Tuesday, March 20, 2018

Focusing on What Really Creates Your Trading Success

One of the most important articles I've written was recently posted to Forbes.  It examines the odds of sustained trading success and the factors that raise those odds.

It turns out that trading success requires:  a) personality strengths; b) cognitive strengths; and c) a developmental process that leverages those strengths in finding good risk/reward opportunities.

Great performers--great actors/actresses, great athletes, great musicians--are great at some-thing.  When we're great at something, we intrinsically enjoy exercising those talents and skills.  That intrinsic excitement drives and supercharges our learning process.

Elite performance never came from standard learning efforts.  It's what sets our soul on fire that leads to deep and sustained learning.

What sets your soul on fire, in and out of markets?  Most likely, that's the performance path to pursue.

Further Reading:


Sunday, March 18, 2018

Brett Steenbarger's Podcasts

Below are interview/podcasts that I have participated in recently on the topic of trading psychology.  The groups hosting the podcasts represent unusually valuable resources for traders and are worth checking out:


Friday, March 16, 2018

The Importance of Idea Velocity in Trading

One's skill as a trader is only as good as one's ability to generate ideas worth trading.  This is an underappreciated aspect of trading performance.

Specifically, we can look at the idea velocity of a trader--the number of independent ideas generated per unit of time--as an important component of trading success.

Why is this?

Imagine a trader who generated one good trading idea per year.  That one trade would have to be sized quite meaningfully and held for quite a while to generate a year's worth of income.  Indeed, it really wouldn't be a trade; it would be an investment.  But with only one idea per year, it would be an undiversified investment.  If the idea didn't work out, losses could be significant, but more importantly there would be no other source of returns.  Over time, such a low velocity trader/investor would have a very lumpy set of returns, unless they just happened to hit one big idea after another infallibly.

At the other end of the spectrum, imagine the skilled daytrader who notices many different trades setting up among many different stocks or instruments.  That trader is highly diversified on a serial basis, as each day's returns reflects the probabilistic outcome of many bets.  That will produce a smoother equity curve.

The skilled hedge fund manager generates many independent trade ideas at one time and weights them properly within a portfolio to achieve diversification benefit.  The idea velocity is achieved by researching across multiple markets and strategies and putting on many bets at once.

In my recent webinar (you can listen to it here), I emphasized that there are two broad sets of skills that define successful trading:  pattern recognition and analysis.  I also pointed out that extraordinary returns in trading come from unusual talents and skills in at least one of these areas.  An important way that these skills are manifest is through idea velocity.  When someone is a great pattern recognizer, they recognize many patterns.  When someone has great analytical skill, they research effectively and generate many ideas.  Profound talent and skill manifest themselves in creativity.

A recognition of the importance of idea velocity helps us appreciate why, increasingly, we're seeing superior returns among discretionary portfolio managers who make use of quantitative models and trading strategies.  Computers simply have more bandwidth than people, both in terms of the number of patterns that can be recognized and the number of markets and strategies that can be researched.  Moreover, the use of automation enables the trader to not only generate many ideas but trade them simultaneously--again vastly expanding the number of sound, independent bets placed per unit of time.

A recognition of the importance of idea velocity also helps us appreciate why traders learn and perform better in team settings.  Teams model more and different ideas and ways of generating ideas and teams share ideas they generate.  A team of discretionary traders, each of who generates independent models and automates their trading strategies, is powerfully diversified, able to make money in dozens of ways.  

Idea velocity encourages us to get broader, not just bigger.

Further Reading:


Tuesday, March 13, 2018

Is Your Trading Authentic?

My subway ride to the hedge fund where I'm working today was an interesting one.  I was standing on the platform waiting for the next train.  I was thinking about something I had read on the train ride from Connecticut to the city.  The gist of what I read was that, in biblical times, people worshiped by sacrificing animals.  Today our worship can take a different form:  by sacrificing our animal needs and desires and using them for spiritual growth and development.  Thus, for instance, I can work as a trading coach to accumulate money and material things, or I can work to become a meaningful part of people's and use the money earned to better my family and the world.  It's not that we fight against our animal nature; it's that we tame it, elevate it, and direct it wisely.  We can eat for gluttony or we can eat for health.

So that's what I was thinking about standing on the subway platform.  A young woman walked in front of me listening to music on headphones and bopping about.  She then turned around, walked in front of me again, and kept grooving to the music.  By the third time she did this, I felt a little distracted, a little annoyed.

The train stopped, we got on, and Ms. Headphones continued to bop on the train.  I was going to sit down, but I noticed a man lying down on the seat.  He was noticeably dirty and smelled bad.  My impression was that he was a homeless person.  I stood nearby but chose to not sit next to the man.

Ms. Headphones, still dancing to her music and smiling, took off the shawl she was wearing and wrapped it around the man.  She then offered him a piece of gum.  He looked up bleary eyed, took the shawl off of himself, wadded it up, and used it as a pillow.  She looked at me, we both smiled, and she continued her dance.

So I'm reading and thinking about using the animal/material world to achieve a higher purpose, but this young woman was actually living the lesson.  Out of her happiness--her dance--she freely gave of herself, oblivious to the man's appearance and smell. 

Authenticity is about living our truths, not just talking them or studying them.

How authentic is your trading?

If someone watched you trade, would they know what your plans were for the day?  Would they know what you were working on?  

There is talking the talk and there is walking the walk.  If we are not authentic in our trading--actually acting on our beliefs and understandings--all our plans and journal entries are empty.  There is a profound message in the young woman's actions:  we find our authenticity when we live our joy and we find joy when we are who we are meant to be.

Further Reading:


Saturday, March 10, 2018

How Fast is the Learning Curve for Traders?

Trading is one of the most challenging, stimulating, and potentially rewarding careers I can think of.  Every day is a new challenge.  Every day pushes us to overcome the biases and tendencies that get in the way of sound decision-making.  Like all great performance activities, trading rewards our self-development.

But what are reasonable expectations for a learning curve for traders?  Some years ago, I looked at research concerning the success rates of day traders and the numbers were sobering.  Over 80% of traders were unprofitable in the study and, after expenses, only a small proportion were profitable.  Not surprisingly, the smallest traders tended to be the least successful.  The larger ones, of course, were large precisely because they had accumulated some degree of success.

This is not only true of day traders.  Research by Barber and Odean finds that individual investors consistently underperform the market and fall prey to trading biases.  Recent research finds that the average active trader not only loses money, but persists in trading after being unprofitable.

That's the part that trading educators, coaches, brokerage firms, and others don't like to emphasize.  Just like in acting, just like in music, just like in athletics:  many are called, few are chosen.  The proportion of people who can make their living from golf, chess, football, or car racing is a fraction of the people who participate in those activities.

What that means is that any developing trader has to approach their learning curves with eyes wide open and ask the questions, "Am I on track?  Is this where I'm going to find my success?"  It's nice to dream of trading success, but it's important to understand the realities of making it as a trader.

Bella at SMB recently wrote about a trader who was now earning a nice paycheck after 18 months of trading.  I happen to know this trader personally and heartily agree that he has a bright future.  I also know that we had recognized his potential during his first year of trading.  Still, it has taken a while to bring home that paycheck.  In his admirably honest post, Bella notes that it typically takes 18 months to two years for a trader to achieve significant profitability (i.e., to make a living from their trading).  And that is with considerable mentoring, support, education, and coaching.  

In an earlier post on the failure rate of prop traders, Bella notes that every developing trader needs to anticipate 6-8 months of hard work and study when they start out.  My experience is that it is during that initial 6-8 month period that we see the shape of learning curves.  During the first year, the trader develops his or her style of trading, builds a playbook of opportunities, and displays growing consistency in following and profiting from that playbook.

During the second year, the trader builds on that consistency to take more risk, manage that risk well, and find new sources of opportunity.  It is after the first year of trading better that the trader becomes bigger, and that's when the paychecks start.  If traders are still struggling to find consistency and their own style after a year of effort, the conditional probabilities of meaningful success go way down.  When innate talents fuel skill acquisition, learning curves are quicker and steeper.  I have found that success in year one is highly predictive of longer term success.

And so it is in all performance fields.  If, by your junior year of college, you are only able to make the second team of your school's basketball squad, you probably should be planning alternatives to an NBA career.  That doesn't mean you can't enjoy basketball as an avocation, and it doesn't mean that your accomplishment is meaningless.  It just means that your greatest career success will be found elsewhere.

This month alone I have heard from several traders who have spent years--and all their family's money--pursuing one trading strategy after another.  They are broken people, and they have hurt their families in the process.  They could not let go of the dream, and it became a nightmare.

If you're a developing trader, pour yourself into learning.  Find yourself mentors and colleagues you can learn from.  Work as hard on your trading outside of market hours as when you are trading.  And then gauge your progress.  Have the courage to let your dreams become realities, and have the wisdom to not allow them to become nightmares.


Friday, March 09, 2018

A Surprising Best Practice of Successful Traders

Here's an interesting observation I've made about traders who are doing well recently versus those not doing so well:

It's not just the quality of the trades that distinguishes the successful trader, but the quality of the time during market hours when they are not trading.

The least successful traders are glued to screens throughout the day and have very little structured, quality time away from the screens.  

The more successful traders take breaks during the day and keep themselves fresh and focused.

The most successful traders have a structured non-trading process during market hours.  They are just as plan-oriented in their non-trading time as in their trading time.  When markets are open and they are not trading, they have processes they follow to identify new opportunities and to maintain their performance zone.  

Productively planning and structuring your non-trading time:  that is an unappreciated best practice.  The great traders are highly productive when they are *not* trading.  A big step that can move your trading forward is to start keeping a report card where you grade the quality of your time during the trading day when you are not trading.

On Monday at noon EST, I'll be joining Jigsaw Trading for a free webinar on three psychological techniques to improve trading psychology.  In that session, I will go into detail about specific practices I see best traders engaging in during non-trading hours.  Registration for the session can be found here; I hope to see you there!


Wednesday, March 07, 2018

Three Techniques for Mastering Your Trading Psychology

This coming Monday, March 12th, at 12:00 noon EST, Jigsaw Trading will be hosting me for a webinar on three powerful psychological techniques to aid our trading.  The registration for the free session can be found here.

This session will be different from my recent presentations, as we will focus on three specific psychological techniques that have been found to be effective in controlled outcome research.  These methods effectively address such issues as performance pressure/anxiety; frustration/overtrading; and loss of trading discipline.  

The goal is to describe these techniques in how-to terms that will allow traders to take skills away, practice them, and truly become their own trading coaches.  And, even if you're like the puppy and just want a comfortable spot, you're welcome on the couch on Monday!  Look forward to seeing you there--



Sunday, March 04, 2018

Who is Controlling the Market?

One of my favorite measures of buying and selling pressure is the moment to moment upticks versus downticks across all listed stocks.  Most of us are familiar with the NYSE TICK measure ($TICK), which tracks the number of stocks trading on upticks versus downticks for all New York Stock Exchange listed issues.  The U.S. TICK ($TICK.US-ST on the e-Signal platform) measure simply extends this measurement to all stocks, and so it is more inclusive of small cap issues.  

Another strength of the U.S. TICK measure is that its opening readings look at upticks/downticks from the opening prices of stocks, not from the prior day's close.  As a result, the numbers are not skewed by the overnight gap in prices:  we get a purer sense of buying and selling flows during the day session itself.

The major value of the U.S. TICK measure, however, is that it tells us who is controlling the market:  the buyers or the sellers.  If we get persistent and high positive readings, we know that institutions are lifting offers across a wide range of stocks.  Conversely, persistent and extreme negative readings tell us that institutions are hitting bids across the universe of shares.  (If your trading platform does not track U.S. TICK, the standard $TICK measure is also quite informative of who controls the market).

Notice on 3/2/18 how the evolving U.S. TICK numbers were positive and got more positive as the morning progressed.  We barely saw any net selling pressure whatsoever.  Even in the afternoon pullbacks, buying and selling activity were only relatively balanced (pullbacks to the zero area) and price held well off the morning lows.  

(As an aside, the outperformance of U.S. TICK relative to $TICK was a nice tell for the relative strength of small cap shares that day).

This ability to see how the tug of war between buyers and sellers is evolving as the market unfolds helps us check our assumptions and adjust to how the market is *actually* changing.  I came into the day with bearish expectations, partly due to our difficulty in bouncing from oversold levels and partly due to the trade war news.  The early strength in buying pressure was a great indication that the market, in fact, was dominated by the buyers.  Sure enough we experienced an upside trend day, where we opened near the day's lows and closed near the day's highs.

Once we can observe the ebbs and flows of buyers and sellers, we're in a much better place to trade what we see and not what we expect.

Further Reading:

Three Questions to Ask About Any Market - most popular TraderFeed post 


Thursday, March 01, 2018

What Is Your Trading Battle Rhythm?

In a recent Forbes article, a special operations leader made use of the term "battle rhythm".  His point was that businesses tend to operate on cycles of observing, planning, and implementing that are too slow for the business landscape.  SEAL teams have to work with rapid battle rhythms, as the battlefield is ever-changing.  This means that teams are highly active and interactive, continually gathering information and processing that information to shape tactics and strategy.  Operating in a fast environment with a slow battle rhythm is like drawing a sword in battle and moving slowly.  If it's a sword battlefield, you need dancers, not plodders.

This helps to explain why many traders either fail to make money or fail to perform consistently:  their battle rhythm does not keep pace with their trading frequency.  In other words, they may plan once a day (early in the morning) and then fail to adapt when markets change character and direction during the day.  If your trading is much more frequent than your planning, eventually you'll get stuck when markets zig instead of zag.

When we see a trader who can place many trades per day and make money consistently, we tend to marvel at the speed of his or her pattern recognition.  In talking with these traders, however, what jumps out is the speed of their decision-making processes.  They truly work with rapid battle rhythms, constantly taking in market information, assessing its implications, and shifting tactics accordingly.  One trader I recently met with rapidly switched from trading individual stocks making idiosyncratic moves to trading the broad indexes and back again solely on the basis of how things were moving relative to each other.

When our battle rhythm doesn't keep up with our trading, we set the stage for inevitable frustration.  The market will change more quickly than our planning will adapt.  Success requires that we trade a time frame that is longer than the time it takes us to observe market conditions, make sense of them, and figure out their relevance for our trading.  We overtrade when we place new trades faster than we can engage in new thinking.

Further Reading:  


Monday, February 26, 2018

Collaborative Learning: A Totally Different Trading Edge

What if the success rate among traders is low, not simply because of the complexity of markets, but because the learning methods traders employ are not suited to complexity?

What if the greatest edge we could achieve in markets comes, not from another indicator or software tool, but from revolutionary ways of learning and understanding markets?

Considerable research suggests that active learning methods are superior to passive ones, with particular benefits associated with team-based learning, including greater engagement of students and greater depth of learning in such fields as medicine and psychology.

As I note in the latest Forbes article, structuring mentoring and coaching within trading teams has greatly increased the success of training traders.  The technique of the daily report card, in which traders review key aspects of their trading daily and share their grades and observations with mentors, coaches, and peer traders, has meaningfully accelerated the learning curves of many traders who have adopted this framework.

If you have not achieved the trading results you desire, I encourage you to consider the possibility that the problem may not lie with your psychology or with your use of any particular set of trading tools.  Rather, you may be honing your skills in entirely the wrong way.  You would never learn and master basketball, chess, or surgery in a classroom or through videos, followed by solo experimentation.  Why would the performance domain of trading be any different?

I encourage you to reflect upon the daily report card framework and how turning learning into an active and interactive enterprise could accelerate your learning curve.


Sunday, February 25, 2018

Best Practices of Best Traders

Here is the link to the recent Best Practices of Best Traders webinar sponsored by Futures.io.  

The sound quality is not great in the very first portion of the session, but we get that corrected for the majority of the presentation.  My apologies about that.

A very important takeaway is that, at certain times, *you* are a best trader.

It is when you are trading at your best that you discover your best practices.

Here are a few questions you can ask yourself to uncover the best within you:

How do I generate my best trading ideas?  What do I look at?  What information do I draw upon?  How do I best prepare for trading with research?  With conversations with other traders?  When I figure out what is going on in a stock or in a market, what exactly am I figuring out?  What patterns in market behavior make sense to me?  How do I best detect those patterns?

How am I best at risk taking?  When I'm trading well, how do I determine as quickly as possible that my idea and/or my trade are wrong?  How do I decide to take quick profits, and how do I decide to let trades run?  In my best trading, how do I size positions?  How do I respond to winning trades and losing ones?

In my best trading, how am I managing myself?  How do I best sustain focus?  How do I keep my energy level high?  How do I maintain a quality life outside of trading?  When I'm trading well, how do I take breaks during the trading day?  How do I best use my time before trading starts and after?

Focusing on these questions will help you understand the ingredients that go into your trading success.  As I emphasize in the Trading Psychology 2.0 book, it's not enough to simply note our best practices.  The goal is to turn these successful practices into positive habit patterns and ongoing processes.  

A huge part of trading success is becoming more and more consistent with our strengths...more and more consistent in doing what we do when we are successful.

Saturday, February 24, 2018

Profiting From a Dirty Secret of Trading

Kudos to Downtown Josh Brown for picking up on a Bloomberg article by Ben Carlson that illustrates how it's not rising rates that are a threat for stocks, but inflation.  Ben notes the human tendency to think in narratives:  this is happening because of that.  Such narratives quickly become consensus within and across trading floors.  That leads to a kind of conformity born of laziness.  Traders don't develop their own models of rates and inflation, so pick up on dominant narratives.  Excellent shorter-term opportunities can arise when those narratives are driving trader and investor behavior and excellent longer-term opportunities can arise when those consensus narratives are disconfirmed.

Jeff Miller points out that trading problems typically arise when markets change and we are no longer in our comfort zones.  (His site, by the way, does a nice job of tracking inflation numbers, economic sector by sector.)  We become particularly uncomfortable when our dominant narratives are challenged.  When we can't make meaning out of what we're seeing, we understandably behave in reactive ways to lessen our discomfort.

We gain flexibility when we view market narratives as hypotheses and not as conclusions.  This is where tracking correlations among markets can be incredibly helpful.  So often, traders focus on their own markets, failing to notice macro drivers that--rightly or wrongly--are impelling near term market flows.  On Friday, I was chatting with a valued trading colleague and we noted early in the session that the market's dominant cycle was cresting.  That led to a nice, early short trade in the ES futures.  As rates began to move lower, however, and stocks could not sustain downside momentum, I recognized that the "lower bonds, lower stocks" risk-parity bears had an opportunity to be trapped.  The unwind of that narrative led to nice trades as we detected the potential to move from a cyclical to a trending short-term trading environment.

There's a dirty secret no one likes to talk about:  large traders often don't do their own research.  They construct narratives based on recent price action and what others are saying on the sell side, trading floors, etc.  That conformity creates opportunity and is a great reason for tracking market chatter--but only as hypotheses!

Further Reading:


Monday, February 19, 2018

A Powerful Technique for Changing Your Trading Psychology

From an evolutionary perspective, it makes sense that we make complex behaviors automatic.  Once we can perform tasks mindlessly, we can direct our mind to more immediate, pressing matters.  This is how we can drive a car and hold a meaningful conversation.  It's also how we can carry out morning routines without effort, allowing us to focus on plans for the day ahead.  Our ability to automatize activity greatly expands our scope of thought and action.

What happens, however, when our automatic routines no longer serve a useful purpose?  They remain as habit patterns and they are the activities, patterns, and behaviors we're most comfortable with.  Many of the problems we face in life today reflect the fact that we're living patterns in the present that, at one time, had an adaptive value.  Now they bring negative consequences.

Consider the trader who hesitates before acting on a signal and, when he acts, does so in small size.  That pattern of behavior was part of prudence during the trader's early learning period.  It guaranteed that he didn't act rashly and impulsively, and it kept losses small.  Now that the trader has learned and is showing profitability, the old prudent behaviors make him risk averse.  Yesterday's solutions, carried forward to a new reality, become today's problems.

To change an old pattern of thought, feeling, or action, we have to be willing to exit our comfort zone.  That means standing outside our patterns and actively viewing them as problems.  At one time in the alcoholic's life, drinking was a means of socializing and a tool for feeling better.  Fast forward to the point of alcohol abuse, and now drinking is bringing negative consequences for work, health, and relationships.  Alcoholics who change view drinking as their problem, their enemy: they take the automatic pattern and use guilt, disgust, and anger to regain choice over how they think and what they do.  Change begins when we view our problems as our problems

One of the most powerful change techniques in psychology is to take a pattern that is interfering with your happiness, fulfillment, and/or success and actively rehearse that pattern in your mind--visualize it, feel it--while you remind yourself of all the ways that it has hurt you.  Literally, you're bringing that pattern to mind--maybe it's overtrading or trading too small--and imagining how many times you've flushed money down the toilet, how many ways this problem has stood in the way of your success.

Can you imagine how angry you would become if someone hijacked your keyboard and screens and started placing random trades, losing you money?  Well, that is happening to you every time your negative thought and behavior patterns hijack your trading psychology.  Getting angry at those patterns is the first step in refusing to identify with them.  It's a way of standing up for the healthy parts of ourselves and saying, "I'm not letting you hijack me!"

Visualizing old ways of thinking, feeling, and acting that now bring us pain and allowing ourselves to fully feel all the disgust, guilt, remorse, and anger associated with the consequences of those patterns completely changes our trading psychology.  We no longer fall into comfortable habits, because we no longer feel comfortable with those habits.  We have turned them into enemies.  That is powerful.

This visualization and reframing is just one example of a broader psychological strategy of mental rehearsal.  There are many other ways to use mental rehearsal to build new, positive habit patterns and to reprogram emotional responses to situations.  This week's Forbes article looks at the science behind mental rehearsal and ways in which we use this method to change our lives.  It's amazing how, when we change our mind about our problems, we truly change our minds.

Further Reading:


Sunday, February 18, 2018

Free Trading Psychology Webinar With Futures.io

This Thursday, the good folks at Futures.io will be hosting a presentation where I'll be talking about the best practices of traders who are currently experiencing significant success.  Because I work as a coach at multiple trading firms, I'm able to see who is doing well, who isn't, and what makes the difference.  In this presentation, I'll focus on specific strategies that you can employ to replicate those best practices of best traders.

Here is the link to register for the event.  We'll be meeting up after the market close at 4:30 PM EST on Thursday, and there will be plenty of time for Q&A.  Look forward to seeing you there!


Friday, February 16, 2018

Lessons in Trading and Psychology - 5: Cycles

Many times, traders become frustrated and fall into a negative psychology because they are looking for one thing, while the market is doing something else.  In that sense, frustration gives us information: that we are possibly out of sync with what we are trading.

Above we see the S&P futures (blue line) plotted from February 12th through Friday's close (February 16th).  If we were to create a regression line to best fit this action, we would see a line with a decent fit and a positive slope.  That tells us there is a trend component to how the market is trading over that time horizon.

Notice, however, the trend is far from a smooth upward line.  The red line captures a dominant cycle within the trend, where a 50-bar rate of change is expressed in standard deviation units (left axis).  Each bar captures movement in event time, not chronological time.  In this chart, each bar is drawn when the futures have changed price 500 times.  

The event time bars adjust our time series for the volatility of the market's price action.  When we have low volatility, we draw fewer bars and vice versa.  Standardizing the market view this way provides us with a more stable time series, and that helps us better assess cycles within the market.  Those cycles tell us when we are relatively overbought or oversold.

In an upward trend, buying the market when we approach a 2 standard deviation cycle trough ends up providing pretty good entry.  Indeed, we can define a trend by the presence of cycle troughs/peaks at successively higher/lower price levels.  Notice also how the frequency of the dominant cycle gives us a window on how "choppy" the market may be--and how changes in the frequency give us a clue as to whether a trend is waxing or waning.

Stocks or instruments displaying greater clarity/consistency of trends and cycles might be the best trading vehicles for a trader.

Looking at price behavior in new ways opens new trading possibilities--and that can expand our psychology, fueling our understanding and sense of mastery.

Further Reading:


Wednesday, February 14, 2018

Lessons in Trading and Psychology - 4: Volatility

When we understand what is going on in the market, it gives us a psychological sense of clarity and control.  Much of our worst, reactive trading occurs when we feel out of control.  Looking closely at how the market is moving can provide us with understanding--and that can be tremendously helpful not only to our trading, but also to our trading psychology.

In hearing from many traders recently, I'm finding that they are having a difficult time adapting to the market's shifting volatility.  With volatility declining--and the volatility of volatility waning--we get choppier market conditions.  With volatility expanding--and greater vol of vol--we see momentum moves.  Many times, traders are zigging when they should be zagging because they are misreading--or *not* reading--market volatility.

Above is a tool I created in about 40 minutes from historical data via the e-Signal platform.  Here we're looking at the volatility (high/low range) in each five minute bar in SPY relative to the average range for that same time bar over the prior five trading sessions.  So, for example, we're seeing how today's 9:30 - 9:35 AM EST bar compares in size to the average 9:30 - 9:35 AM EST bar for the prior five trading sessions.

Note how, from the very start of trading yesterday, we were seeing relative ratios below 1.0.  That means we're getting less movement in each time period than we've seen over the past week of trading.  Very quickly that can alert you to the fact that this is not likely to be a high momentum market.  In the lower volatility environment, moves are less likely to extend and we want to be more selective about taking trades and opportunistic about taking profits.

Note also how it would be easy to create this relative volatility measure for any stock or index you're following.  We typically look closely at price movements and trends; we're less likely to examine how volatility is trending.  Adapting our trading to the market environment allows us to recognize when we should be trading moves and when we should be fading them.  That can eliminate a helluva lot of frustration!

Further Reading:


Saturday, February 10, 2018

Lessons in Trading and Psychology - 3: Identifying Intraday Reversals

OK, so recall what we talked about in the previous post that looked at how we can use volume to understand market movements:  each day in the market offers us one or more important learning lessons.  Our job in reviewing the day is to extract these lessons, so that we can improve our ability to recognize opportunities in real time.

Above we see yesterday's market (SPY) plotted against five minute closing values for the NYSE TICK.  Recall that we visited the $TICK measure in the first lesson post that dealt with changes of market regime over a period of days.  Now we are examining the change of market character that occurred intraday in Friday's market.  Note that the scale for the $TICK values is in standard deviation units, so that we can see how stocks are trading relative to a recent lookback period.

Note how the $TICK line quickly moved below zero during the morning session and largely stayed below zero for most the morning.  This tells us that stocks were persistently trading with weakness (on downticks) throughout those morning hours.  Something interesting happened midday, however.  As we made new lows in SPY, we were seeing much less selling pressure.  Indeed, the final low was preceded by a sizable spurt in buying.  From that final low, we saw a significant spurt in buying and stayed above the zero line for most of the remainder of the day.

In short, we saw in transition from selling pressure to buying pressure, with a waning of selling preceding the upsurge in buying.  The trader seeing this shift in supply/demand was alerted to the likelihood that this was not a trend day to the downside and, indeed, there were many traders leaning short who might need to cover.

Notice also that once we surged above two standard deviations in the $TICK measure (both to the downside in the morning and to the upside during the afternoon), we tended to get follow through of price movement (momentum).  Just noticing these dynamics helps keep a trader on the right side of market movement, knowing when to trade a market move and when to fade it.

Further Reading:


Wednesday, February 07, 2018

Lessons in Trading and Psychology - 2: Volume

Every day the markets teach us lessons in trading and psychology.  Our job is to become good students and learn from these lessons to improve our craft.  In the first post in this series, we took a look at detecting regime changes by assessing shifts in buying and selling pressure.  In this installment, we'll take a look at volume and its significance.

On any time scale, volume correlates very highly with volatility.  During the recent decline, for example, we traded well over 200 million shares in SPY.  During the low volatility push higher prior to the decline, we commonly traded under 100 million shares.  Who are these additional participants?  For the most part, they are value players trying to take advantage of unusually high or low prices; short-term directional traders trying to take advantage of the movement; and longer time frame participants stopping our of positions.  In short, when we see added volume, it means that the proportion of directional traders relative to market makers has increased.  This facilitates market movement.

Conversely, when we see volume dry up, it means that directional traders are not perceiving opportunity in that instrument.  That leads to less movement on all time scales and what short-term traders experience as "choppy".

OK, with that in mind, let's take a look at yesterday's trade in the ES futures depicted above.  A number of traders who sent me their journals made money on the opening drive.  They recognized that we were oversold and that volume was strong at the open, with buying significantly exceeding selling.  The combination of high volume, buying interest from value participants, and short-covering from those leaning the opposite way created a momentum thrust.

An important way we can identify high volume at the open is with the measurement of relative volume.  In relative volume, we take the average volume for each time of day (above we have five-minute time intervals) and see how today's volume from 9:30 AM EST to 9:35 AM EST compares with the average volume at that time of day.  High relative volume tells us we have high participation from directional players.  In the first three five-minute segments of the day yesterday, we had volume between 2 and 4 standard deviations above average.

Note how having the right data helps you make the right adjustment in your trading.  We commonly think of psychology as helping our trading, but approaching trading the right way--with the right information--is a big part of having the right mindset.

Interestingly, a number of the traders who wrote to me and who made money in the early morning move gave back money midday.  Why is that?  

Click on the chart above and you'll see how volume moved meaningfully lower in the midday hours.  By the time we bottomed during the 2 PM EST hour, the average five-minute volume had fallen to about one-fifth of what we saw in the opening periods.  With that waning of volume, we have waning volatility:  no more momentum.  Traders who did not pay enough attention to volume implicitly assumed that we were still in a momentum market.  Every move was taken as a potential breakout--only to reverse due to the lack of participation.  The trader who paid attention to volume was able to adjust expectations and either scalp smaller moves or stand aside altogether.

When we get excited about making money, we often become tunnel-visioned and don't step back to see what volume is doing.

Even worse, when we get excited, we don't step back to observe what is happening on the larger time frame.  Notice how volume is drying up as the sellers are coming in.  We had quite negative NYSE TICK readings during that 2 PM EST period and yet volume was drying up.  Moreover, with all that selling pressure, we couldn't retrace more than about half of the early morning move.  Recognizing that larger pattern set us up for the late day continuation of the upside momentum trade as volume picked back up.

This is how psychology integrates with trading:  The cognitive flexibility to shift between price action and volume and the flexibility to shift from moment-to-moment to the larger time frame complements the ability to track buying and selling pressure and its shifts.  When we become self-focused and P/L focused, we lose that cognitive flexibility.  We no longer trade with perspective.  So much of trading success is using our psychology to detect patterns in the market's psychology.

Further Reading:


Sunday, February 04, 2018

Lessons in Trading and Psychology - 1: Regime Changes

In this series of posts, we'll look at ways of integrating trading psychology and the process of trading.  It is my hope that the series will illustrate the richness of the relationship between trading and psychology--a depth rarely captured in traditional writings on the topic.

Here we see a chart of SPY (blue line; 5 minute values) from December 15th through this past Friday, February 2nd.  In red, we see a 2-hour moving average of NYSE TICK values over that same period.  Recall that this measure captures the number of stocks trading on upticks minus the number trading on downticks at each moment of the trading day.  The symbol is $TICK on the e-Signal platform and most others

Note that for a good part of the first half of the chart, the NYSE TICK values stayed above the zero line.  As SPY moved higher, we saw evidence of buying strength:  more stocks trading on upticks than downticks.  Look, however, what happened in the second half of the chart.  The distribution of TICK values shifted and we now saw more selling pressure than buying pressure--even as SPY moved to all time highs.

In other words, the psychology of the market changed--we shifted from a buying regime to a selling one--well before SPY made its recent correction.  The change in the distribution of TICK values alerted us to market vulnerability.

Here is an analogy:  suppose the economy of the U.S. is quite strong in large urban areas of the east and west coasts, but weak everywhere else.  A company's sales continue to rise, but when management looks at the distribution of sales, they see that fewer and fewer regions are holding up the rest.  An alert management would not be high-fiving over record earnings.  They would be reducing production and shifting the product mix to prepare for potential economic downturn.

The psychological takeaway is that we need to drill down and look beneath the market surface and approach each fresh set of data with an open mind.  On the day we made a peak in SPY, we had 599 stocks make fresh three month highs and 199 register new monthly lows.  Two weeks before that, we had almost 900 new three month highs against 135 lows (data from Barchart.com).  The open mind respects price action and market strength, but also is alert to cracks beneath the surface.  Then, when price can no longer sustain new highs, volatility increases, and TICK readings become very negative, that alertness allows for a quick transition to the new regime.

You have to have the right information, and you have to have the right mindset of openness.  That is an important way that trading and psychology come together to create success.

Further Reading:


Friday, February 02, 2018

How to Prevent Emotional Trading

Trader Stewie recently pointed out something I've found in my own trading:  trades taken primarily for emotional reasons rarely prove profitable.  A number of the traders I work with email me their trading journals daily.  It's amazing how often the profitable days are relatively simple and easy: the trader has certain ideas that they trade, certain ways of entering those trades with good risk/reward, and certain ways of sizing those trades and managing those positions.  When they are patient and selective and focused, they trade the right ways without a lot of drama and they do well.

Conversely, when markets are moving quickly and others around them are making money and they lose money on their first trades, trading becomes frenzied and frustrated.  Patience and focus go out the window and the trader becomes reactive, chasing moves, trading marginal opportunities.  That generally means entering positions at poor levels and getting stopped out.

Now, yes, there are psychological techniques for becoming aware of our emotional responses, stepping back from them, and refocusing ourselves.  But why do such disruptions occur so frequently for otherwise sane, level-headed people and what can we do to prevent them?

A key to unraveling this challenge is examining the opposite of the trading frenzy:  periods when nothing is occurring in markets.  Action is slow, volatility is low, and things are chopping around.  Is this a nice rest period for traders?  Hell, no!  Boredom ends up becoming as much as a trigger as frustration.  The trader, feeling a press to make money and do something, tries to manufacture opportunity.  Every move to an X minute, X hour, or X day new high or low is seized upon as the start of a trend and the mean reversion stops them out.

The reason the boredom is so difficult to weather is that traders are *needing* some degree of excitement, challenge, and action from their work.  They are trading to meet a set of emotional needs, not just to maximize their reward relative to risk.  Similarly, they may be trading to outperform others out of a competitive need, or they may be trading to fill a missing need for self esteem.  It is those unmet needs that impel the emotional responses and poor trading.

Trading is a great endeavor, but it cannot be burdened with the expectation that it fill our personal emptiness.  Imagine the surgeon who is bored in his life and looks forward to the thrill of cutting when he gets to the operating room.  Is that really the physician who you want to heal you?  The speaker who cares so much about the approval of the audience is the same speaker that suddenly goes blank and freezes up.  Needing the outcome destroys the process of doing.

This is why I am wary of traders who insist that trading is their great passion and who spend so much of their time watching prices.  The successful traders I work with have complete lives that fulfill their passions.  They don't need market action or thrill because they have plenty of stimulation outside of market hours.  They don't need to prove themselves in markets because they experience their worth as spouses, parents, friends, family members, and as spiritual beings.

Prevention is always the best cure.  If emotions interfere with your trading, figure out the unmet needs that trigger those emotions and then figure out how you can begin meeting those needs *outside* of markets.  You will have a calm, focused mind--and you'll be best able to surf the expectable emotional waves--when you have a fulfilling, gratifying life.  

Further Reading: