bounce.  This measure tracks upticks versus downticks for all listed stocks, not just those on NYSE.  

*  The one fly in the ointment that I see is the low volume and volatility, which are associated historically with subnormal forward returns over an intermediate-term horizon.  My measure of cumulative upticking and downticking is not yet at such a low point that would suggest poor near-term returns.  As a rule, bull moves die with an absence of buyers.  It's something I'm monitoring daily.

Sunday, March 27, 2016

Random Observations

*  If you decompose market behavior into a linear, trend component and one or more cyclical components, you can identify optimal time horizons for holding positions.  Those optimal horizons are much longer than traders and portfolio managers typically hold.  Most people hold positions for shorter-than-optimal periods because of such factors as the need to trade, the fear of losing money, overly tight risk management, etc. 

*  Trends and cycles become more regular and noticeable when measured in event time, as opposed to chronological time.  A simple example of event time would be bars denominated in volume rather than minutes, hours, days, or weeks.  When assessing long-term cycles, the key is finding a way to measure event time given the variability of volume across instruments, across decades.  Such event cycles are least stable over short time horizons; much more stable over longer horizons, per the first point above.

*  Who is in the market determines how the market will move.  If we look at each transaction in each stock traded and assess whether the trade occurs on an uptick or downtick--and if we cumulate those data daily for many years--what we see is that a) buying and selling (activity on upticks and downticks) are different activities with their separate impacts on future market behavior; b) the total activity of participants (total upticking and downticking) is a good proxy for institutional participation in markets; and c) the market is significantly more likely to rise following periods of high institutional participation.  To simplify a bit, cycles occur because of the waxing and waning participation of agents that move the market.

*  Strong buying (activity on upticks) tends to fuel future buying (momentum).  Heavy selling (activity on downticks) tends to fuel future buying (value).  Weak buying and selling (little activity) tends to lead to subnormal returns per the point above.  Shifts in buying and selling over even a short time horizon can impact returns days and even weeks forward.

*  The worst traders are permabears and permabulls.  By definition, they do not adapt to market cycles.  They trade their predilections, not the objective activity of the marketplace.  

*  An argument can be made that the lows put in during January and February were part of a longer-term cyclical bottom and that the recent upswing has significantly more (event) time to run.  Frankly, I can think of many reasons for the market to weaken from here, but that's not what my analyses are telling me.  

Further Reading:  Trading Coaches As Whores

Saturday, March 26, 2016

Learning How We Learn: Maximizing Our Trading Environments

I recently wrote about the importance of sustaining a positive mindset by learning from our setbacks.  Confidence comes, not from doing everything right, but from knowing that you can learn from mistakes and become better over time.

But how do we learn best?  Might it be the case that we struggle as traders because we fail to play to our learning strengths?

Consider the average trading floor at a proprietary trading firm, hedge fund, or bank.  What you'll likely see is rows of traders at stations sitting side by side and surrounded by multiple monitors.  Some monitors track news events, some chart markets, some follow prices of various instruments, some keep on top of email.

Can this truly be the best learning environment for everyone?

For many traders, this environment is toxic.  It trains them to be distracted; it takes away from focused concentration.  It encourages groupthink.  It encourages superficial commentary/conversation and maximizes exposure to data--not necessarily the translation of data into useful information.

Is the learning environment better for the solo trader at home?  More multiple screens and potential data overload, with online chat substituting for the rows of traders.  

When I am following markets, I have the data sent to my spreadsheets.  In spreadsheets I can actively manipulate and analyze the information in ways not possible via charts on the screen.  While engaging in those analyses, I'm not watching multiple screens.  I sit alone in an office and have no screens open for chat.  I've learned that I learn best in an environment that helps me focus--and, most importantly, that helps me sustain access to fresh ideas and intuitions.

Other traders are quite different.  They learn very well through discussion with other traders.  Still others learn by reading research articles and gaining a big picture grasp of the market.  I like to look at high frequency data and shifts in those data to identify emerging patterns in individual markets.  That is very different from the investor who develops a broad thesis and then applies it to different markets.

Research tells us that creativity is a function of two processes:  1) deep analysis of information and 2) synthesis of the information to see new connections and relationships.  The first process requires immersion in data; the second requires stepping back from data for big picture reflection.  

Does your trading environment maximize true, focused immersion in information?  Does it facilitate getting away from the trees in order to see the forest?

You wouldn't live in a home that was cluttered, noisy, and unclean; why accept that as your trading environment?

Further Reading:  Learning From Our Genius--And Our Idiocy

Monday, March 21, 2016

Trading Notes for the Week of March 21, 2016

Friday, March 25th

*  Perhaps the most common psychological challenge I hear from traders is how to keep a positive mindset during periods of drawdown.  It's very difficult to lose money for a stretch of time when you're pouring your heart and best efforts into markets.  But there is no surer way of missing opportunities than becoming self-focused and negatively focused.  This recent article focuses on how we can sustain well-being and a positive mindset even when everything seems to be going wrong.

*  Stocks bounced from their short-term oversold situation noted yesterday with the swing overbought/oversold measure. I am watching breadth closely here, as it would not surprise me to see a more selective phase of the market cycle going forward.  The relative performance of small caps is of particular interest. 

*  I'm seeing increasing talk of direct monetary stimulus to economies.  I suspect this will be actively considered if we get a renewed deterioration of financial conditions and concerns re: deflation.  The implications for asset prices (weak currencies, strong commodities) would be significant.

*  I've been putting considerable work into a set of swing measures that track overbought/oversold conditions and volatility.  These are based on event time, where each bar represents an amount of volume or price movement in the market, not a unit of chronological time.  The OBOS measure captures momentum and value effects on a swing basis:  swing returns in ES have been best when we're significantly overbought (+.54%) and significantly oversold (+.49%).  Returns have been subnormal between these extremes (-.05%).  Although I need to keep the specifics of the measure proprietary and limited to the managers I work with, I'll happily update periodically on this blog.  Swing returns from current levels of OBOS and vol have not been significantly positive or negative.

*  Here is a swing volatility measure that looks at the volatility of the event bars.  Note how we're near levels that have recently corresponded to market peaks.  This is yet another reason I'm watching breadth closely.

Thursday, March 24th

*  Thanks to Aaron Fifield for interviewing me for the Chat With Traders podcast.  We touch on a number of topics relevant to factors that make for trading success.  He's assembled an excellent lineup of interviews worth checking out.

*  We've seen a recent pullback in stocks and oil; yesterday's close saw an expanded number of stocks making new lows amidst relative weakness among small caps.  I will be tracking breadth closely here, as we might be seeing a more selective phase of the recent market strength.  Below is a chart of stocks across all exchanges making fresh 3-month highs vs. lows:

*  I've been exploring a swing overbought/oversold measure based on event bars.  As you can see, we've recently entered oversold territory.  As long as these swing lows are occurring at successive price highs, I'm willing to give the benefit of the doubt to the bulls.  The chart tracks the measure through the recent move higher.

Wednesday, March 23rd

*  We saw an early selloff due to the Brussels news, but this was bought relatively early in the NY session.  It's a good example of how, in a momentum environment, participants want to get long even on relatively modest dips.  That being said, my breadth volatility measures (volatility of daily breadth numbers) has been coming down and that has led to subnormal returns over the near-term horizon.

*  Interestingly, we're hovering near our highs, but yesterday saw only about 40% of SPX stocks trading above their 3-day moving averages.  During these momentum periods, corrections tend to be rotational and we're seeing some of that.  Housing, financials, consumer staples, utilities--all have been off their highs recently.  Technology has been stronger.

*  My cycle measure continues in elevated territory, again unlike much of what we saw in 2015, where strength led to weakness.  That continued elevation on a shorter-term cycle measure suggests that a longer-term cycle is at play and that this has been more than a bounce in a bear market.

Tuesday, March 22nd

*  We're seeing some consolidation overnight following a modest up day yesterday.  While SPX closed higher, we returned to underperformance of small caps and the number of stocks across all exchanges making new monthly highs dropped from 1660 to 886.  New monthly lows also dropped, however, as we're still not seeing distinctive weakness in any sector.  Volume and volatility dropped; VIX is now below 14.  More on volatility below.

*  Below is a short-term measure of the number of SPX stocks making fresh 5, 20, and 100-day highs versus lows.  Notice how we have stayed elevated for a number of consecutive days and how this is different from what we saw through much of 2015.  Whereas "overbought" readings were opportunities to sell last year, so far in this rise we're seeing momentum and strength leading to further strength--one of the signature characteristics of a fresh market cycle.

*  Despite the market's strength and momentum, the rally has not had a lot of fans.  I notice on the Stock Twits site, for example, that messages regarding SPY are 40% bullish, 60% bearish.  That ratio hasn't changed much during the last two weeks of gains.  I also notice that shares outstanding for the SPY ETF have once again dipped, now dropping below their levels from 5, 10, and 20 days ago.  Very interestingly, the number of shares outstanding for SPY has dropped over the course of the rally from mid-February.  Share redemption has generally been associated with superior returns over a multi-week horizon.

*  As mentioned above, volatility has dropped over the course of this market rally.  Equally notably, my pure volatility measure (volatility per unit of trading volume for the ES futures) has dropped significantly (see below) and is getting to levels that have been seen at recent market highs.  I am very open to the possibility that we're going into a different phase of the market cycle where we'll see lower volume, less movement per unit of volume, and more of a grinding trade.  For traders accustomed to the movement that we saw for the first couple of months of this year, that transition to a low vol regime can be challenging, requiring a fresh approach to setting targets, stops, and holding periods.

Monday, March 21st

*  So often, in our trading goals, it's set and forget.  We set goals, but often fail to follow through.  This article draws upon recent research to identify how can we become more productive--better at pursuing and reaching the goals that we define.

*  Stocks closed higher overall on Friday, and we're now seeing over 90% of SPX shares trading above their 20- and 50-day moving averages.  That is unusual strength off the February lows.  My measure of upticks versus downticks among NYSE stocks (NYSE TICK) showed solid strength on Fed day and, as the chart below shows, has been in an uptrend on a cumulative basis, eclipsing its previous high.  I believe we're pricing in a more favorable environment for equities, given QE overseas and a moderating Fed.

*  Yet another way of tracking the strength and weakness of shares is to look at each stock on the NYSE and see if it has closed above or below its Bollinger Bands.  (Raw data from Stock Charts).  As the chart below shows, we have reversed the pattern of net weakness from 2015 and early 2016 and have been persistently above the zero line in recent days.  Bottom line, I'm not seeing the kind of deterioration that would normally precede a major market reversal.

*  A while back I mentioned the shares outstanding in the SPY ETF as a useful sentiment gauge and noted that it had been flashing bearish sentiment, even after the liftoff from the February lows.  Sure enough, history repeated and we continued higher.  Now we're seeing an expansion in shares outstanding (net bullish sentiment).  In the past that has led to subnormal returns for SPY.

Sunday, March 20, 2016

A Different View Of Stock Market Strength And Weakness

Sometimes, an important indication of market strength is the absence of weakness.

An interesting example comes from the Stockspotter site, which offers cycle-based forecasts for stocks and ETFs.  I've tracked the cumulative number of buy and sell signals from the site since late 2013.  When there have been fewer than 10 sell signals on a given day (N = 225), the next ten days in SPY have averaged a gain of +.47%.  When there have been more than 10 sell signals on a given day (N = 317), the next ten days have averaged a loss of -.06%.  Interestingly, when there were few sell signals, the number of buy signals didn't matter.  It was the absence of weakness that was most important.

Another notable example comes from the Stock Charts site, where I've tracked buy and sell signals from technical systems for all NYSE stocks going back to mid-2014.  When we've had few sell signals in the Bollinger Band indicator, based on a median split of the data, the next 20 days in SPY have averaged a gain of +.43%.  When we've had a high number of sell signals based on the median split, the next 20 days have averaged a loss of -.14%.  In this case, the number of buy signals *did* matter; superior gains have come from having many buy signals and few sells.

Still a different pattern emerged when I tracked the number of stocks across all exchanges making fresh one-month lows.  (Data from the Barchart site).  Based on a quartile split of the data from mid 2010, when I first began archiving these data, returns over a 10-day horizon were superior when there were few new lows (bottom quartile; average SPY gain of +.60%) and also when there were many new lows (top quartile; average gain of +.81%).  All other occasions averaged a gain of only +.18%.

The takeaway here is that strength and weakness are not necessarily flip sides of the same coin.  Momentum and mean reversion effects are the results of interplays between strength and weakness, such that the absence of strength or the absence of weakness themselves become meaningful measures.  I believe this can be explained by the dynamics of market cycles, which themselves are the result of high strength/low weakness giving way to high strength/high weakness and then low strength/high weakness and low strength/low weakness.  

Across multiple measures, the recent market rise has been one of low weakness.  Those expecting mean reversion have been sorely disappointed.  There is more to market behavior than mere "overbought" and "oversold"--and dissecting strength vs. weakness is one way to identify where we're at in market cycles.

Further Reading:   Finding Opportunity in Market Cycles

Saturday, March 19, 2016

Passion, Purpose, And Why Traders Fail

There are four overarching themes in the Trading Psychology 2.0 book that account for success in financial markets: 

*  Adapting to changing markets;
*  Building on strengths
*  Cultivating creativity
*  Developing best practices and processes

These ABCD themes are interwoven:  we adapt to changing markets by becoming more creative and generating new and better trade ideas.  We build on our strengths and channel those into best practices.  By continually learning from our trading successes and setbacks, we refine our best practices, build on our strengths, and adapt to market conditions.

Many traders fail because they are playing the wrong game.  They pursue trading by following others, not by exercising their strengths.  They insist that trading is their interest and passion, but there is little energy in their attitude and no creative spark.  We experience excitement and interest when we play to our strengths: the exercise of strengths is intrinsically rewarding.  When traders veer from their strengths and attempt to make money in ways that don't match their personality or cognitive styles, trading becomes inherently frustrating.

What is our life's purpose?  We don't always know what we're meant to be doing during our time on this earth, but our passions--the deep, intrinsic fulfillments that come from exercising strengths--point the way to our purposes.  In previous writing, I shared that I pursued full time trading a little over a decade ago.  I made progress, I made money--and I was wholly unfulfilled.  Indeed, I found myself chatting with traders more than trading, and I missed quite a few trades that way!  Why?  Because my greatest passion--and my greatest strengths--lie in working with people.  I became a psychologist for a reason.  Doing well in markets is rewarding, but--for me--couldn't replace the deep reward of becoming a valuable resource in another person's development.

I've met longer time frame traders who came to shops where risk was managed quite tightly.  The risk management constraints nudged them to shorter holding periods and turned them from investors to traders.  But their strengths were analytical and thematic, not based in rapid pattern recognition and decision-making.  Slowly, they stopped enjoying their work; they stopped working as hard; and they lost the energy and drive that had experienced in their earlier trading.  They were playing the wrong game.

If you're not finding fulfillment in your trading, consider the possibility that you are trying to fit into trading rather than make trading an exercise of your deepest interests, talents, and skills.  Consider, too, the possibility that your greatest fulfillment and exercise of strengths may lie outside financial markets.  If you are honest with yourself and follow your true passions--your deepest gratification--you're most likely to find your purpose.  You're meant to be the person you are when you're truly at your best.

Further Reading:  Our Struggles Develop Our Strengths

Note:  Throughout my writing of this post, Mia has been on my desk, at my side, nuzzling and licking my left hand.  It is difficult to type when a cat is rubbing against your hand, but the ideas flow much more quickly.  It's yet another way that our passions fuel our creativity--and our happiness.

Monday, March 14, 2016

Trading Notes For The Week Of March 14, 2016

Friday, March 18th

Steve Spencer of SMB emphasizes that price action following a catalytic event provides us with important information.  This is especially true when we see a change in the distribution of transactions following a news event or other catalyst.  Increased volume and a new skew of volume lifting offers versus hitting bids, for example, tells us that fresh buying flows have come into the market.  This calls for an updating of our views of the stock or index.

*  This lesson has been especially relevant in the wake of the Fed announcement.  My cumulative measure of upticks vs. downticks has hit new highs for this move and breadth, which had been waning, vaulted to new highs.  Below we can see the chart of stocks across all changes making fresh 3-month new highs vs. lows.  The vigor of buying following the Fed announcement suggests that this, indeed, was a game changer.  Central banks globally are opting for accommodation and, historically, that has been favorable toward stocks.

*  The China/deflation thesis, which dominated discussion during recent market weakness, is far less discussed I find, given oil strength and USD weakness.  For stocks, in a negative interest rate world, anything safe with yield continues to find interest.

Thursday, March 17th

Interesting commentary on the fear of missing market moves from Victor Niederhoffer.  Many a bad trade is made because of the ego, not because of the objective market opportunity.

*  We saw a rise to new highs on the heels of the Fed announcement, with solid buying interest.  Recent posts have commented on weak breadth and, for the market overall, the breadth picture did not improve despite the Fed-related strength.  Across all exchanges, we saw 753 new monthly highs against 254 lows.  The latter is again an uptick in new lows and the new highs are half of what we saw two weeks ago.  Among SPX shares only, stocks making fresh 100-day new highs versus lows did expand to a marginal new peak.  Much of the weakness is among small cap shares, though financial and health care stocks within SPX are also lagging.  With the mixed breadth picture, I'm not surprised to see some retracement of yesterday's gains in premarket trade today.

*  Breadth issues notwithstanding, it's clear that this has been a vigorous bull move from the February lows.  Note below how we've stayed "overbought" on my multiperiod strength measure (daily tracking of SPX stocks making 5, 20, and 100-day new highs versus lows) for a number of days.  This only occurs in trending markets.  While the breadth issues often precede correction, my base case is to view such a correction as a buying opportunity.  


*  I'm working on creating a cycle-based measure of short-term momentum and value effects in the ES market.  The idea is to identify when markets are most likely to continue versus reverse their most recent directional movement.  Interestingly, the market's rise yesterday occurred on a low value of the momentum measure.  More to come on this research.

Wednesday, March 16th

*  Jim Dalton, who has pioneered trading via Market Profile, is offering his final mentorship program before his retirement.  I also see Terry Liberman will be doing a webinar with Jim later today.  When I taught an internship program in Chicago many years ago, Jim's work was the only mandated reading.  I continue to find Market Profile helpful as a conceptual framework for thinking about market behavior.

*  After some early weakness, we saw buying in stocks, but small caps continue to notably underperform large caps.  As a result, we see continuing deterioration among the breadth measures.  New monthly lows ticked up to 192, the highest level since February 24th and monthly highs dipped to 451.  Relatively weak sectors recently include energy shares (XLE) and healthcare (XLV).  Today's trading will be dominated by the afternoon's Fed announcement.  

*  We continue quite stretched on my intermediate strength measure, which looks at the number of SPX shares making fresh 5, 20, and 100-day highs versus lows.  (Data from Index Indicators).  If the Fed-related trade can't break us from the breadth deterioration, I expect an intermediate-term correction.  That would not necessarily be an end to the bull move from February's lows, but could suggest a new, topping phase to the current market cycle.  During a topping phase we can see higher overall prices for the index, but with deterioration in some sectors contributing to lagging breadth.  

*  Here is a unique intraday indicator that looks at buying pressure among all U.S. listed shares.  It tracks upticks among all shares (data from e-Signal) and expresses the result in standard deviation units.  This shows us when significant buying is coming into the market.  It also shows us when there is a meaningful absence of buying.  (A corresponding measure tracks significant selling and absence of selling pressure).  It helps longer-term positions when those are going with the flows.  The chart below shows yesterday's market.

Tuesday, March 15th

*  I'll be making an addition to these market notes and including each day links to readings that I find particularly informative and useful.  To kick this off, check out the Paststat blog for daily trading ideas based upon historical patterns, including this one based upon seasonality.  From my perspective, such patterns are the starting point for analysis, not an end point.  Once we see a pattern, the hard work remains of deciding: 1) is the current market regime typical of the period covered by the historical test; 2) is there a sound reason for the existence of the pattern, or might the pattern be a random occurrence; and 3) what is the variability around the pattern (could you survive the exceptional instances)?  Factoring market history into trading decisions is no guarantee of success--it's easy to look in so many places that some "significant" pattern appears--but ignorance of market history is not exactly a promising alternative.

*  The relative absence of selling pressure in Monday's session was noteworthy and helped lead to higher prices for much of the session before a late selling burst.  Selling has continued overnight with no new shot in the arm from the Bank of Japan.  Trading was unusually slow on Monday and we could get more of the same ahead of tomorrow's Fed announcement.  Note how short-term breadth has been strong for a number of days; the measure below tracks the percentage of SPX stocks closing above their 3, 5, and 10-day moving averages.  (Data from Index Indicators).

 *  The market looks tired to me--for the first time since the liftoff from the February lows.  Specifically, we're getting fewer shares registering new highs during market rallies.  Much of that relative weakness is coming from small cap shares.  Yesterday we saw 921 stocks across all exchanges make fresh monthly highs against over 2000 last week.  (Data from the Barchart site).  No individual sector within the SPX looks distinctively weak and I'm not at all convinced that we're going into bear mode.  Rather, I expect a normal correction within a bull move.  With the absence of selling having trouble bringing us higher, I'm leaning toward selling bounces that cannot keep us above the overnight highs.  Of course, the upcoming Fed announcement will provide a major catalyst for stocks tomorrow.

Monday, March 14th

*  Those who know me well know that I do not subscribe to the idea that successful trading is mostly a function of psychology.  Without an objective trading edge, one's frame of mind will simply dictate the rate at which we part with our capital.  Still, psychology is necessary, if not sufficient, for success and yesterday's post was perhaps my clearest explanation why.

*  We closed near the highs on Friday, continuing the upswing following the post-ECB selloff.  The rise left us quite stretched short-term, with over 90% of SPX stocks trading above their 3, 5, 10, and 20-day moving averages.  This in itself is not a common occurrence.  Going back to 2006, I could only find 12 instances of this happening when VIX has been below 20.  Interestingly, 3 were up, 9 down the next day for a net loss, but 10 were up, 2 down after 3 days.  We're trading a bit lower premarket as I write; the depth of a next pullback will tell us a lot about possible upside momentum over the next few days.

*  One concern starting to enter my head is that Friday's highs were the first in which we saw sizable breadth divergences.  If we look at all stocks across all exchanges, we can see that 1087 made fresh monthly highs on Friday against 2082 the prior Friday.  Much of this is a function of relative weakness among small caps.  We only had 92 new monthly lows on Friday, so nothing is standing out as weak and I'm not expecting any grand reversal.  I am concerned, however, that we could see a decent pullback from these levels as part of the start of a topping process.  Bottom line is that I was happy to take profits late Friday and I'm happy to stay on the sidelines and see what the bears can bring.  Ideally, I'd like to be a buyer of weakness early in the week for at least a retest of highs thereafter.  But I'm not seeing favorably skewed risk/reward right here, right now.

Sunday, March 13, 2016

The True Reason Psychology Is Central To Trading

Traders have an enduring interest in psychology because they recognize the degree to which success requires change.  This occurs at two levels.  First, most fundamentally, markets behave in ways that run counter to normal human biases and tendencies.  If we simply follow our feelings and sell when markets look scariest and buy when they are most euphoric, we will lose money with alarming consistency.  If we seek the comfort of the herd and buy when others are optimistic and sell when they are pessimistic, we similarly court negative returns.  To trade markets successfully, we must wire ourselves as markets are wired--and that requires changes in how we think and feel.

A second level at which change is central to trading is that markets themselves are always changing.  Sometimes we observe momentum in markets; other times we experience mean reversion within trading ranges.  Sometimes markets are volatile and we can harvest large moves.  Other times, volatility is low and we must take what markets give us.  If we simply had to rewire ourselves to fit markets once and for all, that would be challenging enough.  To rewire ourselves as markets continually change requires unusual flexibility--and a capacity for continuous change.

This, most fundamentally, is why psychology is important to trading.  In adapting to markets, we must continually adapt.  We must change at a pace no slower than markets themselves change--or we will be left behind.

Once we realize the importance of change to trading success--and the need for relatively rapid and continuous change--the crucial question becomes, "How do we effect change?  How do we adapt ourselves to ever-changing environments?"

I address this issue in my most recent posting for Forbes.  It is little appreciated that there is a deep research literature on human change processes.  It goes relatively unnoticed to the general public because it has been conducted under the umbrella of outcome research in psychotherapy and counseling.  The study of how people make changes in therapy--and how they sustain those changes--has become a central theme of that outcome literature.  As the Forbes article makes clear, we change, not by motivating ourselves or trying to talk ourselves into thinking or behaving differently, but by absorbing new life experience.  

Do you wish to become a more patient trader?  You can write in your journal, and you can attach sticky-note reminders to your screen, but ultimately you will become a patient trader when you experience yourself as a patient person.  That means using your non-trading life to cultivate patience, placing yourself in roles that push you to be the patient person you wish to become.  Perhaps your child is having trouble with math in school and you can act as a patient tutor.  Perhaps your home needs curb appeal and you can grow and maintain a garden.  Doing things with patience, one small step at a time, builds the patient identity.  So it is with all the changes we seek to make.

We will never become greater risk-takers in markets if we approach life with risk aversion.  We will never be organized and disciplined in trading if we are scattered in our daily lives.  Everything in life, approached properly, is an opportunity to exercise the capacities we most require in our trading.  This is how becoming a better trader is a path to becoming a better person.

If we can move one stone at a time, make one small change here and now and another one the next day and yet another the next, before long we will have moved a mountain.  What the research on change tells us unequivocally is that we change when we internalize new ways of doing and viewing and we internalize those new ways through repeated, fresh experience.  Every day is an opportunity to move a stone, in our trading, in our relationships, in our lives.  We can become the best traders possible by cultivating trading strengths in our personal lives.

Further Reading:  The Most Powerful Change Technique Of All

Saturday, March 12, 2016

Trading With Your Brain--And Your Gut

It's been said that many traders who claim to trade based on intuition are actually more into wishin'.  The gut can be used as a great excuse for not using the brain.  The reality is that the gut and brain can act in harmony, and it is the trading plan that accomplishes this synthesis.

A good example can be found in the current stock market.  If you've been following my trading notes, you know that I've been highlighting the vigor of the recent market.  Following February's lows, which saw considerably fewer stocks making new lows relative to the January bottom, the launch has been strong.  Indeed, as of Friday's close, we had over 90% of SPX stocks close above their 3, 5, 10, and 20-day moving averages and almost as many above their 50-day averages.  Only a handful of days in the past ten years have displayed such broad strength.  

So during this vigorous rise, my plan has been to be a buyer of weakness.  That's the brain, the head, the analysis:  I've looked at past market cycles and the behavior of momentum early in the bull phase of those cycles and know that strength has tended to beget further strength.  The plan provides my strategy.

But when will this weakness materialize?  I have no f*cking clue.  But I'll know it when I see it--that's the role of the gut.

In yesterday's trade, we had already traded considerably higher in overnight hours, so I wanted to be a buyer of intraday weakness.  When early selling could not take us to meaningfully negative readings on the uptick/downtick measures I follow and could not keep us beneath the session's opening price, I became a buyer.  I acted on my strategy with tactics--the gut provided those tactics, identifying that we were getting sellers and sellers could not move the market.

Differentiating strategy from tactics helps a trader figure out his or her mistakes.  If you've been a bear during the recent market period and losing as a result, your problem has been one of strategy.  Whatever has led you to your directional stance has been wrong.  It's a problem of the brain, a flaw of analysis.

On the other hand, if you've had market direction correct but implemented your trades unsuccessfully, that's a problem of tactics.  Your gut is failing you.  That happened to me this past week when I bought weakness following the breakdown of trade on Thursday (the reversal of the ECB impact) and bought too early.  The market continued meaningfully lower and I stopped out with a loss.  In my review, I saw clearly that I had identified when there was weakness, but did not wait for that weakness to dry up.  I was too eager to buy and never waited for that gut sense that sellers could no longer push the market lower.

That failure of the gut often occurs when we become so focused on the plan that we stop listening to our experience.  It's equally problematic when we trade our feel and fail to plan.  We might pick up a short-term pattern, only to be run over by what is occurring in the larger picture.  I've found it helpful to do all my planning before the market open and then stay open to experience during the trading session.  Failure comes from lack of preparation before the open (not feeding the brain) and staying too plan focused during the trading day (overriding the gut).

One of the great challenges of discretionary trading is that we have two information processing systems operating at all times: one intellectual, one intuitive.  Trading with half a brain is the surest way to trade half-assed.

Further Reading:  Paying the Tuition for Your Intuition

Monday, March 07, 2016

Trading Notes For The Week Of March 7, 2016

Friday, March 11th

*  Thursday's ECB meeting brought stock buying and euro selling--and then a sharp reversal of both during the day before a rally late in the day and overnight brought us back toward the highs.  As the one-hour oscillator of upticks/downticks for all listed stocks shows below, the selling was quite broad during yesterday's selloff and the buying has been broad on the reversal.  New highs vs. lows for listed stocks deteriorated yesterday, so I will be watching breadth going forward to see if participation expands or contracts on upside moves.

*  We've turned down on the cumulative number of buy vs. sell signals given by the Wilder Parabolic-SAR system.  That tracks all NYSE shares on an end-of-day basis (raw data from Stock Charts).  Note that, during vigorous upward cycle phases, such as we had in October of last year, the cumulative SAR measure will peak ahead of price.  So far, during the deterioration in the measure, price has held up well.  I lean toward buying weakness that remains above yesterday's lows.

*  I noticed some underperformance of small cap shares yesterday.  One day does not make a trend, but during the vigorous rise from the February lows, small caps were outperformers.  I will be watching that relative performance going forward, as it could offer clues as to the eventual turning of the cycle.

Thursday, March 10th

*  Wednesday saw rangebound markets, as selling greeted early strength, but stocks by and large held against their prior day's lows.  We closed with under 50% of SPX stocks under their 3 and 5-day moving averages.  Going into the ECB announcement, we need to see the lows of the last two days hold up in order to continue the vigorous uptrend from the February lows.

*  Here is a chart of the number of NYSE stocks giving buy signals versus sell signals with respect to their Bollinger Bands--a very useful measure of broad market strength vs. weakness.  Note the upthrust from the February lows, followed by a pullback in buy signals, but not at a point where we're getting net sell signals.  It is common for thrusts higher in the Bollinger measure to be followed by further price strength; market rises become vulnerable when we begin seeing net sell signals. Note how thrusts lower in the measure have represented good buying opportunities as a whole.

I recently wrote on the topic of a powerful measure of stock market sentiment.  Interestingly, that measure shows a net reduction of SPY shares outstanding over the past 5, 10, and 20 trading sessions.  That configuration has tended to lead to price gains over the next 5-20 trading sessions.

Wednesday, March 9th

*  Monday's post talked about a normal correction from stretched levels and we got that yesterday, as about 19% of SPX stocks closed above their 3-day moving averages and 26% above their 5-day averages.  In an uptrend, we expect short-term oversold levels to occur at successively higher price lows.  We're seeing a bounce in overnight trade and my base case is that yesterday's lows hold as we set up a test of the recent highs.  Of course, market response to tomorrow's ECB announcement could have a lot to do with whether that base case plays out or not.

*  Yesterday, stocks across all exchanges making fresh monthly highs dropped from 1720 to 719; new lows rose from 80 to 88.  In general, I only become concerned about the reversals of cycle uptrends when new lows expand meaningfully.  The past week we've had the lowest number of new monthly lows in years.  The absence of weakness ends up being as strong a predictor as the presence of strength.  Markets generally turn because one or more sectors are rolling over, creating the expansion of new lows.

*  Here's a look at the performance of major stock market sectors from the Finviz site.  Note how the sectors that led performance on the downside (utilities) are now lagging and how those most hurt in the downturn (raw materials) are now leading performers.  If the uptrend is to continue, we would want to see broad participation of the sectors; a rally with strong sector rotation is what often leads to a more prolonged correction.


Tuesday, March 8th

*  After a sizable run higher, we're beginning to see signs of distribution.  While the number of stocks across all exchanges hitting fresh monthly highs was impressive yesterday (1720), that number was below the levels seen the prior day (2082) and the day before that (1868).  Small cap and midcap stocks continue to outperform.  NASDAQ shares have been relatively weak; commodity-related shares have been relatively strong.  Consumer staples shares (XLP) hit a new high yesterday, part of a theme that I believe will emerge in this world of growing negative interest rates:  the appeal of stable, high quality stocks that offer relatively safe and attractive yields.  Such stocks are richly valued already, but could see bubble-like performance should central banks continue down the negative rate path.

*  Commodities have staged a significant rally; DBC is now above its December 31st close (see below).  The U.S. dollar (UUP) is down on the year.  With ECB coming up on Thursday, might we be pricing in significant reflation, and might the central banks in Japan and Europe be embarking on stimulus measures above and beyond negative interest rates and bond-buying?  That would be a most significant macro development.

*  The recent selling around the 2000 level in ES notwithstanding, I continue to be impressed by the vigor of the rally off the February lows.  Note below how we've gone from an overbought situation to an even more overbought one, with stocks moving steadily higher.  (Chart tracks SPX stocks making new highs versus lows over 5, 20, and 100-day lookback periods).  If indeed we're getting reflation from central banks, the implications for stocks would not be short-term and could continue to power shares higher.

Monday, March 7th

If our trading does not provide these four psychological benefits, we're apt to underperform and lose our ability to perform in the zone.  We can best manage our positions if we're managing ourselves well.

*  We saw some broad selling late on Friday and so far have not been able to bounce in overnight trading.  Friday closed with over 80% of SPX stocks closing above their 5, 10, 20, and 50-day moving averages, but a waning percentage closing above their 3-day averages.  (Data from Index Indicators).  I would not be surprised to see a normal correction of the recent strength; that should terminate above the late February lows to sustain the current uptrend.  I would also not be surprised to see subdued risk-taking ahead of this week's ECB meeting.

*  The intermediate-term cycle measures that I track continue to be stretched to the upside.  Note how we've rallied in the face of an "overbought" cycle.  That momentum suggests that we're not yet at a point where we would expect the uptrend to meaningfully reverse.  

*  One measure I track is the volatility of market breadth.  Specifically, I track the volatility of the daily readings of SPX 500 stocks making fresh new highs and lows on a 5, 20, and 100-day basis.  We recently hit a meaningfully low level in that measure.  Since 2010, when we've been in the lowest quartile of readings for breadth volatility (as at present), the next five days in SPX have averaged a gain of only .01%.  When we've been in the highest quartile, the next five days in SPX have averaged a gain of +.44%.  It's one more measure that makes me open to the possibility of some short-term correction of the recent market strength.

Sunday, March 06, 2016

Update On A Powerful Measure of Stock Market Sentiment

A little appreciated sentiment indicator is the number of ETF shares created or redeemed over a period of time.  When investors have an appetite for an ETF, the shares outstanding increase.  When investors pull in their horns, net shares are redeemed.  This dynamic makes the shares outstanding for the popular SPY ETF a useful measure of market sentiment.

One might think that shares outstanding are a simple function of contemporaneous price change.  When prices rise, shares are created; when they fall, shares are redeemed.  It turns out, however, that this is not the case.  Since 2006, when I first began archiving these data, the correlation between daily price change in SPY and the number of SPY shares outstanding has been -.03.

Going back to 2006, when net shares were created over a 20 day period, the next 20 days in SPY averaged a loss of -.08.  When net shares were redeemed over the same period, the next 20 days in SPY averaged a gain of +1.98%.  In other words, essentially all the market's gains over that period occurred during a time when investors were dumping the ETF.

Nor are the data different if we look at the more recent period from 2012 to the present.  When shares were created over a 20 day period, the next 20 days in SPY averaged a loss of -.76%.  When shares were redeemed over a 20 day period, the next 20 days in SPY averaged a gain of +1.90%.  When investors have most demanded the ETF shares, subsequent performance has been most dampened; when investors have most hated the ETF, forward performance has been best.  

Stocks have rallied hard over the past week and over the past week net shares were created.  Since 2012, that has led to subnormal performance over the next week.  Still, as the chart above shows, over the course of the recent market bounce from February lows, net shares were actually redeemed.  Investors have not believed in this rally and, if history holds, that's one indication that the rise could continue.

Further Reading:  Equity Put-Call Ratio as a Sentiment Gauge

Saturday, March 05, 2016

Acceptance as a Trading Virtue

I recently wrote on the topic of how the ways in which we analyze markets can generate the frustration we experience as traders.  When we try to fit markets into the ways we prefer to trade, we not only distort our processing of information; we also create inevitable drawdowns.  One trader, needing to trade trends, views a non-trending market as "choppy" and untradable.  But the trader who views markets in terms of cycles knows that there are trending periods in markets and there are mean-reverting periods.  There are higher frequency cycles and there are lower frequency ones.  The markets will tell us how they're trading.  We can listen and adapt or we can impose our own agendas and accumulate frustration.

Similarly, life has its cycles as well.  Sometimes we profit in our life experience and sometimes we face career or relationship setbacks.  Rarely does life progress in a straight line.  If we view our setbacks as opportunities to learn and adjust, we can continuously grown.  If we view our setbacks as failures, we will always internalize the sense of falling short and never sustain the confidence needed to truly move forward.

The trading psychology literature speaks a great deal of discipline and confidence and emotional control.  Rarely do we focus on acceptance as a cardinal virtue.  If we can accept the present and learn from it, we can forge a profitable future--in markets and in life.

Further Reading:  The Single Most Important Trait of Successful Traders